While Prospect Capital Corporation (NASDAQ:PSEC) continues to report record originations, the company is failing to pull those numbers to the net investment income (NII) line. Not only did the last quarter show essentially flat NII, but also it occurred on a substantially higher share base.
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 (NYSE:BDC) under the Investment Company Act of 1940.
As highlighted in a previous article, the record origination pace brought into question fears over another equity raise similar to the one that crushed the stock back in November. Instead the company took the steps to utilize an ATM type transaction to raise equity via selling 17.2 million shares over the last three months. While helping to prevent a massive sell-off, does this type of transaction place a ceiling on the stock? The constant selling of shares has to work similar to a stock buyback plan that places a floor on a stock.
After origination records of more than $750M in Q4, the company shockingly exceeded that with a huge close to Q1 that helped the origination total hit $784.4 million. The company only had repayments of $102.5 million leading to net investments of $681.9 million for the quarter.
The June quarter is off to a strong start with $163.8 million of new and follow-on investments. Most of the loans are for senior secured loans or investments in residential apartments in Florida. Some investors are likely concerned about the increased investments in CLOs. Considering the issues of the last financial crisis, the instruments are nowhere near the toxic debt of the past suggesting the fear are over blown this time around.
Prospect lists a pipeline of $500 million that no doubt is impressive, but it still leaves investors wondering if the opportunities will be funded with more equity that limits the stock upside and dilutes earnings in the near-term. If the deals are truly worthwhile and the stock is undervalued, than the company needs to quit funding new originations via equity. The company should leverage up the balance sheet and let the stock run.
Net Investment Income Stalling
The biggest concern with Prospect Capital is that the NII has stalled even with the substantial increases in originations and equity raises. All that work on originating new loans yielding on average 13.9% doesn't do shareholders any good if it doesn't lead to an increase per share in the NII.
For Q113, the NII was $59.6 million or $0.26 per share. Unfortunately the NII was higher than last years $58.1 million, but the income per share was considerably lower than the $0.51 reported in Q112.
Prospect does forecast a potential jump in NII up to $0.32 a share for the current quarter assuming all goes well. Part of the gains will come from a full quarter of income contribution from the new originations during the March quarter that were mostly deployed during the last few weeks of the quarter.
Only Trading At Book Value
With a 12.2% dividend yield, most investors would think that this BDC would eventually trade substantially above book value. Prospect reported that the NAV dropped to $10.71 with the stock trading at $10.81 on the close Friday. In essence, the stock is trading virtually at book value though the company has gone six years without a loan hitting non-accrual. The stock has been a money machine for investors yet the 12% yield is consistently bypassed for lesser yielding stocks and even junk bonds. In essence, Prospect could be considered the ultimate high-yield bond, as the Barclays Capital High Yield Bond ETF (NYSEARCA:JNK) now only yields 6.4%.
In reality, very few BDCs actually trade considerably above book value. As the chart below shows, only Main Street Capital (NYSE:MAIN) trades at even a multiple above 1.2x book value. Other BDCs such as Ares Capital (NASDAQ:ARCC), Fifth Street Capital (NASDAQ:FSC), KKR Financial (KRN), Solar Capital (NASDAQ:SLRC) and TICC Capital (NASDAQ:TICC) trade in the general 1x book value of Prospect Capital.
5-Year Chart - Book Value
Bizarre Earnings Conference Call
In what has to be termed one of the most bizarre earnings conference calls, the company took numerous questions from private investors that bogged down any useful fundamental conversation. It even led to the company obtaining personal phone numbers on the public call of the private investors in question. On one hand, management should be commended for listening to questions from investors outside the mainstream of Wall Street analysts. On the other hand, allowing a few investors to sidetrack the conversation doesn't help the investment community understand the future prospects of the stock. In the future, the company should take precise questions from private investors and eliminate the rambling and follow-on questions.
In the end, an unidentified analyst peppered the management team about slowing down the origination pace in order to digest all of the equity and debt raised in the past few quarters. More time should've been spent on flushing out why or why not this analyst was accurate.
At the current stock price, Prospect Capital trades at a little above NAV. Patient investors should've jumped on the stock when it plunged to $10.25 last month for no apparent reason, but investors need to realize that every month passes and your missing out on a $0.11 distribution.
With the equity distribution agreement or ATM, it doesn't appear that the stock will see much of a swoon anytime soon though the plan will effectively cap the stock price from increasing much above book value. The noticeable attribute of Main Street Capital that trades considerably above book value was the limited origination pace during the first quarter. That BDC isn't constantly loaning money and raising equity with an unnoticeable benefit to existing shareholders.
Investors looking for solid monthly dividends can buy Prospect on the next swoon below NAV, but until the company becomes less aggressive the stock isn't likely to trade much above NAV.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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