2023-12-14 10:44:37 ET
Summary
- Oaktree Specialty Lending Corp. reported a solid quarter with a 3.2% total NAV return and a flat adjusted net income.
- Non-accruals fell due to a couple of favorable resolutions; however, it was another quarter of net realized losses.
- The company's valuation is fairly-valued at the moment and we would look to add the stock at a discount of 3-5% to the sector average valuation.
In this article, we catch up on the latest quarterly results of Oaktree Specialty Lending Corp (OCSL). The company notched another solid quarter with a 3.2% total NAV return. OCSL trades at an 11% yield and a 2% premium to book.
OCSL is primarily focused on secured loans with a low allocation to equity securities. Its sector overweights are software and healthcare - a fairly common combination in the BDC space.
OCSL
Quarter Update
Adjusted net income (adjusted for merger accounting) stayed flat for the third quarter in a row at $0.62. This runs counter to the wider sector trend of continued net income rises. For instance, over the last year, OCSL net income has risen less than half that of the median BDC in our coverage. As we discuss in a section below, this is due to a number of net income headwinds such as falling leverage and a high level of floating-rate liabilities.
Systematic Income BDC Tool
The regular dividend was kept unchanged at $0.55. This leaves dividend coverage at a fairly healthy 113%. OCSL also declared a one-off $0.07 special in order to minimize the level of excise tax.
Systematic Income BDC Tool
The NAV rose by 0.3%, primarily as a result of retained income. Realized and unrealized gains were roughly offsetting.
Oddly enough the signs are different between the NAV bridge chart above and the rest of the presentation. The chart shows net realized gains while the presentation elsewhere shows net realized losses and vice-versa for the unrealized item. The 10K shows net realized losses and agrees with the item below so that's probably correct.
OCSL
The NAV has been fairly flat over the last year, however it remains quite a bit below its 2021 level. As we have discussed several times before, OCSL has tended to be relatively conservative with its marks so the hope is that, if public credit spreads remain stable or tighten further, the NAV will likely be written back up, at least in part.
Systematic Income
The company said it was opportunistically selling out of public debt investments. Recall that OCSL, unlike nearly all other BDCs, also play in the bank loan market, purchasing securities in the secondary market when valuations are attractive (as they were in parts of 2022) and selling them when loan prices rally back close to par such as now. This adds another level of returns to the BDC, unavailable to other sector players.
Income Dynamics
Net new investments were down sharply as repayments exceeded new fundings by $250m. Although this appears to be due to a kind of summer deal lull, other BDCs did not see a similar level of portfolio reduction. Next quarter is likely to see a partial reversal of this development.
Systematic Income BDC Tool
As a result, leverage fell sharply to 1x and sits towards the lower end of the targeted range of 0.9-1.25x.
Systematic Income BDC Tool
Both asset and liability yields rose by around 0.4%. OCSL has a below-average yield gap between asset and liabilities due to its mostly floating-rate liability profile.
Systematic Income BDC Tool
The yield on new commitments over the quarter fell relative to the previous quarter and was below the portfolio yield due to a large amount of sponsored deals. This is a slight headwind to future net income.
Recall that in January, OCSL completed the merger with the Oaktree Strategic Income II, Inc., adding $572m of investments into the broader portfolio. Oaktree will waive $9m of the base management fee across two years which comes out to around a tenth of the total base fee over this period. Over the quarter, OCSL waived another $1.5 million in fees. This results in a 2 cent or 3% uplift to net income which will disappear eventually.
The company issued a $300m 2029 bond at a rate of 7.1%, swapping it to SOFR + 3.126%. The 3% spread looks unusually high for an investment-grade issuer and is more in line with a BB- issuer or 3 notches below the company's actual credit rating. It's not clear what's going on here and could be due to unfortunate timing.
Out of 5 financing sources only one is fixed-rate. Management said they plan to rely mostly on floating-rate debt going forward in order to better match the asset side of the balance sheet. This is fairly unusual in the sector - only TSLX in our coverage does something similar. It does mean that the company's net income will not fall as quickly as that of most other BDCs once short-term rates start to fall.
OCSL
Portfolio Quality
The portfolio had 4 positions on non-accrual with a fair-value of 1.8% - in line with the median and below the average. A previous non-accrual position was fully repaid. Another holding emerged from bankruptcy and was placed back on accrual. However, it was offset by one new loan moving to non-accrual. This is mitigated by the fact that 70% of the original funded amount has already been repaid.
Systematic Income BDC Tool
The company's first-lien allocation has steadily increased over the past year (we add the joint venture position to first-lien loans held directly by OCSL). It is now in line with the sector median.
Systematic Income BDC Tool
It was a fifth quarter of net realized losses and this figure is worth watching as it has been growing. This indicator also suggests that the sizable drop in the NAV over the last couple of years is at risk of not being fully written up.
Systematic Income BDC Tool
Return And Valuation Profile
OCSL has seen a lot of variability in its valuation over the last year or so, in line with the rest of the BDC sector. At the moment it's trading at an elevated level though well off the peak earlier in the year.
Systematic Income
Outside of the early 2023 valuation blip, the company's valuation differential to the sector average is on the higher side historically. That said, the premium is currently only 1% to the sector average valuation.
Systematic Income
The company's performance is mixed - it has outperformed the sector on a 1Y and 5Y total NAV return basis but underperformed on a 3Y basis.
Systematic Income BDC Tool
The underperformance during 2022 continues to weigh on its longer-term performance metrics.
Systematic Income BDC Tool
Stance And Takeaways
Overall, OCSL has put up a good quarter. Portfolio quality metrics were somewhat mixed and this is an area of performance worth watching.
Over the past year, we downsized our allocation to OCSL (red lines) when its valuation blew out to a double-digit premium relative to the sector. The stock is fairly valued at the moment and we would look to add to our position on a valuation discount of 3-5% versus the sector.
Systematic Income
For further details see:
Oaktree Specialty: A Special Dividend To Mark A Solid Year For This 11%-Yielding BDC