Is This 11.3% Yield Finally Safe After a Dividend Cut?
Can a Dividend Cut Be Good News?
Nobody likes dividend cuts. But unfortunately, that’s what happened to Alcentra Capital Corp (NASDAQ:ABDC) recently.
When the company reported fourth-quarter and full-year 2017 financial results after the closing bell on Tuesday, it announced that its board of directors had reduced its quarterly dividend rate from $0.25 per share to $0.18 per share, representing a 28% decrease. (Source: “Alcentra Capital Corporation Announces Fourth Quarter Earnings Of $0.28 Per Share And Full Year 2017 Financial Results Of $1.32 Per Share. Declaration Of Reduced Quarterly Dividend Of $0.18 Per Share For Q1 2018,” Alcentra Capital Corp, March 14, 2018.)
The stock market did not like the news. On Wednesday morning, ABDC stock plunged more than 18%. Ouch!
However, the dividend cut shouldn’t really come as a surprise. When the company reported third-quarter results back in November 2017, it showed that for the first nine months of last year, it declared total dividends of $1.05 per share. And yet the company’s net investment income totaled just $1.03 per share for the period. (Source: “Alcentra Capital Corporation Announces Third Quarter 2017 Financial Results, Dividend Policy, And Share Repurchase Plan,” Alcentra Capital Corp, November 6, 2017.)
As I have said plenty of times in the past, dividends come from profits. If a company can’t generate enough profits to cover its payout, a dividend cut could arrive soon.
And that’s basically the story behind Alcentra’s distribution cut. According to the company’s Chief Executive officer David Scopelliti, “The board’s view on the dividend policy is to make distributions to shareholders in line with the earnings potential of the portfolio.” (Source: Alcentra Capital Corp, March 14, 2018, op cit.)
In 2016, Alcentra earned a net investment income of $1.66 per share. In 2017, the amount dropped to $1.32 per share.
Still, because dividend yield moves inversely to share price, the latest tumble in ABDC stock means that even after a dividend cut, Alcentra is still a high-yield company. With a quarterly dividend rate of $0.18 per share and a stock price of $6.36, ABDC stock offers an annual yield of 11.3%.
In general, companies that have slashed their dividends before won’t hesitate when they have to do it again. So the big question now is, is Alcentra’s current payout safe?
Well, Alcentra is structured as a business development company, meaning it has to distribute at least 90% of its taxable income to shareholders in the form of dividends. So if the company can make enough profits from its operations, it will likely maintain its dividend.
Alcentra’s business is quite simple. It makes money by investing in both lower-middle-market and middle-market companies, mostly through debt investments. As of December 31, 2017, the company has a portfolio fair value of $287.6 million, with a weighted average debt portfolio yield of 11.3%. (Source: “Alcentra Capital Corporation Q4 & Fiscal Year 2017 Investor Presentation,” Alcentra Capital Corp, last accessed March 15, 2018.)
But those numbers are from the past. Right now, Alcentra is trying to reposition its portfolio by adding senior secured floating loans to manage its default risk and interest rate risk. Moreover, it plans to focus on larger companies and reduce its exposure to lower-middle-market unsecured subordinated debt.
The move would certainly boost the risk profile of Alcentra’s portfolio. But since low-risk debt typically yields less than the high-risk ones, it’s uncertain what the transition would do to the company’s portfolio yield.
Ultimately, given Alcentra’s net investment income of $0.28 per share in the fourth quarter of 2017, the reduced quarterly dividend rate of $0.18 per share seems to be safe. If the company can successfully improve its portfolio’s risk profile, ABDC stock’s 11.3% yield would be worth a look.