A pessimist sees the issue in each alternative; an optimist sees the chance in each issue.” – Winston Churchill
OK, I admit it. I’m an optimist. I typically wish to view the glass as being half full in my strategy towards life, particularly relating to investing. Thus, I used to be drawn to this perception from KKR & Co. Inc. (KKR) concerning their outlook for 2024 after I determined to start out researching up to date data for this text.
Importantly, although, we nonetheless assume that too many individuals are locked into the paradigm that the S&P 500 is buying and selling at lofty headline valuations and the U.S. financial system is topping out and headed for a tough touchdown. In consequence, they’re sitting idle, as they really feel there may be little to no worth available in the market past Money (i.e., regardless of a robust 12 months in threat property, there may be nonetheless a report $5.6 trillion of property in cash market accounts).
And KKR ought to have a fairly good deal with on the place the doubtless alternatives are for strong investments heading into the brand new 12 months. In any case, they’ve about $174B invested in Personal Fairness, $202B in Credit score, $56B in Infrastructure, and $65B in Actual Property investments, in line with their web site.
The Credit score market specifically provides distinctive alternatives in 2024. The truth is, in line with views expressed by Oaktree Capital of their current market commentary, the present marketplace for credit score traders provides one of the best alternative for the reason that GFC partly because of the a lot bigger dimension of the credit score market immediately in addition to the risk-adjusted elevated excessive yields which might be out there within the present atmosphere.
From one other perspective supplied by Alliance Bernstein, company credit score is ripe for high-yield alternatives in 2024 regardless of weakening financial fundamentals. They argue that within the US no less than, credit standing upgrades surpassed downgrades in 2023 and most high-yield market debt doesn’t mature earlier than 2026, whereas yields and spreads stay elevated.
By way of the KKR Credit score portfolio, one of many premier funding automobiles that’s below the KKR umbrella is a BDC that I’ve beforehand written about, FS KKR Capital (NYSE:FSK). I final coated FSK in March 2023, proper after the collapse of Silicon Valley Financial institution when many BDCs have been getting pummeled together with the remainder of the monetary sector. On the time, I wrote that I favored FSK for its excessive yield distribution; the big low cost to ebook worth; and the full return efficiency in comparison with the opposite two largest BDCs on the time: Ares Capital (ARCC) and Blue Owl Capital (OBDC), which was referred to as Owl Rock Capital again then. The truth is, over the previous 3 years, FSK has continued to outperform these different two massive BDCs by a substantial margin.
I rated FSK a Sturdy Purchase in March 2023 after I wrote that evaluation and it has delivered a complete return of about 28% since then. On the finish of December, I wrote an article that reviewed the top-performing BDCs for 2023 and FSK was nonetheless buying and selling at a reduction of -19% at the moment and was within the prime 20 based mostly on complete return by market worth for 2023.
Now on the finish of January 2024, FSK nonetheless trades at an enormous low cost to ebook worth, provides a excessive yield distribution, and continues to outperform its friends (though OBDC is catching up and did present a greater complete return in 2023). I nonetheless fee FSK a Sturdy Purchase immediately and can assessment among the explanation why I really feel this manner within the paragraphs under. I at present personal shares of FSK in my Earnings Compounder portfolio and it’s considered one of my largest BDC holdings.
With a present market cap of roughly $5.8 billion, FSK is at present the third largest BDC that’s publicly traded, with ARCC being the biggest and OBDC coming in second at $5.88B. As of the tip of September 2023, the newest knowledge out there, the low cost to ebook worth remained at almost -17% regardless of the rise in market worth within the six months since I final coated the inventory.
From the fund’s Q323 reality sheet, we will see that the portfolio consists of about 200 issuers throughout 24 totally different industries which might be principally US-based personal firms with no less than $100M in EBITDA. The portfolio provides a weighted common annual yield of 12.1%. Roughly 68% of these investments are first lien senior secured debt and 89% are floating fee. Most of these investments mature after 2025 with lower than 10% of debt maturing earlier than then. Whole investments at truthful worth as of 9/30/23 equaled about $14.7B. The non-accrual fee of these investments as of 9/30 was 2.4%.
This slide from the corporate’s Q3 earnings presentation summarizes that data.
Along with the annual recurring income from these portfolio holdings, there may be an extra supply of recurring annual income from the three way partnership with South Carolina Retirement Techniques Group Belief that quantities to about $200M in further revenue. As of the tip of Q323 the NAV of the portfolio was $24.89 and the annualized yield on the inventory in 2023 was about 15%.
As of the market shut on 1/26/24, the inventory worth traded at $20.68 and provides a present ahead yield of about 12.5% (not together with particular dividends) based mostly on the newest quarterly dividend of $0.64 paid on January 3.
