2023-05-20 01:21:17 ET
Summary
- BDCs were up on the week, buoyed by strong earnings numbers.
- Companies in the sector continue to manage the amount of their outstanding shares with largely positive consequences for investors.
- We highlight earnings from CGBD and GBDC.
This article was first released to Systematic Income subscribers and free trials on May 13.
Welcome to another installment of our BDC Market Weekly Review, where we discuss market activity in the Business Development Company ("BDC") sector from both the bottom-up - highlighting individual news and events - as well as the top-down - providing an overview of the broader market.
We also try to add some historical context as well as relevant themes that look to be driving the market or that investors ought to be mindful of. This update covers the period through the last week of April.
Market Action
BDCs were up around 1% on the week, supported by scattered dividend hikes and good earnings reports. Month-to-date, BDCs are slightly down along with most other income sectors.
Valuation has traded around the current 90% level for the last few weeks which is a bit more than 10% below the longer-term average. This looks in the fair-value range to us and we would look to add to our BDC holdings closer to an 85% figure.
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Market Themes
In the last few weeks BDCs have continued to manage the outstanding amount of their common shares by either issuing new shares or authorizing share buybacks.
For example, the Owl Rock Capital Corporation ( ORCC ) authorized a stock repurchase program of up to $150m of its stock (vs. $4.9bn market cap). Not all BDCs act on their stock repurchase programs but this is certainly nice to have. There are incentives pointing in opposite directions as far as stock repurchases are concerned.
On the one hand, it reduces total assets which also reduces BDC fees. On the other hand, it’s an easy way to drive NAV gains if the shares are purchased at a significant discount to NAV (ORCC trades at a 15% discount to book). It’s also an easy way to push the stock price higher, even if marginally, which is not a bad result for managers who often hold a lot of stock. Both of these factors (NAV and price gains) are positives for shareholders.
BDCs also continue to issue new shares. Sixth Street Specialty Lending ( TSLX ) recently announced a public offering of 4.5m shares (0.675m greenshoe) at $17.6, about 4% below its previous close and about 6% above the NAV.
Although a sharp drop in the price is optically unpleasant (the stock fell 4% on the news), a public offering priced above the NAV is a win-win for everybody. It allows the company to add new equity capital to either lower leverage or to finance new investments as well as organically grow fees (perhaps to hire more people etc.).
It’s also a win for investors in two ways. First, it is accretive to the NAV which generates a small positive return with no effort and two, it temporarily depresses the stock price, allowing investors waiting in the wings to add to the stock at a more attractive price.
Market Commentary
Carlyle Secured Lending ( CGBD ) had a good quarter with a 3.3% total return (roughly in line with the sector). NAV rose 0.6% and net income increased by about 4%. Non-accruals moved higher and remain above the sector average at 3.5% on a fair-value basis though not by much.
CGBD outperformed the sector average across all time periods and particularly over the past year with a 12% total NAV return vs. a 4.5% average.
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Given the company’s strong performance, the days where it used to trade at a 25% discount to the sector valuation (and when it was added to the High Income Portfolio) are likely gone. The position was pared when it traded within 5% of the sector valuation. It remains attractive at around a 12% valuation below sector average and it would make sense to add it back on a further valuation drop.
Golub Capital ( GBDC ) posted good results with a 2.4% total NAV return for the quarter. The NAV rose marginally and net income increased by 14%. Non-accruals fell (on both fair-value and at-cost) which is fairly unusual in this quarter for the sector.
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Net realized gains came in at a slight loss though the cumulative number over the last 2+ years is positive (i.e. there are cumulative realized gains). Overall a very solid result from a higher-quality BDC. It remains in a couple of the Income Portfolios. It closed at an 89% valuation (vs. 90% sector average) and a 10.1% yield.
Stance and Takeaways
We have now processed the majority of BDC earnings results in our coverage and the quarterly numbers are striking. All companies we have looked at so far generated positive total NAV returns over Q1 with an average return of around 3.4% or an impressive 14% annualized. That's a terrific result for investors in the sector.
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And although non-accruals have ticked up around 0.4% on average (0.1% on median) that's a fairly small move, particularly in the context of modest realized losses. The sector is currently priced for performance that is much worse than what we have seen over Q1 which leaves a decent amount of margin of safety and some room for cautious optimism for Q2 results.
For further details see:
BDC Weekly Review: BDCs Busy With Share Issuance And Buybacks