Main Street Capital Corporation (NYSE:MAIN) Q4 2023 Earnings Call Transcript
Main Street Capital Corporation (NYSE:MAIN) Q4 2023 Earnings Call Transcript February 23, 2024
Main Street Capital Corporation isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).
Operator: Greetings, and welcome to the Main Street Capital Corporation Fourth 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. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Zach Vaughan with Dennard Lascar Investor Relations. Thank you, Mr. Vaughan. You may begin.
Zach Vaughan: Thank you, Operator, and good morning, everyone. Thank you for joining us for Main Street Capital Corporation's fourth quarter 2023 earnings conference call. Joining me today with prepared comments are Dwayne Hyzak, Chief Executive Officer; David Magdol, President and Chief Investment Officer; and Jesse Morris, Chief Financial Officer and Chief Operating Officer. Also participating for the Q&A portion of the call is, Nick Meserve, Managing Director and Head of Main Street's Private Credit Investment Group. Main Street issued a press release yesterday afternoon that details the company's fourth quarter financial and operating results. This document is available on the Investor Relations section of the company's website at mainstcapital.com.
A replay of today's call will be available beginning an hour after the completion of the call, and will remain available until March 1. 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 through the Internet and can be accessed on the company's homepage. Please note that information reported on this call speaks only as of today, February 23, 2024, and therefore, you are advised that 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.
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 these statements as a result of risks, uncertainties, and other factors, including, but not limited to, the factors set forth in the company's filings with the Securities and Exchange Commission which can be found on the company's website, or at sec.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 or DNII. DNII is net investment income or NII as determined in accordance with U.S. Generally Accepted Accounting Principles, or GAAP, excluding the impact of non-cash compensation expenses.
Management believes that presenting DNII and the related per share amount are useful and appropriate supplemental disclosures for analyzing Main Street's financial performance since non-cash compensation expenses do not result in a net cash impact to Main Street upon settlement. Please refer to yesterday's press release for a reconciliation of these non-GAAP measures to the most directly comparable GAAP financial measures. Two additional key performance indicators that management will be discussing on this call, are net asset value or NAV, and return on equity or ROE. NAV is defined as total assets minus total liabilities and is also reported on a per share basis. Main Street defines ROE as the net increase in net assets resulting from operations divided by the average quarterly total net assets.
Please note that 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's CEO, Dwayne Hyzak.
Dwayne Hyzak: Thanks, Zach. Good morning, everyone, and thank you for joining us. We appreciate your participation in this morning's call. We hope that everyone is doing well. On today's call, I will provide my usual updates regarding our performance in the quarter, while also providing a few updates on our performance for the full-year. I'll also provide updates on our asset management activities, our recent dividend declarations, our expectations for dividends going forward, our recent investment activities and current investment pipeline, and several other noteworthy updates. Following my comments, David and Jesse will provide additional comments regarding our investment strategy, investment portfolio, financial results, capital structure and leverage, and our expectations for the first quarter of 2024, after which we'll be happy to take your questions.
We're extremely pleased with our fourth quarter results, which closed another record year for us. Our fourth quarter performance resulted in a new quarterly record for NII per share, DNII per share equal to our existing quarterly record that we achieved earlier this year, a new record for NAV per share for the sixth consecutive quarter, and an annualized return on equity of approximately 23% for the quarter. Our performance in the fourth quarter continued our positive performance in the first three quarters of 2023, and resulted in new annual records for NII per share and DNII per share, and a return on equity of approximately 19% for the year. These positive results demonstrate the continued and sustainable strength of our overall platform, the benefits of our differentiated and diversified investment strategies, the unique contributions of our asset management business, and the continued underlying strength and quality of our portfolio companies.
We are further pleased we were able to generate these returns while intentionally maintaining a conservative capital structure and liquidity position during 2023. The continued positive momentum across our platform during 2023 allowed us to deliver significantly increased value to our shareholders, with a 25% increase in the total dividends paid to our shareholders in 2023. Despite this significant increase, our DNII still exceeded the total dividends paid to our shareholders by over 17%. In addition to these record-breaking results, with the continued support from our long-term lender relationships and the benefits of our recent investment-grade debt offering, in January, we entered the New Year with a strong liquidity position and a conservative leverage profile, and are excited about the prospects for significant growth in both our lower middle market and private loan investment strategies.
