BIZD - Gladstone Capital: Capture Monthly Income At A Discount

2023-09-22 12:42:12 ET

Summary

• GLAD currently sits at a dividend yield of 9.8% and pays its distribution out on a monthly basis.
• Their portfolio contains floating rate loans, which positions them to benefit from a high-interest environment.
• GLAD previously traded at a 17% average premium over the NAV. Currently, GLAD only trades at a 9% premium so this may indicate an opportunity.

Overview

I recently wrote an analysis on Gladstone Investment ( GAIN ) and I think it's only fair that I also cover the brother fund, Gladstone Capital ( GLAD ). GLAD is a well-managed business development company that has been providing loans to lower middle market businesses since its inception in 2001. GLAD pulls in their revenue from the interest they make on these loans. As shareholders of GLAD, we can get a slice of the profit through the monthly dividend distributions.

GLAD's total return performance is almost on par with [[SPY]] and proves to be a good choice for investors that want to prioritize a bit of monthly income. This, in addition to currently trading under the average premium to NAV, may be an opportune time to start a position in this high quality BDC. Comparing GLAD to the VanEck BDC Income ETF ( BIZD ), we can see that GLAD has also seen success in outperforming the BDC index.

Portfolio & Strategy

Diversity of GLAD's portfolio is spread throughout 13 different industries, and a majority of these sources are sponsor backed. GLAD's portfolio is well-diversified, with a focus on recession-resistant industries that remain stable during periods of economic uncertainty. They have exhibited strong portfolio growth in the past year, primarily driven by new investments. As of the most recent earnings , they reported a NII (net interest income) of $0.31 per share. The BDC's investment strategy places significant emphasis on First and Second Liens, considered the safest forms of debt for such companies.

Management's investment strategy places significant emphasis on First and Second Liens, considered the safest forms of debt for such companies. Approximately 74% of its investments are in First Liens, while another 17% are in Second Liens, ensuring that over 90% of its investments are secured loans. Furthermore, Gladstone Capital's portfolio is well-diversified, with a focus on recession-resistant industries that remain stable during periods of economic. These are all reassuring facts to support a buy at these levels when taking the high interest rate environment into consideration.

GLAD has a sourcing strategy that identifies firms with an operational cash flow ranging from $3 million to $15 million. Their strategy is to maintain a diverse portfolio within industries that offer value. Management's strategy is to steer clear of financial services, early-stage or high-tech enterprises, as well as most consumer, commodity, or cyclical businesses.

Dividend

GLAD currently sits at a dividend yield of 9.8% and pays its distribution out on a monthly basis. With an 85% payout ratio, this BDC has room to enhance its dividend. In fact, GLAD raised the dividend only a few months ago to $.0825 per share. The Fed has recently confirmed that they expect higher interest rates to stick around for some time, so we can expect the profitability to continue.

Given its strong management, sound credit quality, and expanding portfolio, GLAD has managed to stay on par with SPY. Trading in some of the total return in exchange for a fat 9.8% yield makes this an interesting option for investors that prioritize income as part of their portfolio.

A key driver of NII (net interest income) growth for GLAD is its portfolio's exposure to floating-rate loans. So while we can expect interest rates to remain high, we can assume that profitability will remain strong for GLAD.

We received confirmation of the strong performance over the last earnings call as well.

Our net investment income increased to $11.7 million for the quarter, or $0.31 per share, which is up 21% from last quarter and 68% from the same period last year. The net realized and unrealized gain on the portfolio for the period came in at $200,000 positive. However, undistributed earnings for the quarter lifted NAV per share by $0.08 to $9.27. - Bob Marcotte - President

Gladstone Capital has already raised its dividend once recently and maintains a moderate payout ratio of 85%, leaving room for further dividend growth. There was also a recent supplemental dividend paid out. GLAD doesn't have a consistent history of supplemental dividends, but since we are now in a high interest rate environment, I do think it's highly possibly that we can see additional supplemental payments in the future.

NAV

Over a 3-year period, the price of GLAD traded at a 17% average premium over the NAV (net asset value). Currently, GLAD only trades at a 9% premium, so this may indicate a small upside if you were to buy shares today. The premium reached as high as 45% over the NAV back in 2021 and as low as a 41% discount in 2020.

Although the swings between the price and NAV relationship are wild, I do believe that now the price has stabilized and this entry point at the modest 17% premium is highly attractive. The NAV has been steadily rising over the last decade, and we can paint a better picture of the price relationship by looking at the graph below.

Conclusion

Gladstone Capital emerges as a compelling investment opportunity for income-focused investors seeking monthly dividend distributions. With a strong portfolio diversification strategy and a strong emphasis on secure investments such as First and Second Liens, GLAD is positioned to perform well.

Currently offering an enticing 9.8% dividend yield, GLAD's monthly payouts and a moderate payout ratio of 85% leave room for potential dividend growth. The recent increase in dividends and the possibility of supplemental payments in a high-interest-rate landscape add to its appeal. Additionally, GLAD's trading at a 9% premium to NAV presents an opportunity for capital appreciation.

While maintaining its strong credit quality and portfolio growth, GLAD may face risks associated with borrower defaults on floating-rate loans or shifts in interest rates. However, given the overall favorable conditions and the company's solid performance, GLAD remains an attractive choice for income-seeking investors. It's worth monitoring these potential risks but, for now, GLAD stands as a promising high-yield option in today's market landscape.

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