Recently, I've been reading a lot of chatter on SA about Medley Capital (NYSE:MCC) with some analysts and contributors claiming MCC will plummet to the sub-$1 range and others claiming it to be a great bargain. I thought I'd do a little arithmetic today to get to the bottom of things.
Before all else, let's establish a baseline. MCC is currently trading at $6.65 a share. We know for 100% certain, that in one week's time, MCC will pay a $0.30 per share cash dividend. One week is certainly not a long time to wait, so we may as well call it cash in hand. Thus, at the current moment, the net cost to purchase a share of MCC is really $6.35 a share - the baseline from which we will conduct this analysis.
First, let's make some projections using simple arithmetic over the next 20 quarters.
MCC as of Q2 2016 has a NAV per share of $9.80. Compared to its NAV per share of $12.00 in 2011, this represents an 18.33% drop over 5.5 years, or an annualized decline of 3.3% a year. Let's assume MCC will continue this trend.
Now, let's assume NII is about proportional to NAV (as would make sense). And further, we know for the last quarter, NII was 0.26 a share. And further, let's assume that henceforth MCC will distribute exactly the NII as dividend each quarter - an assumption we can make since as of now it is exceeding NII in distribution and as a BDC it must distribute almost the entirety of its NII to avoid corporate taxation.
Lastly, let's assume the stock continues to trade well below NAV. At the current moment, MCC trades at an approximate 32% discount to NAV. For our analysis, we will assume the stock price will trade at an even steeper 35% discount to NAV for the foreseeable future.
Given these assumptions, we make some projections for the returns for the next 20 quarters in the chart below:
As is demonstrated by the chart, if performance were to remain the same, MCC would net an investor buying in today an approximate 50% return (as denoted by the figure highlighted in green) over the next five years assuming the investor simply held the dividend returns in cash. If we take into consideration the effects of compounding, the actual return would likely be even greater than this.
A discussion of a few counterarguments
Now, of course, someone arguing the stock price will drop to sub-$1 will likely point to one of the following:
"Performance will continue to get worse." But realistically, how bad can it get? Even if we assume a 10% annualized decline in NAV that number in green at the very end is still $8.11, not a great performance, but still a net positive return and certainly not the end of the world. And besides, let's consider how unrealistic 10% is. At current 1x leverage, that would mean even with a 100% loss given default, we would have to see 5% of the loans default within the year. In its worst year, MCC has not seen that kind of decline and so it would be hard to project a sustained decline at this rate.
"MCC continually fails to cover the dividend." This is true, but wait. In our assumption, we assumed it would continually adjust the dividend to only distribute the NII, so our assertions still remain true. Furthermore, anyone saying this is looking at the dividend the wrong way? Coverage is actually irrelevant to the situation. When trading this far below NAV, we should instead view this as "MCC continues to make dividend distribution in excess of NII," which is a good thing. When trading below NAV, you are acquiring at a discount, whereas the distribution is paid at book value - an instant gain. And so, the longer MCC maintains dividends in excess of NII, the better off investors are.
"The fees are too damn high." Please refer to this article and read the second half for an explanation of why management fees are irrelevant to future share price.
"MCC is a Madoff style Ponzi and the books are cooked." Well, if you believe this, then I suppose you should step out of this stock, but I have not seen any substantive evidence to support this wild assertion.
Conclusions: Deal or No Deal?
MCC is certainly not a $1 stock, and at the current price levels is definitely not a sell. In fact, I would call it fairly priced and leaning toward a buy. At current price levels, there is very little downside risk, and the stock is very likely to generate a decent net return over the next few years. As for me, I will continue to hold my current shares and will definitely add to my position should there be any substantial price drops without the corresponding bad news in the near future.
Disclosure: I am/we are long MCC.
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.