Floating Rate Loans And Defensive Sectors Will Support Strong Long Term Earnings Power

Catalysts

About PennantPark Floating Rate Capital

PennantPark Floating Rate Capital provides senior secured floating rate loans and strategic capital to core middle market companies across resilient, cash flow generative sectors.

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

• The scaling of the new PSSL 2 joint venture toward a targeted portfolio size in excess of $1 billion, supported by an expandable, low-cost credit facility priced at SOFR plus 175 basis points, should meaningfully increase fee income and interest income, lifting net investment income and earnings above the current dividend level over time.
• A sustained shift by private equity sponsors toward relationship-based direct lending in the core middle market, where leverage is moderate and spreads remain in the SOFR plus 4.75 to 5.25 range, positions the company to capture a higher volume of attractive originations, supporting long-term revenue growth and stable net margins.
• The portfolio acquisition of seasoned, self-originated loans with above-market spreads, combined with future opportunities to acquire similar pools, adds immediate scale and earnings power while amortizing fixed expenses over a larger asset base, which should enhance operating leverage and boost earnings per share.
• Ongoing capital rotation out of equity co-investments into new first-lien, income-producing assets as M&A activity improves, while still monetizing strong historical equity returns, can recycle gains into higher-yielding loans, supporting both realized gains and a higher, more predictable run rate of net investment income.
• Concentration in defensive sectors such as government services, defense, health care and software, which tend to maintain strong free cash flow even in slower consumer environments, should limit credit losses and nonaccruals and thereby protect net asset value and preserve healthy net interest margins.

Assumptions

How have these above catalysts been quantified?

• Analysts are assuming PennantPark Floating Rate Capital's revenue will grow by 3.6% annually over the next 3 years.
• Analysts assume that profit margins will increase from 25.4% today to 41.1% in 3 years time.
• Analysts expect earnings to reach $119.5 million (and earnings per share of $1.2) by about December 2028, up from $66.4 million today.
• 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 14.5x on those 2028 earnings, up from 13.9x today. This future PE is lower than the current PE for the US Capital Markets industry at 25.0x.
• Analysts expect the number of shares outstanding to grow by 7.0% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 9.77%, as per the Simply Wall St company report.

Risks

What could happen that would invalidate this narrative?

• A sustained softening of the consumer, continued high inflation and tariff related cost pressures could weigh on portfolio company revenue growth, particularly in consumer facing names and logistics exposed borrowers, which would gradually erode interest coverage ratios and pressure PennantPark Floating Rate Capital's net interest margins and earnings.
• A cyclical or prolonged downturn in middle market M&A and exit activity would slow realizations from equity co investments that have historically delivered a 25% internal rate of return and a two times multiple on invested capital, limiting the ability to recycle gains into new high yielding loans and constraining long term growth in revenue and net investment income.
• If credit conditions deteriorate from the current low nonaccrual level of 0.4% at cost and median leverage of 4.5 times, a rise in borrower defaults or restructurings could reverse the long run loss experience of 11 basis points annually on invested capital, driving higher realized and unrealized losses, reducing net asset value and depressing future earnings.
• An environment of declining benchmark rates over the long term would reduce the yield on PennantPark Floating Rate Capital's largely floating rate loan book, while funding costs on its own debt and joint venture structures may not reset as quickly or as fully, compressing the spread between asset yields and financing costs and weakening net margins and dividend coverage.

Valuation

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

• The analysts have a consensus price target of $10.79 for PennantPark Floating Rate 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 $11.5, and the most bearish reporting a price target of just $9.5.
  
• In order for you to agree with the analysts, you'd need to believe that by 2028, revenues will be $290.7 million, earnings will come to $119.5 million, and it would be trading on a PE ratio of 14.5x, assuming you use a discount rate of 9.8%.
  
• Given the current share price of $9.29, the analyst price target of $10.79 is 13.9% higher.
  
• 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.