What to Buy: PennantPark Investment Corp (NSDQ: PNNT)

Why Now: Although this business development company (BDC) is a risky investment because it principally finances highly leveraged companies that don’t have access to the capital markets, management proved their underwriting prowess during the 2008-09 Great Recession. In fact, PennantPark was one of only two BDCs that didn’t cut its dividend during that time period. Even better, it actually raised it!

A majority of PennantPark’s portfolio is comprised of subordinated and second lien debt, with smaller allocations to senior debt and equity. While subordinated debt involves greater risk than debt that’s higher up in a firm’s capital structure, it’s also what powers this BDC’s impressive payout.

And the seasoned management team running the portfolio won’t stretch for deals in which it lacks confidence. Management’s willingness to idle capital until it finds the right scenario means that it won’t be chasing deals that entail excessive risk for a questionable payoff.

The success of this approach is evidenced by PennantPark’s impressive underwriting record: It’s suffered only seven non-accruals out of 224 investments since the company’s inception in early 2007.

While the Wells Fargo BDC Index (WFBDC) is at a 52-week high, PennantPark is off almost 8 percent from its trailing 12-month high, which it hit in mid-March. That offers us an attractive opportunity to build a position in a company that’s devoted to a steady, growing dividend.

With a yield of 9.9 percent, PennantPark Investment Corp is a buy up to 11.50.

Who Are These Guys, Anyway?

Before we proceed with a detailed analysis of our recommendation, you may have noticed two new faces peering out at you from our Big Yield Hunting website. For the sake of expedience, we’ll briefly describe our own backgrounds in the third person, but please know that we’re chafing at the awkwardness of such pretense.

After almost eight years at The Hulbert Financial Digest (HFD), the watchdog of the investment newsletter industry, Ari Charney was ready to shift from helping investors find the right newsletter to helping them select the right securities for their portfolios.

During his time at Investing Daily, Ari has been a bit of a generalist, contributing investment advice or edits to nearly every newsletter in Investing Daily’s considerable roster. Among his numerous credits, he’s been the managing editor of Louis Rukeyser’s Wall Street and Louis Rukeyser’s Mutual Funds, as well as an investment analyst at Personal Finance.

But Ari’s favorite role was as a columnist for Investing Daily’s Stocks to Watch, where he applied a data-driven approach to discovering beaten-down stocks that were poised to turnaround. Indeed, those efforts closely align with Big Yield Hunting’s mandate.

And while Ari relishes the prospect of the hunt for big yields, his time at the HFD also taught him the importance of maintaining a keen eye toward risk. So while the typical Big Yield Hunting play is quite risky, Ari will be focused on finding an appropriate tradeoff between high yield and high risk.

Like Ari, Khoa Nguyen is also a hardcore data junkie, an attribute that’s served him well as Investing Daily’s research editor and as an investment analyst for its flagship newsletter Personal Finance, as well as Louis Rukeyser’s Wall Street and Louis Rukeyser’s Mutual Funds, among others.

For his personal portfolio, Khoa often favors aggressive growth stocks, which should temper Ari’s tendency toward risk aversion. But Khoa has also been thoroughly steeped in Investing Daily’s approach to finding stocks with safe, sustainable dividends. And he supplements his fundamental approach to stock-picking with top-down macroeconomic analysis.

The Story

The high-yield equity space is fraught with troubled companies, whose payouts often depend on a significant operational turnaround. We’re not opposed to such plays, which can be highly profitable if they have a catalyst for change.

Indeed, we’ll likely include them among our mix of recommendations in the months to come. And the Portfolio we inherited has a number of companies emerging from difficult circumstances, which we’ll continue to monitor while collecting dividends and with the ultimate goal of booking profits.

But with a sluggish global economy and a US stock market trading near an all-time high, we wanted our inaugural recommendation to be stress-tested against a potential downturn.

For now, this business development company (BDC) offers the prospect of slow growth, but with an enviable payout to which management is firmly committed. We suspect that’s precisely the sort of play for which Big Yield Hunting subscribers have been yearning.