We appreciate the hard work and efforts of the management teams and employees at our portfolio companies, and continue to be encouraged by the favorable performance of the companies in our diversified lower middle market and private loan investment strategies. We remain confident that these strategies, together with the benefits of our asset management business and our cost-efficient operating structure will allow us to continue to deliver superior results for our shareholders in the future. These positive results combined with our favorable outlook for the first quarter resulted in our recommendations to our Board of Directors for our most recent dividend announcements, which I'll discuss in more detail later. Our NAV per share increased in the quarter due to several factors, including the impact of the net fair value increases in our investment portfolio, the accretive impact of our equity issuances, and our retention of the excess NII above our dividends paid.
The continued favorable performance of certain of our lower middle market portfolio companies resulted in strong dividend income contributions in another quarter of significant fair value appreciation in the equity investments in those portfolio companies. As we look forward to the next few quarters, we remain excited about our expectations for our lower middle market portfolio companies, and the opportunity for continued dividend income and additional fair value appreciation from this portfolio in the future. Our lower middle market investment activity in the fourth quarter returned to levels consistent with our normal expectations, with new investments of $92 million in the quarter, including investments totaling $68 million in two new portfolio companies, and resulting in a net increase of $66 million after repayments and other investment activity.
Our private loan investment activities in the quarter included new investments of $160 million, which together with higher than expected repayment activity in the quarter, resulted in a net decrease in our private loan investments of $113 million. We've also continued to produce attractive results in our asset management business. The fund we advise through our external investment manager continue to experience favorable performance in the fourth quarter, resulting in significant incentive fee income for our asset management business for the fifth consecutive quarter, and together with our recurring base management fees, a significant contribution to our net investment income. We also benefited from significant fair value appreciation in the value of the external investment manager due to a combination of increased fee income, growth in assets under management, and broader market-based drivers.
We remain excited about our plans for the external funds that we manage as we execute our investment strategies and other strategic initiatives. And we are optimistic about the future performance of the funds and the attractive returns we are providing to the investors of each fund. We also remain optimistic about our strategy for growing our asset management business within our internally managed structure, and increasing the contributions from this unique benefit to our Main Street stakeholders. As part of this growth strategy, we're happy to update that we've made continued progress with the fundraising activities on our second private loan fund, and we look forward to the continued growth of this new fund over the next few quarters, and the related additional recurring base management fees and incentive fee opportunities.
Based upon our results for the fourth quarter, combined with our favorable outlook in each of our primary investment strategies and for our asset management business, earlier this week, our Board declared a supplemental dividend of $0.30 per share payable in March, representing our 10th consecutive and largest to date quarterly supplemental dividend. Our Board also declared regular monthly dividends for the second quarter of 2024, of $0.24 per share, payable on each of April, May, and June, representing a 6.7% increase from the second quarter of 2023. The supplemental dividend for March is a result of our strong performance in the fourth quarter, which resulted in DNII per share which exceeded our regular monthly dividends paid during the quarter by $0.42 per share or 59%.
The March 2024 supplemental dividend will result in total supplemental dividends paid during the trailing 12-month period of $1.075 per share, representing an additional 39% paid to our shareholders in excess of our regular monthly dividends, and implying a current total yield to our shareholders of approximately 9%. After multiple increases to our monthly dividends during 2023, and the significant supplemental dividend paid in December, our DNII per share for the fourth quarter still exceeded our total dividends paid by $0.14 per share or 14%. We are pleased to be able to deliver this significant additional value to our shareholders, while still conservatively retaining a portion of our excess earnings to support our capital structure and investment portfolio against the risks associated with the current continued general economic uncertainty, and to further enhance the growth of our NAV per share.
As we've previously mentioned, we currently expect to recommend that our Board declare future supplemental dividends to the extent DNII significantly exceeds our regular monthly dividends paid in future quarters. And we maintain a stable to positive NAV. Based upon our expectations for the continued favorable performance in the first quarter, we currently anticipate proposing an additional supplemental dividend payable in June, 2024. Now turning to our current investment pipeline, as of today, I would characterize our lower middle market investment pipeline as average. Despite the current board economic uncertainty, we expect to continue to be active in our lower middle market strategy. Consistent with our experience in prior period of broad economic uncertainty, we believe that the unique and flexible financing solutions that we can provide to our lower middle market continues and their owners and management teams, and our differentiated long-term to permanent holding periods should be an even more attractive solution in the current environment, and should result in very attractive investment opportunities.
