Introduction

As income investors, we all have stocks that we favor as a result of their strong income generation. Altria (MO) and Capital Southwest (CSWC) are a couple that come to mind when I think of companies that generate great income for their shareholders.

But I also enjoy searching for those with huge potential to do the same in the foreseeable future. Whether they are going through changes in their business model, or are a small-cap company that fly under investor's radar. One BDC that I recently stumbled across that fits this description is Logan Ridge Finance Corporation (NASDAQ:LRFC). And in this article, I discuss the company's fundamentals, recent earnings, and why they may deserve a spot in your income-focused portfolio.

Who Is Logan Ridge Finance Corp?

LRFC is a BDC, like many of its peers, that focuses on lending to lower middle-market & middle-market companies through debt & equity investments. They are externally managed and some of their top ten industries include defensive sectors like Healthcare, Business Services, Information Technology, and Consumer Products. The BDC IPO'd roughly a decade ago and is based out of the state of Maryland.

Solid Earnings Report

Despite a miss on both net and total investment income during Q1 earnings, Logan Ridge Finance Corp delivered a solid report. NII of $0.35 missed estimates by a penny, while TII missed by $0.1 million. This came in at $5 million for the quarter.

However, I think the BDC delivered a solid earnings report because it managed to grow both its top & bottom lines quarter-over-quarter. Net investment income grew roughly 59% from $0.22 in the prior quarter, while total investment income grew nearly 14%. This was due to a one-time reversal of $0.6 million of accrued income from a portfolio company placed on non-accrual status in the quarter prior.

They also deployed nearly $9 million in capital into new and existing portfolio companies during the quarter, continuing on their path to unlocking growth for the foreseeable future. The most impressive metric during the quarter, however, was that management continued to take advantage of the discount to its NAV price of $33.71 by repurchasing nearly 22k shares.

The current program expires in March of next year. And I expect management to continue buying back shares, which will likely positively impact their NAV while enhancing their dividend safety as well.

Furthermore, LRFC grew their NAV from the prior quarter's $33.34, driven by net realized & unrealized gains as well as out-earning the base dividend. Repurchasing shares at a discount is crucial for BDC management teams, as this is accretive to NAV growth over time.

This also positively impacts their bottom-line growth over time. However, NAV did decline by roughly $1 from $34.63 in the year ago quarter. This is something I typically like to see grow over time and something investors should keep a close eye on moving forward.

Annual Performance

Looking out past the company's recent earnings, LRFC's performance has been a little inconsistent, but nevertheless decent considering the challenging macro environment. Additionally, management has been trying to find their footing since taking over in 2021, which they have seen some positives since. They also managed to achieve their highest level of investment income last year, as well as reintroduce the quarterly dividend.

NII was $1.43 for the full-year, well-above their annual dividend payment of $0.96. In the chart below you can see LRFC's financials were a little inconsistent with both net investment and total investment income dropping in the back half of the year. I'll touch on these later in the article. However, as previously mentioned, current management in coming into their third year in charge of the company. And they are seemingly on the right track with their share repurchases and new investments.

Portfolio Quality

Another metric that stood out to me was LRFC's overall portfolio quality. For being a smaller-cap BDC with a market cap of $60.5 million, their first-lien exposure was solid at 66.5%. This increased from the prior quarter's 65.4%. For context, smaller peers WhiteHorse Finance's (WHF) first-lien exposure was 80.6% while Monroe Capital's (MRCC) was slightly higher at 82%.

However, management has been strengthening their portfolio by increasing their exposure to first-lien loans, putting them in a stronger position to navigate future headwinds. Additionally, their debt portfolio had significantly higher exposure to first-lien loans, at nearly 81%. Moreover, this has steadily increased over time, as seen in the chart below.

I also compare them to larger peers Ares Capital (ARCC) and Capital Southwest, who both had percentages of 66.5% and 86.5% respectively. So, in comparison, LRFC's exposure is decent. For some analysts, a higher exposure to first-lien loans is often a preference when selecting BDCs.

However, a lower exposure doesn't necessarily mean underperformance, hence Ares Capital. BDCs can combat this by retaining extra capital in the form of spillover. They can use this to cover their dividend or lend to an underperforming borrower if they experience headwinds temporarily. And while higher exposure is a plus, it's not a showstopper for me when investing in the sector.

Furthermore, most of LRFC's portfolio companies were performing solidly at 93.1% with nearly 7% underperforming. This is in comparison to WHF, whose portfolio companies were performing at roughly a 96% capacity.

