Assessing the safety of a company’s dividend during these times is difficult. Many companies have withdrawn guidance, as it is nearly impossible to know how a business’s customers will respond over the next six to 12 months.
However, there are some instances when determining the prospects of a company’s dividend is not terribly hard. That’s the case with Prospect Capital (Nasdaq: PSEC), which is likely facing a dividend cut in the next 12 months.
Prospect Capital is a business development company (BDC). It mostly lends money to a wide variety of businesses, though it will occasionally take an equity position.
Its portfolio includes…
- An equity stake in Ark-La-Tex Wireline Services LLC, a 31-year-old oil field services company based in Shreveport, Louisiana
- Secured debt in EXC Holdings III, which manufactures electronic components
- Secured debt in Versant Health Holdco, which provides vision and eye health plans.
Last year, Prospect Capital paid out $245 million in dividends off $313 million in net investment income.
Net investment income is what we use to measure a BDC’s ability to pay its dividend. So in 2019, the company was able to afford what it paid out to shareholders.
This year is anyone’s guess. Management has not provided guidance for 2020, and there are no Wall Street estimates.
But you don’t need an MBA from Wharton to know that net investment income is likely to be down this year, as surely some companies in its portfolio will not be able to make their interest payments.
Prospect Capital has its own interest obligations. It has a lot of debt. In fact, it has 7 1/2 times more debt than earnings before interest, taxes, depreciation and amortization (EBITDA).
Prospect will have to continue to service that debt no matter what its borrowers are doing. And that will likely cause the dividend to be reduced.
It wouldn’t be the first time, either. Management has slashed the dividend multiple times already in the previous decade. So it probably wouldn’t hesitate to do so again.
The stock currently comes with a monthly dividend of $0.06 per share, which equals an annual yield of 18%. Prospect Capital could cut the dividend in half and it would still be a very attractive 9%.
Considering its high debt load, its likelihood of reduced net investment income and its tendency to lower the dividend when times get tough, Prospect Capital’s dividend cannot be considered safe. Expect a dividend cut in the next 12 months.
Dividend Safety Rating: F
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Good investing,
Marc