2023-11-17 10:48:44 ET
Summary
- Oaktree Specialty Lending Corporation has an 86% Senior Secured Lending focus.
- The company had an 89% dividend pay-out ratio in the last quarter, suggesting the dividend is well-covered.
- While the stock is not selling at a discount to NAV, it remains a solid hold for passive income investors.
- Increasing NII risks related to interest rates are a potential headwind for OCSL.
Oaktree Specialty Lending Corporation (OCSL) is a well-managed business development company with a large percentage of First and Second Liens as well as strong dividend coverage in the third quarter.
Oaktree Specialty Lending's credit quality improved and it also announced a $0.07 per share special dividend as a means to distribute excess portfolio income.
Though Oaktree Specialty Lending is not selling at a discount to NAV, I think the BDC remains a solid Hold for passive income investors concerned primarily with growing their incomes.
My Rating History
Oaktree Specialty Lending attracted a lowered stock classification ( HOLD ) on my part in August for two reasons:
- Oaktree Specialty Lending suffered a deterioration in credit quality, as shown by a substantial rise in the non-accrual ratio.
- Oaktree Specialty Lending's discount to NAV fully disappeared.
Improving credit quality and the payment of a special dividend in the last quarter were favorable developments. The fact that a discount to NAV is still not available is the reason why I am not modifying my stock classification. Hold.
Portfolio Composition And Loan Activity
No major change in Oaktree Specialty Lending's portfolio took place in the third quarter: The portfolio remained overweight in First and Second Liens which accounted for 76% and 10% of investments. The BDC's total portfolio in 3Q-23 was $2.89 billion compared to $3.14 billion in 2Q-23. The decline in portfolio value happened because of an accelerated pace of repayments while the origination business as such remained under pressure from high interest rates.
Portfolio Composition (Oaktree Specialty Lending)
Due to an increase in repayments (3Q-23 saw the highest level of repayments, sales in a year), Oaktree Specialty Lending saw a decline in net new investments of $247.3 million. Oaktree Specialty Lending did make new loan commitments in 3Q-23, in the amount of $87.5 million, but the origination business still suffers from headwinds to loan demand in a high-rate environment.
I don't expect this to change in the near future, but in the medium term, interest rates should decline. Inflation for October was 3.2% , down from 3.7% in September, making it less probable that interest rates will continue to go up.
Investment Activity (Oaktree Specialty Lending)
Improving Credit Quality
Oaktree Specialty Lending had four investments on non-accrual at the end of the last quarter, reflecting an improvement of one investment compared to the June quarter. The non-accrual ratio improved to 1.8% (on a fair value basis) compared to 3.1% in the prior quarter.
Dividend Coverage Remained Steady, Special Dividend Announcement
Oaktree Specialty Lending earned $0.62 per share in adjusted NII in the last quarter, reflecting an increase of 13% YoY, thanks primarily to higher interest rates prevailing in the U.S. economy.
Oaktree Specialty Lending paid out $0.55 per share in 3Q-23 which translates into a pay-out ratio of 89%. To distribute excess portfolio income, Oaktree Specialty Lending announced the payment of a $0.07 per share special dividend that will be paid to shareholders on December 29, 2023 to stockholders of record on December 15, 2023. The announcement of a special dividend lifts OCSL's leading dividend yield to 11.4%.
Dividend (Author Created Table Using BDC Information)
Oaktree Specialty Lending invested 86% of its portfolio into floating-rate investments which means the company's NII will rise as long as the central bank maintains its hawkish position on inflation.
However, recent evidence in terms of inflation data suggests that inflation is cooling and this means that OCSL, and other floating-rate BDCs, are dealing with prospects of falling NII moving forward. The U.S.'s annualized inflation rate dropped to 3.2% in October , reflecting the lowest level since July 2023. This makes it probable that interest rates will fall next year, potentially causing challenges for OCSL's NII growth.
Oaktree Specialty Lending Sells At Net Asset Value
I would rate Oaktree Specialty Lending as a higher quality BDC given its long credit investment experience, robust dividend coverage and history of dividend growth.
The BDC's dividend growth has recently slowed, but Oaktree Specialty Lending's 11% dividend yield is comfortably covered by adjusted NII.
OCSL is selling for 1.02x NAV which is, I would say, in-line with other BDCs. Thus, my stock classification was and still is Hold. I would consider adding to my OCSL position at 0.9x NAV and think about peeling back my position by 50% at 1.1x NAV.
Why Oaktree Specialty Lending Might See A Higher/Lower NAV Multiple
Oaktree Specialty Lending's debt portfolio is invested primarily in floating-rate debt (the total exposure is 86%). The central bank is less likely to raise interest rates following the inflation numbers for the month of October, but this also means that net interest income upside related to the floating-rate debt portion of the BDC's portfolio is less attractive.
My Conclusion
Oaktree Specialty Lending is a well-managed BDC and it covered its dividend with adjusted NII comfortably in the last quarter. The BDC enjoyed a decline in non-accruals which indicates improving overall portfolio quality.
Oaktree Specialty Lending also announced a $0.07 per share special dividend which lifts the dividend yield to 11.4%. I think OCSL makes a solid enough value proposition for income-minded investors to keep holding the stock.
I would considering buying and selling OCSL at 0.9x and 1.1x NAV. Hold for now.
For further details see:
Oaktree Specialty Lending: 11.4% Yield, Special Distribution, 1.01x NAV