Gladstone Capital Stock: An 8% Growing Yield You May Have Overlooked (NASDAQ:GLAD)

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Having growth stocks in your portfolio can be fun when times are good, but can be hard to bear after the music stops, especially when looking at unrealized losses and no dividend income to boot. Such can be the case with once high-flying tech stocks like Meta Platforms (META) and Salesforce (RCMP), which are now trading at a low price compared to just a year ago.

That’s why it pays to have income stocks that literally work for you by generating a recurring income stream. This brings me to Gladstone Capital (NASDAQ:GLAD), which is one of a handful of BDCs that pay their investors a monthly income stream. In this article, I clarify whether the stock is currently buy or hold, so let’s get started.

Why GLAD?

Gladstone Capital is a BDC managed externally by Gladstone Management Corp., with its namesake David Gladstone serving as chairman of the company. It is owned by the Gladstone family of companies, including REITs Gladstone Land (LAND), Gladstone Commercial (GOOD) and its BDC counterpart, Gladstone Investment (GAIN).

Currently, GLAD holds a diversified portfolio of investments with a fair market value of $650 million in 52 companies. As shown below, the bulk of GLAD’s portfolio is in the business services, healthcare, education, manufacturing, and aerospace/defense segments.

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GLAD Industries Portfolio (Investor Presentation)

GLAD differs from its BDC sibling, GAIN, in that it has lower exposure to equity investments and higher exposure to secured debt. This makes GLAD a traditional BDC with a more assured recurring revenue stream compared to a private equity/BDC hybrid that GAIN is more like.

As shown below, 89% of GLAD’s investment portfolio is comprised of secured debt (71% first lien, 18% second lien), with the remaining 11% comprised of equity upside potential through relative to its net asset value.

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Composition of the GLAD portfolio (Investor Presentation)

GLAD is seeing encouraging growth in the current economic environment, with originations outpacing portfolio outflows and refinancings over the past year. This generated a net increase of $92 million in total investments over the last four quarters. This is driven by strong demand from PE sponsors for flexible, one-stop first lien/unitranche financing, which increased first lien debt from 61% of GLAD’s portfolio in the prior year period. at 71% on 09/30/22.

Meanwhile, GLAD is posting a stable book value, with net asset value per share down just $0.04 sequentially in the quarter ended 9/30/22. It is also benefiting from rising rates, since 88.5% of its loan portfolio is subject to floating rates with minimum floors. This contributed to net investment income sequential growth of 8.6% to $0.22 and allowed GLAD to increase its monthly dividend to $0.07 with a payout ratio of 100%. Encouragingly, management expects to be able to increase distribution in the coming quarters, as shown below on the recent conference call:

With our floating rate investments exceeding our floating rate liabilities by approximately $400 million and current floating rates up approximately 125 basis points for the quarter, we expect our net interest margin to be approximately $1.25 million this quarter. Based on the performance of the portfolio and as net interest income is realized, we expect to be able to consider increased distributions to shareholders in the coming quarters.

GLAD is also moderately leveraged with a leverage ratio of 1.1x, well below the regulatory limit of 2.0x, and is more or less comparable to most other BDCs. Its portfolio companies also appear to be in too good a shape, with 89% of them having a debt-to-EBITDA ratio of less than 3.5x.

While GLAD has a lot going for it. My biggest problem is the evaluation. At the current price of $10.49, GLAD is no longer cheap at the book value price of 1.15x. As shown below, GLAD is now heading towards the top of its 5-year valuation range.

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GLAD Price to book (Looking for Alpha)

While this might be an acceptable valuation in a normal market, there are simply too many other attractive BDCs with higher yields. For example, Capital Southwest (CSWC), Hercules Capital (HTGC), and Horizon Technology Finance (HRZN), which also pays monthly, all offer higher returns than GLAD.

Key takeaway for investors

While GLAD may show strong performance, its yield is currently not as attractive on a relative basis and its valuation is no longer cheap by its historical standards. This is considering higher yielding alternatives available in the BDC space right now. As such, I view GLAD as a reserve until its price approaches a 1.05x price to net asset value ratio.

Sallie R. Loera