2023-09-05 19:28:24 ET
Summary
- Sixth Street Specialty Lending, Inc. delivered strong Q2 results with a 4% total NAV return and a 4% increase in dividends.
- The portfolio is well-diversified, focusing on the Tech, Healthcare, and Human Resources sectors.
- Sixth Street remains a top performer in the sector with consistent performance and a reasonable valuation.
In this article we discuss the latest quarterly results from the Business Development Company ("BDC") Sixth Street Specialty Lending, Inc. ( TSLX ). TSLX delivered a strong Q2 with a 4% total NAV return, continuing its sector outperformance. The company declared a base dividend of $0.46 and a $0.02 increase in the supplemental to $0.06 for a total dividend increase of 4%.
The portfolio is well-diversified and focused on the typical Tech and Healthcare sectors alongside Human Resources, which is a bit unusual for BDCs.
Quarter Update
Adjusted net investment income rose to $0.59 - a 7% increase from the previous quarter. This was still below the Q4 figure, however, recall that the company had a non-recurring income of $0.12 in Q4.
A low level of fee-related income (green bars) remains a headwind for the company (and many others in the sector). This is due primarily to a subdued level of risk sentiment in equity markets as well as the fact that a lot of deals are only pushed over the line in the last quarter of the year.
Coverage of the base dividend from adjusted net income is a very healthy 128%. Total dividend coverage based on the recently declared Q3 dividend of $0.52 is 113%.
The spillover was around $0.90 or close to 2 quarters of the base dividend.
The NAV rose by 0.9%, as a result of various positive factors such as unrealized appreciation, realized gains and equity offering NAV accretion.
Income Dynamics
Net new investments came in positive on the quarter.
Leverage fell after rising over the last year, in part due to the equity offering. Once the BBBY loan is repaid it should push leverage lower, creating additional lending opportunities. The target leverage range remains 0.9-1.25x.
Asset yield increased marginally to 14% while cost of debt rose at a faster pace to 7.1%. TSLX has a very high cost of debt relative to other higher-quality BDCs because it swaps all of its debt to floating rates. This has obviously been a drag on its net income over the past year or more. Other investment-grade BDCs have a cost of debt that is 1-2% below the level of TSLX.
If there is a silver lining, it is that this disadvantage will diminish over the coming years if rates stay elevated and as the bonds of other BDCs mature are refinanced at higher coupons. The company's high level of asset yield also means it boasts a slightly above-average level of yield differential.
The company's recent equity issuance not only generated NAV accretion but also allowed the company to allocate more capital than would have been available organically in today's attractive lending environment.
Portfolio Quality
There is one company on non-accrual, and there were no new investments added to non-accrual in the past quarter.
The company has continued its stellar track record of net realized gains .
PIK rose to 4.1% but remains below the sector average.
Portfolio quality, as indicated by internal ratings , remained stable.
Interest coverage declined to 2.1x. Less than 5% of the core portfolio (91% of the total portfolio) has interest coverage below 1x.
Return And Valuation Profile
TSLX has tended to trade at a premium valuation relative to the broader sector. This makes sense in the context of its very strong performance - it remains one of the best performers in the sector.
On a 5Y total NAV return basis, it is only behind Hercules Capital (HTGC) in our coverage. In this sense it is a superior alternative to Main Street (MAIN) or Capital Southwest (CSWC) given its much lower valuation and stronger performance.
Performance has also been very consistent - it has only underperformed the sector in two of the last 20 quarters.
Despite its premium level, the valuation is fairly reasonable. 5Y total NAV returns per unit of valuation is one of the highest in our coverage.
Stance and Takeaways
Sixth Street Specialty Lending, Inc. remains one of the strongest and most consistent performers in the sector while trading at a valuation that is well below several other strong BDCs. Coverage is high which leaves room for additional net income gains, particularly as fee-sourced income is at a rock-bottom level. The portfolio is focused on first-lien loans and the quality of the holdings has been resilient.
After adding the stock in mid-March at a very attractive sub-105% valuation, we recently exited our TSLX allocation after it hit a valuation level of 125%. This looked a bit rich for us so we are happy to sit it out with a higher margin-of-safety allocation. The macro picture continues to worsen so we wouldn't be surprised to see the stock trade at a more attractive level by the end of the year.
For further details see:
Sixth Street Specialty Lending Q2 Update: Strong Results, Boost To The Supplemental