Stellus Capital investment: one of BDC’s top monthly-paying gems (NYSE: SCM)

metamorworks

Stellus Capital Investment Company (NYSE: SCM) receives a high rating from me due to the good performance of BDC’s credit portfolio, the unreasonably high discount to net asset value and the income potential of the portfolio.

Given the current performance of the portfolio, the business development company is trading at an excessive implied net asset value discount, and Stellus Capital Investment currently pays special dividends which contribute to the effective dividend yield.

A BDC with exceptional portfolio growth

Stellus Capital Investment is a business development firm that seeks to invest in private companies with annual EBITDA between $5 million and $50 million.

The business development company went public ten years ago in 2012 with $173.8 million in net assets at the time. Stellus Capital Investment produced constant growth in net assets over the past decade, primarily through secondary equity offerings. As of March 31, 2022, BDC’s net assets had increased to $285.0 million.

Stellus Capital investment portfolio growth

Portfolio Growth (Stellus Capital Investment Corp.)

Stellus Capital Investment‘s portfolio value has steadily increased over the past decade, as has the number of portfolio companies in which BDC has invested. The long-term growth trend is very positive, especially as Stellus Capital Investment’s portfolio has continued to grow throughout the COVID-19 pandemic.

The number of portfolio investments hit an all-time high of 78 in 1Q-22, while BDC’s total portfolio value was an all-time high at $838 million as of March 31, 2022.

Stellus Capital Investment - Number of portfolio investments

Number of portfolio investments (Stellus Capital Investment Corp.)

Stellus Capital Investment focuses only on senior liens, the safest debt investments a BDC can make. Approximately 91% of SCM’s portfolio was invested in various senior investments, with the remaining 8% in junior secured debt and only 1% in unsecured debt. 97% of these debt investments were in interest-bearing variable rate assets.

Stellus Capital Investment - Debt Securities Portfolio

Debt investment portfolio (Stellus Capital Investment Corp.)

Covered dividend payment

Stellus Capital Investment covered its dividend with basic net investment income for the full year. SCM had a payout ratio of 88% (based on regular dividend payments), with excess profits being distributed as special dividends. If BDC maintains its current payout ratio, SCM will most likely continue to pay the monthly dividend of $0.02 per share.

Stellus Capital Investment - Dividend and payout ratio

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

A 10% yield sold at a 20% discount to NAV

Stellus Capital Investment shares have a dividend yield of 9.8% based on a monthly dividend payment of $0.093 per share. That said, the effective dividend yield could reach 11.9% if BDC continues to pay a special monthly supplement of $0.02 per share, as Stellus Capital Investment currently does.

An investment in SCM at the time of its IPO ten years ago would have resulted in total distributions of $12.33 per share, or 85% of Stellus Capital Investment’s net asset value as of March 31, 2022.

BDC started with distributions of $0.18 per share in 2012 and could pay up to $1.36 per share in 2022 if management decides to maintain its special monthly dividend of $0.02 per share.

Stellus Capital Investment - Distribution share since IPO

Distribution share since IPO (Stellus Capital Investment Corp.)

Aside from a strong impression in terms of net asset growth, Stellus Capital Investment is a BDC that I believe should not be trading at a discount to net asset value, especially not a 20% discount.

Stellus Capital Investment’s portfolio is diversified and BDC’s low payout ratio suggests SCM may be trading at a premium to NAV.

SCM price at book value
Data by YCharts

Why Stellus Capital Investment Could See a Drop in Share Price

Stellus Capital Investment currently has many of the characteristics I look for in a high-quality BDC: strong and consistent net asset growth, a dividend covered by net investment income, and floating rate exposure that positions BDC for portfolio income growth. if interest rates rise.

However, there are risks, which seem to stem mainly from the general state of the economy. Stellus Capital Investment’s ability to find profitable new investments may be limited during a recession, and BDC’s portfolio may deteriorate, which could result in investment losses for Stellus Capital Investment and its shareholders.

My conclusion

Stellus Capital Investment has produced consistent growth in net assets over a decade, which is a testament not only to BDC’s ability to attract capital, but also to its ability to find attractive investment opportunities in different markets.

The business development company has distributed about 88% of its LTM NII, and special dividends, which are currently paid out at $0.02 per share per month, could boost SCM’s effective stock yield to 11.9%.

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