We are excited about these new investment opportunities. And we expect that our current pipeline will be helpful as we work to maintain our positive momentum from 2023 into the future. We also continue to be very pleased with the performance of our private credit team and the results they have provided for our private loan portfolio and our asset management business. And as of today, I would characterize our private loan investment pipeline as average. With that, I would turn the call cover to David.
David Magdol: Thanks, Dwayne, and good morning, everyone. Each yearend provides a good opportunity to look back at our history and highlight the results of our unique and diversified investment strategies and discuss how these strategies have enabled us to deliver attractive returns to our shareholders over an extended period of time. Since our IPO in 2007, we have increased our monthly dividend per share by 118%. And we have declared cumulative total dividend for shareholders of $40.56 per share or over 2.7 times our IPO price of $15 per share. Our total return to shareholders since our IPO calculated using our stock price as of yesterday's close and assuming reinvestment of all dividends received since our IPO, was 11 times money invested.
This compares very favorably to the 3.4 times money invested for the S&P 500 over the same period of time, and is significantly higher when compared to other BDCs. As we previously discussed, we believe that the primary drivers of our long-term success have been and will continue to be our focus on making both debt and equity investments in the underserved lower and middle market supporting our private credit activities to the benefit of our stakeholders and for the clients of our asset management business which also benefits our stakeholders, our internally managed structure which allows us to maintain an industry-leading cost structure and a strong alignment of interest between our employees and our shareholders as a result of team's meaningful stock ownership.
Most notably and uniquely, our lower middle market strategy provides attractive leverage points and income yields on our first linen debt investments are also creating a true partnership with the management teams and other equity owners of our portfolio companies through our flexible and highly aligned equity ownership structures. This approach provides significant downside protection through our first lien debt investments and preferred equity positions while still providing the benefits of alignment and significant upside potential through these equity investments which we make alongside our portfolio company management team partners. Main Street's long-term historical track record of investing in a lower middle market coupled with our view that this market continues to underserved, gives us confidence that we will be able to continue to find attractive new investment opportunities in this primary area of investment focus for our business.
Our ability to provide highly customized and differentiated capital solutions for the predominately family-owned businesses that exist in the lower middle market has been and continues to be a strong differentiator for us. In 2023, Main Street invested $301 million in our lower middle market strategy. A $197 million of this capital was deployed in six new lower middle market platform companies with the remaining $104 million predominately representing follow-on investments in existing, seasoned, and well-performing lower middle market companies. Consistent with our comments in prior quarters, these follow-on investments were made to support the growth strategies in some of our highest performing portfolio companies, which makes this aspect of our lower middle market investment activity very exciting for us.
Our follow-on investments are typically used to support multiple objectives including acquisitions, product or geographic expansion opportunities, and recapitalization transactions. Most importantly, these follow-on investments support proven management teams that we believe intrinsically pose less investment risk when compared to providing capital to new portfolio companies. Since we are significant equity owners in our lower middle market companies, we benefit from participating alongside the proven managers needs businesses as they strive to achieve meaningful equity value creations. As we have stated in the past as our lower middle market portfolio companies perform over time, they naturally deleverage with free cash flow generated from operations.
This allows us along with our lower middle market portfolio management team partners to benefit from a larger portion of the portfolio company's cash flow after debt service which can be available for distributions to the equity owners. Given the strength and quality of our lower middle market portfolio and the long-term holding period for many of our companies, we expect dividend income to continue to be significant contributor to our results in 2024. Additionally, this deleveraging coupled with the attractive overall strong underlying operating results of our lower middle market portfolio companies allowed us to keep $72 million in net fair value appreciation in 2023 to the lower middle market portfolio. This benefit from our lower middle market equity investments is unique among BDCs with our fair value appreciation available to offset losses which we will naturally incur in our investment strategies given the fact that we are investing in non-investment grade asset classes.
Our unrealized equity appreciation also provides potential upside to Main Street's net asset value that the investment strategies of other BDCs simply do not have. The last important area I'd like to cover regarding our 2023 accomplishments are the impressive contributions that our private credit team delivered during the year. Our private credit team continued to execute on our strategy to dedicate significant resources towards growing the private loan segment of our business while deemphasizing our middle market portfolio, which, as a reminder, includes investments in larger syndicated loans. Our purposeful and intentional strategic shift over the last six years to grow our private loan portfolio is primarily driven by our belief that an attractive and growing direct lending environment exists and that the private loan investments provide a very attractive risk-adjusted return profile for Main Street and for the clients of our asset management business.
