FS KKR Capital Corp (NYSE:FSK) is a prominent business development company (BDC) that has established itself as a leading provider of financing solutions to middle-market companies in the United States. With a diversified investment portfolio and a steadfast commitment to disciplined underwriting, FSK has navigated the evolving credit markets with resilience, positioning itself for continued success.
Business Overview and History FS KKR Capital Corp was initially incorporated in 2007 and commenced investment operations in 2009. The company operates as a closed-end, non-diversified management investment company that has elected to be regulated as a BDC under the Investment Company Act of 1940. FSK primarily invests in the debt of middle-market U.S. companies, with a focus on originated transactions sourced through the extensive network of its external investment adviser, FSKKR Advisor, LLC.
In its early years, FSK faced challenges in building its investment portfolio and generating consistent investment income. The company's portfolio was impacted by the global financial crisis, with several portfolio companies experiencing distress. During this time, FSK worked closely with its portfolio companies, providing additional capital and support where necessary to weather the economic downturn.
As the economy recovered, FSK was able to grow its portfolio and investment income. A significant milestone in the company's history came in 2018 when it completed a merger with FS Investment Corporation. This merger substantially increased the size and scale of FSK's operations, enhancing its origination capabilities, diversifying its portfolio, and improving operational efficiencies.
Despite these achievements, FSK has continued to face challenges. The COVID-19 pandemic in 2020 had a significant impact on several of the company's portfolio companies, particularly those in more affected industries like retail and hospitality. Once again, FSK worked closely with its portfolio to provide support and navigate the difficult environment. The company also had to adapt its investment and operational processes to the remote work environment imposed by the pandemic.
Over the years, FSK has demonstrated a consistent and prudent approach to portfolio management. As of September 30, 2024, the company's investment portfolio had a fair value of $13.9 billion, consisting of 217 portfolio companies. The portfolio is well-diversified across various industries, with the top 10 largest investments accounting for approximately 20% of the total fair value.
Financial Performance and Liquidity FS KKR Capital Corp has maintained a strong financial profile, with steady growth in its investment portfolio and disciplined capital management. As of September 30, 2024, the company reported net assets of $6.67 billion, or $23.82 per share. The company's net debt to equity ratio stood at 109%, well within its targeted leverage range.
For the fiscal year 2023, FSK reported revenue of $779 million and net income of $696 million. The company generated operating cash flow (OCF) and free cash flow (FCF) of $1.38 billion each for the same period. In the most recent quarter (Q3 2024), FSK reported revenue of $441 million, representing a 4.11% year-over-year increase. Net income for the quarter stood at $160 million, with OCF and FCF both at $923 million.
During the nine months ended September 30, 2024, FSK generated net investment income of $642 million, or $2.29 per share, and a net increase in net assets resulting from operations of $438 million, or $1.56 per share. The company's weighted average yield on accruing debt investments was 11.5% as of the end of the third quarter.
FS KKR Capital Corp maintains ample liquidity to support its investment activities and meet its obligations. As of September 30, 2024, the company had $4.4 billion in available liquidity, consisting of $371 million in cash and cash equivalents, and $3.54 billion in undrawn capacity under its senior secured revolving credit facility and other credit facilities. The company's gross debt-to-equity ratio stood at 121%, while the net debt-to-equity ratio was 109%.
Investment Strategy and Origination Capabilities The core of FS KKR Capital Corp's strategy is to provide financing solutions to middle-market companies, with a focus on originated transactions. The company's investment adviser, FSKKR Advisor, has a deep and experienced team that leverages its extensive network to source and underwrite high-quality investment opportunities.
During the third quarter of 2024, FSK originated $1.1 billion in new investments, with approximately 57% of the new capital allocated to add-on financings to existing portfolio companies and long-term KKR relationships. The company's new investments were predominantly in first-lien loans, with the remaining portion allocated to asset-based finance investments.
