Trinity Capital Q2: Dividend increase with more to come (NASDAQ:TRIN)

Darren415

This article was first published to Systematic Income subscribers and free trials on August 12.

In this article, we catch up with the second quarter results of business development company Trinity Capital (NASDAQ:TRIN). TRIN is currently trading at a total dividend yield of 14.4% and a valuation of 108%.

The company has a flavor of venture debt with, unusually for a BDC, a large allocation to equipment financing.

TRIN

TRIN

Outside of this focus on manufacturing borrowers, the company has a more traditional BDC allocation to information, technology and scientific services, among others.

TRIN

TRIN

Historically, the company had a relatively high allocation to stocks and warrants, but this has moved more in line with the industry average as a number of larger positions with net gains have been made. TRIN still maintains 125 warrant positions in 75 portfolio companies, giving it additional upside potential.

TRIN

TRIN

Quarterly update

TRIN issued approximately $60 million worth of shares in the second quarter, resulting in an increase of approximately 2% in net asset value. The company has grown its asset base aggressively and issuing additional shares at a premium to net asset value is an attractive way to do so, even if it puts pressure on the stock. Along the same lines, the company has also raised about $3 million through its ATM offering program.

NAV Bridge

TRIN

The company then tapped its 7% bond roughly the same amount to leverage the equity provided by issuing shares. The additional bond was issued at 99.52% principal, resulting in one of the highest bond yields in the BDC space. This speaks to the fact that TRIN does not have an investment rating from the top 3 agencies, which is likely due to its short track record as well as a lower tier one allocation.

The Net asset value fell approximately 3.5% in the quarter, primarily due to an unrealized impairment of approximately 5% as well as the $0.15 surcharge.

Systematic income

Systematic income

In terms of total net asset value return, TRIN achieved a positive return 0.3% for the quarter, outperforming the sector.

Systematic income

Systematic income

Net investment income decreased to $0.486 from $0.569. Our numbers are slightly different from the overall numbers reported by TRIN (Q2 NII of $0.51) – our number is an after-tax number.

BDC Systematic Income Tool

BDC Systematic Income Tool

The drop in net profit is explained by three factors. First, there was an unexpected drop in commission income – the first quarter figure was unusually high. Second, the equity issuance has been a temporary drag on revenue which will be reversed in the next quarter when cash is fully allocated and tapped. And third, the company had higher management fees due to an increase in staff.

BDC Systematic Income Tool

BDC Systematic Income Tool

Cover core dividend remains strong at 116% and should continue to improve, all else equal, as we discuss in the Revenue Dynamics section.

BDC Systematic Income Tool

BDC Systematic Income Tool

Finally, it should be noted that the CEO has continued to acquire shares recently.

BDC Systematic Income Tool

BDC Systematic Income Tool

Revenue dynamics

In this section, we highlight some of the key factors that will determine net profit over the medium term.

TRIN continues to allocate capital at an aggressive pace. Net new investments continued to operate at a double digit rate.

BDC Systematic Income Tool

BDC Systematic Income Tool

This partly reflects the recent share issuance as well as the continued increase in leverage. Leverage is at the upper end of the target range of 1.15-1.35x and management said they plan to bring it down towards 1.25x.

BDC Systematic Income Tool

BDC Systematic Income Tool

Asset returns stable during the second quarter while debt burden tear down. This is very different from the trend in the broader sector where asset returns and interest charges on debt have tended to rise.

BDC Systematic Income Tool

BDC Systematic Income Tool

The company has a relatively high proportion of fixed-rate assets, so its asset-side performance will be less sensitive to rising short-term rates.

BDC Systematic Income Tool

BDC Systematic Income Tool

The decrease in interest expense on debt is explained by an increase in the use of the variable rate and low interest rate credit facility. The debt burden will increase once the new bond tap is factored in.

Net income beta on rising rates is positive, but accounts for around 60% of the broader market.

BDC Systematic Income Tool

BDC Systematic Income Tool

From the company exploitation charges remain quite high. First, interest expense is about 1.5% higher than the industry average. And second, non-interest expenses are also about 1% higher than the industry average, even though the company is managed internally. Both of these numbers will likely approach the industry average over time.

BDC Systematic Income Tool

BDC Systematic Income Tool

Portfolio quality

There are four companies on not cumulated portfolio with a fair value base of 0.6%, up slightly from 0.5% but still below the industry average.

BDC Systematic Income Tool

BDC Systematic Income Tool

TRIN had a realized loss in the position of Store Intelligence which was previously deprecated on an unrealized basis and achieved a full recovery based on this demarked level. At the very least, it’s good to see that realized losses are being taken without further downside surprises in the valuation.

BDC Systematic Income Tool

BDC Systematic Income Tool

The internal weighted average portfolio rating worsened slightly from the prior quarter – a fairly common trend across the industry given the headwinds for business metrics such as interest coverage and the like.

BDC Systematic Income Tool

BDC Systematic Income Tool

It’s worth nothing that TRIN has some bitcoin mining exposure through its equipment finance portfolio. The company has loans to three publicly traded digital asset mining and hosting companies, which equates to about 7% of its portfolio at cost. The sector has taken a hit this year. On the call, management indicated that loans are still around 90% LTV, which is quite high, although miners should be profitable at a bitcoin price above $8,000 versus $24,000 at this day.

Evaluation and performance profile

TRIN has traded in a very wide 95-130% valuation range over the past few months and is currently in the middle of that range.

Systematic income

Systematic income

It has also tended to trade above the sector’s average valuation historically.

Systematic income

Systematic income

This chart shows this more clearly, highlighting that TRIN has tended to trade at a valuation around 4% above the sector average (blue line) which is now closer to 6% at the time of this writing. lines, which makes it a bit pricey on that basis.

Systematic income

Systematic income

TRIN does not have a long public track record, but of the 5 quarters we have data for, it has outperformed the sector in 4 of them. Over the past year, it has outperformed the broader sector by almost 5%.

BDC Systematic Income Tool

BDC Systematic Income Tool

Take away food

Overall, TRIN had a decent quarter. Although NAV underperformed, total NAV return was positive in the second quarter, slightly above the BDC average. Net income should continue to grow and we should see additional dividends coming in later this year due to the significant fallout.

The stock price has somewhat underperformed the sector since the start of the year, however, it was quite an expensive valuation, so that’s not too surprising. The public offering as well as the ATM issuance also kept pressure on the price.

From a BDC portfolio allocation perspective, TRIN offers additional diversification potential. Its flavor of venture debt (also seen in a few other BDCs) as well as its equipment finance business (much less common) offers a different source of return than traditional middle-market BDC.

In our view, TRIN is an attractive buy at an average valuation slightly above the industry average. That’s why we moved to a TRIN position in our high-income portfolio when its valuation premium to the sector was in the low single digits, lower than it is now. At current valuations, we are not adding to the position and the stock is rated Hold. The stock should remain volatile and should offer investors a better entry point.

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