During 2023, Main Street invested $507 million in our private loan strategy while decreasing our middle market portfolio by 27% on a cost basis. As a result of these investment activities during the year, our private loan portfolio represented 39% of our total investments at cost at year end, and our middle market portfolio declined by 300 basis points to represent only 8% of our total investments at cost. As Dwayne discussed earlier, our private loan capabilities also support our key strategic objective to continue to grow our asset management business. As of December 31st, we had investments in 190 companies spanning across more than 50 different industries. Our largest portfolio companies, excluding the external investment manager, represented only 3.7% of our total investment income for the year and 3.5% of our total investment portfolio fair value at year end.
The majority of our portfolio investments represented less than 1% of our income and our assets. Now, turning to our investment activity in the fourth quarter, we made total investments in our lower middle market portfolio of $92 million, including investments of $68 million in two new lower middle market portfolio companies, which after aggregate repayments on debt investments and return of invested equity capital and a decrease in cost basis due to a realized loss, resulted in a net increase in our lower middle market portfolio of $66 million. During the quarter, we also completed $160 million in total private loan investments, which after aggregate repayments and sales of debt investments and a decrease in cost basis due to a realized loss, resulted in a net decrease in our private loan portfolio of $113 million.
Finally, during the quarter, we had a net decrease in our middle market portfolio of $50 million as a result of our continued focus to de-emphasize this strategy and portfolio. At year-end, our lower middle market portfolio included investments in 80 companies, representing $2.3 billion of fair value, which is 27% above our related cost basis. We had investments in 87 companies in our private loan portfolio, representing $1.5 billion of fair value. In our middle market portfolio, we had investments in 23 companies, representing $244 million of fair value. The total investment portfolio at fair value at year-end was 15% above our related cost basis. Additional details in our investment portfolio at year-end are included in the press release that we issued yesterday.
With that, I will turn the call over to Jesse to cover our financial results, capital structure, and liquidity position.
Jesse Morris: Thank you, David. To echo Dwayne's and David's comments, we are pleased with the operating results for the fourth quarter, which included a number of quarterly records and capped a year in which Main Street achieved records for distributable net investment income and net asset value, each on a per share basis. Our total investment income for the fourth quarter was $129.3 million, increasing by $15.4 million or 13.6% over the fourth quarter of 2022, and by $6.1 million or 4.9% from the third quarter of 2023. The positive momentum we experienced during the first three quarters continued in the fourth quarter and culminated in a year with strong levels of interest, dividend, and fee income, which again demonstrated the continued strength of our differentiated investment and asset management strategies.
The fourth quarter included elevated levels of certain income considered less consistent or nonrecurring in nature, including dividends from our equity investments and accelerated prepayment, repricing, and other activity related to our debt investments. In the aggregate, these items totaled $5.3 million and were comparable to the average of the prior four quarters were 1.1 million higher than such items in the fourth quarter of 2022 and 4.7 million higher than the third quarter of 2023. Interest income increased by $14.4 million from a year-ago, and $1.3 million over the third quarter. The increase over the prior year was driven primarily by increases in benchmark index rates, net investment activity and $2.3 million in increased accelerated OID income.
The increase over the third quarter was primarily driven by $3.1 million increase in accelerated OID income, partially offset by decreased levels of interest bearing debt investments at quarter end as a result of elevated levels of repayments, offsetting new and follow-on investments. Dividend income increased by $1.4 million or 6.1% over a year ago, including a $1.2 million decrease in unusual or nonrecurring dividends and increased by $2.6 million or 12.2% from the third quarter, including a $0.5 million increase in unusual or nonrecurring dividends. The increases in dividend income are a result of the continued underlying strength of our portfolio companies and the benefits from our asset management business. Fee income was comparable to a year ago and increased by $2.2 million from the third quarter driven by closing fees resulting from an increased investment activity and our lower middle market investment strategy and increased prepayment fees driven by repayment activity in our private loan portfolio.
Prepayment and other fee income considered nonrecurring was comparable to a year ago and increased by $1.2 million from the third quarter of 2023. Our operating expenses increased by $1.2 million over the fourth quarter of 2022, largely driven by increases in interest expense and compensation related expenses, partially offset by an increase in expenses allocated to the external investment manager. The ratio of our total operating expenses, excluding interest expense as a percentage of our average total assets, was 1.3% for both the quarter on an annualized basis and the year and continues to be amongst the lowest in our industry. Our external investment manager contributed $9.2 million to our net investment income during the fourth quarter, an increase of $2.2 million from the same quarter a year ago, which resulted in a total of $33.4 million for the year, representing an increase of $11.1 million or 50% over the prior year.
