Stellus Capital Stock: Another chance to buy this 8.6% yielding BDC

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Weakness in the share price of business development company Stellus Capital Investment Corporation (NYSE: SCM) translates into a new buying opportunity for its 8.6% yield.

Stellus Capital’s share price recently fell to $13, allowing income investors to buy BDC at a 9% discount on book value.

Stellus Capital pays a monthly dividend that is covered by basic net investment income, and BDC’s investment portfolio is diversified, protecting against economic downturns. All things considered, Stellus Capital is a buy in my opinion.

A growing BDC with solid portfolio quality

Stellus Capital stands out from other business development firms because of its emphasis on relatively secure first lien. First liens are the highest forms of debt and are generally secured loans with a very low probability of default.

By focusing on First Liens, which represent 92% of Stellus Capital’s debt investment portfolio, the business development firm is laying the foundation for strong portfolio performance even as macroeconomic conditions change.

The remaining 8% of Stellus Capital’s portfolio is comprised of 8% junior secured debt and less than 1% unsecured debt. Importantly, 97% of Stellus Capital’s investments are variable rate, meaning they will earn higher interest rates.

Debt portfolio

Debt portfolio (Stellus Capital Investment Corp.)

Stellus Capital’s investment portfolio was well diversified and valued at $852 million in 2Q-22 (on a fair value basis). Stellus Capital has little exposure to the retail and energy sectors, both known to have volatile and vulnerable cash flows during recessions.

Instead, Stellus Capital, like many other business development firms, focuses on services businesses (26% portfolio representation), pharmaceuticals (11%) and aerospace and defense (7%) . These industries provide consistent income and cash flow, which reduces the risk of default on Stellus Capital’s investment loans.

Portfolio overview

Portfolio overview (Stellus Capital Investment Corp.)

Dividend coverage and dividend growth

Stellus Capital has adequate dividend coverage, with basic net investment income covering the dividend payout.

Stellus Capital earned $0.29 per share in basic net investment income in the second quarter and paid $0.28 per share (cumulative) in the same quarter. The payout ratio in 2Q-22 was 97%, compared to a payout ratio of 91% in the previous twelve months.

Dividend and payout ratio

Dividend and payout ratio (The author created a table using information from BDC)

Stellus Capital has paid a cumulative dividend of $12.67 per share since its IPO and currently pays a basic monthly dividend of $0.0933 per share.

At today’s prices, the total dividend payout equates to a yield of 8.6% (excluding additional monthly dividends).

Stellus Capital recently paid additional dividends of $0.02 per share, which were announced through September. I expect Stellus Capital to eventually revert to only paying the dividend of $0.0933 per share, which is the only dividend I consider when calculating BDC’s dividend yield.

Cumulative dividend

Cumulative dividend (Stellus Capital Investment Corp.)

Convincing P/B multiple

Stellus Capital is now available at a higher discount to book value due to the recent stock decline. Stellus Capital’s net asset value at the end of last quarter (2Q-22) was $14.32, so a stock price of $13.06 implies a 9% discount to value. liquidation.

As previously reported, the discount widened again in September, solely due to general market weakness and a desire to take profits on stocks that have performed well for shareholders in recent months.

Why Stellus Capital Could See a Lower Valuation

Stellus Capital, as previously noted, has a diversified, safety-focused investment portfolio with sufficient net investment income to fund a generous monthly dividend over the past year.

That said, the diversification and resilience of Stellus Capital’s portfolio may be tested in a severe stress scenario, such as a deep recession resulting in higher investment losses.

Absent a recession, I believe Stellus Capital is a business development company that can expand its portfolio and even increase its dividend payout.

My conclusion

The September pullback provides another opportunity to buy shares of Stellus Capital. The business development company is well managed, reliably covers its dividend with basic net investment income, and Stellus Capital’s exceptional focus on senior debt provides BDC with an additional layer of security that other BDCs do not offer to their shareholders.

Stellus Capital also pays a monthly dividend, which may appeal to investors who prefer to receive distributions on a monthly basis.

Stellus Capital’s 8.6% dividend yield is attractive given the stock’s 9% discount to net asset value.

Sallie R. Loera