Apollo Investment Earnings: Good Enough

The stock market has been punishing Apollo Investment (AINV) since its earnings announcement (see press release here), 10-Q release (see SEC filings here) and conference call (see transcript here). We’ve reviewed the first two and listened to the conference call, and are perplexed by the negative reaction.

We’re not saying the results were stellar. Despite raising more capital earlier, and growing assets, Net Investment Income was slightly down in absolute terms and down in Per Share terms from $0.34 last quarter to just $0.30. Plus, 3 new companies joined the non-accrual party (although 1 did come off). Most negative of all (from our perspective) AINV incurred Realized Losses of ($152mn) from “cleansing” its portfolio. On the conference call management did admit the financing market for larger companies, in which Apollo operates, had become over-heated in pricing terms. This might suggest that new loans added might not generate the risk commensurate spreads.

However, not much of that came out of a clear blue sky. We’re no geniuses but had already predicted that earnings per share would drop this quarter because of the dilution from the recent equity raise. Moreover-as management pointed out-all the new non-accruing companies had been in trouble for awhile. The Realized Losses were hard to swallow but it’s been an industry-wide trend to start selling off one’s losers now that the market for loans has rebounded. As for narrowing spreads, management also talked about the coming rebound in the “primary” market, which means new LBOs are beginning to come through the system, and will require financing in the second half of 2010. That should be good for asset formation and fee generation.

The question we ask ourselves (simplistic as it might seem) is whether Apollo’s dividend at $0.28 a share is safe. Taking all the available facts, we’re still comfortable that no cut is imminent. It’s true that the margin between Net Investment Income Per Share has narrowed (there’s only two cents seperating the two). There may even be another drop in Net Investment Income Per Share in the next quarter. Apollo, though, has a savings account to subsidize its dividend: undistributed income of $115mn or $0.66 per share. That’s been growing since the end of the last tax year.

We’re also satisfied with the Company’s Liquidity. The Company has renegotiated its Revolver, and sits on $600mn plus of unused capacity. Pricing is fair at Libor + 3%. Debt to equity is reasonable at 0.5 to 1.:00. Management is willing to let that metric float up to 0.7:10, which is a prospective 34% increase. Or, in other words, AINV is likely to grow assets, and earnings in the quarters ahead. Of course, there are the headwinds of bad debts. Management almost promised on the conference call that bad debts have peaked, but no one can be sure of that. Still, non-accruals are not horrendous at 8.6% of the investment portfolio at cost. Even a modest increase in this area would not be a disaster.

The stock price is down to $9.855. On the annualized dividend of $1.12, that’s a yield of 11.4%. If we’re right that earnings per share are close to the bottom for a well managed company with only moderate leverage that’s good enough for us.

Disclosure: Author holds a long position in ARCC