Prospect Capital Ready For Reversal?

For a good portion of this year, stock prices in Prospect Capital Corporation (NASDAQ:PSEC) have been trading under pressure -- falling below the $10 mark for the first time in roughly two years.  Most of the selling came after Prospect announced increases in its revolving credit facility commitments.  But the stock’s solid history as one of the best dividend plays in the market, sustained strength in quarterly earnings performances, and recent news of massive share buying suggests that this year’s declines in PSEC are overdone and ready for reversal.  For those looking for impressive dividends in a yield-starved market environment, Prospect Capital still looks like one of the best choices out there.

Stable Earnings Calm Initial Fears



Chart Source: CornerTrader

On November 6th, Prospect released its earnings report for the first quarter of fiscal year 2015.  “With profits coming in at $84.1 million along with revenues of $202 million for the period,” said Matthew Klawinski of 4K Research, “the report largely met consensus estimates and helped calm some of the initial fears of deteriorating numbers.”  This translates to $0.24 per share, or $0.27 per share adjusted for non-recurring costs -- significantly reducing the possibility for any doomsday scenarios for the stock and its high-yielding dividend (13.7%).  


Source: Prospect Capital First Quarter Earnings Presentation

On a yearly basis, Prospect’s revenues improved by 25.5% and the consensus analyst estimate is now showing expected per-share earnings of $1.15 for the current fiscal year.  Supporting the positive outlook is the fact that Prospect is on pace to see net investment income surpass the figures posted for 2014 -- no small feat given that Prospect has already accomplished this for eight straight years  On the negative side, we did see a -2.3% year-over-year decline in net asset value (to $10.47 per share).  But this is hardly enough to justify the 14% decline we are now seeing in the stock’s year-to-date performance.  

Massive Share Buying At Upper Levels

In addition to this, we have started to see massive share buying at the managerial level.  Earlier this month, Prospect’s CEO John F. Barry raised his own exposure to more than 4.5 million shares -- a highly encouraging signal given the underlying positives seen in the latest earnings report.  This is also a signal to investors that there is real opportunity here with the stock trading at historic lows. 

Specifically, it makes a lot more sense for investors to focus on long-term areas like Prospect’s expanding real estate investments and collateralized loan obligations (CLOs) through private spinoffs -- as this is a much better indication of where Prospect is headed in terms of its ability to generate strong quarterly returns.  At this stage, there is nothing to suggest any significant changes in the appreciation of Prospect’s CLO investments, and this is another indicator that this year’s sell-off is likely overdone and ready for reversal.


Source: Prospect Capital First Quarter Earnings Presentation

To gain some perspective, the chart above compares PSEC’s total return performance against that of the main stock benchmarks.  The results here should be somewhat surprising, given the forceful moves we have seen in equity markets over the last few years.  Since 2005, those invested in PSEC captured better cumulative returns than those positioned in all three US stock benchmarks, helped largely by Prospect’s stable payout history.  If these trends are any indication of where the stock is headed next, this year’s drop will be viewed as one of the best buying opportunities we have seen in some time.

Of course, no stock investment is without its risks and one sticking point for PSEC investors can be seen in the fact that Prospect failed to declare dividends for February-March 2015 in its latest earnings call.  But the dividend reduction risks here are not as extreme as some analysts have argued, and factors like Prospect’s monetization event with Echelon Aviation  should help Prospect maintain its dividend through the period.  Even if that is not the case, and Prospect is forced to cut its dividend to 11-12%, there are few similarly positioned opportunities available in the current market environment.  At Friday’s close, PSEC was trading at $9.69 per share, which is a NAV discount of nearly 7.5%.  This makes the stock an excellent ‘prospect’ for those looking to buy a solid income generator at a great historical value.