Gladstone Investment's Dividend Sustainability Analysis (Includes April-December 2019 And Fiscal 2020 Special Periodic Dividend Projections)

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About: Gladstone Investment (GAIN), Includes: AINV, ARCC, BDCL, BDCS, BIZD, BLK, FSK, GBDC, MAIN, MCC, MDLY, MO, NEWT, OAK, OCSI, OCSL, PFLT, PSEC, SLRC, TCPC, TSLX
by: Scott Kennedy
Summary

Due to recent events, this article assesses GAIN’s dividend sustainability over the foreseeable future by performing three tests based on historical and projected future quarterly results.

The first two tests analyze GAIN’s net ICTI and cumulative UTI which are based on IRC methodologies.

It is important for readers to understand the difference between GAIN’s NII and net ICTI regarding consistent, reliable dividend sustainability metrics and projections (which my BDC track record has proven).

The third test focuses on the probability of GAIN continuing to provide special periodic dividends in the future.  This includes projections for the first and second half of fiscal 2020.

Summarized results from the three tests performed, including a projection of GAIN’s monthly dividend for April-December 2019, are stated within the “Conclusions Drawn”section of the article.

Author’s Note: This article is a detailed analysis of Gladstone Investment Corp.’s (GAIN) dividend sustainability. I have performed this analysis due to the number of readers who have specifically requested such an analysis be performed on GAIN in light of recent earnings/events. For readers who just want the summarized conclusions/results, I would suggest to scroll down to the “Conclusions Drawn” section at the bottom of the article.

Focus of Article:

The focus of this article is to provide a detailed analysis with supporting documentation (via three tests) on the dividend sustainability of GAIN through 2019. This analysis will be provided after a brief overview of GAIN’s regulated investment company (“RIC”) classification per the Internal Revenue Code (“IRC”). The first two tests will focus on GAIN’s net investment company taxable income (“ICTI”) and the company’s undistributed taxable income (“UTI”). These two tests will be termed “Test 1” and “Test 2.” The third test will focus on GAIN’s unrealized appreciation (depreciation) on investments account and be termed “Test 3.”

Understanding the tax and dividend payout characteristics of GAIN will provide investors with an overall better understanding of the business development company (“BDC”) sector as a whole. From reading this article, investors will better understand how a RIC per the IRC comes up with the company’s current dividend per share rate and specific signs when an impending increase or decrease should occur. In the past, I have covered a handful of sector peers’ IRC metrics via similar articles (ultimately based on reader requests).

At the end of this article, there will be a conclusion based on the results obtained from Test 1, Test 2, and Test 3 about the dividend sustainability of GAIN. I will also provide my projection regarding GAIN’s monthly dividend per share rate for April-December 2019 and my projection regarding the company’s special periodic dividend for the first and second half of fiscal 2020. My Buy, Sell, or Hold recommendation and current price target for GAIN are also stated in the “Conclusions Drawn” section at the end of the article.

Side Note: It should be noted GAIN’s fiscal year-end, based on Generally Accepted Accounting Principles (“GAAP”), is March 31st of a given year. GAIN’s tax year-end, based on IRC methodologies, is also March 31st of a given year. Readers should understand this point as the analysis is presented below.

Discussion of GAIN’s RIC Classification per the IRC:

As a BDC, GAIN elects to be treated as a RIC under Subchapter M of the IRC. To continue to qualify annually as a RIC, the IRC requires GAIN to meet certain “source-of-income” and “asset diversification” requirements. These requirements are beyond the scope of this article and will not be mentioned again. There is one specific provision which pertains to GAIN’s dividend sustainability that should be discussed. As a RIC, GAIN is required to distribute to shareholders at least 90% of the company’s ICTI and net capital gains (in excess of any capital loss carryforward balance; if applicable) in any given tax year in order to be eligible for the tax benefits allowed in regards to this type of entity. This is a very similar taxation treatment when compared to a real estate investment trust (“REIT”) entity. If GAIN qualifies to be taxed as a RIC, the company avoids double taxation by being allowed to take a dividends paid deduction at the corporate level.

Several book to tax adjustments need to be determined to properly convert GAIN’s earnings per share (“EPS”) figure to the company’s ICTI. Next, one would need to determine GAIN’s net capital gains for the specified time period. Net capital gains consist of realized short-term net capital gains in excess of realized long-term net capital losses for each tax year. While some sector peers continue to have a material capital loss carryforward balance from prior years, GAIN currently is one of several BDC exceptions. Within the prior tax year, GAIN “shifted” from having a capital loss carryforward balance to eliminating this balance. This is an important (and positive) trend for readers to understand.

