Looking for Monthly Dividends? Consider This 10.7% Yielder
Prospect Capital Corporation: A Monthly Dividend Stock
Today’s chart highlights one of the most generous monthly dividend payers in today’s market, Prospect Capital Corporation (NASDAQ:PSEC).
If you’ve been following this column, you’d know that monthly dividend stocks tend to come from two main types of businesses: real estate and lending. Prospect Capital Corporation is from the latter. Structured as a business development company (BDC), Prospect Capital provides financing solutions to middle-market businesses in the U.S. and Canada.
While Prospect Capital makes both debt and equity investments, it has a strong focus on senior and secured lending. As of September 30, 2018, the company has 44.3% of its portfolio invested in first-lien loans, plus another 21.7% invested in second-lien loans. (Source: “Middle Market Finance and Private Equity,” Prospect Capital Corporation, last accessed January 14, 2018.)
Note that in the lending business, if you are a lender of first lien, you would be the first one in line to get paid if the borrower defaults and goes through liquidation.
The business is quite profitable, too. By the end of September 2018, the annualized yield across all investments in the company’s portfolio stood at 10.8%.
By earning an oversized interest income stream from its loan portfolio, Prospect Capital Corporation can pay generous regular dividends.
With a monthly dividend rate of $0.06 per share, PSEC stock has an annual yield of 10.7%.
A Rare Find
If you’ve been on the hunt for monthly dividends, you’d know that a yield like this is extremely impressive.
Because of their more frequent payout schedule, monthly dividend stocks make it easier for income investors to budget their daily expenses. Unsurprisingly, they’ve been highly sought after. As investors bid up their share prices over the years, the yield on most monthly dividend stocks got lower.
Still, as I always say, income investors should treat ultra-high yielders with a grain of salt.
This is because while a company can offer a high current payout today, if it does not have the resource to back its dividend policy, it would have no choice but to cut its payout at some point down the road.
So, should dividend safety be a concern for PSEC stock investors?
Well, let’s take a look at the financials.
Is the Monthly Dividend Safe?
Since Prospect Capital is in the investment business, its key performance metric is net investment income. By comparing this figure to the company’s dividend payment in a given reporting period, we can see whether it made enough money to cover its payout.
According to the latest earnings report, Prospect Capital Corporation generated a net investment income of $85.2 million, or $0.23 per share in the first quarter of its fiscal 2019, which ended September 30, 2018. The amount represented a solid improvement from the $63.7 million, or $0.18 per share, earned in the year-ago period. (Source: “Prospect Capital Reports September 2018 Quarterly Results and Declares Additional Monthly Distributions,” Prospect Capital Corporation, November 6, 2018.)
And since the company declared three monthly dividends totaling $0.18 per share during the quarter, it achieved a payout ratio of 78.3%, leaving a sizable margin of safety.
In other words, despite offering a jaw-dropping yield of over 10%, PSEC stock’s dividend remained safe as of the September quarter.
The chart below shows the company’s payout ratio in the past four quarters. The percentages are calculated by dividing PSEC’s declared dividends by its net investment income in each quarter.
Prospect Capital Corporation’s Payout Ratio
For risk-averse income investors, a payout ratio that’s trending lower is certainly a welcoming sign.
And it gets even better. By the end of the September 2018, 87.8% of Prospect Capital’s interest-bearing assets bore interest at floating rates. Meanwhile, 85% of its liabilities bore interest at fixed rate.
This means the company is well-positioned for the current rising interest rate environment. As interest rates go up, Prospect Capital will generate substantially higher interest income due to its large floating rate portfolio, while the increase in its interest expense would be much smaller due to its mostly fixed rate liabilities. The result would be an increase in net investment income.
Normally, when a company offers a well-covered high dividend and has prospects like this, investors would rush towards it. But that’s not the case here.
While shares of PSEC stock started trending up in recent weeks, the stock is still down more than 10% since the high it reached last summer.
Also worth noting is that Prospect Capital had a net asset value of $9.39 per share at the end of September 2018. But today, its stock trades at just $6.71 apiece.
The company will report it December quarterly results early next month. If PSEC’s fundamentals haven’t changed much in the last few months, its current stock price would represent quite a discount compared to its net asset value.
The Bottom Line on PSEC Stock
At the end of the day, I want to point out that like many double-digit yielders, PSEC stock is not perfect.
In particular, the company has cut its payout before. In 2017, Prospect Capital reduced its monthly dividend rate from $0.08333 per share to $0.06 per share, translating to a 28% decrease. (Source: “Dividends,” Prospect Capital Corporation, last accessed January 14, 2018.)
Still, the latest financial reports suggest that Prospect Capital has no problem meeting its new dividend obligation. If the company can keep covering its payouts, PSEC stock’s 10.7% yield could be worth a look.