Neutral (GLAD, $8.18)
Growth Headwinds and High Leverage - Initiating With A Neutral Rating And $8 Price Target.
July 06, 2015
Christopher R. Testa
Investment Conclusion. We are initiating coverage of Gladstone Capital Corporation (GLAD) with a Neutral rating and $8 price target. Gladstone is a business development company (BDC) focused on lower middle market companies with EBITDA of between $3 million - $15 million. Gladstone currently has significant unrealized losses at 25% of NAV with the majority of the problem assets being attributed to legacy investments. The company is 49.9% senior debt with 39.0% in senior subordinated debt, and 11.1% in preferred and common equity combined. Over the past three fiscal years GLAD has not done a meaningful equity raise or repurchase which is very uncommon for a BDC. Gladstone’s funding is 34.8% preferred equity with the remainder being a credit facility of which 67% of the capacity is drawn. While the excess capacity in the credit facility permits some growth, it is limited by the need to keep D/E in check given the subordinated nature of roughly half of GLAD’s portfolio. Despite being about 50% senior secured, GLAD’s D/E is at 0.87x which we think is significantly higher than it should be. Gladstone is trading at a 14% discount to NAV and the company has been reluctant to issue equity, especially at a discount to NAV, over the past several years to assist in funding portfolio growth although it has recently announced a $50 million ATM (at-themarket) equity issuance program. The discounted NAV multiple will make any use of the ATM at this time dilutive and thus the company will be forced to push the asset coverage limit or shed assets and delever – we think the latter is more likely as the company looks to sell legacy problem assets. The high leverage, discounted NAV multiple, and problem assets are cause for concern for GLAD. The company will need to successfully recycle assets to bring down leverage and make more prudent, senior and less cyclical investments going forward to trade at higher multiples on both a NAV and NII basis. Our $8 price target implies an estimated 2016 (Price/Net Investment Income) P/ NII of 9.8x, dividend yield of 10.5%, and (Price/Net Asset Value) P/NAV of 0.77x compared to the BDC sector averages of 9.0x, 10.7%, and 0.91x, respectively.
Source: S&P Capital IQ, National Securities Corporation Estimates
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