Prospect Capital’s Quarter a Buying Opportunity

Source: Thinkstock

Source: Thinkstock

Everybody needs to own a solid dividend payer. In my prior articles, I have made recommendations for some real estate investment trusts — my two favorite being Annaly (NYSE:NLY) and Javelin Mortgage (NYSE:JMI). I continue to recommend both at current levels as its dividends are secure and earnings have been strong.

One stock I have owned since the summer of 2013 is a business development company, or BDC. The company is Prospect Capital (NASDAQ:PSEC), whose primary operations involve lending money to small companies to help them grow and expand, while being paid back with interest. In a way, it is similar to a venture capital fund. The stock has been solid. It has traded in a range of $10.00 to $12.00 for years. A solid strategy has been to buy on the dips and reinvest the dividends to compound the investment. The best part? This stock sports a 12 percent yield and pays monthly dividends.

Further, after declaring dividends for the remainder of 2014, it will have paid out 74 consecutive payments. The dividends are being raised topping out at 11.0600 cents per share in December 2014. The purpose of this article is to highlight the key points of the quarterly report and discuss why today’s pull back is an opportunity.

Signs of strength

At the time of this writing, Prospect Capital is down 5 percent to $10.24. It is in response to the company’s quarterly report, which overall was strong but some saw as disappointing. For the quarter, Prospect Capital saw a net increase in net assets resulting from operations of $82.1 million or $0.26 per weighted average number of shares. In the comparable year ago quarter, Prospect Capital saw $44.4 million or $0.20 per weighted average number of shares for the quarter. Thus, the net increase in net assets increased year-over-year by 84.8 percent and 30.0 percent on a dollars and per share basis, respectively. Net investment income, or NII, was $98.5 million or $0.31 per weighted average number of shares for the quarter. For comparable 2013 quarter, Prospect Capital’s NII was $59.6 million or $0.26 per weighted average number of shares for the quarter. Thus, NII increased year-over-year by 65.3 percent and 19.2 percet on a dollars and per share basis, respectively.

As mentioned above, Prospect Capital is increasing monthly cash distributions to shareholders through December 2014, ranging from 11.0425 cents per share for May 2014 to 11.0600 cents per share for December 2014. Prospect’s current stock price of $10.24 as of May 5, 2014 delivers to shareholders a current dividend yield of 12.7 percent. Prospect Capital is able to raise the dividends because the company generated cumulative NII in excess of cumulative distributions to shareholders since Prospect’s initial public offering (IPO) ten years ago.

For the June 2013 fiscal year, Prospect Capital’s NII in excess of distributions to shareholders was $53.4 million and $0.26 per share. For the nine months ended March 31, 2014, distributions were in excess of NII by $16.8 million and $0.04 per share, distributing some of the excess, which was built up in the previous two fiscal years. Since Prospect Capital’s IPO ten years ago, the company will have distributed $13.26 per share to initial shareholders and over $1.3 billion in cumulative distributions to all shareholders by the end of 2014.

Some weakness

Prospect Capital’s net asset value per share as of March 31, 2014 declined to $10.68 per share, a loss of $0.05 per share from December 31, 2013 and $0.04 per share from June 30, 2013. In total, Prospect Capital has $3.56 billion in net assets. Prospect Capital’s debt to equity ratio stood at a significant 67.9 percent after subtraction of cash and equivalents as of March 31, 2014, up from 48.0 percent as of December 31, 2013 and 55.7 percent as of June 30, 2013.

Partially explaining this increase is Prospect Capital’s objective to grow net investment income per share in the coming quarters by focusing on matched-book funding to finance disciplined and accretive originations across its diversified lines of business. Thus, as a result of some of this activity, the quarter may appear weak. Here is a summary of the investments made during the quarter, which will pay off in future quarters, potentially translating to increased dividends to shareholders:

