Prospect Capital Corp.: 10.6% Covered Yield And 26% Discount To NAV

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About: Prospect Capital Corporation (PSEC)
by: Achilles Research

Summary

Prospect Capital Corp. presented decent financial results for its first fiscal quarter yesterday after the market closed.

The business development company pulled in $0.23/share in net investment income, outearning its cumulative quarterly dividend payout of $0.18/share.

Shares are currently priced at a ~26 percent discount to net asset value.

An investment in PSEC yields 10.6 percent.

Prospect Capital Corp. (PSEC) released a convincing deck of financials for its first fiscal quarter yesterday after the market closed. The business development company once again outearned its dividend with net investment income which improved the company's distribution coverage considerably. Shares continue to sell for a large discount to net asset value, and an investment in Prospect Capital Corp. yields 10.6 percent.

Prospect Capital Corp. - First Fiscal Quarter Results

Prospect Capital Corp. reported better-than-expected results for its first fiscal quarter. The business development company said that it pulled in $0.23/share in net investment income in the last quarter which compares favorably to a consensus NII estimate of just $0.21/share, thanks to an increase in dividend income. A year ago, Prospect Capital Corp. earned just $0.18/share.

Since Prospect Capital Corp. earned more money than it paid out (and since the company didn't have any meaningful net realized gains/losses or saw a change in unrealized gains/losses in the last quarter), the BDC's net asset value increased from $9.35/share to $9.39/share at the end of the September quarter.

Here's a net asset value roll-forward.

Source: Prospect Capital Corp. Earnings Release

Prospect Capital Corp. - Portfolio Overview

Prospect Capital Corp. is structured as a business development company which means the BDC is required to distribute the majority of its earnings/taxable income to shareholders on a regular basis.

Prospect Capital Corp. primarily invests in U.S. middle market companies. The majority of its investments are relatively secure first and second liens.

Here's a portfolio snapshot as of the end of the June quarter (most recently available).

Source: Prospect Capital Corp. Investor Presentation

Prospect Capital Corp. is widely diversified in terms of industry. The business development company also has very little exposure (~3 percent) to the volatile energy industry.

Source: Prospect Capital Corp.

As far as portfolio quality is concerned, Prospect Capital Corp. has decent credit quality at the time of writing. Non-accruals (which are essentially non-performing loans), measured as a percentage of total assets and on a fair value-basis, hit 2.4 percent in the quarter ending September.

The lower the non-accrual ratio, obviously, the higher the portfolio quality.

Here's a non-accrual trend for PSEC for the last six calendar quarters.

Source: Achilles Research

What About The Dividend?

Prospect Capital Corp.'s distribution coverage stats continued to improve last quarter.

The business development company outearned its cumulative quarterly dividend payout in each of the last four quarters (Prospect Capital Corp. previously underearned its dividend for a couple of quarters, see chart).

Here are Prospect Capital Corp.'s major dividend coverage stats, updated for the first fiscal quarter (Q3-2018).

Source: Achilles Research

Since Prospect Capital Corp. now outearns its dividend with net investment income, I don't see the dividend being at risk over the short haul. Though management slashed its dividend payout twice in three years, the current dividend, in my opinion, is quite safe.

Prospect Capital Corp. also declared three more stable monthly dividends of $0.06/share each for the months of November, December and January.

Valuation

Prospect Capital Corp. - partly due to its large dividend cuts in the past - sells for a considerable discount to net asset value.

Today, income investors could scoop up PSEC at a ~26 percent discount to net asset value.

Chart PSEC Price to Book Value data by YCharts

Prospect Capital Corp. is also by far the cheapest BDC in the sector in terms of P/NAV-ratio.

Chart PSEC Price to Book Value data by YCharts

Strategy

In another piece I penned on PSEC, titled "Prospect Capital Corp.: Here's Your Action Plan," I said this:

I am going to buy Prospect Capital again if the share price dips below $6.50 (implying a ~3 percent drop from today's price), which translates into a 30 percent NAV discount. A price below $6.50 is a 'Buy' in my opinion; anything below the $6.00 price level (equivalent to a 35 percent or larger discount to NAV) is a 'Strong Buy.'

This recommendation has not changed in light of Prospect Capital Corp.'s most recent earnings release. I am going to add to my existing long position only below the $6.50 price level. Hence, I currently rate PSEC as a "hold."

Risk Factors Investors Need To Consider

Prospect Capital Corp. is a high-risk, high-yield income vehicle, and the company has reduced its high dividend payout in the past. The BDC has shown a willingness to underearn its dividend payout in the past, before ultimately cutting its dividend. Should PSEC again start to underearn its dividend with NII, this would be a major red flag for income investors. Dividend investors need to continuously monitor the BDC's distribution coverage stats going forward in order to react timely to a deterioration in portfolio quality and/or earnings power.

Your Takeaway

Prospect Capital Corp. released robust financial results for the first fiscal quarter as the BDC's net investment income widely exceeded its going cumulative distribution rate. Further, the BDC announced three more stable dividends which provides short-term dividend visibility. I don't expect Prospect Capital Corp., in light of improving distribution coverage stats, to reduce its payout in the next 2, 3 quarters. I currently rate Prospect Capital Corp. as a Hold, but have previously stated that I would consider adding to my long position at or below $6.50.

If you like to read more of my articles, and like to be kept up to date with the companies I cover, I kindly ask you that you scroll to the top of this page and click "Follow." I am largely investing in dividend paying stocks, but also venture out occasionally and cover special situations that offer appealing reward-to-risk ratios and have potential for significant capital appreciation. Above all, my immediate investment goal is to achieve financial independence.

Disclosure: I am/we are long PSEC, MAIN, ARCC, GAIN.

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.