We continue to cover business development companies, known as BDCs, in our recent articles in 2022. In the low yield environment, BDCs have emerged in 2021 as an increasingly popular choice for investors. income seeking attractive returns. BDCs offer retail investors exposure to private companies, which are often also funded by venture capitalists. BDCs were trapped in the COVID Crash of 2020, due to uncertainty about how their holding companies would handle the changed environment of lockdowns and sheltering in place.
It turns out that the majority of them did well, with their holdings weathering the storm, which became increasingly evident as the earnings reports came in.
Prospect Capital (PSEC) is one of the largest BDCs in the market, among the top 5 market capitalizations in the sector. Unrecognized PSEC expense has steadily improved over the past 6 quarters, from 0.9% of assets in Q2 ’20 to 0.4% in Q4 ’21.
Founded in 2004, New York-based Prospect Capital (PSEC) provides private debt and private equity to middle-market companies in the United States, with a focus on sponsor-backed transactions and loans direct to established owner-operated businesses.
PSEC invests primarily in senior 1st and 2nd lien 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 and $500M per transaction in companies with EBITDA between $5M and $150M, sales value between $25M and $500M and enterprise value between $5 million and $1,000 million. It also finances co-investments for larger transactions. It is one of the largest BDCs, with $6.5 billion in assets under management. Insiders hold a large share of PSEC, at 27.9%. (PSEC website)
1st Liens represented 46.7% of PSEC’s portfolio, as of 12/31/21, compared to 49.4% in Q3 21. Other senior secured debt increased to 19.5%, compared to 16.5% in Q3 21. Equity investments represented 23.1%, while subordinated bonds represented 10.6%, as of 12/31/21. 76.8% of PSEC’s investments have underlying guarantees.
The overall portfolio return was 8.1% as of 12/31/21, compared to 9% in Q3 21, while the return on interest-earning assets was 10.6%, compared to 11.6% in Q3 21 :
Management stuck with the $0.06 payout, announcing the ex-dividend and payout dates for PSEC’s Q1 22 monthly distributions this week. They usually go ex-dividend in the last week of the month and pay out 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 dividend growth rate of -6.5% over 5 years, due to dividend cuts in 2015 and 2017.
PSEC had a positive NII/dividend hedge throughout 2021. We also factored realized gains, to arrive at a net 2021 hedge factor of 1.11X:
Distributions from January to July 2021 had a return of capital of 15.84%, 0% from August to December 2021. The 2021 distributions were composed of 41.6% short-term or interest-related capital gains, 63.48% being Section 163J interest dividends. 97.32% were unqualified.
PSEC announced its 2nd fiscal quarter, ending 12/31/21, this week.
During the December 2021 quarter, Investment Originations doubled, to $855M, and redemptions increased by approximately $120M, increasing Net Originations 4x, to $411M.
Management also released year-to-date numbers for the current quarter, showing originations of $284 million, repayments of $108 million and net originations of $176 million, so far in 2022:
The fourth quarter of 2021 saw modest revenue growth, while NII increased by around 5% and NII/Share increased by 4.76%. NAV/share increased 18% to $10.60 from $8.96 in Q4 20.
Calendar year 2021 revenue growth jumped approximately 44%, with NII up 59% and diluted NII/share up approximately 56%. The number of shares increased by 9.65% in 2021:
At its 2/11/22 closing price of $8.33, PSEC is selling at a 21.42% discount to its net asset value of $10.60/share, against an average 6% premium to net asset value for the BDC industry. Additionally, it sells for a price of 10.28X/NII per share, against the industry average of 13.49X, while its EV/EBITDA of 12.93X is also much lower.
Its dividend yield of 8.64% is roughly within industry averages:
Profitability and leverage:
While PSEC’s ROE improved to 6.90%, its ROA and ROE remained below industry averages. EBIT margin remained stable, 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.
PSEC’s price performance was mixed. It has outperformed the S&P over the past year and so far in 2021, while lagging the BDC averages in 2021 and over the past quarter and month. It has lagged the wider financial sector in all of these periods.
Looking back, we show that PSEC has been declining since adolescence. Some income investors have had a disappointing time with PSEC over the years, due to falling prices and 2 dividend cuts in 2015 and 2017.
87% of PSEC’s interest-bearing assets are floating rate, while 80% of its assets are fixed rate – good news for the rising rate era we are about to enter. 95% of its floating loans have LIBOR floors at an average of 1.35%:
During the December 2021 quarter, PSEC had $32.6 million of debt issuance in a range of 2.25% to 4.25%, and redeemed/repaid $143.6 million of debt, reducing the debt of $130.95 million:
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