Jonathan Moreland
Jonathan Moreland

Inside the Markets: Prospect Capital Still Worth the Risk

Here’s why.

October 19, 2009
by Jonathan Moreland

[DISCLOSURE: Readers should assume that all stocks mentioned in this column are owned by the author and/or his firm unless otherwise noted.]

The dust has settled after a slew of news over the past several weeks for Prospect Capital (NASDAQ: PSEC), and the resultant view remains positive for the firm.

As some CPA Insider™ readers may know, Prospect Capital (Prospect) is a publicly-traded business development company (BDC) that primarily makes private equity and mezzanine debt investments. Prospect has historically leaned towards investments in the fields of energy and industrial sectors, including materials.

Insiders helped me into this high-yielding winner in late May with their bullish buys of their own shares. And with this company’s insider profile and business prospects still looking good, my opinion remains bullish on these shares.

To be sure, Prospect’s financial results for its fourth quarter (ended June 30) were hardly “all good” as the saying goes. Fourth-quarter earnings-per-share (EPS) of 32 cents were seven cents below expectations, and the firm’s net-asset-value (NAV) fell from $14.19 per share at the end of its third quarter to $12.40. Management further guided down expectations for Prospect’s first quarter (ending September 30), to be between 25 cents and 30 cents. When I entered this stock four months ago, expectations were for first-quarter EPS of 37 cents. For the full year, Prospect earned $1.87 per share — down slightly from the $1.91 earned the year before.

Battling Higher With a Full War Chest

Nonetheless, shares of Prospect have been unfazed by those negative headlines. Your investor-clients can correctly expect Prospect’s recent equity raises (another large one of which was announced subsequent to the earnings release), as well as the company’s corporate actions, to be longer-term positives.

Prospect’s management has quantified the future accretion from their August acquisition of Patriot Capital (NASDAQ: PCAP) as adding at least nine cents per quarter to EPS after the deal closes this quarter. This is still not enough for analysts to forecast EPS growth for Prospect in the coming year. The average of a large range of fiscal 2010 earnings expectations is only $1.44. Even the high-end of analysts’ expectations tops out at $1.80 per share.

But your client-investors’ expectations — and a still-low valuation — are keeping Prospect’s stock moving north. The firm expects to make more opportunistic, accretive acquisitions in the coming year. Prospect also continues to increase both its cash on hand via equity offerings, and its credit facilities for that purpose.

The positive expectations from more acquisitions are reflected in the bullish reception for Prospect’s many equity offerings. From March through August of this year, Prospect raised $180.7 million in gross proceeds by offering equity at increasingly higher prices. The average price of the offerings through August was $8.38.

The fact that Prospect’s shares continue to offer a solid indicated yield of around 15 percent adds comfort to the macroeconomic and secular market-risks investors are shouldering with that bet. That these shares still trade at a 13-percent discount to NAV even after their ascent (and the near-term descent in NAV) further indicates that the risk/reward profile to new money in this stock remains acceptable.

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Jonathan Moreland is the director of research at New York-based InsiderInsights.com. View a FREE trial issue of the firm's weekly newsletter InsiderInsights. Readers should note that the opinions expressed in this column are solely of the author’s and does not necessarily reflect the views of the AICPA or the AICPA CPA Insider™ e-newsletter.