When GAIN’s ICTI and net capital gains are combined, this comprises the company’s net ICTI which is also known as its annual distribution requirement (“ADR”). Regarding GAIN’s ADR, the company has an additional option available if it fails to distribute 90% of its net ICTI within a given year. GAIN is allowed to carryover its net ICTI into the following year. However, GAIN must distribute the company’s remaining net ICTI for a given tax year through declared dividends prior to the filing of its tax return for that applicable year. This is also known as the spillback provision which GAIN has continued to utilize. If GAIN fails to comply with this provision, the company will be declassified as a RIC per the IRC. If this were to occur, all of GAIN’s net ICTI would be subject to taxation at regular corporate tax rates at the company level. This notion is extremely important to understand as the analysis is presented below.

GAIN’s Primary Factor Regarding Setting an Appropriate Dividend Per Share Rate - Intend to Cover the Company’s ADR with Net ICTI:

To fully understand and accurately project a BDC’s dividend sustainability, readers must understand the subtle differences between a company’s net investment income (“NII”) and net ICTI figures/cumulative UTI balances. As stated earlier, due to the fact GAIN continues to not have a capital loss carryforward balance, this is an extremely important concept to understand. Simply put, not having this balance continues to “de-couple” GAIN’s quarterly NII and net ICTI and notably widens the gap between the company’s cumulative overdistributed NII and cumulative UTI balances. As such, readers/contributors not considering IRC methodologies greatly lower the probability of providing accurate projections over a prolonged period of time. Since this is such an important concept to understand, let us briefly discuss this distinction.

NII is a GAAP figure which is based on the accrual method of accounting. ICTI and net ICTI are IRC figures which are “generally” based on the cash method of accounting (some exceptions to this notion [for instance, payment-in-kind income and differing depreciation/amortization time tables] but I am keeping it simple for this discussion). Income and expense recognition of certain accounting transactions differ between GAAP and the IRC (book versus tax accounting treatments). A majority of GAIN’s book to tax differences (either temporary or permanent in nature) consist of the following: 1) deferred financing fees on loans and deferred offering costs in relation to equity raises; 2) pre-tax book income (losses) related to certain subsidiaries; 3) expenses not currently deductible; and 4) income tax (provision) benefit of certain subsidiaries. Let us now move on to GAIN’s dividend sustainability analysis.

To test GAIN’s primary factor, I believe it is necessary to analyze and discuss the company’s historical net ICTI figures to see if the company’s quarterly/annual dividend distributions were being covered. This will lead to a better understanding of the overall trends regarding this particular metric and possible pitfalls that may arise in the future. This includes GAIN using the company’s cumulative UTI balance on any quarterly/annual net ICTI overpayments. I also believe it is desirable to analyze and discuss my projected GAIN net ICTI figure for the fiscal fourth quarter of 2019 to see if the company’s projected dividend distributions will be covered.

By using this methodology, I have consistently provided highly accurate projections within the BDC sector over multiple years (including the most accurate projections on Seeking Alpha). Table 1 below shows GAIN’s annual net ICTI for fiscal 2016, 2017, and 2018. Table 1 also shows GAIN’s net ICTI for the fiscal first, second, and third quarters of 2019 and my projection for the fiscal fourth quarter of 2019.

Table 1 - GAIN Net ICTI and Cumulative UTI Analysis (IRC Methodologies Based on Quarterly/Annual Timeframes)

GAIN Net ICTI and Cumulative UTI Analysis (Source: Table created entirely by myself, partially using GAIN data obtained from the SEC’s EDGAR Database)

All ACTUAL figures within Table 1 above are checked and verified, either directly or through reconciliations, to various spreadsheets and data from GAIN's supporting documentation (excludes all ratios). Table 1 will be the main source of information as Test 1 and Test 2 are analyzed below.

Test 1 - Quarterly Net ICTI Versus Quarterly Distributions Analysis:

  • See Red References “E, F, G, (F / E)” in Table 1 Above Next to the March 31, 2019 Column

Using Table 1 above as a reference, I take GAIN's quarterly/annual "net ICTI" figure (see red reference "E") and subtract this amount by the quarterly/annual "distributions from net ICTI" figure (see red reference "F"). If red reference "E" is greater than red reference "F," then GAIN technically had enough annual net ICTI to pay out the company’s dividend distributions for that particular period of time (both monthly and special periodic dividends when applicable). Any excess net ICTI left over, after accounting for GAIN’s dividend distributions, is added to the company’s cumulative UTI balance. This particular balance will be analyzed within Test 2 later in the article. If red reference "E" is less than red reference "F," then GAIN technically did not have enough quarterly/annual net ICTI to pay out the company’s dividend distributions for a particular period and must use a portion of the cumulative UTI balance to help with the overpayment.

