Capital Southwest Adds Capital to Your Portfolio

I am bullish on Capital Southwest Corp. (CSWC) stock.

Capital Southwest is a middle-market lending and credit-focused business development corporation (BDC). The U. S. government created BDCs in 1980.

Essentially, BDCs charge high interest rates, make riskier loans, and collect substantial origination fees well beyond terms from traditional lenders. Capital Southwest specializes in lending to middle-market businesses.

It provides private equity to firms needing mezzanine and late money. Capital can be used for buyouts and recapitalization. CSWC avoids angel and startup financing, investments in publicly traded companies, real estate developers, and troubled companies. (See CSWC stock charts on TipRanks)

Share prices are up 97.5% over the past year. The price upturn occurred when COVID-19 vaccines hit the market. Business investments took off. The lending cycle has steadily gone higher over the past eight months. In September 2021, CSWC raised its quarterly dividend 6.9%, from $0.44 to $0.47 per share.

CSWC boasts $1.2 billion worth of investable capital. The company had funded $1.6 billion in new credit investments as of June 30. On August 3, the company reported earnings of $57.2 million per year on revenue of $71.5 million per year. Capital’s long-term assets are about double its liabilities. The company’s first-lien investments top 90% of its portfolio.   

Hands-On Management

Insiders own about 8% of the company’s shares. Institutions own 27.5% percent. This year, officers and directors bought many more shares between $20.57 and $27.75, and sold few. The president and CFO are in their sixth years in office. The senior managing director has been in office for nearly five years.

The company holds a “Perfect 10” TipRanks Smart Score, expecting the company to outperform, because of rising bullish sentiment, its positive technicals, strong momentum, and insider buying.

Risks to Consider

Investor sentiment appears to be softening. Hedge fund holdings decreased last quarter. CSWC investors ought to be wary of the effects inflation, labor shortages, supply chain issues, and increasing numbers of unemployment claims might have on the growth of the company.

Capital’s debt-to-equity ratio is high (122.7%). The operating cash flow is negative. Cash flow barely covers interest payments. It does not cover the debt.

Total shares this year grew by nearly 20%, diluting shareholders. The threat remains it may happen again. CSWC has a high level of non-cash earnings.

In August, the CFO announced a restructuring of the company debt facility, extending its term for final maturity from 2023 to 2026. The current dividend yields 10%, but beware. Dividend payments have historically been volatile.

Wall Street’s Take

The good news is the dividend is covered by earnings. Eleven other BDCs announced dividend increases this year. CSWC should hold its dividend for the next 12 months. Note that BDCs must pay 90% of their annual taxable income to shareholders.

Wall Street gives CSWC a Strong Buy consensus rating from analysts. The average CSWC price target of $26.25 implies 2.7% upside potential.

Bottom Line

The company is valued fairly. Management will be able to deleverage the debt with increasing earnings and profitability.

The business outlook is getting better, but bank loans remain scarce. More businesses are turning to BDCs.

Disclosure: At the time of publication, Harold Goldmeier did not have a position in any of the securities mentioned in this article.

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