Golub Capital BDC: Strong BDC Yield Trading at 12% Below NAV (NASDAQ:GBDC)

Golub Capital BDC(NASDAQ:GBDC) recently completed a merger with Golub Capital 3 BDC, which significantly increased the value of the BDC’s market portfolio. Golub Capital’s net investment income is outpacing dividends by a significant margin. The yield was safe at 12% in Q2, providing a safe yield for income investors. Golub Capital is also compelling in terms of non-accrual ratios, which have been up since the merger, but are very favorable over the long term. I also like that Golub Capital’s stock has recently fallen below its net asset value, which is likely related to the recent selloff in the BDC sector. I think the pullback is a buying opportunity for Golub Capital and the risk profile for income investors is tilted to the upside!

Previous evaluation

June Golub Capital stock rated as a Buy — 11% yield and upside related to merger deal — Because BDC had a catalyst related to its merger with Golub Capital 3 BDC. The Golub Capital merger was expected to create a much larger and more diverse BDC that would drive transaction synergies and generate returns for investors. Golub Capital’s portfolio value increased significantly after the merger, and the BDC generated significant net investment income while maintaining good balance sheet quality.

Completion of merger and growth of portfolio

The merger with Golub Capital 3 BDC resulted in a significant increase in the BDC’s portfolio value in Q2. The increase in portfolio value to $7.87 billion (+46% Q/Q) was almost entirely due to the merger of the two BDCs and was not a result of a significant boost to the BDC’s origins. As in the past, Golub Capital’s portfolio primarily consists of first-lien bonds, so there was no significant change in the portfolio structure following the merger.

Golub Capital’s non-debt ratio deteriorated slightly after the merger, but not significantly. The BDC’s non-debt ratio, which measures the amount of problem loans and non-performing loans in its portfolio, stood at 1.0% (at fair value) at the end of the June quarter. Although the non-debt ratio increased by 0.1 PP quarter-over-quarter, Golub Capital’s non-debt trend over the past year is positive, indicating that asset quality has improved significantly prior to the merger.

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(Source: Author)

Golub Capital generated net investment income (after-tax) of $92.7 million in Q2 2024, up 26% year-over-year. The increase in net investment income is due to the BDC combining its portfolio with an acquisition target, so investors should not expect the current NII trend to continue. However, Golub Capital provided guidance on deal synergies, including a reduction in incentive fees for earnings and capital gains.

Golub Capital’s dividend coverage profile looks healthier than ever, with the BDC generating a coverage of 1.18X compared to Q1’24’s 1.31X. I calculated the dividend coverage ratio by dividing the company’s net investment income by GBDC’s regular dividend of $0.39 per share. However, investors should note that Golub Capital paid a supplemental dividend of $0.11 per share last quarter. As a result, Golub Capital’s stock yield is 12%, as opposed to the 11% yield calculated based solely on regular dividends.

Golub Capital is a bargain

After acquiring Golub Capital 3 BDC, the asset value was combined and the net asset value also increased. In the second quarter of 2024, Golub Capital’s BDC reached $15.32 per share, which is an increase from the net asset value of $15.12 per share before the acquisition.

Income investors are currently receiving a 4% discount to their net asset value, as BDCs are being sold in anticipation of the Fed cutting the federal funds rate. The positive inflation report in July (inflation was just 2.9%) and the weak jobs report last week virtually guarantee a cut in the federal funds rate later this month. Rate cuts are generally perceived as a negative event for BDCs, especially those with funds invested in variable-rate debt.

I believe Golub Capital could trade at a P/NAV ratio of 1.1x given its low accrual ratio and significant excess dividend coverage. A 10% premium to net asset value implies a fair value close to $16.85 per share, which is achievable if the BDC captures the synergy potential associated with a merger with Golub Capital 3 BDC.

Golub Capital Risks

As things stand, I see no issues with the non-accrual ratio or the NII performance of the BDC. Golub Capital’s dividend coverage profile strongly supports regular dividends, and the company is reducing its fees, which I expect to be a positive catalyst for NII growth. What would change my mind about Golub Capital would be if the BDC’s non-performing loan ratio increases or if the BDC fails to generate sufficient net investment income.

Closing thoughts

Golub Capital has just completed its merger with Golub Capital 3 BDC, which has delivered significant increases in portfolio value and net investment income. Golub Capital has also supported its dividend well with net investment income in Q2 2024 and is poised to capture the synergies of the merger, which will further improve the company’s dividend coverage profile.

Golub Capital’s non-performing loan ratio increased slightly last quarter, but the long-term (1 year) trend of non-performing loans is actually very positive. Non-performing loan ratio decreased by about 33% last year. Also, due to the selloff in the BDC industry in recent weeks, Golub Capital’s stock price is now below its net asset value, improving its risk profile while providing income investors with a higher yield.