Test 1 – Analysis and Results:

Still using Table 1 above as a reference, GAIN had annual net ICTI of $25.6, $26.4, and $28.9 million for fiscal 2016, 2017, and 2018, respectively. In comparison, GAIN had annual common stock dividend distributions of ($22.7), ($22.7), and ($28.9) million, respectively. When calculated, GAIN had an annual underpayment of net ICTI of $2.9, $3.6, and less than $0.1 million (rounded) for fiscal 2016, 2017, and 2018, respectively (see red reference “(E – F) = G”). This calculates to an annual dividend distributions payout ratio of 89%, 86%, and 100%, respectively (see red reference “(F / E)”). When combined, GAIN had an underpayment of net ICTI of $6.5 million during fiscal 2016-2018 which calculates to a three-year dividend distributions payout ratio of 92%. In my opinion, most readers would view this as a minor underpayment of net ICTI.

Side Note: GAIN currently has two series of preferred stock with a “mandatorily redeemable” characteristic. Simply put, these two series of preferred stock have a set maturity/redeemable date. Due to this more unique characteristic, GAAP methodologies dictate GAIN should expense all preferred stock dividend distributions within the company’s interest expense account. This is due to the fact GAIN’s preferred stock has characteristics more similar to a typical fixed-rate bond/outstanding borrowing. Within Table 1 above, I did not include such preferred stock dividend distributions within reference “G” above. This is due to the fact such distributions are already accounted for/expensed within GAIN’s income statement (hence represented within the company’s NII/EPS figures). If one were to include such preferred stock dividend distributions within the common stock dividend distributions figure within Table 1, one would also have to increase GAIN’s NII/EPS by an equal amount. Since this is merely a classification scenario (net effect of $0), including the notion to reduce an additional “layer” of reconciliations, I have not reclassified such preferred stock dividend distributions within Table 1 above. If one were to reclassify such amounts, currently reference G would increase by approximately $2.1 million quarterly while net ICTI would increase by this same amount. This also has no impact on Test 2’s cumulative UTI results discussed later in the article.

Moving to fiscal 2019, GAIN had net ICTI of $14.2, ($8.5), and $82.8 million for the fiscal first, second, and third quarters of 2019, respectively. I am projecting GAIN will report net ICTI of ($2.0) million for the fiscal fourth quarter of 2019. In comparison, GAIN had common stock dividend distributions of ($8.6), ($6.6), and ($8.7) million, respectively. I am projecting GAIN will have common stock dividend distributions of ($6.7) million for the fiscal fourth quarter of 2019. When calculated, GAIN had an underpayment (overpayment) of net ICTI of $5.6, ($15.1), and $74.2 million for the fiscal first, second, and third quarters of 2019, respectively. When calculated, I am projecting GAIN will have an overpayment of net ICTI of ($8.7) million for the fiscal fourth quarter of 2019. This calculates to an annual dividend distributions payout ratio of only 35% for fiscal year 2019. Simply put, this is an extremely low payout ratio. In addition, this includes accounting for both of GAIN’s special periodic dividends totaling $0.12 per common share for fiscal 2019.

The modestly above average net ICTI for the fiscal first quarter of 2019 was mainly due to the realized/capital gain within Drew Foam Companies, Inc. (Drew Foam). GAIN reported a net realized gain of $13.8 million during the fiscal first quarter of 2019. The modestly below average net ICTI for the fiscal second quarter of 2019 was mainly due to realized/capital losses within NDLI, Inc. (“NDLI”). This portfolio company was previously written-down and this was merely an unrealized to realized loss reclassification (“cleaning up” the balance sheet).

As I previously correctly projected, GAIN’s net ICTI for the fiscal third quarter of 2019 had a massive “bounce back.” The extremely above average net ICTI was mainly due to realized/capital gains within Cambridge Sound Management, Inc. (Cambridge) and Logo Sportswear, Inc. (Logo Sportswear). When combined, GAIN reported a net realized gain of $76.8 million during the fiscal third quarter of 2019. I am projecting GAIN’s modestly below average net ICTI for the fiscal fourth quarter of 2019 will mainly be due to the realized/capital loss within SOG Specialty Knives & Tools, LLC (SOG Knives).

When looking at Test 1 on a “standalone” basis, I believe GAIN’s massive realized/capital gain in regards to Cambridge and Logo Sportswear has secured the company’s dividend sustainability through at least calendar year 2019 (most of fiscal year 2020). This even considers the possibility of GAIN incurring some realized/capital losses on several of the company’s underperforming portfolio investments over the foreseeable future (for instance the recent restructuring of SOG Knives). To take this dividend sustainability analysis a step further, let us now perform Test 2.

