Prospect Capital Corp.: Should You Still Buy This 10.5%-Yielding BDC Dividend Dog?

Summary

• Prospect Capital Corp. released Q2-2019 financial results on Wednesday after the market closed.
• The BDC reported net investment income that matched expectations but also reported a rather steep NAV drop based on unrealized losses in its portfolio.
• Shares are now priced at a 24 percent discount to Q2-2019 NAV.
• An investment in PSEC yields 10.5 percent.

Prospect Capital Corp. (NASDAQ:PSEC) reported financials for its second fiscal quarter yesterday after the market closed. The business development company covered its dividend with net investment income in the last quarter but also reported a sequential NAV drop. Prospect Capital Corp. makes a moderately attractive value proposition for high-yield investors that seek to capture high, recurring dividend income going forward. An investment in PSEC at today's price yields 10.5 percent.

Prospect Capital Corp. - Earnings Snapshot

Prospect Capital Corp. reported results for its second fiscal quarter on Wednesday that matched estimates. The business development company said it pulled in $0.22/share in net investment income compared to $0.23/share in NII in the previous quarter. The consensus was for Prospect Capital Corp. to also report Q2-2019 earnings of $0.22/share.

However, Prospect Capital Corp.'s net asset value dropped in the last quarter. The BDC said its NAV hit $9.02/share at the end of the December quarter due to unrealized losses in its portfolio. In the previous quarter, Prospect Capital Corp.'s net asset value stood at $9.39/share in the previous quarter, which reflects a 3.9 percent decrease.

Here's a NAV bridge.

Source: Prospect Capital Corp. Earnings Release

In terms of portfolio quality, the business development company saw an uptick in non-accruals which rose from 2.4 percent in the quarter ending September to 3.6 percent in the quarter ending December. Loans are placed on non-accrual status if the collection of interest payments and the repayment of the principal is at risk. The deterioration in Prospect Capital Corp.'s portfolio quality and associated NAV drop were the two negatives in the BDC's earnings release.

Here's Prospect Capital Corp.'s non-accrual trend over the last six quarters.

Source: Achilles Research

Distribution Coverage

Prospect Capital Corp. outearned its dividend with net investment income in the last quarter, which is good for investors as it signals dividend sustainability. Prospect Capital Corp. pulled in an average of $0.21/share in net investment income in the last five quarters (PSEC's new dividend went into effect five quarters ago) compared to an average cumulative dividend payout of $0.18/share.

Here are Prospect Capital Corp.'s dividend coverage stats over the last twelve quarters (quarters depicted in the chart below are calendar quarters).

Source: Achilles Research

Prospect Capital Corp. also declared three more stable dividends of $0.06/share each for the months of February, March, and April.

Considerable NAV Discount

Prospect Capital Corp.'s shares are currently priced at a ~24 percent discount to the last reported net asset value, but I expect this discount to widen again over the short-haul as investors will most likely use the opportunity to ditch Prospect Capital Corp.'s shares in light of last quarter's NAV drop.

Prospect Capital Corp. remains one of the cheapest BDCs in the sector based on P/NAV-ratio.

Data by YCharts

Should You Buy?

Prospect Capital Corp. makes an O.K. but not great value proposition at today's valuation point. In the past, buying Prospect Capital Corp. at a 30-40 percent discount to NAV was often a good opportunity to open a starter position and earn attractive risk-adjusted returns. The NAV drop and decrease in overall portfolio quality will likely trigger an expansion of Prospect Capital Corp.'s NAV discount in the coming days. I consider PSEC a "Strong Buy" below $6 and would consider buying again at $6.30 (implying a ~30 percent discount to Q2-2019 NAV).

Risk Factors Investors Should Consider

Prospect Capital Corp. is vulnerable to an economic downturn that could put pressure on the dividend in case the BDC's portfolio quality and distribution coverage deteriorate. Investors that are worried about a U.S. recession may want to shift funds into higher-quality business development companies, such as the two discussed here and here.

Your Takeaway

Prospect Capital Corp. continued to cover its dividend payout with net investment income in the last quarter, which was the good news. The bad news was that the BDC saw a surprisingly steep drop in NAV (~3.9 percent) quarter over quarter, thanks to unrealized portfolio losses related to market turmoil in Q4-2019 and a decrease in credit quality. I'd again consider buying PSEC at a 30%+ discount to the last reported NAV, potential entry price ~$6.30 or below.

Analyst’s Disclosure: I am/we are long PSEC, MAIN, GSBD. 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.