Prospect Capital: This High-Yield Investment Is The Best In BDC, Part Two

Mar. 4.14 | About: Prospect Capital (PSEC)

In the first part of our article on Prospect Capital (NASDAQ:PSEC), we took a deeper look at the fundamentals of the BDC and assessed why it is one of the best names in the industry. In this article, we want to take some more time to examine several valuations as well as predict a price target for the company moving forward. We will be looking at multiples valuation as well as assessing a price target through projections. Further, we will examine the key factors influencing the company.

Multiples Valuation

Assumptions

1. We will use three multiples to calculate the target price for PSEC. P/E valuation accounts for 50% of the final target price; P/B and EV/EBITDA each accounts for 25% of the final target price.

2. The difference between the multiples of PSEC and Peer Group Average will decrease to zero.

3. We will use trailing multiples to perform the valuations.

4. Current Closing Price is $11.04 as of 02/28/14.

5. EPS, BVPS (Book Value Per Share), EBITDA used in the multiples are from the latest filings of PSEC.

As of 02/28/14

EPS

BVPS

EBITDA

PSEC

1.27

10.73

0.40 million

Click to enlarge


(Source: Bloomberg Terminal)

6. P/E, P/B and EV/EBITDA of PSEC and Peer Group Average are listed below.

As of 02/28/14

P/E

P/B

EV/EBITDA

PSEC

8.55

1.03

12.93

Peer Group Avg

12.38

1.17

11.48

Click to enlarge

(Source: Bloomberg Terminal)

7. We will take multiples expansion into consideration and do the valuation under 5 scenarios.

The result of P/E valuation is listed below:

P/E Expansion

Target P/E

Target Price

Upside Potential

-10%

11.14

14.14

28%

-5%

11.76

14.93

35%

0

12.38

15.75

42%

5%

12.99

16.49

49%

10%

13.62

17.29

56%

Click to enlarge

In the P/E valuation part, under the worst scenario, there is an upside potential of 28% for PSEC.

The result of P/B valuation is listed below:

P/B Expansion

Target P/B

Target Price

Upside Potential

-10%

1.05

11.63

5%

-5%

1.11

12.27

11%

0

1.17

12.92

17%

5%

1.23

13.56

23%

10%

1.29

14.21

29%

Click to enlarge

In the P/B valuation part, under the worst scenario, there is an upside potential of 5 % for PSEC.

The result of EV/EBITDA valuation is listed below:

EV/EBITDA Expansion

Target EV/EBITDA

EV (Million)

Target Price

Upside Potential

-10%

10.33

4.13

7.62

-31%

-5%

10.91

4.36

8.38

-24%

0%

11.48

4.59

9.13

-17%

5%

12.05

4.82

9.88

-10%

10%

12.62

5.05

10.63

-4%

Click to enlarge

In the EV/EBITDA valuation part, under the best scenario, there is a downside potential of -4% for PSEC.

Based on assumption 1, the final target price for PSEC under multiples valuation equals to,

15.75*0.5+12.92*0.25+9.13*0.25=13.39.

Projections

2009

2010

2011

2012

2013

2014E

Net Increase in Net Assets Per Share

1.11

0.33

1.38

1.67

1.07

Distributions Per Share

1.62

1.33

1.21

1.22

1.28

1.32

Difference(Line 1-Line 2)

-0.51

-1.00

0.17

0.45

-0.21

Dividend Yield (%)

17.61

13.78

11.97

10.71

11.85

11.86

Weighted Average Shares Outstanding(Million)

35

19

118

190

220

Debt/Equity

0.26

0.21

0.31

0.45

0.61

Click to enlarge

Source: Company Filings and Oxen Group Estimate

Change of Key Factors

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In the recent three years, under the worst situation, net increase in net asset per share is 0.21 lower than the dividend distribution per share. To completely cover the distribution, net increase in net asset per share has to be 19.62% higher. If we hold PSEC's operating situation the same (the increase of debt/equity leads to the same increase in net increase of net asset per share), to cover the dividend distribution, debt/equity has to be increased to 0.73 from 0.61 (19.62% increase), which is lower than management's upside limit of 0.75. This situation is consistent with what we have talked about in Part 1 of our report that to increase the leverage is a feasible option for PSEC (we do not recommend the option of continuous issuance of common stock because the dividend cannot be covered even under the current situation).

We chose to use the average growth rate to estimate the dividend per share and dividend yield. Target Price equals to 1.32/11.86%=11.13.

So far, we have adopted multiple and dividend projection, respectively to reach the target price. To get our final target price, we decide to give 50% weight to each method. Thus our final target price equals to 0.5*13.39+0.5*11.13=12.26

With shares at 11, we do see decent upside in our very conservative estimates. In our more aggressive scenarios, that we are definitely interested in due to our fundamental analysis that is bullish, we see the stock worth around $15. With a 12% dividend, and 2014 upside of 10-20% at least, this is a name we definitely like.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Business relationship disclosure: I have no business relationship with any company whose stock is mentioned in this article. The Oxen Group is a team of analysts. This article was written by David Ristau, one of our writers. We did not receive compensation for this article (other than from Seeking Alpha), and we have no business relationship with any company whose stock is mentioned in this article.