Test 2 – Cumulative UTI Coverage of Outstanding Shares of Common Stock Ratio Analysis:

  • See Red References “I, K, (I / K)” in Table 1 Above Next to the March 31, 2019 Column

Once again using Table 1 above as a reference, I take GAIN's "cumulative UTI” figure (see red reference “I") and divide this amount by the company’s "outstanding shares of common stock" figure (see red reference "K"). From this calculation, GAIN's "cumulative UTI coverage of outstanding shares of common stock ratio” is obtained (see red reference "(I / K)"). The higher this ratio is, the more positive the results regarding GAIN's future dividend sustainability. Simply put, this ratio shows the amount of cumulative UTI covering the number of outstanding shares of common stock for that specified point in time.

Test 2 - Analysis and Results:

Still using Table 1 above as a reference, GAIN had a cumulative UTI balance of $6.9, $10.5, and $10.5 million at the end of the fiscal fourth quarter of 2016, 2017, and 2018, respectively. Due to GAIN's three-year minor underpayment of net ICTI (as discussed in Test 1 earlier), the company’s cumulative UTI balance increased from $4.0 million as of 3/31/2015 to $10.5 million as of 3/31/2018. GAIN had 30.2, 30.2, and 32.7 million outstanding shares of common stock, respectively. When calculated, GAIN had a cumulative UTI coverage of outstanding shares of common stock ratio of 0.23, 0.35, and 0.32 at the end of the fiscal fourth quarter of 2016, 2017, and 2018, respectively. In my opinion, GAIN's cumulative UTI balance as of 3/31/2018 was at a fairly attractive level (was near the mean of the fifteen BDC peers I currently cover). In addition, it should be noted GAIN distributed special periodic dividends totaling $0.12 per common share during fiscal year 2018 (which most BDC peers did not declare).

Moving to fiscal year 2019, I am projecting GAIN will have a cumulative UTI balance of $66.5 million at the end of the fiscal fourth quarter of 2019. I am projecting GAIN will have 32.8 million outstanding shares of common stock. When calculated, I am projecting GAIN will have a cumulative UTI coverage of outstanding shares of common stock ratio of 2.03 at the end of the fiscal fourth quarter of 2019 (as of 3/31/2019). In my opinion, my projection of GAIN's cumulative UTI balance as of 3/31/2019 will be at an extremely attractive level (especially when compared to all of GAIN’s BDC peers I currently cover). I would point out this includes accounting for GAIN's special period dividends totaling $0.12 per common share during fiscal year 2019 as well.

Compared to what occurred with some BDC peers like Apollo Investment Corp. (OTC:AINV), FS KKR Capital Corp. (FSK) (formerly FS Investment Corp.; FSIC), Oaktree (OAK) Strategic Income Corp. (OCSI), Oaktree Specialty Lending Corp. (OCSL), Medley Capital Corp. (MCC), and Prospect Capital Corp. (PSEC) who had material dividend per share reductions over the past several years, GAIN has continued to have sufficient net ICTI for the company’s dividend distributions (with a massive surplus addition during fiscal year 2019). This includes accounting for GAIN’s special periodic dividends. This is one of the main reasons why I believe GAIN should trade at a premium to the company’s current NAV and at a premium to most of its BDC peers.

In my opinion, considering Test 2 on a standalone basis, the evidence provided above helps support GAIN’s steady–slightly increasing monthly dividend per share rate over the past several years and over the foreseeable future. Test 2 also supports GAIN’s special periodic dividends that were/are projected to be distributed during fiscal year 2018-2020.

In fact, there is a very high probability GAIN will have to distribute a very large special periodic dividend (whether in cash or stock) prior to the company’s filing of its annual tax return for fiscal 2019 (likely by the end of calendar year 2019). This is due to the rules governing the use of the spillback provision which was discussed earlier in the article. As a quick “refresher,” under the spillback provision, a RIC per the IRC must distribute the company’s remaining net ICTI for a given tax year through declared dividends prior to the filing of its tax return for that applicable year. If GAIN fails to comply with this provision, the company will be declassified as a RIC per the IRC. If this were to occur, all of GAIN’s net ICTI would be subject to taxation at regular corporate tax rates at the company level.

Now, there is one extraordinary measure that could be taken by a RIC for relief of this provision but that is a scenario I believe shareholders would strongly be against. In a nutshell, a RIC would pay corporate taxes on the undistributed capital gain at the BDC level. In my professional opinion, it would make much more sense to “pass-through” the company’s capital gains to shareholders versus GAIN paying taxes on such gains (which would be a notable amount). I would not be opposed to GAIN issuing new common stock in lieu of cash under this specific scenario; as long as the then current stock price is near, at, or above current NAV.

