Q2 2021 Main Street Capital Corp Earnings Call
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Greetings and welcome to the main Street Capital Corp, Second quarter earnings Conference call. At this time all participants are in a listen only mode. A brief question and answer session will follow the formal presentation. If anyone should require operator assistance. During the conference. Please press star zero on your telephone keypad as a reminder, this conference.
And is being recorded and is now my pleasure to introduce your host Zach Vaughan with Dennard Lascar Investor Relations. Thank you Mr. Vaughan you may begin.
Thank you operator, and good morning, everyone. Thank you for joining us for main Street capital Corporation's second quarter 2021 earnings Conference call.
Main Street issued a press release yesterday afternoon, the details of the company's second quarter financial and operating results. This document is available on the Investor Relations section of the company's website at main SG capital Dot com.
A replay of today's call will be available beginning an hour after the completion of the call and will remain available until August 13th.
Information on how to access the replay was included in yesterday's release.
We also advise you that this conference call is being broadcast live for the Internet and can be accessed on the company's homepage.
Please note that information reported on this call speaks only as of today August 6.2021, and therefore, you're advised the time sensitive information may no longer be accurate at the time of any replay listening or transcript reading.
Today's call will contain forward looking statements. Many of these forward looking statements can be identified by the use of words, such as anticipates believes expects intends will should may or similar expressions of.
These statements are based on management's estimates assumptions and projections as of the date of this call and there are no guarantees of future performance.
Actual results may differ materially from the results expressed or implied in the statements as a result of risks uncertainties and other factors, including but not limited to the factors set forth and the company's filings with the Securities and Exchange Commission, which can be found on the company's website or SEC dot Gov.
Main Street assumes no obligation to update any of these statements unless required by law.
During today's call management will discuss non-GAAP financial measures, including distributable net investment income.
Please refer to yesterday's press release for a reconciliation of these measures to the most directly comparable GAAP financial measures.
Certain information discussed on this call, including information related to portfolio companies was derived from third party sources and has not been independently verified.
And now I'll turn the call over to main Street CEO Duane Hughes zone.
Thanks, Matt Good morning, everyone and thank you for joining US. We appreciate your taking the time to join US and we hope that everyone is doing well and staying healthy and safe.
Joining me today with prepared comments are David Mangal, our president and Chief investment Officer, and Jesse Morris, Our executive Vice President and Chief operating Officer.
Also joining us for the Q&A portion of our call are Vince Foster our executive Chairman.
Nick Meserve, our managing director and head of our private credit, formerly middle market investment group and Brent Smith, our CFO.
On today's call I'll provide my normal updates regarding our performance and the quarter, while also providing updates on our asset management activities, our investment activities and current investment pipeline.
Our recent dividend increase and our expectations for dividends going forward and several other updates.
Following my comments, David and Jesse will provide additional comments on our investment strategy investment portfolio financial results and future expectations, after which we'll be happy to take your questions.
We are pleased with our second quarter results, which we believe demonstrate the strength and momentum of our main street platform.
And the quality and strong performance of our diversified group of portfolio companies.
The quarter represented our third consecutive quarter of sequential growth and total investment income with a total investment income for the quarter, representing a significant increase from our pre pandemic levels and with all components of income above their pre pandemic levels.
Our performance resulted in distributable net distributable net investment income or DNI, while and access of our monthly dividends paid to shareholders during the quarter and significantly higher than last year.
Along with continued improvement and our net asset value per share.
Our results also included a net increase and net assets from operations of $1.39 per share and an annualized return on equity for the quarter over 24% both of which are main Street records.
As we look forward to the second half of the year. We're excited about our investment activity since quarter end and the size and quality of our current investment pipeline and both our lower middle market and private loan investment strategies and believe we're very well positioned to continue to execute on these attractive investment opportunities due to our conservative capital structure and significantly.
Quiddity position.
The operating performance across most of our portfolio of companies continue to improve during the quarter, resulting in over $35 million of net depreciation and our lower middle market investment portfolio and of 3.4% increase and our net asset value or NAV per share and the quarter.
The strong performance of our portfolio of companies combined with ongoing organic and acquisition growth activities at several of our high performing portfolio of companies provides us optimism about our ability to generate incremental fair value improvement and NAV per share increases over the next few quarters.
We also made continued progress and our asset management business during the quarter.
This includes progress that MST income fund the non traded BDC, we advised through our external investment manager, which increased its investment portfolio by over 14% during the second quarter and paid an increased dividend for the fund shareholders and July.
