2023-10-22 02:51:49 ET
Summary
- Blackstone Secured Lending could benefit from a rate hike in November due to surging inflation rates.
- The BDC has a well-managed portfolio with superior credit quality and is trading at a minimal premium to net asset value.
- Despite a downturn in loan originations, Blackstone Secured Lending offers solid dividend coverage and is an attractive investment in a rising-rate environment.
I am adjusting my outlook for Blackstone Secured Lending Fund (NYSE: BXSL ) in the context of reaccelerating inflation rates. As a consequence to surging inflation, Blackstone Secured Lending as well as other BDCs with aggressive postures towards floating-rate loans could be beneficiaries of a new rate hike in November.
I think that Blackstone Secured Lending is a well-managed BDC, particularly because of its superior credit quality, and has upside potential in a rising-rate environment. The BDC’s dividend quality is high and Blackstone Secured Lending sells at a minimal 2% premium to net asset value.
My Rating History
When I composed my thoughts on Blackstone Secured Lending in March of this year , I argued that the BDC was fully valued and that I would consider the BDC as a passive income investment at a $23 price level.
Given the reacceleration of inflation in the last two months and taking into account BXSL’s aggressive floating-rate investment positioning, I bought the most recent drop and presently have a stock classification of Buy on Blackstone Secured Lending.
Blackstone Secured Lending’s Portfolio And Inflation Trend
Blackstone Secured Lending’s investment portfolio primarily consists of First Lien Senior Secured Debt (98.4%) and floating-rate investments (98.7%). The combination of a First Lien-centric investment portfolio on one side (which provides downside protection in the case of a recession) and a focus on rate hikes (NII upside) in a rising-rate environment make Blackstone Secured Lending an attractive BDC to buy for passive income investors even though the stock is trading at NAV.
At the end of the second quarter, Blackstone Secured Lending’s portfolio was valued at $9.3 billion and the BDC’s originations have trended south in 2023.
In the first six months of the year, Blackstone Secured Lending experienced a significant downturn in its origination business, due to higher costs which weighed in turn on loan demand. In the most recent quarter, Blackstone Secured Lending made only $144 million in new investment commitments compared to more than twice that amount in the year-ago period ($326 million).
Resurging inflation is the reason why I have doubled down on Blackstone Secured Lending’s stock, even though I previously pointed at a re-entry price of $23, implying a 0.9x discount to NAV.
Inflation has reared its ugly head again in the last three months and inflation was up 3.7% YoY in September, making a rate hike at next month’s Fed meeting much more likely.
BDCs with aggressive floating-rate positioning (close to 100% of debt investments), like Blackstone Secured Lending, are cyclical NII plays that are to be preferred over BDCs that don’t have as much exposure to floating-rate senior loans.
Debt And Liquidity
Blackstone Secured Lending had $1.8 billion in liquidity (cash and undrawn debt) as of the end of the second quarter which gives the BDC substantial firepower for new investments.
In terms of funding, only 12% of debt is maturing until June 2025 and the BDC mostly finances itself with unsecured debt and equity.
Superior Credit Quality
At the end of the second quarter, Blackstone Secured Lending had only one investment on non-accrual which equated to a 0.1% non-accrual ratio. At the end of 2022, no non-accruals were reported.
Typically, the average BDC has a small number of debt investments on non-accrual and the majority of BDCs that I analyze have non-accruals, mostly, ranging from 0.5-2.0%. Credit quality is definitely one factor that sets BXSL apart from other BDCs.
Very Solid Dividend Coverage For This 11% Yielding BDC
Blackstone Secured Lending earned $3.69 per share in LTM NII while paying out $2.60 per share, which translates into a dividend payout ratio of just 70%. The BDC raised its dividend payout by 17% at the beginning of the year and has since maintained a stable $0.70 per share dividend. In last year’s 3Q, Blackstone Secured Lending paid a special dividend of $0.20 per share which is not included in the calculation table below. Including the special dividend, BXSL paid out 100% of 3Q-22 NII and 76% of LTM NII.
2% Premium To Net Asset Value
Blackstone Secured Lending is selling at a rather moderate 2% premium to NAV and the BDC is only slightly more expensive than Oaktree Specialty Lending Corp. ( OCSL ) , Blue Owl Capital Corporation ( OBDC ), Golub Capital BDC ( GBDC ), or Goldman Sachs BDC ( GSBD ) . The slight premium to NAV is probably explained by the BDC’s near-perfect credit quality and very high dividend excess coverage.
Other BDCs have higher non-accrual ratios and therefore higher loan risks. For instance, Oaktree Specialty Lending’s non-accrual ratio was 2.4% in the second quarter while Golub Capital’s non-accrual ratio was 1.5%. The higher degree of loan quality (and correspondingly lower risk) is why BXSL is trading at a premium to NAV. The BDC also primarily focuses on First Lien debt helps drive the 'quality BDC' aspect as well.
Blackstone Secured Lending has a good shot of growing its NAV as long as the company remains on top of its credit quality. An increase in loan defaults would negatively impact its non-accrual ratio as well as its NII potential moving forward. The BDC’s NAV is growing and stood at $26.30 per share, up 5.2% since 2018.
Why Blackstone Secured Lending Could See A Lower Valuation (Downside Risks)
The two wild cards for Blackstone Secured Lending are an end to the present rate-hiking cycle and a downturn in the economy, both of which could lead to an increase in non-accruals as well as a decline in loan originations. A drop in NAV as well as a decline in dividend coverage and a deterioration of credit quality are the three big downside risks with BXSL.
To reduce risk, I am now overweighting those BDCs that either trade at substantial discounts to NAV or have superior credit quality. BXSL offers both and the risk/reward appears in favor of passive income investors.
My Conclusion
Blackstone Secured Lending is a well-managed BDC that maintained excellent credit quality in the first six months of the year and that could profit from a new uptick in inflation.
Prices kept going up in the last three months and inflation surged 3.7% higher in September, reflecting the third consecutive monthly increase. This suggests that the central bank will follow suit next month and hike rates again which would benefit BXSL’s floating-rate debt portfolio.
Blackstone Secured Lending’s stock is selling just at a 2% premium to net asset value despite perfect credit quality and the BDC covers its dividend pay-out, which is growing, with net investment income as well.
The focus on highly secured First Lien debt and high asset quality are reasons why I am reneging from my earlier re-entry price target for BXSL and continue to view the BDC as a compelling buy for passive income investors.
For further details see:
Blackstone Secured Lending: Superior Credit Quality, Strong Coverage, Undervalued 11.2% Yield