It is better to have a permanent income than to be fascinating. – Oscar Wilde
FS KKR Capital Corp. (NYSE:FSK), a business development corporation (BDC), derives its revenue by investing in senior secured loans, junior loans, certain subordinated loans and private equity from private mid-market domestic companies with the aim of stimulate business and employment and help shareholders earn healthy dividends. First lien secured loans and second lien loans have low credit risk. As of September 30, 2021, FSK had invested approximately 84% of its assets in senior secured loans and asset-based financing. Therefore, I would rate his credit profile as low risk.
You may already know that BDCs are not treated as taxable entities and that, to qualify as a non-taxable entity, a BDC must distribute at least 90% of its investment income to its shareholders each year. FSK’s TTM dividend yield is a whopping 11.09% and on paper this looks like a solid investment for income investors. However, things are not as simple as they seem and investors are advised to understand the risks associated with the capital deployed.
FSK price momentum and market risks
At the start of 2017, the price of FSK was hovering around $44. Since then, it’s slipped. When COVID-19 hit the market, FSK’s price fell to around $8 and has since recovered to $22.20 as of January 19, 2022. BDC’s prices had fallen due to unrealized mark-to-market valuations and declining book values.
As of the quarter ended September 2021, FSK had invested 14% of its funds in companies manufacturing capital goods, 10.5% in healthcare companies and 17% in software companies. These are growth-oriented games that rely on capital, and so any over-aggressiveness from the Fed can drastically reduce their outlook and depress the price of FSK.
The Fibonacci retracement levels on the charts suggest that FSK has strong support at $16 and resistance at around $25. The stock has been floating more or less in this range since August 2020 (see chart above).
Investors should consider that after the Fed stops the inflow of liquidity and starts raising rates, FSK’s business may suffer. Current market conditions and data suggest that FSK’s price momentum has a medium risk profile based on its Fibonacci retracement levels. Thus, investors should look beyond the attractive dividend yield and consider capital conservation before deciding to invest in FSK.
By the way, Fitch Ratings estimates that BDCs will have a neutral 2022.
FSK’s basic EPS fell to $0.95 in the quarter ended September 2021 as its paid-up capital fell from $3.87 billion in the quarter ended March 2021 to $7.51 billion in the quarter ended June 2021. FSK’s adjusted net investment income was $0.64 per share in September. quarter of 2021, and the company distributed $0.65 in dividend. Analysts estimate it will end up paying around $2.40 in 2022, giving it a dividend yield of 10.81% based on its market price of $22.20 as of January 19, 2021.
FSK has a strong balance sheet backed by $16.62 billion in assets. Long-term debt is $8.492 billion, or 51% of the total balance sheet. Although FSK’s revenues and earnings may be rocked by interest rate hikes and disruptive business conditions, the data suggests that FSK has sufficient assets to absorb the shocks ahead.
FSK’s net asset value was $27.14 in September 2021, and its current market price is trading at an 18.20% discount to that net asset value.
Comparison with peers
A quick comparison of FSK’s dividend yield with peers like Oaktree Specialty Lending Corporation (NASDAQ: OCSL), BlackRock TCP Capital Corp. (NASDAQ: TCPC), and Sixth Street Specialty Lending (NYSE: TSLX) reveals that FSK is one of the major outperformers of its peers on both the TTM dividend yield and the 4-year average yield fronts.
The data suggests that FSK has a strong balance sheet, its investments have a low risk profile and is being managed effectively – moreover, the company has been paying dividends consistently for 7 years. In addition, its price reduction seems limited.
FSK’s estimated forward dividend yield of 10.81% also looks solid and its market price is trading at a substantial discount to its net asset value.
Therefore, at these prices, I am optimistic about FSK’s long-term revenue generation prospects, with the caveat that an overly aggressive Fed can disrupt this. Long-term income investors who aren’t put off by some price volatility may consider placing a portion of their funds in FSK.
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