We remain excited about our plans for the fund as we continue to execute and our investment strategies and other strategic initiatives and we are optimistic with our outlook for the future performance of the fund.
At Ms private loans on 1 <unk>.
Privately held fund that we launched a few quarters ago, we accepted significantly increased capital commitments from investors and continue to grow its investment portfolio through its co investment activities with main street, and MSC income fund and our private loan investment strategy.
The growth of our asset management business has been significantly beneficial to our ability to execute our private loan strategy and we expect these benefits to increase and the future.
We remain excited about our strategy for growing our asset management business within our internally managed structure and increase and the contributions from this unique benefit to our main street shareholders.
Based upon our results for the second quarter and the positive developments at our existing portfolio companies combined with our favorable outlook and each of our core investment strategies and for our growing asset management business and the benefits of our efficient operating structure and strong liquidity position.
Earlier this week, our board declared an increase to our monthly dividends for the fourth quarter to 21 per share payable and each of October November and December representing a 2.4% increase from our monthly dividends for the third quarter.
We are also confident that we will be and positioned to generate the NII at level sufficient to provide continued coverage of our monthly dividends and increase future dividends and 2022, consistent with our long term historical practices.
Now turning to some additional details on our investment activities and the second quarter and our current investment pipeline, we completed lower middle market investments of $26 million and the quarter.
As of today, I would characterize our lower middle market investment pipeline as well above average.
We remain very active and our lower middle market strategy and we are excited about the investment opportunities and the current pipeline.
Consistent with our activities since the beginning of the pandemic, our recent investments and the current pipeline includes several follow on investments and existing portfolio companies as we and our companies actively look to execute on various growth opportunities.
We view these follow on investment opportunities is very attractive as they allow us to make follow on investments and some of our top performing companies and management teams and provide the opportunity for meaningful equity value creation through these accretive acquisitions and continued fair value appreciation on these investments going forward.
As we noted in our comments last quarter, we believe that several factors are driving the significant increase in activity and our current pipeline.
These factors include and increased focus on financial and estate planning priorities by many entrepreneur owners after the difficult environment experienced broadly across the economy. Since early 2020, combined with significant uncertainty and concern regarding increasing future tax rates, particularly taxes on capital gains.
Consistent with our historical experiences over the last 2 decades as the industry, leading partner for lower middle market companies and their management teams, we believe that our unique combined debt and equity investment offerings and our ability to be a long term to permanent partner for the companies we invest in <unk>.
<unk> positions us to be a favorite of investment partner for these business owners.
We expect the disposition will continue to result, and attractive new lower middle market originations for our main street platform through the end of the year.
Due to the strength and quality of our lower middle market portfolio of companies. We have also experienced robust interest and a number of for these portfolio companies, which could result in a few additional exits and significant realized gains and additional fair value appreciation over the balance of the year.
During the second quarter. We also continued the successful focus of our investments and our private loan strategy, resulting in new investments totaling approximately $200 million and representing a record level of originations for the strategy.
As of today I'd characterize our private loan investment pipeline as above average.
With that I will turn the call over to David.
Thanks, Dwayne and good morning, everyone.
And as Dwayne highlighted in his remarks, we believe our second quarter financial results demonstrate the strength of main street platform, our differentiated investment approach and our unique internally managed operating model.
We are excited that our investment income generated during the quarter was at an all time high.
We're also pleased to report that the overall operating performance for the majority of our portfolio of companies with strong and the quarter and resulted in both significant increases in our NAV per share as well as the achievement of several significant positive milestones and our lower middle market strategy.
As we've discussed in the past the primary driver of our long term success has been and continues to be our focus on the underserved lower middle market and specifically our strategy of investing and both the debt and equity and lower middle market companies and partnership alongside strong existing management teams.
Our equity investments closely align our interest with our portfolio of company management teams and allow us to share and the equity upside on a current basis through dividend income and and a long term basis through the equity appreciation is there of companies grow and perform.
These equity investments support growth and main street realized income through the dividend income, we received and the periodic realized gains upon the exit of those businesses.
This quarter, our lower middle market portfolio of companies generated the highest level of dividend income and our firm's history, which we view as of important milestone and continued validation of our unique lower middle market investment strategy.
In addition to the benefit we received from the dividends paid from our lower middle market portfolio of companies main Street also significantly benefits from both the unrealized and realized the equity appreciation as the portfolio of companies, we invest and both deleveraged and grow over time.
We achieved another meaningful milestone and the second quarter as our lower middle market investments achieve the greatest level of quarterly fair value appreciation and our history.