Getting back to Test 2, the following were the 12/31/2018 cumulative UTI coverage of outstanding shares of common stock ratios for GAIN and fourteen of the BDC stocks I currently cover (very good comparison tool/metric):

1) GAIN: 2.29* (0.20 as of 12/31/2017)

2) TPG Specialty Lending Inc. (TSLX): 1.22 (1.06 as of 12/31/2017)

3) Ares Capital Corp. (ARCC): 0.76 (0.81 as of 12/31/2017)

4) Main Street Capital Corp. (MAIN): 0.68 (0.72 as of 12/31/2017)

5) FSK: 0.36 (0.60 as of 12/31/2017)

6) Solar Capital Ltd. (SLRC): 0.31 (0.21 as of 12/31/2017)

6) PennantPark Floating Rate Capital Ltd. (PFLT): 0.31 (0.06 as of 12/31/2017)

8) NEWTEK Business Services Corp. (NEWT): 0.15 (0.20 as of 12/31/2017)

9) Golub Capital BDC Inc. (GBDC): 0.06 (0.04 as of 12/31/2017)

10) PSEC: 0.05** (0.02 as of 12/31/2017)

11) OCSL: 0.04 (0.14 as of 12/31/2017)

12) BlackRock (BLK) TCP Capital Corp. (TCPC): 0.03 (0.06 as of 12/31/2017)

13) OCSI: 0.01 (0.06 as of 12/31/2017)

14) AINV: 0.00; No cumulative UTI (0.00 as of 12/31/2017)

14) MCC: 0.00; No cumulative UTI (0.30 as of 12/31/2017)

* = As indicated earlier, notable capital gains on Cambridge and Logo Sportswear during the calendar fourth quarter of 2018

**= Based on an Internal Revenue Code (“IRC”) tax year-end of August 31st (tax year 2019 began 9/1/2018)

As readers can see, some BDC peers like to be cautious when it comes to distributing out its cumulative UTI (for instance TSLX, ARCC, and even some could argue MAIN and FSK) while some companies like to distribute most of its “built-up” cumulative UTI annually; whether it is through a special periodic dividend twice a year (for instance GAIN), at the end of the calendar year (for instance GBDC), or through an increased dividend in the second half of the year (for instance NEWT). This is a good segway in transitioning to a more “forward-looking” sustainability analysis regarding GAIN’s special periodic dividend.

Test 3 – Cumulative Unrealized Appreciation Coverage of Outstanding Shares of Common Stock Ratio Analysis:

- See Red References “L, K, (L / K)” in Table 2 Below Next to the March 31, 2019 Column

To begin Test 3, let us first take a look at the information provided in Table 2 below.

Table 2 - GAIN Cumulative Unrealized Appreciation Coverage of Outstanding Shares of Common Stock Ratio Analysis (Based on Quarterly/Annual Timeframes)

GAIN Cumulative Unrealized Appreciation Coverage of Outstanding Shares of Common Stock Ratio Analysis (Source: Table created by me, partially using GAIN data obtained from the SEC’s EDGAR Database [link provided below Table 1])

Using Table 2 above as a reference, I take GAIN's "cumulative unrealized appreciation (depreciation) on investments” figure (see red reference “L") and divides this amount by the company’s "outstanding shares of common stock" figure (see red reference "K"). From this calculation, GAIN's "cumulative unrealized appreciation (depreciation) coverage of outstanding shares of common stock ratio” is obtained (see red reference "(L / K)"). The higher this ratio is, the more positive the results regarding GAIN continuing to declare future special periodic dividends beyond fiscal year 2020. Basically, this ratio shows the amount of cumulative unrealized appreciation covering the number of outstanding shares of common stock for a specified point in time. Since GAIN has continued to gradually increase the company’s investment portfolio, through borrowings and periodic equity offerings, this ratio shows if the company has been able to/will be able to increase its cumulative unrealized appreciation balance by a similar proportion.

I believe this is a good test to perform because GAIN’s unrealized investment appreciation (depreciation) will eventually become a realized event. However, one unknown variable is time. It cannot be determined if GAIN will realize a particular investment gain (loss) during the next quarter, next year, or further out on the time horizon. However, it is a general “rule of thumb” that the larger a company’s cumulative unrealized appreciation balance becomes, the greater the probability of realized gains occurring at some point in the future. In the end, management has the ultimate decision when to realize/“monetize” certain investments within GAIN’s portfolio. As such, I believe Test 3 is a good indicator of possible future realized/capital gains which directly leads to GAIN being able to continue to pay special periodic dividends beyond fiscal year 2020 (forward-looking metric).

