My Next Buy Is 7.5%-Yielding Sixth Street Specialty Lending
- TSLX is a very high quality BDC, with a stellar track record of delivering shareholder returns.
- This includes the pandemic period during which it maintained healthy profitability, and saw NAV/share growth.
- I also highlight the valuation, regular and special dividends, balance sheet, and risks worth considering.
BDCs are well-known for being an asset class that pays a high dividend yield. However, a true measure of quality lies in how well the company has preserved shareholder capital and delivered returns over time. In this article, I'm focused on Sixth Street Specialty Lending (NYSE:TSLX), which has done well for its shareholders since inception. I evaluate what makes TSLX a BDC worth buying at present, so let's get started.
Why TSLX Is A Buy
Sixth Street Specialty Lending is an externally managed BDC that invests in U.S. based middle-market companies, through direct originations of senior secured loans, and to a lesser extent, mezzanine loans and equity securities. TSLX benefits from its affiliation with its manager, Sixth Street, a global investment firm with over $50B in assets under management. TSLX also charges a fair base management fee of 1.5%, which is in line with industry bellwether Ares Capital (ARCC).
I view this as being a big plus for TSLX, as it gets the benefit from the "big brother" expertise, and deal flow that comes along with it. This strategy has served TSLX well over the years. As seen below, an investment in TSLX ten years ago (TSLX was a private company back then) would have doubled in intrinsic value, based on accumulated dividends and steady improvement in NAV. This tells me that management has been good stewards of shareholder capital.
(Source: Q4'20 Investor Presentation)
More recently, TSLX's total return performance has surpassed that of its well-recognized peers, Main Street Capital (MAIN) and Ares Capital, and even that of the S&P 500 (SPY). As seen below, TSLX has produced a total return of 130% over the trailing 5 years, surpassing the 116% return of the S&P 500, and the 94% and 105% returns of MAIN and ARCC, respectively.
(Source: Seeking Alpha)
At present, TSLX has a portfolio fair value of $2.3B, spread across 70 investments. I see the portfolio as being rather safe, as 96% of it is in the form of first-lien secured debt, with less than 1% exposure to 2nd lien and mezzanine debt instruments. Much of the remaining 4% is in the form of equity investments, which provide a growth kicker.
TSLX has continued to provide steady growth amidst a difficult economic backdrop. This is illustrated by the improvement in NAV/share over the pandemic period, from $16.83 at the end of 2019 to $17.16 at the end of 2020. It's worth noting that TSLX's NAV/share became $15.86 after the recent $1.25 per share special dividend. These strong results were driven by the 16% economic return that TSLX achieved during 2020, exceeding its average 12.2% economic return since IPO through 2019. Meanwhile, TSLX's non-accruals remain very low, at just 0.9% of the portfolio at fair value.
(Source: Q4'20 Investor Presentation)
Plus, the NII/share actually increased during Q2 and Q3'20 before coming back down to $0.48 per share in the fourth quarter. I'm not too concerned about the slight decline in YoY NII/share, as $0.02 of it was related to a capital gains incentive fee expense. Adding this back results in an adjusted NII/share of $0.50, which is very close to the $0.51 generated in Q4'19.
Looking forward, I see the potential for further improvements in the NII/share, as interest rates have seen an upward revision this year. TSLX has 99.1% floating rate debt investments, and low interest rates have resulted in a drop in the weighted average portfolio yield from 10.7% at the end of 2019 to 10.2% at the end of 2020. Given the exposure to interest rates, TSLX should see a higher portfolio yield in the first half of this year, considering that interest rates have now recovered to 1.67%, as of April 6th.
Plus, management is optimistic on deal flow this year, and is prepared to take advantage of market volatility, as noted during the recent conference call:
"In the near-to-medium term, we believe this could create windows of volatility and risk-off behavior in the broader markets, which would once again allow us to opportunistically deploy capital like we did this spring and summer.
In the meantime, however, we felt that it was prudent to focus our originations efforts on sectors and themes that have been the hallmark of our above-market returns and continue to reinforce the defensive nature of our portfolio."
This is supported by the healthy balance sheet, with a debt to equity ratio of 0.95x, sitting well below the 2.0x regulatory limit, and is slightly less than the 1.0x level at the end of 2019. Meanwhile, TSLX's 7.5% dividend yield is well-covered, at an 83% payout ratio. We also mustn't forget that TSLX pays special dividends, which contribute to the total return story. While the recent $1.25 dividend was rather high and somewhat of an anomaly, TSLX did manage to pay $0.66 in special dividends in 2020, spread across 4 uneven installments.
Turning to valuation, I continue to find TSLX to be attractively valued at the current price of $21.80 with a price to book value of 1.27x. As seen below, this is more or less in line with TSLX's historical average prior to the pandemic. While this may seem expensive for an externally-managed BDC, I find it to be reasonable, considering TSLX's stellar track record of shareholder returns.
(Source: Seeking Alpha)
No investment is risk-free, and the following points are worth considering:
- BDCs, including TSLX, are sensitive to interest rates, as low rates negatively impact portfolio yield. While I'm encouraged by the recent upswing in interest rates, there's no guarantee that this trend won't reverse.
- Sixth Street Partners (TSLX's advisor) is currently in litigation to prevent its stakeholder Dyal Capital Partners from merging with its competitor Owl Rock Capital Corp. (ORCC). That's because Sixth Street believes this will create a conflict of interest between Dyal and TSLX. This is something worth monitoring and considering.
TSLX is a premier BDC with a stellar track record of delivering shareholder returns. This includes the pandemic period during which it saw healthy NII/share and NAV/share performance. This is supported by a conservative management style, with primarily first lien loans, a shareholder-friendly fee structure, and a healthy balance sheet. I continue to see value in TSLX at the current price and view it as a Buy.
This article was written by
I'm a U.S. based financial writer with an MBA in Finance. I have over 14 years of investment experience, and generally focus on stocks that are more defensive in nature, with a medium to long-term horizon. My goal is to share useful and insightful knowledge and analysis with readers. Contributing author for Hoya Capital Income Builder.
Analyst’s Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in TSLX over 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.
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