2023-08-08 13:55:05 ET
Summary
- Capital Southwest just hiked its base dividend by 3.7% for a double-digit 10.3% annualized forward yield.
- The BDC saw its NAV per share for its recent fiscal 2023 second quarter come in at $16.38, roughly flat versus the first quarter.
- The commons are currently trading at a large 30% premium to NAV.
- The hiked dividend is 120% covered by second quarter net investment income which grew by 17 cents over its year-ago comp.
Capital Southwest (CSWC) just hiked its quarterly cash dividend by 3.7% to $0.56 per share to move up its annualized forward yield to 10.3%. Further, the BDC will also payout a $0.06 per share supplemental, a 20% increase from the prior supplemental for an incremental 1.1% forward yield. The income is the prize and CSWC has raised its base dividend from $0.41 per share at the onset of the pandemic to its current level, a 10.9% three-year compound annual growth rate that outstrips the headline CPI increase over the same time frame. The internally-managed middle market-focused business development company now sports a 33.3% total return since the start of 2023.
This has come on the back of a regression of market fears around a possible hard landing as CPI continues to move down to the Fed's 2% target rate. JPMorgan has scrapped its forecast for a US recession this year with Goldman Sachs also reducing the probability of a 2024 US recession to 20% from 25%. Hence, a macroeconomic backdrop characterized by a resilient economy, lower inflation, and high-interest rates is building for BDCs. CSWC is heavy on floating rate loans which formed 97% of its credit portfolio as of the end of its recently reported fiscal 2023 second quarter.
It's important to note that the party will eventually come to an end once rates embark on a process of normalization. However, there likely won't be a greater than 100 basis points move on the Fed funds rate before the start of the summer of 2024. This higher rate environment will continue to form a tailwind for investment income with further dividend raises likely through 2023. With the market currently pricing in an 85.5% chance of the Fed keeping rates unchanged at its current 5.25% to 5.5% range at their next FOMC meeting on September 20, the 25-basis point hike in July could very well be the final of the current monetary tightening cycle.
Beat Drives Optimism To New Highs
CSWC recorded a total investment income of $40.4 million to beat consensus estimates for TII of $38.7 million. This was sequential growth of $3.2 million from the first quarter and came on the back of an increase in its average debt investments outstanding and a weighted average yield on debt investments of 12.9%. CSWC's total investment portfolio as of the end of the second quarter held a fair value of $1.3 billion and was mostly composed of first-lien floating rate loans from a $1.1 billion credit portfolio.
First lien exposure has grown 700 basis points from the onset of the pandemic with the average investment hold size also falling to 1.2% as of the end of the second quarter. Hence, even as shareholders are set to benefit from the inherent stability of CSWC's intrinsically safer credit exposure, the dividend is being hiked to new highs and total returns have been strong with NAV maintaining its strength. Total net asset value as of the end of the second quarter was $636.2 million, around $16.38 per share. This was broadly flat versus $16.37 in the prior first quarter but was a decline of roughly 16 cents from the year-ago period.
Net Investment Income And Dividend Coverage Implies Further Near-Term Dividend Raises
BDCs face a balancing act between protecting NAV per share and providing the income that their shareholders require. CSWC performed well for the quarter on the back of the upsized base dividend and supplemental. However, the BDC is currently swapping hands at a roughly 30% premium to NAV. This has moved to quite a gap versus its historical level so some caution is urged on starting a new position. Critically, the price follows the NAV and CSWC has managed the long-term trend of this positively.
The BDC originated $111.9 million in new commitments during the second quarter with 88.1% of this, around $98.6 million, going to six new portfolio companies. Add-on commitments in seven portfolio companies were at $13.3 million. This comes against loans on non-accrual status ending the second quarter at $22.4 million, around 1.7% of CSWC's total investment portfolio. CSWC reported a net investment income of $0.67 per share, up $0.17 over the year-ago comp to drive 120% coverage of the base dividend. If we include the supplemental, the BDC is set to pay out around 92.5% of NII to shareholders. Assuming non-accruals stay low, the BDC should see third-quarter NII move up on the back of a still-growing credit portfolio and the July interest rate hike. CSWC is a hold against a healthy outlook for dividend growth and the stability of its NAV.
For further details see:
Capital Southwest: We're All Getting A Dividend Raise