Main Street Capital Corporation (NYSE:MAIN) Q1 2024 Earnings Call Transcript

Main Street Capital Corporation (NYSE:MAIN) Q1 2024 Earnings Call Transcript May 10, 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 First 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. Thank you, Zach. You may begin.

Zach Vaughan: Thank you, operator, and good morning everyone. Thank you for joining us for Main Street Capital Corporation’s first quarter 2024 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 first 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 May 17. 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, May 10, 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 on this morning’s call and 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 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 second quarter of 2024, after which we’ll be happy to take your questions.

We are pleased with our first quarter results, which were highlighted by an annualized return on equity of 17.2% for the quarter, a new record for NAV per share and NII per share and DNII per share that significantly exceeded the dividends paid to our shareholders. In addition, our positive performance in the quarter increased our return on equity for the trailing twelve month period to an impressive 19.3%. Our DNII per share in the first quarter exceeded the monthly dividends paid to our shareholders by 54% and the total dividends paid to our shareholders by 9%, representing a significant level of dividend coverage. And this is after increasing the total dividends paid to our shareholders in the first quarter by 20% as compared to the same period of last year.

We believe that 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 also very pleased that we generated growth in both our lower middle market and private loan investment portfolios and ended the quarter with attractive pipelines in both strategies, which we believe will be helpful as we work to maintain our positive momentum from the last few quarters into the future. We remain encouraged by the continued favorable performance of our diversified lower middle market and private loan investment strategies and 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.

Additionally, with the continued support of our long-term lender relationships and the benefits of our January investment grade debt offering, we continue to maintain strong liquidity, a conservative leverage profile and more than adequate flexibility to fund our current prospects for growth in both our lower middle market and private loan investment strategies. These positive results, combined with our favorable outlook for the second quarter, resulted in our recommendations to our Board of Directors for our most recent dividend announcements, which I will discuss in more detail later. Our NAV per share increased in the quarter primarily due to the impact of net fair value increases in our investment portfolio and our retention of excess NII above our total dividends paid, which Jesse will discuss in more detail.

The continued favorable performance of the majority of our lower middle market portfolio companies resulted in another quarter of significant net fair value appreciation in the equity investments in the lower middle market portfolio, and we are excited about the follow-on investments we made in several of our high-performing lower middle market portfolio companies. During the quarter, we supported three lower middle market portfolio companies in completing strategic acquisitions, each of which were funded by follow-on debt investments by Main Street, for a total of $52 million of incremental debt investments in these portfolio companies. We expect that these follow-on investments will help drive additional fair value appreciation in these portfolio companies in future quarters, in addition to the highly attractive interest income provided by these debt investments.

We’ve also seen increased interest from potential buyers in several of our lower middle market portfolio companies that could lead to favorable realizations over the next few quarters, and which we believe highlights the strength and quality of our portfolio companies. We are pleased with our investment activity in the first quarter. This activity included total lower middle market investments of $92 million, resulting in a net increase in lower middle market investments of $67 million after repayments and other investment activity. Our private loan investment activities in the quarter included new investments of $155 million and slightly moderated repayment activity as compared to the significant level of repayment activity experienced in the fourth quarter, resulting in a net increase in our private loan investments of $55 million.

As a result of our favorable investment activity, our total investment portfolio grew by approximately 6% on a cost basis. Given our conservative capital structure and strong liquidity position, we remain very well positioned to continue the growth of our investment portfolio over the next few quarters. We’ve also continued to produce positive results in our asset management business. The funds we advised through our external investment manager continued to experience favorable performance in the first quarter, resulting in significant incentive fee income for our asset management business for the sixth 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 external investment manager due to a combination of the continued increase in 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 remain optimistic about our strategy for growing our asset management business within our internally managed structure and are actively working to increase the contributions from this unique benefit to our Main Street stakeholders. As part of this growth strategy, we continue to focus on the near-term growth of our assets under management and the related, additional, recurring base management fee and incentive fee opportunities as we work to create additional value for both the investors in these funds and Main Street in the future.

Based upon our results for the first 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 June, representing our 11th consecutive quarterly supplemental dividend and an increase to our regular monthly dividends for the third quarter of 2024 to $0.245 per share, our 6th increase to our monthly dividends over the last eight quarters. The third quarter regular monthly dividends are payable in each of July, August and September and represent a 6.5% increase from the third quarter of 2023. The supplemental dividend for June is a result of our strong performance in the first quarter and will result in total supplemental dividends paid during the trailing 12-month period of $1.15 per share, representing an additional 41% paid to our shareholders in excess of our regular monthly dividends and a current total yield we are providing to our shareholders of over 8%.

