2023-03-12 06:03:32 ET
Summary
- Owl Rock offers passive income investors a well-covered dividend.
- Owl Rock has special dividend potential in a rising-rate environment.
- The BDC’s stock is still available at a discount to net asset value.
Owl Rock Capital Corporation ( ORCC ) is a well-managed business development company with consistent dividend coverage and portfolio growth.
In 2022, Owl Rock's dividend was covered by net investment income, and if the central bank raises interest rates in 2023, the BDC may pay additional supplemental dividends.
Since the BDC's portfolio as a whole is doing well, I believe that Owl Rock shouldn't be trading at a discount to net asset value, and ORCC is a buy.
Owl Rock’s Investment Portfolio Is Safety-Oriented, Growing And Well-Performing
Owl Rock's investment portfolio is geared toward safety and consists primarily of first liens, which pose a very low risk of causing loan write-offs. First Liens are loans with strong security that offer lenders a lot of default protection.
However, there are other BDCs that offer even higher First Lien representation, with a First Lien percentage of 71% at the end of the December quarter.
Sixth Street Specialty Lending, Inc. ( TSLX ) , one such BDC, had a 90% First Lien representation .
Owl Rock also owned Second Liens (14% of portfolio), Common Equity (8%), Preferred Equity (3%) and Unsecured Debt/Investment Funds (both 2%) in addition to First Liens.
At the end of 2022, approximately 86% of Owl Rock's loans were senior secured loans, and 98% of those loans had floating rates, giving Owl Rock a greater chance of profiting if the central bank raised interest rates in 2023.
At the end of the December quarter, Owl Rock's investment portfolio was valued at $13.0 billion, representing a YoY increase of 2.1%.
Only three portfolio investments were non-accrual at the end of 4Q-22, demonstrating the portfolio's strong performance. Based on fair value, the investment value at risk was $153.6 million, or 1.3% of Owl Rock's portfolio value.
Overall, the portfolio quality of Owl Rock is respectable despite the addition of one portfolio company to non-accruals in the fourth quarter.
What Happened In Owl Rock’s Fourth Quarter?
The total amount of new investment fundings in 4Q-22 was $184.1 million, which was the least amount in 2022. Owl Rock and other business development companies' investment activity slowed last year in large part as a result of higher interest rates that have made borrowing more expensive.
First Liens and Common Equity made up about half of Owl Rock's new investment fundings in the fourth quarter. But for the second consecutive quarter, the BDC's net funded investment activity—the difference between active fundings/payments and repaid/sold investments—was positive.
Owl Rock’s Dividend Coverage Is Around 90% And Has Improved
Looking at Owl Rock's financial achievements in 2022, we can see that the business development company improved its dividend pay-out ratio as a result of rising NII.
With $1.26 in dividend payments and $1.41 in net investment income per share in 2022, Owl Rock had an 89% dividend pay-out ratio.
Because Owl Rock paid an additional $0.04 per share supplemental dividend to distribute portfolio access income, the actual dividend payout for the fourth quarter was higher than the $0.33 per share shown in the illustration table below. Whatever the case, Owl Rock easily used NII to cover its increased dividend in 4Q-22.
Trading At An 11% Discount To Net Asset Value
An investor's margin of safety is increased, and his overall returns may be increased, if he can purchase business development companies for less than their net asset value.
Currently, Owl Rock's stock is trading at an 11% discount to net asset value, which I don't think is quite appropriate given the increase in dividend coverage the BDC has experienced, particularly over the past two quarters.
When a business development company has a respectable portfolio quality and consistently covers its dividend with NII, as ORCC does, I like to purchase its shares at a net asset value discount. However, I only do this when the company is eligible.
Why Owl Rock Might See A Lower/Higher Valuation
The investment portfolio of Owl Rock, which comprises about 98% of floating rate securities, will reset to the upside if the central bank raises key interest rates.
In order to combat inflation, the central bank acted quite aggressively in 2022, and it is likely that 2023 will see at least a few more interest rate increases, which would be profitable for Owl Rock.
However, a change in this trend could actively undermine Owl Rock's potential for income from the BDC's portfolio of floating-rate investments.
Increasing loan defaults could also pose a challenge for Owl Rock in the future.
My Conclusion
A well-run business development company, Owl Rock outperformed its dividend in 4Q-22 and 2022 with NII.
The BDC also pays additional dividends, the most recent of which was $0.04 per share, enhancing the already impressive dividend yield of 9.8%.
In addition to the exposure to floating rates, I believe that Owl Rock should still be purchased due to the discount to valuation and the BDC's potential to pay supplemental dividends in a rising interest rate environment.
For further details see:
Owl Rock: I Am Still Buying This 9.8% Yielding BDC