Apollo Investment Stock: Still Overvalued For Me (NASDAQ:AINV)


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Investment thesis

Apollo Investment (AINV) is a BDC with a dividend yield of 9.46% and could be an income investor’s dream. Unfortunately, at the moment it’s closer to a long-term nightmare. I can see 10-15% price appreciation in the short term, but I don’t see a long term winning business. The company is trading 18% below its net asset value but remains overvalued with below average expense ratios, a stable book value and unable to recover from the 2020 crisis. Management is used to announcing dividend cuts when necessary and has not made any increases in the last ten years. For me, to consider a position in AINV, their book value must remain stable and grow in 2022 and the share price should trade under $10 with the same fundamentals as today.

business model

Apollo Investment Corporation, a Maryland corporation established in 2004, is an externally managed, non-diversified, closed-end investment company that has elected to be treated as a business development company. The company offers customized financing solutions to middle market private companies, primarily in the United States. AINV is BDC and benefits from its affiliation with Apollo Global Management, Inc., (APO), an alternative investment manager.

In 2016, management began to reposition the company’s investment portfolio into safer assets while reducing exposure to unsecured debt, the oil and gas sector, and CLOs. As of September 30, 2021, their portfolio consisted of 92% senior secured loans and 7% junior secured loans. Currently, the company has a portfolio of 144 companies and the average company exposure is $15.8 million. On the company’s investor relations website, we can see that their portfolio is 100% floating rate, but in reality, this is only true for their business loan portfolio. It seems management likes to present themselves creatively, but I prefer to see a clear picture. In fact, their total investment portfolio consists of 12% fixed rate assets and 7% non-performing and non-accrual assets.

Composition of the Apollo investment portfolio

Second quarter of fiscal 2022

Finances and income

Latest quarterly results

The company reported fair results for the second quarter and will announce its next quarterly results on February 4, 2022. Net investment income for the quarter ended September 30, 2021 decreased from the prior quarter. The NII was $21.2 million ($0.33 per share) in the second quarter of 2021, compared to $25.3 million ($0.39 per share) for the quarter ended June 30, 2021. The NII increased also decreased in the second quarter from September 30, 2020, which was $27.9. million ($0.43 per share). The company’s NAV is down, but for the past year it has been rising slightly. The net asset value per share as of September 30, 2021 was $16.07, compared to $16.02 as of June 30, 2021. The 0.3% increase was mainly due to the net appreciation of the corporate loan portfolio.

The net asset value also increased in the second quarter compared to the year-over-year figures, because as of September 30, 2020, the net asset value was $15.44. AINV made several new investments after the late 2020 new portfolio investments. AINV invested in 24 companies and the investments totaled $332 million during the second quarter. In the first quarter, the company invested $222 million in 18 companies. In 2021, share buybacks resumed with 145,572 common shares repurchased in the first quarter and 450,953 common shares repurchased in the second quarter. The company may reduce its unrealized losses in the oil and gas sector mainly due to the increase in the price of oil and this will improve further in the next quarter with exorbitant oil prices, but the unrealized losses in the shipping have worsened due to supply chain issues.

Evaluation

AINV is overvalued due to several factors. For a short term investor, the company may be a good choice but in the long term, I am far from confident about AINV’s price appreciation. The company’s book value has been declining since 2014 and management was only able to maintain current levels in 2021. Despite these issues, the company is trading 18% below its net asset value.

Apollo Investment Action
Data by YCharts

AINV’s expense ratio is 33.46%, an average figure in the BDC industry. To put that number into context, Bain Capital Specialty Finance, Inc. (BCSF), which has a similar market cap to AINV, has an expense ratio of 28.54%, and SLR Investment Corp. (SLRC) has an expense ratio of 31.06%. Ares Capital (ARCC) has a market capitalization of more than ten times as AINV has an expense ratio of 35.97%. Based on these numbers among its closest market capitalization peers, AINV has a slightly higher expense ratio, meaning management may allocate capital less efficiently than its peers. The company also has a return on equity of 13%, which isn’t bad, but compared to the BDC industry average of 17%, AINV is overvalued at this price.

We can also say that AINV is not the stock that recovers the fastest after a crisis. If we take a look at the company’s price chart, we can see that they couldn’t recover from the 2008 financial crisis and they also couldn’t recover from the COVID crisis. Even after ten years of financial crisis of 2008, the share price could not reach new heights and the same is true after the COVID crisis. The share price is still below February 2020 levels and at the moment there is no indication that AINV will behave differently than after the Great Recession. Based on all of these factors, I find the current stock price to be too high for me to invest in.

Company specific risks

The company faces several risks, both external and internal. An increase in interest rates could decrease the value of any investments the Company holds that pay fixed interest rates, and will also increase AINV’s interest expense, thereby decreasing net income. With interest rate hikes looking inevitable and analysts calculating 4 rate hikes for 2022, these increases could make an investment in AINV common stock less attractive if management cannot raise the dividend rate (which she hasn’t been able to do for the past ten years). Variation in LIBOR will also be a potential risk factor for AINV. The replacement of US dollar LIBOR with Guaranteed Overnight Funding Rate (“SOFR”) may reduce income on the Company’s floating rate debt investments in the short term.

They also depend, to a large extent, on Apollo Global Management’s access to APO’s investment professionals and partners and the information and transaction feeds generated by APO’s investment professionals. as part of their investment and portfolio management activities. AINV as a business is a consequence of APO’s fundraising and IPO in 2004, so AINV is still significantly dependent on APO. AINV’s ability to achieve its investment objective depends on management’s ability to grow, which depends on management’s ability to identify, invest in and monitor companies that meet their investment criteria. Management has made several bad choices over the past 4-5 years in capital allocation, such as Spotted Hawk and Glacier Oil & Gas. These decisions can adversely affect the expense ratio and the overall efficiency of the business.

My opinion on the AINV dividend

Current dividend

Apollo has paid consecutive dividends for 17 years, but has no history of consecutive dividend growth. Unfortunately they have a massive cut history with 3 cuts in the last 10 years and no increases. The dividend is down more than 63% since 2011. The company yields 9.46% and pays a quarterly dividend of $0.35 per share. Management has been trying to offset the 2020 dividend cut with regular special dividends since November 2020. It has paid $0.05 per share every quarter since and in the latest quarterly results, management said it had the intention to maintain this special dividend for the first quarter of 2022.

Future sustainability

Apollo’s payout ratio is pushed to the limits of around 100%. It depends on earnings and cash flow and whether the company can meet its earnings estimates. However, it seems to me that the special dividend will stop in 2022 due to external factors such as interest rate hikes and general market volatility. Also, management is used to cutting the dividend easily and in Apollo’s corporate culture for the past 10 years, this was the dominant policy of the company.

Payout ratio of AINV shares

The table is created by the author. All figures are taken from the company’s financial statements and SA earnings estimates.

Summary

Any BDCs with lots of floating rate interest expense and fixed rate interest income will struggle with interest rate hikes in 2022. AINV is in a pretty good position but the valuation is too high for me. Although it is trading 18% below its net asset value, the trend in book value, expense ratio and lagging recovery make it overvalued. I would consider a position in AINV if management can increase its book value in 2022 or make its first dividend increase and the stock price would fall below $10.

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