BUY (MRCC, $14.26)
Significant Spare Capacity In Debt and Increasing Pricing Power in Senior Secured Loans - Initating With A Buy Rating And $16 Price Target.
January 21, 2015
Christopher R. Testa
Investment Conclusion. We are initiating coverage of Monroe Capital Corporation (MRCC) with a BUY rating and $16 price target. In our view, the company has the ability to grow net investment income (NII) per share over the next two years while issuing a minimal amount of equity which should lead to respectable dividend increases. The company still has plenty of Small Business Administration (SBA) debentures they can utilize with a current $40 million commitment of which only 34% is currently outstanding. In 2014 Monroe consistently increased its exposure to senior secured loans and reduced exposure to subordinated loans but still earned higher effective yields on its portfolio. This demonstrates that MRCC truly has pricing power in the loans it originates, rather than simply shifting the portfolio into a riskier composition to maintain yields. MRCC can continue to do this with similar results, in our view, because it can lever up the senior secured loans with spare capacity in SBA debentures and/or its revolver should it begin to lose pricing power on its senior secured loans. The seniority of the loans combined with excellent asset quality should enable Monroe to increase leverage due to the lack of subordination in the majority of its portfolio. Our $16 price target implies an estimated 2016 Price/Net Investment Income (P/ NII) of 9.5x, dividend yield of 9.8%, and Price/Net Asset Value (P/NAV) of 1.05x compared to the BDC sector averages of 8.7x, 10.9%, and 0.90x, respectively.
*Note: Adjusted NII = NII excluding incentive fees on capital gains.
Source: S&P Capital IQ, National Securities Corporation Estimates
We believe that MRCC will continue to improve or at least maintain effective portfolio yields even while shifting more into senior secured first lien loans. MRCC finished 1Q13 with 60.6% of its portfolio in unitranche loans and 30.4% in senior secured loans. As of 3Q14 the mix has nearly reversed itself completely, with senior secured now comprising 58.7% of fair value and unitranche at 34.0%. The unitranche...
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