2023-12-14 17:00:00 ET
Summary
- Main Street Capital and Oaktree Specialty Lending Corp are two great stocks for building a dividend snowball in 2024.
- MAIN offers a growing monthly dividend and has a well-diversified portfolio with a focus on first-lien loans.
- OCSL pays a quarterly dividend and has steadily increased its distributions over the years, and has materially improved since being taken over.
- Both are investment grade rated and have strong balance sheets with well-laddered debt maturities and ample liquidity going into 2024.
Introduction
With the most wonderful time of the year upon us it's only right I talk about building your dividend snowball going into 2024. When you think of Christmas, you think of lights, gifts, family & friends, and snow. Of course, that's all dependent on where you live. If you live in San Diego like I do, then you don't get the luxury of playing with family and friends in the snow, but you can build your dividend snowball. The next year will be very important, especially for dividend investors. Know why? Because everyone is on the fence about rate cuts. Will the Fed keep rates elevated throughout 2024, will they cut, deflation worries, etc. Me personally, and I've talked about this, I expect our first cut sometime in the latter half of the year. But whether they decide to cut, keep them the same, or raise these two stocks will help build your dividend snowball. Let's get into these two fantastic stocks and why they're great for compounding.
#1 Main Street Capital ( MAIN )
How could one write an article about building their dividend income without the monthly paying BDC, Main Street Capital? I last discussed MAIN in an article published last month which you can read here . MAIN has long been one of my favorite BDCs. I've held them before and have been waiting for a while to get back in at a good price. But for good reason the stock usually trades at a pretty large premium to its NAV. I like the stock in the mid to low $30's but honestly don't see them touching that price anytime soon. But one thing the market has taught me is patience, and I've learned that I will likely get my chance to own them again.
Along with the regular monthly dividend of $0.235 payable this week, they also declared a special dividend of $0.275 payable at the end of this month, just in time for the new year. Merry Christmas! So, in total investors get a dividend payout of $0.51 for the month of December. This is well-covered by the NII of $1.04 the BDC brought in for the 3rd quarter this past November, exceeding the monthly dividends paid by 51%. They also brought in $123.24 million which missed estimates by $0.55 million. These were both down from Q2's $1.12 and $127.6 million respectively.
One reason MAIN is able to payout special and supplementals along with a growing monthly dividend is their internally managed structure. These typically align more with shareholders which usually leads to more increased dividends over time. Externally managed BDCs on the other hand tend to be more conservative similar to Ares Capital ( ARCC ), who prefer to roll over their extra income.
Furthermore, the monthly paying BDC has already declared a total of $0.72 in dividends for the first quarter of 2024. Since its inception, they have never decreased its regular monthly dividend, which is impressive. This even includes during the Great Financial Crisis and the recent pandemic in 2020. As seen in the chart below, not only has MAIN increased their dividend, but they also managed to grow their NAV and DNII nicely over the same period. So, investors don't have to worry about if the yield is sustainable or not. And you also get a growing monthly dividend to help compound and build your dividend snowball much quicker.
Portfolio Quality
One way the BDC has been able to grow their NAV, DNII, and monthly dividend is by maintaining a well-diversified portfolio. At quarter end, the BDC had a total of 195 companies across 50 industries. This is in comparison to the largest BDC and peer, ARCC, who is diversified in half the amount (25). Additionally, their portfolio has an astronomical first lien focus at 99%! This is important especially in the current macro environment as more companies are facing downward pressures. Being invested in first-lien loans assures the company has a higher likelihood of collecting income because they have the head of the line privileges of loan payments.
They have 8% of their portfolio invested in Internet Software & Services with 6% in both Professional Services and Construction & Engineering. Furthermore, the BDC is well-diversified by geography and not just concentrated in one location. As you can see below, a larger percentage of their portfolio is invested on the Western Coast of the United States.
#2 Oaktree Specialty Lending Corporation ( OCSL )
This BDC is a newcomer for me. I've heard several good things about them from readers here on SA and now they've jumped on my radar because of their high dividend. In comparison, this is higher than one of my absolute favorite BDC holdings, ARCC. So, they are a great addition to any dividend-focused portfolio. Unlike MAIN, Oaktree is externally managed. They also pay a quarterly dividend of $0.55 instead of a monthly one like MAIN. Additionally, they declared a special dividend of $0.07 which is payable along with the regular dividend on the 29th of December. During their Q4 earnings in November, the BDC's adjusted net income was $0.62, consistent with Q3. This was up nearly 13% from $0.55 at the end of 2022 and $0.61 in Q1.
As you can see below, the cumulative quarterly distributions paid per share have increased steadily over the last 6 years. NAV has also increased steadily over the years but remained flat this year at $19.63 per share. Total net investment income of $2.47 for fiscal year '23 exceeds the total dividend amount of $2.27 paid this year by $0.20. This includes the special of $0.07.