One thing to note is WhiteHorse Finance's portfolio is larger at $697 million in comparison to $200.1 million for Logan Ridge Finance. Additionally, WHF's EBITDA range for their portfolio companies is higher at $50 million - $350 million compared to $5 million - $50 million for the latter.

This is also something for investors to consider, as these companies could be viewed as riskier as a result of their smaller size. Moreover, when they face headwinds like the current macro environment or a recession, this will also negatively impact their lenders' financials.

Balance Sheet

Logan Ridge's balance sheet was solid, with $8.3 million in cash and available liquidity on their revolver in an amount of $23 million. Furthermore, their debt maturities were well-staggered, with $50 million maturing more than 2 years from now in October 2026.

This had a weighted-average interest rate of 6%, which the company will likely refinance at a lower rate. After that, their next maturity isn't until May of the following year, with $75 million. Their leverage was slightly higher than WHF's 1.19x at 1.3x. However, this is in management's preference range and stayed flat year-over-year.

Dividend

Since re-initiating the dividend in 2023 after suspending it during the pandemic and turning quarterly from monthly, management has worked tirelessly to regain shareholder confidence in the company. Since then, they have increased the dividend more than 80%, which is impressive all things considered.

Additionally, they recently increased the distribution 3% from $0.32 during the most recent quarter, making this the 5th consecutive increase. And by out-earning the dividend, LRFC's dividend coverage was 106%.

This is in comparison to peers Monroe Capital and WhiteHorse Finance who had coverage of 100% and 122% respectively. Great Elm Capital Corp (GECC), another smaller peer, had the same coverage of 106% as LRFC. I typically like to see higher coverage from my BDC holdings, but considering projected lower interest rates and share repurchases, I anticipate higher NII is likely in the coming months.

Credit Quality Risks

As previously mentioned, Logan Ridge Finance Corp is a smaller BDC with a market cap of less than $100 million, which could be considered risky for some investors. Aside from this and a lower trading volume, their smaller size also poses risks associated to their borrowers.

Non-accruals were higher than I'd like to see, accounting for 8.7% and 6.8% of the portfolio at cost & fair value, respectively. Year-over-year this increased from 6.4% and 4.9% respectively, likely a result of the higher interest rate environment. Of the 3 companies, however, only one, Sequoia, a healthcare management company, has a significant impact on the company's financials.

Management touched on this, stating the company still has some issues to work through, but they've made progress on the other two. Moreover, as interest rates decline over the coming months, I anticipate LRFC could see some of these companies removed as tighter financial conditions ease as a result of lower interest rates. If so, this could have a positive impact on their financials, likely affecting the share price similarly.

Additionally, if the economy falls into a recession, avoiding a soft landing, this could cause non-accruals to rise further. Furthermore, this would likely put borrowers at risk of filing for bankruptcy depending on the severity of the downturn. If so, this could have a significant impact on the company's financials going forward.

Valuation

At the current price of $22.35 at the time of writing, this gives LRFC a discount of nearly 34%, lower than the roughly 40% discount over the past 3 years. As you can see from the chart, the BDC is up double-digits over the past year, likely a result of higher interest rates and their frequent dividend increases recently.

Since the start of 2024 the share price has traded in a range of $22 - $23, and I expect this will likely continue moving forward as management works through headwinds and focuses on growth, which will likely happen in the back half of the year and into 2025.

Additionally, earnings are not expected to see a significant decline over the next two years like some peers. As earnings decline as a result of their floating rate portfolios, some BDCs will likely see pullbacks because of this.

For BDCs, the current macro environment caused slower M&A activity as sellers were reluctant over the past 12 to 18 months. And with this, LRFC may be an attractive opportunity to pick up a risky, but higher-yielding stock at a discount to its NAV price.

Wall Street and Quant seem very high on the BDC, with strong buy ratings from both. While I disagree currently, they do have a lot of potential and have shown confidence recently with the 5 dividend increases. Despite this, however, their dividend coverage and credit quality risks keep me from upgrading them to a buy.

Final Thoughts

Logan Ridge Finance Corporation could be considered a risky, but attractive investment opportunity for income-focused investors. The BDC has been making efforts to strengthen its portfolio with its increasing exposure to first-lien loans.

Additionally, their balance sheet is solid with well-laddered debt maturities, increasing flexibility for future dividend raises. However, they do pose some significant risks due to their smaller size, lower trading volume, and uptick in non-accruals over the past year.

Furthermore, although they currently cover the dividend, I would like to see how the BDC grows their net investment income as well as seeing a decrease in non-accruals in the coming months before considering upgrading them. As a result, I currently rate Logan Ridge Finance Corp a hold.

Editor's Note: This article covers one or more microcap stocks. Please be aware of the risks associated with these stocks.