Citi Trader Author's Note: This article is a detailed see at Main Street Capital Corp.'s "near-term" (NYSE:MAIN) dividend sustainability. I have performed this analysis due to the growing number of readers who have specifically requested such an analysis be performed on MAIN. For readers who just want the summarized conclusions/results, I would suggest to scroll down to the "Conclusions Drawn" part at the bottom of the article.
The focus this article is to provide a detailed analysis with supporting documentation (via three tests) on the "near-term" dividend sustainability of MAIN. This analysis will be provided after a brief overview of its regulated investment company ("RIC") classification per the Internal Revenue Code ("IRC"). After a discussion of this topic, I will be performing three dividend sustainability tests. The first two tests will focus on MAIN's net investment company taxable income ("ICTI") and the company's undistributed taxable income ("UTI"). These two tests will be termed "TEST 1" and "TEST 2". The third test will focus on the company's "unrealized appreciation (depreciation) on investments" account and be termed "TEST 3". At the end of this article, there will be a conclusion, based on the results obtained from TEST 1, TEST 2, and TEST 3, about the near-term dividend sustainability of MAIN. At the end of this article, I will also provide my projection regarding MAIN's monthly dividend per share rate for September-November 2015 (to be paid in October-December 2015) and the company's next special periodic dividend per share range that should be declared sometime during the fourth quarter of 2015.
I am writing this particular article due to the new growing requests from readers that such an analysis be performed on MAIN. Understanding the tax and dividend payout characteristics of MAIN will provide investors with an overall better understanding of the business development company ("BDC") sector as a whole. From reading this article, investors will better understand how an RIC per the IRC comes up with the company's current dividend per share rate, and particular signs when an impending increase or decrease should occur.
Side Note: I usually provide this type of particular analysis on Prospect Capital Corp. (NASDAQ:PSEC) at periodic intervals. However, due to the fact this specific business development company ("BDC") is in the process of "spinning off" several investment portfolios, I believe a PSEC dividend sustainability analysis cannot be fully performed at this point in time. This is due to the assumption if/when PSEC's spin-offs are finalized, a material portion of the net investment income ("NII") and net ICTI attributable to these three investment portfolios will stop to exist and be replaced by income generated from new investments. These new investments may have different underlying interest terms and/or there could be a delay in deploying this newly obtained capital, which would have a direct impact on several dividend sustainability metrics. As of the date of this article, since there has been no "finalized" terms provided to the public regarding the PSEC's proposed spin-offs, I have decided to chorus from writing this specific type of analysis on that company.
As a BDC, MAIN elects to be treated as an RIC under "Subchapter M" of the IRC. To continue to qualify annually as an RIC, the IRC requires MAIN to meet sure "source-of-income" and "asset diversification" requirements. These requirements are beyond the scope of this article and will not be mentioned again. However, there is one specific provision relative to MAIN's dividend sustainability analysis that should be discussed. As an RIC, MAIN is required to distribute to shareholders at least 90% of the company's "ICTI" and "net capital gains" (in excess of its "capital loss carryforward" balance, provided applicable) in any given tax year in order to be eligible for the tax benefits allowed in regards to this type of entity. If MAIN qualifies to be taxed as an RIC, the company avoids double taxation by being allowed to take a "dividends paid deduction" at the corporate level.
To begin obtaining MAIN's ICTI, one would first determine the company's "net increase (decrease) in net assets resulting from operations" figure within its "consolidated statement of operations" (income statement). Next, several "book to tax" adjustments need to be determined to properly change MAIN's net increase (decrease) in net assets resulting from operations figure to the company's ICTI. Next, one would need to determine its net capital gains for the specified time period. Net capital gains consist of the realized short-term net capital gains in excess of realized long-term net capital losses for each tax year. While most BDC peers continue to have a material capital loss carryforward from prior years, MAIN currently is one of the infrequent exceptions. In fact, Citi Trader continues to be the only BDC I have covered which has never had a capital loss carryforward dating all the way back to the company's initial public offering ("IPO") (excludes all newly created or converted BDC peers). In my professional opinion, this is a VERY important notion for readers to understand. Readers will better understand why as the dividend sustainability analysis is presented below. When MAIN's ICTI and net capital gains are combined, this comprises the company's "net ICTI", which is also known as its "annual distribution requirement" ("ADR").