On November 6, 2023, the corporate introduced Q3 outcomes that included NII of $.84 per share, up from $0.82 per share for the quarter ended June 30. On account of the robust quarterly outcomes, the corporate Board additionally declared particular dividends to be paid within the first half of 2024 as defined within the Q3 press launch.
Through the third quarter, we generated 9% year-over-year progress in our adjusted internet funding revenue and our internet asset worth grew roughly 1% in comparison with the prior quarter,” stated Michael C. Forman, Chief Govt Officer & Chairman. “Our continued robust efficiency allows us to reward stockholders with a sexy $0.75 per share complete distribution within the fourth quarter in addition to to offer stockholders with a continuation of our particular distributions in the course of the first half of 2024.
These particular distributions will likely be paid in equal installments within the first two quarters of 2024, much like what was paid in 2023 as defined within the announcement:
FSK’s board of administrators has declared further particular distributions totaling $0.10 per share to be paid in two equal installments throughout 2024. The primary $0.05 per share particular distribution will likely be paid on or about February 28, 2024 to stockholders of report as of February 14, 2024. The second $0.05 per share particular distribution will likely be paid on or about Might 29, 2024 to stockholders of report as of Might 15, 2024. FSK’s board of administrators beforehand declared particular distributions totaling $0.15 per share to be paid in three equal installments by the tip of 2023.
The corporate delivered stronger than anticipated third quarter outcomes with NAV growing from Q2 to Q3 and NII exceeding distributions paid. Steering for This autumn was supplied in the course of the earnings name with additional robust efficiency anticipated for This autumn in addition to defined by CFO Steven Lilly:
Detailed fourth quarter steerage is as follows: our recurring curiosity revenue on a GAAP foundation is predicted to approximate $377 million. We count on recurring dividend revenue related to our three way partnership to approximate $53 million. We count on different payment and dividend revenue to approximate $23 million as we count on regular course asset-based finance dividends to be incrementally decrease within the fourth quarter.
FSK additionally decreased internet debt to fairness ranges in Q3 to 110% from 113% within the earlier quarter and elevated the liquidity and borrowing capability. The borrowing capability on the finish of September elevated to $3.6 billion in out there liquidity, giving them ample capital to spend money on new alternatives that will come up within the coming months. Subsequent to the quarter finish in November the corporate raised one other $400M in a public providing of unsecured notes with the proceeds supposed for use to additional pay down present debt or for use for different “basic company functions”.
Whereas conventional banks are reducing again on company lending, particularly for the reason that March 2023 banking disaster with a purpose to shield themselves from future liquidity points, BDCs like FSK are choosing up the slack. Because the US financial system continues to prosper regardless of ongoing fears of recession or no less than a “onerous touchdown” as a consequence of greater rates of interest, the demand for company lending continues to stay elevated whereas default charges are nonetheless traditionally low, though beginning to improve barely in 2024.
Personal credit score can also be enjoying a extra necessary position in company financing as mentioned on this current view of market traits from Wilmington Belief, and with entry to Personal Fairness through KKR, that pattern opens up further avenues for FSK to leverage.
The mortgage market has undergone vital structural shifts in 2023. Financial uncertainties and rising rates of interest have modified borrower wants, lender priorities, and approaches to establishing offers. Personal lending has had probably the most vital impression by capturing market share from conventional industrial banks and broadly syndicated lending. These personal loans develop extra versatile and customised with every passing 12 months.
The truth is, in an funding technique dialogue from peer BDC Blue Owl Capital, the “direct lending” strategy has been gaining in reputation and allows debtors to barter with lenders for phrases that profit each.
Direct lending is the place a single or a small group of non-bank lenders (or direct lenders) present financing options on to a non-public firm (or borrower) who usually search loans to finance progress alternatives and their day-to-day operations.
The direct lender and borrower immediately negotiate personalized options that go well with the wants of each events. These debtors are usually privately held and/or owned by personal fairness corporations and are in search of a dependable various to a financial institution.
Within the case of FSK, the entry to Personal Fairness and different credit score property within the KKR household, together with the KKR Earnings Alternatives Fund (KIO), has resulted in regular enhancements in quarterly outcomes every quarter for the previous 5 quarters as proven on this slide from the Q323 earnings presentation.
With no less than two quarters price of undistributed spillover revenue (based mostly on feedback made by administration in the course of the Q3 earnings name), and with over $3B in out there liquidity, FSK seems to be properly positioned heading into the primary half of 2024. I reiterate my Sturdy Purchase score and can look so as to add extra shares of FSK to my very own portfolio on any market correction when/if the value pulls again under $20. You probably have not thought-about FSK to your personal revenue portfolio, I like to recommend giving them a glance.