Capital Southwest: High Quality But Awaiting A Better Price Point

seekingalpha07-23

Capital Southwest has been a strong performer in the BDC sector, with a total return comprised of both price appreciation and a high distribution rate.CSWC's portfolio strategy focuses on lower middle...

Source Link

Disclaimer: Investing carries risk. This is not financial advice. The above content should not be regarded as an offer, recommendation, or solicitation on acquiring or disposing of any financial products, any associated discussions, comments, or posts by author or other users should not be considered as such either. It is solely for general information purpose only, which does not consider your own investment objectives, financial situations or needs. TTM assumes no responsibility or warranty for the accuracy and completeness of the information, investors should do their own research and may seek professional advice before investing.

Comments

We need your insight to fill this gap

Leave a comment

{"i18n":{"language":"en_US"},"isChannel":false,"data":{"share":"https://ttm.financial/m/news/2453082215?lang=en_US&edition=fundamental","thumbnail":"https://static.seekingalpha.com/cdn/s3/uploads/getty_images/1077235824/image_1077235824.jpg","is_english":true,"pubTime":"2024-07-23 18:52","share_image_url":"https://static.laohu8.com/5a36db9d73b4222bc376d24ccc48c8a4","id":"2453082215","market":"fut","top_or_hot":-1,"title":"Capital Southwest: High Quality But Awaiting A Better Price Point","media":"seekingalpha","content":"<div>\n<p>Capital Southwest has been a strong performer in the BDC sector, with a total return comprised of both price appreciation and a high distribution rate.CSWC's portfolio strategy focuses on lower middle...</p>\n\n<a href=\"https://seekingalpha.com/article/4705709-capital-southwest-high-quality-but-awaiting-a-better-price-point\">Source Link</a>\n\n</div>\n","source":"seekingalpha","html":"<!DOCTYPE html>\n<html>\n<head>\n<meta http-equiv=\"Content-Type\" content=\"text/html; charset=utf-8\" />\n<meta name=\"viewport\" content=\"width=device-width,initial-scale=1.0,minimum-scale=1.0,maximum-scale=1.0,user-scalable=no\"/>\n<meta name=\"format-detection\" content=\"telephone=no,email=no,address=no\" />\n<title>Capital Southwest: High Quality But Awaiting A Better Price Point</title>\n<style type=\"text/css\">\na,abbr,acronym,address,applet,article,aside,audio,b,big,blockquote,body,canvas,caption,center,cite,code,dd,del,details,dfn,div,dl,dt,\nem,embed,fieldset,figcaption,figure,footer,form,h1,h2,h3,h4,h5,h6,header,hgroup,html,i,iframe,img,ins,kbd,label,legend,li,mark,menu,nav,\nobject,ol,output,p,pre,q,ruby,s,samp,section,small,span,strike,strong,sub,summary,sup,table,tbody,td,tfoot,th,thead,time,tr,tt,u,ul,var,video{ font:inherit;margin:0;padding:0;vertical-align:baseline;border:0 }\nbody{ font-size:16px; line-height:1.5; color:#999; background:transparent; }\n.wrapper{ overflow:hidden;word-break:break-all;padding:10px; }\nh1,h2{ font-weight:normal; line-height:1.35; margin-bottom:.6em; }\nh3,h4,h5,h6{ line-height:1.35; margin-bottom:1em; }\nh1{ font-size:24px; }\nh2{ font-size:20px; }\nh3{ font-size:18px; }\nh4{ font-size:16px; }\nh5{ font-size:14px; }\nh6{ font-size:12px; }\np,ul,ol,blockquote,dl,table{ margin:1.2em 0; }\nul,ol{ margin-left:2em; }\nul{ list-style:disc; }\nol{ list-style:decimal; }\nli,li p{ margin:10px 0;}\nimg{ max-width:100%;display:block;margin:0 auto 1em; }\nblockquote{ color:#B5B2B1; border-left:3px solid #aaa; padding:1em; }\nstrong,b{font-weight:bold;}\nem,i{font-style:italic;}\ntable{ width:100%;border-collapse:collapse;border-spacing:1px;margin:1em 0;font-size:.9em; }\nth,td{ padding:5px;text-align:left;border:1px solid #aaa; }\nth{ font-weight:bold;background:#5d5d5d; }\n.symbol-link{font-weight:bold;}\n/* header{ border-bottom:1px solid #494756; } */\n.title{ margin:0 0 8px;line-height:1.3;color:#ddd; }\n.meta {color:#5e5c6d;font-size:13px;margin:0 0 .5em; }\na{text-decoration:none; color:#2a4b87;}\n.meta .head { display: inline-block; overflow: hidden}\n.head .h-thumb { width: 30px; height: 30px; margin: 0; padding: 0; border-radius: 50%; float: left;}\n.head .h-content { margin: 0; padding: 0 0 0 9px; float: left;}\n.head .h-name {font-size: 13px; color: #eee; margin: 0;}\n.head .h-time {font-size: 11px; color: #7E829C; margin: 0;line-height: 11px;}\n.small {font-size: 12.5px; display: inline-block; transform: scale(0.9); -webkit-transform: scale(0.9); transform-origin: left; -webkit-transform-origin: left;}\n.smaller {font-size: 12.5px; display: inline-block; transform: scale(0.8); -webkit-transform: scale(0.8); transform-origin: left; -webkit-transform-origin: left;}\n.bt-text {font-size: 12px;margin: 1.5em 0 0 0}\n.bt-text p {margin: 0}\n</style>\n</head>\n<body>\n<div class=\"wrapper\">\n<header>\n<h2 class=\"title\">\nCapital Southwest: High Quality But Awaiting A Better Price Point\n</h2>\n\n<h4 class=\"meta\">\n\n\n2024-07-23 18:52 GMT+8&nbsp;&nbsp;&nbsp;<a href=https://seekingalpha.com/article/4705709-capital-southwest-high-quality-but-awaiting-a-better-price-point><strong>seekingalpha</strong></a>\n\n\n</h4>\n\n</header>\n<article>\n<div>\n<p>Capital Southwest has been a strong performer in the BDC sector, with a total return comprised of both price appreciation and a high distribution rate.CSWC's portfolio strategy focuses on lower middle...</p>\n\n<a href=\"https://seekingalpha.com/article/4705709-capital-southwest-high-quality-but-awaiting-a-better-price-point\">Source Link</a>\n\n</div>\n\n\n</article>\n</div>\n</body>\n</html>\n","isBrief":false,"type":0,"news_type":1,"symbol":"CCAP","symbol_name":"Crescent Capital BDC Inc","start_time":0,"source_url":"https://seekingalpha.com/article/4705709-capital-southwest-high-quality-but-awaiting-a-better-price-point","article_id":"2453082215","we_media_id":null,"thumbnails":["https://static.seekingalpha.com/cdn/s3/uploads/getty_images/1077235824/image_1077235824.jpg"],"rights":null,"url":"https://stock-news.laohu8.com/highlight/detail?id=2453082215","pubTimestamp":1721731972,"sourceInfo":{"source_id":"seekingalpha","name":"Seeking Alpha"},"weMediaInfo":null,"summary":"Capital Southwest has been a strong performer in the BDC sector, with a total return comprised of both price appreciation and a high distribution rate.CSWC's portfolio strategy focuses on lower middle","collect":0,"end_time":0,"defaultTopTitle":"seekingalpha.com","property":[],"viewcount":null,"language":"en","relate_stocks":{"CCAP":"Crescent Capital BDC Inc","BK4585":"ETF&股票定投概念","BK4135":"资产管理与托管银行","BK4588":"碎股","TSLX":"TPG Specialty Lending Inc","CSWC":"西南资本","MAIN":"Main Street Capital"},"translate_title":"首都西南：高品质但等待更好的价格点","themeId":null,"isJumpTheme":false,"ttsUrl":null,"symbols_score_info":{"CCAP":1,"CSWC":1,"MAIN":1,"TSLX":1,"US10Y.BOND":0.9,"US12M.BOND":0.9,"US2Y.BOND":0.9,"US30Y.BOND":0.9,"US3Y.BOND":0.9,"US5Y.BOND":0.9,"US6M.BOND":0.9,"US7Y.BOND":0.9,"US912797HE00.BOND":0.6,"US912797GW17.BOND":0.6,"US912797GL51.BOND":0.6,"US912797GK78.BOND":0.6},"content_text":"Capital Southwest has been a strong performer in the BDC sector, with a total return comprised of both price appreciation and a high distribution rate.CSWC's portfolio strategy focuses on lower middle market companies, with a large emphasis on first lien debt investments for stability.While CSWC's net investment income has benefited from higher interest rates, potential future rate cuts may impact the price, presenting a better entry opportunity.The current dividend yield sits at 8.7% and is well supported by net investment income.CSWC trades at a massive premium to net asset value. I believe that future interest rate changes may present a more attractive price level.   BrankospejsOverview Business Development Companies have remained one of the best places to ride out this higher interest rate environment. Capital Southwest (NASDAQ:CSWC) has been one of my strongest performing BDCs over the last twelve months, and the price has run up near all-time high levels. I previously covered CSWC back in March, and since then, it has outpaced the total return of the S&P 500. Looking back over the last five-year period, CSWC has provided a total return of about 125% and some solid price upside of about 22%. While the price has delivered some modest growth, the high distribution rate is the primary contributor to the high total return. Data by YChartsNow that the price has run up, the current distribution yield sits at 8.7%. CSWC has rewarded long time shareholders with consistent supplemental dividends as well as base