Protected Principal Retirement Strategy: Dipping Into The Shallow End Of The BDC Pool

Includes: OXSQ, PSEC
by: Akaralph

In two SA articles I wrote on December 13 (here) and on January 6 (here), I addressed the potential place that business development companies (BDCs) have in the Protected Principal Retirement Strategy portfolio. I provided an overview of the primary metrics used to evaluate them, and identified two specifically that met most, or all, of my criteria. The following presents an update on each, the rationale for purchase and information pertaining to the purchase of each for our portfolio.

Prospect Capital (NASDAQ:PSEC)

PSEC is a full-service BDC, i.e., they offer most any type of financing (mezzanine, buyouts, recapitalization, etc.) across a wide range of industry sectors. It seems to primarily target companies in the energy and industrial sectors. Typical investments range from $10 million to $250 million.

Evaluation metrics of primary importance in making a purchase decision of a BDC focus on the present (and potential future yield), the current dividend/earnings per share ratio, next year's dividend/earnings per share ratio, and the present price/net asset value.

PSEC has recently increased its monthly dividend from $.102 to $.11, and currently yields almost 12 percent. Earnings for the quarter ended in September 2012 were $.46, easily covering the dividend.

PSEC's 2012 dividend/earnings per share ratio is .89, and based upon the 2013 earnings estimate of $1.37, the forward dividend/earnings per share ratio would be around .97.

The price to net asset value is 1.00.

During the first week of this year, Barclays initiated coverage on PSEC with an "Overweight" rating and a price target of $12.

My desire for initiating a position in PSEC was to enter when the yield reached about 12.5 percent. Using the formula Target Price = Dividend/Desired Yield, I came up with an entry price of approximately $10.56 ($1.32/.125).

Around mid-December, PSEC announced an offering of senior convertible notes. The underlying stock price reached a low in the $10.50s, and I was able to purchase a small position (500 shares) for the portfolio at $10.60 (close to my target).

As I have mentioned in prior articles, I am not much of an advocate of technical analysis (except for trendlines and gaps). PSEC has a gap to be filled in the low $10.40s, and I have a limit order in for additional shares should that gap be filled.

TICC Capital (TICC)

TICC invests in a manner similar to PSEC, except it typically invests between $5 million and $30 million per transaction, primarily in technology companies.

In September 2012, TICC increased its quarterly dividend from $.27 to $.29, and yields about 11 percent. Quarterly earnings were a little light of covering the dividend.

For the full year (2012), TICC's dividend/earnings per share ratio should be .99, and for 2013, the ratio is estimated to be .95.

The price/net asset value is 1.03 (a little outside of my ideal criteria).

Barclay's also initiated coverage on TICC at "Equal Weight."

My target entry for TICC was a yield of 12 percent, or a price around $9.66 ($1.16/.12). Shortly after the Ex-Div date of 12/13, the stock price declined to these levels and I purchased 800 shares between $9.70 and $9.80.

TICC has moved up nicely since the purchase, however, there is a gap to be filled around the $10.15 level, and I might be tempted to enter a limit order for a few hundred more shares at that level.

Disclosure: I am long PSEC, TICC. 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.

Additional disclosure: The information presented in this article does not constitute a buy recommendation for any of the stocks discussed.