Khoa: To start, you should probably bore everyone with a brief overview of what a BDC is. Actually, try not to bore everyone.

Ari:  Thanks for your indulgence, but sometimes boring is best.

BDCs were first organized as a result of the Small Business Investment Incentive Act of 1980. The legislation was intended to create closed-end funds to offer small and middle-market firms access to financing that the capital markets had failed to provide on their own.

BDCs are similar to private equity firms in that they provide mostly private companies with long-term debt and some equity financing.

Khoa: Okay, so BDCs are essentially publicly traded private equity? I like any security that lets me ride the smart money’s coattails.

Ari: That’s an apt description. Of course, now that some well-known private-equity firms, such as Kohlberg Kravis Roberts & Co (NYSE: KKR) have gone public, that’s no longer such a noteworthy distinction.

Khoa: Okay, I’ll be in the other room. Text me when you’re done with this overview, and you’re ready to actually talk about the stock.

Ari: I think you’ll want to stick around because I’m about to explain why BDCs offer such sizable yields.

Khoa: I’m still here. But I’m also still worried that you’re boring everyone.

Ari: Sorry, but this format doesn’t lend itself to hand puppets.

Khoa: How about balloon animals?

Ari: Umm … No.

Anyway, in addition to their similarities to private equity, BDCs are also structured as pass-through entities, just like real estate investment trusts (REIT) and master limited partnerships (MLP). Because this structure minimizes their tax liability at the corporate level, they’re required to distribute at least 90 percent of their profits to shareholders.

Although BDCs’ largely illiquid investments in small, growing companies can make them extraordinarily risky securities, their debt portfolios throw off handsome yields–often in excess of 10 percent–to compensate for the risk inherent in these investments.

Right now, there are about 30 BDCs altogether. With a yield of 9.9 percent, PennantPark Investment Corp (NSDQ: PNNT) comes in toward the middle of that range.

Khoa: When we discussed PennantPark last week, I know you had already done hours and hours of research to arrive at this pick. In fact, you were in a bit of a manic state. You threw a dizzying array of numbers and statistics in my direction. So now’s your chance to make sense out of the muddle.

Ari: Finding our inaugural recommendation was a veritable odyssey of the mind …

Khoa: Wait a minute. What does that even mean? Sounds like all that research fried your brain.

Ari: Well, I know you spent considerable time working your own leads, so you’re well aware of just how difficult it is to find a high-yielding stock that isn’t on the verge of falling apart. The good news is that PennantPark may invest in highly leveraged companies, but it’s not a troubled company itself.

Perhaps the best way of discussing this BDC is to describe what I was looking for and how PennantPark measured up. Of course, I wanted to find a BDC with a yield high enough to satisfy the demands of our subscribers. But I also wanted one that had been stress-tested by navigating the 2008-09 Great Recession.

In terms of market capitalization, the overall BDC space is tiny relative to its pass-through peers: It has a total market cap of just $18.2 billion, compared to about $255 billion and $478 billion for MLPs and REITs, respectively. But Wall Street is starting to capitalize on income-hungry investors’ demand for yield. Of the 15 BDCs whose high yields and market cap qualify them for our coverage universe (i.e., yields greater than 7.5 percent and a market cap of $300 million or more), five made their initial public offerings (IPO) after the financial crisis.

I still reviewed these newer BDCs pretty thoroughly, but ultimately couldn’t get comfortable with them unless I knew we’d be partnering with a seasoned management team that knows what it’s like to be at the helm under incredibly challenging conditions. At the same time, some of the BDCs that have been around since the early part of the last decade are still pretty battered from the downturn.

Khoa: Tell me more about the management team. Were all of them with the company during that period?

Ari: For the most part, yes: CEO Arthur Penn and two of his three portfolio managers have been with PennantPark since its IPO in April 2007. Penn was oringally one of the co-founders of another BDC called Apollo Investment Corp (NSDQ: AINV). The third portfolio manager joined the firm in December 2009, but prior to that, he was a partner at Apollo.

These four principals have an average of more than 20 years of experience in leveraged finance, distressed debt and private equity.

Khoa: So how did PennantPark fare during the financial crisis?

