Owl Rock Capital Stock: Will benefit from rising rates (NYSE: ORCC)
Are you looking for a good investment with high yield and increasing rates? Take a closer look at Owl Rock Capital (ORCC).
business development companies have attracted increased interest from income-oriented investors seeking higher and sustainable dividend yields. This industry lends to private companies, often in conjunction with sponsors/lenders, such as venture capitalists, thereby giving retail investors exposure to unlisted companies.
Like most businesses, BDCs were heavily discounted in the COVID Crash of 2020. Since BDC invest in private companies, investors abandoned them, as they were extremely suspicious of the resilience of these companies in a pandemic environment.
It turns out that most BDCs came out of 2020 in good shape, with their underlying holdings weathering the storm. The fact that other sponsors made large investments in these companies certainly helped, as they were able to provide support.
Investing in BDCs can be tricky business. As in any other industry you invest in, you need to trust management and believe that they will be able to deliver on their promises.
In our conversation with Jonathan Lamm, CFO of ORCC, many key points were raised, but one that stands out relates to how BDC values its holdings.
In the case of ORCC, the companies it owns are valued and appraised each quarter by an independent firm, Duff & Phelps. This does not apply to everyone BDCsome of whom perform some or all of this process internally, which constitutes a conflict of interest.
Why is this so important? Because it directly affects a BDC’s “net change in unrealized gains,” which is tied to the BDC’s net asset value, net asset value, which is one of the key metrics used by investors.
As we mentioned, 2020 has been a difficult year for BDC. ORCC’s 2021 10K shows that its unrealized gains were actually a loss of $76 million in 2020 due to markdowns. However, this reversed significantly in 2021, with the swing in unrealized gains increasing to ~$180M, a positive swing of $256M, as conditions improved:
Another point is management’s underwriting expertise, which is normally reflected in portfolio ratings each quarter. Although some BDCs do not publish a quarterly rating table, ORCC does, with ratings ranging from 1 -, “Borrower is performing above expectations”, to 5 – “Borrower is performing significantly below expectations”. expectations and indicates that the risk of the loan has increased significantly since origination or acquisition.” (ORCC website)
ORCC’s holdings ratings improved throughout 2021, with #4-rated investments falling from $218 million in Q1 2021 to just $16 million in Q4 21. Unearned investments as of 31/ 12/21 as a percentage of total debt investments at cost and fair value were only 0.2% and 0.1%, respectively. At the end of the 12/31/21 quarter, there were two non-recognized holding company investments.
These low non-recognitions are no accident – as CFO Lamm reminded me, ORCC has one of the lowest loss ratios in the BDC industry, at only 15 basis points annualized.
ORCC’s $12.7 billion portfolio spans 143 companies, with an average EBITDA of $136 million and a return on assets of 7.7%.
The rate hike will have a positive impact:
Another topic we discussed was the effect of rising rates on ORCC’s revenue. Good news for both assets and liabilities: 99% of ORCC’s debt investments are at variable rates, a strong point in the new environment of rising rates, with an average LIBOR floor of 85 basis points.
On the liability side, ~50% of ORCC’s debt is fixed rate, so ORCC should benefit from a rising rate environment.
After the 2008 financial crisis, it became increasingly difficult for middle and lower market businesses to access capital from banks, which led to the emergence of unitranche loans.
There are two main types of unitranche loans: straight and bifurcated. Direct loans are stretched senior loans that offer five to six rounds of leverage, which is tied to the borrower’s debt to EBITDA ratio, while bifurcated loans deal with first loan and loan terms. last loan.
Unitranche loans have become a larger part of ORCC’s portfolio – its access to the large $35 billion Blue Owl platform gives it access to these larger loan investments. Management has evaluated more than 40 deals with install sizes greater than $1 billion and signed or closed about half of them in 2021. It estimates that unitranches make up about 40% of the portfolio.
As we pointed out in a previous article on ORCC, size matters – ORCC is the the third–the largest BDC, with a market capitalization of $5.73 billion, compared to the BDC industry average of $1.45 billion.
ORCC had a robust Q4 21, with revenue up 27%, NII up 20% and NII/Share up 20.7%. NAV/unit increased 2.3% to $15.08, while unrealized gains were $81M, down 32%, and realized gains increased 60%. The number of shares was roughly stable.
New investment commitments and financings totaled $1,589 and $1,460 respectively for Q4 ’21. Commitments were spread across 42 holdings in 31 portfolio companies, including 22 new portfolio companies. ORCC received full refunds on nine holding companies and partial refunds on 12 holding companies. Net funded investment activity was $550 million.
At its closing price on 02/25/22 of $15.07, ORCC is selling at a slight discount to its 12/31/21 NAV/share of $15.08, which compares favorably to BDC’s average 5% premium to NAV. ORCC’s price/NII of 12.15X is also below the industry average of 13.26X, while its EV/EBIT is in line.
At its closing price of $15.07 on February 25, 2022, ORCC is yielding 8.23%. Management has declared a regular distribution of $0.31, which will be ex-dividend on 3/30/22, with a payment date of 5/13/22.
In previous earnings calls, management said it was targeting greater than 1X dividend coverage in the second half of 2021. This was a big deal because, like many BDCs, ORCC had benefited from fee exemptions, which enabled it to cover its dividends. However, these fee waivers expired in the fourth quarter of 2020.
It was an uphill battle, but management delivered on its promise of positive dividend coverage, growing from just 0.84X in Q1 ’21, and steadily improving, to 1.06X in Q3 ’21, and more , at 1.13X in Q4 ’21.
Their rolling dividend coverage is expected to increase in 2022 as these sub-1X quarters fall off the average.
Profitability and leverage:
2021 saw a marked improvement in ROA and ROE, while EBIT margin and EBIT/interest coverage were both lower. Debt leverage has increased in 2021, but that’s part of the BDC industry landscape – management needs to take on a little debt to boost profits. The trick is not to let the debt get overloaded. CFO Lamm felt that the current 1.13X – 1.19X is a sweet spot for ORCC.
Debt and liquidity:
ORCC had $1.8 billion in cash liquidity and undrawn debt as of 12/31/21. Its first debt maturity is not until December 2023, when a $500 million SPV matures. Management increased commitments in ORCC’s revolving credit facility by $100 million to $1.655 billion in 2021. The company has four investment grade ratings.
In some of our previous articles, we have referred to ORCC as speculative buying. However, at this point, we turn it into a buy, based on management performance in 2021, and achieve good dividend coverage, even paying an incentive fee. ORCC’s profitability is expected to rise in the era of rising rates, and it has ample access to larger investment deals and funding, which should serve it well.
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