2023-08-30 14:00:00 ET
Summary
- Blue Owl Capital Corporation investors who ignored the doom and gloom calls in late 2022 have seen their investment perform admirably.
- OBDC focuses on middle-market companies and has benefited from the rapid increase in interest rates. But investors should consider potential peaking in rates.
- Despite that, OBDC's "A" valuation grade suggests earnings growth headwinds are likely priced in, indicating further room for upside.
- I provide the argument on why OBDC investors who sat out its recovery should wait no longer as it moves toward its early 2022 highs.
- Maintain Buy on OBDC's high yield opportunity.
Blue Owl Capital Corporation (OBDC) investors who added after its post-earnings August lows have experienced a remarkable revival as buyers returned robustly.
Accordingly, OBDC's price action has recovered to levels last seen in early August, coinciding with its second-quarter or FQ2 earnings release . As such, the near-term buy point is no longer optimal, although its medium- to long-term recovery thesis remains intact.
The leading business development company, or BDC, focuses on middle-market companies and is externally managed by Blue Owl Credit Advisors LLC. Accordingly, Blue Owl Credit Advisors is affiliated with Blue Owl Capital (OWL), with OBDC focusing on the direct-lending segment as a specialty finance company.
Given its portfolio construction, Blue Owl BDC has benefited significantly from the rapid increase in interest rates over the past year, lifting its net investment income or NII per share to a remarkable $0.48 in Q2. Despite that, investors need to consider the potential peaking in interest rates in the near term. As such, the rates-driven earnings accretion could stall or even decline moving ahead.
Accordingly, analysts' estimates suggest that Blue Owl BDC's NII per share could have peaked in Q2 before falling through H1'24. It also aligns with management's commentary, suggesting that " elevated rates are expected to be temporary, and that rates may go down over the next 12 to 18 months." Management's observation is consistent with the recent cooling inflation data, as the Fed maintains its data dependency on future rate decisions.
Therefore, the rate tailwinds that drove OBDC's earnings growth are expected to normalize. That said, investors need to assess whether the market has priced in the NII growth headwinds in its current valuation.
I noted that OBDC last traded at a forward NII per share multiple of 7.5x, below its mean of 9.8x. Its forward dividend yield of 11.5% is also close to the one standard deviation zone over its average of 10.1%, implying relative undervaluation. Seeking Alpha's Quant assigned OBDC a best-in-class "A" valuation grade, corroborating the above metrics. Hence, I assessed that OBDC remains attractively priced despite recovering well from its lows in October 2022. In other words, the market has likely discounted its NII growth headwinds over the next year, suggesting OBDC could have further room for recovery if management can outperform.
Concerns over the credit profile of its portfolio companies will likely be under intense scrutiny. Management expects further stress on some companies if the higher-for-longer stance continues. However, it doesn't seem like it will threaten the overall earnings profile for OBDC, which could be detrimental to its dividend payout ratio. Despite that, I believe investors must continue monitoring the credit performance of its worst performers to assess the impact on its NII bridge moving ahead.
OBDC price chart (weekly) (TradingView)
OBDC bottomed out in October 2022 and has not looked back since. All the significant dips since then were robustly defended by dip buyers, absorbing the selling pressure confidently.
OBDC has also recovered its medium-term uptrend, bolstering investors' confidence to buy steep pullbacks, including the recent one in August.
The current buy point is not optimal from the near-term perspective. However, I believe OBDC remains well-primed to re-test its recent August highs, given its robust earnings profile and attractive valuation.
As such, the current levels are still reasonable to add exposure (while expecting volatility) with an eye toward retaking its August highs before moving upward to potentially re-test its early 2022 highs.
Rating: Maintain Buy. Please note that a Buy rating is equivalent to a Bullish or Market Outperform rating.
Important note: Investors are reminded to do their due diligence and not rely on the information provided as financial advice. Please always apply independent thinking and note that the rating is not intended to time a specific entry/exit at the point of writing unless otherwise specified.
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Blue Owl BDC: High Yield Opportunity Doesn't Lie, Grab More While It's Cheap