In a market that can't get enough yield, it's interesting that a dividend grower can yield nearly 12%. In fact, Prospect Capital Corporation (PSEC) has consistently increased the monthly dividend ever since the bottom of the financial crisis impact in 2010.
Prospect Capital is a leading provider of flexible private debt and equity capital to sponsor-owned and non-sponsor-owned middle market companies in the United States and Canada. It trades as a closed-end investment company that has elected to be treated as a business development company ((BDC)) under the Investment Company Act of 1940.
Amazingly the stock can yield nearly 12% even though the company only had to shave the quarterly dividend payouts from $0.41 to $0.30 in the worst financial crisis in 70 years. While investors trade the stock as if extreme risk exists, most of the related BDCs came through the crisis with only minor burns.
Though the stock trades at Net Asset Value ((NAV)), the question remains whether investors will ever pay up for the high dividends.
Ultimately an investment in the BDC firms has to do with the quality of the transactions the company secures. The company had origination records of more than $2.25B in 2012 and more than $750M in Q4. These numbers were partially aided by additional capital raised during the year via public stock offerings.
Some recent transactions:
- January 15, 2013 - Provided $27M of secured second-lien debt financing for CHC companies, one of the leading outsourced providers of healthcare services to correctional facilities in the US.
- January 8, 2013 - Provided $70M of debt financing for the acquisition of Thomson Reuters Property Tax Services by Ryan, LLC.
- January 7, 2013 - Funded a $43.5M recapitalization of the businesses of Credit Central Holdings, Inc. The company is a specialty finance business based in South Carolina.
- January 4, 2013 - Funded a recapitalization of Valley Electric Company of Mt. Vernon, Inc. with $53M of combined debt and equity financing. The Washington based company is one of the largest 50 electrical contractors in the US.
- December 31, 2013 - Provided a $30M first-lien senior secured loan to support the recapitalization of Spartan Energy Services, a leading provider of thru tubing and flow control services to oil and gas companies operating throughout the US.
As these transactions highlight, the company has a diversified group of companies funded with different arrangements of debt and equity financing.
The dividend history is crucial when understanding the investment rationale for this stock. Knowing how a company that makes investments in middle market companies navigated the Great Recession helps understand the potential risk in this investment.
The company quickly went from quarterly dividend payments of below $0.20 in the middle of 2005 to nearly $0.40 by the end of 2006. In essence, the dividend spiked 100% right before the financial crisis and dropped in 2010 to more in line with the previous pattern. Note the 2010 cut dividend rate of $0.30 quarterly is 50% higher than the yield in 2005.
By mid-2010, the dividend was switched to monthly payments and has consistently increased a slight amount each month. The below table provided by the company highlights the history over the last 17 months:
Table - Dividend History
The stock remains at the mid-2012 levels after a stock offering crushed it at the start of November. The company sold 35M shares at $11.10 and combined with the Q3 earnings report sent the stock down to $9.60. A significant loss initially and a huge buying opportunity for alert investors.
Another article by BDC Review suggests investors should wait to buy the stock until after the Q4 earnings release and another potential equity offering. Clearly another drop below $10 would provide an extremely attractive entry point.
The following chart compares the stock to the portfolio companies and other BDCs over the last six months. American Capital (ACAS), Ares Capital (ARCC), Fifth Street Finance (FSC) and Main Street Capital (MAIN) have all had better returns in that time period.
data by YCharts
As mentioned in previous articles, American Capital provides a unique opportunity to purchase a BDC trading below NAV. Investors looking for yield instead should look no further than the consistently large payments from Prospect Capital. While the other BDCs provide solid and attractive dividends, Prospect has the highest offering at this point with Fifth Street close at over 10% and Main Street the lowest below 6%.
Prospect Capital doesn't offer the substantial value as American Capital, but it does offer a huge yield that investors appear to be ignoring. The feared risks in the sector appear overblown as the majority of the stocks survived the once in a lifetime Great Recession with only minor hiccups.
What would be your investment thesis if these stocks didn't face another scenario over the next 20 or 50 years? Especially considering the worst that happened to Prospect was a roughly 25% dividend cut. Clearly anybody holding the stock from when it hit nearly $19 at the end of 2006 has suffered some financial pain, but any investors holding for the long-term have collected some high dividends over that period.
No doubt the middle market firms invested in by Prospect will struggle during the next recession, but the stock should hold solid from these levels allowing investors to collect huge dividends.
Disclosure: I am long ACAS.
Additional disclosure: Please consult your financial advisor before making any investment decisions.