ARCC - Blue Owl Capital: New Year's Resolution To Buy More Income

2024-01-09 08:10:00 ET

Summary

• Blue Owl Capital is a large BDC with a well-diversified portfolio and a track record of preserving and growing its NAV per share.
• OBDC benefits from an elevated interest rate environment and has raised its regular dividend by 13% over the past 12 months.
• At present, it offers a high dividend yield, a discount to NAV, and continued opportunities to grow, making it an attractive investment.

I like capital gains as much as the next person, but let’s face it, it’s income that pays the bills. That’s why it’s helpful to build an ever-increasing income stream that has the potential to make a tangible impact to improve one’s livelihood.

This is where BDCs shine, and unlike the S&P 500 ( SPY ), their returns are far more diversified across a broad spectrum of portfolio companies, and aren’t largely tied to just a handful of companies like Apple ( AAPL ) and Tesla ( TSLA ) that bear risks of their own and have an outsized influence over them.

This brings me to the large BDC, Blue Owl Capital ( OBDC ), which I last covered here back in July of last year, noting its steady growth in NAV per share and high liquidity. Notably, OBDC has actually beaten the market average in both price and total return of 12.5% and 17.9% since my last piece, outpacing the 5.6% rise in SPY over the same timeframe.

In this article, I provide an update and discuss why OBDC remains an appealing pick for high income and potentially strong total returns, so let’s get started!

Why OBDC?

Blue Owl Capital Corp, formerly known as Owl Rock Capital, is an externally-managed BDC that’s the second largest by portfolio size, sitting behind industry leader Ares Capital ( ARCC ). At present, OBDC has investments in 187 companies with a portfolio fair value of $12.9 billion.

OBDC employs a strategy that balances yield with portfolio safety. This is reflected by the majority (83%) of its investments being first lien senior secured debt. Second lien secured debt comprises another 14% for a higher yield (than first lien), with the remainder being mostly comprised of common equity (9%) for potential future upside to OBDC’s NAV/share should the value of the underlying companies grow.

OBDC also carries a well-diversified portfolio, in which no single investment represents over 3.7% of the portfolio value. It also has a good mix of both growth and defensive segments. This is reflected by OBDC’s top segments internet software, insurance, food and beverage, asset-based lending, manufacturing, and healthcare technology making up 46% of portfolio value, as shown below.

Importantly, OBDC has a fairly good track record of preserving and growing its NAV per share, which is a good indicator of long-term value. OBDC’s NAV/share has now more than recovered since falling in 2020 and 2022. It now sits above the value at IPO in 2019 and has improved every quarter since the middle of 2022, as shown below. The latest improvement in OBDC’s NAV/share was driven by $0.05 per share in realized and unrealized gains in its portfolio combined with OBDC out-earning its dividend with net investment income.

Meanwhile, OBDC has continued to benefit from an elevated interest rate environment. This is reflected by OBDC’s net investment income ROE of 12.7% during the third quarter, which is up 250 basis points from 10.2% in the prior year period. This has enabled OBDC to comfortably raise its regular dividend by 13% since the start of 2022, while paying special dividends which ranged from $0.04 to $0.08 per share in every quarter of 2023. The current regular dividend rate is well-covered by a 71% payout ratio (88% payout ratio when including the special dividend), based on NII/share of $0.49 in the last reported quarter.

Meanwhile, OBDC’s portfolio remains in overall healthy shape, with investments on non-accrual representing just 0.9% of portfolio fair value (1.1% of portfolio cost). It’s worth noting that since inception, OBDC has deployed $25 billion worth of capital and experienced a net loss ratio of just 15 basis points. As shown below, the internal performance rating has remained rather steady since the end of 2022, and investments in the lowest quality (Tier 5) have dropped by 30 basis points to just 0.1% of the portfolio.

Looking ahead, OBDC’s portfolio companies should continue to perform well on back of a strong economy, as they grew Revenue and EBITDA by 10% and 12% YoY, respectively, during the last reported months. A positive future outlook is supported by the recently published December Jobs Report , which shows that U.S. payrolls rose by 216,000 last month, which is much better than the expected 170,000. This resulted in a better than expected unemployment rate of 3.7%, sitting below the 3.8% expectation.

This also means that interest rates could stay elevated for some time, which benefits OBDC in that 98% of its investments are floating rate. OBDC is also well-positioned to make opportunistic investments, as it carries a reasonably safe debt-to-equity ratio of 1.13x, sitting well below the 2.0x statutory limit for BDCs.

Moreover, OBDC has plenty of retained capital to fund growth after paying the dividend, as noted earlier, and it also has $1.9 billion in liquidity as of the last reported quarter. OBDC also has limited debt maturities in 2024, allowing it to take advantage of interest rate arbitrage between what it charges borrowers and what it pays its lenders. This is considering the fact that just 52% of OBDC’s own debt is floating rate, compared to 98% of OBDC’s debt investments being floating rate. As shown below, near term debt maturities this year are also relatively limited.

Risks to OBDC include higher interest rate, which on one hand benefits its NII, but also raises interest expense for OBDC’s borrowers. This is reflected by the weighted average interest coverage ratio of OBDC’s borrowers declining from 2.5x to 1.8x over the past 12 reported months. Management expects for the interest rate coverage of its borrowers to decline to 1.5x by the middle of this year before trending higher, and this is something worth paying attention to.

Other risks include general macroeconomic risks, which non-public companies like the ones OBDC invests in are more vulnerable to due to their smaller size (compared to public companies) and fewer avenues to raise capital.

Considering all the above, I continue to view OBDC as being a good value at the current price of $14.96. That’s because OBDC still trades at a discount to NAV with a price-to-book ratio of 0.97x, despite demonstrating a steadily increasing NAV/share as a result of portfolio appreciation and retained capital after funding the dividend. As shown below, OBDC also trades at a discount to Ares Capital, which carries a price-to-book ratio of 1.07x.

Investor Takeaway

Overall, OBDC offers investors a good mix of steady NAV growth and dividend income, while maintaining a well-diversified portfolio with low credit losses. Its largely floating rate investment portfolio is also benefitting in the current higher interest rate environment, and it has plenty of retained capital to fund future investments. Looking ahead, interest rates may not decline as fast as what some on Wall Street believe, especially after a strong December jobs report, and that's good for OBDC.

Lastly, I continue to view OBDC as being a good value as it trades at a discount to NAV while yielding an attractive 9.4% with potential to go above 10% when special dividends are included. With the overall market trading at a frothy valuation, a reasonable New Year's Resolution may be to buy more quality income stocks like OBDC. I reiterate my 'Buy' rating on OBDC stock.

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