increases over the last few years. This has been a result of the higher interest rate environment that CSWC has been able to efficiently capitalize on. The strong performance has led CSWC to trade at a massive premium to net asset value. I now stay cautious on increasing my position size at these levels, since I think that there's a good chance we see a price retraction eventually. There are a few different economic indicators that may signal a change in the interest rate environment, and this is why I wanted to provide an updated analysis. Just to provide a bit of context, Capital Southwest operates as a business development company that aims to generate its earnings from lending capital to lower middle market companies. An added bonus is that CSWC is internally managed, and I've noticed that these BDCs tend to perform a bit better than their externally managed counterparts. This is because there are no externally focused management fee structures in place that can chew into the BDC's earnings. As a result, more of the returns flow through to investors in the form of higher distribution increases, more supplemental dividends, and more price growth since a higher rate of earnings are retained. Let's first start by digging into CSWC's portfolio strategy and what makes it such a great fund. Portfolio Strategy CSWC likes to operate in the lower middle market sector because there are a lot more companies that fall into this range which management can choose from, and it also offers higher growth potential. They invest into companies that have an EBITDA within the range of $3M to $20M. Most of their investments are in the form of debt capital investments, but CSWC also makes some equity investments to boost returns. However, most of their portfolio is in the form of first lien debt investments. We can see from the visual below, the credit portfolio has also consistently growth year over year, which reinforces the quality behind CSWC's ability to create value.   CSWC PresentationThe large 97% emphasis on first lien debt investments is something that I really like because it offers a better sense of stability and reassures me that all invested capital has a lower chance of being lost with a bad investment. This is because first lien senior secured debt sits at the top of the corporate capital structure. This means that this form of debt has the utmost highest priority of repayment in cases where a portfolio company may be going through a bankruptcy and liquidating assets. This helps ensure that CSWC doesn't lose all invested capital on a bad deal. Additionally, their strategy is to maintain a focus on floating rate investments. As of their latest report, 97.4% of their portfolio is exposed to floating rate investments. The remaining 2.6% of the portfolio is on a fixed rate basis. This focus on floating rate has helped the BDC rake in higher levels of income through increased interest payments from their borrowers. Therefore, CSWC will likely continue benefiting from an environment of higher interest rates.    CSWC PresentationThey also maintain a diverse range of exposure across different industries as a way to mitigate any sort of concentration risk to one specific industry or sector. Healthcare services remained the highest industry exposure, accounting for 14% of the portfolio. This is closely followed by business services and media & marketing, both making up 12% respectively. There are currently 116 different portfolio companies within, and the average debt investment size per holding sits at $12.5M. Financials & Risk CSWC will be reported their Q1 earnings on this upcoming August 5th and I anticipate earnings to remain solid and in line with prior quarters. They did announce some preliminary results that see net investment income landed between $0.62 per share to $0.63 per share. As part of these preliminary results, they estimate net asset value to fall between $16.55 per share to $16.65 per share, which would be a slight decrease down from the prior quarter's NAV of $16.77 per share. Just for reference, the net investment income results would also be a slight decrease from the prior quarter's total of $0.66 per share. The decreases may be a result of shifting portfolio weights, but we will have to await the official earnings