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Dismal Earnings for American Capital

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American Capital Ltd. reported second-quarter 2013 operating income of 16 cents per share, lagging the Zacks Consensus Estimate by 9 cents. Moreover, the results compared unfavorably with the prior-year quarter’s earnings of 58 cents per share.

Lower-than-expected results were attributable to lower top line, followed by a rise in non-accrual loans. Further, the low interest environment during the quarter was a negative. However, new investments and reduction of debt acted as the positives.

Net operating income for the quarter came in at $49 million, substantially down from $194 million reported in the prior-year quarter. Net earnings were reported at $21 million, or 7 cents per share, against $237 million or 71 cents per share in the prior-year quarter.

Performance in Detail

Total operating revenue was $130 million in the quarter, down 20% from $163 million in the prior-year quarter, due to lower interest and dividend income. Additionally, operating revenue was below the Zacks Consensus Estimate of $139 million.

In the quarter under review, total interest and dividend income was $118 million, down 22% year over year. The weighted average effective interest rate on the company's debt investments as of Jun 30, 2013, was 10.4%, decreasing 20 basis points from the end of the prior quarter. However, fee income remained stable at $12 million compared with the prior-year quarter.

Operating expenses decreased 2% year over year to $65 million. The decline in interest expenses was partially offset by elevated salaries, benefits and stock-based compensation and higher general and administrative expenses.

As of Jun 30, 2013, non-accrual loans were $245 million, representing 14.2% of total loans at fair value, up from $208 million of non-accrual loans, indicating 11.3% of total loans at fair value, as of Mar 31, 2013. The increase in non-accrual loans were mainly driven by investments in three portfolio companies by American Capital.

Net asset value (NAV) per share came in at $19.28 in the quarter, up 1.0% or 24 cents per share sequentially. In spite of the volatile capital markets affecting valuations of the investment portfolio in the quarter, the overall underlying performance of American Capital’s portfolio companies continue to remain a positive. Management not only anticipates an improvement in the portfolio along with an economic recovery but also expects to post a better book value.

American Capital’s asset coverage ratio improved substantially to 1,009% from 956% in the prior quarter and 661% in the prior-year quarter. The company repaid securitized debt of $49 million in the quarter under review and increased investments by $50 million while strengthening its balance sheet. Moreover, the company recorded $150 million of cash proceeds from realizations of portfolio investments during the quarter.

Share Repurchase Update

During second-quarter 2013, American Capital repurchased 9.1 million shares worth $125 million, at an average price of $13.77 per share. Since the beginning of the new repurchase program, adopted in Sep 2011, the company repurchased 70.4 million shares of common stock for $748 million at an average price of $10.63 per share.

Our Viewpoint

American Capital’s successful restructuring of debt in 2012 empowered it with sufficient operating flexibility. Moreover, the capital deployment by the company is expected to renew investors’ confidence.

The company is also capable of providing flexible financing solutions ranging from a variety of senior debt and uni-tranche to mezzanine and equity co-investments. Further, American Capital provides multi-currency funding with underwriting platform globally, thereby boosting growth of its portfolio companies. Such benefits provided by the company compel private equity clients to consider it as an investment partner, which in turn, helps it diversify.

Though the improved portfolio performance is expected to continue with the economic recovery, we believe the low interest rate environment and global cues might act as headwinds in the upcoming quarters.

Shares of American Capital currently carry a Zacks Rank #4 (Sell). However, some companies in the same sector that are worth considering include KCAP Financial Inc. (KCAP - Free Report) , Hercules Technology Growth Capital, Inc. (HTGC - Free Report) and MCG Capital Corporation . All the 3 companies carry a Zacks Rank #2 (Buy).

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