MidCap Financial Investment Corporation posed for outsized dividend growth (NASDAQ:MFIC)

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Sometimes, to describe investment opportunities, a few words are enough. For MidCap Financial Investment Corporation (NASDAQ:IMFC), a business development company (BDC), this is indeed the case. Of the call:

“When the new tariff structure becomes effective, we expect to earn significantly more than this base dividend of $0.37, and will reassess our dividend at that time.”

The implied amount is important, certainly the most important issue for this article and investors. Put on your thinking cap and let’s do an assessment.

The September quarterly report

We start with the quarterly report for September:

  • Won $0.35.
  • The net leverage was 1.4x. (Perfectly in line with the objectives.)
  • A second lien became non-cumulative, putting the total miss counts at 1%, which is very low.
  • The new commitments come with wider spreads, lower levels of leverage and higher documentation.
  • Had NAVI of $15.45, net loss of $6.6 million, $0.10 per share. (Excluding issuances from Chyron and K&N, the loan portfolio was down only slightly.)
  • The company did not purchase any shares.
  • Announcement of a dividend of $0.37.

Math

The discussion during the call glossed over much of the future earnings growth except for this statement, “a 100 basis point and 200 basis point increase in benchmark rates would result in incremental gains annual fees of approximately $0.13 and $0.26, respectively.” Putting this into perspective, an author wrote, “The funds rate was expected to peak at 4.50%-4.75% or higher in the first quarter of 2023.” This represents rates about 1.5% to 2.0% higher than the September quarter, or an annual increase in earnings of $0.20 to $0.25.

We have noted in other articles the likely long-term effects of the new reduced fee model announced last quarter, but still dormant until January. Of Apollo Investment presents its new brand (MidCap Financial Investment) and Model (The Tanner Powell):

“So if you’re assuming some reduction in yield and some reduction in leverage from where we were now, you’re talking about an increase in ROE from the 8 lows to the 9 lows, a 10% increase of ROE, a bit like a base case.”

A 10% improvement in ROE brings about $0.04 per quarter (0.1 * $0.35). The lower incentive commission, from 20% to 17.5%, adds a penny per quarter.

Adding the increases with the last quarter number equals $0.10 + $0.35 or $0.45 + on a quarterly basis. Half of the change will appear in the next few months, the balance over a few years. MidCap is set to increase its dividend by 30%+. When looking at valuation, a 9% return could generate a stock price close to $20. Yes, investors should recognize that higher Fed interest rates may ease before the investment portfolio reaches full maturity, leaving earnings somewhat below the upper bound.

Debt-to-income coverage

An important pattern approach used by MidCap with its debt essentially functions as an upward biased hedge. Finian O’Shea, of Wells Fargo Securities, asked, “How much of an issue is net investment income? Leases may be flat or stagnant and LIBOR base rates are rising…Are you covered?” Howard Widra, Executive Chairman, responded:

“Well, we’ve established leases. So they’re not rate-based. They’re sort of fixed, and the debt is fixed. Yes, we have fixed-rate debt in our securitization. So we’re not not really affected by that.”

This approach acts in the same way as hedging, it leaves this issue free from pressures in conditions of rising interest rates.

The Price and Risk of Lagging Stocks

With prices stretched around $12, MidCap Financial Investment Corporation remains a bargain for investors. With its forward yield of over 12% generated by virgin 1st position liens, investors should take note. We personally understand MidCap’s (Apollo) checkerboard past performance, but our view is not through a rear view mirror. Our view is through the windshield and the forward direction of the business.

Remember that periods of recession, such as the situation today, add risks, in particular the risk of default, the risk of finding viable investments. But, within our thinking cap, a 12% return upside is too tempting to resist. Yet, we would not buy shares or add shares all at once. Buying during periods of major negative markets seems smarter and will produce richer returns. For us, MidCap Financial Investment Corporation is a buy.

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