Test 3 - Analysis and Results:

Still using Table 2 above as a reference, GAIN had a cumulative unrealized appreciation (depreciation) balance of ($30.5), ($23.6), and $13.8 million at the end of the fiscal fourth quarter of 2016, 2017, and 2018, respectively. GAIN had 30.3, 30.3, and 32.7 million outstanding shares of common stock, respectively. When calculated, GAIN had a cumulative unrealized appreciation coverage of outstanding shares of common stock ratio of (1.01), (0.78), and 0.42 at the end of the fiscal fourth quarter of 2016, 2017, and 2018, respectively. As such, over the span of three fiscal years, GAIN’s ratio went from being notably negative as of 3/31/2016 to fairly attractive as of 3/31/2018 (especially when compared to most sector peers who had deficit balances).

Moving to fiscal year 2019, I am projecting GAIN will have a cumulative unrealized appreciation balance of $15.8 million at the end of the fiscal fourth quarter of 2019. This would calculate to a cumulative unrealized appreciation coverage of outstanding shares of common stock ratio of 0.48. I believe this projected ratio as of 3/31/2019 is at a fairly attractive level.

Readers should also notice how this specific ratio changed during the course of the fiscal first, second, and third quarters of 2019. During the first half of fiscal year 2019, this ratio notably increased mainly due to unrealized equity appreciation within Galaxy Tool Holding Corp. (Galaxy Tool), Brunswick Bowling Products, Inc. (Brunswick), and Cambridge. Readers should also notice the material decrease to this ratio during GAIN’s fiscal third quarter of 2019. This was mainly due to unrealized to realized reclassifications regarding Cambridge and Logo Sportswear. With that being said, I am anticipating this ratio will once again gradually increase over time.

This projection is directly related to passage of the Tax Cuts and Jobs Act (“TCJA”) and continued strong operating performance by some portfolio companies. Most of GAIN’s underlying portfolio companies recently had a reduced effective tax rate (or pass-through rate; dependent upon entity status) regarding their “earnings and profit” (E&P) statement (an IRC methodology) due to the recent passage of the TCJA. This positively impacts GAIN’s equity investments within these applicable portfolio companies (lower taxes typically equate to higher enterprise value [EV]).

Using a baseball analogy in reference to GAIN’s investment portfolio over the past several years, the company has had a handful of “strikeouts” (non-accrual debt investments; worthless equity investments) while also having a handful of “grand slams” (consistently performing debt investments at an attractive interest rate along with notable equity appreciation). Per a monetary standpoint, GAIN’s grand slams have “trumped” the company’s strikeouts. Even if GAIN’s cumulative unrealized appreciation balance once again turned negative during calendar year 2019, the company still has its massive cumulative UTI surplus discussed earlier. As such, I would not be surprised if management went ahead and “cleaned up” GAIN’s balance sheet during calendar year 2019 regarding several of the company’s non-accrual debt investments and worthless equity investments which are already completely written down. This would include a realization of B-Dry, LLC (B-Dry), The Mountain Corp. (Mountain), PSI Molded Plastics, Inc. (PSI Molded), and SOG Knives. Again, I am not saying this will happen. However, I am stating management has this option since GAIN currently has an exceedingly large cumulative UTI balance.

Conclusions Drawn:

To sum up the information in this article, three dividend sustainability tests were performed on GAIN. The first two tests were based on GAIN’s net ICTI and cumulative UTI which are based on IRC methodologies. Test 1 provided the following information in regards to GAIN’s annual net ICTI payout ratio for fiscal 2016, 2017, 2018, and my projection for 2019, respectively:

GAIN’s Fiscal 2016, 2017, and 2018 Net ICTI Payout Ratio: 89%, 86%, and 100%

My Projected GAIN’s 2019 Net ICTI Payout Ratio: 35%

When looking at Test 1 on a standalone basis, I believe GAIN’s modest net ICTI net underpayment for fiscal 2016-2017 and matching of net ICTI for fiscal 2018 could be perceived as a slight cautionary trend regarding the company’s dividend sustainability. However, I also believe this general interpretation would be a preliminary rush to judgment. I would stress to readers this payout ratio includes all of GAIN’s special periodic dividends that were distributed during fiscal 2017–2018 totaling $0.24 per common share. This is important to understand.

Readers should also understand I am projecting GAIN will have a massive underpayment of net ICTI during fiscal year 2019 due to notable net realized/capital gains that were recorded during the company’s fiscal third quarter of 2019 (calendar fourth quarter of 2018). This was mainly the result of realized/capital gains from Cambridge and Logo Sportswear.

