New Mountain Finance Stock: 9.4% Smart Yield for Tough Times (NASDAQ: NMFC)

Mars Bars

Falling portfolio values ​​can be discouraging for many investors, including seasoned veterans. It is important, however, to keep in mind that bull markets “are born on pessimism, grow on skepticism, mature on optimism and die on euphoria,” as the late great investor Sir Sir John Templeton.

That’s why it’s important to keep your mind focused on building value for the portfolio rather than thinking about the end of the bear market. This brings me to New Mountain Finance (NASDAQ: NMFC), which now boasts a dividend yield of well over 9%. This article explains why the latest decline presents a solid buying opportunity for income investors, so let’s get started.

Why NMFC?

New Mountain Finance Corp. is an externally managed BDC that was founded during the Great Financial Crisis in 2008 and became publicly traded in 2011. It is externally managed by New Mountain, which is an alternative investment company that manages private and public equities , and credit funds with more than $37 billion in assets under management.

NMFC holds a diversified portfolio with a fair market value of $3.1 billion, spread across defensive and growth sectors, with enterprise software, healthcare and business services being its top 3 segments. As shown below, the remaining segments of NMFC are composed of economically essential segments such as education, net rental and distribution.

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Composition of the NMFC portfolio (presentation to investors)

NMFC’s portfolio is also doing well amid market volatility, with net asset value per share down just 1% ($0.14) on a sequential QoQ basis to $13.42 at the end of the second quarter. . I am not concerned about this slight drop in NAV, as it was mainly due to broad market movements, partially offset by a net increase of $0.13 in NAV per share on NMFC’s portfolio.

Additionally, NMFC is benefiting from the rising rate environment as it is now generating a 10.3% yield on cost, 150 basis points higher than the 8.8% year-on-year former. This was one of the factors that enabled NMFC to generate an NII per share of $0.31, which more than fully covered its quarterly dividend of $0.30.

Moreover, the overall portfolio is quite healthy with 91% of investments rated green (its lowest risk level). The percentage of investments in the lowest red and orange positions also declined, from 8.4% of the portfolio in the first quarter to just 2.4% at the end of the second quarter. Unrecorded investments also remain low, representing only 1.36% of the fair market value of the portfolio.

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NMFC Portfolio Ratings (Investor Presentation)

Risks for NMFC include its lower exposure to top-tier investments (56% of the portfolio) than some of its peers. However, this percentage increases to 68% when NMFC’s senior loan programs and net lease investments are included. In addition, NMFC’s junior debt (18% of the portfolio) offers higher yields and its 7% exposure to common stocks gives it the potential for higher net asset value.

NMFC is clearly a company that has weathered economic cycles quite well, maintaining a fairly stable net asset value per share over the past decade. This allowed NMFC to produce a total return of 198% in the 10 years to the end of May, far exceeding the 73% of the Credit Suisse High Yield Index and BDC’s sector average of 66%.

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NMFC NAV/Stock History (Presentation to Investors)

Looking ahead, NMFC remains well positioned for rising rates, as 89% of its bond investment portfolio is floating rate, while only 46% of its borrowings are floating rate. It also maintains reasonable leverage with a statutory debt-to-equity ratio of 1.27x, comfortably below the regulatory limit of 2.0x. Deal activity may not be as high as what NMFC saw during the start-up days of the second half of 2021, but there are still attractive opportunities, as management highlighted on the recent conference call. :

Our strategy of lending to non-cyclical defensive companies provides an additional margin of safety compared to the broader lending market. While new deal activity remains significantly lower than in the second half of 2021, we continue to see attractive investment opportunities in a market where spreads are at least 100 basis points wider than they were. at the beginning of the year. Deal structures for most new direct lending investments remain attractive with sponsor equity contributions consistently between 60% and 80%.

Finally, it is important to highlight that the global direct lending market continues to take a significant share of the syndicated loan and high yield bond asset classes, as our private finance solutions provide ease of execution, clarity prices and security of capital not currently available in these other markets.

Finally, I find a good alignment of interests between NMFC and its shareholders, with employees holding 12% of the outstanding shares. I see value in the stock, especially after the recent drop to $12.80, which equates to a 5% discount to book value. As shown below, NMFC has generated a slight premium to NAV over the past 3 years outside of 2020. Analysts on the sell side have a consensus buy rating with an average price target of $13.67 . This translates into a potential total return of 16% over one year, including dividends.

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NMFC price to NAV (seeking Alpha)

Key takeaway for investors

New Mountain Finance is a well-run BDC with a solid track record of stable net asset value per share and outsized total returns. It continues to generate good returns for shareholders as well as attractive risk-adjusted returns. While the stock may not be terribly cheap at current levels, I believe it represents good value after the recent decline for potentially strong earnings and long-term returns.