Owl Rock Capital Stock: 9.6% return, 11% discount (NYSE:ORCC)
Looking for a high yield investment that benefits from rising interest rates?
Take a look at Owl Rock Capital (NYSE: ORCC), the 3rd largest company in the industry of the Business Development Corporation, BDC.
A key bright spot for ORCC in the stream rate hike environment is that 99% of its assets are floating rate, while 47% of outstanding debt is fixed rate. Thereafter, a 100 basis point increase in rates would add approximately $0.04/share per quarter to net investment income, NII, after taking into account the impact of income-based fees.
LIBOR is currently at 2.36%, down from 1.79% a month ago, and much higher than just 0.09% a year ago. The majority of ORCC borrowers have floors of 100bps – management expects the benefits of the rate increases to begin in the 2nd half of 2022, and we can see this has already started happening in second quarter of 2022.
ORCC’s average yield on debt and income jumped 100 basis points in Q2 22 to 8.9% from 7.9% in Q1 22, while its interest rate on outstanding debt only increased by 30 basis points, to 3.2%:
ORCC benefits from its size – it is the 3rd largest BDC by market capitalization, with access to the massive $44.8 billion platform of its parent company, Blue Owl (OWL), which includes several other companies and 4 types of direct lending segments – Diversified, Technology, 1st Link, and Opportunistic, in addition to its $6.8 billion in assets under management in its Wellfleet CLOs.
ORCC’s $12.6 billion portfolio includes 88% senior secured investments and 73% senior secured investments in 168 companies, with an average annual EBITDA of $151 million. Management has done a good job of selecting these investments – there is only a 13 basis point loss since inception.
Valuations of portfolio companies:
Management reviews and evaluates ORCC’s holdings quarterly, on a 1 to 5 level system, with 1 being the best financial performance and 5 the lowest.
As of 6/30/22, there was 1 non-recognized company, which equated to only 0.1% of ORCC’s portfolio (on a fair value basis), one of the highest levels bottom of the BDC sector. Upper Tiers 1-2 accounted for 89.5% of the portfolio, as in Q1 22:
ORCC’s top 4 sectors account for ~38% of its holdings, with software and internet services leading at ~12%, followed by financial services at ~10%, down from 9% in Q1 22. a weighting of 8.8%, restaurants at 7%, same as in Q1 22. The majority of the portfolio is made up of non-cyclical companies in service-oriented sectors, such as software, insurance and healthcare.
Q2 2022 investment income increased 9.75% to $273.3m from $249m in Q1 2021. Net investment income was $125.1m, up 5 %, compared to $119 million a year ago.
Net asset value/unit fell $0.40 from $14.88 in the first quarter to $14.48 as of 6/30/22, primarily due to net changes in unrealized gains from approximately $159 million. There was a decline in the value of portfolio units due to market adjustments due to the impact of widening credit spreads.
ORCC experienced good growth in H1 2022, with total investment income up 14%, NII up 11.6% and NII/share up 12.5%. The number of shares was roughly stable.
In Q2 ’22, new investment commitments totaled $603.4 million in 16 new portfolio companies and 10 existing portfolio companies. This figure increased by approximately 14%, compared to $530.4 million in Q1 22, in 17 new portfolio companies and 4 existing portfolio companies.
The principal amount of new investments financed was $341.3 million, with a total principal amount of $488.3 million in sales and redemptions.
One of the advantages of ORCC’s size is that, unlike many smaller BDCs, it is capable of closing large transactions. For example, in Q2 22, management evaluated over 20 opportunities for $1 billion deals.
Financings were much lower in the 1st half of 2022 compared to 2021, with higher rates reducing refinancings and market uncertainty leading to lower M&A activity.
ORCC recently announced an equity commitment to Emergent Asset Management. Emergent is a new holding company created to invest in a leasing platform focused on rail and aviation assets.
Leverage and profitability:
Management increased leverage to 1.24X, within its target range, from 0.92X in pre-pandemic Q4 2020, to boost earnings. Rising debt isn’t seen as a bad thing by BDCs, which pay 90% of their taxable income to shareholders. The key here is that management is able to avoid over-indebtedness. ORCC’s debt/NAV is roughly in line with the BDC industry average of 1.13X, as is its EBIT/interest coverage.
ROA and ROE are down slightly compared to Q4 20, as is EBIT margin and EBIT/interest coverage.
Debt & Liquidity:
ORCC has no debt maturing before April 2024, when $460 million comes due. It ended the second quarter of 2022 with $1.7 billion in liquidity, made up of $1.4 billion in unused capacity on its credit facility and $0.3 billion in cash.
At its 8/4/22 closing price of $12.83, ORCC yields 9.66%. It will then be ex-dividend on 09/29/22, with a payment date of 11/15/22.
A big challenge for ORCC over the past 2 years has been to be able to cover its quarterly dividends when the incentive fee waivers expired. Management took on this challenge, starting in the third quarter of 2021 with a hedge of 1.06X. The NII/Dividend hedge was 1.03X in Q2 22, with a back hedge of 1.06X:
At its closing price on 8/4/22 of $12.83, ORCC is selling at an 11.4% discount to NAV, well below BDC’s industry average premium of 4%.
ORCC is also selling at a much cheaper earnings multiple of 9.79X, compared to the industry average of 13.93X.
Although it has underperformed the BDC industry, the broader financials sector, and the S&P 500 over the past month and quarter, ORCC has outperformed them over the past year and up. now in 2022:
Analyst price targets:
At $12.83, ORCC is 15% below analysts’ mid-price target of $15.09 and almost 20% below the highest target of $16.00.
We rate ORCC as a BUY, based on its attractive dividend yield, earnings outlook in a rising rate environment, low valuations and sound management.
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