NGP Capital is an energy financial services company which invests primarily in energy companies that have net asset values or annual revenues of less than $500 million. The company’s objective is to generate both current income and capital appreciation primarily through debt investments with certain equity components. The company targets investments in domestic exploration and production businesses and midstream businesses that gather, process and transport oil and gas. NGPC’s portfolio investments generally range in size from $10 million to $50 million. The typical targeted investment primarily consists of debt instruments, including senior and subordinated loans combined with an equity component, as well as subordinated loans and subordinated loans with equity components and redeemable preferred stock or similar securities.
Valuation NGP’s balance sheet shows a net asset value of $13.96 per share (March 31, 2006) with 47% of that net asset value held in U.S. Treasury Bills. The stock currently trades around $14.50 per share, or an approximate 3.8% premium to NAV. (Please see Abram's excellent write-up in Decmeber 05 when NGPC was trading at a slight discount to NAV.) I feel comfortable with this slight premium due to management quality, a promote which appears reasonable, and the fact that a former drag on the stock (capital deployment) is being addressed by 2006 investing activity.
Since the company’s IPO in November of 2004, NGP has only put 46% of their capital to work in targeted portfolio investments; therefore, the yield has been far less than what many investors anticipated. I view this as a positive indication of capital allocation discipline. Management refuses to overpay for portfolio investments and are willing to sit in cash until the appropriate investment at the right price materializes. Buyers anticipating a faster ramp of investment and yield are probably long gone from the stock. I believe the slight premium to NAV might exhibit evidence of this, though NGP still trades at a pretty good discount to other similar companies (ACAS, AINV, ALD, GLAD) in spite of possessing superior attributes.
The current catalyst is that since the end of the first quarter of this year, NGP has increased their allocation to target investments by 17%. Couple the increased allocation to target investments along with the current pace of investment; I calculate the anticipated distribution rate for next year will be roughly $1.40 to $1.50, or a distribution yield of 10.5% to 11% based on the current stock price.
The market generally “trades” business development companies at a yield of 8%. Further, it is rare that they trade below NAV. If NGPC pays $1.40 next year, an investment today will yield 9.66% on cost. The market will might reasonably bid the company’s stock up to $17.50 in order to maintain the yield at 8% all things being equal. I believe an investment at current levels gives one the potential for 20%+ capital appreciation coupled with a yield on cost of almost 10%.
Additionally, I believe NGPC is not just another business development company. The company’s management team has a twenty year track record of success along with industry and technical expertise in their core competency of energy finance. The typical portfolio investment is based on current tangible assets and secured by pledges of reserves, pipelines and other assets—the risk of capital loss is low. NGPC will also have investment portfolio companies employ hedging strategies on current and future production in order to limit downside and preserve potential upside to portfolio investments. Lastly, NGP’s process is repeatable and scaleable and remains focused on the energy sector of the economy which faces increasing demand for its products and services.
BDC ad nauseum
Apologies in advance: I imagine everyone is aware of BDC mechanics, but just to be safe, I'll remind you that NGPC is organized as a Business Development Company (BDC) as well as a Regulated Investment Company (RIC). BDCs were created in order to stimulate investment in small companies that otherwise have limited access to capital. The benefit of this BDC/RIC structure is that the company pays no corporate federal income tax. In order to qualify for this favorable tax status, the BDC/RIC must annually distribute at least 90% of its taxable income. A BDC/RIC must also invest at least 70% of its assets in securities of private companies and public companies not listed on a national exchange while 50% of its investments must be in smaller transactions that individually are less than 5% of the company’s total capital. Debt-to-capitalization cannot exceed 50%, the board of directors must be independent and the company must offer to provide management assistance to portfolio companies. Obviously, NGPC complies with all such requirements.
Continued and disciplined deployment of their cash by terrific and proven allocator's of capital.