Neutral on American Capital
We have reaffirmed our Neutral recommendation on American Capital Ltd. (ACAS), following a detailed analysis of the company’s fundamentals in light of the current economic environment and the restructuring initiatives by the company.
American Capital’s fourth-quarter 2011 operating income of 24 cents per share surpassed the Zacks Consensus Estimate by 4 cents. Moreover, the results outshined the prior-year quarter’s earnings by 5 cents per share. The favorable result was due to a rise in fee as well as interest and dividend income in the quarter.
Including deferred tax benefit of $428 million recorded in the quarter, net operating income for the quarter was $229 million, or 67 cents per share, significantly up from $67 million or 19 cents per share in the prior-year quarter.
In February 2012, American Capital announced the divesture of its portfolio company Aptara Inc., following the divesture of other portfolio company-CIBT Solutions Inc. (:CIBT) in January. Moreover, in October 2011, the company had announced the divestiture of its portfolio company Sixnet Holdings LLC. We expect these restructuring initiatives to significantly reduce operating costs.
During the second half of 2011, American Capital repurchased a total of 17.6 million shares of its common stock in the open market for $134 million. The average purchase price was $7.61 per share. American Capital foresees additional stock repurchases or dividend payments by the end of December 2012.
The authorization of the new share buyback program and resumption of dividend payments raise our hopes for enhanced investor confidence in the company.
American Capital’s successful restructuring of debt provided it with sufficient operating flexibility and the company also continues to lessen risk from its balance sheet through a number of initiatives including repayment of debt. Moreover, new investment opportunities are expected to continue along with the economic recovery.
However, we believe earnings are affected by the spread between the interest rate on investments and the interest rate at which the company has borrowed funds. An increase or decrease in interest rates could reduce the spread between the investment rate and the borrowing rate, thereby, adversely affecting the overall profitability. An unsettled economic environment is also a cause of concern.
We believe that the risk-reward profile for American Capital is currently balanced and hence, we have reiterated our Neutral recommendation on the shares. American Capital currently retains its Zacks #3 Rank, which translates into a short-term ‘Hold’ rating. One of American Capital’s peers, Ares Capital Corporation (ARCC) retains a Zacks #2 Rank (a short-term ‘Buy’ rating).
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