Earnings call: Stellus Capital reports steady Q3 growth, eyes Q4 gains

Stellus Capital Investment Corporation (NYSE: NYSE:SCM) discussed its third-quarter financial results on November 8, 2024, reporting solid performance and providing optimistic projections for the fourth quarter. CEO Robert Ladd and CFO Todd Huskinson shared that the company's net investment income per share stood at $0.39 on a GAAP basis and $0.40 on a core basis.

Stellus also announced an increase in net asset value per share by $0.19, with its investment portfolio valued at $908.7 million across 99 companies. The company's portfolio is expected to grow further in Q4, with forecasted equity realizations and loan repayments enhancing its financial position. A dividend of $0.40 per share has been declared for Q4, underscoring the company's commitment to shareholder returns.

Key Takeaways

• Stellus Capital reported GAAP net investment income of $0.39 per share and core net investment income of $0.40 per share for Q3 2024.
• The company's net asset value per share increased by $0.19.
• Since its IPO, Stellus has invested approximately $2.5 billion in over 195 companies.
• The investment portfolio is valued at $908.7 million across 99 companies.
• For Q4, Stellus anticipates growing its portfolio to between $930 million and $950 million.
• Projected Q4 loan repayments are approximately $29 million, with equity realizations of about $5.3 million.
• A dividend of $0.40 per share for Q4 has been declared, payable monthly.
• Potential transaction expected in Q4 could lead to appreciation.
• Spillover income of $42 million reported as of the end of Q3, excluding anticipated realized gains for Q4.
• The average yield is currently in the 6s, despite a decrease in new onboarding spreads from the 6s to the 5s.

Company Outlook

• Stellus expects to grow its investment portfolio to between $930 million and $950 million by the end of the year.
• The company is actively engaged in 10 to 15 deals that could contribute to this growth.
• The next financial report is scheduled for spring, following the anticipated Q4 developments.

Bearish Highlights

• The company noted a decrease in new onboarding spreads from the 6s to the 5s, potentially indicating tighter margins.

Bullish Highlights

• Stellus has generated $1.6 billion in repayments and distributed over $273 million in dividends since its IPO.
• A potential transaction in Q4 could lead to appreciation of the company's assets.
• The company has a substantial spillover income of $42 million, which will be distributed without tax implications.

Misses

• Specific details on non-accrual loans and the impact of fluctuating interest rates on earnings were discussed but not quantified in the call summary.

Q&A Highlights

• CEO Robert Ladd expressed confidence in achieving the projected portfolio size by year-end, attributing this to the 10 to 15 active deals currently underway.
• Ladd confirmed that the spillover income and anticipated realized gains for Q4 will be distributed tax-free, providing clarity on the company's financial strategy.

Stellus Capital Investment Corporation remains focused on growth and shareholder value as it moves into the fourth quarter, with strategic transactions on the horizon that could further enhance its financial standing. The company's steady performance and proactive approach to portfolio management suggest a continued commitment to its investment objectives and shareholder returns.

InvestingPro Insights

Stellus Capital Investment Corporation's (NYSE: SCM) financial performance and outlook, as discussed in their recent earnings call, are further supported by key metrics and insights from InvestingPro.

The company's commitment to shareholder returns, highlighted by the declared Q4 dividend of $0.40 per share, is underscored by InvestingPro data showing a substantial dividend yield of 11.65%. This aligns with one of the InvestingPro Tips, which notes that SCM "pays a significant dividend to shareholders." Moreover, the company has maintained dividend payments for 13 consecutive years, demonstrating a consistent track record of returning value to investors.

SCM's financial stability is reflected in its price-to-earnings (P/E) ratio of 10.79, suggesting that the stock may be reasonably valued relative to its earnings. This valuation metric, combined with the company's reported growth in net asset value per share, paints a picture of a company that is managing its financial resources effectively.

The company's revenue growth of 14.49% over the last twelve months as of Q2 2024 supports management's optimistic projections for portfolio growth in Q4. This growth trajectory is particularly impressive given the challenging economic environment and aligns with the company's stated goals for expansion.