After multiple increases to our monthly dividend and the significant supplemental dividend paid in March, our DNII per share for the first quarter still exceeded our total dividends paid by $0.09 per share or 9%. 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 general economic uncertainty, and to further enhance the growth of our NAV per share. We currently expect to recommend that our Board continue to 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 continued favorable performance in the second quarter, we currently anticipate proposing an additional supplemental dividend payable on September 2024. Now, turning to our current investment pipeline. As of today, I would characterize our lower middle market investment pipeline as above average. Consistent with our experience in prior periods of broad economic uncertainty, we believe that the unique and flexible financing solutions that we provide to our lower middle market companies and their owners and management teams, and our differentiated long-term to permanent holding periods represent an even more attractive solution in the current environment and we are confident in our expectations for strong lower middle market investment activity over the remainder of 2024.

We also continue to be very pleased with the performance of our private credit team and the significant growth they have provided for our private loan portfolio and our asset management business. And as of today, I would also characterize our private loan investment pipeline as above average. With that, I will turn the call over to David.

David Magdol: Thanks Dwayne, and good morning, everyone. As Dwayne highlighted in his remarks, we believe that our strong first quarter financial results continue to demonstrate the strength of Main Street’s platform, our differentiated investment approach and our unique operating model. We are pleased to report that the overall operating performance for most of our portfolio companies continues to be positive, which contributed to our attractive first quarter financial results. Each quarter, we try to highlight key aspects of our differentiated investment strategy. This quarter, we’d like to revisit several reasons why we believe that our structure is a publicly traded BDC with the significant benefits of permanent capital is a great match with our focus on investing in both the debt and equity capital in lower middle market businesses.

First, on the new lower middle market investment side, we believe that our permanent capital structure allows us to be an ideal long-term to permanent partner for the owners of privately held businesses. One of the challenges of a typical limited term specific private equity fund is that they cannot represent a long-term partnership solution for a retiring business owner or their management teams. Our permanent capital structure and long-term to permanent investment strategy in the lower middle market allows us the flexibility to compete for new investments by providing significantly more beneficial structural consideration as opposed to relying solely on price to gain a competitive advantage. Ultimately, we believe this can generate highly attractive investment structures that more traditional private equity funds cannot provide.

In addition, our ability to be a long-term to permanent partner to the companies we invest in allows the long-term owners of these businesses and their management teams the ability to maintain the identity and independence of their companies, while also achieving the best long-term outcomes for all of their company’s stakeholders. Second, our long-term holding periods also help generate a diversified portfolio of mature companies that typically have lower relative leverage since they have generally used free cash flow from operations to deleverage over time. As our companies deleverage, we work proactively with our portfolio company executives and individual equity owners to decide how they can generate the best returns for the equity owners of the businesses.

This tends to create three attractive opportunities for our high performing lower middle market portfolio companies. The opportunity for long-term equity capital appreciation through the reinvestment of cash flows or through deleveraging, the opportunity to pay significant dividends to the shareholders of the business and the opportunity to effectively take advantage of internal and external growth strategies and initiatives as they arise. In our more high performing situations, we often see our portfolio company executives and equity owners take advantage of multiple value creation opportunities. We are well aligned with our portfolio company operating partners to evaluate and pursue the best alternatives to create shareholder value since we share in the benefits of equity ownership with them.

Alternatively, should our portfolio company face difficult industry headwinds or other challenges since they have lower relative leverage profiles, they tend to be well positioned to work through any negative economic cycles as they arise and they have the added benefit of a highly aligned partner in Main Street to help them work through a potential rough patch. The first quarter of 2024 represented another strong period for add-on investments for our lower middle market companies whereby we supported five portfolio companies with additional capital for growth or recapitalization initiatives. Because of Main Street’s strong capital availability and ability to provide both debt and equity capital to our portfolio companies, we are well situated to move quickly to support our portfolio companies not only on the initial transaction, but also when they identify growth initiatives.