  • January 8, 2014 — a $161.5 million follow-on investment in Broder Bros., Co. to support an acquisition.
  • January 17, 2014 — a $6.6 million follow-on investment in APH Property Holdings, LLC to acquire the Gulf Coast II Portfolio, a portfolio of two multi-family residential properties located in Alabama and Florida.
  • January 31, 2014 — a $4.8 million follow-on investment in NPH Property Holdings, LLC to acquire Island Club, a multi-family residential property located in Jacksonville, Florida.
  • February 4, 2014 — a secured debt investment of $25.0 million in Ikaria, Inc., a biotherapeutics company focused on developing and commercializing innovative therapies designed to meet the unique and complex medical needs of critically ill patients.
  • February 5, 2014 — an investment of $32.4 million to purchase subordinated notes in ING IM CLO 2014-1, Ltd.
  • February 7, 2014 — an investment of $23.1 million to purchase subordinated notes in Halcyon Loan Advisors Funding 2014-1 Ltd.
  • February 11, 2014 — $7.0 million follow-on investment in InterDent, Inc. to fund an acquisition.
  • February 11, 2014 — secured debt investment of $10.0 million in TriMark USA, LLC, a foodservice equipment and supplies distributor and provider of custom kitchen design services.
  • February 19, 2014 — provided $17.0 million of secured floating rate financing to support the acquisition of Venio LLC by Lovell Minnick Partners. Keane provides unclaimed property services to many of the nation’s largest financial institutions including transfer agents, mutual funds, banks, brokerages, and insurance companies.

  • March 7, 2014 — provided $78.0 million of senior secured floating rate debt to support the continued growth of Tolt Solutions, Inc., a retail-focused information technology services company, providing customized network architecture solutions, installation, deployment, maintenance, and customer support to retailers nationwide.
  • March 12, 2014 — secured debt investment of $10.0 million in Tectum Holdings, Inc., a manufacturer of aftermarket accessories for the light-truck market.
  • March 18, 2014 — $28.3 million follow-on investment in LaserShip, Inc., of which $22.25 million was funded at closing, to finance an acquisition.
  • March 20, 2014 — New Star Metals, Inc. repaid a $50.5 million loan.
  • March 25, 2014 — a secured debt investment of $28.5 million in Global Employment Solutions, Inc., a provider of contract and permanent placement staffing services, with a strategic focus on the information technology segment.
  • March 26, 2014 — Material Handling Services, LLC repaid a $64.5 million loan.
  • March 28, 2014 — provided $277.5 million of secured floating rate debt to support the refinancing of Instant Web, LLC, a provider of direct marketing solutions to direct marketers for acquisition and loyalty programs in the United States.
  • March 31, 2014 — a secured debt investment of $60.0 million in United States Environmental Services, LLC, a provider of industrial, environmental, and maritime services in the Gulf States region.
  • March 31, 2014 — provided a $153.5 million follow-on senior secured debt investment in Progrexion Holdings, Inc. to fund a dividend recapitalization.
  • March 31, 2014 — invested $246.3 million in cash and issued 2,306,294 unregistered shares of common stock to support the recapitalization of Harbortouch Payments, LLC (Harbortouch), a provider of transaction processing services and point-of-sale equipment used by merchants across the United States. Through the recapitalization, Prospect acquired a controlling interest in Harbortouch. After the recapitalization, Prospect received repayment of the $23.9 million loan previously outstanding.
  • March 31, 2014 — provided $78.5 million of debt and $14.1 million of equity financing to Echelon Aviation LLC (Echelon), a newly established aircraft leasing portfolio company. Prospect Capital is the controlling equity owner of Echelon.

Conclusion

While I have recommended some strong real estate investment trusts in the past, and continue to do so, BDC’s are strong investment opportunities. On the surface, the Prospect Capital quarter may have appeared weak to some. The stock is being nailed and it is a buying opportunity in my opinion. The company has made significant investments in the prior quarter and I expect these to pay off in future quarters. Prospect Capital also declared dividends for the remainder of the year, and is raising the monthly distributions. While the dividend coverage ratio was less than one (meaning the company paid out more than it earned), I suspect this is temporary given the investments made. With a book value of $10.68, and having paid out over $13.00 in dividends in a decade per share, the stock is at a significant bargain at current levels.

Disclosure: Christopher F. Davis is long shares of Prospect Capital and Javelin Mortgage Investment.

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