Prospect Capital Corporation: This Company Yields 12% and Pays …

Another High-Yield Stock to Think About

To most people, the name Prospect Capital Corporation (NASDAQ:PSEC) probably doesn’t ring a bell. But if you are looking for oversized dividends, this company—which belongs to a group that I call “alternative banks”—just might be one of the most generous payers on the market.

Let me explain.

Prospect Capital is a business development company (BDC) headquartered in New York City. It provides financing solutions to middle-market businesses in the U.S., with a focus on sponsor-backed transactions and direct lending to established owner-operated companies.

And while Prospect Capital provides both debt and equity financing, it invests primarily in first lien and second lien senior loans and mezzanine debt. As a result, it can earn a predictable stream of interest income.

As of December 31, 2019, secured first lien debt, secured second lien debt, subordinated structured notes, and unsecured and other debt accounted for 82% of PSEC’s portfolio by fair value. So only 18% was invested in equity instruments. (Source: “Prospect Capital Reports December 2019 Quarterly Results and Declares Additional Monthly Distributions,” Prospect Capital Corporation, February 10, 2020.)

PSEC maintains a well-diversified portfolio. At the end of 2019, the company’s $5.3-billion portfolio was diversified across 120 different companies.

The business is quite lucrative, too. At the end of 2019, the annualized current yield on Prospect Capital’s investments was 10.3%.

And keep in mind that BDCs are pass-through entities. As long as a BDC distributes at least 90% of its profits to investors through regular dividend payments, it pays little to no income tax at the corporate level. Therefore, by earning outsized interest income from its debt investments, Prospect Capital Corporation can pay a very generous dividend.

Right now, the company has a monthly dividend rate of $0.06 per share, which translates to an annual yield of about 12%.

So, not only does Prospect Capital offer a yield that’s higher than for most stocks, but the company pays more frequently as well.

Of course, when most companies yield less than five percent, a monthly dividend stock with a double-digit yield can seem too good to be true. So the big question now is, can PSEC afford those outsized dividend payments?

Is the Dividend Safe at Prospect Capital Corporation?

According to the company’s  latest earnings report, Prospect Capital generated net investment income of $67.9 million in the second quarter of its fiscal-year 2020, which ended December 31, 2019. For the quarter, the company paid three monthly cash distributions totaling $66.2 million. That allowed the BDC to achieve a dividend coverage ratio of 1.03 times, meaning it managed to outearn its payout. (Source: Ibid.)

In the first six months of Prospect Capital’s fiscal-year 2020, the company’s net investment income totaled $138.9 million. Its cash distributions to shareholders, on the other hand, totaled $132.3 million for this period. So again, the company’s profits covered the payout.

In Prospect’s latest earnings release, management announced monthly cash distributions of $0.06 per share for February, March, and April 2020. These will be the 139th, 140th, and 141st consecutive cash distributions paid to Prospect Capital stock owners. Dividends for May, June, and July are expected to be announced in May 2020.

At this point I want to mention that, as is the case with all stocks, dividends from BDCs are not always carved in stone. Looking at PSEC, even though the company stands as one of the highest-yielding names on the market, and it has a long track record of paying dividends, its payout didn’t always go up. For instance, in 2017, the company reduced its monthly distribution rate from $0.0833 per share to $0.06 per share. (Source: “Dividend,” Prospect Capital Corporation, last accessed February 27, 2020.)

No one likes dividend cuts. And a less-than-stellar distribution history is probably one of the reasons behind PSEC stock’s lackluster price performance in recent years. In fact, because of the BDC’s subdued trading levels, it might be able to offer good value for money—something that’s rarely found in today’s bloated stock market.

Consider this: as of December 31, 2019, Prospect Capital Corporation had a net asset value of $8.66 per share. And yet, Prospect Capital stock trades at just $5.82 per share at the time of this writing. Therefore, if the company’s fundamentals didn’t change much over the last two months, its current share price would represent a discount to its net asset value of more than 24%.

Ultimately, I wouldn’t call PSEC stock a slam dunk. But for investors who understand the underlying risks with high-yield BDCs, its oversized monthly distributions could be worth a look.

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