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Oaktree Specialty Lending:  Is It Now Too Expensive To Own?

|About: Oaktree Specialty Lending Corporation (OCSL), Includes: OAK
Summary

There is a price that any asset is worth a buy.

Where does Oaktree Specialty now stand?

Why I sold a second tranche of my position yesterday.

I started buying OCSL last May when the shares were trading at $4.35.  The reason was because I believed them to be much too cheap compared to the value of the portfolio and the skills of the new manager Oaktree Capital (OAK).

Here is a link to a blog post I wrote regarding the purchase:

I Bought Oaktree Specialty Lending With A High Degree Of Confidence. - KMR holder

Over the past 13 months I have made a total of 7 buys with my position in OCSL eventually becoming my third largest position.  Today it is my second after my sale of the manager OAK. In February I sold about 18% of the position after the run up in price after the February conference call.  Last week after the May conference call the stock ran up even more and has continued to rally to prices above $5.70 yesterday, and I took the opportunity to sell 20% of my remaining position for $5.69.

My goal with the investment was to achieve high teens annual returns on the the purchase over a period of 2-3 years during which I believed that the market would come to understand that the severe discount to NAV of OCSL's portfolio would rationalize as the new management reworked the investment portfolio and monetized the bad assets while putting the capital to work on a sounder basis.  Much of the necessary work has been done in the one year since my purchase and a high teens annual return going forward seem less likely because the stock price has closed much of the discount to NAV.

The discount to NAV has shrunk from 35% to less than 15%.  Because of that, I believe that the level of capital risk has increased. At the same time the 8.5% yield at purchase has been reduced to under 7%.  At NAV the portfolio would yield less than 6%.  As the discount shrinks even, as the NAV increases, the investment becomes less desirable to me.  

My first sale back in February was at $5.19, for a 19.3% profit and an 19% reduction in my capital at risk.

My sale yesterday was at $5.69, for a 30.8% profit while I reduced my remaining capital at risk by an additional 20%.

Both of these gains do not include the 8.5% annual yield on my initial cost that I received in dividends over 3 and 4 quarters respectively.

My whole point here is that by buying the shares initially at a 35% discount to NAV, there was little capital risk because of the quality of the new manager.  One factor that is unique to BDC investing is that each quarter the manager tells investors what the portfolio is worth.  If the investor trusts the abilities of the manger to value the portfolio, it is quite easy to determine if you are paying too much or too little to own your share of the portfolio.  I continued to add as long as that discount remained greater than 25%.  At less than 15% today I will continue to hold an over-weight position in OCSL but significantly less than before.  I expect that OakTree will continue to grow the NAV of the portfolio because it now holds more performing assets and its leverage is at a reduced interest rate.  They have actually taken some leverage out of the portfolio as they continue to sell assets to eager buyers at good prices.  I also expect that the newer loans issued by Oaktree will have less credit issues over the next few years, than those that have been sold.

In my opinion, the answer to the question that led to this blog post, is no.  OCSL is not too expensive to own, but not as heavily as it was when I bought it.  I believe that it is too expensive to buy and I would only add to my position today below $5.  Should the price continue to climb in the next month or two, I would continue to sell.  Especially if the price got to $5.90 or higher, and would likely close my position as the share price gets much closer to NAV at $6.55.  At that point I would expect future annual total returns to be limited to 10% or so, and I would look elsewhere for value and greater capital safety.

Disclosure: I am/we are long OAK OCSL.

Additional disclosure: I could buy or sell shares in OCSL as described in the article. I plan on holding the remaining 10% of my OAK position until year end, but could sell earlier if conditions change..