Summary
- Oaktree Specialty Lending covered its dividend with adjusted net investment income in the December quarter.
- Credit quality remained perfect and the portfolio is growing.
- OCSL’s valuation has upside.
In February, Oaktree Specialty Lending Corporation (OCSL) reported NII and NAV results for the December quarter, and the business development company impressed on a number of metrics.
With a non-accrual ratio of 0%, Oaktree Specialty Lending covered its dividend with adjusted net investment income and maintained perfect credit quality.
Oaktree Specialty Lending's portfolio is expanding, and the BDC increased its dividend by 1.9% to $0.55 per share per quarter. In addition, in January, the business development company completed a 1-for-3 reverse share split.
The dividend is well-covered, and the 10.7% yield is appealing to passive income investors.
OCSL Sets The Standard For Portfolio Quality
Oaktree Specialty Lending's investment portfolio is expanding and performing well, which I believe are the two main requirements we have for a business development company.
The investment portfolio of Oaktree Specialty Lending was valued at $2.64 billion at the end of the December quarter, representing a 6% increase QoQ due to net new investments made by the company. The portfolio increased by seven companies to 156, and First Liens, the highest quality debt option for business development companies, remained dominant.
In terms of asset allocation, the portfolio did not change significantly in the December quarter. Oaktree Specialty Lending's portfolio was primarily made up of high quality first liens, which accounted for 71.9% of the portfolio at fair value, and second liens, which accounted for 14.4%. In total, First and Second Liens accounted for 86.3% of Oaktree Specialty Lending's investment portfolio.
Asset Allocation (Oaktree Specialty Lending Corp)
In the December quarter, Oaktree Specialty Lending made $250 million in new investment commitments in response to strong demand for new investment capital.
$214 million (86%) was invested in First Liens, $21 million in Unsecured Debt (8%), $10 million in Second Liens (4%), and $5 million in Equity (2%). Total net new investment fundings totaled $274 million, the most of any quarter in 2022.
New Investments (Oaktree Specialty Lending Corp)
A Great Reason To Buy OCSL: Solid Dividend Coverage And Potential For Dividend Growth
In the December quarter, Oaktree Specialty Lending earned $0.61 in adjusted net investment income per share and paid a quarterly distribution of $0.54 per share. Due to the 1-for-3 reverse share split completed in January, Oaktree Specialty Lending has restated its per share amounts for prior quarters.
In the last twelve months, Oaktree Specialty Lending earned $2.20 per share in adjusted net investment income from its diversified investment portfolio and paid out a total distribution of $2.025 per share, not including the special distribution of $0.42 per share declared in the previous quarter.
In those twelve months, OCSL's dividend pay-out ratio was 92%.
Adjusted Net Investment Income (Oaktree Specialty Lending Corp)
Oaktree Specialty Lending increased its quarterly dividend payout by 1.9% to $0.55 per share due to strong financial results and portfolio growth, bringing OCSL's forward dividend yield to 10.7%.
NII, in my opinion, adequately covers the dividend.
Oaktree Specialty Lending Is Undervalued
Considering the business development company's strong credit quality and solid dividend coverage, I believe OCSL could and should trade at a 15-25% premium to net asset value.
The current premium to NAV, which stood at $19.63 in OCSL's earnings release, is about 5%, so I definitely see some upside in Oaktree Specialty Lending's valuation, especially if the BDC's portfolio quality continues to shine in the future.
Why OCSL Could See A Lower Valuation
Oaktree Specialty Lending, like any other business development company, faces valuation risk, and the BDC could trade at a discount to book value again, particularly if the United States experiences a recession in 2023 and portfolio quality deteriorates. This is not yet the case, and investors do not need to be concerned about deteriorating asset quality.
Having said that, an increase in the non-accrual ratio would be sufficient reason to reconsider Oaktree Specialty Lending's value proposition.
My Conclusion
Oaktree Specialty Lending, in my opinion, is the best business development company that passive income investors, particularly those concerned about a recession, can buy right now.
The BDC has repeatedly demonstrated that it can earn its dividend from net investment income while also growing its portfolio and maintaining good portfolio quality. With its safety-first investment focus, management is very experienced and has earned the trust of investors.
I believe OCSL stock will be a long-term holding for me, and I hope I never have to sell this income stock.
For further details see:
Oaktree Specialty Lending: Best-Of-Breed BDC With A 10.7% Yield