This is an extract from an earlier article at Systematic Income Premium.
In this article, we catch up on the latest quarterly results of Golub Capital BDC (GBDC). The company delivered a good result for fiscal Q3 2023, with a 3% total NAV return. It trades at an 11.4% total dividend yield and a 3% discount to book.
In our last update last quarter, we mentioned that we were disappointed in a lack of a dividend hike given strong net income growth and high coverage. GBDC didn’t disappoint this time around, with a 12% dividend bump and a new supplemental, resulting in a 24% total dividend rise.
The company also reduced its already relatively low management fee to 1% of total assets.
Its portfolio targets primarily floating-rate first-lien loans and is very well diversified with over 300 positions. Top sectors include software and healthcare.
Quarter Update
In our last update, we discussed how net income growth was going to slow down from its double-digit pace to a single-digit level due to the flatlining of short-term rates. That’s more or less what happened this quarter, as adjusted net income increased by 5% to a new record of $0.44.
To make up for failing to hike the dividend last quarter, GBDC not only made a double-digit base hike this quarter but also introduced a supplemental dividend. Had the company kept the previous dividend, its coverage would have increased to a silly 133%.
The base dividend was increased to $0.37 from $0.33 or over 12%. The new supplemental dividend will be set in a formulaic fashion to pay out half of the excess adjusted net income over the base dividend. Base dividend coverage is a very healthy 119%. The adjusted net income yield of the company is 12.2% – slightly below the sector average.
The NAV increased by 0.7% – the second consecutive increase and a nice turnaround from three previous consecutive drops.
The gain in the NAV was entirely due to retained income as a realized loss was offset by unrealized appreciation.
The company repurchased 0.5m shares during the quarter at a weighted-average price of $12.96 or 12.6% below the NAV, generating a small tailwind for the NAV.
Income Dynamics
As highlighted above, GBDC is reducing its base management fee from 1.375% to 1% effective July 1. This may not seem like much but it’s important for two reasons. One, GBDC already has a relatively low management fee so this move pushes its fee to the lowest level in our coverage universe, currently shared only by two other BDCs.
And two, the fee is applied on all investments less cash which multiplies its impact on net income. In short, as a back of the envelope, given leverage of 1.2x the fee reduction generates a net income tailwind closer to 0.825% – quite substantial at around 7% of the company’s current net income.
Portfolio turnover continued to grow net income as new investments are going into the portfolio at a higher yield than those they are replacing.
Net new investments were slightly positive.
Asset yields increased by 0.5%, primarily due to a further increase in base rates. However, as the chart shows, the pace of increases has fallen off substantially and will rise only slightly next quarter. The company’s cost of debt is among the lowest in the sector, giving it a competitive advantage. Its next bond maturity is the Apr 2024 3.375% bond. This is the company’s highest coupon bond so the refinancing will not be very painful for its net income.
Valuation And Return Profile
GBDC has put up pretty good returns over the longer-term and has beaten the sector over the past year in total NAV terms. There are two reasons for its longer-term underperformance. One was the misguided rights offering in the middle of COVID which proved to be needlessly expensive and damaging for performance. This is something that’s unlikely to be repeated. And two, its relatively conservative underwriting stance both in terms of its low equity and high first-lien allocation.
The company underperformed over 2021, which was a strong market environment; however, it has done much better in a more risk-off period since 2022, outperforming in 5 of 6 quarters.
Its valuation has bounced strongly recently.
The fee reduction discussed above should permanently boost the company’s valuation by around 6%.
Stance and Takeaways
Golub Capital BDC put up a strong quarter with a 3% total NAV return while portfolio quality remained resilient with a modest level of non-accruals. It remains an attractive holding in the current environment due to its higher-quality portfolio and conservative underwriting. The sharp rise in the dividend and a drop in the management fee should generate a tailwind for its valuation which remains attractive. Golub Capital BDC is one of the largest BDC holdings in our Income Portfolios.
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