Ari: Well, PennantPark was one of just two BDCs to not cut or suspend its distribution during the downturn. In fact, it actually boosted its payout by 9.1 percent in late 2008, just as the market started to really sell off in earnest. And it’s never cut its dividend.

Khoa: What about its share price? Did PennantPark get crushed like so many of its fellow financial sector stocks?

Ari: Indeed, it did, even though it managed to maintain its distribution. But it’s hard to blame investors for dumping a BDC during a financial crisis. Excluding the reinvestment of dividends, the stock dropped nearly 64 percent in 2008, while the WFBDC index fell almost 52 percent and the S&P 500 lost 38.5 percent.

Khoa: Yowzers.

Ari: Yeah, that’s brutal. The following year, however, PennantPark’s shares skyrocketed a staggering 260 percent. And they gained another 49 percent in 2010. On a dividend-reinvested basis, the few investors who were able to tolerate such heart-stopping volatility have gained 15.2 percent annualized since the beginning of 2008 versus 9.2 percent for the WFBDC and 4.6 percent for the S&P.

But even with the lackluster economic environment at present, I’d like to think that the financial crisis was a generational event. Still, it’s worthwhile knowing what can happen should a downturn of that magnitude happen again.

Khoa: Out of curiosity, what was the other BDC that maintained its payout during the financial crisis? And why aren’t we recommending that stock instead?

Ari: Triangle Capital Corp (NYSE: TCAP). But that company currently trades at more than double its net asset value (NAV), a premium that’s pushed its yield down to 7.3 percent. By comparison, PennantPark trades at a 7.6 percent premium to the NAV it reported at the end of the first quarter, which was $10.50 per share. And of course, its yield is much higher.

Although I don’t like paying a premium for assets, even a modest one, the average price-to-NAV among BDCs is around 1.19. PennantPark comes in well under that average, and it has better growth prospects than the BDCs that trade at a discount to NAV.

Khoa: Was PennantPark able to fully cover its distribution during the financial crisis?

Ari: It did so in two out of four quarters in 2008, as well as all four quarters in 2009. But it should be noted that BDCs don’t always fully cover their distributions. PennantPark’s record in this area is about average. Subsequent to that, it missed covering its distribution twice in 2010, once in 2012, as well as for the first quarter in 2013.

During the first quarter, the company’s net investment income, which is the relevant measure of profits for a BDC, missed covering its dividend due to a couple of one-time items, including debt issuance costs and a restructuring of a debt investment into equity. Absent those two items, the company would have comfortably covered its distribution. Nevertheless, net investment income per share still grew 16.7 percent year over year.

Khoa: Did management offer any sort of guidance regarding the dividend?

Ari: I like management’s approach to dividend policy. While many of PennantPark’s peers are chasing deals of questionable quality to support and grow their payouts, management would rather adhere to its judicious underwriting process, even if that means idling capital. Fortunately, as management noted in its recent earnings call, middle-market companies’ demand for financing continues to exceed lending capacity. In other words, PennantPark is still operating in an environment that allows it to be choosy.

CEO Arthur Penn acknowledged falling short of covering the dividend, but I found his candor and conservatism refreshing:

“We anticipate continuing the steady, stable dividend stream going forward. We are particularly content under-earning the dividend temporarily as we carefully and prudently invest in this environment. We are fortunate to have plenty of excess liquidity that we can use for both defensive and offensive purposes. As a result of our focus on high-quality new investments, solid performance of existing investments and continuing diversification, our portfolio is constructed to withstand market and economic volatility.”

In fact, that most recent miss has kept the BDC’s shares somewhat depressed relative to its competitors. While the Wells Fargo BDC Index (WFBDC) is at a 52-week high, PennantPark is off almost 8 percent from its trailing 12-month high, which it hit in mid-March. I like it when an already compelling investment goes on sale.

Khoa: I noticed that it’s been six quarters since PennantPark last boosted their dividend. Is there hope of that happening again anytime soon?

Ari: Well, first I’d like to see them cover their dividend before they raise it again.

