Capital Southwest: High Quality But Awaiting A Better Price Point

Core Viewpoint - Business Development Companies (BDCs) like Capital Southwest (CSWC) have performed well in a high interest rate environment, with CSWC showing a total return of approximately 125% over the last five years and a distribution yield of 8.7% [1][12]. Financial Performance - CSWC's net investment income (NII) per share has increased as interest rates rose, with NII per share reaching $0.38 in Q1 2021 and growing consistently thereafter [5]. - The most recent earnings call indicated a non-accrual rate of 2.3% of fair value, slightly up from 2.2%, suggesting some pressure from high interest rates on portfolio companies [6]. - CSWC has committed $154 million to new credit investments with a weighted average yield of 13.3% over the last quarter [6]. Investment Strategy - CSWC focuses on lower middle market companies, primarily investing in first lien debt, which constitutes 97% of its portfolio, providing stability and lower risk of capital loss [13][14]. - The portfolio is heavily weighted towards floating rate investments (97.4%), allowing CSWC to benefit from rising interest rates [14]. Market Position - CSWC currently trades at a premium to net asset value (NAV) of about 56.7%, significantly higher than the average premium of 35% over the past three years [7]. - The company has consistently issued supplemental dividends and increased base distributions, with a compound annual growth rate (CAGR) of 9.08% over the last five years [24]. Economic Outlook - The Federal Reserve's interest rate decisions, particularly in the context of the upcoming US presidential elections, may lead to potential rate cuts, which could impact CSWC's pricing and investment income [9][20]. - Future interest rate cuts are expected to lower NII, presenting a more attractive entry point for new investors [21][30].