Owl Rock Capital Stock: We Buy This 8.6% Yield (NYSE:ORCC)
This article is co-produced with Nicholas Ward.
Since its IPO in 2019, Owl Rock Capital Corporation (NYSE: ORCC) has been one of our favorite BDCs, thanks in large part to the company’s conservative and disciplined management team.
ORCC has done very well as it has restructured its portfolio quite a bit over the last year or so and the company recently released what we thought was a strong Q4/full year report. However, since then, ORCC shares have sold off from the $15.10 area to its current price of $14.54.
This liquidation pushed ORCC’s dividend yield above the 8.5% threshold. It also pushed its P/NAV ratio below the 1.0x level. Therefore, we wanted to highlight what we believe is an irrational drop in this name, which continues to be one of our favorite high-yield investments in today’s market.
Because ORCC is a relatively young BDC, the company lacks the established dividend payout history and multi-year dividend growth streak that many investors look for when thinking about passive income vehicles. High quality ; However, when we look at that 8.55% yield, we believe the fundamentals of the company point to a relatively safe dividend (which is rare for a stock with such a high yield in the current low rate environment).
Since its inception, ORCC has made very regular dividend payments. ORCC has paid a dividend of $0.31/share since its IPO, with 5 additional special dividends to boot.
ORCC has not paid a special dividend in over a year due to the expiration of its management fee agreement. Since then, ORCC has had to increase its NII to cover its dividend organically. However, throughout 2021, ORCC management was able to meet its guidance and in the third and fourth quarters, the company’s NII exceeded the payout level of $0.31/share.
It’s impressive to see a business run as efficiently and accurately as ORCC did in 2021. Management’s guidance has been accurate with respect to NII’s growth story, and now that ORCC has released its fourth quarter 2021 earnings report, let’s take a look at the company’s performance, with a particular focus on the continued safety of dividends.
As long-time followers of ORCC know, this management team has quite ambitious goals to increase its leverage ratios with the goal of increasing the NII once its management fee expires. ORCC’s management team is known for its focus on high quality assets/loans which has historically resulted in extraordinarily low non-accumulation rates.
Throughout 2021, ORCC was able to increase its leverage ratio, as well as slightly increase the risk profile of its loan portfolio, helping its NII meet its growth targets. But, as you’ll see in a moment, the company hasn’t sacrificed its standards when it comes to the portfolio loans it makes and continues to offer top non-credit ratings.
With specific regard to loans in default, ORCC noted that as of 12/31/2021, there were 2 loans made to 1 holding company, which represented 0.01% of the total fair value of the portfolio, in a situation of non-regularization .
As a conservative BDC investor, you can’t ask for a better return than that.
ORCC CEO Craig Packer discussed the 2021 annual results in the fourth quarter press release:
“2021 was a landmark year for us. We fully deployed our portfolio, increased our leverage comfortably within our target range, maintained very good credit performance and continued to optimize our balance sheet. This resulted in our quarterly net investment income highest of the year, representing an annualized ROE of approximately 9%. We are extremely pleased with the results this quarter and look forward to continuing to serve our shareholders in 2022.”
Now, getting back to the dividend hedge, looking at the company’s recent Q4 report, we see that ORCC’s NII has improved to $0.35/share (from $0.33/ action in Q3 on a sequential basis).
From the chart below, it is clear that ORCC’s NII has moved in the right direction over the past year. During the fourth quarter, the Company’s NII dividend coverage was 88.6%.
Regarding the increase in leverage and continued investment push by this management team, in its fourth quarter report, ORCC stated, “For the full fiscal year ended December 31, 2021, new investment commitments totaled $6,824.8 million. This compares to $3,444.8 million for the fiscal year ended December 31, 2020.”
Looking at the types of loans taken out by management, we see that ORCC is still heavily focused on senior securities.
Regarding the distribution of its loan, the company said:
“As of December 31, 2021, on a fair value basis, our portfolio consisted of 74.9% first-tier secured debt investments, 15.1% second-tier secured debt investments ranking, 1.5% investments in unsecured debt, 1.9% investments in funds and investment vehicles, 2.1% investments in preferred shares and 4.5% investments in common shares. »
During the fourth quarter earnings report, management highlighted year-end 2020 portfolio metrics, to give investors a comparative view. They said,
“As of December 31, 2020, on a fair value basis, our portfolio consisted of 77.5% senior secured debt investments, 18.5% senior secured debt investments, 0 .5% investments in unsecured debt, 1.0% investments in funds and vehicles, 0.2% investments in preferred shares and 2.3% investments in common shares.
As you can see, in 2021 they raised the risk profile of their investment portfolio a bit; however, this is not necessarily a bad thing.
Historically, we’ve seen other well-known/top-notch BDCs, which as crowd favorites Main Street Capital (MAIN), use common stock deals to increase their growth rates and help sustain a reliably growing dividend over time.
It appears that ORCC has embraced this strategy a bit more over the past year as they attempt to improve their adjusted risk/reward profile in an effort to meet their NII targets.
Going forward, we wouldn’t be surprised to see equity investments continue to grow as a percentage of ORCC’s loan portfolio. This could eventually lead the market to place a higher multiple on ORCC once it establishes higher growth rates. However, it is clear that senior loans will continue to dominate ORCC’s debt exposure, which is likely to reassure investors.
Management continues to do a good job of maintaining a well-diversified portfolio. We believe that the focus when looking at BDC’s portfolio should always be on loan quality and non-recognition rates, not necessarily the industries in which they exist, but nonetheless, we are pleased with the mix overall ORCC loan portfolio.
As for the portfolio’s debt maturity following ORCC’s recent investment surge, we see that the company has no pressing issues in this regard.
Management has done a good job of staggering its maturing dates. ORCC maintains a high degree of liquidity. And, in the meantime, the company generates strong spreads on its investments due to its strong balance sheet, relatively high credit rating (ORCC’s S&P 500 credit rating is BBB-, the same as MAIN’s ) and the low weighted average interest rate of only 2.9%.
Finally, we will discuss net asset value (“NAV”) which often plays a key role in fair value estimates across the BDC space. Generally speaking, a conservative NAV ratio in the BDC space is 1.0x and after the recent drop in ORCC, the company is now trading with a NAV ratio of 0.96x.
As you can see below, ORCC’s net asset value increased again during the fourth quarter, to $15.08/share, up slightly from the third quarter result of $14.95. .
A year ago, that figure was $14.74. As you can see from the chart below, ORCC’s NAV has steadily increased throughout 2021.
Even after ORCC’s recent pullback, its shares have outperformed the market by a significant percentage in 2022 so far. They are up 2.11% year-to-date, as opposed to the S&P 500’s 11.5% loss.
It’s clear that during the market’s flight to safety, investors favored this relatively conservative, high-yielding BDC. And, with interest rates likely to rise, we wouldn’t be surprised to see this trend continue.
Overall, ORCC continues to perform well and we maintain our bullish outlook on this company as the highest rated high yield stock. ORCC’s 8.55% return, combined with ongoing multiple expansion prospects, leads us to believe that this stock offers double-digit total return potential going forward.