Great Elm Capital Corp. (NASDAQ: GECC) is a diversified business development company (BDC) that seeks to generate current income and capital appreciation through investments in debt and income-generating equity securities, including investments in specialty finance businesses. With a focus on middle-market companies, GECC has built a robust portfolio that has demonstrated resilience in the face of economic volatility.

Financials

For the fiscal year ended December 31, 2023, GECC reported annual net income of $25,333,000 and annual revenue of $30,203,000. GECC's annual operating cash flow and free cash flow both stood at $25,683,000, showcasing its ability to generate consistent cash flows to support its operations and investment activities.

In the second quarter of 2024, GECC generated net investment income (NII) of $3.1 million, or $0.32 per share, compared to $3.2 million, or $0.37 per share, in the first quarter of 2024. The sequential decline was largely attributed to cash drag and the increased share count from GECC's June equity issuance, as well as the timing of distributions from certain positions, particularly GECC's CLO investments.

GECC's net asset value (NAV) per share as of June 30, 2024, was $12.06, down from $12.57 as of March 31, 2024. The reduction was primarily due to the write-down of certain illiquid Level 3 investments on non-accrual status, which adversely affected NAV by approximately $0.40 per share in the quarter. However, GECC believes the bulk of the impacts to NAV from these portfolio companies has been realized, positioning it to recapture NAV moving forward.

As of June 30, 2024, GECC's asset coverage ratio stood at 171%, compared to 180% as of March 31, 2024. Pro forma for the July bond issuance, the asset coverage ratio would be approximately 163%. GECC's total debt outstanding was approximately $178 million, with its $25 million revolving credit facility remaining undrawn. Cash and money market securities totaled approximately $3 million, and pro forma for the July bond issuance, total debt outstanding was approximately $200 million.

GECC's Board of Directors has authorized a $0.35 per share cash distribution for the quarter ending September 30, 2024, payable on September 30, 2024, to stockholders of record as of September 16. This distribution equates to an 11.6% annualized dividend yield on GECC's June 30 NAV of $12.06 per share.

Business Overview

GECC is an externally managed BDC that seeks to generate current income and capital appreciation through investments in debt and income-generating equity securities, including investments in specialty finance businesses. GECC sources these transactions directly with issuers and in the secondary markets through relationships with industry professionals.

In September 2023, GECC contributed investments in certain of its operating company subsidiaries and other specialty finance assets to its formerly wholly owned subsidiary, Great Elm Specialty Finance, LLC (GESF), in exchange for equity and subordinated indebtedness in GESF. A strategic investor purchased approximately 12.5% of the equity interests and subordinated indebtedness in GESF, with GECC retaining approximately 87.5% ownership.

Through its subsidiaries, GESF provides a variety of financing options along a "continuum of lending" to middle-market borrowers, including receivables factoring, asset-based and asset-backed lending, lender finance, and equipment financing. GESF expects to generate both revenue and cost synergies across its specialty finance company subsidiaries.

Diversified Investment Portfolio

GECC's investment portfolio is well-diversified across various industries, with a focus on secured debt instruments of middle-market companies and income-generating equity investments in specialty finance businesses. As of June 30, 2024, GECC's portfolio consisted of 51 debt investments across 41 companies, totaling approximately $219.8 million at fair value, and 15 equity investments in 14 companies, with an aggregate fair value of approximately $77.9 million.

The portfolio's industry composition is diverse, with the largest exposures in Specialty Finance (15.04%), Structured Finance (9.44%), Chemicals (8.54%), and Transportation Equipment Manufacturing (8.07%). Geographically, the majority of the portfolio is concentrated in the United States (88.61%), with additional exposure to Canada (5.51%), Bermuda (3.97%), Europe (3.36%), and Australia (0.98%).

Notably, GECC has been actively enhancing the composition of its portfolio, with first lien loans and CLOs now making up 60% of the portfolio, up from 44% last year. This strategic shift has strengthened the portfolio's credit quality and yield profile, which stood at over 13% at the end of the second quarter of 2024.

Expansion into CLO Investments

One of GECC's key strategic initiatives has been the expansion into collateralized loan obligation (CLO) investments. In April 2024, GECC created a joint venture, CLO Formation JV, LLC, to hold investments in CLOs and related warehouse entities. The JV is already generating distributions, with its first sizable distribution received in July 2024.

GECC expects the CLO JV to be a source of increasing income as GECC further invests in the portfolio. Over time, GECC anticipates potential returns ranging from the mid-teens to low 20% from its CLO investment portfolio. By incorporating structured financial vehicles into its portfolio, GECC has gained exposure to instruments that have historically demonstrated strong returns on equity across various economic cycles.

Liquidity

GECC has taken several steps to strengthen its liquidity and capital structure in 2024. In June 2024, GECC successfully raised $12 million in equity at net asset value from Prosper Peak Holdings, a special purpose vehicle in which Great Elm Group, the parent company of GECC's investment manager, owns a 25% stake.

This equity raise followed a $24 million equity raise at net asset value in February 2024, which was also supported by a $6 million investment from Great Elm Group. Additionally, in July 2024, GECC issued an additional $22 million of its 8.50% notes due 2029 (GECCI Notes) through a registered direct offering to an institutional investor.

These financing activities, along with GECC's undrawn $25 million revolving credit facility, have bolstered GECC's liquidity and financial position, enabling it to execute on its investment pipeline at greater scale. As of June 30, 2024, GECC had cash and money market securities totaling approximately $3 million.

Outlook

Looking ahead, GECC remains focused on growing its net investment income and covering its dividend. GECC believes it is well-positioned to achieve this goal, with the expected increase in distributions from its CLO JV investments and the impact of its recent capital raises.

Risks and Challenges

GECC faces certain risks, including the ongoing volatility in the macroeconomic environment, uncertainty surrounding the timing of interest rate cuts, and a turbulent election year. GECC is maintaining a disciplined approach to capital deployment, directing investments towards opportunities that are primed to perform across various economic cycles and prioritizing credit quality to minimize the risk of permanent capital loss.

Conclusion

Great Elm Capital Corp. is a diversified BDC that has demonstrated its ability to generate consistent returns for shareholders. With a focus on secured debt instruments and a strategic expansion into CLO investments, GECC has strengthened its portfolio composition and yield profile. GECC's recent capital raising activities have bolstered its liquidity and financial position, positioning it for sustainable, long-term growth. While GECC faces certain macroeconomic risks, its disciplined investment approach and diversified portfolio make it well-equipped to navigate the current environment and continue delivering attractive risk-adjusted returns.