Income Investors Might Be 'Glad' to Own Gladstone

| About: Gladstone Capital (GLAD)

Gladstone Capital [NDQ:GLAD] August 19, 2009 - $7.89 /share

Dividend = $0.07 monthly = 10.6% current yield

Gladstone Capital (NASDAQ:GLAD) seeks to provide high current income through investment in debt of established businesses that are family owned or held by LBO funds. Their IPO came in August of 2001. They have elected to be treated as a business development company and, for tax purposes, they are a regulated investment company. As such, they pay almost no corporate taxes and are required to pass through virtually all their income to their shareholders on an annual basis.

Like almost all financial companies Gladstone suffered through the credit market turmoil and posted a loss of $1.08 /share in 2008. It is expected that fiscal Q4 (FYs end September 30) will show a $0.23 gain and that FY 2010 will come in at around $0.90 - $.092 /share in profits.

Here are their per share numbers as reported by Value Line:

FY EPS Div. B/V Avg. P/E 52-wk Range
2002 0.75 0.81 12.97 23.4x 14.50-19.50
2003 1.09 1.10 12.97 16.6x 15.50-23.10
2004 1.02 1.37 13.50 21.2x 18.90-25.80
2005 1.33 1.52 13.41 17.7x 19.80-26.50
2006 2.10 1.64 14.02 10.3x 19.90-25.40
2007 1.13 1.68 14.97 20.1x 17.00-24.80
2008 d1.08 1.68 12.89 NMF 4.70-19.90

If the consensus view for about $0.90 /share in year-ahead earnings then GLAD’s multiple is just under 8.8x. That’s extremely low compared with all historical levels. (See chart above for comparisons.)

Gladstone issued over six million new shares last year to firm up the balance sheet and they reduced the dividend to the current rate of $0.07 per month to bring it in line with distributable earnings. The current yield of 10.6% appears safe barring any further credit market craziness.

Book value was $11.86 /share as of June 30, putting today’s share price at a 33.4% discount to asset value.

Gladstone has applied for a Small Business Administration license that would give them access to funds on more favorable terms in both interest rates as well as maturities.

Overall, Gladstone offers risk tolerant investors good current income and a chance for significant capital gains. A rebound to even 10x FY 2010 projections would bring these shares back to at least $9.00 or 14% above last week’s close.

That’s a pretty conservative target as GLAD shares actually traded as high as $14.50 in each calendar year from 2001 right through 2008. They were over $10 earlier this month.

Anyone willing to limit upside to mitigate risk could consider selling March $10 calls for about $0.50 /share. That would cap best-case total return at about 37% for the six month period until expiration while offering about 6% extra of downside protection.

Disclosure: Author is long GLAD shares.

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