We are reiterating our recommendation on American Capital Ltd. (ACAS) following the company’s earnings release. The reaffirmation takes into account the company’s business model, strategic initiatives, opportunities and challenges.
American Capital’s 5 cent shortfall in the second quarter followed a rise in debt refinancing costs; the company posted an operating income of 9 cents per share while the Zacks Consensus Estimate was 14 cents. However, the results were unchanged from the prior year quarter.
The global financial crisis limited American Capital’s access to the debt and equity capital markets and resulted in a significant depreciation of its investment portfolio and over-leveraging of balance sheet. The company has suffered payment default on a material financial obligation.
However, in June, American Capital announced that it has accomplished restructuring of $2.4 billion of debt. The restructuring involved the change of its line of credit into a term loan facility and an exchange or repayment of its outstanding public and private notes. This led to a debt reduction of $1.03 billion for the company.
American Capital’s successful debt restructuring has afforded it a sufficient operating flexibility and prevented the company from filing for bankruptcy, which management had earlier cautioned about. It also continues to de-risk its balance sheet through a number of initiatives.
American Capital plans to diminish debt by another $310 million by year end and reduce average leverage to 0.6−1.0. The company intends to make future leverage based on balance sheet securitizations. Future investments would have a substantially higher proportion of debt versus equity investments in order to de-risk the asset mix.
However, we think that limited accessibility to capital and increased funding costs have weakened the company’s strategic position in its sector. The resumption of dividend payments is not expected in the near term, given the projections for capital losses.
Due to realized losses, American Capital has no remaining undistributed taxable income for 2009 tax year and projects no 2010 taxable income due to carry over capital losses and additional ordinary loan losses from assets that are already depreciated in its books. Moreover, the company anticipates capital losses to carry forward into the 2011 tax year. As a result, we do not expect dividend payments to resume in the near term.
American Capital currently carries a Zacks #3 Rank (Hold), implying no clear directional pressure on the stocks over the next one to three months. Considering both the positive and the negative aspects of retaining this share in an investor’s kitty, we have a long term Neutral stance on the stock.