Trinity Capital Stock: 11.8% return BDC with favorable earnings (NASDAQ:TRIN)
This article was first published to Systematic Income Subscribers and Free Trials on March 22
In this article, we highlight BDC Trinity Capital (NASDAQ:TRIN) that we recently added to our BDC tool, making it the 29th company in our coverage. The company achieved the industry’s best fourth-quarter NAV total return, adding to its already impressive track record. It also increased its dividend to keep pace with the growth in its net profit, which we expect to increase further. The company’s valuation is about 8% above the industry average to date. We would consider a rotation to TRIN in our high-income portfolio closer to a valuation of 105% – a level it has dipped below a few times over the past two months.
A quick overview
TRIN is an internally managed BDC that focuses on secured lending (~70%) and, quite unusually, equipment financing (23%) for growth-stage businesses as part of venture capital . The company has 41 employees and manages an investment portfolio of $873 million, placing it in the middle of the pack in the sector. The company’s stock/warrant allocation is high relative to the sector at 15.7% (although it’s a more modest 7.2% at cost).
The company has continued to move towards a more floating rate asset profile, which should allow its revenues to grow as short-term rates rise.
In terms of sector exposure, the portfolio favors the manufacturing, information and science/technology sectors.
Fourth quarter update
Last week, TRIN announced an 11% hike in its dividend to $0.40 from $0.36 – a fifth consecutive quarterly increase. It also declared an additional dividend of $0.15 and plans to declare one for each of the remaining 3 quarters this year. This brings the company’s dividend yield to 11.8% – one of the highest in the industry and 2.5% above the industry average.
The dividend increase is not really a surprise. As the chart below shows, the company has taken a fairly conservative dividend stance, with NII exceeding its dividend in each of the past 7 quarters, often by a substantial margin.
Total investment income increased by 8.3%, partly due to a near doubling of commission income (green bars below). Although we expect total investment income to continue to increase, we do not expect commission income to be as high in the first quarter given seasonality factors and higher discount margins. broads / a lower sense of risk on equities, leading to fewer prepayments and exits.
TRIN generated the industry’s best quarterly total net asset value return (in our coverage) with a 14% gain primarily due to unrealized appreciation as well as retained earnings, resulting in an increase in net asset value of nearly by 12%. he company closed the gap between its NII and dividends, notably with the announcement of new additional dividends. These will act as a drag on NAV (but not on NAV total returns, of course), so we don’t expect similar stellar NAV gains in the future, all else equal.
TRIN has outperformed the sector in each of the three quarters of its short history as a publicly traded BDC. A strong venture capital environment and positive risk sentiment in the equity market has supported the company’s net asset value, which is overweight in equities/warrants relative to the broader sector with the fourth highest equity allocation. high in the sector. Four of the company’s holdings in the fourth quarter exited the portfolio via SPAC mergers and one via a traditional IPO.
The company issued $75 million of 4.25% 2026 bonds in the fourth quarter, which reduced its weighted average cost of debt by about 0.6% to 5.11%. Despite this, TRIN has one of the highest debt interest cost levels – around 1.7% above the industry average. This is likely due to its higher equity allocation and lack of a publicly traded track record.
This high level of debt interest cost means that the company’s operating expenses are quite high – around 1% above the industry average. However, even if we exclude debt interest, its OpEx is still above the industry average. This speaks to the fact that investors should not automatically assume that an internally managed BDC necessarily has a lower fee structure.
In the first quarter, TRIN recorded the sale of Lucid Motors (LCID) and Matterport (MTTR) for $59.8 million. In the fourth quarter, these positions were marked at a combined $78.9 million, a drag of $19.1 million due to the decline in the value of stocks in January from their year-end levels. This equates to approximately $0.70 per share or approximately 4.3% of net asset value. In other words, all things being equal, the sale pulls the net asset value towards $15.7 from $16.4 in the fourth quarter. This suggests that at the time of this writing, the valuation is closer to 119% than 114%.
Net new investment was very strong last quarter and was consistently positive, supporting revenue growth.
The portfolio’s holdings in the two worst ratings (called Watch/Default) have tended to decline in recent quarters.
It appears that the company has braced itself for a rise in short-term rates, as its floating rate asset allocation has increased and its floating rate liability profile has narrowed. In short, TRIN is well positioned to take advantage of higher short-term rates. He expects to receive about a 7% increase in NII for a 1% increase in Libor (Libor has already risen by more than half that amount since the December filing), or about 5% more than the industry average and around 13% for a 2% rise in Libor – in line with the industry average.
Indebtedness has continued to increase in recent quarters and should contribute to additional investment income in the coming quarters.
Fair value defaults have increased slightly but remain at moderate levels and about half the industry average (slightly below the industry median).
A look at assessment
There are two schools of thought about opening positions at BDC. The first is that valuation is extremely important because it is the primary driver of investor return – the higher the valuation at entry, the better the resulting return for investors.
This approach has two corollaries. First, valuations tend to bounce all the time, so chasing a stock makes little sense. The second is that sometimes the valuation is just too high to provide a decent margin of safety and/or an attractive prospective return.
And while TRIN doesn’t boast a long history as a publicly traded stock, its limited history suggests that its valuation has indeed rebounded a lot.
Despite its very solid performance history, its valuation has even fallen below the sector average, an attractive level, notably close to 100%.
The second approach to valuations is that if you find a successful player it is important to establish a position because after a few quarters or years the valuation on a cost basis will likely be correct. For example, paying a seemingly high valuation of 115% (i.e. $15.74 price = 115% x $13.69 T1-21 NAV) at the end of last year’s Q1 would mean a current valuation on a cost basis of 96% (i.e. $15.74 / last net asset value of $16.40) – an incredibly attractive level for a strongly outperforming sector. Obviously, no one knew that the company’s NAV would rise nearly 20% to $16.40, but BDC’s strong historical performance tends to see consistent gains in NAV due to cumulative net gains made and not made.
In our opinion, there is truth in both positions. There is an old adage in the markets that specifically points out that trying to get a slightly better entry point can cost an investor attractive returns. At the same time, ignoring valuations altogether is also not a sensible investment strategy.
In terms of fair value valuation relative to the broader industry, there is no long track record that would give us great confidence in identifying a valuation target. However, a look at the company’s 2-year return profile suggests its valuation is likely around 110-125% in the current environment. That doesn’t mean investors should buy at this level, as there are arguably equally strong BDCs trading below fair value. That said, an opportunistic entry position at the low end of the range would be attractive. In our own High Income portfolio, we would strongly consider an allocation closer to a 105% valuation.
Overall, TRIN is well positioned to grow revenue in the coming quarters. The interest cost of its debt continued to decline while the return on its assets remained stable. Its net new investments and its leverage have increased. The quality of the portfolio improved while defaults remained relatively low. Finally, the company increased its floating rate asset profile and decreased its floating rate liabilities, which increased its earnings beta to rising short-term rates.
Recent stock market weakness and the decline in a number of exits highlight the company’s heightened vulnerability to equity valuations, but this is unlikely to result in a significant decline in book value unless prices stocks don’t fall much more from here.
TRIN remains an attractive higher-beta allocation that patient investors may be able to grab at a more attractive valuation than it trades today. At the moment, we like Fidus Investment (FDUS) as the highest equity allocation BDC in our portfolios, which has generated equally strong total NAV returns as TRIN, but trades at a significantly cheaper valuation. We would consider moving or directly adding TRIN on a move in valuation closer to 105%.