Golub Capital: This 9.7% Dividend Yield Is A Buy (NASDAQ:GBDC)

There are over three dozen publicly traded business development companies. They range from $11 billion market cap Ares Capital (ARCC) to Rand Capital (RAND) whose equity value of $34 million renders it the smallest publicly traded BDC. Golub Capital (NASDAQ:GBDC) at a $2.57 billion market cap has been a relatively under-the-radar BDC with healthy total returns of 28% year-to-date, an investment grade “BBB” credit rating from Fitch, and dividends that have grown by an 11% compounded annual growth rate over the last two years. GBDC last paid a quarterly cash dividend of $0.37 per share, left unchanged sequentially, for a 9.7% annualized forward dividend yield. There was also a $0.07 per share supplemental paid out.

Fitch stated that its decision to upgrade GBDC a notch from “BBB-” was driven by the BDC’s continued access to the unsecured debt market. The rating agency also cited expectations that following the recent $450 million issuance in aggregate principal amount of 7.050% notes due 2028, GBDC’s unsecured debt will remain greater than 40% of total debt outstanding. Critically, GBDC’s focus on first-lien senior secured loans to middle market companies backed by partnership-oriented private equity sponsors has rendered it a slightly more defensive and stable BDC.

Loan Portfolio, Net Asset Value, And Underwriting Quality

New York-based GBDC’s investment portfolio at the end of its fiscal 2024 fourth quarter, which ended September 30, 2023, had a fair value of $5.52 billion across 342 investments. The portfolio is 99% floating rate loans with companies in the software industry constituting 26%. Critically, first lien senior secured loans form a dominant 94% of the portfolio with GBDC’s largest ten investments forming 15% of the portfolio.

The portfolio is up 1.3% from its year-ago comp but dipped sequentially. This dip came despite new investment commitments during the fourth quarter of $129.6 million outpacing exits and sales of $119.3 million. Net funds growth was down $8.4 million sequentially as it takes into account other variables including changes in unamortized fees, net funding on revolvers, and net change in unrealized depreciation.

The BDC’s net asset value at the end of the fourth quarter at $15.02 per share grew by 19 cents sequentially driven by GBDC’s adjusted net investment income of $0.50 per share outpacing its quarterly base dividend distribution and the supplemental paid in September.

Hence, the commons are currently changing hands at a small 2% premium to NAV, reversing a discount that had been in place since the start of 2022. NAV growth forms one of the core factors to look for when investing in a BDC and GBDC has arrested a broad decline in NAV that kicked off at the start of 2022. This drove the previous discount with the market increasingly confident that the BDC will be able to maintain the NAV upswing in place since the second quarter of GBDC’s fiscal 2023. Adjusted NII per share meant the BDC covered its base quarterly dividend by 135%, a roughly 74% payout ratio.

Risks And The Macro Picture For 2024

Loans on non-accrual status at the end of the fourth quarter stood at 1.2% at fair value, a sequential decline from 1.5%. This was as investments rated 4 and 5, the most optimal on GBDC’s internal performance rating scale came in at 85.1%, a decline from 86% in the third quarter. There has been a marginal decline in the performance of the portfolio with investments rated 4 and 5 at 89.3% at the start of the fiscal year, hence there’s been a 420 basis points decline through the fiscal year.

This comes as 2024 offers the first interest rate cuts since early 2020 when the outbreak of the pandemic forced the Fed to cut rates to what now retrospectively seems like a remarkable 0% to 0.25%. The Fed’s recent December dot plot showed three interest rate cuts next year for a total of 75 basis points with the CME FedWatch Tool showing 2x this amount. Current base market expectations being for interest rates to exit 2024 at 3.75% to 4.00%.

GBDC’s debt-to-equity ratio is higher than some of its most relevant peers but still very much within a level of prudence. Hence, the BDC should not experience any heightened volatility in the event of the US economy flashing deeper shades of red next year. Whilst I’ve already hit my ceiling in terms of total BDC positions at seven, GBDC is being rated as a buy with its investment grade credit rating and healthy credit quality set within a small premium to NAV.