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Since buying low and selling high is a well-known investment fundamental, I believe that lesser-known lower-middle-market lender Monro Capital (NASDAQ:MRCC), may be one of the options that is fully consistent in principle.its share price fell Value has fallen nearly 27% over the past three years due to temporary setbacks such as lower net asset value and higher unrealized losses. Nonetheless, BDC looks fundamentally sound, with significant support from end markets. Furthermore, its dividends are fully covered by net investment income, and earnings are expected to continue to exceed dividend payments over the long term. The company has also improved its debt and liquidity position, while the credit quality of its portfolio is good, with non-accruals accounting for approximately 1.50% of the total portfolio.
Direct Lending Outlook vs. Monero Position
Founded in 2004, Monroe Capital is a The business development firm specializes in the lower- to mid-end private credit market, using a variety of strategies such as senior secured first lien debt investments and private equity financings. Private credit markets have been boosted over the past decade by tighter lending policies from traditional banks and significant growth in lower-middle-market companies. However, market conditions are extremely volatile in 2023 due to recession risks, decades of high inflation, and one of the fastest rate hikes by the Federal Reserve. All of this resulted in sluggish growth in the private credit market and increased unrealized losses by business development companies. Monroe Capital also experienced unrealized losses, ending 2023 with a net asset value of $9.58 per share, compared with $10.39 per share at the end of 2022.
On the positive side, the company’s portfolio has a healthy credit profile and non-accruals remain at around 1.5%, in line with the industry average. Additionally, the outlook improved significantly over the past quarter thanks to the Federal Reserve’s pivot and moderate economic growth. In addition to this, record equity dry powder also hints at strong deal activity in 2024.By the end of 2023, global private equity firms are sitting on Record The United States has $2.59 trillion in cash reserves for acquisitions and other investments, while private equity dry powder reserves are approximately $645 billion.
On the earnings call, Monroe Capital CEO Ted Koenig also expressed confidence in the trading activity. Direct loan volumes increased 31% in the fourth quarter compared with the third quarter, he said, with momentum expected to continue into 2024 on increased confidence in broader market conditions and signs of record dry powder and limited partner capital deployments Year.
Direct lenders such as Monroe will benefit from growing opportunities and a more active M&A environment. Current market dynamics continue to provide favorable impetus for private credit. While pricing has generally stabilized in recent months, loan-to-value ratios and leverage add-on points remain at attractive levels. These transaction structures provide compelling risk-adjusted returns to primarily first-lien senior secured lenders.
New investment commitments of $10 million in the fourth quarter, compared with just $2 million in the previous quarter, are a clear indication that Monroe is looking to capitalize on attractive opportunities. The company’s portfolio credit quality, diversification and cash position also appear to be sufficient to support its growth strategy. Its $488.4 million portfolio consists of 96 debt and equity investments in more than 10 industries, with an average investment size of $5 million. Significant diversification allows the company to take advantage of opportunities across various industries and helps reduce downside risk during periods of volatility. Additionally, 82% of its portfolio debt investments are first lien.
In terms of liquidity, the company has significantly reduced its debt-to-equity ratio to 1.50 times from 1.60 times in the previous quarter. Its total debt fell to $304.1 million at the end of the fourth quarter, compared with $331 million in the previous quarter. Rather than using existing cash resources and raising additional debt, the company is aggressively redeploying its capital from earnings to fund new investments and reduce debt. In the fourth quarter, the company paid $32.6 million in full in three installments. In addition to the returns, the company has an $80.9 million revolving credit facility and $10 million in cash to invest in growth opportunities.It can also issue new shares to raise capital, as many other BDCs are using various method To fund investments and pay down debt. Currently, Monro Capital has not approved any stock issuance plans.
High dividends are sustainable
Although multiple Seeking Alpha analysts have raised concerns about Monero’s dividend stability, I believe Monro’s 13.5% dividend yield is sustainable and its quarterly dividend of $0.25 per share is safe. There appears to be no dividend yield trap for Monero, as its dividend is fully covered by its net investment income. In fact, for the past 15 consecutive quarters, its investment income has fully covered its dividend payments. In the most recent quarter, the company’s adjusted net investment income per share was $0.28, reflecting a dividend coverage ratio of 1.1. For all of 2023, its investment income of $1.07 per share also exceeded its annual dividend of $1 per share.
Additionally, there is no risk to dividends in 2024 and beyond due to expected increased loan demand, strong quarterly portfolio credit, and an effective portfolio yield of over 12%. The company’s dividend also appears to be safe, based on Wall Street’s 2024 net investment income outlook of $1.02 per share. However, given its significant acceleration in investment in new opportunities and increased demand for private credit, I believe the company is well positioned to beat Wall Street’s expectations.
Monroe Capital trades at deep discount
It’s important to understand that a low valuation doesn’t always indicate that a stock is undervalued. For example, a stock trading at a low valuation for an extended period reflects a business experiencing permanent challenges or slowing end-market demand. Additionally, financial data, investment strategies, and fundamentals can also help avoid value traps. In my opinion, a stock is undervalued when it has the characteristics of both a low valuation and strong fundamentals.
In the case of Monero Capital, its price gains are likely to be supported by fundamentals and valuation. Fundamental factors include stable credit markets, solid economic growth and strong trading activity prospects, which I have discussed in detail. At the same time, its shares also look significantly undervalued based on valuations such as price-to-earnings and book-to-book ratios. Its price-to-earnings ratio is 6.8, lower than the industry median of 11 times and the industry average of 8 times. While its net asset value has declined over the past few quarters due to unrealized losses, it remains elevated compared to its current share price of $7. As of December 2023, the company’s net asset value was $9.40 per share.
Risk factors to consider
There are many risk factors to consider when investing in Monero Capital. The biggest risk factor in 2024 may be a hard landing by the Fed. Although the possibility of a hard landing is currently limited due to moderate economic growth and a strong job market, risk factors may increase if the Fed keeps interest rates higher for longer. High interest rates can have a negative impact on investor confidence, trading activity and economic growth. Additionally, the company’s high debt-to-equity ratio is another key factor to watch in 2024 and beyond. Last year, the company successfully used investment sales and returns to reduce debt and fund investments in growth opportunities.
In summary
Monro Capital appears to be one of the best options for long-term investors who believe they can earn healthy returns by buying and holding undervalued but fundamentally strong stocks. Currently, Monro’s stock is trading at a discount based on both valuation and fundamentals. Furthermore, its current dividend payments are completely safe, given its potential to generate earnings above its dividend. The end market outlook is also strong, and momentum is expected to increase once the Federal Reserve begins cutting interest rates in the second half of the year.
