Not all dividend investors are the same, some like to live at a low return with the promise of a higher future income, while others prefer a higher income now. REITs, MLPs, and BDCs are ideal options for those who You fit into the latter category, and that brings me to the big BDC, Owl Rock Capital (New York Stock Exchange: ORCC). In this article, I highlight why the recent dip provides an attractive entry point for high incomes, so let’s get started.
Owl Rock Capital is one of the “younger” BDCs in the market, established in 2015. It is managed by Owl Rock Capital Advisors, and since its inception, it has grown to be the No. 3 largest BDC by asset size.
ORCC focuses on providing direct lending solutions to the middle market in the United States, as defined by those companies with annual EBITDA in the $10 to $250 million range. It has a solid track record, with an annual loss rate since its inception of only 13 basis points.
ORCC has a fairly large portfolio with a fair market value of $12.8 billion distributed over 157 companies. That’s up from $12.7 billion and 143 companies at the end of last year. The portfolio is also well diversified across primarily non-cyclical and technical industries.
As shown below, ORCC’s top ten accounts for just 22% of the fair value of the portfolio, and the top 5 borrower industries are in the perennial and growing sectors of technology, financial services, insurance, food and beverage, and healthcare.
ORCC is also well prepared for potential macroeconomic headwinds, with its portfolio consisting primarily of secured debt with 74% first mortgage, 15% second mortgage, and the remainder consisting of unsecured, preferred, and public equity (5% of portfolio) for potential capital appreciation. upward. Also encouraging is that non-accrual remains very low, with only one non-accrual portfolio company representing just 0.1% of the portfolio’s fair value.
Furthermore, 99% of ORCC’s debt investments are in the form of floating rate debt, which puts it well positioned in a price-rising environment. This is significant, given that Barclays Bank (BCS) recently forecast a 75 basis point raise by the Federal Reserve at its June meeting. Management comments seem to support this thesis, as they expect benefits from higher rates in the second half of the year, as noted during the recent conference call:
I’d also like to spend a minute on how we expect price increases to affect ORCC. We expect to benefit financially from the higher rates in the second half of the year. As I discussed last quarter, once prices rise across the lower floors on the asset side, and is reflected in the interest rate elections for borrowers, we expect investment income to increase significantly. The general LIBOR rate started at 21 basis points and increased by about 80 basis points over the first quarter. The majority of our borrowers own 100 basis points, so this increase did not benefit interest income in the first quarter.
The majority of our borrowers also reset their borrowing rate quarterly at the end of each calendar quarter. Furthermore, since LIBOR was around 100 basis points at the beginning of April, we expect interest income to be limited in the second quarter. As LIBOR continued to rise in the second quarter and based on our observation of the forward curve, we expect higher interest rates to benefit interest income in a more material way, once borrowing rates reset for the third quarter.
One concern investors may have with ORCC relates to the fact that the stock’s NAV fell by $0.20 to $14.88. However, I’m not too concerned, as it was related to an unrealized decline in the fair market value of the portfolio due to wider credit spreads in the market.
Looking to the future, ORCC may see further devaluation of assets considering the macroeconomic challenges. However, there may be a positive side, as current stock market challenges may delay liquidity events for portfolio companies in the form of IPOs and leveraged purchases. This, in turn, can lead to an increased demand for debt financing solutions offered by loan development centers such as ORCC.
Meanwhile, ORCC maintains a healthy balance sheet, with a debt-to-equity ratio of 1.17x, and it remains well below the 2.0x statutory limit. The recent weakness in stock prices has also pushed the dividend yield to 9.4%. However, it should be noted that the dividend coverage is a tight 100%. I would like to see coverage improve in the coming quarters as ORCC sees benefit from higher interest rates.
I see the value of ORCC at the current price of $13.26, which is well below the 52-week high of $15.33 that was reached as recently as April. This translates to a book value price of just 0.89x, and it occupies the lower end of its valuation range, which has been trending near 1.0x for most of the previous 12 months. Sell-side analysts have a consensus rating of buy on ORCC, with an average target price of $15.34. This means a one-year potential total return of 25% including dividends.
Owl Rock Capital is a very large BDC that has seen a significant weakening in stock prices in recent months. It enjoys a very low historical loss rate, with non-accrued receivables representing only 0.1% of the fair value of its portfolio. Looking to the future, ORCC should see the material benefits from a high rate environment. ORCC is buying at the current price of the high income.