2023-10-10 10:00:00 ET
Summary
- Blue Owl Capital is a relatively new BDC focused on providing direct lending solutions to U.S. middle-market companies.
- OBDC has a diversified portfolio with a focus on Internet Software & Services and Insurance companies.
- The company has a conservative balance sheet, well-laddered debt maturities, and a focus on first-lien investments.
- OBDC currently trades at a discount to NAV and offers upside to its price target.
- During market uncertainty, finding good companies can turn out to be very rewarding for shareholders willing to hold for the long term.
Introduction
We've all heard the saying, When life gives you lemons, make lemonade. And while most of us probably know what that means, how many of us actually apply it to real-life situations like the market right now? I've been thinking of this lately. There's so much uncertainty and the higher for longer rates are starting to be felt throughout the economy. The way I see it, if it happens it happens, and I'm going to continue investing in the market no matter what. And while many are running to treasuries, I'm staying in the fire to see what opportunities I can find. I'm running to the sale instead of away from it. Sure the stock market is risky, but if there's no risk, then there's most likely no reward. That's my mindset, but I also understand that every investor is different. There is absolutely nothing wrong with putting your cash into a money market fund or CD, that's just not my preference. I've covered a few BDCs before but today I want to cover Blue Owl Capital ( OBDC ) and why I think you should consider them for your portfolio.
Business Overview
Similar to Ares Capital ( ARCC ), OBDC is an externally managed BDC focused on providing direct lending solutions to U.S. middle-market companies. Their external manager is Blue Owl Credit Advisors ( OWL ). Blue Owl's credit platform is a New York-based direct lending platform with approximately $74 billion in assets under management [AUM]. OWL was founded in 2016 by Douglas Ostrover, Mark Lipschultz, and Craig Parker whom previously held senior executive roles at GSO/Blackstone ( BX ) and Goldman Sachs ( GS ). OBDC IPO'd in 2019 and is the third largest BDC behind ARCC and FSK KKR Capital ( FSK ). At the time of IPO, OBDC was the second largest BDC behind ARCC until the merger completed by FSK in 2021. So the company is actually fairly new having IPO'd just four short years ago.
Diversified Portfolio
When it comes to BDC's, ARCC is considered the creme de la creme by many. One reason for this is their long track record of success. When looking at investing in a company, one of the first things to look at is a their track record. Although history doesn't predict future performance, it can tell you a lot about a company. How did they operate in times of uncertainty before? Certain macro environments?
But with a company like ODBC, there's not much to go off of. You have the pandemic that happened in 2020, but that's it. Most of us like to see how a company did in the GFC, or the dot com crash if they've been around that long. But just because a company hasn't been around for a long time, that doesn't mean they're not a good investment. All we can do is go off the data we have.
I actually enjoy finding newer companies. How many times have we looked at a stock's history and said Man I wish I had invested back then. Or I wish I had money to place into the stock market when that company went public. It's the afterthought that always leaves us wondering what could have been if I just would have pulled the trigger.
Most of OBDC's portfolio consists of Internet Software & Services at 13% and Insurance at 10%. The company ended Q2 with $12.9 billion in total portfolio investments across 187 companies and 30 industries. One thing I like about OBDC is their geographical location. 33% of their companies are located in the Southern region with the Western & Northeastern region both coming in at 21%.
In 2022 , populations of cities & towns in the South and West regions experienced the most growth over a yearly period. This is extremely important because population trends are tied to states' economic and government finances. More people usually means more workers, but also more people to buy goods and services, which generates more revenue. Of course there are other things that affect this as well, but a growing or declining population plays a significant role.
Another metric I like that differs OBDC from peers like ARCC is their larger portfolio focus on insurance companies. In my previous articles on Aflac ( AFL ) and Old Republic International ( ORI ), I discussed how the insurance market has held up and tends to outperform the overall market during times of uncertainty. OBDC lends to companies such as AmeriLife, providers of life & health insurance, and BrightWay Insurance, providers of property, vehicle, and other types. Additionally, they also lend to Ardonagh Group, one of the UK's largest independent insurance distribution platforms, and a top 20 broker globally.
First-Lien Focus
The company currently has 69% first-lien investments with second-lien senior secured loans at 14%. 98% of their loans are also floating rate investments with the other 2% being fixed. This benefits the company in high interest rate environments like current. Since the start of rate hikes, the company has paid out a total of 4 special dividends while raising it once over the same period. This has equaled a total of $0.20 of additional dividend per share. Although they have only increased the regular dividend by $0.02 since rate hikes began, this tells me management prefers to be more conservative than a lot of other BDCs.