FSK's disciplined underwriting approach has enabled the company to maintain a robust credit quality, with non-accruals representing 1.7% of the portfolio on a fair value basis as of September 30, 2024. The company's portfolio companies have demonstrated resilience, with a 13% year-over-year EBITDA growth rate for investments made since April 2018.
As of September 30, 2024, FSK's investment portfolio consisted of the following asset classes based on fair value:
- Senior Secured Loans - First Lien: 59.9% - Senior Secured Loans - Second Lien: 6.2% - Other Senior Secured Debt: 0.9% - Subordinated Debt: 1.6% - Asset Based Finance: 14.3% - Credit Opportunities Partners JV, LLC: 9.9% - Equity/Other: 7.2%
The weighted average annual yield on the company's accruing debt investments was 11.9% as of September 30, 2024. 68.6% of the portfolio investments based on fair value were debt investments paying variable interest rates, while 8.2% were debt investments paying fixed interest rates.
Asset-Based Finance Capabilities In addition to its direct lending activities, FS KKR Capital Corp has developed a strong asset-based finance (ABF) platform, which has become an integral part of its investment strategy. The company's ABF team, in collaboration with the broader KKR network, has been able to access niche sectors and structure complex transactions that many market participants are unable to execute due to size, complexity, or platform capabilities.
During the third quarter, FSK made a $94 million commitment to a multi-billion-dollar transaction to purchase a pool of seasoned private student loans from Discover Financial Services. This transaction is an example of the company's ability to leverage its ABF expertise and relationships to source attractive investment opportunities that complement its direct lending activities.
Revenue Generation and Expenses FS KKR Capital Corp generates revenue primarily from interest income on the debt investments it holds. The company also generates revenue from non-recurring fees, such as commitment, closing, origination, structuring, diligence, monitoring, and prepayment fees, as well as dividend and other distributions on the equity or other securities it holds.
The company's key expense items include management fees paid to the investment adviser, subordinated income incentive fees, interest expense from financing arrangements, and other general and administrative expenses. For the nine months ended September 30, 2024, the company's ratio of operating expenses to average net assets was 13.06% and the ratio of net operating expenses, excluding certain expenses, to average net assets was 2.78%.
Guidance and Outlook For the fourth quarter of 2024, FS KKR Capital Corp expects to report GAAP net investment income of approximately $0.63 per share and adjusted net investment income of approximately $0.68 per share. This guidance reflects the company's disciplined approach to portfolio management and its ability to navigate the evolving market conditions.
The projected decrease in adjusted net investment income from $0.74 per share in Q3 2024 to $0.68 per share in Q4 2024 is primarily attributed to the reduction in interest rates by the Federal Reserve in September and lower anticipated fee income in Q4 compared to Q3. It's worth noting that FSK exceeded its public guidance for Q3 2024, generating net investment income of $0.77 per share and adjusted net investment income of $0.74 per share, compared to the guidance of approximately $0.72 per share and $0.70 per share, respectively.
FSK has indicated that it has sufficient spillover income to bridge any gaps between their earnings and their $0.70 per share total quarterly distribution, demonstrating the company's commitment to maintaining its dividend policy.
Looking ahead, FSK is well-positioned to capitalize on the anticipated improvements in the M&A environment and the continued growth in new investment opportunities. The company's diversified investment portfolio, strong liquidity position, and disciplined underwriting standards position it to navigate the complex lending landscape effectively.
Conclusion FS KKR Capital Corp has demonstrated its ability to navigate the dynamic credit markets with a consistent and disciplined approach. The company's diversified investment portfolio, strong origination capabilities, and asset-based finance expertise have enabled it to generate consistent returns for its shareholders. With a focus on middle-market U.S. companies and a well-structured portfolio across various asset classes, FSK continues to maintain a strong market position in the BDC sector. As the lending landscape continues to evolve, FSK is poised to leverage its competitive advantages and capitalize on the opportunities that lie ahead, while maintaining its commitment to generating current income and long-term capital appreciation for its investors.