WhiteHorse Finance (NASDAQ: WHF) is an externally managed business development company (BDC) focused on making investments in lower middle-market companies.
Managed by H.I.G WhiteHorse Advisors, WHF went public in 2012. The primary objective of WHF as a BDC is to generate risk-adjusted returns through senior secured loans across a diverse range of industries.
Despite its smaller market cap of approximately $300 million, WHF aims to maintain a disciplined underwriting approach to identify quality investments that generate high returns.
Portfolio Composition
WhiteHorse Finance’s debt investment portfolio is highly diversified across various industries, which helps mitigate concentration risk. The largest industry segment is broadline retail, accounting for 6.2% of the portfolio, followed by application software at 5.6% and commodity chemicals at 5.2%.
The portfolio is primarily composed of over 80% first lien senior secured debt. This type of debt sits at the top of the corporate capital structure, ensuring a higher priority for repayment and mitigating repayment risk.
Additionally, 98.9% of the portfolio consists of floating rate investments, allowing WHF to benefit from the higher interest rate environment by increasing income from the loans provided.
Financial Performance
WhiteHorse Finance recently reported its Q1 earnings, with net investment income (NII) per share totaling $0.465. NII has shown a gradual increase, reflecting the company’s ability to grow its portfolio and earnings in a high interest rate environment.
The rise in NII began around Q2 2022, coinciding with rapidly increasing interest rates.
Despite the growth in NII, the net asset value (NAV) has decreased over the past year due to a decline in investments at fair value. However, total investments at fair value increased to nearly $698 million, with additional investments in five new portfolio companies totaling $44.7 million and eight investments in existing portfolio companies totaling $10.3 million during the quarter.
Gross leverage levels increased slightly to a rate of 1.26x, and cash on hand decreased to $20.9 million from $22.2 million in Q1 2023. The amount of other assets increased to $16.2 million from $9.6 million in the prior year.
Dividend Sustainability
WhiteHorse Finance’s current dividend yield is 11.7%, with the latest declared quarterly dividend of $0.385 per share. The NII of $0.465 per share covers the dividend by a comfortable margin of 120.8%. The high dividend yield is a significant appeal for investors, providing a substantial income stream when compounded over time.
The dividend has grown at a compound annual growth rate (CAGR) of 2% over the last three years.
Risk Profile
While higher interest rates boost NII, they also increase the financial stress on portfolio companies, which may struggle with higher interest payments. WHF’s non-accrual rate is currently 3%, higher than the peer BDC average. Non-accruals represent portfolio companies that are no longer servicing their debt payments.
For comparison, peer BDCs such as Ares Capital (ARCC), Main Street Capital (MAIN), and Golub Capital (GBDC) have non-accrual rates of 1.3%, 0.6%, and 1.1%, respectively.
Investment performance ratings within WHF’s portfolio have worsened, with a decrease in companies rated 1 (best quality) and an increase in those rated 2 and 5 (worst quality). This trend indicates potential repayment risks and declining portfolio quality.
Valuation
Despite the declining NAV, WHF’s stock price has climbed above its pre-pandemic level, trading at a slight discount to NAV of 3%. Historically, the stock has traded at an average discount of 6.4% over the last three years. Given the lack of NAV growth, WHF’s valuation may not fully reflect the credit quality concerns and decreasing NAV.
The average Wall Street price target for WHF is $13.20 per share, representing a slight upside of less than 1%. The highest target is $14 per share, and the lowest is $12.50 per share. Considering the consistent decrease in NAV, the stock price may adjust downward.
Assessing Risks and Rewards
WhiteHorse Finance has a well-structured portfolio and a strong dividend yield covered by NII. However, the lack of NAV growth and potential risks associated with higher interest rates and non-accruals raise concerns.
Despite efficiently capitalizing on the high interest rate environment to grow earnings, this has not translated into meaningful NAV growth.
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Joel Gbolade is a seasoned financial writer with over seven years of experience in freelance content creation. Specializing in the financial niche and stock market, he has crafted engaging content for numerous websites. His background in technology extends to data processing and computer proficiency, enriching his comprehensive skill set in the financial realm.
