Published Wed, 13 Mar 2019 12:40:37 on Income Investors
A Monthly Dividend Stock Most People Have Never Heard of
If you want to earn a passive income, monthly dividend stocks are worth checking out.
Rather than issuing dividends every quarter like most stocks, these companies pay investors on a monthly basis. And since most of our bills are due every month, a monthly stream of dividends can go a long way towards balancing the budget for a passive income investor.
That’s why today, I want to show you one of the most generous monthly dividend payers in the current stock market, Capitala Finance Corp (Nasdaq: CPTA).
Headquartered in Charlotte, North Carolina, Capitala Finance Corp is a business development company (BDC). Like many BDCs, the company provides financing solutions to lower-middle-market businesses in the U.S.
Capitala focuses primarily on businesses with a history of generating revenue and positive cash flow. Its target borrower typically has annual revenue of between $10 million and $200 million and trailing twelve-month earnings before interest, tax, depreciation and amortization of $4.5 million to $30 million.
Because lower-middle-market businesses are not as established as the big corporations, traditional banks don’t always lend to them. And due to the more stringent banking regulations put in place in recent years, it’s even harder for these businesses to get a loan these days.
That’s where Capitala Finance Corp finds its opportunity. By providing financing solutions to these underserved lower-middle-market businesses, the company earns outsized interest payments. According to the latest investor presentation, the weighted average yield of Capitala’s debt investments at the end of 2018 was 11.9%. (Source: “Investor Update Q4 2018,” Capitala Finance Corp, last accessed March 6, 2019.)
Furthermore, because the company is structured as a BDC, it must pass at least 90% of its profits to shareholders through regular dividend payments. In exchange for this mandatory distribution requirement, BDCs pay little to no income tax at the corporate level.
And as I said, this is a monthly dividend stock.
Right now, Capitala Finance Corp has a monthly dividend rate of $0.0833 per share. With its shares trading at $7.67 apiece, CPTA stock offers a yield of 13%.
Capitala Finance Corp: Is the Payout Safe?
Of course, for investors who want to use monthly dividends to cover daily expenses, dividend safety is of utmost importance. So the big question now is, can the company cover its oversized payout?
Well, like most BDCs, Capitala Finance Corp reports something called “net investment income.” To see whether the payout was safe in a given reporting period, all you need to do is to compare the company’s net investment income to its dividend payment for that period.
On that front, in 2018, Capitala Finance Corp generated net investment income of $16.0 million, or $1.00 per share. The company’s dividends, on the other hand, also totaled $16.0 million, or $1.00 per share, for the year. In other words, the company did make enough money to cover its dividend last year, but it didn’t leave any room for error. (Source: “Capitala Finance Corp. Reports Fourth Quarter and Full Year 2018 Results,” Capitala Finance Corp, March 4, 2019.)
Also worth noting is that the company’s quarterly coverage wasn’t always consistent. In particular, Capitala Finance Corp’s net investment income per share for the four quarters of 2018 were $0.28, $0.26, $0.24, and $0.22, respectively. Each quarter, the company paid three monthly dividends totaling $0.25 per share. So while the company managed to earn more than enough profits to cover its dividend in the first and second quarters, it didn’t do as good a job in second half of the year.
Still, the company has no plan to cut the payout.
“As we move into 2019, management is focused on a number of priorities,” said Joseph Alala III, president and CEO of Capitala Finance Corp. “Consistent coverage of our dividends, maintain the dividend and continue to have no return of capital, continued reduction of nonaccrual risk rate 3 investments, stable and preferably growing our net asset value per share, meaningful reduction of our equity portfolio through monetizations.” (Source: “Capitala Finance Corp (CPTA) CEO Joseph Alala III on Q4 2018 Results – Earnings Call Transcript,” Seeking Alpha, March 5, 2019.)
One Thing to Watch for in 2019
By now, you can probably see that CPTA stock is not exactly perfect. As a risk-averse income investor, I like to see companies outearning their dividends on a consistent basis.
Still, there is one thing that could lead to an improvement in Capitala Finance Corp’s dividend safety rating: interest rates.
You see, like many BDCs, Capitala has exposure to interest rates through its interest-bearing assets and liabilities.
And here’s the cheerful part: as of December 31, 2018, 97% of the company’s funded liabilities are fixed-rate. Therefore, as interest rates go up—a trend that has been happening for quite a while—it won’t experience a big increase in interest expense.
At the same time, Capitala Finance Corp had 59% of its debt investment bearing interest at floating rates. Therefore, the company would earn higher interest income when rates increase.
In fact, management has estimated that if the benchmark interest rates go up by 100 basis points, Capitala Finance Corp would earn an additional $2.0 million in annual investment income, yet its annual interest expense would only go up by $100,000. At the bottom line, such scenario would allow the company to earn an extra $1.9 million, or $0.12 per share, in annual net investment income. (Source: Capitala Finance Corp, op cit.)
Senior Secured Lending Portfolio
Add it up and you’ll see that despite posting a less-than-stellar dividend coverage recently, Capitala Finance Corp does have a portfolio positioned to generate more profits. It should also be noted that the portfolio has as strong focus on senior secured lending.
As of December 31, 2018, the company’s $449.0-million portfolio consists of 53% first-lien debt, seven percent second-lien debt, 16% subordinated debt, 21% equity, and three percent Capitala Senior Loan Fund II, LLC. These investments were diversified across 44 companies coming from more than 10 different industries.
The share of senior secured loans in Capitala Finance Corp’s portfolio has also been rising over time. The chart below shows the percentage of first-lien debt in the company’s total debt portfolio since the end of 2014:
Source: Capitala Finance Corp, op cit.
In particular, all of the company’s investments made in 2018 were first-lien.
If you are a first-lien lender, you’ll be the first one in line to get paid in the event of borrower liquidation. Therefore, Capitala Finance Corp’s increasing focus on senior secured loans certainly helped improve the risk profile of its debt portfolio.
The Bottom Line on Capitala Finance Corp
So there you have it.
Capitala Finance Corp pays generous monthly dividends, with a staggering 13% annual yield. It has an investment portfolio well-positioned to generate more income to be distributed to shareholders, but its dividend coverage could use some improvement.
I wouldn’t say CPTA stock a surefire bet, but it’s certainty one of the top monthly dividend stocks to watch for yield-seeking investors in 2019.
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