Gladstone Capital Corporation (GLAD), a business development company, recently announced its second quarter earnings. A deep dive into its most recent 10-Q, along with the continued negative trends in asset impairments, are my motivation for suggesting this stock as a candidate to sell short.
Earnings
Gladstone reported net income of $0.23 per share, which covers the monthly dividend of $0.07. The current stock price of $8.74 results in an annualized yield of 9.6%. Quarter over quarter, net investment income has decreased from $0.25 to $0.23.
Net Asset Value
GLAD reported Net Asset Value (NAV) at quarter end of $8.91. Over the past seven quarters (from earliest to latest), the NAV change is as follows: 11.85, 11.18, 10.34, 10.16, 9.90, 9.62, 8.91. GLAD management has lost $2.94 of NAV, while only paying out $1.47 in dividends. During the past quarter, GLAD paid out $0.21 in dividends with a drop in book value of $0.71. The trend of paying dividends, while eroding book value, continued in Q2 2012.
Portfolio Performance
GLAD's entire portfolio was valued at 76 cents on the dollar. This represents a 100 basis point, or 1 cent decrease, from Q1 2012. The drop in portfolio value was driven by unrealized depreciation in numerous portfolio holdings.
Per the latest 10-Q, the following table lists all investments on non-accrual (i.e. not generating income) status.
Company | Description |
Access Television | cable airtime (infomercials) |
BERTL | web-based evaluator of imaging products |
Kansas Cable | cable, internet provider |
Lindmark Acquisitions | advertising |
LocalTel | Yellow pages publishing |
US Healthcare Communications | Magazine publishing |
Sunshine Media Holdings | Publishing |
Viapack | Manufacturing-polyethylene film |
No new loans were placed on non-accrual status relative to Q1 2012. Analysts asked GLAD management about loans on non-accrual during the latest conference call, and management commented:
I don't throw cold water on anybody else's valuations but I do say that we are being extremely conservative, when you take a company that for whatever reason misses couple of quarters and doesn't make what it suppose to make and you see the risk rating go down as well as the valuation go down by 50% or 60%, it's a bit harsh. I know we will recover some if not all on some of these. And we'll just have to see. I don't want to make any promises, but I think we will be just fine.
Hearing management say it will be fine, without saying why or how, does not make me feel overly confident that it will be.
What is even more important is the health of the portfolio companies that are currently providing income to GLAD for distribution to shareholders. In the table below, I list all the portfolio companies that are currently generating income, but are valued at 75 cents on the dollar or below. The valuations for the previous three quarters are provided, and the valuation metric is cents on the dollar.
Company | Description | Value - Q4 2011 | Value - Q1 2012 | Value - Q2 2012 |
BAS Broadcasting | Radio station operator | 0.70 | 0.55 | 0.30 |
Chinese Yellow Pages Company | Publisher of Chinese language directories | 0.70 | 0.60 | 0.50 |
GFRC Holdings | Manufacturing glass fiber reinforced concrete | 0.65 | 0.55 | 0.50 |
Heartland Communications Group | Radio station operator | 0.39 | 0.35 | 0.33 |
International Junior Golf Training | Golf training | 0.73 | 0.67 | 0.60 |
Legend Communications of Wyoming | Operator of radio stations | 0.50 | 0.52 | 0.50 |
Sunburst Media | Radio station operator | 0.55 | 0.40 | 0.30 |
No new companies have been placed on this list. However, the valuations of all of the companies have dropped quarter over quarter. It appears that these troubled companies are poised to cause GLAD future problems based on their continued drop in valuation. If these companies eventually get placed on non-accrual status, it is likely that future net investment income will suffer.
Here is management`s statement on the asset deterioration in the portfolio:
The cumulative net unrealized depreciation of our investments does not impact our current ability to pay distributions to stockholders. But does indicate that the asset value is lower and that there maybe future realized losses that could ultimately reduce our distributions.
Raising Capital
Since BDCs payout nearly all of their earnings, they need to raise equity to fund their continued investments. GLAD currently trades nearly at NAV, so I would not be surprised if it attempts to issue new stock in the near future. Stock prices typically decline when such announcements are made, as current shareholders are getting diluted.
Disclosure: I am short GLAD.