Regarding MAIN's ADR, the company has an extra option available if Citi Trader fails to distribute 90% of its net ICTI within a given year. MAIN is allowed to carryover its net ICTI into the following year. However, Citi Trader must distribute the company's remaining net ICTI from the prior year through declared dividends prior to the filing of its tax return for the previous year. This is also known as the "spillback provision". If MAIN fails to conform with this provision, the company will be declassified as an RIC per the IRC. If this were to occur, all of MAIN's net ICTI would be subject to taxation at steady corporate tax rates. The company intends to distribute, at a minimum, 90% of its net ICTI during a tax year.
Side Note: It should be noted if MAIN intends to distribute less than 98% of the company's ICTI or less than 98.2% of its net capital gains in a tax year (the spillback provision does not apply in this circumstance), the retained portion would be subject to a 4% non-deductible federal excise tax. Over the past several years, Citi Trader has accrued (and subsequently paid) an annual excise tax in the range of $1.4-1.8 million.
To "fully" understand and accurately project a BDC's dividend sustainability, one must understand the subtle differences between its NII and net ICTI figures/cumulative balances. As stated earlier, due to the fact that MAIN continues to not have a capital loss carryforward, this is an extremely important concept for readers to understand. As such, let us briefly discuss this distinction.
NII is a "Generally Accepted Accounting Principles" ("GAAP") figure which is based on the accrual method of accounting. ICTI and net ICTI are IRC figures which are "generally" based on the cash method of accounting (some exceptions to this notion, but I am keeping Citi Trader simple for this discussion). Income and expense recognition of sure accounting transactions vary between GAAP and the IRC (book versus tax accounting treatments). A majority of MAIN's book to tax differences (either transitority or permanent in nature) consist of the following: 1) deferred financing fees on loans and deferred offering costs in relation to equity offerings; 2) pre-tax book income (losses) related to the Internal Investment Manager; 3) share-based compensation expense; and 4) income tax (provisions) benefits. There are several extra book to tax adjustments that MAIN periodically recognizes. However, for the purposes of this article, further discussion of these additional adjustments is unwarranted. Let us now move on to the company's dividend sustainability analysis.
To test MAIN's primary factor, I believe it is necessary to analyze and discuss the company's historical quarterly net ICTI figures to see if its quarterly dividend distributions were being covered. This will lead to a better understanding of the overall trends regarding this particular component and possible pitfalls that may arise in the future. This includes MAIN using its cumulative UTI balance on any quarterly/annual net ICTI overpayments. Table 1 below shows MAIN's net ICTI from the first quarter of 2015 going back to the company's first quarter of 2013.
Table 1 - MAIN Net ICTI and Cumulative UTI Analysis (IRC Methodologies Based on Quarterly Time Frames)
(Source: Table created entirely by myself, partially using MAIN data obtained from the SEC's EDGAR Database)
Using Table 1 above as a reference, all figures are checked and tied back, either directly or through reconciliations, to various spreadsheets and data from MAIN's supporting documentation (excludes some calculated figures and all ratios). Table 1 will be the leading source of information as TEST 1 and TEST 2 are analyzed below.
