The BDC sector - after 3 weeks of higher prices - dropped back again in the week ended July 5, 2022. At this point, the sector is about 5% above its 52 week low and (15%) below its 52 week high. 16 BDCs out of 43 are trading within 5% of their lowest point in the last year, and 10 between 5%-10%. That's not the worst we've seen in 2022 and there are still 10 players trading above net book value per share, but at one point in April there were 20.
Which is all to say that this remains a good time for BDC bargain hunters, unless you believe there is still substantial price erosion to go and choose to market time. In any case, our 5 year proprietary BDC valuation model projects the average annual return is at 16.6%. Furthermore, there are 12 names which we expect to generate a total return over 5 years of 100% or more. Some are set to earn a lot more for those willing to invest under these difficult conditions. There are another 20 names which we project will return 15%-20% per annum.
Many Fish In The Sea
Or, in other words, there is plenty of choice, both of prospective BDCs but also of sectors. Virtually all the BDC market segments have candidates for very high returns, including large cap (FSK); middle market (AINV, CCAP); lower middle market (CSWC) and venture debt (HTGC, HRZN,TPVG, TRIN). Even some previously under-performing BDCs of the past offer the prospect of superior performance in the future (FCRD, PFX) and those with idiosyncratic strategies (SLRC).
The one stand-out, though, for yet another week is middle-market focused Cion Investment (CION). As recently as July 14, 2022 the BDC was at a new 52 week low, but closed at $8.20. At this point, the $1.8bn in AUM BDC is an incredible (46%) below its 52 week high and trades at 51% of net book value. Mathematically, this means the market expects CION to lose ($463mn) of its equity by writing off 26% of its investment assets. Yet, through its entire 10 year history (mostly spent as a private BDC) total losses have amounted to ($136mn).
The BDC itself is motoring on, and has paid out two $0.28 regular distributions for the first two quarters of 2022. We expect this will continue in the IIIQ, to be announced with the IIQ earnings release. Also, management has promised at least one "special" dividend a year. The regular distributions are expected to reach $1.12 in 2022 and $1.30 all-in with the special.
(We're confident about the $0.18 special based on the BDC's prior history of paying out earnings in this way, and based on projected 2022 earnings set by the analysts at $1.31 per share in 2022 and the $0.13 per share of undistributed earnings at year end 2021).
At the $1.12 level, the current yield is 13.7% and 15.9% at the $1.30 projection. From a price to 2022 earnings standpoint, CION is trading at a 6.3x multiple. In 2023, the analysts expect even higher EPS ($1.33). For our part - focused as we are on distributions - we project $1.35 in 2023, rising to $1.40 by 2026. None of that seems outrageous when you consider IQ 2022 EPS annualized was $1.36, and that was with CION still much under-leveraged versus its plan, and without any benefit from higher rates.
On the credit side, CION does have 5 non accruals but they mostly date back several years and have a negligible value of $10mn. No new non accruals have been added in some time. Total underperformers amount to 11% of the portfolio, and that's trending down from IVQ 2021 at 14%. That's not the best level in the sector, but still within what we consider normal (under 15%).
Out Of Whack
With 92% of its portfolio assets in first lien debt, and widely diversified over 115 different companies, CION simply does not fit the profile of a BDC that one would expect to see earnings, NAV and distributions drop dramatically, as the market price suggests. In fact - and speaking in very general terms - the current price implies investors expect earnings/distributions will ultimately fall (40%) or more from their current level. It's possible because anything is possible but is completely at variance with the data; the analyst projections and common sense.
We project CION will achieve a total return of 205% over the next 5 years, or 41% per annum - far and way our Best Idea this week. As noted, our assumptions include that modest increase in distributions to $1.40, thanks mostly to a larger portfolio. (None of our projections factor in the benefit from higher rates). We also assume 5 years out what seems inconceivable right now, a price to dividend multiple of 13.0x. That's in line with what similarly sized BDCs that have gained favor with investors trade for during good times.
Even when we tested the model with CION only paying out the current $1.12 dividend for the next 5 years, the total return remained impressive at 146%/29% annual. Then dropping the terminal multiple to 10.0x from 13.0x reduced the total return further to 105% - still in the superior zone.
As Low As We Go
Only when we reduced the distribution to $0.82 from year two through five (leaving $1.12 in year one) and maintaining a 10.0x terminal multiple did CION's total return begin to look ordinary: 54% over 5 years, or 11% per annum. Even that is hardly a disaster despite a near (40%) climb down from the distributions levels we are expecting.
As always in these situations when stocks are trading so low, somebody is wrong about the long term outlook. We are clearly "fighting the tape" with this selection. Admittedly, CION has a short history as a public company, does not have the huge platform that most other large cap BDCs enjoy and historical credit performance has been middling. Nonetheless - we believe - the BDC is greatly oversold - probably due to private investors selling out whenever allowed. In a BDC sector replete with opportunities since prices have dropped (16%) on average from their April 2022 highs, CION stands out.
Are We There Yet ?
We can't imagine CION falling much further in price, but we thought very much the same 6 months ago when we first recommended the BDC as a Best Idea. The upcoming earnings release may prove a turning point, but there are no guarantees with the overall environment in such turmoil. We'll keep track of CION's progress from time to time on these pages.
July 17, 2022