Though management was relatively sanguine about the middle-market lending space in their first-quarter earnings call, competition is causing yield spreads to tighten. That basically means that the difference between the rate at which BDCs borrow and the rate at which they lend is narrowing, which constrains profits.

Management expects a slow-growth environment for their portfolio. That comports with Wall Street analysts’ consensus 12-month price target, which is 3.4 percent higher than where shares trade presently. Many other BDCs have consensus price targets with similarly modest expectations. That’s simply a reflection of the present environment.

But as long as management remains committed to the payout at its present level, then I’m happy to lock in a nearly 10 percent yield, with the hope that circumstances will permit them to raise the dividend again in the future.   

Khoa: Earlier, you mentioned that other BDCs are chasing questionable deals. Can you expand on that?

Ari: Many BDCs have larded their portfolios with debt resulting from financings in 2012 and 2013, both of which are considered riskier vintages than prior years. At present, it’s not uncommon to see BDCs where 50 percent to 65 percent of the loans held in their portfolios have been originated since the beginning of 2012.

By contrast, PennantPark’s investments are more evenly staggered across the trailing three years, with 20.5 percent of the portfolio originated in 2010, 27.5 percent in 2011, 28.9 percent in 2012, and 5.3 percent so far in 2013.

Khoa:  What kind of debt do they hold?

Ari: Their $1.1 billion portfolio is dominated by second lien and subordinated debt: 39 percent in subordinated debt, 22 percent in second lien debt, 26 percent in first lien senior secured debt, and 13 percent in preferred and common equity.

I had originally ruled out PennantPark because I really wanted a BDC whose portfolio was mostly senior secured debt, which means it’s at the top of the capital structure, just behind a company’s credit revolver. In the event of default, that means investors in such securities are more likely to be made whole than those who hold more junior debt.

But just because a BDC invests mostly in senior debt, those deals can still sour if the underwriting process is slipshod. And that’s definitely a risk in this environment, where the rush to get deals done to support payouts is forcing many BDCs that traditionally invest in senior debt to move lower in the capital structure or issue senior debt that has significantly higher coupons.

Thomson Reuters recently conducted a survey of middle-market lenders’ experiences during the first quarter, which offers further evidence of this push into riskier assets. One respondent memorably replied, “We did deals we did not love—fingers crossed!”

Khoa: Yikes! So this particular company was basically just rolling the dice on these deals.

Ari: Yeah, I know. I find that kind of attitude utterly disgraceful. Whoever said that is clearly happy to take investors’ money, while having no skin in the game themselves. By contrast, read through an earnings call transcript with PennantPark’s management team, and you’ll be struck again and again by their willingness to wait for just the right deal.

While other BDCs are starting to invest in more junior debt, PennantPark has historically focused on this arena, so it’s still well within its comfort zone. And its subordinated and second lien debt originations have been in a fairly consistent range of 63.5 percent to 68.4 percent of the portfolio since the beginning of 2011. Originations of senior secured debt have ranged between 23.1 percent and 27.2 percent of assets during that period, though there were no such deals during the first quarter of 2013.

Despite the greater risk of subordinated and second lien debt, PennantPark has had a remarkably low level of non-accruals, which is when borrowers are delinquent or full payment of interest or principal is in doubt. Just seven loans out of 224 investments have entered non-accrual status since the BDC’s inception in early 2007. I’ve reviewed the portfolios of a number of other BDCs whose holdings are mostly senior debt, and the percentage of assets currently in non-accrual range from 1 percent to 4 percent. At quarter-end, none of PennantPark’s portfolio was in non-accrual.

Khoa: That’s impressive. You mentioned competitors stretching for yield. Has PennantPark done the same?

Ari: Yes, somewhat. But it’s largely avoided the siren song of the 14 percent-plus bucket, which has lured so many of its competitors. Just 4.6 percent of its portfolio was invested in this coupon range last year, while no such deals were done during the first quarter. Instead, 69.4 percent of financings were in the 12 percent to 14 percent range in 2012, and 60.1 percent were in this range during the first quarter. At quarter-end, their portfolio had a weighted average yield of 13.5 percent.

