Middle-Market Co-Investments And Liquidity Will Support Future Opportunities

Key Takeaways

• Strong portfolio growth and strategic investments positively influence revenue and earnings by leveraging asset value appreciation.
  
• Robust liquidity and conservative leverage strategies support ongoing investment and revenue expansion, strengthening the balance sheet.
  
• Intense competition and economic risks could compress margins, impact earnings stability, and require additional reserves, affecting Capital Southwest's profitability.

Catalysts

A business development company specializing in credit and private equity and venture capital investments in middle market companies, mezzanine, later stage, mature, late venture, emerging growth, buyouts, industry consolidation, recapitalizations and growth capital investments.

• Expected strong net portfolio growth in the December quarter due to a healthy backlog of deals, which should positively impact revenue growth.
  
• Strategic equity co-investments in portfolio companies allow for potential asset value appreciation and future equity distributions, positively affecting earnings.
  
• The company's robust balance sheet liquidity and conservative leverage strategy enable continued investment in new and existing portfolio growth opportunities, aiding revenue expansion.
  
• Capital raising through an equity ATM program is expected to support balance sheet strength and future net earning capacity.
  
• Anticipated reductions in interest rates in the future could improve net margins by lowering interest expenses on variable rate debt.

Capital Southwest Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming Capital Southwest's revenue will grow by 7.4% annually over the next 3 years.
• Analysts assume that profit margins will increase from 37.8% today to 67.9% in 3 years time.
• Analysts expect earnings to reach $163.9 million (and earnings per share of $2.4) by about December 2027, up from $73.7 million today.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 13.2x on those 2027 earnings, down from 13.8x today. This future PE is lower than the current PE for the US Capital Markets industry at 23.4x.
• Analysts expect the number of shares outstanding to grow by 12.76% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 8.14%, as per the Simply Wall St company report.

Capital Southwest Future Earnings Per Share Growth

Risks

• Capital Southwest faces fierce competition in the lower middle market, leading to tighter spreads on new deals, which could pressure net margins and limit future earnings growth.
  
• The company's deal flow has been lumpy and could result in slower net portfolio growth if market conditions don't improve, possibly affecting revenue and earnings stability.
  
• Portfolio yields have faced compression due to tighter loan pricing and elevated nonaccruals, potentially impacting future revenue from interest income.
  
• Any economic downturn impacting the lower-end consumer or slowing business-to-business transactions may lead to higher risk of credit losses, negatively impacting earnings.
  
• There is a concern about rising nonaccrual rates, which could harm net margins and necessitate additional reserves or write-offs, reducing overall profitability.

Valuation

• The analysts have a consensus price target of $25.17 for Capital Southwest based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $28.0, and the most bearish reporting a price target of just $21.0.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2027, revenues will be $241.4 million, earnings will come to $163.9 million, and it would be trading on a PE ratio of 13.2x, assuming you use a discount rate of 8.1%.
• Given the current share price of $21.25, the analyst's price target of $25.17 is 15.6% higher.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.