Stellus Capital: Latest Results
Stellus Capital (SCM) reported Adjusted Net Investment Income Per Share of $0.28. That’s below the analyst median estimate of $0.31 for the quarter.
The result is also below the prior quarter’s adjusted earnings of $0.31. And the $0.34 distribution.
For the year, Adjusted Net Investment Income Per Share was $1.24, after adding back the expense of debt refinancing.
NAV ended up at $13.81, up from $13.69 in 2016, helped by Realized Gains during the year.
We’ve reviewed the press release, the 10-K and the Conference Call transcript. (The first two are above. The transcript will be added later when a public version comes available).
The quarter’s earnings – and the year as a whole – were affected by heavy repayments at a time when SCM had more capital to put to work.
Total investment assets barely increased over the full year, but shares outstanding from 12.5mn to 16.0mn.
Almost half the portfolio “turned over” during the year.
However, in the first weeks of 2018 – as SCM reports – a number of new deals have been booked and no repayments as yet.
That has boosted borrowings on the Revolver to $83mn from $44mn and probably used up some of the BDC’s cash sitting on its balance sheet at year end.
More on that below.
SCM’s non-accruals increased to 2 borrowers from 1 the prior quarter.
In November 2017 – as the notes to the 10-K show but not mentioned in the press release – Grupo Hima San Pablo‘s Second Lien loan for $4.1mn became non-performing.
The value on the books was written down from $2mn to $0.9mn.
This was a high paying loan with a yield of 13.75%, and shaved off some income in the quarter and will do so again going forward.
However, SCM’s $4.7mn in the first lien debt of the Puerto Rican hospital chain remains on performing status, and discounted only about (15%) from cost.
By the way, MAIN – which is also in the senior debt tranche – carries its position at a (25%) discount.
The junior debt is due in July and the senior debt came due on January 31. How this debt gets refinanced will be a key issue.
Otherwise credit quality looks to be in good shape.
We count 5 Watch List names in total on a 48 company portfolio, including Grupo Hima.
Three of the positions are not meaningful to either NAV or the BDC’s income.
There’s Glori Energy Production – an energy play that went wrong – where the only stake remaining is a $1.05mn (at cost) equity position which was valued up by $50,000 this quarter, and is now close to par.
Binder & Binder
Then there’s the remainder of SCM’s biggest set-back to date: Binder & Binder. The only asset remaining is a “residual claim”.
That’s non-income producing, with a cost of $400,000 and a value of $380,000.
That seems to have come down by $100K since September 2017, suggesting some recovery was made.
The $6.8mn Second Lien loan to Hostway Corporation remains non income producing, but that has been the case from – at least- June 2017.
The valuation is unchanged at a modest (11%) discount to cost.
Finally, SCM has $1.3mn invested in debt and equity in Wise Holdings,LLC. The latter has been written down to zero and the debt by a third.
This quarter the debt was written down to $0.88mn from $1.01mn, according to Advantage Data’s records.
The company was already on our Watch List since last quarter.
However, the income at risk (the most important item we look out for) is $0.160mn a year on a BDC with nearly $40mn in Investment Income.
Judging by the BDC’s internal investment rating the total percentage of assets – at FMV- in the under-performing category remains unchanged from the prior quarter at 11%.
That was $39.3mn in total dollars at risk, but 90% (or $37mn) is in the least worrisome Category 3.
Our own count – based on this quick 10-K survey – is only $13.3mn at risk from a value standpoint.
The biggest threat to income come from the Grupo Hima senior loan or the Wise Holding unsecured loan going on non-accrual in 2018.
Together the investment income that COULD be lost is under $0.6mn a year, or 3.3% of 2017’s Net Investment Income.
That’s under 1 cent a quarter per share of potential income loss from the most obvious under-performing candidates.
SCM does occasionally book equity gains.
Currently there are 3 material non income producing investments that could get sold and generate a return with a value of $8.4mn.
Re-invested into yielding instruments at 10.0%, these could add $0.84mn to investment income in the future, offsetting both NAV and earnings loss from the 5 under-performing credits.
Far more important to SCM’s earnings in 2018 will be the ability to build up its portfolio in the year ahead to increase revenues.
So far in the IQ 2018, the BDC has added $62mn in new investments, mostly in the form of yielding debt.
That’s a 16% increase in portfolio assets.
We estimate a third was paid with cash and the other two thirds by drawing on the Revolver or the SBIC.
Plus a portfolio company paid out an unusual $1.35mn dividend that will benefit earnings in the current quarter.
(SCM only booked $1.6mn in “Other Income” in all of last year, so this is likely to boost the first quarter’s results).
On the Conference Call, management made clear its intention to boost the size of the portfolio to over $500mn in 2018.
And increase earnings to meet the dividend liability.
Helping the BDC’s plans are $60mn of undrawn SBIC debt, the undrawn amounts on the Revolver and cash on the balance sheet.
Notwithstanding the Grupo Hima loan going on non-accrual and SCM under-earning its dividend for another quarter, the BDC Reporter is relatively optimistic.
We expect recurring earnings to bounce back in 2018 as the portfolio grows on a net basis and to “cover” the dividend both for the quarter and year as a whole.
Helping out will be a lower cost on the Unsecured Notes thanks to last year’s refinancing, and slightly cheaper bank revolver.
Even if SCM misses its goals by a few cents, it’s possible the Investment Advisor will waive fees -which they have not had to do of late – to ensure the dividend is covered.
We have a minority view.
Looking at SCM’s stock price – both before and after the earnings release – investors are clearly skeptical.
From a high of $14.52, SCM has dropped (22%) in recent months.
The market may be in a “Show Me” mood where SCM is concerned. In early trading – after results were announced – the stock is slightly off at $11.56.
That’s a (16%) discount to the latest book value and a yield of 11.8%.
That suggests Mr Market is not convinced the BDC can maintain the $0.34 quarterly payout for much longer.
Even on the Conference Call a couple of analysts were palpably expressing doubts about SCM’s ability to achieve their earnings-growing goals and even questioning management’s judgement in seeking to boost assets.
(In a microcosm this is a reflection of the “this-can’t-continue” view that many investors have about leveraged loan investing in 2018 and beyond, and an example of the shift in sentiment that we’ve been calling out for months)
For better or worse, the BDC Reporter is more optimistic, both about SCM and leveraged finance in the year ahead.
Beyond that it’s anybody’s guess.
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