Golub Capital Stock: This is a doubling opportunity (NASDAQ: GBDC)
Golub Capital BDC Inc. (NASDAQ: GBDC) is a well-managed business development company that has recently been listed for sale by the market.
Given the company’s strong and performing credit portfolio, BDC shares are trading at excessive discount. With the central bank becoming increasingly aggressive in raising interest rates to fight inflation, BDCs with exposure to floating rate loans could outperform stocks in more cyclical sectors.
Golub Capital – Market woes create a buying opportunity
In recent months, stock prices have only moved in one direction: south. With the stock market in a bear market and interest rates set to rise in 2022, Golub Capital could be an investment firm that outperforms broader indices.
Golub Capital pays a generous dividend that is covered by net investment income, has growing book value and a strong credit portfolio that reduces the risk of significant capital losses for the business development company and its shareholders.
Golub Capital’s stock is down 14% year-to-date, and there’s clearly an opportunity to take advantage of the slump here.
Portfolio and new creations
Golub Capital is focused on senior debt, which represents 94% of BDC’s portfolio as of March 31, 2022. First liens are highly secured loans with a historically low loss rate.
The total investment value, including junior debt (1%) and equity (5%) positions, was $5.4 billion, an increase of $279.4 million quarter-on-quarter. The focus on first lien is what makes Golub Capital appealing to yield-seeking dividend investors concerned about rising loan defaults and rising interest rates. Rising interest rates are often associated with a late-stage bull market, and a recession has recently become more likely.
With the risk of recession increasing, BDCs like Golub Capital that invest in relatively safe first lien have a good chance of returning money to shareholders. In 1Q-22, approximately 96% of new investments were made in top-tier investments, further strengthening Golub Capital’s investment portfolio.
Watch this key metric to gauge GBDC’s recession performance
With a recession becoming more likely, it is essential to prioritize quality over yield. Quality business development companies have not only increased their book value over time (as Golub Capital has), but they also have a low non-booking ratio.
This ratio indicates how much Golub Capital has already invested: a high non-recognition ratio indicates high loan losses, while a low non-recognition ratio indicates a well-functioning credit portfolio.
Golub Capital’s non-recognition ratio increased by 0.2 QoQ percentage points to 1.1%, but it remains low enough to suggest that the company is not experiencing major investment problems. As noted earlier, the focus on first lien suggests that the non-accumulation ratio will remain low going forward.
Net investment income and payout ratio
Golub Capital’s book value increased 3.3% year-on-year to $15.35 per share in 1Q-22, indicating the company’s prudent capital allocation decisions. Although Golub Capital’s book value has grown steadily over the past five quarters, the company has a relatively low margin of safety: the payout ratio, based on adjusted net investment income, was 101% previous year, indicating that there are risks for investors if the credit portfolio starts to underperform and some borrowers experience difficulties.
Multiple of book value
Since Golub Capital’s stock has recently been corrected, GBDC can be purchased at a higher discount to book value. GBDC’s book value was $15.35 per share as of March 31, 2022, implying that Golub Capital’s current valuation implies a 16% discount to book value, whereas GBDC has historically traded at book value or at a small premium to book value.
As Golub Capital’s credit quality remains high and the company covers its dividend with adjusted net investment income, the discount has reached an attractive level.
The price-to-book ratio of the GBDC chart should be reconciled with 0.84x.
Why Golub Capital could see a lower valuation
A recession seems to be on the horizon for 2022, which implies the need for strict risk management. Golub Capital’s non-recognition ratio appears to be in good shape at the moment, but it is subject to change. A decline in portfolio quality, reflected by a higher non-book ratio, would almost certainly result in the stock being traded at an even deeper discount to its book value.
I believe the decline represents a double opportunity because management has done a great job of running the business while incurring minimal capital losses.
However, if Golub Capital’s portfolio suffers credit losses and its net investment income declines as a result, investors could see a lower dividend.
I think GBDC will be able to weather a recession due to its low non-booking rate and focus on top tier investments. The fact that the stock is now trading at a 16% discount to its book value only adds to GBDC’s appeal as a dividend investment.