Our lower middle market investments were the primary driver behind our significant pretax net unrealized depreciation this quarter of over <unk> 50 per share.
Additionally, in the second quarter, we had a good example of the value creation, we can achieve with our lower middle market equity investments as we fully exited our ownership position and American trailer rental group or <unk>, which represented a $17 million realized gain.
As is typical with many of our lower middle market investments. We initially made a minority equity and debt investment and <unk> and 2017 to support the change of control of transaction and growth capital financing.
The company utilized additional debt and equity provided by main street to grow as it executed a multiple of accretive acquisitions and fleet expansion opportunities.
On our equity investment and <unk> represented of total internal rate of return of 61% and of 3 times money invested.
And on accumulative basis, including our debt and equity investments of <unk> represented 28% internal rate of return or of 1.7 times money invested.
Realized gains like the provide and offset against the inevitable credit losses that will be experienced when investing and non investment grade debt as we do for the vast majority of the investments and our portfolio.
Now turning to the overall composition and results from our investment portfolio consistent with prior quarters. The contributions from our lower middle market portfolio continued to be well diversified with over 60% of our lower middle market companies with equity investments, having appreciation at quarter end and with over 60% of those companies that are flow through entities for tax purposes.
Contributing to our dividend income over the last 12 months.
In addition, we also of several equity investments and non flow through entities, which have contributed to our dividend income over the last 12 months.
Our investment activity and the second quarter included total investments and our lower middle market portfolio of approximately $26 million.
Which after aggregate repayments on debt investments and return of invested equity capital from a combination of the successful exit of our investments and herc and other repayment activity, resulting from the strong performance of our portfolio of companies resulted in the net decrease and our lower middle market portfolio of approximately $37 million.
Since the end of the second quarter, we have subsequently made investments totaling in excess of $50 million and the lower middle market and as Dwayne mentioned, our current pipeline of new and add on investment opportunities remains very strong.
We also made of $198 million and total private loan investments, which after aggregate repayments of debt resulted in the net increase and our private loan portfolio of approximately $105 million.
Finally, we had a net increase and our middle market portfolio of approximately $17 million.
We're excited with the pace of new and follow on private loan investment opportunities that are private credit investment team has been able to achieve.
The growth and our private loan portfolio is consistent with our stated strategic goal over the last few years to continue to grow the private loan portfolio as a greater proportion of our overall portfolio and the results of our private credit team had and the quarter are further evidence of the successful execution of this strategy.
As of June 30, we had investments and 177 portfolio companies spanning across over 50 industries.
Largest portfolio of company represented approximately 2.7% of our total investment portfolio of fair value of quarter, and and 3.2% of our total investment income for the last 12 months.
The vast majority of our portfolio of investments represented less than 1% of our assets and our income.
At quarter, and our lower middle market portfolio included investments of 69 companies representing over $1.3 billion of fair value, which is over 20% above our cost basis.
Our private loan portfolio included total investments and 69 unique companies, representing approximately $863 million of fair value and.
And our middle market portfolio had investments and 39 companies, representing approximately $434 million of fair value.
The total investment portfolio at fair value of quarter and was approximately 109% of the related cost basis.
In summary main streets investment portfolio continues to perform at a high level, which we believe will allow us to deliver on our stated goal of creating significant shareholder value through achieving increasing NAV appreciation and dividends paid to our shareholders with that I will turn the call over to adjusted to cover our financial results capital structure and liquidity position.
And.
Thank you David.
Turning to a summary of our financial results, our total investment income and the second quarter increased by $15.3 million over the same period and 2022 of total of $67.3 million drew.
Driven by increases in both interest and dividend income.
Of particular note dividend income increased by $10.8 million, which more than doubled the level of dividends a year ago and included a net increase of $2.6 million that is generally considered less consistent or nonrecurring.
This increase and investment income it's further evidence of the strength of our underlying portfolio companies and their management teams and main Street has continued success and deploying capital to support our portfolio of companies growth initiatives and execute new platform investments that Duane and David discussed and the earlier remarks.
Our operating expenses, excluding noncash share based compensation.
<unk> increased by $4.2 million over the same period of the prior year, primarily driven by increases in compensation expense and interest expense and the quarter.
The increase and compensation expenses, primarily due to higher levels of incentive compensation accruals, which is directly related to the improved performance and.
And the investment and additional personnel to grow our investment team.
Despite these compensation expense increases the ratio of our total operating expenses, excluding interest expense as.