Khoa: I know some BDCs specialize in particular sectors, such as technology or healthcare. Does PennantPark focus on a certain niche or is it more broadly diversified?

Ari: As you can see in the accompanying graphic, PennantPark’s portfolio is very broadly diversified, with investments in 58 different companies across 31 industries. Most industry allocations range from 2 percent to 5 percent, while the single largest allocation at present is in the utilities/energy space (8 percent of assets). The average size of each investment is $19.2 million.

Source: PennantPark Investment Corp

Management takes a value-oriented approach to selecting credits, with a focus on companies that generate positive free cash flow and have experienced management teams, a competitive edge, and growth potential.

Khoa: One concern I have about financials is their use of leverage. In this case, you’ve described a company that specializes in highly leveraged companies. Does it then layer on additional leverage with its own sources of financing?

Ari: Most BDCs have used the ensuing recovery since the downturn to deleverage, while issuing new debt at historically low interest rates. By law, a BDC’s total debt outstanding is not allowed to exceed equity, so that amounts to a maximum debt-to-equity ratio of 1.0.

Khoa: How does PennantPark stack up in this department?

Ari: Again, it’s slightly below average, with a debt-to-equity ratio of 0.5, compared to 0.6 for its peers. That’s good.

Despite the aforementioned limit on leverage, BDCs do have one avenue that allows them to exceed statutory leverage. Fortunately, it’s relatively low risk and affords a great deal of flexibility.   

The Small Business Administration (SBA) has a Small Business Investment Company (SBIC) program whose rules allow BDCs to essentially set up a sub-portfolio of investments largely financed with SBA borrowings. The program has actually been around since 1958, but it started attracting greater attention from the BDC and hedge fund crowd when new capital dried up during the downturn.

Here’s how the program works: For each slug of equity that a BDC invests in its SBIC, the SBA will match it on a 2-to-1 basis, though under certain circumstances, it can go even higher than that.

For example, PennantPark funded its first SBIC with $75 million in equity, which allowed it to borrow $150 million in low-interest debentures from the SBA. It has a license for a second SBIC, which is only funded with a couple million so far. But once the second SBIC is funded with $37.5 million, PennantPark will then receive an additional $75 million from the SBA.

And in this environment of historically low interest rates, SBIC capital is dirt cheap for debt that has a relatively long-term duration of 10 years. The weighted average rate of PennantPark’s $150 million in SBA debentures is just 4.04 percent, including upfront fees that are amortized over the life of the loan. That’s only slightly higher than the 3.04 percent weighted average rate on the short-term borrowings from their credit revolver.

SBIC debt offers BDCs significant flexibility because it’s non-recourse and excluded from asset coverage ratios, and it doesn’t require principal payments prior to maturity.

Khoa: Since we’re talking about raising capital for new investments, do BDCs do a lot of secondary equity issuances like MLPs and REITs?

Ari: They do. Since its IPO in 2007, PennantPark has done a total of six follow-on offerings, including two last year. Although these offerings are initially dilutive to existing shareholders, they’re one of the key ways in which these entities grow over time.

But it doesn’t look like PennantPark will necessarily have to do another secondary issuance for a while, as they have substantial liquidity at their disposal: $258.3 million available from their credit facility, $75 million in SBIC financing, $68.8 million in net proceeds from their recent issuance of 6.25 percent notes due 2025, and $17.3 million in cash on their balance sheet.

That’s equivalent to about 37.6 percent of their portfolio at quarter-end. Given their average portfolio turnover rate of 23.5 percent over the past five fiscal years, they should have ample liquidity to account for turnover, while growing their portfolio, without having to resort to another secondary issuance for another year or so.

Khoa: I know you like to look at insider activity whenever you analyze a company. Are these guys eating their own cooking?

Ari: Management owns about 1.1 percent of shares outstanding, so it would be nice if they had an even larger stake in the company.

However, one of the independent directors on their board recently bought an enormous quantity of shares on the open market. In February, he purchased 85,900 shares of PennantPark for an average price of $11.36 per share, which is right around where the shares trade today.

