Business development company (BDC) Apollo Investment Corporation (NASDAQ: AINV) reported its fiscal first-quarter earnings, revealing that it covered its dividend with net investment income, despite a slight decrease in net investment income compared to the year-ago period.
Apollo Investment's fiscal Q1: The raw numbers
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Business development company earnings can generally be measured in two ways. The first measure is net investment income (also called net operating income), which includes all sources of income and expenses, excluding any capital gains or losses. The second measure is net income, which is net investment income, plus or minus capital gains or losses.
Net investment income is generally viewed as a barometer for the health of a BDC's dividend over the short term (a few quarterly reporting periods), as it excludes capital gains and losses that can result from fluctuations in investment values that may be related to technical factors, rather than the portfolio's true value over the long haul. (In the context of your own personal stock portfolio, you likely wouldn't think of a 5% change in value over the course of a quarter as meaningful to the investment thesis over the next five years, for example.)
Of course, like all financial companies, net income ultimately determines true dividend-paying capacity over longer periods of time (years or decades).
What happened this quarter?
- Apollo Investment reported that its portfolio grew this quarter, as new investments exceeded investments that were sold or repaid. Net investment activity of $90.1 million pushed its net leverage ratio to 0.62 times its equity, up from 0.55 times in the sequential quarter. The company targets a leverage ratio of about 0.6 to 0.7 times its equity, below the legal maximum of one times equity for business development companies.
- Apollo's large investments this quarter included deploying approximately $40 million into its aircraft leasing arm (Merx Aviation) as well as a $24 million loan to Erickson, which was completed in concert with MidCap Financial. Previously, Apollo outlined its relationship with MidCap as an opportunity to underwrite lower-yielding, lower-risk loans than what it traditionally put in its portfolio. It's good to see some new investment volume.
- Apollo cleaned out its closet of some underperforming oil & gas, education, and structured finance investments. It realized losses in Venoco, Delta Career Education Corporation, and a holding company for SquareTwo Financial investments, among others. Because these investments were marked down in prior quarters, the losses had already been accounted for.
- Apollo's oil & gas exposure, a source of substantial losses in recent years, has been whittled down to 6.6% of the company's investment portfolio by fair value, down from 7.2% in the sequential quarter. A modest amount of incremental capital was injected into Glacier Oil & Gas and Spotted Hawk (SHD Oil & Gas), two credits that make up the majority of its oil & gas exposure.
What management had to say
In the press release, James Zelter, Apollo Investment's chief executive officer, commented:
It seems that Apollo Investment has put an end to bleeding book value from its legacy investments and energy-exposed portfolio companies, given the year-over-year decline in capital losses this quarter.
The company reported that its portfolio has shifted meaningfully, with 74% of its portfolio now invested in what it calls its "core strategies" of corporate lending, aviation leasing, life sciences, and lender finance. Last year, 59% of the portfolio invested in these core strategies.
As the portfolio shifts in composition, investors will want to see that the company can continue to earn its quarterly dividend of $0.15 per share from net investment income. While a lower-risk portfolio could serve the company well, lower-risk investments come with lower investment yields. Apollo Investment will have to carefully balance a "barbell" strategy, in which it supplements lower yields on corporate debt with higher yields from aircraft leasing and other less-traditional BDC investments.
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