InvestingPro Tips also highlight that SCM's stock generally trades with low price volatility, which may appeal to investors seeking stability in their portfolio. Additionally, the tip indicating that "liquid assets exceed short-term obligations" suggests a strong balance sheet, which is crucial for a company in the investment management sector.

For investors interested in a deeper dive into SCM's financial health and prospects, InvestingPro offers 6 additional tips, providing a more comprehensive analysis of the company's position in the market.

Full transcript - Stellus Capital Investment (SCM) Q3 2024:

Operator: Good day, ladies and gentlemen, and thank you for standing by. At this time, I would like to welcome everyone to Stellus Capital Investment Corporation's Conference Call to report Financial Results for its Third Fiscal Quarter ended September 30, 2024. Participants are currently on a listen-only mode and we will have a question-and-answer session following the presentation. [Operator Instructions] This conference is being recorded today, November 8, 2024. It is now my pleasure to turn the call over to Mr. Robert Ladd, Chief Executive Officer of Stellus Capital Investment Corporation. Mr. Ladd, you may begin your conference.

Robert Ladd: Thank you, Ali, and good morning, everyone, and thank you for joining the call. Welcome to our conference call covering the quarter ended September 30th of this year. Joining me this morning is Todd Huskinson, our Chief Financial Officer, who will cover important information about forward-looking statements as well as an overview of our financial information.

Todd Huskinson: Thank you, Rob. I'd like to remind everyone that today's call is being recorded. Please note that this call is the property of Stellus Capital Investment Corporation, and that any unauthorized broadcast of this call in any form is strictly prohibited. Audio replay of the call will be available by using the telephone number and PIN provided in our press release announcing this call. I'd also like to call your attention to the customary safe harbor disclosure in our press release regarding forward-looking information. Today's conference call may also include forward-looking statements and projections, and we ask that you refer to our most recent filing with the SEC for important factors that could cause actual results to differ materially from these projections. We will not update any forward-looking statements unless required by law. To obtain copies of our latest SEC filings, please visit our website at www.stelluscapital.com under the Public Investors link or call us at (713) 292-5400. Now I'll cover our operating results for the quarter. I would like to start with our life-to-date activity. Since our IPO in November 2012, we've invested approximately $2.5 billion in over 195 companies and received approximately $1.6 billion of repayments while maintaining stable asset quality. We've paid over $273 million of dividends to our investors, which represents $16.28 per share to an investor in our IPO in November 2012, which was offered at $15 per share. Turning now to operating results. In the third quarter, we generated $0.39 per share of GAAP net investment income, and core net investment income was $0.40 per share, which excludes estimated excise taxes. Net asset value per share increased $0.19 during the quarter due to net unrealized depreciation on our investment portfolio primarily related to one equity investment. Our ATM program was also active during the quarter, and we issued $14.6 million in shares at an average gross price of $13.79. All issuances were above net asset value. With respect to portfolio and asset quality, we ended the quarter with an investment portfolio at fair value of $908.7 million across 99 portfolio companies, up from $899.7 million across 100 companies as of June 30, 2024. During the third quarter, we invested $9.4 million in one new portfolio company and had $8.4 million in other investment activity at par. We also received one full repayment totaling $8.4 million and received $5.5 million of other repayments, both at par. We also received one equity realization that generated proceeds of $2.6 million and a realized gain of $2.2 million. At September 30, 98% of our loans were secured and 95% were priced at floating rates. The average loan per company is $9.5 million, and the largest overall investment is $19.6 million, both at fair value. All but one of our portfolio companies are backed by a private equity fund. Overall, our asset quality is slightly better than planned. At fair value, 26% of our portfolio is rated a 1, or ahead of plan, and 18% of the portfolio is marked at an investment category of 3 or below, meaning not meeting plan or expectations. Currently, we have loans to six portfolio companies that are on non-accrual, which comprised 4.7% of the fair value of the total loan portfolio. And with that, I'll turn it back over to Rob to discuss the overall outlook.