These purchases amounted to nearly $976,000. That’s an extraordinary vote of confidence in management’s ability to grow the portfolio and support the dividend.

Khoa: Once we establish this position, how should we monitor it over time?

Ari: First, if the market or economy were to enter what appears to be a protracted downturn, we might want to liquidate our shares toward the beginning of such an event before selling momentum really starts to accelerate. Although management has earned our trust with the payout, I don’t think most investors have the fortitude to stomach a selloff like the one that happened in 2008.

Although we’re not market timers, my hope would be that we could buy back shares as the market is bottoming and potentially lock in an even higher payout, assuming the quality of PennantPark’s underlying portfolio remains the same. However, aggressive investors with a high tolerance for risk could stick it out while continuing to collect the dividend.

But assuming the market remains in bullish mode, I’ll be watching to see whether the company is able to cover its payout. For instance, if it falls short of the payout for four consecutive quarters, I’d find that worrisome, and we’d have to revisit our original thesis.

Additionally, I’d want to see evidence that management is maintaining its underwriting discipline with broad diversification, limited non-accruals, and by not overly committing its portfolio to a particular vintage.

Finally, we’ll have to keep an eye on any changes in Federal Reserve policy that could affect this space.

Still, my hope is that this is one of the few Big Yield Hunting recommendations that’s actually worth holding for the long term.

Khoa: What about tax considerations?

Ari: A BDC’s distribution can include a combination of qualified dividend income, capital gains and return of capital. For the past four quarters, PennantPark’s distribution has consisted entirely of qualified dividend income.

Because a BDC pays minimal taxes at the corporate level and distributes at least 90 percent of net investment income to investors, the income component of a distribution is taxed as ordinary income, which results in the issuance of IRS Form 1099 at tax time. As such, its shares are best suited for tax-advantaged accounts, such as an IRA or Roth IRA.

Khoa: Well, you’ve said a lot. You’ve probably even said too much. But I like this pick.

Ari: I’m exhausted. Next time, you get to do all the heavy lifting.

The record date for PennantPark’s next $0.28 quarterly dividend should occur on or around June 21. With a yield of 9.9 percent, PennantPark is a buy below 11.50.

Portfolio Updates

Aditya Birla Minerals Ltd (ASX: ABY, OTC: ABWAF) reported that fiscal 2013 copper production fell 16 percent, to 69,291 metric tons. The volume of ore mined increased 20 percent, to 3.38 million metric tons, as the company’s Nifty and Mt. Gordon operations both showed significant volume growth.

However, the cost of production rose AUD0.05 per pound, to AUD2.50, from the prior year’s average. Copper prices have been depressed due to China’s slowing growth and continued uncertainty in Europe. Higher expenses coupled with lower-than-expected sales cause a loss of AUD8.3 million in net profit after taxes.

Aditya has not declared a dividend for 2013, but still has AUD100 million in cash on hand and less than AUD1 million in debt.

Aditya is a “hold” as we await the next dividend announcement.

BreitBurn Energy Partners LP (NSDQ: BBEP) reported total net production for the first quarter jumped 18 percent to a quarterly record high of 2.35 million barrels of oil equivalent (BOE).

The company’s net liquids production, which accounted for 51 percent of total production, rose 40 percent to a record 1.21 million BOE. At this outstanding rate of growth, BreitBurn’s liquids production is expected to comprise about 55 percent of total production by the end of 2013.

The company is on track to meet management’s full-year production guidance of 9.5 million BOE to 10.1 million BOE.

BreitBurn declared a $0.475 per unit payout in the first quarter, which is up 1.1 percent sequentially and 4.4 percent from a year ago. This latest boost was its 12th consecutive quarterly increase since reinstating its distribution in early 2010.

Sales for the first quarter rose 6.3 percent year over year, to $120.3 million. Although BreitBurn posted a $36.3 million loss this quarter, the company is on pace to be profitable this year.

While the company’s coverage ratio is currently 0.7, management expects coverage of the distribution to increase to 1.1. or 1.2 by the fourth quarter, due to an increase in cash flow during the second half of the year.

