2023-06-07 08:12:12 ET
Summary
- We discuss quarterly results from Golub Capital BDC and highlight key income dynamics of the portfolio.
- GBDC delivered a double-digit net income rise and a small gain in the NAV.
- Non-accruals fell and remain below the sector average.
- GBDC is fairly valued at the moment. We would look to add closer to a 10% discount to the sector average valuation.
This article was first released to Systematic Income subscribers and free trials on May 31.
In this article we catch up on the latest quarterly results of the Golub Capital BDC ( GBDC ). The company delivered a good result with a 2.4% total NAV return with both a rise in net income and a rise in the NAV.
Last quarter we expected another sharp net income rise and a possible dividend hike. We got the former but not the latter. BDCs are growing increasingly conservative in their distributions as many expect a potential reversal of rate hikes they have enjoyed since 2022.
GBDC remains an attractive higher credit-quality BDC choice and continues to trade at a decent valuation at a 10% discount to book (vs. a 7% sector average). It has a 10% dividend yield and a core net income yield of 12.7%.
The portfolio targets primarily floating-rate first-lien loans and is very well diversified with over 300 positions. Top sectors include software and healthcare.
Quarter Update
Adjusted net investment income increased by 13.5% to $0.42 - a record for GBDC, primarily due to the rise in base rates. This was slightly above the 12% increase in the previous quarter. The dividend was kept unchanged for the second straight quarter. Given the flatlining in short-term rates we don't expect another double-digit increase in net income in the following quarter however a single-digit bump is very likely.
Because the dividend remained the same at $0.33, dividend coverage increased to a very high 127%.
The NAV ticked up slightly after three months of drops.
The rise in the NAV was entirely due to retained earnings as there was a total of $0.08 (or about 0.5%) of realized and unrealized losses during the quarter.
The company repurchased 0.75m shares (about 0.4% of outstanding) at a weighted-average price of $12.84 or about 13% below the NAV. This is very good timing as it appears to have happened during the March swoon after the start of the bank tantrum. The stock has traded consistently above that level after 24-March. The buyback added $0.01 to the $14.73 NAV.
Buying back shares sends a signal to shareholders that management is happy to grow the NAV and support the share price at the cost of management fees. It also highlights that at a valuation of 87% the company is ready to come in and start buying shares. This should increase investor conviction at buying shares around that level.
Income Dynamics
Net new investments were slightly positive which should be a small tailwind to net income.
Leverage ticked up slightly on the back of share buybacks and net new investments.
There are two other important related dynamics that are growing income. One is that the rate on new investments has consistently exceeded the rate on investments that paid off. This suggests that the company is taking advantage of widening credit spreads. This is echoed in the spread of new investments which has also grown over the last year by over 1%.
Portfolio yield increased sharply by over 1% to 11.1% while interest expense increased by 0.4% to 4.8%. The company's net investment spread of 6.3% is a tad above the median BDC despite the fact that GBDC has a significantly higher-quality portfolio than the average BDC.
An attractive net spread level is largely due to the company's favorable level of interest expense which is, in turn, due to its timely bond issuance which boasts a rockbottom weighted-average coupon of 2.7%. This is in the context of BDCs like GAIN and SAR recently issuing bonds with coupons at or above 8%. The bond is coming due in about a year with the next in 2026.
Overall, net income should continue to rise over the next quarter though we shouldn't expect another double-digit gain. If the Fed keeps rates on hold over the rest of the year, it will pressure GBDC to lift the dividend once again.
Portfolio Quality
Non-accruals decreased by 1 due to a write-off of a holding that was already carried at zero. Separately, total non-accruals fell to 1.7% fair value and remain below the sector average.
Portfolio quality , as gauged by internal ratings, deteriorated slightly for another quarter. However, the two worst buckets remained at the same level while a chunk of the quality migration was due to the reduction in the highest-quality bucket which is not a worrying indicator.
For the first time in a couple of years the company had net realized losses . The overall track record is fairly strong, however.
Valuation And Return Profile
GBDC has had somewhat inconsistent performance over the last few years. It underperformed in the immediate post-COVID environment and outperformed more recently from about the start of 2022.
Its underperformance in the post-COVID environment is due to two factors: one idiosyncratic and one systemic. The idiosyncratic factor was its, in retrospect, ill-advised rights offering which knocked off a good chunk of NAV - something we covered in our previous updates.
The systemic factor for its underperformance in the post-COVID environment was its lower-yield / first-lien stance and its lower reliance on fee income. 2021 was a great year for BDCs with a lot of deal activity so it makes sense that GBDC underperformed somewhat.
However, now that risk sentiment has turned south, GBDC has started to outperform once again as we can see in the chart above where the yellow line has moved above zero.
We can also see this in the total NAV performance chart below across various time horizons. GBDC outperformed over the last 10 year period and the last 1 year period and underperforms over periods in between.
Our view on the company is that it's not going to be one of the very best performers given its lower beta profile but it could certainly match sector performance and, possibly, deliver slight outperformance as well. In this context we view it as attractive when it starts to trade at a substantial discount to the sector, particularly in an uncertain macro environment,
The company's valuation has moved to a lower plateau and, in our view, it's unlikely we see the previous highs reclaimed.
It has also moved to trade from a premium to a discount to the broader sector. Over the last couple of years it has tended to trade at an average 5% discount to the average sector valuation.
We would look to trim the position when it reaches valuation parity with the sector and add when it reaches a 10% discount to the sector average.
Stance and Takeaways
GBDC remains one of the larger BDC holdings across our Income Portfolios. Its low level of interest expense, well above average first-lien allocation, a high level of diversification, higher-quality underwriting and modest valuation makes it a good pick in the current environment.
We recently completed a circular rotation between FDUS and GBDC. The chart below plots valuations of both companies over the last year.
In March we rotated to GBDC from FDUS as we thought GBDC looked fairly cheap vs. FDUS. Then in May, once the valuation differential closed substantially, we moved back to FDUS.
The chart below shows the valuation differential more clearly. In March we moved to GBDC when it traded at a valuation about 16% below that of FDUS (i.e. 86% for GBDC vs. 102% for FDUS) and reversed this when the valuation gap closed from 16% to about 6%. It's unusual to see such a swift relative valuation retracement but it's hard to say no to a double-digit gain in just a couple of months on the position.
In the Core Income Portfolio we have a more restricted BDC population at our disposal which excludes FDUS given its higher equity allocation. In that portfolio our last GBDC trade was to rotate to GBDC from OCSL last December when OCSL traded up to what looked to us an overly expensive valuation. Since then, GBDC has outperformed OCSL by about 7%. The chart below normalizes total returns of the two stocks to 100 at the point of the rotation for clarity.
For further details see:
Golub Capital: Time To Shine For This 10%-Yielding BDC