ARCC - BXSL: Q3 Update - Another Quarter Of Outperformance

2023-11-29 12:02:12 ET

Summary

• Blackstone Secured Lending Fund delivered a 4.0% total NAV return, outperforming the sector once again.
• The BXSL closed-end fund is trading at a 6% premium to book value and has a dividend yield of 10.9%.
• Net investment income fell in Q3 due to lower interest and fee income, higher incentive fees, and an increase in new shares.
• BXSL stock no longer trades as cheap as it has in the past, however, a drop to the sector average valuation would make us upsize our allocation.

In this article, we discuss the latest quarterly results from the Business Development Company ("BDC") Blackstone Secured Lending Fund ( BXSL ). The company delivered a 4.0% total NAV return, outperforming the sector once again.

Blackstone is one of the largest BDCs with a focus on upper middle-market borrowers. It has the largest exposure to software and healthcare companies, something we see across most other BDCs.

BXSL is trading at a 6% premium to book value (about 5% rich to the sector average valuation) and a dividend yield of 10.9%. Its net income yield on price is 13.4% - below the 14% average.

Quarter Update

Net investment income fell from Q2 levels to $0.95. In our previous update , we suggested that, due to some unusual factors, the company could see a drop in net income in Q3, and this is what happened.

The drop was due to a combination of the fall in the numerator from lower interest and fee income plus higher incentive fees and an increase in the denominator as the company issued $210m of new shares (an increase of about 5%), diluting the existing income until the capital is leveraged and put to work.

The company declared the same $0.77 dividend as in Q2. Dividend coverage is a healthy 123%. With the fee waiver now having ended, coverage is closer to 115% as net income will fall by $0.06 or about 7% in Q4. This is why we expect another drop in net income next quarter.

The NAV increased for the 4th quarter in a row.

This was primarily due to retained income and a small net realized gain.

The NAV now stands at a record since the IPO.

Income Dynamics

Net new investments came in positive after net falls over the previous 4 quarters.

Despite this increase, leverage continued to fall sharply. This was primarily due to a significant increase in new shares as well as a rise in the NAV. Leverage came in at the lower end of the 1-1.25x target range.

The company's interest expense is one of the lowest in the sector (roughly 4th among BDCs in our coverage) which gives it a competitive advantage. Its net interest margin, however, is roughly average due to a high level of first-lien debt which means its portfolio asset yield is fairly low. Its next bond refinancing is in January 2026.

Both asset yield and interest expense have leveled off and are unlikely to change materially until the Fed makes a change in its current paused stance.

The company is generating a margin of 0.6% on its portfolio turnover as new deals are coming into the portfolio at a higher yield than deals leaving it - another small tailwind to net income.

Portfolio Quality

One company remained on non-accrual , rounding down to less than 0.1% on a fair-value basis. This was slightly lower than the previous quarter due to a restructuring.

PIK remained well-behaved and below the sector average.

About 10% of the portfolio has interest coverage below 1x on a current 5.5% short-term rate basis. Although this sounds high, the company estimates that it is about half that of the broader market.

There were no amendments during the quarter related to covenant or payment relief.

Return And Valuation Profile

BXSL has been a consistent outperformer since its IPO.

Over the past year the company delivered a total NAV return of close to double that of the broader sector (in our coverage)

The valuation has recovered from its relatively depressed level in 2022.

The company used to trade at a discount to the sector. However, it now tends to trade consistently at a premium to the sector of 2-10%.

As the chart below shows, we have tended to add BXSL when its valuation traded below the sector average and sell when it moved up well above the sector average.

We especially like to pair BXSL with Ares Capital (ARCC) in our relative value allocation. The chart below shows the pattern of our holdings. Our rough guideline was to switch to ARCC when it traded at a lower valuation than BXSL and vice-versa.

Since the start of this simple strategy in the middle of last year, it outperformed the best performer - BXSL - by 10%.

We continue to carry a modest allocation to BXSL across two of our Income Portfolios. Given Blackstone Secured Lending Fund's strong performance, it's unlikely we will see its valuation move sharply below the sector average. However, a drop towards the average valuation would make us upsize our allocation.

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