Including the reinvestment of distributions, unitholders who bought BreitBurn when it was first recommended back in late 2011 are up 29.2 percent. We believe the company is capable of maintaining its payout, with its prospects improving later in the year.

BreitBurn is a buy below 21.

After three consecutive quarters of falling sales, Bonavista Energy Corp’s (TSX: BNP, OTC: BNPUF) first-quarter sales of CAD227.5 million were essentially level with the year-ago period. However, profits slid 59 percent to CAD16.6 million.

Back in December, the company cut its monthly dividend 41.7 percent, to CAD0.07. Although a dividend cut often sparks a selloff, most companies’ improved financial condition thereafter can eventually lead to gains in share price. Indeed, this stock has returned 17.2 percent since initial recommendation.

The company’s numbers are expected to improve further this year, though dividend growth is unlikely for now.

Bonavista remains a “hold.”

LRR Energy LP (NYSE: LRE) reported average production of 5,900 barrels of oil equivalent per day (BOE/D) during the first quarter, up 9.3 percent year over year, but down 0.6 percent sequentially. Production was negatively impacted by infrastructure constraints in the Permian Basin, a higher Midland-to-Cushing oil price differential (an average of $7.88 per barrel), and poor weather conditions.

This resulted in adjusted distributable cash flow (DCF) of $0.34 per share, for a coverage ratio of 0.6–its second consecutive quarter where DCF failed to cover its payout.

During the quarter, the company acquired oil and natural gas properties in Oklahoma in a dropdown transaction from general partner Lime Rock Resources for $38.2 million.

The master limited partnership (MLP) boosted its quarterly payout 0.5 percent, to $0.4825.

Management affirmed its full-year guidance and estimates that production will recover to about 6,500 BOE/D. It also expects a second-quarter coverage ratio of 1.0.

Barring any mishaps, LRR should be able to over its payout through the end of the year.

LRR Energy is a buy below 18.

Natural Resource Partners LP (NYSE: NRP) reported that first-quarter revenue rose 3 percent, to $94.3 million. However, profits fell 7 percent, to $46.9 million.

Distributable cash flow (DCF) came in at $44.5 million, down 10 percent from a year ago. The decline in DCF is due to a drop in coal royalty revenues from the Central Appalachia. With metallurgical coal prices near multi-year lows due to weaker global demand for steel, the master limited partnership (MLP) suffered a 21 percent decline in volume of Central Appalachian coal and a 28 percent drop in sales.

Despite the strain on its distribution, Natural Resource Partners has ample liquidity ($76 million in cash and $152 million available from its credit facility) to fund its distribution through year-end.

Buy Natural Resource Partners below 22.

PetroBakken Energy Ltd (TSX: PBN, OTC: PBKEF) reported first-quarter production of about 49,000 barrels of oil equivalent per day (BOE/D), which was largely in line with analysts’ estimates.

Its funds flow from operations (FFO) of CAD177 million came in 5 percent lower than the year-ago period, but was able to safely cover the company’s payout of CAD47 million (dividends represented about 27 percent of FFO).

PetroBakken also announced it renewed its CAD1.4 billion credit facility, from which its drawn about CAD1.1 billion.

During the quarter, the company spent about 45 percent of its $675 million capital program drilling 53 of its projected 129 wells. PetroBakken expects average production growth of 8 percent to 12 percent for 2013, and a production rate of 49,000 BOE/D to 52,000 BOE/D by the end of the year.

PetroBakken is a buy below 10.

Oil and natural gas producer QR Energy LP (NYSE: QRE) reported first-quarter distributable cash flow (DCF) of $31.7 million, down 19 percent sequentially, but up 32.6 percent from a year ago.

This was due in part to lease operating expenses that were 7 percent higher than the fourth quarter, as a result of its acquisition of the East Texas Oil Field. Nevertheless, the master limited partnership (MLP) still managed to cover its distribution, with a coverage ratio of 1.0.

Average production was 17,789 barrels of oil equivalent per day (BOE/D), which was up 4 percent from the fourth quarter and 31.1 percent versus a year ago. Oil sales accounted for nearly 84 percent of the MLP’s $104.9 million in quarterly revenue, while natural gas and natural gas liquids represented 8.4 percent and 6.9 percent of revenue, respectively.