report to gather more insights about it. Looking at the earnings history, we can see exactly how CSWC's portfolio of floating rate investments have been able to bring in higher amounts of income. Taking a look at 2021, the net investment income per share amounted to $0.38 in the first quarter. For reference, interest rates were still near zero levels throughout all of 2021 and didn't begin to get hiked until the start of 2022. We can see the story play out here, as NII per share consistently grew as interest rates were hiked. Higher interest rates directly correlate to more earnings through the increased levels of interest income that CSWC can generate from borrowers.   Seeking AlphaHowever, the higher interest rates can also cause additional strain on some portfolio companies that may be underperforming. As interest rates remain at their decade high, it may make it difficult for some borrowers to retain earnings and grow efficiently due to the higher expenses and cost of debt. This is typically measured by the non-accrual rate. Non-accruals measure the rate of portfolio companies that are materially underperforming initial expectations and can no longer keep up with the required debt payments. A rising non-accrual rate can indicate that a BDC's portfolio has less borrowers contributing to their earnings growth and can help us gauge how efficient management's underwriting process is. As of the most recent earnings call, the non-accruals sat at 2.3% of fair value. For reference, when I last covered CSCWC, the non-accruals sat at about 2.2% of fair value. As a result, we can see that the continued pressure of higher interest rates have started to weigh on the portfolio. Just for reference, here are the non-accrual rate of some peer BDCs:  Main Street Capital (MAIN): 0.5% non-accrual rate at fair value. Sixth Street Specialty Lending (TSLX): 1.1% non-accrual rate at fair value. Crescent Capital (CCAP): 0.9% non-accrual rate at fair value.  Therefore, if we remain in a 'higher for longer' interest rate environment, we may see non-accruals increase over time. However, I do believe that there's a greater possibility for interest rate cuts over the next twelve months. These non-accruals can be offset by the increased priority of new investments that CSWC continues to make. They have committed $154M to new credit investments over the last quarter and these have a weighted average yield of 13.3%. This was allocated towards six new portfolio companies and five add-on commitments to existing portfolio companies. Additionally, the BDC has $32.3M in cash and equivalents to help serve as an added buffer to any potential headwinds. Valuation & Outlook Since CSWC operates as a BDC, the price can vary from the underlying value of its net assets. As a result, investors can capitalize by building a position in BDCs while they trade at an attractive discount to net asset value. However, since the tail end of the pandemic, the price has traded at an astronomically high premium to NAV. The price now trades at a premium to NAV of about 56.7%. For reference, the price has traded at an average premium to NAV of about 35% over the last three-year period. Looking at the below ten-year chart, we can see that the price traded at a discount for a majority of the decade prior to 2020. The price has continued to increase alongside the growth of CSWC's portfolio value. However, I do not believe that this sort of premium is likely to be sustained as the interest rate environment begins to change. Wall St. seems to agree with this sentiment, since they have an average price target of $25.75 per share, which represents a slight downside of 0.5% from the current price level. However, I imagine that most investors looking at CSWC aren't aiming to capture upside growth and instead prioritize maxing out the income potential.   