Stellus Capital: This 12% Yield Is Too Good To Miss

seekingalpha06-04

Stellus Capital Investment Corporation is a solid buy for passive income on the pullback.The company is positioned to profit from a higher-for-longer rate environment.The stock is selling at a ...

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PM Images Stellus Capital Investment Corporation (NYSE:SCM) is a solid buy for passive income on the pullback, in my view. The business development company covered its dividend with net investment income in 1Q24 and though the pay-out ratio has risen QoQ, I think that the dividend is reasonably safe, particularly in a moderate inflation environment that incentivizes the central bank to keep interest rates steady at the present level. As Stellus Capital Investment also exposed to a high percentage of floating-rate loans in its investment portfolio, SCM will continue to profit from a higher-for-longer rate environment. Stellus Capital Investment’s stock is selling for a moderate premium to net asset value on the latest pullback also. My Rating History My stock classification on Stellus Capital Investment was Hold in March as the business development company was producing good dividend coverage. I am changing my stock classification to ‘Buy’ primarily because the BDC’s stock price recently pulled back without any company news which in my view translates to an enhanced risk/reward relationship. I also think that the central bank may not cut interest rates at all in 2024 which would obviously further benefit Stellus Capital Investment. Portfolio Review Stellus Capital Investment is structured as an (externally-managed) business development company under the Investment Company Act of 1940 and its main investment focus is on middle market companies that are typically privately-held and that have between $5 million and $50 million in annual EBITDA. As of March 31, 2024, Stellus Capital Investment had $875.9 million worth of investments in its portfolio, the majority being Senior Secured First Liens. All Senior Secured Loans, First and Second Liens, combined were valued at $794.8 million, or 91% of the entire investment portfolio. Compared to the previous quarter, the portfolio value went up by $1.4 million. Portfolio Review (Stellus Capital Investment) One important feature of Stellus Capital Investment is that the BDC is positioned to profit from interest rate hikes and the company is still 98% floating-rate positioned. This means that in the case that inflation is not receding, Stellus Capital Investment would probably see net investment income tailwinds that could also lead to a lower dividend pay-out ratio in the remaining three quarters of the year. The central bank so far as not moved on cutting short-term interest rates at all, and it may not start cutting until 2025 if inflation holds up above 3% (which it presently is). A delayed timeline for rate cuts would be a big boon for the business development company and bode well for net investment income growth in 2H24. Broad Industry Diversification (Stellus Capital Investment) Stellus Capital Investment earned $26.0 million in total investment income in 1Q24, up 8% YoY whereas net investment income was reported at $10.2 million, up 13% YoY thanks to strong non-interest income sources as well as an income incentive fee waiver. With the central bank proving to be quite reluctant when it comes to lowering interest rates, I think that a higher-for-longer rate environment is going to benefit Stellus Capital Investment more than other BDCs, primarily because the company is so aggressively leaning on floating-rate loans for its net investment income growth. Income Statement Summary (Stellus Capital Investment) Dividend Pay-Out Trend Is Still Looking Quite Good, Despite A QoQ Increase Stellus Capital Investment managed to easily cover its 1Q24 dividend, which presently runs at $0.1333 per share per month (12% annualized stock yield), with net investment income of $0.44 per share. The dividend pay-out ratio was 91% in 1Q24 and 82% in the last twelve months. Moving forward, I do think that Stellus Capital Investment has a way to improve its dividend pay-out ratio: The central bank may not be interested in lowering interest rates at all in 2024 which would be a boon for SCM’s net investment income growth. This could then also translate into a higher margin of safety for passive income investors and a lower dividend pay-out ratio. Dividend (Author Created Table Using BDC Information) Moderate 3% Premium To Net Asset Value Business development companies have seen a bit of selling pressure as of late, probably due to profit taking as some BDCs, including Stellus Capital Investment, did rack up a solid YTD performance. I think the most recent pullback is a buying opportunity for passive income investors as Stellus Capital Investment is solidly covering its dividend with net investment income and the BDC’s valuation is quite moderate with a NAV premium of only 3%. Ares Capital Corp. (ARCC), Golub Capital BDC Inc. (GBDC) and Blue Owl Capital Corp. (OBDC) all sell at similar NAV multiples (small premiums to net asset value of up to 10%) while also being overly floating-rate positioned. I think that a 3% premium to net asset value is a very sensible valuation for Stellus Capital Investment and I do anticipate for the stock to rebound in the short term as the BDC’s fundamentals look healthy. A 1.10x NAV multiple reflects an intrinsic value of $14.75 which at a present stock price of $13.88 could potentially lead to 6% upside. Data by YCharts Why Stellus Capital Investment Might Disappoint As An Investment Passive income investors primarily buy business development companies for purposes of income generation and, thus, are mainly concerned with the dividend pay-out ratio. In the case of Stellus Capital Investment, the dividend is well-covered, but 12%-yielding business development companies do have risk, otherwise they wouldn’t pay a 12% stock yield. My Conclusion Stellus Capital Investment is a tempting buy candidate now that the stock has pulled back a little last week. The business development company is managing to cover its $0.40 per share per quarter dividend pay-out with net investment income and the company is growing its income quite well. The moderate valuation after last week’s pullback makes a buy for passive income investors particularly attractive, in my view.  That the yield has risen to 12% on the pullback, certainly, makes the stock even more compelling from a yield, but also risk/reward point of view and I am comfortable being a buyer here for SCM.","kind":null,"is_publish_news":true,"is_publish_highlight":false,"is_publish_live":null,"is_publish_wemedia":null,"editions":null,"column":"","sentiment":"","news_tag":"","news_rank":0,"symbols":[],"gpt_button":1},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.24.2","shortVersion":"4.24.2","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2440069287"}