Today, the environment for add-on acquisitions by our portfolio companies remains strong. We welcome the opportunity to make incremental investments in our most successful lower middle market companies as we strive to create long-term value for Main Street shareholders alongside the other equity owners at the portfolio companies. Our lower middle market portfolio is currently comprised of 47 companies which have been in our portfolio for greater than five years and 22 of which who have been in our portfolio for greater than a decade. We are excited about our partnerships with companies that have proven long-term track records with Main Street. A recent example of our supporting a seasoned portfolio company management team in executing their growth strategies took place when Main Street supported our portfolio company Gulf Manufacturing or GMI and a highly strategic acquisition.

We made our original investment in GMI over 16 years ago and in the first quarter Main Street was pleased to provide 100% of the cash needs for GMI to complete a strategic acquisition. This acquisition provides the combined company and its owners, including management, the opportunity to benefit from the significant equity value creation opportunities produced through combined cross-selling prospects, economies of scale and other synergies that are expected to exist from the larger combined platform. GMI’s acquisition is representative of the attractive opportunities we believe exist within our existing lower middle market portfolio to put incremental capital to work supporting both internal and external growth initiatives at the portfolio company level.

We believe our seasoned lower middle market portfolio will continue to provide attractive follow on investment opportunities in the future. Now, turning back to our lower middle market portfolio, the contributions from this portfolio continue to be well diversified with 49 of our 81 lower middle market companies with equity investments having appreciation at quarter end and with 48 of these companies contributing to our dividend income over the last 12 months. Additionally, more than half of our lower middle market companies experienced increases in their trailing 12-month EBITDA in the first quarter of this year when compared to the fourth quarter of last year, which we believe demonstrates the underlying strength of our lower middle market portfolio.

Now, turning to the overall composition and results from our investment portfolio, as of March 31, we continue to maintain a highly diversified portfolio with investments in 191 companies spanning across numerous industries and end markets. Our largest portfolio of companies, excluding our external asset manager represented only 3.5% of our total investment income for the trailing 12-month period and 3.5% of our total investment portfolio fair value at quarter end. The majority of our portfolio investments represented less than 1% of our income and our assets. Our investment activity in the first quarter included total investments in our lower middle market portfolio of approximately $92 million, which after aggregate repayments on debt investments and return of invested equity capital, resulted in a net increase in our lower middle market portfolio of $67 million, driven by the capabilities and relationships of our private credit team, we also made $155 million in total private loan investments, which after aggregate investment activity resulted in a net increase in our private loan portfolio of $55 million.

Finally, during the quarter, we had a continued net decrease in our middle market portfolio of $22 million. At the end of the first quarter, our lower middle market portfolio included investments in 81 companies representing $2.4 billion of fair value, which is 28% above our cost basis. We had investments in 88 companies in our private loan portfolio representing $1.5 billion of fair value. And in our middle market portfolio, we had investments in 22 companies representing $239 million of fair value. The total investment portfolio at fair value at quarter end was 115% of the related cost basis. In summary, Main Street’s investment portfolio continues to perform at a high level and deliver on our long-term goals. Additional details on our investment portfolio of quarter 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 very pleased with our operating results for the first quarter. Our total investment income for the first quarter was $131.6 million, increasing by $11.4 million or 9.4% over the first quarter of 2023 and by $2.3 million or 1.8% from the fourth quarter 2023. Positive momentum we experienced during 2023 continued in the first quarter and resulted in strong levels of investment income, which we believe as Dwayne and David touched on, demonstrates the continued strength of our differentiated investment and asset management strategies. The first quarter included elevated levels of certain income considered less consistent or non-recurring in nature, which include dividends from our equity investments and accelerated prepayment, repricing and other activity related to our debt investments.

In the aggregate, these items totaled $7.5 million and were $2.1 million higher than the average of the prior four quarters, $2.2 million higher than the fourth quarter and $1.8 million lower than the first quarter of 2023. Interest income increased by $6.7 million from a year ago and decreased $0.6 million from the fourth quarter. The increase over the prior year was driven primarily by increases in benchmark index rates and increased net investment activity. The decrease from the fourth quarter was primarily driven by a decrease in accelerated OID income partially offset by increased net investment activity. Dividend income decreased by $1.4 million or 5.9% when compared to a year ago, driven primarily by a $5.3 million decrease in less consistent or non-recurring dividends.

