Prospect Capital: How Safe Is The Dividend?

| About: Prospect Capital (PSEC)
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Summary

Prospect Capital is scheduled to report fiscal Q3 earnings in a couple of weeks.

The company beat expectations last quarter and the stock is up 30%.

Stable income, steady NAV and a safe dividend are what the market needs to stay happy. Any more is gravy.

Prospect Capital Corporation (NASDAQ:PSEC) is scheduled to report earnings May 10th. Last quarter the company beat NII expectations along with a positive forward outlook. What can we expect this quarter?

Net Investment Income Steady

Net investment income should remain steady but there is a chance it may be a little stronger. One of the long running efforts of management has been to roll lower yielding assets into higher yielding ones. These efforts have been bearing fruit in recent quarters and could do so again this quarter, serving to increase net portfolio yield. At last report, the portfolio yield was 13.3%, up 1% YOY and 0.3% from the previous quarter.

The analysts agree with this assessment. The low estimate is $0.24 and high is $0.29 with an average of $0.26. Consensus rose by a penny just after the release of the previous quarter's results and have held steady since then. In that time, full-year consensus rose from $1.01 to $1.05 before stabilizing at $1.04.

NAV And Discount Still Provide Opportunity

Net asset value fell last quarter, about -5%, but this fall should not be continued this quarter. The drop was due largely to market conditions and not due to a material defect in the portfolio. According to statements in the fiscal Q2 earnings report the decline was "unrealized depreciation based on volatility in the capital markets."

"We estimate approximately 74% of the unrealized write-down we experienced this quarter related to macro changes in the capital markets as opposed to specific portfolio credit issues, approximately 18% related to energy-related companies in the portfolio and the remaining 8% related to specific non-energy individual credit matters."

Since then, stabilization in the energy market and credit market has been seen. Barring unforeseen deterioration, this stabilization should support NAV if not affect an increase.

The company's discount to NAV remains steep. Even with the recent run up the stock is trading at a 20% discount. Those who got in when it was trading at 30% got a really great deal, but at this level, the deal is still pretty good. The long running average is closer to 12%, providing plenty of room for the stock to run up as sentiment in the BDC arena improves. A move in line with the average discount could put the stock at $8.50.

Dividend Stable And Healthy

A dividend of $1.00 annually, paid monthly, should remain stable. At current prices, this is about 13%. The distribution is more than covered by NAV and safe in that respect. Even if NII comes in at the low end of the range, $0.24, distribution remains covered into the next quarter. The company already produced earnings of $0.54 per share in the first half; $0.24 brings this up to $0.78, or 78% coverage three quarters through the year. Using low estimates, coverage should run at least 102% into the end of the year. Using high estimates, it goes up to about 110%.

Add in the fact that both top executives at the company have more than doubled their holdings over the past two quarters provides additional reason to think the dividend is safe.

Updates On Spin Offs

Spin-offs were a hot topic last year when the company began to make the first moves in three potential spins. Recently this talk has died down but should not be forgotten. Possibilities for spins included parts of the CLO, estate and online lending portions of the portfolio and were contingent on a number of factors. Factors included regulatory hurdles and market conditions; regulatory hurdles were not expected to be great and market conditions have improved. The broad market is trading near its all-time high. Headlines in the news also point to the possibility as more and more sources report a warming of the stagnated IPO market.

The spins are expected to unlock shareholder value through multiple expansions and other avenues intended to drive portfolio growth. If they happen, yay. If not, the sub-businesses will still be positive additions and help drive earnings into the future.

Sales Of Shares Below NAV

The company has a history of selling shares below NAV in order to raise capital for portfolio growth. This practice was halted over a year ago as share price was driven down but are still on the table. The company made provisions last fall for the possibility but as yet, it has not been acted on. Based on comments from management, the move was more to help secure the company's investment grade credit rating than anything else. If they do decide to raise money in this way, it may dilute shareholder value in the near term but likely make up for it in earnings down the road.

Conclusion

We can expect a decent earnings report this quarter. NII should be stable, there is a possibility for it to beat, the dividend is healthy, yield is still near 13%, outlook is good and the discount to NAV remains attractive. Now that the stock is breaking above resistance, it could easily move higher until earnings, and then earnings could drive momentum. If earnings are on the high side or NAV improves, the $8.50 price target will be low indeed.

Disclosure: I am/we are long PSEC.

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.