Private Credit Demand And Asset Based Finance Will Support Earnings Resilience

Catalysts

About FS KKR Capital

FS KKR Capital is a business development company that provides predominantly senior secured and asset-based financing to upper middle market companies through a diversified, income-oriented credit platform.

What are the underlying business or industry changes driving this perspective?

• Rising M&A activity and a steadily improving capital markets backdrop are expanding FSK's direct lending pipeline, which should support sustained origination volumes and help stabilize or grow total investment income and earnings.
• The continued migration of larger, high quality borrowers from syndicated bank markets into private credit is reinforcing FSK's focus on upper middle market, first lien lending, which can underpin portfolio yields while containing credit costs and protecting net margins.
• Structural demand for private credit from sponsors seeking speed and certainty of execution is deepening FSK's role in repeat, relationship based financings, which should drive recurring deployment opportunities, fee income and more resilient revenue through cycles.
• Expansion and disciplined use of the asset based finance sleeve, which has delivered attractive realized IRRs and lower default experience, provides a complementary growth engine that can offset pressure from lower base rates and support net investment income.
• Ongoing rationalization of legacy problem assets, including restructurings that convert to income producing positions, is reducing nonaccruals and freeing capital to redeploy into higher yielding credit investments, which should enhance portfolio returns and future earnings power.

Assumptions

How have these above catalysts been quantified?

• Analysts are assuming FS KKR Capital's revenue will decrease by 7.6% annually over the next 3 years.
• Analysts assume that profit margins will increase from 17.2% today to 63.4% in 3 years time.
• Analysts expect earnings to reach $788.7 million (and earnings per share of $2.83) by about December 2028, up from $272.0 million today. However, there is some disagreement amongst the analysts with the more bearish ones expecting earnings as low as $688.6 million.
• In order for the above numbers to justify the price target of the analysts, the company would need to trade at a PE ratio of 8.8x on those 2028 earnings, down from 16.2x today. This future PE is lower than the current PE for the US Capital Markets industry at 25.8x.
• Analysts expect the number of shares outstanding to remain consistent over the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 12.5%, as per the Simply Wall St company report.

Risks

What could happen that would invalidate this narrative?

• A prolonged decline in base rates from recent highs could compress asset yields faster than FSK can reprice liabilities or redeploy into higher-spread opportunities, which would pressure total investment income and net investment income over time.
• If competitive capital formation in private credit continues and spreads remain tight despite growing M&A volumes, FSK may be forced to accept lower coupons to maintain origination volumes, weighing on portfolio yields and net margins.
• Tariff related volatility and lingering government shutdown risks, even on a low to mid single digit exposure, could still trigger stress in a handful of portfolio companies, potentially increasing nonaccruals and impairments and thereby reducing earnings and net asset value accretion.
• Refinancing older, cheaper fixed rate unsecured debt in a structurally higher credit spread environment could lift FSK's average funding cost, eroding the spread between asset yields and liabilities and reducing net investment income and dividend capacity.
• Dependence on maintaining a high level of distributions, including a base plus supplemental framework targeting an annualized 10% yield on net asset value, could limit retained earnings and balance sheet flexibility, making it harder to absorb future credit losses and dampening long term earnings growth.

Valuation

How have all the factors above been brought together to estimate a fair value?

• The analysts have a consensus price target of $17.32 for FS KKR Capital based on their expectations of its future earnings growth, profit margins and other risk factors.
  
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $22.0, and the most bearish reporting a price target of just $15.0.
  
• In order for you to agree with the analysts, you'd need to believe that by 2028, revenues will be $1.2 billion, earnings will come to $788.7 million, and it would be trading on a PE ratio of 8.8x, assuming you use a discount rate of 12.5%.
  
• Given the current share price of $15.75, the analyst price target of $17.32 is 9.1% higher. The relatively low difference between the current share price and the analyst consensus price target indicates that they believe on average, the company is fairly priced.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.