Overview
Capital Southwest Corporation (NASDAQ:CSWC) is a diversified business development company (BDC) that has established itself as a premier provider of debt and equity capital to lower middle market companies across the United States. With a strong track record of generating attractive risk-adjusted returns for its shareholders, CSWC has demonstrated its ability to navigate various market environments while maintaining a well-diversified and conservatively structured investment portfolio.
Financials
For the fiscal year ended March 31, 2023, CSWC reported annual net income of $83,389,000, annual revenue of $138,526,000, annual operating cash flow of $100,652,000, and annual free cash flow of $100,639,000. The company's performance during this period highlights its consistent ability to generate robust financial results and deliver value to its shareholders.
During the fourth quarter of fiscal year 2023, CSWC generated pre-tax net investment income of $29.8 million, or $0.68 per share, which more than covered the $0.57 per share regular dividend and $0.06 per share supplemental dividend paid to shareholders. The company's net asset value (NAV) per share ended the quarter at $16.77, flat compared to the prior quarter but up $0.40 per share from the year-ago period.
Portfolio Performance
CSWC's investment portfolio continued to exhibit strong performance, with 94.7% of the portfolio at fair value rated in the top two categories on the company's four-point internal rating scale. The portfolio's weighted average yield stood at 12.7%, and the weighted average leverage through CSWC's security was a conservative 3.6x EBITDA. Notably, the company's portfolio companies demonstrated healthy cash flow coverage of 3.2x on their debt obligations, despite the higher interest rate environment.
The company's diversified investment portfolio is predominantly composed of first lien senior secured loans, accounting for 88.7% of the total portfolio at fair value. CSWC's equity co-investments, which represented 8.9% of the portfolio, continued to provide shareholders with participation in the attractive upside of the growing lower middle market businesses, with the equity portfolio marked at 141% of cost and representing $38.5 million in embedded unrealized appreciation, or $0.85 per share.
Investment Activity
During the quarter, CSWC made $157.5 million in new commitments, including $123.5 million in first lien senior secured debt to six new portfolio companies and $31.1 million in first lien senior secured debt and $143,000 in equity to five existing portfolio companies. The company's disciplined investment approach and strong origination capabilities have enabled it to maintain a well-diversified portfolio, with the average investment exposure per portfolio company standing at 0.9% as of the end of the fiscal year.
Liquidity
CSWC's balance sheet remains well-capitalized, with approximately $398 million in cash and undrawn leverage commitments, representing 2.8x the $140 million in unfunded commitments across the portfolio. The company's regulatory leverage ratio ended the quarter at 0.82x debt-to-equity, well within its target range. During the quarter, CSWC raised a new $150 million senior secured SPV credit facility led by Deutsche Bank, further diversifying its sources of capital.
Outlook
Looking ahead, CSWC's management team remains cautiously optimistic about the market environment, acknowledging the increased competition and spread tightening in the lower middle market. However, the company's conservative underwriting approach, strong sponsor relationships, and flexible capital structure position it well to continue generating attractive risk-adjusted returns for its shareholders.
Dividend
The company's Board of Directors has declared a regular dividend of $0.57 per share and a supplemental dividend of $0.06 per share for the June 2023 quarter, reflecting CSWC's commitment to delivering consistent income to its shareholders. The company's undistributed taxable income stood at $0.64 per share as of the end of the fiscal year, providing a solid foundation for future dividend payments.
Conclusion
In conclusion, Capital Southwest Corporation's diversified investment portfolio, disciplined underwriting, and well-capitalized balance sheet have enabled the company to deliver consistent financial performance and shareholder returns. As the company navigates the evolving market landscape, its experienced management team, flexible capital structure, and strong sponsor relationships position CSWC as a compelling investment opportunity in the BDC space.