Management forecasts full-year 2013 average production to range from 17,800 BOE/D to 18,200 BOE/D.

QR Energy maintained its $0.4875 quarterly distribution, for a forward yield of 11.3 percent. Unit prices are currently 17.7 percent below their 52-week high.

Among Wall Street analysts, 13 rate the MLP a “buy” and three rate it a “hold.” The consensus 12-month price target is 20.75, which is 20.2 percent above the current unit price.

QR Energy is a buy below 21.

Windstream Corp (NYSE: WIN) has been under pressure in the aftermath of fellow rural telecom CenturyLink Inc’s (NYSE: CTL) Feb. 14, 2013, announcement that it was cutting its distribution by 26 percent.

CenturyLink’s announcement immediately led to speculation that other high-yielding stocks–particularly high-yielding independent telecoms–are headed for dividend cuts. Hence Windstream’s steep decline. The stock is currently down 21.3 percent from its 52-week high.

This speculation also manifested itself in a sharp rise in Windstream’s short interest. The percentage of Windstream’s float held short is now up to 12.1 percent, which is equivalent to 11.9 days of average trading volume.

But management declared another $0.25 per share dividend on May 8, which will be paid July 15 to shareholders of record on June 28. And Windstream posted solid if unspectacular results on May 9 that provide further support for the dividend.

Business service revenue was up 2 percent year over year to $914 million, while consumer broadband service revenue grew by 5 percent to $117 million. Total business and consumer broadband revenue–which is Windstream’s strategic focus–now represent 71 percent of total revenue.

Adjusted free cash flow for the period was $248 million.

Management noted that the business channel now represents 63 percent of revenue and will be an essential driver of future growth. Consumer broadband growth was driven by increased sales of broadband features and faster speeds.

Overall consumer service revenue was $328 million, a decrease of 2 percent from the same period a year ago, as voice and long-distance revenue declined $14 million, or 7 percent, due to fewer voice lines and declining feature packages.

Total enterprise customers–who generate $750 or more in revenue per month–grew 7 percent year over year, while average service revenue per business customer per month increased 6 percent from the same period a year ago.

Total revenue and sales of $1.5 billion were 2 percent lower than a year ago, as adjusted operating income before depreciation and amortization (OIBDA) was flat at $587 million.

Data and integrated services revenues were $400 million, an increase of 8 percent from the same period a year ago, primarily due to growth in integrated voice and data services, data center and managed services. Carrier service revenues were $167 million, an increase of 3 percent year over year, largely related to fiber-to-the-tower installations.

Windstream spent $234 million on capital expenditures (CAPEX) during the quarter, including $165 million in recurring CAPEX and $69 million on fiber-to-the-tower projects as part of the broadband stimulus investment. Recurring CAPEX remained at 11 percent of revenue, within management’s 11 percent to 13 percent target range.

CAPEX will trend higher during the first half of 2013 and then decrease “considerably” in the third and fourth quarter as the fiber-to-the-tower and stimulus investments decline.

Windstream’s business performance and steady consumer results again largely offset continued declines in its wholesale business. Wholesale revenue was $152 million, a decline of 17 percent from the same period a year ago due to lower switched access revenues from declining consumer voice lines and lower intrastate access rates as part of inter-carrier compensation reform implemented in July 2012.

During its first-quarter earnings conference call management reiterated its commitment to its dividend, noting, “The dividend remains core to Windstream’s strategy and we believe it is the best way to return value to our shareholders.”

Windstream refinanced debt and reduced interest costs, and the company has another opportunity to cut costs via the refinancing of a note coming due in August 2013. Management also plans to reduce company debt by over $200 million this year by directing excess free cash flow after the dividend to debt repayment.

Looking beyond 2013, Windstream expects stable adjusted OIBDA results, combined with further reductions in capital spending and cash interest, which will position the company to generate solid and sustainable free cash flow, even with the expectation that cash taxes will increase, absent the continuation of bonus depreciation.

Windstream is a buy below 11.