Summary
- Goldman Sachs BDC covered its dividend with net investment income in 4Q-22 and achieved great dividend excess coverage.
- Management originated exclusively First Liens in 4Q-22, highlighting a portfolio strategy that prioritizes safety and predictability.
- GSBD has 7-16% upside potential, in my view, which comes in addition to a covered 11% dividend yield.
In the fourth quarter, Goldman Sachs BDC ( GSBD ) covered its $0.45 per share dividend with net investment income, and the business development company has an interest rate upside tied to its floating rate investment portfolio.
The stock of Goldman Sachs BDC is available at a small premium to net asset value and has re-rating potential.
While passive income investors should not expect a dividend increase in 2023, I believe the BDC's income potential in a rising-rate environment is undervalued, especially given that the dividend is very well covered by NII.
Well-Performing, Safety-First Investment Portfolio
Goldman Sachs BDC is a safety-focused BDC income play that I believe provides passive income investors with protection if a recession occurs in 2023.
The reason for this is that the BDC is overweighting highly rated debt instruments such as First and Second Liens, which are secured and have a very low default probability. As a result, the risk of a total investment write-off is greatly reduced.
Goldman Sachs BDC's investment portfolio consisted of 92% First Liens, 6% Second Liens, and 2% other Unsecured Debt and Equity investments. At the end of the December quarter, the company had investments with a fair value of $3.51 billion.
Goldman Sachs BDC made new investments in the fourth quarter, all of which were in the First Lien category, supporting my argument that Goldman Sachs BDC is a risk-averse business development firm. In terms of 2022 originations, 99% went to the most expensive type of debt, First Liens.
Goldman Sachs BDC's investment portfolio is also industry-diversified. The three largest industries in Goldman Sachs BDC's portfolio, accounting for 37.2% of investments, are software, financial services, and healthcare. These industries have one thing in common: they are not overly vulnerable to economic contractions and provide stable cash flows, which reduces Goldman Sachs BDC's lending risk.
It is also worth noting that GSBD has almost entirely allocated its investment capital to floating rate loans. With inflation appearing to be on the rise this year (inflation was up 0.5% month on month in January 2023), Goldman Sachs BDC's floating rate exposure could pay off for the firm, which has carefully constructed its portfolio to benefit from interest tailwinds.
Dividend Coverage Remained Solid
The very well-covered dividend that Goldman Sachs BDC offers passive income investors is a compelling reason to consider the business development company.
In the December quarter, Goldman Sachs BDC earned $0.66 per share in net investment income but paid out only $0.45 per share, resulting in a dividend pay-out ratio of only 68%.
Goldman Sachs BDC earned $2.24 in net investment income over the last year and paid a consistent $0.45 per share per quarter dividend.
The dividend pay-out ratio was 80.4% in 2022, and it could improve in 2023 as the BDC's floating rate exposure pays off in a rising-rate environment.
GSBD Is Trading At A Small Premium To NAV
Goldman Sachs BDC is trading at a small premium to net asset value, but given the BDC's dividend coverage and defensively-positioned investment portfolio with floating rate exposure, I believe GSBD deserves to trade at a higher NAV multiple.
The net asset value of Goldman Sachs BDC at the end of 2022 was $14.61, representing a 12% NAV premium. When considering the strength of the BDC's dividend coverage, I believe GSBD could trade at 1.20-1.30x NAV, or a 20-30% premium to net asset value. Thus, the fair value of GSBD could be between $17.50 and $19.00, representing a 7-16% increase in the stock.
Why GSBD Could See A Lower Valuation
A decline in portfolio quality and a significant change in the central bank's interest rate policy this year could alter Goldman Sachs BDC's outlook.
Although the business development company is well-managed and defensively oriented, passive income investors should monitor the company's net investment income trajectory and dividend coverage.
If GSBD begins to underearn its dividend with NII, a dividend cut could result in not only lower dividend income, but also a reduced (discount) valuation multiple.
My Conclusion
Three aspects of my Goldman Sachs BDC investment are important to me.
First, the portfolio is defensively positioned, and the BDC originated a majority of First Liens in 2022, lowering my overall downside risk.
Second, GSBD has floating rate exposure, which means that if inflation returns in 2023, Goldman Sachs BDC will benefit.
Third, the BDC's 2022 pay-out ratio of 80%, as well as its 11% covered dividend yield, are both strong.
Because Goldman Sachs BDC's valuation reflects a potential upside in the stock price, I will continue to recommend GSBD to passive income investors seeking high and stable dividend income.
For further details see:
Goldman Sachs BDC: 11% Yield, Interest Rate Upside, Small Premium To NAV