To gain further clarity, Test 2 was then performed which analyzed GAIN’s cumulative UTI balance. Test 2 provided the following information in regards to GAIN’s cumulative UTI coverage of outstanding shares of common stock ratio at the end of fiscal 2016, 2017, 2018, and my projection at the end of 2019, respectively:

GAIN’s Cumulative UTI Coverage of Outstanding Shares of Common Stock Ratio as of 3/31/2016, 3/31/2017, and 3/31/2018: 0.23, 0.35, and 0.32

My Projected GAIN’s Cumulative UTI Coverage of Outstanding Shares of Common Stock Ratio as of 3/31/2019: 2.03

In my opinion, considering Test 2 on a standalone basis, the evidence provided above helps support GAIN’s steady–slightly increasing monthly dividend per share rate over the past several years and over the foreseeable future. Test 2 also supports GAIN’s special periodic dividends that were/are projected to be distributed from fiscal 2018-2020.

When looking at the results from Test 1 and Test 2, I have concluded the probability of GAIN being able to maintain-slightly increase the company’s monthly dividend per share rate in its next several sets of dividend declarations is very high (90%). As such, I am projecting GAIN will declare the following monthly dividends:

Dividend for April-September 2019: $0.068-0.072 per common share

Dividend for October-December 2019: $0.070-0.075 per common share

Next, Test 3 provided the following information in regards to GAIN’s cumulative unrealized appreciation (depreciation) coverage of outstanding shares of common stock ratio at the end of fiscal 2016, 2017, 2018, and my projection at the end of 2019, respectively:

GAIN’s Cumulative Unrealized Appreciation (Depreciation) Coverage of Outstanding Shares of Common Stock Ratio as of 3/31/2016, 3/31/2017, and 3/31/2018: (1.01), (0.78), and 0.42

My Projected GAIN Cumulative UTI Coverage of Outstanding Shares of Common Stock Ratio as of 3/31/2019: 0.48

When looking at the results from Test 2 and Test 3, I have concluded the probability of GAIN being able to declare a semi-annual special periodic dividend through at least the second half of fiscal 2020 is very high (90%). Furthermore, due to the amount of built-up cumulative UTI from GAIN’s notable realized/capital gains in Cambridge and Logo Sportswear, I believe the company will need to either declare a notable “one/two-time” special periodic dividend or notably increase the frequency of its special periodic dividends during fiscal year 2020 to be in compliance with the IRC’s spillback provision. As such, I am projecting GAIN will declare the following special periodic dividends during fiscal 2020:

Special Periodic Dividend for the First Half of Fiscal 2020 (Likely to Be Distributed June 2019): $0.06-0.30 per common share

Special Periodic Dividend for the Second Half of Fiscal 2020 (Likely to Be Distributed December 2019): $0.10-0.30 per common share

If GAIN decides to distribute the company’s “regular” semi-annual special periodic dividend towards the lower end of my projected ranges above, then I believe the Board of Directors (“BoD”) will need to declare additional special periodic dividends at some point during fiscal year 2020.

A prior BDC comparison article I wrote provided some recent, more generalized dividend sustainability metrics regarding fifteen BDC peers that I cover (including GAIN). For additional analysis related to this topic, I refer readers to the following article:

Ares Capital's Dividend, NAV, And Valuation Vs. 14 BDC Peers - Part 2 (Indications Of An Undervalued Stock)

My Buy, Sell, or Hold Recommendation:

From the analysis provided above, including additional factors not discussed within this article, I currently rate GAIN as a Sell when the company’s stock price is trading at or greater than a 7.5% premium to the mean of my projected NAV as of 3/31/2019 range ($12.70 per share), a Hold when trading at less than a 7.5% premium but less than a (2.5%) discount to the mean of my projected NAV as of 12/31/2018 range, and a Buy when trading at or greater than a (2.5%) discount to the mean of my projected NAV as of 3/31/2019 range. These ranges are unchanged when compared to my last GAIN article (approximately nine months ago).

Therefore, I currently rate GAIN as a Buy. As such, I currently believe GAIN is undervalued. My current price target for GAIN is approximately $13.65 per share. This is currently the price where my recommendation would change to a Sell. The current price where my recommendation would change to a Hold is approximately $12.40 per share. Long-term holders of GAIN should gain comfort that I currently believe the company’s dividend sustainability, through at least fiscal 2020, is very high.

Final Note: Each investor's Buy, Sell, or Hold decision is based on one's risk tolerance, time horizon, and dividend income goals. My personal recommendation will not fit each reader’s current investing strategy. The factual information provided within this article is intended to help assist readers when it comes to investing strategies/decisions.

Current BDC Sector Stock Disclosures:

On 3/13/2019, I initiated a position in GAIN at a weighted average purchase price of $11.625 per share. This weighted average per share price excludes all dividends received/reinvested. This GAIN trade was disclosed to readers in real time (that day) via the StockTalks feature of Seeking Alpha.

