For investors looking for consistent dividend income, Golub Capital BDC (NASDAQ: GBDC) presents a tempting opportunity. GBDC recently released its first quarter financial results and knocked it out of the park with strong NII (net investment income), which translates to a an increased chance of more additional dividends being paid throughout the year. The dividend yield is currently over 10%, so you have the opportunity to create a significant income stream. GBDC should continue to benefit from the current higher interest rate environment, given its exposure to variable rate loans.
Golub Capital BDC operates as a specialist business development company, focused on providing financial support to middle market businesses. Its targeted industries include consumer services, automotive, health technology, insurance, healthcare equipment, hotels, restaurants, leisure, healthcare providers, IT services and retail. specialty retail in the United States. GBDC uses a strategic investment approach, offering senior and junior debt, equity, various loan structures and warrants to support mid-market companies.
I previously rated GBDC a Buy and said I thought the upside potential was limited. The price has risen about 5% since then, and my outlook has changed slightly after reviewing post-earnings results. As interest rates are expected to remain higher on average, I think it's likely that more investors will flock to higher yielding assets like GBDC. Since GBDC has an excellent management team and consistently earns more than distributions, it is a great choice for income-oriented investors.
In its results published for the first quarter, Golub Capital BDC demonstrated stable performance on various key indicators. Let's focus on NII's growth, since that's what indicates the health of BDC. Net investment income per share increased to $0.50 per share, compared to NII of $0.37 in the prior year quarter. This performance is likely attributed to high credit quality, consistent with previous quarters, as well as a higher average base interest rate. Additionally, GBDC made new investment commitments to its portfolio worth $58.6 million and put $36.4 million into action.
Their credit performance was generally good. The share of investments for which they did not receive interest payments fell to 1.1% of their total investments at fair value. As a result, the quarterly base distribution was increased by 5.4% in January, and I expect further increases if the NII remains strong.
If we don't get an increase, then I at least think it's likely that we'll continue to see additional distribution announced. For example, an additional distribution of $0.07 per share was declared on February 2, 2024, continuing the company's commitment to rewarding shareholders.
Although the adjusted net loss per share was ($0.05), this was a significant improvement over the prior year's loss of ($0.22). Additionally, the distributions paid per share were $0.44, including the surcharge, which was still covered by the $0.50 NII. This equates to a healthy dividend cover of 113%, so there is currently no risk to the dividend since they have consistently exceeded the distribution.
Looking at the portfolio composition, we can see that 94% of their portfolio is senior loans. More specifically, 86% of this amount is made up of senior one-stop loans. A single senior loan combines senior and subordinated debt into a single facility, providing borrowers with access to larger amounts of capital. This structure simplifies the lending process for both borrowers and lenders, but single senior loans may carry higher risk than regular senior loans because they include subordinate debt. Although still considered investment grade, subordinated debt is given lower priority for repayment in the event of default.
Exposure to 99% variable rate loans is a significant contributor to higher profitability levels. Since it appears that projections are calling for a higher average interest rate even after the Fed cuts, I expect GBDC to do very well with NII growth. At the start of the year, we heard about rate cuts in March. Since the recent Fed meeting, it appears that plans have changed and rate cuts are underway. not expected this would happen after March. I think this means we'll continue to see NII growth for now, but I'm curious how this will play out once rates are finally reduced. I think this might have a short-term effect, but ultimately higher rates would be a good thing because it would translate into more profits for BDCs.
GBDC has an internal rating system that evaluates the quality of a borrower. The system is a scale of 1 to 5, with 5 being the highest loan quality. The credit quality of GBDC's portfolio remained strong with over 85% of investments rated with a performance rating of 4 or higher. The portfolio had only 14.6% of borrowers with a rating of 3 and 0.3% of borrowers with a rating of 2. Additionally, the percentage of investments without accumulation remained low, constituting 1.7%. and 1.1% of total debt investments at cost and fair price. value, respectively.
Dividend and valuation
After the recently announced 5.4% increase to $0.39/share, the current dividend yield is over 10%. With an extremely healthy distribution ratio of 75% and additional NII growth, I believe we are on track for continued increases and additional distributions. Additional additional distribution was announcement on February 2 and will be payable on March 15. The 3-year CAGR (compound annual growth rate) of dividends stands at 5.27%, which is pretty good for a BDC that already pays a yield above 10%.
GBDC shares currently trade at a slight premium to net asset value (NAV) of just 2%. While we would all love to buy stocks at a discount, I still don't think it's a bad entry point. Over the last three years, the highest premium to NAV was 8.34% and the largest discount to NAV we saw was -19.35%. Before the madness of the pandemic, stocks frequently traded at a premium to net asset value of between 10% and 20%. Now that the average interest rate is expected to be higher than we've seen over the past decade, entry here is attractive.
Ultimately, I think GBDC is useful in a portfolio that values income. Now that the outlook for the interest rate environment has changed, I think we can expect a decent rise in prices. As rates get higher, investors are likely to put money into higher-yielding assets to maximize returns. Also keep in mind that quality funds tend to trade at a premium when investors see the consistent value that management is able to deliver to shareholders.
While I believe GBDC's portfolio is high quality in terms of diversity, credit ratings and loan structure, I believe there is still some interest rate sensitivity. Since the fund structure is primarily based on a floating rate structure, they have inherent vulnerabilities. One potential risk is that unexpected increases in interest rates could exceed the revenue generated by these loans. While I think this possibility is extremely low right now and it doesn't make sense to raise rates right now, it's worth mentioning.
Focusing on variable rate loans can also increase portfolio concentration risk. This could make GBDC vulnerable to unexpected events in specific sectors or among certain borrowers. For example, the majority of their portfolio is software companies. While other sectors seem much more balanced, software is heavily weighted, which opens the door to vulnerabilities.
In conclusion, Golub Capital BDC continues to be an excellent choice for investors looking for consistent dividend income. With its recent stellar earnings performance and net investment income (NII) growth, GBDC is poised to potentially increase its incremental dividends throughout the year. The company's dividend yield of over 10% provides investors with the opportunity to generate a substantial income stream with a strong track record of growth to date.
Additionally, GBDC is expected to benefit from the current higher interest rate environment due to its exposure to variable rate loans. Despite the slight risk associated with its portfolio, particularly with the inclusion of subordinated debt in senior one-stop loans, GBDC maintains strong credit quality with a large majority of highly rated investments. With shares trading at a slight premium to net asset value, Golub Capital BDC still presents an attractive entry point given its high-quality management.