ORCC - Owl Rock Capital: Cash Flow Is King

2023-07-03 08:15:00 ET

Summary

• ORCC has seen a growth in its book value per share since the dip in 2020 and is benefitting from the higher interest rate environment.
• The company is well-positioned to take advantage of middle-market lending opportunities, with $1.7 billion in liquidity and a sound debt-to-equity ratio.
• Given its attractive 9.8% dividend yield and discount to NAV, ORCC is potentially a great choice for high-income investors.

It seems that euphoria around AI stocks remain in full swing, with names like Super Micro Computer ( SMCI ), Nvidia ( NVDA ), and AMD ( AMD ) all capping off last week with gains ranging from 3% to 6% on Friday.

While there's no telling how much higher those names will go in the near term, I continue to believe that cash flow is sanity for most investors. Investing in income stocks may also reduce anxiety for investors, as you can just hold onto them while they make regular payouts.

This is in stark contrast to speculative growth stocks, where their rally can seem like a game of musical chairs. Selling too early can lead to FOMO (fear of missing out), and selling too late can result in regret over not cashing out earlier.

This brings me to Owl Rock Capital ( ORCC ), which has demonstrated a strong track record of shareholder returns. I last covered ORCC here back in May, discussing its well-positioned portfolio and discount to NAV. In this article, I provide an update and discuss why ORCC remains a great choice for high income.

Why ORCC?

Owl Rock Capital (soon to be rebranded to Blue Owl Capital) is an externally-managed BDC that's one of the biggest on the market today. It has built a sizable $13.2 billion portfolio fair value (up from $13 billion at the end of 2022) comprised of 187 companies.

ORCC maintains a fairly conservative investment strategy, with 85% of its investments being senior secured debt, including 71% first lien and 14% second lien. Just 2% of its investments are unsecured debt and 8% of investments are common equity, giving ORCC more potential for NAV/share growth through appreciation in value.

This strategy appears to have worked out well for ORCC, as it's been able to grow its book value per share meaningfully since dipping during the pandemic in 2020. As shown below, ORCC's NAV/share is now close to where it was when first became public back in 2019.

ORCC, like its peers, is greatly benefitting from a higher interest rate environment, as NII per share soared by 35% YoY to $0.45 per share during the first quarter, marking a record high for ORCC since its inception. This enabled ORCC to declare a $0.06 special dividend in addition to its regular $0.33 dividend. ORCC's 1.36x NII to regular dividend coverage also gives it plenty of flexibility in retained capital to reinvest into its portfolio companies and pay special dividends down the line. As shown below, ORCC's NII/share has trended up every quarter over the past year.

At the same time, portfolio quality appears to be solid, as it has just 2 portfolio companies on non-accrual, representing just 0.3% of portfolio fair value. As shown below, portfolio quality has remained rather stable, with no investments rated at the highest risk tier, and just 0.4% of investments rated in the second to last highest risk tier.

Looking ahead, ORCC should benefit from potentially 2 or more rate hikes for the remainder of this year, given that 98% of its debt portfolio is floating rate. Plus, a potential pullback in lending from regional banks due to concerns around commercial real estate, especially as it relates to borrowers carrying highly leveraged office properties.

This puts BDCs with capital on hand in position to take advantage of middle market lending opportunities. In this respect, ORCC is well-positioned, as it has $1.7 billion in liquidity and carries a sound debt to equity ratio of 1.21x, sitting well below the 2.0x regulatory limit.

Moreover, a reported slowdown in Venture Capital activity this year could be a boost for BDCs, as borrowers who were accustomed to raising "easy" equity capital in an era of low interest rates find the current market to be far more tepid. This makes it more likely for borrowers to seek debt capital from the likes of BDCs like ORCC to fund growth.

Risks to the thesis include the potential for a recession, which may put strain on borrowers' ability to make payments against loans. Plus, substantially higher interest rates may impede on borrowers' ability to service their payments to ORCC. Also, there is no telling where rates will land in the medium to long-term, and lower interest rates would result in a decline in ORCC's net investment income.

Lastly, ORCC appears to be good value at the current price of $13.42, equating to a price-to-book value of 0.89x. As shown below, ORCC continues to trade at a discount to Ares Capital ( ARCC ), which trades at a price-to-book value of 1.02x, despite ORCC's ability to grow its NAV/share while maintaining a low non-accrual rate. Considering all the above, I believe ORCC deserves to trade at or close to NAV, resulting in potential double-digit total returns in the near term.

Investor Takeaway

Owl Rock Capital is seeing increasing cash flows and generates a substantial buffer between its net investment income and regular dividend payout. It has managed to produce a solid track record in terms of NAV/share and NII growth while maintaining strong portfolio quality. Given its attractive 9.8% dividend yield and discount to NAV, together with the potential for more rate hikes this year, I believe ORCC is a great choice for high income investors who are looking for high income.

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