Growth Since The Start Of Rate Hikes
During Q2 earnings ODBC reported net investment income of $0.48, compared to $0.45 in Q1. Even with the declared $0.07 special dividend included, the company comfortably out earned its total dividend payments. And this was apparent by the $0.11 increase in NAV quarter-over-quarter. Below is a look at OBDC's growth since the start of rate hikes last year. Furthermore, the stock is currently trading at a double-digit discount to its NAV currently. Another reason for the company impressively growing its NAV are share buybacks.
As most readers know, BDCs typically issue shares to raise capital, but OBDC has been repurchasing shares, returning more cash to its shareholders in conjunction with the special dividends. In the last year, management has repurchased a total of 4.1 million shares with $100 million left on the current program. Management has stated that they plan to be more opportunistic as the stock has performed well over the last year.
Conservative Balance Sheet
As previously mentioned, OBDC's management seems to be a bit more conservative than some BDCs, which I actually prefer to see. And this is apparent by their well-laddered debt maturities. The company has a total of approximately $8.7 billion in debt on its balance sheet with none maturing in 2023 and only $400 million in April of next year. This has a fixed rate of 5.25%.
Although many are expecting a higher for longer environment, I think we are closer to rate cuts than hikes but of course this is all data dependent going forward. But I don't see this as a problem. OBDC had plenty of available cash and undrawn debt with $1.8 billion in liquidity at quarter end. Most of their debt has a maturity date of 2027 and beyond. So even if we were to remain higher, their debt load is very manageable with $925 million in 2025, which has a fixed rate of 4.0%. Additionally, the BDC has investment-grade ratings from both Fitch and S&P.
Risks
The biggest risk for BDCs in the current environment is the likelihood for non-accruals to rise. At the end of the quarter, OBDC did witness a rise in their non-accrual ratio to 0.9%, which rose from 0.3% in Q1. If the FED decides to hike interest rates significantly from here, investors would most definitely see a rise in non-accruals, which would affect company cash flows going forward. Portfolio companies would also have to service their debt at higher rates, continuing to put stress on businesses. As far as management is concerned they consider this to be a very manageable risk but should continue to keep an eye out for portfolio companies showing any signs of stress as economic conditions evolve.
Another risk is the rise in PIK income. OBDC did see a rise in PIK income year-over-year. For those not familiar with this, PIK income also known as Payment-in-Kind. This is when companies conduct payments using goods & services instead of cash. This can sometimes be concerning for investors as PIK income rises, signaling trouble and credit concerns for companies within a portfolio. And although this can help them preserve cash, they also face higher interest assessments, which can be worrying in environments such as now.
But one thing investors should be aware of is that this is sometimes advantageous to the BDC as they get compensated for allowing companies this flexibility. Another thing to note is lenders usually allow this only for a certain period of time, usually 2 or 3 years. Although OBDC saw a rise year-over-year, this was actually down in Q2 because of repayments made in the quarter. The good thing regarding Blue Owl is that 90% of these were structured as PIK from the beginning, not due to credit concerns. But investors should keep a close eye for rises in non-accruals and PIK income going forward.
Buy While It's Cheap
As I mentioned previously, OBDC is trading at roughly a 13% discount to its NAV at the time of writing. The company has a price target of $15.21, which is right in-line with its NAV per share of $15.26. As the company continues their opportunistic buybacks, I expect to see OBDC growing their NAV in the foreseeable future, most likely leading to share price appreciation. Since October of 2022, the stock rebounded from a low of less than $11 to a high of $14.29, but has since declined over the last month due to rising treasury rates and overall market sentiment.
Conclusion
OBDC is a fairly new BDC but seems to be on the right track, from first-lien focus, to 98% of their debt being floating rate. Additionally, the company managed to grow its NAV and net investment income nicely since the start of interest rate hikes in 2022. Although a higher for longer will continue to have an impact on portfolio companies, I expect OBDC's conservative management team to look for opportunities to repurchase its shares, rewarding shareholders in the process. I think the company's share price currently reflects the current macro environment which is why it trades at a discount to NAV. No company is without risk and portfolio companies will continue to face stress going forward if rates remain high or the FED decides to raise next meeting. If so, investors should keep any eye out for rises in PIK income and non-accruals.
For further details see:
When Market Uncertainty Gives You Lemons, Make Dividend Lemonade With Blue Owl Capital