Warning: This 12% Yield is No Longer Safe

Prospect Capital Corp. (Nasdaq: PSEC) is easily one of the most requested stocks in The Safety Net column, due to its attractive 12.1% yield.

Back in October, I downgraded the stock’s dividend safety rating to a “B,” which was still fairly strong. Although net investment income was not covering the dividend, the company had a stellar track record of raising the dividend every month for nearly five years. Plus, it had just raised money that could be put toward new investments that would increase net investment income.

[ad#Google Adsense 336×280-IA]Though I did downgrade the stock, I didn’t expect a dividend cut in the near term.

But that’s exactly what happened.

In December, management slashed the dividend to $0.0833 from over $0.11.

The reason for the cut was management took a more conservative approach in its investments, accepting lower yields in order to reduce risk.

Prospect Capital is a business development company (BDC) that invests in or lends money to other businesses.

In conference calls prior to the dividend cut, management implied that it had enough resources to continue to pay the dividend… yet it still cut the dividend.

People who are caught cheating don’t get the benefit of the doubt a second time.

That’s why Tom Brady and the Patriots are getting hammered for deflating footballs. If the Patriots had never cheated before – by spying on opponents during practice – this mess with the footballs would have been a minor incident.

Dividend cutters are like cheaters in my book (especially if they say or imply they won’t cut the dividend). Once management has shown the willingness to reduce the dividend, my guard goes up, even if the company gets back on track and raises the dividend consistently afterward. I’ll always remember that the company is not reluctant to lower the dividend.

A CEO who has cut the dividend will do so again if he has to. Whereas a CEO whose company has a 30-year track record of annual dividend raises will usually find a way to boost the dividend even during lean years.

Still Not Enough Income
In the fiscal third quarter, which ended in March, Prospect Capital’s net investment income was $0.24 per share, $0.04 below what the company paid in dividends.

For the first nine months of the fiscal year, net investment income was $0.78 per share, while dividends paid were $0.94. That’s a problem, as the company pays dividends out of net investment income, not taxable earnings.

So we have a company that is not making enough money to sustain the dividend.

But now we can no longer trust management at its word. The previous dividend-raising track record is out the window.

Prospect Capital already declared its monthly dividends through August.

But I wouldn’t count on the dividend remaining at the same level after that.

Dividend Safety Rating: D

Hoping your longs go up and your shorts go down,

Marc

[ad#sa-income]

Source: Wealthy Retirement