Though Gladstone Funding Company (NASDAQ:GAIN) not too long ago elevated its month-to-month distribution by 6.7% and declared a particular dividend, the inventory is now pretty valued in my view, and the corporate’s refined deal with fairness securities creates threat for the BDC and its traders if the market strikes in opposition to the BDC.
Gladstone Funding coated its dividend with internet funding revenue within the third quarter, however the premium to e book worth, nonetheless small, and the danger posed by the fairness portion of the BDC’s portfolio are compelling causes to keep away from the inventory.
Fairness-Heavy Funding Portfolio
Gladstone Funding’s portfolio is made up of 57% first-lien debt, 10% second-lien debt, and a large portion of widespread and most popular fairness (33%).
Even supposing the portfolio’s secured whole proportion of investments is 67%, I consider the enterprise growth firm has an excessive amount of fairness publicity, and due to this fact threat.
Most enterprise growth corporations have a transparent deal with First and Second Lien debt and solely make investments a small portion of their funds in high-risk fairness securities.
A inventory market correction and a slowing U.S. economic system translate into an undesirable valuation threat for Gladstone Funding, and I might not be comfy proudly owning a BDC with such a excessive fairness publicity except a really substantial low cost to internet asset worth was supplied. Gladstone Funding’s portfolio was value $737.9 million as of September 30, 2022.
Dividend Coated By Internet Funding Revenue
Gladstone Funding coated its month-to-month dividend cost of $0.225 per share with internet funding revenue and adjusted internet funding revenue within the third quarter.
The dividend pay-out ratio based mostly on adjusted NII was 78% within the third quarter, in comparison with an 85% dividend pay-out ratio within the earlier 12 months.
Between 2018 and 2023, Gladstone Funding elevated its common distribution by 5% per 12 months. Just lately, the enterprise growth agency elevated its common month-to-month distribution from $0.075 per share to $0.08 per share, a 6.7% improve. Administration additionally declared a particular dividend of $0.12 per share, payable on December 15, 2022. GAIN at the moment pays a inventory yield of seven.8% when mixed with the particular dividend.
Gladstone Funding Seemingly Pretty Valued Now
I used to be extra bullish on GAIN when it was buying and selling at a 9% low cost to internet asset worth, however now that it’s buying and selling at a 3% premium to NAV, I consider the BDC is pretty valued.
As an alternative of Gladstone Funding, I like to recommend Oaktree Specialty Lending Company (OCSL), which is a robust BDC funding with wonderful asset high quality, a safety-oriented debt portfolio, restricted fairness publicity, and is run by a staff with sturdy credit score administration expertise.
Why Gladstone Funding May See A Decrease/Increased Valuation
Gladstone Funding is at the moment buying and selling at a premium to internet asset worth, and the inventory is now totally valued in my view. Having stated that, a rise in non-accruals poses a threat to Gladstone Funding’s portfolio efficiency, probably leading to a decline in dividend protection and the BDC buying and selling at a reduction to internet asset worth.
The BDC’s dividend pay-out is roofed by NII, so a rise in non-accruals or an surprising decline in portfolio revenue might end in a lower in Gladstone Funding’s dividend pay-out.
Then there’s the danger that Gladstone Funding’s fairness portfolio will under-perform throughout a recession, when traders hardly ever pay excessive multiples for fairness exits.
Total, I consider GAIN’s dangers outweigh its potential upside, provided that the inventory is already buying and selling at a premium to NAV.
Gladstone Funding is a well-managed enterprise growth firm, however its above-average portfolio threat isn’t correctly mirrored within the BDC’s valuation resulting from its massive investments in Fairness, which additionally represents a threat notably within the subsequent recession.
I’m all for purchasing well-run enterprise growth corporations at a reduction to e book worth, however I consider the overall return potential for passive revenue traders diminishes as soon as the worth exceeds internet asset worth.
For my part, Oaktree Specialty Lending is a a lot better alternative for passive revenue traders in search of predictable dividend revenue from a well-run BDC with wonderful credit score high quality.