Investcorp Credit Management BDC: Prepare for a Dividend Cut (NASDAQ:ICMB)

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Investment thesis

Investcorp BDC Credit Management, Inc. (NASDAQ: ICMB) will face many new challenges in the months and years to come. The company invests in middle market companies, but the US middle market shows a slight decline and this should continue in the coming months. Revenue growth is contracting, labor costs are on the rise, and future investments are on hold for now. These factors will make it even more difficult for ICMB to find large, growing middle-market companies to invest in. The company is slowly but surely destroying shareholder value and its net asset value has been declining for over 5 years. Its dividend yield looks high and attractive, but make no mistake, as analysts and Seeking Alpha’s quantitative rating both suggest a possible dividend cut in the coming years.

business model

Investcorp Credit Management is a business development company that invests in middle-market US companies that have annual revenues of at least $50 million and EBITDA of at least $15 million. Management invests between $5 million and $25 million in each of its portfolio companies. Their goal is to invest in high-growth companies that are expanding their business growth organically or preparing for an acquisition. ICMB is 41st of 48 publicly traded U.S. BDCs by market capitalization.

The US middle market

Since ICMB invests in middle market companies, it is essential for the company and for future investors to have an idea of ​​the trends in the US middle market. Since mid-2020, growth figures, employment figures and total turnover have been solid, but this trend should end in the coming months. The RSM US Middle Market Business Index rose to 130.6 in the second quarter of 2022 from 126.3 in the first quarter, but the third quarter figures could be lower. Typically, revenue growth for mid-market companies is higher than the revenue growth rate for S&P 500 companies. This will likely continue over the next 12 months, but revenue growth over the previous 12 months of 2% is expected to drop to 9.1%, which is a significant drop. Rising labor costs, inflation and global discord will have a negative impact as companies look to maintain aggressive growth rates for the rest of the year and into 2023.

What we can see is that middle market companies are starting to show a greater propensity to hold cash in reserve and expansion plans for the next 12 months are on hold compared to 6 to 8 months. CEOs indicated that they have already paid higher prices for inputs and 74% of them expect to do so in the next two months. With quit trends, mid-market companies need to introduce employee welfare programs and higher wages, which means labor costs have been on the rise since the start of the l year and is likely to remain high for the next few months and even years. Mergers and acquisitions activity between the companies has had a difficult first half of 2022 and analysts expect this trend to continue in 2022. This means that some middle market companies in which ICMB holds shares could have a performance lower than previously expected. In summary, ICMB will struggle to find new investments to add to its portfolio of existing companies. Additionally, due to the already high and continuing rise in interest rates, middle market companies are likely to delay future investments, making ICMB’s situation even more difficult in terms of new loans.

Evaluation

ICMB’s price-to-book ratio has fallen further to 0.63x from 0.67x since my last article and things are not looking great for the company. Over the past 5 years the stock price has fallen almost 56%, neither the valuation of their assets nor the stock price could have recovered from the pandemic crash and I see no signs that it will return to pre-pandemic highs. The net asset value per share has been falling for years. In the third quarter of 2017, the net asset value per share was $12.39 and 2 years later, in the third quarter of 2019, this figure fell to $10.51. During and after the pandemic, the net asset value per share declined further (Q3 2020 – $7.81; Q1 2022 – $6.93). At the same time, the debt-to-equity ratio more than doubled from 0.67x in Q1 2017 to 1.71x at the start of 2022. Due to these factors, ICMB’s total return is currently close to -20% and I can’t see any indication that this might change in future years. Especially if management has to cut the current dividend.

ICMB Total Return

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Company specific risks

There are external and internal risk factors that the business has to deal with. Not to mention the obvious destruction of shareholder value that has been going on for years. The only positive factor is that more than 90% of their loan portfolio is variable rate loans, so the increase in interest rates will not hurt the ICMB. Despite this good news, external factors in the middle market are against the company and the slowdown is making it difficult to find new profitable targets. One of the risks (although common for BDCs) is that the ICMB is managed externally. This means that management is not as committed to the success of the business as internal management would be.

My take on the ICMB dividend

The likelihood of a future dividend cut has increased since my last article. As I mentioned earlier, management may need to cut the dividend. They haven’t yet, but the likelihood has increased since my last post in May. Seeking Alpha’s Dividend Safety Score has fallen to an F, meaning there’s about a 64% chance that management will cut the dividend in coming years. Analyst estimates are the same. They expect a 6.6% drop in the dividend over the next 12 months. ICMB’s current payout ratio is nearly 20% above its 5-year average of 88%. The company’s net profit margin fell 12% from its 5-year average. ICMB’s future dividend is therefore anything but stable and secure at the moment.

Final Thoughts

I stated in my previous article that ICMB might be a fair choice for risk-aware investors, but I no longer consider such risks acceptable. Since my last article, I changed my rating from Hold to Sell. The reasons behind this are simple. External factors backfire on ICMB and management needs to address internal issues as well. The company has continually destroyed shareholder value and now the current dividend is also in jeopardy.

Margie D. Carlisle