SCM - Stellus Capital: A Growing 11.5% Yield Paid Monthly

2023-05-29 08:31:00 ET

Summary

• Stellus Capital has grown its dividend by around 60% since early 2021 to $0.1333 per share, for a forward dividend yield of 11.5%.
• The BDC is currently trading at a small $0.09 premium over NAV per share, reversing what had been a few years of trading at a discount.
• An 88.9% payout ratio has set the backdrop for continued stability for the monthly payouts.

Stellus Capital ( SCM ) has been having a decent 2023. The Houston-based BDC is up around 5% against the broader macroeconomic disruption from the Fed funds rate being hiked to its highest level since 2008. This is one of the most disruptive backdrops for lenders, with the specter of rising non-accrual loans driving tighter underwriting standards. The BDC last declared a monthly cash dividend of $0.1333 per share , in line with its prior payout and for an 11.5% forward yield. The growth of this yield combined with the preservation and expansion of net asset values form the core determinants of alpha here. Crucially, Stellus' double-digit yield paid monthly is safe and backed by a portfolio heavy on first-lien senior secured loans to lower middle-market US businesses.

The dividend has been on an upward ramp since the payouts were switched from a quarterly to a monthly distribution schedule. The initial regular monthly payout of $0.0833 per share in early 2021 has since risen by 60% to its current level. While there's somewhat of a low likelihood of another dividend raise in 2023, net investment income continues to come ahead of consensus and against a healthy pace of net new investments as of the BDC's last reported fiscal 2023 first quarter.

Dual Beats As Discount Turns To Premium

Stellus last reported fiscal 2023 first-quarter earnings that saw total investment income come in at $24.08 million , a 55.5% increase over the year-ago comp and a small beat on consensus estimates. The portfolio grew by $33 million during the quarter to reach $878 million at fair value, with the loan portfolio yielding 11.4%. Net assets came in at $280.9 million, a sequential increase of 1.85% from the fourth quarter. However, NAV per share at $13.87 was around $0.15 lower than the prior fourth quarter due to the expansion in shares outstanding. The externally managed REIT currently has an at-the-money program to raise capital from opportunistic sales above NAV, with proceeds used for portfolio investments. The BDC charges an annual base management fee that's 1.75% of gross assets, in addition to incentive fees on capital gains and net investment income.

Bears would be right to flag that NAV per share on a year-over-year basis fell from $14.59 , a steeper drop that highlights the headwinds being faced by BDC in the current macroeconomic environment. Indeed, the Fed funds rate of 5% to 5.25% has been hiked to a high not seen since 2008 on the back of inflation that still remains far above its averages. Stellus is well-placed against this, with 97% of their loans floating against only 32% of their liabilities funded at a floating rate.

Stellus' market cap actually traded below its book value in the years following the pandemic, but this has fully converged with the stock moving to a $0.09 premium over NAV per share. Hence, the stock is not a clear buy right now. This is not to understate net investment income of $0.45 per share during the first quarter, which grew from $0.28 per share in the year-ago comp and beat consensus estimates by $0.01. However, the current macroeconomic backdrop continues to be defined by disruption, perhaps chaos, and a pertinent embrace of crisis. This is from the debt ceiling impasse to the March regional banking crisis, which flowed on from the 2022 global energy crisis.

A Stable Monthly Income

Stellus' NII of $0.45 meant an 88.9% payout ratio against the 3-month aggregate of its last declared monthly dividend. The BDC made $41.2 in new investments during the first quarter, down around $33.3 million from $74.5 million in the year-ago quarter. With repayments at $5.9 million during the quarter, net new investment activity at $35.3 million fell by 45.3% over its year-ago comp. The lower investment activity is, in essence, forced prudence against the broader disruption and angst around the US potentially falling into a recession just as interest rates remain elevated. The BDC had four loans on non-accrual, around 2% of their loan portfolio at fair value. Stellus has funded another $17.1 million at par in 2 new and 6 existing portfolio companies post-period end.

The BDC expects second-quarter NII to outpace its first quarter on the back of its floating rate loans being repriced higher. However, the market expects the Fed to pause its rate hikes during its June FOMC meeting. This would mark an end to one of the fastest periods of monetary tightening in a generation and would see quarter-on-quarter NII gains for Stellus moderate. I own shares here, but the BDC is not a clear buy at its current price due to its small premium to NAV. This might change in the near future if NAV per share sees some recovery.

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