The $3.9 million increase in dividends deemed recurring is a result of the continued underlying strength of the majority of our portfolio companies and the recurring benefits from our asset management business. Dividends decreased by $1 million or 4.2% from the fourth quarter and included a $1.7 million increase in dividends we characterize as less consistent or non-recurring in nature. Fee income increased by $6.1 million from a year ago and $3.9 million from the fourth quarter. These increases were driven primarily from an increase in fees received from refinancing and prepayment of debt investments and fees related to higher portfolio investment activity. Prepayment and other fee income considered non-recurring increased $3.8 million from a year ago and by $2.1 million from the fourth quarter.

Our operating expenses increased by $2.5 million from a year ago, 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 the quarter on an annualized basis and continues to be among the lowest in our industry. Our external investment manager contributed $8.6 million to our net investment income during the first quarter, an increase of $0.5 million from a year ago and a decrease of $0.6 million from the fourth quarter. The manager earned $3.9 million in incentive fees during the quarter, increasing by $0.6 million over a year ago 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 $28.3 million. This increase was driven by net fair value appreciation in our lower middle market portfolio and in our external investment manager, partially offset by net fair value depreciation in our private loan portfolio. The net fair value appreciation in our lower middle market portfolio was driven by the continued positive performance of certain of our portfolio companies. The fair value appreciation in the external investment manager was a result of a combination of an increase in the fees generated by the manager, driven by the continued strong performance of our asset management business, and an increase in the valuation multiples of publicly traded peers, which we use as one of the benchmarks for valuation purposes.

The net fair value depreciation in our private loan portfolio was driven by the net impact of specific portfolio company underperformance, partially offset by the impact of decreases in market spreads. We recognized net realized losses in our private loan, middle market and other portfolio of a combined $12.8 million in the quarter, which were related to longstanding underperforming investments. The majority of the unrealized depreciation related to these investments was taken in prior periods and as a result, the net impact of these realized losses in the quarter after taking into account the accounting reversals of previously recognized unrealized depreciation was a net fair value decrease of $1.2 million. We ended the first quarter with investments on non-accrual status comprising approximately 0.5% of the total investment portfolio at fair value and approximately 2% at cost.

Net asset value, or NAV increased by $0.34 per share of the fourth quarter and by $2.31, or 8.5% when compared to a year ago to a record NAV per share of $29.54 at the end of the first quarter. Our regulatory debt to equity leverage, calculated as total debt excluding our SBIC debentures divided by net asset value, was 0.7 and our regulatory asset coverage ratio was 2.4 and were intentionally more conservative than our long-term target ranges of 0.8 to 0.9 times and 2.1 to 2.25 times. January of this year, we issued $350 million of unsecured notes maturing in March 2029 with a coupon rate of 6.95%. We utilized the proceeds to repay outstanding borrowings under our credit facilities and on May 1 of this year, we repaid the $450 million due on our May 2024 notes at maturity through borrowings under our credit facilities.

After giving effect to the investment and capital activities thus far this year, we continue to maintain strong liquidity, including cash and availability under our credit facilities of over $900 million. We continue to believe that our conservative leverage, strong liquidity, and continued access to capital are significant strengths that have proven to benefit us historically and have us well positioned for the future, while allowing us to continue to execute our investment strategy. With this current level of liquidity, we currently 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. Coming back to our operating results.

As a result of our strong performance for the quarter, our return on equity for the quarter was 17.2% on an annualized basis. DNII per share for the quarter of $1.11 exceeded the DNII per share for the first quarter last year by $0.04 or 3.7% and was $0.01 or 0.9% lower than the record DNII per share for the fourth quarter. Combined impact of certain investment income considered less consistent are non-recurring in nature, on a per share basis was $0.03 per share above the fourth quarter, $0.02 above the average of the last four quarters and $0.03 below the same quarter a year ago. Total dividends paid in the first quarter were $1.02 per share, including a supplemental dividend of $0.30 per share, an increase of 20% over the total dividends paid during the same period in the prior year.

As Dwayne mentioned, given the strength of our operating results and the outlook for the rest of the year, our Board approved a supplemental dividend of $0.30 per share payable in June 2024. With this supplemental dividend total declared dividends for the second quarter were $1.02 per share, representing a 13% increase over the total dividends paid in the second quarter of last year. Our Board also approved an increase of our recurring monthly dividends to $0.245 per share or a total of $0.735 per share for the third quarter. As we look forward, given the strength of our underlying portfolio, we expect another strong top line and earnings quarter in the second quarter with expected DNII per share of at least $1.03 with the potential for upside driven by the level of dividend income and portfolio investment activities during the quarter.

With that, I will now turn the call back over to the operator so we can take any questions.

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