On 9/6/2017, I re-entered a position in PSEC at a weighted average purchase price of $6.765 per share. On 10/16/2017 and 11/6/2017, I increased my position in PSEC at a weighted average purchase price of $6.285 and $5.66 per share, respectively. When combined, my PSEC position has a weighted average purchase price of $6.077 per share. This weighted average per share price excludes all dividends received/reinvested. Each PSEC trade was disclosed to readers in real time (that day) via the StockTalks feature of Seeking Alpha. I currently have a BUY recommendation on PSEC.

On 2/2/2018, I re-entered a position in MAIN at a weighted average purchase price of $37.425 per share. On 2/5/2018, I increased my position in MAIN at a weighted average purchase price of $35.345 per share. My second purchase was approximately triple the monetary amount of my initial purchase. On 3/1/2018, 10/4/2018, 10/23/2018, 12/18/2018, and 12/21/2018, I increased my position in MAIN at a weighted average purchase price of $35.365, $37.645, $36.674, $35.305, and $33.045 per share, respectively. When combined, my MAIN position has a weighted average purchase price of $34.713 per share. This weighted average per share price excludes all dividends received/reinvested. Each MAIN trade was disclosed to readers in real time (that day) via the StockTalks feature of Seeking Alpha. I currently have a Buy recommendation on MAIN.

On 6/5/2018, I initiated a position in TSLX at a weighted average purchase price of $18.502 per share. On 6/14/2018, I increased my position in TSLX at a weighted average purchase price of $17.855 per share. My second purchase was approximately double the monetary amount of my initial purchase. When combined, my TSLX position has a weighted average purchase price of $18.071 per share. This weighted average per share price excludes all dividends received/reinvested. Each TSLX trade was disclosed to readers in real time (that day) via the StockTalks feature of Seeking Alpha. I currently have a Hold recommendation on TSLX.

On 10/12/2018, I initiated a position in ARCC at a weighted average purchase price of $16.40 per share. On 12/10/2018, 12/18/2018, and 12/21/2018, I increased my position in ARCC at a weighted average purchase price of $16.195, $15.305, and $14.924 per share, respectively. When combined, my ARCC position has a weighted average purchase price of $15.293 per share. This weighted average per share price excludes all dividends received/reinvested. Each ARCC trade was disclosed to readers in real time (that day) via the StockTalks feature of Seeking Alpha. I currently have a Buy recommendation on ARCC.

On 10/12/2018, I re-entered a position in NEWT at a weighted average purchase price of $18.355 per share. On 12/21/2018, I increased my position in NEWT at a weighted average purchase price of $15.705 per share, respectively. When combined, my NEWT position has a weighted average purchase price of $16.462 per share. This weighted average per share price excludes all dividends received/reinvested. Each NEWT trade was disclosed to readers in real time (that day) via the StockTalks feature of Seeking Alpha. I currently have a Hold recommendation on NEWT.

On 10/12/2018, I initiated a position in SLRC at a weighted average purchase price of $20.655 per share. On 12/18/2018, I increased my position in SLRC at a weighted average purchase price of $19.66 per share, respectively. When combined, my SLRC position has a weighted average purchase price of $19.909 per share. This weighted average per share price excludes all dividends received/reinvested. Each SLRC trade was disclosed to readers in real time (that day) via the StockTalks feature of Seeking Alpha. I currently have a Buy recommendation on SLRC.

All trades/investments I have performed over the past several years have been disclosed to readers in real time (that day at the latest) via the StockTalks feature of Seeking Alpha (which cannot be changed/altered). Through this resource, readers can look up all my prior disclosures (buys/sells) regarding all companies I cover here at Seeking Alpha (see my profile page for a list of all stocks covered). Through StockTalk disclosures, at the end of February 2019 I had an unrealized/realized gain “success rate” of 89.7% and a total return (includes dividends received) success rate of 100% out of 39 total positions (no realized total losses; updated monthly [multiple purchases/sales in one stock count as one overall position until fully closed out]). The minor increase in the first percentage, when compared to January 2019, was due to the fact my re-entered position in Altria Group, Inc. (MO) turned positive. I encourage other Seeking Alpha contributors to provide real time buy and sell updates for their readers which would ultimately lead to greater transparency/credibility.

Disclosure: I am/we are long GAIN, ARCC, BLK, MAIN, MO, NEWT, PSEC, SLRC, TSLX. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I currently have no position in AINV, BDCL, BDCS, BIZD, FSK, GBDC, MCC, MDLY, OAK, OCSI, OCSL, PFLT, or TCPC.