2023-06-09 08:05:00 ET
Summary
- Sixth Street Specialty Lending offers an attractive yield and has consistently delivered strong shareholder returns.
- TSLX has a healthy portfolio, reasonable leverage, and is well-positioned to benefit from volatility in the regional bank sector.
- The stock is a strong pick for income investors due to its ample room for special dividends, improving debt-to-equity ratio, and attractive valuation.
High-yielding stocks can be a great way to provide an income "net" for portfolios, especially in times of volatility. That's because while growth stocks can be fun to own in a portfolio, it's income stocks that pay the bills and keep the lights on.
Plus, dividends can be used a source of funds to accumulate more shares when prices are beaten down, should fears around a recession bubble up again in this unpredictable market.
This brings me to Sixth Street Specialty Lending ( TSLX ), which is a quality name in the BDC space, with a long track record of strong shareholder returns. I last covered TSLX here back in March, and the stock has performed admirably since then, giving investors a total return of 12.7%, surpassing the 12% rise in the S&P 500 ( SPY ) over the same timeframe.
In this article, I revisit the stock, highlighting recent developments, and discuss why it remains a solid pick for its 10% yield.
Why TSLX?
Sixth Street Specialty Lending is an externally-managed BDC that invests in the U.S. middle market space, as defined by those companies with a broad range of annual EBITDA in the $10 million to $250 million range.
Remarkably, TSLX has held a steadily improving NAV/share since its inception in 2011, from $14.71 to $16.59 at present. This includes the $0.20 sequential quarter-on-quarter rise in NAV/share from $16.39, after accounting for the $0.09 supplemental dividend paid during the fourth quarter. Notably, Shareholders since IPO have realized 2.56x their original value, based on $37.65 in combined NAV/share and cumulative regular and special dividends.
Meanwhile, TSLX carries a sturdy portfolio of primarily first-lien debt investments, which comprise 91% of the portfolio total. The remainder of the portfolio is comprised of second lien debt, mezzanine debt, and equity for a potential upside kicker to the NAV should investments appreciate in value.
TSLX is also benefitting from a rising rate environment, as 99.2% of its debt investments are floating rate. This resulted in an attractive annualized return on equity of 16.3% and $0.55 in net investment income per share, comparing favorably to the NII/share of $0.49 in the prior year period.
Importantly for income investors, this results in a 1.2x NII-to-regular dividend coverage ratio, leaving ample room for the $0.04 supplemental dividend. TSLX still has $0.87 in spillover income per share, so I would expect for supplemental dividends to continue barring unforeseen circumstances.
Looking ahead, TSLX should benefit from the volatility in the regional bank sector, which is shoring up capital to protect itself from depositor redemptions. Unlike banks, BDCs like TSLX don't have to worry about redemptions due to their permanent equity capital base. This should result in continued low portfolio turnover and muted refinancing activity among the borrower base.
In addition, the Fed is expected to pause interest rate hikes this month, and this should be well received by TSLX's borrower base, giving them some cushion. At the same time, TSLX's portfolio remains healthy, with a weighted average portfolio rating of 1.16 on a scale of 1 to 5, with 1 being the strongest. Investments on non-accrual are also low, representing just 0.7% of portfolio fair value.
TSLX is also reasonably levered with a 1.2x debt to equity ratio, sitting well below the 2.0x statutory limit and carries investment grade credit ratings from S&P and Fitch of BBB- and BBB, respectively. The leverage ratio could also improve in the near-term as management now expects Bed Bath & Beyond to pay down $76 million in outstanding funding at par value, and this would increase TSLX's capacity to fund new investments.
Lastly, TSLX is one of the few externally-managed BDCs to consistently trade at a premium to NAV. While deep value investors may be turned off by the idea of the 1.14x premium at the current price of $18.93, I believe the premium is well-deserved due to the strong track record.
Plus, it also enables management to raise capital in an accretive manner should the need arise. As shown below, TSLX has traditionally been priced at a premium to NAV and it currently sits toward the low end of its valuation range since 2021. Analysts have a consensus Buy rating with an average price target of $20.73 , which could mean a potential 19% total return over the next 12 months.
Investor Takeaway
Sixth Street Specialty Lending is a quality name in the BDC space, and is one that has consistently delivered strong shareholder returns. The stock currently yields an attractive 9.7%, with ample room for yield kickers from special dividends due to its spillover income. It also has a reasonable debt-to-equity ratio which is set to improve from an expected debt paydown from Bed Bath & Beyond. As such, TSLX is a strong pick for income investors considering all the above and its attractive valuation.
For further details see:
Sixth Street Specialty Lending: 9.7% Yield And Investment Grade Credit Rating