2023-03-16 20:54:13 ET
Summary
- We discuss quarterly results from BDC Owl Rock Capital Corp and highlight key income dynamics of the portfolio.
- ORCC had a very good quarter with a double-digit jump in income and a rise in the NAV.
- Non-accruals rose; however, remain below the sector average level.
- The company looks to be over its underperformance hump with a couple of strong quarters and trades at an attractive valuation.
- We expect another rise in net income which should, in turn, lead to a hike in its formulaic supplemental dividend.
In this article we take a look at the Business Development Company Owl Rock Capital Corp. ( ORCC ). This is our first article on ORCC for the simple reason that the stock did not look particularly compelling until recently. This is for two reasons. First, is its valuation prior to 2021 relative to the sector was excessive in our view. The following chart shows the company's valuation differential to the sector average which highlights that prior to Q2-2021 it tended to trade at a premium to the sector.
The second reason we didn't favor ORCC stock, particularly when its valuation moved to trade at a discount to the sector average, was the fact that its performance was simply not very good. The following chart shows the company's quarterly total NAV return (blue bars) versus the sector average (red bars). The yellow line is a 12-month trailing average of the differential (below zero indicates underperformance and vice-versa). We can see that the yellow line dips into negative territory in 2021, indicating a sustained level of underperformance by the company until well into 2022.
These lackluster returns and high starting valuation combined to generate subpar total price returns for ORCC - the stock has underperformed the average BDC by 3.3% per annum over the last 3 years.
However, now with a sensible margin of safety valuation and a turn to outperformance in total NAV terms, the stock is finally worth a look in our view.
ORCC has not yet declared a Q1 supplemental which makes it yield 10.8% at the current base dividend. However, given the formulaic nature of the supplemental, its Q1 yield is very likely to be around 12%.
Quarter Update
Net income continued to tick up in Q4 , rising 11% from the Q3 level.
The company raised its Q4 dividend previously by 6% and introduced a new supplemental dividend component which will be equal to half of earnings in excess of the base dividend. For Q1, the company kept the base dividend flat at $0.33 and has not yet declared a supplemental dividend. Base dividend coverage is 125% while total dividend coverage is 112%.
In Q4 the company approved a repurchase program under which it can buy back up to $150m of the stock. As of February, $52m of the stock was purchased at $12.05 per share or a nearly 20% discount to NAV - a highly accretive development.
The NAV rose by around 1%, roughly offsetting the drops earlier in the year.
The rise in the NAV was due to the combination of outearning the dividend as well as unrealized appreciation.
Income Dynamics
Net new investments were marginally positive. Over the past year repayments and sales roughly matched new fundings, indicating no overall growth in the portfolio. Relatively flat NAVs and above average leverage left little room for an elevated level of net new investments.
The company's net income beta is around 1% above the sector median at 11.6% for a 1% rise in base rates, slightly above the sector average. Management indicated that they expect an additional 0.6% of base rate pass-through to Q1 income levels which should raise Q1 net income by mid-single digits. This suggests an increase in the supplemental dividend of around $0.02 in Q1 or a larger increase in the base dividend.
Apart from the positive impact of base rates, the company increased the overall portfolio spread by around 0.2% by opportunistically rotating out of lower spread loans. This is a fairly common trend in the sector as private loan spreads have been rising over 2022.
Leverage has been pretty flat over the last several quarters. Current leverage is slightly above the sector average.
Portfolio yield rose to 11% while interest expense rose by the same amount. ORCC has a higher than average level of floating-rate debt which results in a fairly average level of interest expense despite its investment-grade ratings.
Portfolio Quality
One name was added to non-accrual in Q4 with the total figure on a fair-value basis rising to 1.3%. This remains below the 2.7% sector median level.
Portfolio quality , according to internal ratings, was fairly stable in Q4.
PIK income is on the high side at around 10% of total revenue for 2022 - an increase over 2021. According to management 85-90% of PIK income is due to PIK at origination rather than a restructure to PIK because of credit issues. In other words, an elevated level of PIK does not appear to be a sign of distress.
The net realized gain / loss profile has improved significantly which echoes the improvement in the NAV profile. The portfolio looks to be much cleaner now.
Management indicated they have not seen an increase in covenant amendments or requests for additional liquidity.
Interest coverage of the portfolio declined to 2.3x from 2.5x in Q3 on an LTM basis which looks to be on the low side in the sector. On a forecasted peak basis, average coverage is expected to be between 1.5-2x. Unfortunately, it's not clear what the portion of the portfolio with negative interest coverage is likely to be.
Points Of Differentiation
ORCC has a roughly median profile in terms of its equity allocation though it flags up as on the high side because of its majority holding in Wingspire which is involved in asset-based lending. It has a slightly lower first-lien allocation and a higher second-lien allocation than the average BDC.
Like many other larger BDCs like [[OCSL]], ORCC and [[BXSL]], its focus is on the upper end of the middle-market sector with a weighted-average EBITDA of $168m.
Valuation and Returns
ORCC does not have a long track record as a public entity. We do have comparative 3Y total NAV returns which are shown below. On this metric ORCC is just below the median and 0.7% above the average BDC. More importantly, however, its performance has improved over the last several quarters, likely due to a cleaner portfolio given its previous run of net realized losses.
The company's valuation looks quite good for its return profile - ORCC is highlighted in red. ORCC has a similar 3Y total NAV return as [[TPCC]], [[WHF]] and [[NMFC]]. However, ORCC has a more stable performance profile than TCPC and is significantly cheaper than WHF and NMFC.
ORCC also looks quite a bit better than GSBD and TPVG which have slightly higher returns but trade at significantly higher valuation. Overall, the combination of decent total NAV returns, decent valuation given those returns relative to other BDCs and an improvement in recent performance suggests ORCC is finally worth a look.
For further details see:
Owl Rock Capital: This BDC Is Finally Worth A Look