We continue to cover Business Development Companies, known as BDCs, in our recent articles in 2022. In the low yield environment, BDCs emerged in 2021 as an increasingly popular choice for income investors searching for attractive yields. BDCs offer retail investors exposure to privately-held firms, which often are also funded by venture capital firms. BDCs got walloped in the COVID Crash of 2020, due to uncertainty as to how their portfolio companies would handle the altered environment of lockdowns and sheltering in place.
As it happens, the majority of them did well, with their holdings weathering the storm, which became increasingly evident as earnings reports rolled in.
Prospect Capital (PSEC) is one of the largest BDCs in the market, among the top 5 market caps for the industry. PSEC’s non-accruals have steadily improved over the past 6 quarters, declining from 0.9% of assets in Q2 ’20 to 0.4% in Q4 ’21.
Profile:
Founded in 2004, NY-based Prospect Capital (PSEC) provides private debt and private equity to middle-market companies in the US, with a focus on sponsor-backed transactions and direct lending to established owner-operated companies.
PSEC invests mainly in 1st and 2nd lien senior loans and mezzanine debt, which in some cases include an equity component. It provides capital to middle-market companies and private equity financial sponsors for refinancings, leveraged buyouts, acquisitions, recapitalizations, later-stage growth investments, and capital expenditures.
It seeks to invest between $10M to $500M per transaction in companies with EBITDA between $5M and $150M, sales value between $25M and $500M, and enterprise value between $5M and $1000M. It fund also co-invests for larger deals. It’s one of the largest BDCs, with $6.5B in assets under management. Insiders have significant ownership of PSEC, at 27.9%. (PSEC site)
Holdings:
1st Liens comprised 46.7% of PSEC’s portfolio, as of 12/31/21, down from 49.4% in Q3 ’21. Other Senior Secured Debt rose to 19.5%, vs. 16.5% in Q3 ’21. Equity Investments formed 23.1%, while Subordinated Notes were at 10.6%, as of 12/31/21. 76.8% of PSEC’s investments have underlying collateral.
The overall portfolio yield was 8.1%, as of 12/31/21, down from 9% in Q3 ’21, while performing interest-bearing holdings’ yield was 10.6%, vs. 11.6% in Q3 ’21:
Dividends:
Management maintained the $.06 payout, announcing the ex-dividend and pay dates for PSEC’s Q1 ’22 monthly distributions this week. They generally go ex-dividend in the last week of the month, and pay in the latter part of the following month.
At its 2/11/22 closing price of $8.33, PSEC yields 8.64%. PSEC has a -6.5% 5-year dividend growth rate, due to dividend cuts in 2015 and 2017.
PSEC had positive NII/Dividend coverage throughout 2021. We also factored in Realized Gains, to arrive at 2021 net coverage factor of 1.11X:
Taxes:
Distributions for January – July 2021 had 15.84% Return of Capital, 0% in August – December 2021. 2021 distributions were comprised of 41.6% short term capital gains or interest-related, 63.48% being Section 163J Interest Dividends. 97.32% were Non-Qualified.
Earnings:
PSEC reported its 2nd fiscal quarter, ending 12/31/21, this week.
During the December 2021 quarter, Investment Originations doubled, to $855M, and repayments were up ~$120M, boosting Net Originations by 4X, to $411M.
Management also posted to date figures for the current quarter, showing Originations of $284M, repayments of $108M, and net originations of $176M, so far in 2022:
Q4 ’21 saw modest top line growth, while NII rose ~5%, and NII/Share rose 4.76%. NAV/Share rose 18%, to $10.60, vs. $8.96 in Q4 ’20.
Full calendar year 2021 top line growth surged ~44%, with NII up 59%, and Diluted NII/Share up ~56%. The share count rose 9.65% in 2021:
Valuations:
At its 2/11/22 closing price of $8.33, PSEC is selling at 21.42% discount to its $10.60/ share NAV, vs. a 6% average premium to NAV for the BDC industry. Additionally, it’s selling at a 10.28X Price/NII per Share, vs. the 13.49X industry average, while its EV/EBITDA of 12.93X is also much lower.
Its 8.64% dividend yield is roughly in line industry averages:
Profitability & Leverage:
While PSEC’s ROE improved to 6.90%, its ROA and ROE still remained below industry averages. EBIT Margin was steady, while EBIT/Interest coverage improved to 3.6X, and Debt/NAV was slightly lower.
PSEC tends to maintain lower debt leverage than the BDC industry.
Performance:
PSEC’s price performance has been mixed. It has outperformed the S&P over the past year and so far in 2021, while trailing BDC averages in 2021, and over the past quarter and month. It has lagged the broad Financial sector in all of these periods.
Looking back further shows PSEC declining from the high teens. Some income investors have had a disappointing time of it with PSEC over the years, due to price declines, and 2 dividend cuts in 2015 and 2017.
Debt:
87% of PSEC’s interest-bearing assets are at floating rates, while 80% of its assets are at fixed rates – good news for the rising rate era we’re about to enter. 95% of its Floating Loans have LIBOR floors at an average of 1.35%:
In the December 2021 quarter term, PSEC had $32.6M in debt issuance at a range of 2.25% to 4.25%, and repurchased/repaid $143.6M in debt, decreasing debt by $130.95M:
All tables furnished by Hidden Dividend Stocks Plus, unless otherwise noted.