NexPoint Credit Strategies - Down 6% From All-Time High, Time To Buy?

Aug. 6.14 | About: NexPoint Credit (NHF)

Summary

Pays 6.2% dividend with 2.9 months of dividend payments sitting in the bank.

In July, the portfolio manager purchased $1.36MM of the stock at $12.33.

Last week's mini-selloff gives an investors an opportunity to pick up the stock 5% cheaper than the portfolio manager.

In my first article, I described my mechanical method for trading Closed-End Funds. Monday morning, I put some money to work and added to my position in NexPoint Credit Strategies (NYSE:NHF). I was happy to do so as I had sold some last week 5% higher.

NexPoint Credit Strategies is a Closed-End Fund that "is invested primarily in below investment grade debt and equity securities and has the ability to hedge risk." As of March 31, 2014, the Fund was 6.6% in Cash, 26.0% Fixed Income and 67.5% Equities/Other. The average market capitalization of its equity positions was $4.4B and the weighted average credit rating of its bonds was B. The top 5 positions are American Airlines Group, Media General, Freedom REIT, Aal Rights, and a short in Oracle.

Friday's closing price of $11.67 is down 6.1% from its all-time high of $12.43. Investors have been burned by this stock in the past when the Fund consistently cut its payout from November 2008 to February 2012 due to issues caused by the Credit Crisis.

The primary concern of NHF investors is the safety of the dividend. On August 1, 2014, the Fund announced that it would pay a dividend of 6c a share with an ex-dividend date of August 20 and a pay date of August 29. The unaudited earnings reveal that the dividend is 101.8% covered by net income. Undistributed net income (UNI) was $11.2MM or 2.9 months of dividend payments. Based on this information, the dividend appears very safe.

The primary catalyst for price appreciation would be a dividend increase. The Fund has raised the dividend 5 times in the last 17 months. Every month I monitor the net income of the Fund which now stands at 6.11c and the UNI (described above). Unfortunately, the UNI has fallen from $15.8MM at the end of May to $11.2MM at the end of July. This may be what is giving the market a cause for concern and a reason to sell the stock.

My confidence is high, however, because the man who knows the most about the Fund, the Portfolio Manager James Dondero, has been accumulating the stock at these prices. Insider Insights indicates that the PM has a program of buying $1.3MM of the Fund every month.

Month $ Shares Price
July 2014 1,357,866 110,127 12.33
June 2014 1,324,273 114,260 11.59
May 2014 1,323,596 114,174 11.59
April 2014 1,316,288 117,768 11.18
March 2014 1,309,164 113,643 11.52
February 2014 1,284,678 120,854 10.63
January 2014 1,278,239 129,102 9.90
December 2013 1,269,992 139,867 9.08
November 2013 1,261,808 144,537 8.73
October 2013 1,253,138 159,839 7.84
September 2013 1,244,214 163,928 7.59
August 2013 1,237,561 162,623 7.61
Total 15,460,817 1,590,722 9.72
Click to enlarge

The Fund has made the Manager $3.1MM from price appreciation on these purchases alone (he has more shares than these) plus another $500K in dividends.

As of Friday's close, Net Asset Value was $13.21 while the closing price was $11.65 which is a discount of 11.7%. Using data provided by CEFConnect.com, I calculate that the weighted average P/D over the last 5 years has been 9.8%. Should the P/D revert to the mean, this represents a price rise of 2.0%.

Price NAV P/D 6mo Avg 1yr 3yr 5yr
11.65 13.21 -11.7% -11.3% -13.3% -10.9% -8.3%
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Source: CEFConnect.com

NAV performance over 5 years has been steady with a weighted average of 28.5%.

1mo 3mo YTD 1yr 3yr 5yr
-3.6% +5.6% +20.2% +59.1% +28.0% +23.6%
Click to enlarge

Should the fund perform at its average long-term appreciation, I see potential returns of 30+%.

In conclusion, I feel very comfortable adding to or initiating a position in NHF here. Monitor the monthly dividend announcements for net income coverage of the Dividend as well as Undistributed net income. I am confident that when the Manager feels confident, he will raise the dividend. He owns over 3.5MM shares, so each half penny rise in the dividend puts another $210,000 in his pocket annually. I love it when the PM's interests match my own.

Disclosure: The author is long NHF. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.