As a percentage of our average total assets was 1.4% for the second quarter on an annualized basis and for the trailing 12 months, which continues to be amongst the lowest and our industry.
The activities of our external investment manager and benefit our net investment income by approximately $3.8 million during the second quarter through the allocation of $2.6 million of operating expenses for services, we provided to it.
And $1.2 million of dividend income and increase of 75% from prior year.
As a reminder in October of 2020.
Main street took over the sole advisor responsibilities of the HMS income fund, which has since been renamed the analyst Day income fund.
This change has resulted in a significant increase from prior year and the benefits from the external investment manager.
Net investment income increased by $11.1 million and the second quarter 2021 over the same period last year and increase of 35%, which outpaced the rate of growth of our total investment income of 29%.
For the first 6 months of the year net investment income as a percentage of total investment income was 63, 1% and improvement of approximately 100 basis points over the full fiscal year of 2020.
Which demonstrates the improving operating leverage underlying main street's overall results.
We recorded a net realized gain of $18 million during the second quarter, resulting from net gains realized from the exit of lower middle market investments are realized gain from the partial exit of the middle market investment and a realized loss from the full exit of the middle market investment.
We recorded net unrealized depreciation on the investment portfolio of $49.1 million during the second quarter.
Which included net appreciation of $36 formula and on our lower middle market portfolio.
The $5.2 million and our private loan portfolio.
And $5.1 million and our other portfolio, which was partially offset by $2.2 million of net depreciation and our middle market portfolio.
In addition, our external investment manager also reflect the depreciation of $4.5 million and driven by increased asset of the funds managed.
Our operating results for the second quarter resulted in an increase and net assets of $95.1 million.
And an increase of net asset value for NAV per share of 77, 2 and the quarter with and NAV.
The $23.42 per share.
We ended the second quarter with non investments on non accrual status comprising approximately 1.2% of the total investment portfolio of fair value and approximately 3.9% of cost.
Our overall capitalization and liquidity remained very strong as our total liquidity is currently in excess of $750 million.
We were very pleased to have further enhanced our capital structure by extending our revolving credit facility and April with an increase in total commitments to $855 million.
We continue to believe that our conservative leverage and strong liquidity and continued access to capital of our significant strength would have us well positioned for the future.
Coming back to our operating results our key measure of our performance as the NII or distributable net income per share.
The NII per share for the second quarter was <unk> 60 per share of.
<unk> 14, or 27% increase over the same period last year and of 6% increase over the first quarter of 2021.
This quarter also marks the third consecutive quarter that arent the NII per share has exceeded the dividends per share paid to our shareholders.
And as Duane noted earlier this week, our board of directors declared an increase and our quarterly dividend to <unk> 63 per share for the fourth quarter.
As we look forward.
We expect that we will generate the NII per share of that the 65 per share and the third quarter.
Based upon our current expectations of visibility.
We believe that there's opportunity for additional upside of DNI and the third quarter and we expect continued strong performance and the fourth quarter.
With that I will now turn the call back over to the operator, so we can take any questions.
Okay.
Thank you.
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Alright. Thanks question is from Kenneth Lee of RBC capital markets. Please state your question.
Hi, Thanks for taking my question just wanted to.
Talk about the the top of of the distributable net investment income for the DNI sounds like.
And that sustainable path of improvement, but just wanted to double check and also.
Yeah, a little bit more detail on what could potentially drive upside to the NII and the third quarter.
Sure. Thanks, Thanks, Ken and I do think we feel good about where DNI sits today and as we look forward to the next couple of quarters, which is why <unk>.
Jesse and his comments gave the guidance that we feel good about 65 with some potential for upside I think when you look at the upside it will be driven by the <unk>.
Pace of new investment activity, how many of the the new lower middle market transactions, we have and our pipeline how many of those can we get close between now and the end of the quarter as well as just the the quarter to quarter volatility we've talked about in the past and we continue to see and the dividend income from certain of our lower middle market companies, how much of that dividend income in the upcoming in <unk> before 930. So.
Those will be the 2 big drivers that could lead to some upsides of that 65% number.
Yeah.
Got you very helpful and Jim.
1.1 other question within the lower and middle market segments.
You talked about.
A lot of volumes for follow on investments.
Just wanted to get a little more detail around what's driving that elevated activity.
Sure Ken So I think we mentioned over the last year kind of since the beginning of the pandemic certain of our companies, particularly the companies that we're performing better throughout the last 12 months to 18 months 1 of the things that they started to embrace more than our company's had embraced historically was growth through acquisition shows we've looked at those companies and have been support.
