THL CREDIT INC TCRD
May 30, 2019 - 4:43pm EST by
gman
2019 2020
Price: 6.68 EPS .98 0
Shares Out. (in M): 32 P/E 6.8 0
Market Cap (in $M): 213 P/FCF 6.8 0
Net Debt (in $M): 0 EBIT 34 0
TEV ($): 213 TEV/EBIT 6.3 0

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  • BDC
  • Discount to NAV
  • Dividend yield
 

Description

THL Credit, Inc. (TCRD)
Significant current income
Significant discount to book value
Ongoing buybacks accretive to book value per share
Potential for sale to larger BDC/liquidation to close gap to book value
Expect 10+% IRR over a 5 year time horizon, supported by 12.6% yield at today’s price
 
Summary:
This is a straight-forward idea to invest in a portfolio of senior-secured, floating rate loans at a
meaningful discount to fair value. The portfolio is managed by a capable asset manager, THL, with
extensive credit markets experience. The manager has spent the last year or so re-positioning the
portfolio towards more 1st lien exposure, more diversification, and a simpler story. The past iteration of
TCRD was CLO equity heavy and concentrated in riskier, credit heavy bets. The portfolio is moving more
towards credit “beta” and away from credit picking. Over time this probably leads to a lower ongoing
ROE profile, but the stock price and price to book ratio have dropped far enough to adjust for this
reality.
 
A combination of dividend income and price appreciation from a reduction in discount to book either
from improved market perception or corporate action will result in 10+% IRR’s over a reasonable time
horizon. Bad outcomes (i.e. loss of capital) would be limited to a significant credit market event and
even then, the current discount to book value already implies serious credit issues that are not present
in today’s market. In a 2% treasury environment and low single digit expected returns for equities, TCRD
presents an attractive risk-reward at today’s prices.
 
 
What follows is a high-level overview. Happy to add more detail in the comments.
 
Significant Current Income:
The portfolio is earning net investment income of about $0.20-$0.25 per share per quarter roughly in
line with the recent $0.21 quarterly distribution. On a book value per share of $8.96 this is a 9.4% yield
in line with returns for generic middle market loans. The stock price, however, trades at a 26% discount
to book value at $6.67 per share. Thus, the yield at the current market price is 12.6%. It’s important to
note that management “right-sized” the distribution in 2019 by cutting from $0.27 per share to $0.21.
The $0.27 level was a step down from $0.34 in the 2014-2016 time-frame, supported by mid-high teen’s
returns from CLO equity. Part of the existing discount to book value is the market’s fear of further cuts in
earnings and distributions. We believe further cuts are unlikely given the assets they are investing in, net
of reasonable credit losses, support current earnings and distribution levels.
 
Significant Discount to Book Value:
The current discount to book value is 26% which is near the all-time low for TCRD. The discount dipped
to 30% in 2016 and late 2018 and represent “outer bounds” for TCRD’s trading history. For historical
context, other BDC’s traded at 50+% discounts to book value in the financial crisis. BDC’s are levered
financial instruments and a major market event will lead to significant price declines. We believe this is
unlikely in the near term and possibly ever again but is a risk (and/or opportunity if you are ready with
capital).
 
The bear case is that the discount is appropriate given consistent declines in book value over the past
few years. Indeed, book value per share declined from a high of $13.58 in 2013 to $8.96 today, a 34%
decline or roughly 7% per year.
Purchasing TCRD today will require an investor to believe that the declines in book value will stop. Based
on the “high-grading” of the portfolio and a move towards credit beta, we believe that is likely. The
current default rate is low and although credit metrics are extended they are not stressed. Thus, credit
beta is likely to generate stable income with minimum default and credit loss in the near term. Second,
the right-sizing of the dividend should reduce the chance of under-earning the distribution. Third, TCRD
has begun buying back shares. At such large discounts to book value, the buybacks should be
meaningfully accretive to book value per share.
 
Sale Potential/Activism:
Activism in the BDC space is tricky given management friendly governance. However, THL appears to be
aware of their underperformance (fee cuts and buyback) and is certainly aware of recent activist
campaigns at various underperforming BDC’s. A few activists have taken positions in TCRD shares
 
(Omega owns 8.75% and Stilwell owns 1.04%), although no noise has been made to date.  
 
Transactions in the BDC space have picked up in recent years as subscale platforms have struggled. The
permanent capital is extremely valuable to a BDC manager so TCRD should have many suitors should
they ultimately decide to give up on the enterprise. THL has not indicated a willingness to sell, but the
manager does own 4% of TCRD and is generally known as a rational actor.A third option would be liquidation.  
 
As an example, ACSF is a subscale BDC that recently liquidated and provided a nice return to investors.  
 
TCRD’s shift to a more “vanilla” portfolio makes a sales or liquidation that much easier.
 
Returns:
TCRD’s portfolio of (short duration) income generating assets trades at a substantial discount to book
value. Under punitive assumptions, you end up with a better than fixed income return and a return in
line with forward return expectations for equities. Assuming a 5 year hold, a 5% reduction in book value
per share annually, an 8% ROE paid out to shareholders, and an exit at a 25% discount to book value
results in a 4.5% IRR.
 
Assuming a 5 year hold, a flat book value per share, a 9% ROE paid out to shareholders, and an exit at a
15% discount to book value results in a 14.2% IRR.
Better outcomes are possible/probable.
 

 

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

1) Continued accretive share buybacks at a large discount to TBV

2) Potential activism forcing a sale

3) earning a 12.6% distribution while you wait

 

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