I am bullish on Capital Southwest Corp. (NASDAQ:) stock.

Capital Southwest (NASDAQ:) is a mid-market lender and credit-focused company for business development. BDCs were established by the U.S. government in 1980.

BDCs, in essence, charge higher interest rates, are more risky, and receive substantial origination fees. These fees go well above the terms offered by traditional lenders. Capital Southwest specialises in middle-market lending.

Capital Southwest provides mezzanine funding and private equity for companies that require it. It can also be used to buyouts or recapitalization. CSWC doesn’t accept startup or angel financing. It also does not invest in public companies. (See CSWC stock charts on TipRanks)

Share prices are up 97.5% over the past year. COVID-19, the first vaccine to be introduced on the market, triggered a price surge. The boom in business investments was evident. In the eight past months, lending has risen steadily. CSWC’s September 2021 quarterly dividend was 6.9% higher, rising from $0.44 per share to $0.47.

CSWC holds $1.2B in capital investable. Up to June 30, the company had made $1.6 million in credit investments. According to August 3rd, the company earned $57.2 million annually on revenues of $71.5million. 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. The remaining 27.5% is owned by institutions. Directors and officers bought many shares in the range of $20.57 to $27.75 this year and only a few were sold. In their sixth year of office, the president and chief financial officer are both in their sixth decade. Nearly five years have passed since the appointment of the senior managing director.

It holds the “Perfect 10” TipRanks Smart Score. The firm expects to perform well because of its rising bullishness, positive technicals and strong momentum.

Risks to Consider

Investor sentiment appears to be softening. Last quarter, hedge fund holdings declined. CSWC investors should be aware of potential effects that inflation, shortages of labor, supply chain problems, rising unemployment claims, and other factors might have on company growth.

Capital’s debt-to-equity ratio is high (122.7%). Negative operating cash flow. Interest payments are barely covered by cash flow. The debt is not covered by cash flow.

The total shares increased by almost 20% this year, diluting shareholders. It is possible that this could happen again. CSWC enjoys a high non-cash income.

CFO Announced a restructuring plan for the company’s debt facility in August. This included extending the term of its final maturity to 2023 and 2026. However, the dividend yield currently stands at 10%. In the past, dividends have been unpredictable.

Wall Street’s Take

The good news is the dividend is covered by earnings. Eleven other BDCs also announced this year dividend increases. CSWC must keep its dividend unchanged for the next twelve months. BDCs are required to pay shareholders 90% of the annual taxable income they earn.

Analysts give CSWC a Strong Buy consensus rating by Wall Street. There is 2.7% upside potential when the average CSWC price target at $26.25 is met.

Bottom Line

The company is valued fairly. With increasing profits and earnings, management can reduce debt.

Although business prospects are improving, banks still remain limited. BDCs are becoming more popular with businesses.

Disclosure: Harold Goldmeier didn’t hold any positions in the securities discussed in this article at the time it was published.

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