There has been plenty of discussion surrounding Prospect Capital (NASDAQ:PSEC) in recent weeks. The company posted its quarterly results not too long ago and they were met with quite a bit of concern by the market.
A weak quarter fuels anxiety
Looking over Prospect Capital's fiscal Q1 2017 numbers, it is easy to see why the market go a bit jumpy. Net investment income, or NII, was just $78.9M or $0.22 per share, compared to $91.4M and $0.26 the previous quarter and, $91.2M and $0.26 one year ago. Anyway you slice it, this represents a 15% decline. Worse, Prospect Capital as not close to covering its $0.25 per share dividend, with a weak coverage ratio of just 0.88x versus 1.04x in the prior periods.
Even when looking at distributable income, which is what Prospect Capital needs to payout to avoid taxes, this metric came in at $0.22 per share versus $0.26 per share in the previous quarter and $0.28 one year ago. This is an even sharper 22% decline year over year and represents a fall in the coverage ratio to 0.88x versus 1.12x.
Prospect Capital was underinvested
While seeing both DI and NII not cover the dividend for the quarter is not good, it is hardly a disaster for Prospect Capital. The reason for the weak numbers is simple-- underinvestment. After the major Harbortouch sale in fiscal Q4 2016, Prospect Capital was left with $160.7M in cash in the quarter that was not generating a return. The company was also underleveraged, with weighted average portfolio net leverage falling to 4.07x EBITDA versus 4.18x last quarter, and 4.36x a year ago.
Indeed, Prospect Capital noted that if it had booked another $460M of 10% annualized coupon earning assets in the quarter, using its cash and credit facility, that its net income would have higher by $7.1M before any structuring fee income from these originations.
Doing the math, this would have probably been good enough to push NII up to $0.25 per share, covering the dividend. This suggests that Prospect Capital can likely cover its dividend if only it were to get more active with its investing.
Net asset value increases slightly after adjusting for dividends
While Prospect Capital's income generation took a hit from lack of investing, its portfolio apparently saw a gain in value in the quarter. Net asset value per share "NAV" was $9.60, down two cents from last quarter. Keep in mind that the dividend was three cents over NII, so essentially this was a return of capital. In other words, you would expect NAV to fall three cents rather than two, so there was a one cent increase. As a result, Prospect Capital's real economic return during the quarter, dividends minus changes to the net asset value, was $0.23 per share, or ~9.6% annualized.
Dividend reaffirmed through January 2017
Lastly, it does not appear that Prospect Capital will be changing its dividend policy anytime soon. The company just declared 3 monthly dividends through the end of January 2017 at the same $0.25 per share quarterly level.
8.333 cents per share for November 2016 (record date of November 30, 2016 and payment date of December 22, 2016);
8.333 cents per share for December 2016 (record date of December 30, 2016 and payment date of January 19, 2017); and
8.333 cents per share for January 2017 (record date of January 31, 2017 and payment date of February 16, 2017).
One or two quarters of not covering the dividend is unlikely to force Prospect Capital in cutting its dividend. Spillback income per share, basically excesses from prior periods, stood at $0.27 per as of quarter end which is down from $0.31 last quarter and flat year over year.
With the stock trading at a 16% discount to NAV and yielding 12.5%, Prospect Capital remains a hold in my book. I do not think the concern over its ability to pay the dividend at the current level is justified. Yes, business was down last quarter. But as noted above, they have some buffer room with the excess distributable income and have ample liquidity to boost returns.
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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.