Fool me once, shame on you; fool me twice, shame on me. This quaint adage springs to mind every time I read an article on Prospect Capital Corp. (NASDAQ: PSEC), a popular business development company (BDC).dividend-yield
BDCs attract income investor attention because of their high-yield dividends. Prospect Capital is no exception. Its current yield is close to 14%. The yield is a selling point even management can’t help emphasizing.
Indeed, it seems whenever a member of Prospect’s management team is interviewed, he can’t help but highlight the yield, along with the value proposition.[ad#Google Adsense 336×280-IA]In an October Seeking Alpha interview, Grier Eliasek, Prospect president and chief operating officer, gushed, “A 14% covered yield at a 30% discount.
That’s crazy. If that (share price) snaps back to NAV (net asset value) in the next year that’s, you know, a 40% plus total return possibility.”
Actually, it’s not so crazy. Since its initial public offering in 2004, Prospect has a long history of high-yield income.
For most of that time, the dividend yield has ranged between 12% and 14%. But there’s a catch that management conveniently neglects to mention: The dividend yield has been maintained, but the dividend payout hasn’t.
There’s the Rub
In the early years, Prospect paid its dividend quarterly. The quarterly dividend was steadily increased until 2010, when the payout reached $0.41 a share. Based on the payout, and the timing of your purchase, you could have captured a 14% yield. Unfortunately, you wouldn’t have kept that yield.
In 2010, Prospect changed its dividend policy: It switched to monthly payments from quarterly. The payout was set at $0.10 per share. You received a dividend monthly but you received only $1.20 per share annually, compared to $1.64 under the previous payout policy.
After slashing the dividend 27% in 2010, Prospect again embraced dividend growth. Every few months it would raise the monthly payout a fraction of a cent per share. By the end of 2014, Prospect was paying $0.111 per share monthly, or $1.33 annually, though the payout was still 19% shy of the previous payout.
At least the dividend was clawing back lost ground, a bullish analyst could argue … until it wasn’t. The payout was slashed again this past February. From February forward, Prospect has paid monthly dividends at $0.083 per share. Instead of receiving $1.33 per share in annual dividends, investors now receive $1.00. That’s a 25% reduction.
But guess what? Prospect shares continue to yield between 12% and 14%. This can mean only one thing – the share price has taken a hit. Indeed, it has. In early 2010, Prospect shares traded near $13. In early 2014, they traded above $11. Today, they trade below $7.50. The yield remains the same, but the share price doesn’t.
All That Glisters Is Not Gold
Is this time different? Is a 40% total return a possibility? Prospect shares trade at a 27% discount to NAV. That’s the steepest discount since early 2009. The last time the discount was so expansive, Prospect shares rose 60% over the next 12 months.
So, yes, 40% is a possibility, but the probability of such a remunerative return is low.
For the past year, Prospect has tried to raise capital through a rights offering on its investments in online lending, real estate and collateralized loan obligations. Prospect management believes that as stand-alone investments, each of these businesses would command a greater value than Prospect Capital’s current valuation.
Prospect management appears alone in holding that belief: so far, no takers. That’s too bad, because Prospect could use the capital. Last month, Standard & Poor’s lowered Prospect’s credit rating to BBB- because of its high debt level.
Skepticism is warranted for another reason: There’s nothing in Prospect’s history that suggests management can create and maintain long-term value for shareholders. Yes, Prospect shares will probably always yield between 12% or 14%, and management will promote that yield, but don’t be fooled. That yield will hold whether Prospect pays $1 per share in annual dividends or $0.10.
Given Prospect’s dividend history over the past five years, one can only speculate which payout will prevail.
— Stephen Mauzy
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Source: Wyatt Investment Research