Gladstone Investment: Attractive Valuation Again, Long-Term Income Opportunity (GAIN)

Written by Nick Ackerman

Today, I wanted to give Gladstone Investment (NASDAQ: GAIN) an updated layout since it’s been a while. Business Development Companies (“BDCs”) may have performed strongly in a higher rate environment, but that doesn’t mean they’re still cannot provide strong returns when rates are low. They don’t expect us to go back to a zero-tariff environment, so that should help as well.

However, GAIN is not your average BDC, rather it is a unique BDC that has never really benefited from a higher rate environment. After their recent earnings showed some disappointment, the shares have fallen, but this may simply represent an attractive time to consider investing in the name. This is more for a long-term investor who can handle the ups and downs that this BDC can take.

In our prior updatewe were more neutral on this name with a “Hold” rating. The rating here seemed too stretched. It appeared to be, at least in part, driven by euphoric sentiment from several special dividends paid last year, with the particularly large supplement of $0.88 paid in December 2023. Results since then have been quite weak for GAIN, although we already far from the lowest levels reached recently.

A more tactical investor could have taken advantage of the highs it was hitting to sell out of the position and retrace at a lower price. That said, I see GAIN as a long-term core position in my portfolio, so I’m not too keen on trading around it. Instead, I’m taking the long-term position and looking for opportunities to add, which I think we’re in right now.

Latest Sour Price Earnings

The recent price drop was BDC’s most recent earnings report; these results weren’t great, to say the least. We have seen some issues arise in their portfolio and the net asset value per share has declined primarily because of these issues. NAV fell from $13.43 to $13.01 – although this is higher than the $12.99 seen a year ago.

Before investing in GAIN, I think it’s also important to understand that GAIN is not your average BDC. It is a buy-out focused BDC with a fairly narrow portfolio of only 23 companies. They tend to provide all financing to a borrower, which includes debt and equity, rather than focusing more on first-guaranteed loans.

This allows for more potential appreciation, which led to the higher supplement growth seen last year. In total, GAIN paid an additional $1.48 during calendar year 2023 – which was in addition to the $0.96 regular monthly distribution paid at $0.08 per month.

In fact, for several years now, GAIN has been able to pay out some special offers quite regularly. So not seeing any this year is giving some investors pause.

However, with this composition, it also tends to mean that the NAV can be a bit more volatile, with an overall higher risk to their operations. With only 23 companies invested in total, this means that each becomes more important to the success of the entire fund.

This can be compared to something like, for example, Blackstone Secured Lending (BXSL), which has 231 companies in which it is invested. That makes each one less important where a few possessions may run out of accumulation, and I don’t foresee a big disruption to BXSL overall.

That being the case, we can see that some new non-accumulations have crept into the GAIN portfolio and this has led to a significant increase in the total non-accumulation percentage.

Beginning June 30, 2024, certain of our loans to B+T Group Acquisition, Inc., Diligent Delivery Systems, Edge Adhesives Holdings, Inc. (“Edge”) and JR Hobbs Co. – Atlanta, LLC (“JR Hobbs”) ”), were non-accrual with a total debt cost basis of $86.1 million or 13.1% of the cost basis of all debt investments in our portfolio and a total fair value of $46.8 million or 7.8% of fair value. the value of all debt investments in our portfolio. As of March 31, 2024, our loans to Edge and JR Hobbs were in non-accrual status with a total debt cost base of $59.1 million or 9.0% of the cost base of all debt investments in our portfolio and a fair aggregate. value of $29.7 million or 4.8% of the fair value of all debt investments in our portfolio.

As we can see, two non-accruals bringing the total to four in the last few earnings meant an increase from 9% to 13.1% of the cost basis. 9% is already quite high compared to other BDCs.

There is some positive news indicated by management though. Of course, it’s kind of their job to be optimistic; Here’s what they had to say on the latest earnings call:

Now, we currently have four non-accrual companies, two of which we just put on non-accrual, which represent approximately 7.8% of the fair value of the debt investments in our portfolio. I really want to emphasize that this is not an indication of any concern at the portfolio level. Two of those companies combine to account for about $32 million of the total debt. And both are now profitable. We anticipate bringing them back to stockpiling sometime next year. We also have significant holdings in these two companies. So, again, this will happen from time to time, but we’re working with these companies to get them back where they need to be. And again, I want to emphasize that our portfolio is performing at a very high level, and I’m not concerned that these two companies have recently become non-accumulating.

The main takeaways here are that they don’t see it as a portfolio-wide concern and expect them to be re-committed before the end of next year.

The rating looks better

Another positive is that with the share price sliding based on these gains, the price of GAIN has become a bit more attractive. First, the yield increases due to the decrease in price. That’s assuming they can maintain their current monthly payment of $0.08. Based on the most recent net investment income of $0.24, that’s enough to cover you.

This narrow coverage isn’t all that unusual either. Last quarter, NII came in at $0.24. Last year, fiscal Q1 saw an NII of $0.25, and fiscal Q1 2023 NII was $0.22. Going back to fiscal Q4 2022, which is actually calendar Q1 2023 — before the Fed starts raising interest rates — GAIN delivered NII of $0.26. So for the most part, GAIN has not benefited significantly from a higher rate environment as we have seen with other BDCs.

Second, the share price discount/premium to the underlying NAV per share has also approached parity – notably, it is trading at a -0.77% discount to its most recent closing price.

Historically, in addition to the NAV itself being quite volatile, the discount/premium on this BDC can also be quite volatile. However, the current level reflects that GAIN could be a decent entry price as it has come down from some of the higher premium levels seen over the past five years or so.

Of course, there is also the period of the Covid pandemic when the discount jumped materially. If one can predict one black swan event, one can simply wait for the next one before investing. While you wait, someone is giving up all the potential dividends that GAIN pays.

Conclusion

GAIN is a unique BDC, but may not be right for everyone given its higher allocation to equity positions. This can be compared to most other BDCs, which focus primarily on lending, often of the first lien type. This can lead to more volatility and risk in the underlying portfolio.

During our last update it seemed more expensive, but I feel more comfortable now that the price has retreated from the upper levels. PROFIT fell substantially amid a shocking earnings report. He started an initial recovery fairly quickly, but has since relapsed. The current valuation provides an entry for long-term income investors.

For investors who are willing to accept higher volatility, history has suggested that GAIN has delivered superior returns over the past five years.

Of course, history is just that, history. There can be no assurance that this BDC can deliver the same results in the next five years as it has in the past. With a more concentrated portfolio, management needs to be more cautious and get far more right than wrong.