(ACAS) American Capital Tops Estimates

American Capital Ltd. (ACAS) reported second quarter 2012 operating income of 58 cents per share, topping the Zacks Consensus Estimate of 21 cents. The results more than doubled from the prior-year quarter’s earnings of 20 cents per share.

The favorable outcome was attributed to top-line growth, followed by decreased operating expenses reflecting better expense management. Moreover, new investments and reduction of debt acted as positives. An increase in non-accrual loans was a negative for the quarter.

Net operating income for the quarter was $194 million, significantly up from $71 million in the prior-year quarter. Net earnings for the quarter were $237 million, or 71 cents per share compared with $410 million or $1.13 per share in the prior-year quarter.

Performance in Detail

Total operating income was $163 million in the quarter, up 15% from $142 million in the prior-year quarter, due to higher interest and dividend income. Additionally, operating income also surpassed the Zacks Consensus Estimate of $141 million.

Total interest and dividend income for the quarter was $151 million, up 15% from $131 million in the prior-year quarter. The weighted average effective interest rate on the company’s private finance debt investments as of June 30, 2012, was 11%, declining 10 basis points from the end of the previous quarter. Fee income also climbed 9% year over year to $12 million.

Operating expenses declined 7% year over year to $66 million. The fall in expenses was attributable to significant declines in interest expenses and reduced salaries, benefits and stock-based compensation.

As of June 30, 2012, non-accrual loans were $243 million, representing 12.3% of total loans at fair value, up from $178 million of non-accrual loans, indicating 8.1% of total loans at fair value, as of March 31, 2012.

Net asset value (NAV) per share came in at $16.62 in the quarter, up 6% or 91 cents per share sequentially. In spite of the volatile capital markets affecting valuations of investment portfolio in the quarter, the overall underlying performance of American Capital’s portfolio companies continue to remain positive.

Management not only anticipates an improvement in the portfolio along with an economic recovery, but also expects to post an enhancement in book value.

American Capital’s asset coverage ratio improved substantially to 661% from 552% in the prior quarter. The company repaid securitized debt of $191 million and increased investments by $103 million while strengthening its balance sheet.

Share Repurchase and Dividend Update

During the second quarter of 2012, American Capital repurchased 9.1 million shares worth $85 million, at an average price of $9.34 per share. Since the beginning of the new repurchase program adopted last year, the company repurchased 32.2 million shares of common stock for $267 million at an average price of $8.30 per share.

Developments During the Quarter

In June 2012, Fitch Ratings lifted its outlook on American Capital to ‘Positive’ from ‘Stable’ as part of its review of six Business Development Companies (BDCs). The rating agency was impressed with American Capital’s steady earnings performance.

Our Viewpoint

American Capital’s successful restructuring of debt empowered it with sufficient operating flexibility. Capital deployment by the company raises our hopes for an enhanced investor confidence and the outlook rating upgrade by Fitch added fuel to the fire.

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

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

Shares of American Capital currently retain a Zacks #3 Rank, which translates into a short-term (1?3 months) Hold rating. Considering the fundamentals, we also maintain a Neutral recommendation on the stock.

Among American Capital’s peers, Apollo Investment Corporation (AINV) will be releasing its fiscal first quarter 2013 results on August 8, 2012.

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