Stellus Capital Investment Corporation (NYSE: SCM) gets a high rating from me because of the BDC’s well-performing loan portfolio, the unreasonably high discount to net asset value and the portfolio’s income potential.
Given the current performance of the portfolio, the business development company is trading at an implied discount to net asset value that is too large, and Stellus Capital Investment currently pays a special dividend that helps the effective dividend yield.
A BDC with exceptional portfolio growth
Stellus Capital Investment is a business development firm that seeks to invest in privately held companies with annual EBITDA between $5 million and $50 million.
The business development company went public a decade ago in 2012, with $173.8 million in net assets at the time. Stellus Capital Investment has achieved consistent net asset growth over the past decade, primarily through secondary offerings. As of March 31, 2022, the BDC’s net assets had increased to $285.0 million.
The value of Stellus Capital Investment’s portfolio has steadily increased over the past decade, as has the number of portfolio companies in which BDC has invested. The long-term growth trend is very positive, especially considering that Stellus Capital Investment’s portfolio continued to grow during the COVID-19 pandemic.
The number of portfolio investments reached an all-time high of 78 in 1Q-22, while the total BDC portfolio value has never been higher than $838 million as of March 31, 2022.
Stellus Capital Investment focuses solely on first liens, the safest debt investments a BDC can make. Approximately 91% of SCM’s portfolio is invested in various first lien investments, with the remaining 8% in second secured debt and only 1% in unsecured debt. 97% of these debt investments were in interest-bearing floating rate assets.
Payment of covered dividends
Stellus Capital Investment has covered its dividend with underlying net investment income for the full fiscal year. SCM has an 88% payout ratio (based on regular dividend payments), with excess earnings distributed as special dividends. If BDC maintains its current payout ratio, SCM will most likely continue to pay a monthly dividend of $0.02 per share.
10% yield, selling at a 20% discount to net asset value
Shares of Stellus Capital Investment have a dividend yield of 9.8% based on a monthly dividend payment of $0.093 per share. That said, the effective dividend yield could reach 11.9% if BDC continues to pay a special monthly supplemental dividend of $0.02 per share, as Stellus Capital Investment currently does.
An investment in SCM at the time of its IPO a decade ago would have resulted in a total distribution of $12.33 per share, representing 85% of Stellus Capital Investment’s net asset value as of March 31, 2022.
BDC started with $0.18 per share in distributions in 2012 and could pay up to $1.36 per share in 2022 if management decides to maintain its special monthly dividend of $0.02 per share.
Aside from a strong net asset growth impression, Stellus Capital Investment is a BDC that I don’t believe should be trading at a discount to net asset value, especially not at a 20% discount.
Stellus Capital Investment’s portfolio is diversified and BDC’s low payout ratio suggests that SCM may be trading at a premium to net asset value.
Why Stellus Capital Investment could see a lower share price
Stellus Capital Investment currently has many of the characteristics I look for in a high-quality BDC: net asset growth that is stable and consistent, a dividend that is covered by net investment income, and floating rate exposure that positions the BDC for income growth from the portfolio if interest rates rise.
However, there are risks that seem to stem primarily from the general state of the economy. Stellus Capital Investment’s ability to find new, profitable investments may be limited during a recession and the BDC portfolio may deteriorate, potentially resulting in investment losses for Stellus Capital Investment and its shareholders.
Stellus Capital Investment has achieved consistent growth in net assets over a decade, which not only testifies to the BDC’s ability to attract capital, but also to its skills in finding attractive investment opportunities in various markets.
The business development company distributed approximately 88% of its LTM NII, and the special dividend, currently paid at $0.02 per share per month, could raise the effective yield on SCM stock to 11.9%.