TEST 1 - Quarterly Net ICTI Versus Quarterly Distributions Analysis:
Using Table 1 above as a reference, I take MAIN's quarterly "net ICTI" figure (see red reference "A") and subtract this amount by the quarterly "distributions from net ICTI" figure (see red reference "B"). If MAIN's red reference "A" is greater than the company's red reference "B", then it technically had enough quarterly net ICTI to pay out the company's dividend distributions for a particular quarter (both monthly and special periodic dividends). Any excess net ICTI left over, after accounting for the dividend distributions, is added to MAIN's cumulative UTI balance. This particular balance will be further discussed within TEST 2 later in the article. If MAIN's red reference "A" is less than the company's red reference "B", then the company technically did not have enough quarterly net ICTI to pay out its dividend distributions for a particular quarter and must use a portion of the cumulative UTI balance to help with the overpayment.
Still using Table 1 above as a reference, MAIN had net ICTI of $21.9, $18.8, $22.5, and $27.7 million for the first, second, third, and fourth quarters of 2013, respectively. In comparison, the company had dividend distributions of ($27.9), ($16.2), ($24.8), and ($29.2) million for the first, second, third, and fourth quarters of 2013, respectively. When calculated, MAIN had an underpayment (overpayment) of net ICTI of ($6.0), $2.6, ($2.4), and ($1.6) million for the first, second, third, and fourth quarters of 2013, respectively (see red reference "(A - B) = C"). This calculates to a dividend distributions payout ratio of 128%, 86%, 111%, and 106% for the first, second, third, and fourth quarters of 2013, respectively (see red reference "(B / A)"). When combined, the company had an annual overpayment of net ICTI of ($7.4) million for 2013, which calculated to an annual dividend distributions payout ratio of 108%. In my opinion, this would be determined as a minor to modest annual overpayment of net ICTI. When looking at TEST 1 on a "standalone" basis, I believe most would agree MAIN's 2013 minor to modest overpayment of net ICTI could be perceived as a potential future concern regarding dividend sustainability.
Moving to the next year, MAIN had net ICTI of $22.4, $22.1, $36.7, and $32.4 million for the first, second, third, and fourth quarters of 2014, respectively. In comparison, it had dividend distributions of ($19.8), ($34.4), ($22.5), and ($35.3) million for the first, second, third, and fourth quarters of 2014, respectively. When calculated, the company had an underpayment (overpayment) of net ICTI of $2.6, ($12.4), $14.2, and ($2.9) million for the first, second, third, and fourth quarters of 2014, respectively. This calculates to a dividend distributions payout ratio of 88%, 156%, 61%, and 109% for the first, second, third, and fourth quarters of 2014, respectively. When combined, MAIN had an annual underpayment of net ICTI of $1.6 million for 2014, which calculated to an annual dividend distributions payout ratio of 99%. In my opinion, some could interpret this was a minor annual overpayment of net ICTI, because this payout ratio was above the 90% IRC distribution requirement which was discussed earlier. When looking at TEST 1 on a standalone basis, I believe some could argue MAIN's 2014 extremely minor underpayment of net ICTI could also be perceived as a potential future concern regarding dividend sustainability. With that being said, even when considering that MAIN had another minor overpayment of net ICTI in the first quarter of 2015, I believe this general construction would be a preliminary "rush to judgment". To take this dividend sustainability analysis a step further, let us now perform TEST 2.
Before we begin TEST 2, I would like to clarify the following two metrics shown within Table 1 above: 1) "cumulative net ICTI (deficit)" (see red reference "D"); and 2) "cumulative UTI" (see red reference "E"). MAIN's cumulative net ICTI (deficit) balance is a running balance that represents the company's quarterly net ICTI underpayments (overpayments) since its initial public offering ("IPO"). This balance shows BOTH positive and negative running balances to directly compare this balance to MAIN's cumulative undistributed NII (deficit) balance, which was not discussed within this article (direct IRC to GAAP comparison). The company's cumulative UTI balance is a running balance that also incorporates its quarterly net ICTI underpayments (overpayments). However, one material difference regarding this specific figure is that it will NEVER have a negative running balance. Technically, all negative balances are shown as $0. While it is not necessary to show both balances, I left MAIN's cumulative net ICTI balances within Table 1 below for informative purposes only, and it will not be mentioned again.
