2023-10-13 12:21:30 ET
Summary
- Sixth Street Specialty Lending is currently paying out a 9.2% base dividend yield.
- The BDC is currently swapping hands for a 19% premium to NAV per share.
- NAV is set to grow further on the back of net investment income spillover and a dividend that is 113% covered.
Sixth Street Specialty Lending ( TSLX ) most recently declared a quarterly cash dividend of $0.46 per share , unchanged from its prior distribution and for a 9.2% annualized forward dividend yield. I don't currently own a position in the ticker, but I've been looking to add another BDC to my stock portfolio to diversify my capital further and to prepare for a possible stop of the music next year. This music describes the most optimal macroeconomic conditions for BDCs in decades with a Fed funds rate currently sitting at 22-year highs of 5.25% to 5.50% driving record investment income and dividend growth for these publicly traded purveyors of private credit. However, whilst the chances of a US recession currently seem low with labor market strength aggregated with continued GDP gains and consumer spending, 2024 could see economic conditions deteriorate.
The proverbial music could stop and a strong BDC positioning is critical to getting out on top of this. I don't expect base rates to pull back next year but heightened economic volatility could drive up non-performing loans. Sixth Street's non-accruals as of the end of its fiscal 2023 second quarter were at 0.6% of its investment portfolio at fair value with no new portfolio companies added to non-accruals during the quarter. The concerned non-accrual was a $26.3 million first-lien loan at amortized cost and $19.1 million at fair value to American Achievement Corp , a graduation cap and gown maker that was forced into involuntary Chapter 11 filing bankruptcy as a result of the pandemic back in 2021. Sixth Street's underwriting standards are strong against a $3.09 billion portfolio at fair value as of the end of the second quarter. This is spread across 86 portfolio companies that are 90.6% first lien loans.
A Low Volatility Portfolio
It's important to note that TSLX is also set to pay out a $0.06 per share supplemental dividend powered by a spillover income of $0.90 per share as of the end of the second quarter. This was on the back of a total investment income of $107.6 million , up from $63.9 million in the year-ago period with a 68% year-over-year growth rate. However, net investment income which came in at $48.8 million was only up 19.5% from $40.8 million in its year-ago comp with interest expenses that grew more than 200% to $32.4 million driving the comparative weakness of NII.
NII per share at $0.59 meant the aggregate dividend was 113% covered. Net asset value at the end of the second quarter was $1.46 billion, around $16.74 per share, and up around 15 cents per share sequentially from the first quarter. TSLX's NAV will likely continue to be pulled up with the BDC over-earnings on its base and supplemental dividend. This comes with its weighted average total yield on debt and income-producing securities at fair value reaching 13.8% at the end of the second quarter, up 40 basis points sequentially.
Diversification, The Premium, And Direction Of Total Returns
TSLX's core focus is on extending credit to middle-market loans to US companies with the BDC also sporting an average loan size of $35 million. I like that the BDC is highly diversified across a number of sectors, so there isn't a heavy overlap with the strong life science and technology exposure from my position in Hercules Capital ( HTGC ). Further, the BDC's top 10 portfolio companies account for roughly 22.9% of its portfolio.
Around $240 million in new investment funding was made during the second quarter with a continued focus on investing in the top of the capital structure as first-lien loans accounted for 87% of this investment amount. The BDC's external advisor is also part of San Francisco-based Sixth Street, a global investment firm with roughly $65 billion of assets under management. I can't stress the low volatility of TSLX's portfolio enough, there's a weighted average of 1.9 financial covenants per credit agreement with the BDC also exercising effective voting control on 89% of its debt investments and with a 31% net loan-to-value ratio across the portfolio
TSLX is currently trading at a 19% premium to NAV per share, so the ticker is a hold with a premium somewhat above its historical range. Fundamentally, the BDC will likely fare well if the more volatile economic backdrop expected next year comes to fruition. The aggregate dividend distribution is set for further supplementals and a possible increase of the base rates against the backdrop of NAV per share rising.
For further details see:
Sixth Street Specialty Lending: The 9.2% Yield Is One To Hold