BDC Update: SLR Investment

Nicholas Marshi -

March 25, 2023

At Last

More than a year after launching BDC Best Ideas - and the Expected Return Table - we're getting around to writing about SLR Investment (SLRC). From the outset, we projected the hybrid BDC (involved in cash flow lending, asset-based lending; equipment finance, and the life sciences) would pay out an annual distribution of $1.6400 through 2027. That's the same as the historic performance, as seen in the Expected Return metrics. At times SLRC has caught investors' fancy, which explains the 13.0x dividend multiple that we use to generate a Target Price of $21.32 - well below the all-time high of some years ago.

Promising

We've now reviewed SLRC's IVQ 2022 results. In the final quarter of the year, the BDC finally "covered" its distribution with recurring earnings - in large thanks to the higher interest rates being charged to borrowers. This is only a waystation as both management's "guidance" and the analyst earnings consensus suggest profitability should increase further in 2023. SLRC reached an annual level of Net Investment Income Per Share of $1.48 in 2022 ($1.64 annualizing the IVQ 2022) but is projected to reach $1.71 in 2023 and hold at $1.69 in 2024 - according to the average of 9 analysts' projections.

Strong

Furthermore, the BDC's balance sheet and its credit standing both seem strong, with plenty of liquidity - a good place to be on the edge of a possible recession. The big bet management has placed on asset-based lending and secured equipment finance seems likely to pay off in the form of plenty of new business and below-average credit losses. NAV Per Share barely dropped in the IVQ 2022, performing better than most BDCs. Given the very granular nature of SLRC's portfolio - spread over hundreds of companies in multiple market segments - we're confident that the damage from any economic recession should be modest, and any earnings loss offset by higher income from a new joint venture; wider spreads on new loans and average higher rates.

Question Mark

What we don't know is whether the higher earnings expected will translate into a greater annual payout than the $1.64 we've projected. At the moment, our expectation is that management will bank any extra income into "undistributed taxable income" to boost net book value while waiting for further developments. We could be wrong, both because we've misread management or the arcane BDC tax rules might require a special distribution or two. For the moment, though, our dividend projections remain unchanged through 2027.

Valuation

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As of the close on Friday, March 24, 2023, SLRC was priced at $14.72, a (20%) discount on net book value per share. Our Target Price of $21.32 would involve a 42% price increase. The total return over 5 years comes to 101% - good in absolute terms but below the current BDC average of 125%. The yield is 11.1%, also below the current BDC sector average.

Why Oh Why?

SLRC's relatively "modest" total return expectations at this time reflect its recent popularity. In 2023, the stock is up 5.8% versus 1.8% for the sector as a whole. However, back as recently as September 2022, SLRC was trading down to $12.32. At that level, the total return would be 140% over 5 years and the yield 13.1%. Maybe there is something to all this "buy low, sell high" investing approach after all. Still, for anyone seeking a differentiated BDC strategy, an unusually high emphasis on first-lien loans, and a long-time external manager, SLRC is a Best Idea, even if you'll only double your money in 5 years and capture a lowish yield by current standards.