Once again using Table 1 above as a reference, I take MAIN's "cumulative undistributed UTI" figure (see red reference "E") and divide this amount by the company's "outstanding shares of common stock" figure (see red reference "G"). From this calculation, its "cumulative UTI coverage of outstanding shares of common inventory ratio" is obtained (see red reference "(E / G)"). The higher this ratio is, the more positive the results regarding MAIN's near-term dividend sustainability. Simply put, this ratio shows the amount of cumulative UTI covering the number of outstanding shares of common inventory for that specified period in time. Since MAIN has continued to gradually increase its investment portfolio, chiefly through periodic equity offerings, this ratio shows if the company has been able to increase its cumulative UTI balance by a similar proportion.
Side Note: In most BDC dividend sustainability analyses, I usually perform a test based on the companies' "cumulative UTI coverage of quarterly dividend distributions" ratio (see red reference "(E / B)"). This ratio divides the company's cumulative UTI by the quarterly dividends distributions. The higher this ratio is, the more positive the results regarding the near-term dividend sustainability. However, while I was performing this test on MAIN, I noticed this ratio was "skewed" whenever the company distributed a periodic special dividend. Therefore, I believe that specific test is less effective when measuring this company's dividend sustainability. As such, I replaced that test with the cumulative UTI coverage of outstanding shares of common stock ratio. With that being said, I still included the cumulative UTI coverage of quarterly dividend distributions ratio within Table 1 for BDC peer comparisons. However, that specific ratio will not be mentioned again within this article.
Still using Table 1 above as a reference, MAIN had a cumulative UTI balance of $38.4, $41.0, $38.6, and $37.0 million at the end of the first, second, third, and fourth quarters of 2013, respectively. Due to its minor net ICTI overpayment in 2013 (as discussed in TEST 1), the company's cumulative UTI balance slightly decreased, from $44.5 million as of 12/31/2012 to $37.0 million as of 12/31/2013. MAIN had 34.8, 35.0, 39.7, and 39.9 million outstanding shares of common stock at the end of the first, second, third, and fourth quarters of 2013, respectively. When calculated, the company had a cumulative UTI coverage of outstanding shares of common stock ratio of 1.10, 1.17, 0.97, and 0.93 at the end of the first, second, third, and fourth quarters of 2013, respectively. Even though this ratio witnessed a minor discount during 2013, it was still at attractive levels throughout the year (especially when compared to those of most BDC peers). Considering MAIN distributed three special periodic dividends during 2013, the company continued to have a quite sizeable cumulative UTI balance (proportionately speaking). This was chiefly due to the material underpayment of net ICTI during 2012, when it had a net realized gain of $16.5 million and no special periodic dividends were declared.
Moving to the next year, MAIN had a cumulative UTI balance of $39.7, $27.3, $41.5, and $38.6 million at the end of the first, second, third, and fourth quarters of 2014, respectively. Due to its minor net ICTI underpayment in 2014 (as discussed in TEST 1), the company's cumulative UTI balance slightly increased, from $37.0 million as of 12/31/2013 to $38.6 million as of 12/31/2014. MAIN had 39.9, 44.9, 44.9, and 45.1 million outstanding shares of common stock at the end of the first, second, third, and fourth quarters of 2014, respectively. When calculated, it had a cumulative UTI coverage of outstanding shares of common stock ratio of 0.99, 0.61, 0.92, and 0.86 at the end of the first, second, third, and fourth quarters of 2014, respectively. Even though MAIN had a minor annual net ICTI underpayment, due to the fact the company continued to increase its outstanding shares of common stock throughout the year, this ratio slightly decreased during 2014. However, with that being said, this ratio was still at attractive levels throughout most of the year (especially when compared to that of most BDC peers). Considering MAIN distributed two special periodic dividends during 2014, the company continued to have a fairly sizeable cumulative UTI balance (proportionately speaking).
