CSWC - Blackstone Secured Lending Q3: The Top BDC To Buy Or Add To For 2024

2024-01-02 11:00:00 ET

Summary

• 2024 is expected to be a great year for BDCs as interest rates are predicted to be significantly lower, leading to attractive price points for investors.
• Blackstone Secured Lending is a top BDC to consider adding or buying due to its defensive positioning and focus on first-lien senior secured loans.
• BXSL has shown strong dividend coverage and has the potential for further growth, making it an attractive investment option in 2024.
• With a recession expected this year, BXSL along with others may see a rise in PIK income and non-accruals despite lower interest rates.

Introduction

First thing I want to say to everyone is Happy New Year. Welcome into 2024. With 2023 now behind us, a volatile year for the market, let's talk about what this new year will bring. Opportunities! Specifically, to add or pick up some quality BDCs at decent or great valuations. With interest rates surging last year, business development companies share prices went up as well. But with rates expected to be below 3% around this time next year (time of writing), I suspect many BDCs will be trading at attractive price points.

Since the start of rate hikes, I haven't even thought of adding to any of my current holdings. As an avid investor in the sector (BIZD), I've gotten pretty accustomed to buying or adding when their price ranges are considered attractive, giving me a margin of safety. One stock I think investors should have at the top of their list is Blackstone Secured Lending (BXSL). This BDC doesn't have a long track record like some of its peers but it has quickly become one of my favorites in the space. In this article I talk about why they should be at the top of your list of BDCs to buy or add to this year.

2024 Will Continue To Be Great For BDCs

Rates are expected to be significantly lower by the end of 2024. Some are even saying they will be below 3% by December . Reason being is because they are expecting a mild recession from the tight consumer spending in 2023. The first cut is expected to happen in the first quarter around March and then accelerate by the second half of the year. I can't predict what the future may bring, but I do expect them to decline. How many times, I don't know. I've heard three and the most recent four. But when they do, BDC prices will likely retract.

So some might say, If their prices are expected to retract, then why will 2024 be a great year? Well, because the macro environment has led to many of their prices to trade significantly higher than their NAVs. And BXSL is no different; although the price has come down a bit from their 52-week high of $29.11.

Some may also say because of their predominantly floating rate portfolios, they won't enjoy all the extra income with lower interest rates. That is somewhat true. And although I do expect the specials and supplementals to slow, they won't go away entirely in 2024. The higher-quality ones like BXSL and others will continue to pay out extra income.

One because rates won't be lowered in a day or a week. But gradually over time. And even if they are below 3% by December, BDCs will have enjoyed extra income from the previous months and from the spill-over some like to carry over. I think some will pay out bigger end-of-year specials. Or some may be conservative like Ares Capital (ARCC) and not (pay out extra income) in preparation for the looming recession.

Better Defensively Positioned

There are not many things I don't like about BXSL. One thing I enjoy about them over some of my other holdings like ARCC and Capital Southwest (CSWC) is that they are better positioned for economic downturns such as a recession. And they have continued focusing on investing in first-lien senior secured loans. This is one way the BDC protects investor capital by having a senior secured debt focus. With 98.4% in first-lien loans, this positions them better financially in case of unexpected hardships compared to ARCC's 43% and CSWC's 84.4% respectively.

They also invest in companies with a higher EBITDA than the average BDC. Most invest in companies with an EBITDA of $3 - $20 million, which is why they are often considered risky. However, BXSL portfolio companies have a weighted-average EBITDA of $185 million, up from $162 million a year ago. Furthermore, they focus on sectors with lower default rates and lower CAPEX like software, health care, and commercial services.

Recent Earnings

BXSL reported its Q3 earnings back in November and delivered another strong quarter. Net investment income of $0.95 was down from Q2 but up from Q1. Total investment income was also up year-over-year by 25%. This was obviously driven by higher rates and their predominantly floating rate portfolio. Many peers have also enjoyed a growth in income because of the floating rate debt portfolios but these can have drawbacks as well of which I'll get into later in the article.

During the quarter, the BDC made $656 million in new investments at par and new investment commitments. Additionally, they made $390 million investment funding compared to $144 million new commitments & $117 million funded during Q2.

Unfunded commitments increased to $761 million compared to $551 million last quarter. They also issued an additional $210.7 million worth of shares which was above NAV, making it accretive to the company. Although this can be looked at as diluting shareholders, BDCs typically conduct share offerings as part of their business model.

If you're looking for lots share buybacks, then you're probably in the wrong sector for that. Although, some have been known to do this on occasion. But when some do, it is a bonus for shareholders. BXSL announced one back in February for $250 million and has also bought back shares over the years.

Strong Dividend Coverage

Besides the defensively positioned portfolio, I also love BXSL's dividend. Unlike many of its peers, they have not paid out any extra income in the form of specials and supplementals. Despite this, the company did raise the regular dividend twice in 2023. BXSL may have chosen not to pay out their extra income in preparation for an expected downturn a.k.a. mild recession.

They raised the dividend in February from $0.60 to $0.70 and from $0.70 to the current $0.77 in June. As you can see in the chart below their dividend coverage has been strong and well-covered by growing Nll. This did drop from $1.06 in Q2 but still remained covered by 123% during the most recent quarter. And as seen by the coverage and growing Nll, I expect their dividend to continue growing for the foreseeable future.

Valuation

As I previously mentioned earlier in the article, several BDCs are now trading at prices above their NAVs. At the time of writing BXSL currently trades at $27.64, above their NAV price of $26.54 at the end of Q3, giving them a ratio of 1.04x. With a quality BDC like Blackstone Secured Lending, I'm actually ok paying a small premium, but with rates expected to decline significantly, I think investors will get their chance to pick up shares at an even better price.

I suspect the price will fall below $25 sometime this year at which time investors should be backing up the truck. Furthermore, the BDC grew its NAV quite nicely in 2023 from $26.10 to $26.54 and I expect more of the same going forward. This also grew more than 3% year-over-year from $25.76. The stock does offer some upside to their price target of $29.75 but due to expected rate cuts, I would wait to get a better margin of safety.

Risk Factors

Another metric that speaks to the high-quality of BXSL is how they've managed to keep their non-accruals low during the high interest rate environment at just 0.1%. Although they've enjoyed the extra income from their predominantly floating rate debt investments, this results in more pressure from their borrowers. Peers like TriplePoint Venture Growth saw their non-accruals rise significantly as a result of the recent environment. At the end of their Q3 TPVG reported a staggering non-accrual rate of 11.1%! I touched on this in a recent article you can read here .

Another risk BDCs have seen rise is their PIK income. BXSL's PIK income remained flat quarter-over-quarter accounting for less than 4% of total investment income. This was also down from nearly 5% year-over-year. But with a mild recession expected sometime this year, this could place further pressure on portfolio companies despite lower interest rates. So, investors should keep an eye on a rise in PIK income & non-accruals if we do indeed enter into a recession.

Bottom Line

Those who follow me know I'm a huge fan of BDCs and BXSL has quickly become one of my favorites in the sector. Although rates are expected to decline this year, I expect the higher-quality BDCs in the sector to continue to outperform and pay out extra income in the form of specials & supplementals.

Additionally, with a recession expected sometime in 2024, investors should be focused on defensively-positioned BDCs in the sector like Blackstone Secured Lending. Because of declining rates and some turbulence expected in the foreseeable future, I think investors will get a chance to pick up a quality dividend-paying stock at a great price. Furthermore, with their first-lien focus, strong dividend coverage, and credit advantage, I think BXSL is the top BDC to add or buy in 2024.

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