CEF DataWhen it comes to utilizing BDCs as a source of high yielding income, the price you buy in matters the most. Therefore, I am holding off on adding more shares at this premium level as I believe that future interest rate cuts can take the price down a bit. The Fed has left interest rates unchanged for the past year as they awaited more economic data to roll in around inflation levels, consumer spending, and the labor market. However, inflation has consistently ticked down over the last three months and now sits at the 3% level. Similarly, the unemployment rate has continued to slowly trend upward over the last twelve months. In addition, the US presidential elections are upcoming this year. Elections typically increase the level of volatility and uncertainty in the markets. Therefore, I believe that the combination of these factors may serve as a strong enough incentive for the Fed to begin cutting interest rates. Data compiled by JPMorgan also shows us that the Fed are more historically more likely to introduce interest rate changes in election years. Over the last 40-year period, there was only one single election year when the Fed left interest rates unchanged.   CSWC PresentationI think that these interest rate cuts will negatively affect the price and present a more attractive entry opportunity for new investors, as well as a more attractive price point for current investors to further accumulate. Lower interest rates would directly translate to lower net investment income totals that are generated from their portfolio of investments. Management provided this transparent table to show what kind of impact future interest rate changes would ultimately have on the annual NII amount. Dividend As of the latest declared quarterly dividend of $0.57 per share, the current dividend yield sits at 8.7%. As previously mentioned, NII per share over the last quarter landed at $0.66 per share. This means that net investment income per share covers the distribution for the quarter at a rate of 115%. Therefore, I believe that the current distribution rate continues to be well-supported through the portfolio's earnings. Not only has the distribution been well-supported, but CSWC has rewarded shareholders with plenty of supplemental distributions.   Seeking AlphaWe can see that there has been a supplemental payment issued to shareholders every single quarter since the start of 2023. Not only has there been supplementals, but the base distribution has grown at an attractive rate too. For instance, the distribution has increased at a CAGR (compound annual growth rate) of 9.08% over the last five-year period. Even on a smaller time frame of three years, the dividend has increased at a CAGR of 4.8%. This level of growth has rewarded long-term shareholders through higher levels of dividend income. I ran a back test of an initial investment of $10,000 to demonstrate how rapid the income growth could happen with consistence. This visual assumes that you also invested a fixed amount of $500 per month throughout the entire holding period, while also reinvesting all dividends received back into CSWC.    CEF DataIn 2016, your annual dividend income would have totaled $528. Fast forward to the full year of 2023, and we can see that the distribution income received would now total $16,030. However, it's important to note that the distributions received from CSWC are classified as ordinary dividends. Ordinary dividends have less favorable tax consequences than qualified dividends you'd received from more traditional dividend growth stocks. Therefore, an investment in CSWC may be better utilized in a tax advantaged account to offset the tax burden here. Taking a look at the 2023 distribution breakdown confirms the ordinary classification.   CSWC 2023 Tax InformationTakeaway  In conclusion, CSWC remains high quality and implements a structure that maintains a balance of risk management and protection against losses. The performance of net investment income has been juiced up from the higher interest rate environment, but I believe that future interest rate cuts may introduce a more attractive price point for both new investors as well as long-term shareholders to accumulate more shares. The price currently trades at a massive premium to NAV of about 56.7%. Therefore, I maintain a hold rating on CSWC to see how economic factors will affect the price over the next twelve months.","kind":null,"is_publish_news":true,"is_publish_highlight":false,"is_publish_live":false,"is_publish_wemedia":null,"editions":null,"column":"","sentiment":"0","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":"4.26.3","shortVersion":"4.26.3","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/2453082215"}