MAIN had a cumulative UTI balance of $37.9 million at the end of the first quarter of 2015. It had 49.6 million outstanding shares of common stock at the end of the first quarter of 2015. When calculated, the company had a cumulative UTI coverage of outstanding shares of common stock ratio of 0.76 at the end of the first quarter of 2015. Even though this was a reduction when compared to the end of the prior quarter, I still believe this was a nice "cushion" to have per se. Compared to what has recently occurred with some higher-yielding BDC peers like PSEC and Medley Capital Corp. (NYSE:MCC) regarding material dividend per share reductions in late 2014/early 2015, MAIN has continued to basically match net ICTI with dividend distributions. This includes taking special periodic dividends into consideration.
In my opinion, considering TEST 2 on a "standalone basis", this evidence helps support MAIN's steady to slightly increasing monthly dividend per share rates over the past several years. TEST 2 also appears to support the company's special periodic dividends that were declared in 2013, 2014, and 2015. Now let us transition to a more "forward-looking" dividend sustainability analysis regarding MAIN's special periodic dividends.
(Source: Table created entirely by myself, partially using MAIN data obtained from the SEC's EDGAR Database [link provided below Table 1])
Using Table 2 above as a reference, I take MAIN's "cumulative unrealized appreciation (depreciation) on investments" figure (see red reference "H") and divide this amount by the company's "outstanding shares of common stock" figure (see red reference "G"). From this calculation, MAIN's "cumulative unrealized appreciation (depreciation) coverage of outstanding shares of common stock ratio" is obtained (see red reference "(H / G)"). The higher this ratio is, the more positive the results regarding MAIN being able to continue to declare special periodic dividends. Basically, this ratio shows the amount of cumulative unrealized gains (losses) covering the number of outstanding shares of common stock for that specified period in time. Since MAIN has continued to gradually increase the company's investment portfolio, chiefly through periodic equity offerings, this ratio shows if the company has been able to increase its cumulative unrealized gains by a similar proportion.
I believe this is a good test to perform, because all of MAIN's unrealized gains (losses) will eventually become a realized event. However, one unknown variable in this equation is time. It cannot be determined if MAIN will realize a particular investment gain (loss) during the next quarter, next year, or even further out on the time horizon. However, it is a general "rule of thumb" that the larger a company's cumulative unrealized gain balance becomes, the greater the probability of realized gains occurring at some point in time. In the end, management makes the ultimate decision of when to realize/monetize certain investments within the company's portfolio. With that being said, I still believe TEST 3 is a good general indicator of possible future realized gains which will directly led to MAIN being able to continue paying special periodic dividends.
Still using Table 2 above as a reference, MAIN had a cumulative unrealized appreciation balance of $19.3, $47.8, $87.3, $106.2, and $94.4 million as of 12/31/2010, 12/31/2011, 12/31/2012, 12/31/2013, and 12/31/2014 respectively. With the exception of 2014, MAIN has been able to steadily increase the company's cumulative net unrealized gain account. The company had 18.8, 26.7, 34.6, 39.9, and 45.1 million outstanding shares of common stock as of 12/31/2010, 12/31/2011, 12/31/2012, 12/31/2013, and 12/31/2014 respectively. When calculated, it had a cumulative unrealized appreciation coverage of outstanding shares of common stock ratio of 1.03, 1.79, 2.52, 2.66, and 2.10 as of 12/31/2010, 12/31/2011, 12/31/2012, 12/31/2013, and 12/31/2014 respectively. With the exception of 2014, MAIN has been able to steadily increase this ratio.
This general trend continued into the first quarter of 2015, when MAIN had a cumulative unrealized appreciation balance of $108.2 million as of 3/31/2015. This was a modest increase when compared to the balance as of 12/31/2014. The company had 49.6 million outstanding shares of common stock as of 3/31/2015. When calculated, it had a cumulative unrealized appreciation coverage of outstanding shares of common stock ratio of 2.18 as of 3/31/2015. As such, I believe this should be seen as a positive signal regarding the potential continuance of special periodic dividends in the future.
