In October of 2017, Oaktree Capital bought Fifth Street Asset Management and renamed it Oaktree Specialty Lending Corp.
Since the beginning of 2018 Oaktree Specialty Lending has seen increasing NAV and coverage of dividends by NII.
These trends combined with a recent positive Moody's rating and Oaktree Specialty Lending's discount to price/NAVPS of 0.82x mean that Oaktree is possibly undervalued for 2020.
Oaktree Specialty Lending's (OCSL) stock price has shot up 20.58% since 2018 under Oaktree's management. Combined with dividends this has resulted in 27% returns for investors. These returns are all backed by positive NAVPS growth over two years and a recent financially sound Moody's rating. Altogether Oaktree Specialty Lending looks like a very solid BDC stock for yield investors in 2020 with a dividend yield of 6.93%.
Oaktree Specialty Lending's January 2018 to January 2020 stock price. Sourced from SA.
Oaktree Specialty Lending is externally managed and administrated by Oaktree Capital Management, L.P. ("Oaktree"). Oaktree is a premier credit manager and leader among alternative investment managers. Oaktree currently manages over $125B in assets. Oaktree Specialty Lending has a market cap of around $766M and total investments at cost of about $1.54B.
Solid Increasing NAVPS
Oaktree Specialty Lending reported another solid quarter in early February. This quarter's NAV improvements add onto a previous string of seven quarters of NAV growth. Since 2018 the company has seen the NAV grow steadily from $858M to $931M. This is on top of the fact that they have not devalued shareholders ownership of NAV by introducing new shares. Since 2018 they have maintained 140,961 shares and NAVPS has increased by 8.5% from $6.09 to $6.61.
Positive Loan Ratings
Oaktree Specialty Lending has consolidated the number of companies in its portfolio from 125 to 106 since 2018. In December of 2019, Fitch assigned Oaktree Specialty Lending a BBB- and stable rating. In January of 2020, Moody's assigned Oaktree Specialty Lending a rating of Baa3 and stable. These ratings have been positive news for the company.
Their total investments at cost are $1.54B with a fair market value of $1.47B, representing a 95% coverage of investments. As of Q1 2020 and Q4 2019 there were three investments that were on non-accrual status.
- Cenegenics had two loans written off for $30M.
- Dominion Diagnostics had a $14.2M write off.
- PLATO Learning had a $2.5M write off.
This is positive since the company had seven investments on non-accrual a year ago. Some possible investment issues that may matriculate in 2020 are the following investments in Citgo Holdings, Covia Holdings (CVIA), and California Pizza Kitchen (NASDAQ:CPKI).
- Their $20M Citgo Holdings debt might be at risk due to it being tied up with Citgo's parent company Petroleos de Venezuela's (PDVSA) debt situation. Recent news suggests Citgo's debt is trading normally though.
- Covia Holdings has a $7.9M loan on the books marked down to $6.4M. Covia may be another victim of default in the oil and gas industry according to this news source.
- Oaktree Specialty Lending also has $3M in California Pizza Kitchen that could be at risk due to Moody's downgrading California Pizza Kitchen to triple C status.
Besides these risk factors above the future looks bright for Oaktree Specialty Lending as the company committed $134M to nine new and four existing portfolio companies in Q1 2020.
Poor Q1, but Solid NII coverage of Dividend Since 2017
Interest income went down for the quarter from $35M to $28M. This decline was attributed to decreased interest rates. The company was also hit by a $5.2M reversal of fees waived expense that became due this quarter. These combined for lower than expected net-investment-income (NII) of $7.8M which is down from $17.3M a year ago. The reversal of fees waived expense was the result of a two year contract being called in and doesn't seem to be overly concerning from a long-term perspective.
The perceived short-term increase in expenses and decline in interest income led to $0.06 net-investment-income-per-share (NIIPS) for the quarter. Unfortunately the (NIIPS) didn't cover the dividend announced of $0.095 per share for the quarter. This is disappointing but ignoring the jump in expenses due to the reversal of fees and the (NIIPS) was on track to cover the dividend for this quarter.
Since 2017 the (NIIPS) has covered the dividend. The increasing gains from operations of net assets also means that this company looks like it is on the right track. The company currently has a forward trading dividend yield of 6.93%.
Sourced from the company's 2020 10Q and 2019 10K
Decreasing Fees Percentages
For fee evaluation investors should consider net-expenses (NE) as a proportion of both total investment income and NAV. These ratios give investors a good idea of the company's expenses as a proportion to the revenues and the underlying assets.
Sourced from the company's 2020 10Q and 2019 10K
As the graph and table highlight expense ratios have significantly decreased under Oaktree's management since 2017. This past quarter's increase in net-expenses compared to last year is the result of the reversal of fee expense discussed previously. I expect this ratio to decrease for the year in the continuing trend since 2017.
Great Returns for Investors
From 2018 when Oaktree started managing the company, investors have seen a 27% total return when accounting for the $0.48 increase in equity and $0.87 of dividends. These returns mean 13.5% annual total returns for investors. Though this is below the S&P 500 returns for last year, it is above the historical averages and is positive for investors in the BDC space.
Technical Analysis and Comps to Peers
Now for technicals. The average 5-year yield of 10.64% is good but understand that the current forward yield is about 7% for the year which is below the peer average expressed in the table of 8.95%. ROA and ROE are both healthy compared to peers. Operating margins are low compared to peers but profit margins are great! I think management is looking to improve the operating margins as hinted by declining expense ratio trends above. Taking into account the healthy NAV growth trend and discount of 19% to P/B or price/NAVPS and this stock looks undervalued. Overall from this peer comparison I get a positive feel for the company.
Moody's January assignment of Baa3 and stable should be a good indicator for investors as to the level of risk of this company. Like most BDCs, Oaktree Specialty Lending is exposed to the fluctuation of interest rates. The company currently has 90.6% of its loans on flexible rates which is good as it means that it can adjust as rates go up or down. The below is a breakdown of the company's loans. The increase in senior secure debt should increase investors' confidence in the relative decrease in risk of the underlying loans.
Sourced from Q1 2020 report
The company has a high exposure to tech and biotechnology that investors may care to consider when investing in this BDC.
Sourced from Oaktree Specialty Lending's website
The company looks good from a risk standpoint in the BDC industry as management seems to be doing the right things. Investors must consider trends in the interest rates before investing as it seems rates may decline further toward zero this year. This is something to monitor from a BDC perspective as it will affect interest income and therefore NII and potentially dividends. Presently Oaktree Specialty Lending looks well positioned for the future though.
Since 2017 Oaktree Specialty Lending has made positive progress for investors under Oaktree management. Investors have seen NAV and NAVPS increases as well as good coverage of the company's dividends by the NII. These improvements with the recent positive ratings by Moody's and Fitch and the present discount of share price to NAVPS mean that Oaktree looks like a solid BDC for investors with a potential 18% upside and a 7% dividend yield.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: The content of this post is not meant as investment advice it is the expressed opinion of the author. The numbers and statistics were developed using public information from involved companies and may as all analyst work contains errors. Any decisions or actions made by readers or actors of this article are the sole responsibility of the readers or actors themselves and have no legal or financial responsibility or bearing on the author.