2023-05-23 15:50:00 ET
Summary
- Due to higher net investment income in 1Q-23, YoY, Owl Rock’s dividend pay-out ratio fell to 73%.
- Owl Rock's portfolio is growing even though originations have declined amid higher capital costs.
- Net asset value discount implies a high margin of safety.
Owl Rock Capital Corporation ( ORCC ) continues to meet my criteria for a high-quality business development company.
In 1Q-23, Owl Rock covered its dividend with NII and achieved solid credit quality with a non-accrual ratio of 0.3% (which was an improvement over 4Q-22).
Despite the fact that Owl Rock's stock price has risen since the company presented results for the last quarter, I believe that the stock's 13% discount to net asset value and 10% covered dividend yield make ORCC a BDC for passive income investors to consider.
A Growing Portfolio With Strong Credit Quality
Owl Rock is a well-managed specialty finance firm that primarily provides investment capital to companies in the upper middle market. Owl Rock is one of the larger business development firms in the industry, with a $13.2 billion investment portfolio.
Despite headwinds to origination growth caused by the central bank raising the cost of investment capital for borrowers, Owl Rock has seen consistent portfolio growth in the last year: In 1Q-23, the total fair value of its investment portfolio increased by about 3% YoY.
At the end of the first quarter, approximately 71% of Owl Rock's investments were in relatively secure First Liens, while 14% were in Second Liens. In Q1'23, the investment percentage for senior secured loans (85% of all investments) remained unchanged.
As I previously stated, the origination activity of business development companies has declined in recent quarters as the central bank increased the cost of borrowing money. This rising interest rate trend in the U.S. economy has had a significant negative impact on Owl Rock's ability to originate new loans.
Owl Rock made only $175.1 million in new investment commitments in the first quarter, a 67% decrease YoY. Other BDCs have also seen a drop in demand for new originations as capital costs rise.
Only two debt investments in Owl Rock's portfolio were on non-accrual status at the end of the first quarter, representing an investment value of 0.3% (based on fair value). Three investments were non-accrual at the end of 4Q-22, accounting for 1.3% of the portfolio (also based on fair value).
Updated Dividend Metrics, Owl Rock’s Dividend Coverage Has Improved Due To Growth In Net Investment Income
It was reassuring to see that Owl Rock benefited from an increase in interest rates, which increased the BDC's net investment income YoY, and that its dividend coverage improved (resulting in a higher margin of safety for the company's dividend): Owl Rock earned $0.45 per share in net investment income in the first quarter, a 45% increase YoY.
As a result, Owl Rock's dividend payout ratio fell from 80% in 4Q-22 to 73% in 1Q-23. Because of the improved dividend coverage, I believe Owl Rock will continue to raise its regular dividend.
Secure A 13% Discount To Net Asset Value
I like to buy Owl Rock and other high-quality business development companies when they are trading at a discount to net asset value because these discounts significantly increase my margin of safety.
Owl Rock's net asset value increased 1.1% QoQ to $15.15, owing to a strong YoY increase in net investment income in 1Q-23.
Passive income investors seeking a solid 10% dividend yield can secure a 13% discount to net asset value based on the current stock price of $13.24.
Other BDCs' NAV discounts have also begun to narrow, following a general recovery following the March selloff in the financial and BDC sectors, and I believe Owl Rock could trade at a premium to net asset value in the long run (as long as the company maintains solid credit quality).
Why Owl Rock Might See A Lower/Higher Valuation
Owl Rock's ability to trade at a lower or higher valuation is primarily determined by the central bank's short-term interest rate path. If inflation continues to moderate, the central bank's main argument for raising interest rates would be undermined, potentially leading to an increase in loan demand but also a decrease in net interest income (98% of Owl Rock's debt investments are in floating rate loans).
The credit quality of the BDC must also be closely monitored in order to detect a shift in operating fundamentals.
My Conclusion
Owl Rock had a fairly successful first quarter, with the business development firm maintaining strong portfolio quality and only a few (2) investments going non-accrual.
With portfolio credit quality remaining very strong and the dividend pay-out ratio falling to 71% in 1Q-23, I believe the business development company has a good chance of increasing dividends again this year.
Despite a drop in originations, I believe Owl Rock remains a solid buy for passive income investors because its stock sells at a 13% discount to net asset value while covering its dividend of net investment income.
For further details see:
Owl Rock: This 10% Yielder Is More Than Just Meets The Eye