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One of our most popular income investments comes with a few risks.
No High Yield Wealth recommendation generates more reader email than Prospect Capital Corp. (NASDAQ: PSEC).
That Prospect generates so much interest might seem curious. Prospect sports a mere $3.3 billion market cap. The High Yield Wealth portfolio features many larger companies of much greater market presence. Most, I’m sure, are much more prevalent in other investment portfolios.
Then again, maybe it’s not so curious.
Prospect is a favorite among income investors who favor high yield over dividend growth. Prospect pays just under $1.33 per share in annual dividends. These dividends are delivered in monthly increments at the rate of $0.11 per share. At the current market price, the dividend generates a generous 14% yield.
The market price that generates such a luscious yield is no doubt reason why my e-mail inbox is filled with Prospect inquiries.
Year to date, Prospect shares are down 15%. The price decline is rightly disconcerting. Prospect has historically been a rather boring investment. The share price typically meanders between $10.50 and $12. As I write, that share price has dipped to $9.50.
So what’s going on with Prospect Capital? After all, it’s a business development company (BDC), and BDCs are bought for reliable high-yield income, not for price action.
Disappointing financial results are one thing “going on.” Recent financial performance has motivated some investors to head for the exit.
Over the trailing 12 months, Prospect has generated net investment income (NII) of $1.16 per share and has paid $1.33 per share in dividends. NII supports the dividend, and Prospect’s NII obviously hasn’t covered the dividend. Instead, asset sales, loan repayments from invested companies, and new share issuance have helped sustain the payout.
Adding to investor distress, Prospect management has provided insufficient dividend guidance. In the past, management has declared many months of dividends in advance. As it stands now, dividends have only been declared through February 2015.
The dividend outlook has been further muddled by a recent surprise announcement.
Prospect plans to spin off its collateralized loan obligations, real estate investments, and peer-to-peer loans into new publicly traded structures. Combined, the REITs, CLOs, and P2P loans make up roughly a quarter of the company’s asset base. Management views the spin-off as a strategy to unlock value.
The CLOs and the P2P loans reportedly generate 20% cash returns annually. Those returns are higher than the returns generated by Prospect’s other assets. Prospect hopes these segments will trade at a higher multiple, thus creating shareholder value.
The devil is in the details. Management has been evasive on a timeframe and the mechanics of the spin-off. That uncertainty has weighed on Prospect’s share price.
If management creates shareholder value, great. But the risk for income investors is that management will cloak a dividend cut under the guise of value creation.
The sum of the parts could end up paying a dividend that’s less than the current $1.33 payout. This concern isn’t without merit. In 2010, when Prospect switched to monthly dividends from quarterly dividends, the annual payout was reduced by 26%. (It has since clawed back some of that lost ground.)
For now, I’m standing pat and giving management the benefit of the doubt. Prospect shares could be one of the better bargains of this holiday shopping season.
My assertion is buttressed by heavy insider buying. In the past month, Prospect CEO John Barry has purchased 110,000 additional shares. COO Grier Eliasek has ponied up to buy 5,000 shares. Since late August, insiders have bought more than 272,000 Prospect shares. Heavy insider buying suggests that management at least has conviction in its value-creating strategies.
I, too, see value in Prospect at today’s lower price. That said, I’m keeping a close eye on Prospect Capital for High Yield Wealth readers.
Special Payouts 5 times Larger than Regular Quarterly Dividends
Every 12 months Darren Young pockets $3,500 in dividends from this company. Frank Gerson, a 70-year-old New Yorker, collects $1,750 in cash payouts from this company. And Charles Lytle, who invested when we first recommended this company to our readers, earns a whopping $7,000 in dividends! If you’d like to earn the same kind of money – up to 8 times a year – just click here to find out everything you need to know.