Golub Capital Stock: I’m buying this 8.6% yielding BDC (NASDAQ:GBDC)

metamorworks

The US economy is in a slump, and persistently high inflation is making it difficult for income investors to protect their purchasing power.

Golub Capital BDC Inc. (NASDAQ: GBDC) can, in my view, help investors mitigate economic risks due to to BDC’s first lien investment strategy.

Golub Capital hedged its dividend with net investment income in 3Q-22, while net asset value fell slightly QoQ. The stock is trading at a 7% discount to net asset value, providing investors with a small margin of safety.

Portfolio shares

Golub Capital invests with a safety mindset, focusing almost entirely on the highest available forms of debt: First Liens.

First Liens accounted for 84% of the business development company’s investments at the end of the quarter, a 4% increase from the previous quarter.

At the end of 2Q-22, the total weighting to First Liens (both one stop and traditional senior) was 94%. The total allocation to investments other than First Liens increased by 2 percentage points year-on-year and remained stable at 6% quarter-on-quarter. Besides First Liens, Golub Capital mainly invests in equities and junior debt.

Portfolio Highlights

Portfolio Highlights (Golub Capital BDC)

Golub Capital’s portfolio value increased by $187.4 million quarter-on-quarter to $5.6 billion, with new investment commitments totaling $449.6 million. In the second quarter, approximately 95% of new investments were made in the First Lien category, which is already Golub Capital’s main investment product. Equity investments accounted for around 5% of new investments in 2Q-22.

Investing activity

Investing activity (Golub Capital BDC)

Yields could be under pressure

Golub Capital’s portfolio yields were flat in 2Q-22, but rates are rising, and BDC’s rising interest rate costs may limit its ability to generate attractive returns going forward. Golub Capital’s investment income return was 7.5% in 2Q-22, up 0.2 percentage points quarter-on-quarter.

Positioned for higher interest rates

Positioned for higher interest rates (Golub Capital BDC)

Credit quality

BDCs invest primarily in high-quality debt securities, so borrowers must be able to repay all the money they borrow. Golub Capital has no major problems in this regard. The business development company’s non-bookings did not increase last quarter, indicating that credit quality remained stable. Non-computings at Golub Capital remained stable in 3Q-22, at 1.1% at fair value or 1.5% at cost.

Non-regularization

Non-regularization (Golub Capital BDC)

Q2’22 dividend distribution measures

Golub Capital’s stronger business results in 3Q-22 were driven by a recovering economy, which enabled solid growth in net investment income compared to the 2021 period. Golub Capital’s net investment income in 3Q-22 22 was $53.9 million, a 28% increase from the previous year’s NII of $42.1 million.

I use Golub Capital’s adjusted net investment income, which includes capital gain incentive fees paid to the external manager, to calculate the dividend payout ratios. BDC’s adjusted NII in 3Q-22 was $0.34 per share, compared to $0.30 in 3Q-21.

As a result, Golub Capital’s dividend payment was easily covered by the adjusted NII (payout ratio of 88%). Golub Capital has distributed 98% of its adjusted net investment income over the past twelve months.

NII, dividend and payout ratio

NII, dividend and payout ratio (The author created a table using information from BDC)

Net asset value fell only marginally

Golub Capital’s net asset value fell $0.21 per share in the third quarter due to an unrealized writedown on BDC investments of $0.24 per share. The decline in net asset value was relatively minor (1.4% from the previous quarter) and BDC’s credit quality remained strong.

NAV per share

NAV per share (Golub Capital BDC)

Golub Capital shares are currently yielding 8.6% and trading at a 7% discount to net asset value. Since BDC is invested in a very conservative debt portfolio, the NAV discount provides a reasonable margin of safety.

Chart
GBDC Price to Book Value data by YCharts

Why Golub Capital could see a lower valuation

I’m not concerned about Golub Capital’s first-link performance at this time. Golub Capital’s safety-focused investment strategy, combined with strong NII growth and low unaccounted charges, indicates that the business development company is managing a healthy investment portfolio.

Things could change for Golub Capital if BDC sees a rapid increase in unrecognized charges, but given the company’s tier-one focus, I don’t see that happening.

My conclusion

I’m buying Golub Capital like crazy because I believe BDC will do well with their conservative approach to underwriting and investing, especially in a downturn.

With the majority of its investments in secure and relatively safe first lien, Golub Capital can be comfortable even if the US economy enters a deeper recession.

Additionally, the business development company maintained good dividend coverage in the third quarter, and the stock is trading at a 7% discount to NAV, which is a plus.

Sallie R. Loera