BXSL - Blackstone Secured Lending: Repeating Its Success In 2024 Could Be Much Harder

2024-01-03 09:00:00 ET

Summary

• Blackstone Secured Lending Fund benefits from Blackstone Credit's strong backing and access to high-quality investment opportunities.
• BXSL focuses on larger companies with debt tranches of $1B or larger, which are expected to manage high-interest rate headwinds better.
• BXSL's mainly variable rate portfolio could be affected by expected rate cuts, and competition in the private lending space is intensifying.
• I explain why astute BXSL dip-buyers correctly ignored the hard landing prognostication at the end of 2022 and bought into BXSL aggressively.
• With the fair valuation gap in BXSL assessed to have normalized, expecting BXSL to replicate its 2023 market outperformance seems increasingly unlikely.

Blackstone Secured Lending Fund (BXSL) is a business development company or BDC externally managed by Blackstone Credit BDC Advisors. As a result, BXSL benefits from Blackstone Credit's massive scale while leveraging its parent, the leading alternative asset manager, Blackstone Inc. (BX). BXSL benefits from Blackstone Credits' "strong backing and potential access to high-quality investment opportunities and expertise." With an AUM of $297B in Blackstone's credit and insurance segment, BXSL investors can rest assured of the BDC's high quality and market confidence in striking earnings accretive deals.

BXSL holders are likely aware of the BDC's key value proposition. The company manages a $9.5B portfolio that consists mainly of "first lien senior secured loans with minimal non-accrual." Blackstone Credit posted a 17-year track record with only a 0.1% loss rate after a $93B deployment. As a result, I have confidence that BXSL should be a key consideration for BDC investors looking to capitalize on Blackstone's expertise in the alternative credit space.

With BXSL focusing on private credit, BDC investors must rely on the manager's expertise, given the information asymmetry. As a result, it's critical to focus our attention on managers who have proven their quality and scale in the alternative credit space. BXSL management underscored its quality in a recent Investor Day . It reminded investors that BXSL focuses on larger companies "with debt tranches of $1B or larger." As a result, these companies are expected to manage the high-interest rate headwinds relatively better than smaller ones. BXSL also believes that there is an "anticipated variance in impact across different private credit providers."

With an average adjusted EBITDA of $185M in its portfolio companies and a focus on less cyclical sectors, BXSL management is confident of sustained performance in the growing private credit space. With the 2023 banking crisis and its aftermath potentially affecting the regulatory requirements of legacy bank lenders, I believe leading BDCs like BXSL could gain further prominence as alternative lenders to private companies. However, it's also important to note that while a high-quality company externally manages BXSL, the competition in the private lending space is expected to intensify.

Coupled with the expected rate cuts by the Fed this year, BXSL's mainly variable rate portfolio (98.8%) could come under pressure, affecting its earnings growth metrics. Investors need to recognize that BXSL isn't BX, which is assessed to have a more well-diversified portfolio to mitigate headwinds in respective sectors or industries. Therefore, BXSL remains as a private credit lender, and lending per se is a highly competitive business. Traditional banks are also looking for partners to increase their exposure in the private credit space, which could potentially squeeze earnings growth momentum, just as interest rates are expected to fall.

In other words, BXSL investors need to ask whether its net investment income or NII growth could have peaked in 2023 (headwind)? They also need to ask whether it matters in 2024 since the economy is not expected to fall into a hard landing (tailwind). Therefore, there are competing headwinds and tailwinds at play, suggesting investors will need to assess the interplay of these factors that could affect investor sentiments in 2024.

BXSL has surged nearly 37% in total return terms over the past year, significantly outperforming the S&P 500 ( SPX ) ( SPY ). The broad BDC market has recovered from its doldrums, suggesting mean-reversion has already occurred, as investors were too pessimistically positioned for a hard landing in 2023. In other words, investors likely priced in recessionary headwinds toward the end of 2022. However, astute BXSL investors correctly assessed these fears as too pessimistic and bought aggressively, contributing to BXSL's relative market outperformance. As a result, the tailwinds I indicated earlier have likely been priced in as we begin 2024 in earnest.

Morningstar price/fair value ratio

Based on Morningstar's price/fair value metrics, it appears that the fair valuation gap has normalized, given the recovery in BDCs over the past year, including BXSL.

From a sector perspective, however, BXSL and its leading peers are still priced at a discount. For instance, BXSL was assigned an "A+" valuation grade. In addition, the largest BDC, Ares Capital (ARCC), was assigned an "A-" valuation grade. In other words, the market may not have fully revalued the BDCs, even as the growth in private credit could continue in 2024. BXSL management argued at its Investor Day that "private credit is not sufficiently understood or followed, with significant spreads compared to other investment classes."

BXSL last traded at a highly attractive forward dividend yield of 11.3%, well above the 10Y ( US10Y ), which fell to 3.87% last week. As a result, there seems to be a substantial margin of safety, as reflected in BXSL's yields, attracting income investors to add exposure. Despite that, BXSL's relative outperformance over the past year could be challenging to replicate in 2024. Investors must consider that interest rates aren't expected to fall to the pre-COVID lows anytime soon. As a result, the market is expected to reflect execution risks in the private credit space to account for the relatively more risky exposure in private companies. Moreover, as explained earlier, I believe the previous hard landing fears have already been re-rated.

Additionally, BXSL has faced resistance below the $29 level since August 2023, as dip buyers who bought at the end of 2022 or early 2023 are likely distributing/reallocating. Let's see.

As seen above, BXSL's buying momentum has not broken through the $29 zone since August 2023. In contrast, BX's price action has already surged past its early 2022 highs, as I discussed in a recent article . Therefore, I believe the market could potentially reallocate to well-beaten sectors in commercial real estate or other cyclical spaces that BXSL might not participate fully in, given its less cyclical focus. As a result, I assessed the resistance from further buying upside since August 2023 makes sense, suggesting the risk/reward seems relatively well-balanced.

Rating: Initiate Hold.

Important note: Investors are reminded to do their due diligence and not rely on the information provided as financial advice. Please always apply independent thinking and note that the rating is not intended to time a specific entry/exit at the point of writing unless otherwise specified.

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