To sum up the information in this article, three dividend sustainability tests were performed on MAIN. The first two tests were based on its net ICTI and cumulative UTI, which are based on IRC methodologies.
TEST 1 provided the following information in regards to MAIN's net ICTI payout ratio for 2013, 2014, and the first quarter of 2015, respectively:
When looking at TEST 1 on a standalone basis, I believe some could argue the company's new minor overpayments of net ICTI could be perceived as a potential future concern regarding dividend sustainability. However, I believe this general construction would be a preliminary hurry to judgment. To include an additional metric into this dividend sustainability analysis (MAIN's cumulative UTI balance), TEST 2 was performed.
TEST 2 provided the following information in regards to the company's cumulative UTI balance for 2013, 2014, and the first quarter of 2015, respectively:
TEST 2 also provided the following information in regards to cumulative UTI coverage of outstanding shares of common stock ratio for 2013, 2014, and the first quarter of 2015, respectively:
MAIN's Cumulative UTI Coverage of Outstanding Shares of Common Stock Ratio as of 12/31/2013: 0.93
MAIN's Cumulative UTI Coverage of Outstanding Shares of Common Stock Ratio as of 12/31/2014: 0.86
MAIN's Cumulative UTI Coverage of Outstanding Shares of Common Stock Ratio as of 3/31/2015: 0.76
In my opinion, considering TEST 2 on a "standalone basis", this evidence helps support MAIN's steady to slightly increasing monthly dividend per share rates over the past several years. TEST 2 also appears to support its special periodic dividends declared in 2013, 2014, and 2015. Even though the ratios above slightly decreased over time, I still believe the company had a nice "cushion" to have per se. Compared to what has recently occurred with some higher-yielding BDC peers, MAIN has continued to basically match net ICTI with dividend distributions. This includes taking special periodic dividends into consideration.
As such, I am projecting MAIN will declare the following monthly dividends for September 2015, October 2015, and November 2015, respectively:
Next, TEST 3 provided the following information in regards to MAIN's cumulative unrealized appreciation balance for 2013, 2014, and the first quarter of 2015, respectively:
TEST 3 also provided the following information in regards to the company's cumulative unrealized appreciation coverage of outstanding shares of common stock ratio for 2013, 2014, and the first quarter of 2015, respectively:
MAIN's Cumulative Unrealized Appreciation Coverage of Outstanding Shares of Common Stock Ratio as of 12/31/2013: 2.66
MAIN's Cumulative Unrealized Appreciation Coverage of Outstanding Shares of Common Stock Ratio as of 12/31/2014: 2.10
MAIN's Cumulative Unrealized Appreciation Coverage of Outstanding Shares of Common Stock Ratio as of 12/31/2013: 2.18
As such, I am projecting the company will declare the following special periodic dividend sometime during the fourth quarter of 2015:
A new comparison article I wrote provided some recent, more general dividend sustainability metrics on several BDC peers (including MAIN). I refer readers to the following article for this BDC comparative analysis:
Prospect Capital's NAV, Dividend, Risk, And Valuation Compared To Several BDC Peers (Post Calendar Q1 2015 Earnings) - Part 2
I currently rate MAIN as a HOLD for existing shareholders, due to the company's strong investment portfolio and low risk of a dividend reduction for the foreseeable future. However, for potential investors looking for valuation, MAIN is currently expensive, in my professional opinion. Simply put, I continue to believe other BDC peers currently offer more attractive valuations. I would start to consider an initial investment in MAIN if the company's stock price-to-CURRENT NAV narrowed to a premium of 25-30%.
Final Note: Each investor's BUY, SELL, or HOLD decision is based on one's risk tolerance, time horizon, and dividend income goals. My personal recommendation will not fit each investor's current investing strategy.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More...)I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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