3 Business Development Companies Yielding Over 6%
Dividend investors shouldn't overlook BDCs when searching for income-generating equities. Here are three we like.
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Investors focused on generating income have a wide variety of choices when it comes to publicly traded equities. There are typical favorites such as utilities or consumer staples stocks, and even real estate investment trusts. But one category that can be overlooked is that of business development companies, or BDCs.
These are closed-end investment companies that typically make debt or equity investments in small, private companies that cannot easily access funding. BDCs are similar to private equity firms, except BDCs tend to lean more heavily on debt investments to generate interest income, which is then largely distributed to shareholders through dividends.
It is this characteristic that makes BDCs appealing for dividend investors, given their generally very high dividend yields. Some BDCs have yields that reach into the double-digits, but most are at least 5%. There are risks to the business model, of course, but here, we’ll highlight three BDCs we like today for their high current yields.
Stellus Capital
Stellus Capital Investment Corp. SCM bills itself as a flexible source of capital for the middle market. The company provides capital solutions to companies with $5 million to $50 million of EBITDA and does so with a variety of instruments, the majority of which are debt. Stellus provides first lien, second lien, mezzanine, convertible debt, and equity investments to a diverse group of customers, generally at high yields, in the U.S. and Canada.
Stellus posted first-quarter earnings on May 9, and results were worse than expected on both the top and bottom lines. It saw $0.44 in adjusted earnings per share, which missed estimates by a penny. Total investment income was $26 million. That was up 8% year over year, but missed estimates by $870 thousand. Net investment income was $10.2 million, up from $9.1 million. However, because the share count rose sharply, on a per-share basis, NII fell from $0.46 to $0.42.
The company’s portfolio had a net change of $23.5 million in unrealized appreciation. Net increase in net assets resulting from operations was $13.1 million, or 54 cents per share. Stellus has reset much of its investment portfolio with higher rates, leading to a very strong portfolio yield. However, a possible headwind to this is interest rates declining off of currently elevated levels. The company’s net assets continue to grow over time.
As a BDC, Stellus is required to pay virtually all its NII in distributions, so the payout ratio will always be high. While the current payout should be safe for the time being, we note that the risk of lower rates means the payout is constantly at risk as well.
SCM currently yields 11.3%.
Prospect Capital
Prospect Capital Corporation PSEC provides private debt and private equity to middle-market companies in the U.S. The company focuses on direct lending to owner-operated companies, as well as sponsor-backed transactions. Prospect invests primarily in first and second lien senior loans and mezzanine debt, with occasional equity investments.
Prospect posted somewhat mixed fiscal third-quarter results on May 8. Net investment income came to $94.4 million, down from $102.2 million a year ago. As a percentage of total net investment income, interest income was 91%, slightly lower than prior quarters. On a per-share basis, NII came to $0.23, down from $0.24 in the December quarter, and down from $0.26 in the March period a year ago.
NAV declined from $9.48 in the March quarter last year to $8.99, but up slightly from $8.92 in the December quarter. For the nine months ended in March, NII rose slightly from $308 million to $316 million from the same nine-month period in 2023.
Scale is the name of the game for BDCs and with a stagnant balance sheet, Prospect has lost some of its relative scale over time. That began to reverse given Q2 2022 results, however, and total assets are reaching new highs again.
The company’s payout ratio was over 100% for several years in the past decade but is slightly under that now given the higher NII-per-share. The dividend is covered by earnings for now, but we see a weak growth outlook as potentially threatening the dividend over time.
PSEC currently yields 13.3%.
Gladstone Investment
Gladstone Investment Corp. GAIN is a business development company that focuses on U.S.-based small- and medium-sized companies. Industries which Gladstone Investment targets include aerospace & defense, oil & gas, machinery, electronics, and media & communications.
Gladstone Investment reported its fourth-quarter (Q4 2023 ended March 31) earnings results on May 8. The company generated total investment income — Gladstone Investment’s revenue equivalent — of $23.7 million during the quarter, which represents an increase of 19% compared to the prior quarter. This number beat the analyst consensus estimate by $0.5 million, as analysts expected a slightly weaker performance for the company’s top line.
Gladstone Investment’s adjusted net investment income-per-share totaled $0.24 during the fiscal fourth quarter. That was up from the previous quarter’s level. Gladstone Investment‘s net asset value per share totaled $13.43 on a per-share basis at the end of the quarter, which was up compared to the NAV-per-share that the company reported at the end of the previous quarter.
Following a NIIPS decline in fiscal 2020, Gladstone Investment has seen its NIIPS recover meaningfully and hit new record highs in fiscal 2021 and fiscal 2022. While net investment income-per-share declined in 2023, slightly higher profits are forecasted for the current fiscal year.
Gladstone Investment’s net investment income per share is quite lumpy. During the financial crisis the company’s profits declined substantially, but Gladstone Investment remained profitable. Over the last five years profits grew by 4.3% annually.
Gladstone Investment’s dividend payout ratio, relative to its net investment income, has been close to or above 100% throughout several years over the last decade. The company usually is more profitable than the net investment income metric suggests, due to the fact that Gladstone Investment can also generate gains from its equity investments, which are not reflected in the net investment income metric.
GAIN currently yields around 7%.
At the time of publication, Ciura had no positions in any stocks mentioned.