Portfolio Quality
Like MAIN and several other BDCs, OCSL also focuses on the Software industry with 16.5% of their portfolio in this segment. A large difference between the two is while MAIN's other two largest industries are Construction & Engineering and Professional Services; Oaktree's is Specialty Retail and Real Estate Management & Development at 5.4% and 5.2% respectively.
During the quarter the BDC also continued to grow and diversify their portfolio with $87 million in new investments, all first lien. Furthermore, they also managed to increase their first-lien exposure from 71% to 76% while decreasing their second-lien exposure from 16% to 10%. This is something I like to see because it improves the risk/return profile which in turn helps them better navigate economic uncertainty.
In totality, OCSL's portfolio value stood at $2.9 billion diversified across 143 companies. This comprised 86% in senior-secured loans with 76% first lien exposure and 86% of their debt investments being floating rate, making them well-prepared for a higher for longer environment. In the coming quarters, I expect them to continue to focus on increasing their first lien loan exposure further strengthening their portfolio.
Balance Sheet Comparison
Going into 2024 investors should look for companies with not only great management teams but strong balance sheets, mainly because of the macro environment. Both BDCs have strong ones with no significant amount of debt maturing in the next year. MAIN has $450 million due in MAY of next year in comparison to OCSL who has no debt maturing until 2025. And even that amount is insignificant compared to their available liquidity. MAIN has a lesser amount of only $150 million due in 2025.
Looking at OCSL's maturities you can see they have double the amount of MAIN in 2025. But they have none maturing after that until 2027 while Main Street has $500 million due. MAIN had $843 million available liquidity at the end of the quarter while OCSL increased theirs to $1.2 billion from $1 billion.
Furthermore, they managed to decrease leverage to 1.01x, down from 1.14x, bringing them within their targeted range of 0.9x to 1.25x. They also had $136 million in cash available and both sport investment grade credit ratings.
Risks & Valuation
I'm sure many investors know a huge risk especially during the current macro environment is the higher potential for loan defaults. During MAIN's latest quarter, their non-accrual status stood at 1.0% of their total investment portfolio at fair value and 3.1% of cost. OCSL's non-accrual status accounted for 1.8% of their total portfolio at fair value and 2.4% of cost. Going forward this is something investors should keep an eye on going forward. Especially if the Fed decides to make good on their promise of a higher-for-longer environment. I think investors will get a feel for this at the upcoming meeting this month.
As I stated previously, I expect a cut but in the latter part of 2024 so portfolio companies will continue to face pressures at least for a few months of the new year. Both BDCs currently trade at premiums to their NAV with the more known MAIN being larger at 1.5x. OCSL on the other hand trades at a smaller premium at 1.0x. Even with MAIN's high premium, this is still less than their 3-year average of 59% which indicates it could be slightly undervalued, especially in the current environment. OCSL's 3-yr average discount of -2.30% indicates it could be overvalued slightly.
But due to the high quality of both, I view paying a small premium as acceptable, especially for those focused on income. These two have not only stable and safe dividends, but both have grown their NAVs over the years which speaks to their management. And being high quality business, paying a small premium is not out of the norm, especially for those who pay dividends. And with high interest rates seemingly coming to an end, investors should enjoy the extra income for as long as they can.
This is also in comparison to the two largest BDCs by market cap ARCC who trades at 1.1x to NAV and Blue Owl Capital Corporation ( OBDC ) who trades at 1.0x. But as I mentioned earlier in the article, Main Street Capital usually trades at a notable premium due to their long track record of monthly dividends.
I usually like a greater margin of safety and a discount to NAV when looking to invest in BDCs. But due to the current state of interest rates, I view both as buys right now, especially if rates remain here throughout 2024. If so, I expect both companies to continue rewarding their shareholders with special dividends for the foreseeable future because of their predominantly floating rate portfolios.
Conclusion
Both Main Street Capital & Oaktree Specialty Lending Corp have done well in the current macro environment due to their predominantly floating rate portfolios. Although the Fed has stated a higher for longer environment on several occasions, I think we are closer to the end of the rate hike cycle. In turn, many BDCs will likely cut their special and supplemental payouts leaving investors with less income to grow their dividend snowball. But I don't see this happening until the second half of the year so investors get to enjoy the extra dividends for some time. Their prices will also decline most likely due to investors rotating back into lower-yielding investments as BDCs become less attractive. But right now, this is the perfect opportunity for investors with a shorter-term outlook to use the income from both of these high-quality BDCs to grow their income before rates are cut sometime in 2024.
For further details see:
2 Stocks To Help Build Your Dividend Income In 2024