The them through the acquisition growth of <unk>.
Hundreds of activities <unk> been going through and we're finally, starting to see some of those those the activities pay dividends through the through transactions that have either closed here recently are there will hopefully will close over the next couple of months.
Great very helpful. Thanks again.
Thank you.
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Our next question is from Robert Dodd of Raymond James Please state your question.
Hi, guys.
And on the pipeline from the low and middle market. I mean, you said well above average I mean, I've heard a lot of above average is in the past a lot of average is I don't the core of Hilton.
The other guy.
And well above average at least for a long time.
So where.
Where would you characterize the.
Portfolio, not just relative to the averages but relative to historic highs in terms of the.
<unk> for activity it sounds.
Barry.
And are you optimistic on that right.
Right now.
Yes, Robert So I think David touched and his comments on the actual closings, we've had today, which is right at $50 million.
You put that together with the current pipeline historically I think we've guided to.
And annual origination.
Origination amount for main street, and the lower middle market kind of and the $225 million range.
If you take that and you separated out and looked at it on a quarterly basis Youre looking at just under $70 million of quarter. If I was to look at the current quarter with the $50 million and we've already closed yes, I think you have potential upside for 1 and a half to 2 times that number for the third quarter. If everything was to go the way that we wanted to but at the same time I will give the caviar.
And then we don't control the timing of closing other transactions exclusively and if there is.
Salary and other parties involved so things have to go well for us to get that upside number.
Understood and.
I mean, what's the.
Can you break down kind of the drivers obviously, there's potential for tax changes.
Last year was very slow for obvious reasons I mean is it just the the <unk>.
Fluids of both of those 2 factors driving the or is there something else that's driving the pipeline and just talking about keeping things can still keep pool, but the.
The map of that much of the long term so any any kind of.
The color you can give all of them kind of what the fact is all of the sort of.
Driving that Linda.
So we do think Robert the taxes, the big driver when you look at the the potential for a significant increase in capital gains tax rates the seller.
At the year, she should be as focused on the net after tax amounts of do you see a significant increase in tax rates that could be of big motivator to transact in the current year before year end. So I do think we're seeing a healthy amount of activity from you or from that potential change of the uncertainty around it and I also think as we've touched on we are seeing.
The the benefits of the focus on and acquisition growth of some of our companies. We are seeing that completed the pipeline as well. So we're very excited about that because if we if we have the opportunity to put additional capital into our best companies and our best management teams, we love doing that and we're seeing that through these follow on acquisition financing.
The opportunities I'd, just add 1 last thing Robert last year with Covid and all of the where the number of transactions of our pulled from the market and came to the market, which really helps us as far as the the number of transactions, we're seeing come through our pipeline.
Okay got it and I appreciate that and then 1 last 1 if I can on the asset management business.
You said for performing well.
The bulk of that today, obviously, the MFC and Thats not.
And in fundraising mode obviously.
And.
Growing by by relaxing of et cetera, but not funded.
1 of your.
Expectations or maybe thats the overstating it hopes maybe aspirations about fund raising and additional capital that can be raised to be managed by the asset management business, which you will receive it.
<unk> earnings.
To the BDC shareholders.
Yes, and obviously if you look at the 2 primary drivers for our asset management business. Obviously came at the income fund is by far of the largest and to your point there. They are not and have not for quite a while been raising equity. We do think they are balance sheet leaves and opportunity for additional leverage or debt capital as the <unk> seen them growth through the.
And the use of <unk>.
Some of that capital and leverage and I think we continue to see and opportunity for for additional growth there for the fund through the use of additional leverage I think that's 1 area of for potential growth on the <unk> the income fund side.
And then on the private loan funds side that really has not been a significant contributor to the asset management business to date, but we do remain optimistic about the pace of fundraising activity that we've seen as well as the opportunity for once we get through the fund raising process and have completed the equity raising to come back and put some some some debt capital and leverage on top of that that equity.
So we think those 2 factors give us quite of bit of a tailwind behind us on the asset management business that should be a really big positive for main street over the next 2 to 4 quarters.
Got it I appreciate it. Thank you. Thank you Robert.
Ladies and gentlemen, we have reached the end of the question and answer session I would now like to turn the floor back over to management for closing comments.
Thank you for everyone for joining US again this morning, and we'll look forward to talking again in early November.
Ladies and gentlemen, thank you for your participation. This does conclude today's teleconference. You may disconnect. Your lines at this time and have a wonderful day.
Yeah.