American Capital: A Penny Ahead - Analyst Blog

American Capital Ltd's (ACAS) third quarter 2010 operating income of 17 cents per share was a penny ahead of the Zacks Consensus Estimate of 16 cents. The results were also ahead of the prior-year quarter's earnings of 11 cents per share. Results were helped by a drop in operating expenses, though partially offset by a decline in interest and dividend income in the reported quarter.

Total interest and dividend income for the quarter was $125 million, down 29% from $176 million in the prior-year quarter. The weighted average effective interest rate on the company's private finance debt investments as of September 30, 2010 was 10.0%, down 30 basis points from the rate at the end of the previous quarter and 10 basis points higher than the rate at the year end 2009. Fee income remained flat compared with the prior-year quarter.

Total operating income was $142 million, down 26% from $193 million in the prior-year quarter, attributed to lower interest and dividend income. Operating income was also below the Zacks Consensus Estimate of $150 million. 

Operating expenses decreased 48% year over year to $83 million, attributing to the decline in interest expenses, general and administrative expenses, salaries, benefits and stock-based compensation expenses and debt refinancing costs. Net realized investment loss was $9 million for the quarter, compared with a loss of $34 million in the prior-year quarter.

As of September 30, 2010, non-accrual loans were $265 million, representing 7.8% of total loans at fair value, down from $308 million of non-accrual loans representing 8.5% of total loans at fair value as of June 30, 2010.

As of September 30, 2010, net asset value (NAV) per share was $9.59, up 5% or 44 cents from NAV per share of $9.15 as of June 30, 2010. Return on equity in the reported quarter was 26.9% on a last twelve months basis. Management expects an improvement in the portfolio along with an economic recovery and thereby post a growth in book value.

American Capital's asset coverage ratio increased to 230% from 206% in the prior quarter. The company repaid $407 million in debt during the reported quarter, which included $200 million of secured debt maturing in 2013. The company expects to pay back another $107 million in debt in the fourth quarter of this year.

The company invested $63 million in the reported quarter together with concluding three add-on acquisitions for portfolio companies. Management remains optimistic and expects a substantial number of mezzanine and second-lien investment opportunities to transform into investments next year, with an increase in the volume of mergers and acquisitions.

Our Take

 American Capital's successful restructuring of $2.4 billion of debt in Junehas afforded it a sufficient operating flexibility and preventedit from filing for bankruptcy, which management had earlier cautioned about. The company also continues to de-risk its balance sheet through a number of initiatives. However, we think that limited accessibility to capital and increased funding costs have weakened the company's strategic position in its sector.

The closest competitors of American Capital − Ares Capital Corporation (ARCC) and Fortress Investment Group LLC (FIG) − are scheduled to release their quarterly earnings on November 4 and 5, respectively. 

American Capital currently retains its Zacks #3 Rank, which translates to a short-term (1−3 months) “Hold” rating. We have a “Neutral” recommendation on the stock for the long term (3−6 months).