Robert Ladd: Okay. Thank you, Todd. As we look ahead to the fourth quarter, I'll cover portfolio growth, equity realizations, capital management, and dividends. Based on an active pipeline, we expect to end the fourth quarter with a portfolio between $930 million and $950 million. We do expect some loan repayments approximately $29 million in the quarter and equity realization proceeds to total about $5.3 million, which will result in realized gains of $4.3 million, one which is disclosed in our subsequent events for $1.7 million of proceeds and a realized gain of over $600,000. As Todd noted earlier, we had a good third quarter for equity issuance under our ATM program. After quarter end, we increased our bank facility by $55 million from $260 million to $315 million and have a meaningful amount of capacity. Given our current capitalization, we have the ability to grow the portfolio to $1 billion plus. And finally, regarding dividends, we did declare the dividend for the fourth quarter at a rate of $0.40 per quarter payable monthly and of which the record date for November, December are forthcoming. And with that, I'll open it up for questions, and Ali, if you'll please begin the question-and-answer session, please.

Operator: Thank you. Ladies and gentlemen, at this time we would be conducting our question-and-answer session. [Operator Instructions] Thank you. Our first question is coming from Paul Johnson with KBW. Your line is live.

Paul Johnson: Good afternoon.

Robert Ladd: Good morning, Paul.

Paul Johnson: Good morning. Thanks for taking my question. With just NII a little light of our expectations and slightly below the dividend this quarter, activity was fairly light, was there any kind of – I mean, was there any sort of temporary drivers there with NII being below the dividend this quarter with the incentive fee waiver and the timing of investments or anything like that?

Robert Ladd: Yes, I'd say nothing unusual. We certainly – one had a lower SOFR rate for the quarter. We did have a little bit of tick-up in non-accrual, but nothing unusual. And as I recall in last quarter, we had a little bit more in other income. So this would have driven last quarter to be a little bit higher. But again, I think a reasonable quarter in terms of expectation, given the current interest rates. But as you noted, Paul, too, that where our investment activity was lighter than expected which, again, as I mentioned, we expect to pick up in the fourth quarter. So that would have impacted a little bit, too. We thought we'd end the third quarter at 930 and ended it closer to 900.

Paul Johnson: Got it. So this – the kind of range that we're in, the $0.39, low 40s, I mean, is that – if there's nothing unusual in there, is that a pretty good run rate going forward?

Robert Ladd: So we'll have to see how other income comes in the quarter in the fourth quarter. But just as a reminder that SOFR did drop, again, our loans would have repriced. Most of them repriced again at 930, and that drove the yield, you'll see, nominally from 11.7 in the prior quarter to 11 even for the fourth quarter.

Paul Johnson: Got it. Okay. So it's mainly the base rates that makes sense. Driving the…

Todd Huskinson: Correct, yes. Declining SOFR curve.

Paul Johnson: Okay. And then can you again just walk through maybe kind of the what drove the write up in the portfolio this quarter, sort of the unrealized gains?

Todd Huskinson: Yes. So there are a number of – we have 99 companies, so a number of movements up and down. We did have one portfolio company that had some meaningful appreciation that's tied to a potential transaction, but just increased value in one of our equity co invests.

Paul Johnson: Got it. So it was just the one company that kind of drove most of the appreciation this quarter then?

Todd Huskinson: That's correct, Paul.

Paul Johnson: Okay. Okay, that's all the questions for me. Thank you.

Robert Ladd: Okay.

Todd Huskinson: Yes, thank you, Paul.

Operator: Thank you. Our next question is coming from Christopher Nolan with Ladenburg Thalmann. Your line is live.

Christopher Nolan: Hey, just a follow-up on Paul's questions on the EPS run rate. So, given the recent Fed action on lowering rates, that would be a downward bias on EPS together with the higher nonaccruals. I just want a little clarification.

Todd Huskinson: Yes, that's right. It should have a little bit of impact again as we move down in the quarter. Interesting, it looked like the Fed's announcement yesterday hadn't changed the forward curve. But again we did have a lower SOFR in the fourth quarter or we will have lower SOFR in the fourth quarter versus the third.