The manager earned $3.8 million in incentive fees during the quarter and $13.4 million for the year, increasing by $1.4 million and $10.9 million respectively over the same periods in the prior year as a result of the positive performance of the assets under management. The manager ended the quarter with total assets under management of $1.5 billion. During the quarter, we recorded net fair value appreciation, including net realized losses and net unrealized appreciation on the investment portfolio of $48.2 million. This increase was driven by net appreciation across each of our investment strategies, largely driven by the continued positive performance of certain of our portfolio companies and the impact from changes in market spreads. The increase in the fair value of our external investment manager was a result of a combination of increases in the fees generated by the external investment manager and the valuation multiples of publicly traded peers, which we use as one of the benchmarks for evaluation purposes.
We ended the fourth quarter with investments on non-accrual status comprising approximately 0.6% of the total investment portfolio fair value and approximately 2.3% of costs. Net asset value or NAV increased by $0.87 per share over the third quarter and by $2.34 or 8.7% when compared to a year ago to a record NAV per share of $29.22 at year end. Our regulatory debt-to-equity leverage calculated as total debt excluding our SBIC debentures divided by net asset value was 0.59 and our regulatory asset coverage ratio was 2.69, both intentionally more conservative than our long-term target ranges of 0.8x to 0.9x and 2.1x to 2.25x. During the fourth quarter, we expanded our total commitments under the SPB facility from $255 million to $430 million and raised $38 million from equity issuances under our aftermarket program.
In January of this year, we issued $350 million of unsecured notes with a coupon rate of 6.95%, maturing in March 2029 and utilized the proceeds to repay outstanding borrowings under our credit facilities. We currently intend to fund the repayment of our May 2024 notes at maturity, primarily through borrowings under the credit facilities. After giving effect to the capital activities in 2023, the issuance of the March 2029 notes and the upcoming repayment of our May 2024 notes, we entered 2024 with strong liquidity including cash and availability under our credit facilities in excess of $1 billion. We continue to believe that our conservative leverage, strong liquidity and continued access to capital are significant strengths that have us well positioned for the future and allow us to continue to execute our investment strategy and growth of our investment portfolio.
With this current level of liquidity, we expect to fund our net new investment activity in 2024 through a greater proportion of debt financing. And as such, we would expect leverage to increase during the course of the year. However, we expect to continue to operate through the year at leverage levels more conservative than our long-term targets. Coming back to our operating results, as a result of our strong performance for the quarter and year, our return on equity for the fourth quarter was 22.9% on an annualized basis and 18.8% for the year. DNII per share for the quarter of $1.12 exceeded the DNII per share for the fourth last year by $0.09 or 8.7% and exceeded the DNII per share for the third quarter by $0.08 or 7.7%. The combined impact of certain investment income considered less consistent are non-recurring in nature on a per share basis was comparable to the average of last four quarters, $0.01 per share above the same quarter a year ago and $0.06 per share above the third quarter.
For the year, these items were $0.15 per share above 2022 levels. DNII per share for the quarter exceeded total regular monthly dividends per share paid to our shareholders in the fourth quarter by $0.415 per share or approximately 59%. Total dividends paid for the year were $3.695 per share, including $0.95 per share in supplemental dividends, an increase of 25% over our total dividends paid during 2022. This week, our board approved a supplemental dividend of $0.30 per share payable in March 2024. With the supplemental dividend, total declared dividends for the first quarter of 2024 were $1.02 per share, representing a 4.1% increase over the total dividends paid in the fourth quarter of 2023 and a 20% increase over the total dividends paid in the first quarter of last year.
As we look forward, given the strength of our underlying portfolio, we expect another strong top line and earnings quarter in the first quarter of 2024 with expected DNII of at least $1.06 per share with the potential upside driven by the level of dividend income and portfolio investment activities during the quarter and we would also expect that we would recommend to our board that it declare another supplemental dividend in the second quarter. With that, I will now turn the call back over to the operator so we can take any questions.
See also 30 Most Walkable Cities In The World and 12 Best Gold Stocks Under $25.
To continue reading the Q&A session, please click here.
