I entered InvestorPlace’s Best Stocks for 2015 contest with business development company Prospect Capital (PSEC, Financial). With 2015 getting off to a rocky start, I’m feeling good about my focus on income and deep value. Prospect Capital sports a 12% dividend yield and trades for just 80% of book value. For Prospect to simply return to book value, we’d be looking at 25% returns. Add in the 12% dividend, and we’re looking at 37% returns. Chip in any special dividends–which management says is a distinct possibility–or any growth in book value, and we’re looking at returns north of 40%.
Today’s I’d like to take a quick look at Prospect’s December investor presentation and highlight a few slides I find to be particularly relevant. Let’s start with Prospect’s bad loans. As a percentage of the portfolio, they continue to trend down. In 2009, 5.8% of the portfolio was classified as “non-accrual.” Today, that number is 0.03%. The key bit of information to glean from this is that Prospect Capital has been de-risking over the past six years. I consider that a good thing. With banks essentially out of the business of lending money due to regulatory fallout and a lack of capital, BDCs like Prospect have been able to step in and make high-quality loans.
Furthermore, Prospect’s portfolio is diversified across industrial sector. With crude oil prices still in freefall, it’s worth mentioning that Prospect’s exposure to oil and gas is just 4%.
Meanwhile, most of Prospect’s lending is secured. 71.5% of its debt portfolio is secured by a first lien position. And another 26.3% is secured by a second lien position.
All told, about 75% of its total portfolio consists of first and second lien loans.
Are there risks? Sure. If we hit a rough patch in the economy, Prospect’s bad debts will creep up again. But given the massive amount of de-risking the company has done in recent years, I see that risk as being very tolerable. If anything, I would say the risk is that Prospect Capital’s portfolio isn’t risky enough. Its conservative portfolio might not allow for the kind of dividend growth investors enjoyed in previous years.
All the same, with U.S. stock valuations looking stretched and bond yields scraping along near all-time lows, Prospect’s 12% dividend is hard to ignore.