Christopher Nolan: Got it. And then the lack of a fee waiver. Should we expect the fee waiver to be a recurring item or just a sort of a one timer?

Robert Ladd: Go ahead, Todd.

Todd Huskinson: Yes. So Chris, thanks for the question. So, it kind of depends on what happens in the quarter of course, which we can't predict. But with respect to gains and losses, at the moment, we don't expect one this quarter, but we do if nothing else changes, would expect to see a waiver maybe in the second quarter of 2025. So in the future. And then nothing after that. But that's if nothing changes. So if there's a change up or down, that could affect the waiver.

Robert Ladd: As you know, Chris, all just a function of the 12 quarter test.

Todd Huskinson: Right, exactly.

Christopher Nolan: Absolutely. And then I guess final question, what's the spillover income?

Todd Huskinson: Stands at $42 million right now.

Christopher Nolan: Okay, thanks guys.

Robert Ladd: Thank you, Chris.

Operator: Apologies ladies and gentlemen, I pressed the wrong button by mistake. Our next question…

Robert Ladd: No worries.

Operator: Apologies. Our next question is coming from Robert Dodd with Raymond (NS:RYMD) James. Your line is live.

Robert Dodd: Hi guys. I think you'd probably prefer to hear them than me. But on the appreciation you mentioned, it's tied to a potential transaction. Is that one of the ones that you think might occur in Q4 or is it a longer term?

Robert Ladd: No, it would – yes, it's a good question. It's expected to occur in Q4.

Robert Dodd: Got it. I got as well that spillover income, Todd, that $42 million, does that include the prospective realized gains that are going to come in Q4 or is that just as of the end of Q3?

Robert Ladd: It says of the end of Q3 but the realized gains expected in Q4 are regular way if you will and we'll be able to distribute them. There will not be a tax impact.

Robert Dodd: Okay, got it, thank you. [Indiscernible] So on the yield, I mean, as you said, right, most of it is base rates. That does look like there has been versus a little bit of spread compression, which obviously is the industry might thematic. Has that leveled out in terms of where new onboarding spreads are today? Has it stabilized, or are we going to continue to see a little bit of that growth a little as we go into Q4 to early next year?

Robert Ladd: Yes, so good question. So we're certainly seeing spreads come down from what were in the 6s to now in the 5s. So the impact of that is rolling through. So you're not seeing – if everything repriced, that would be a different number. So we're seeing that in the fourth quarter. So new opportunities are coming on in the 5s versus the 6s, whereas the average yield currently is probably in the 6s, average spread in the 6s. So it would just be a question if that continues. We certainly have seen it stabilize, certainly not seeing it go down further. One thing that we've seen historically as when you get lower what used to be LIBOR or SOFR, you can see spreads actually stop compressing, because I think, people are also solving for an absolute yield. But in any event baked into the quarter would be things that are being booked more in the 5s than the 6s.

Robert Dodd: Got it, got it. And then obviously, Q3 came in a little – in terms of portfolio overall size, came in a little bit below where you were thinking a quarter ago. So, how confident would you say you are in that $930 million to $950 million by year-end? I mean, it sounds like some things during the quarter flipped but what's the risk of that happening in the year?

Robert Ladd: Yes. No, that's a good question based on last quarter. So if it's helpful, we have 10 to 15 active deals, and we would be pretty confident to get to the $930 million and could be higher. So if it's helpful, our activity has picked up quite meaningfully.

Robert Dodd: Got it. Thank you.

Operator: Thank you. As we have no further questions in the queue at this time, I would like to hand it back to Mr. Ladd for his closing remarks.

Robert Ladd: Okay. Thank you, Ali. And thank you, everyone, for being on and your support of our company. And we look forward to speaking with you in the spring as we report on the whole year. Take care now.

Operator: Thank you. Ladies and gentlemen, this does conclude today's call, and you may disconnect your lines at this time. And we thank you for your participation.

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