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What ORCC's Earnings History Should Tell Us About Valuations

|About: Owl Rock Capital Corporation (ORCC)

Pre-IPO, Owl Rock Capital (ORCC) had earnings growing like a weed as it also grew its portfolio. As long as ORCC can find a market that is willing to pay more than its NAV for new shares - ORCC should be able to continue that growth. But at the same time ORCC was growing shares and income - the NII/share growth and NAV/share growth was relatively flat.

The historical numbers:

Owl Rock Capital Q2-19 Q1-19 Q4-18 Q3-18 Q2-18 Q1-18
Realized and Unrealized Gain 5,042 18,482 -47,970 718 -1,626 5,599
Real + Unreal Gains/share 0.0177 0.0784 -0.2430 0.0044 -0.0133 0.0555

All BDC's had strongly negative "gains" in Q4-18 - as did ORCC. The Realized and Unrealized Gains/share were negative 24 cents for that quarter. The NAV fall was 17 cents (from 15.27 to 15.10) as ORCC had less in dividends than it did in NII.

All the other quarters (with one minor exception) had positive gains that resulted in NAV growth. This is clearly a superior record. It is my perception that this attribute has inertia.

Owl Rock Capital Q2-19 Q1-19 Q4-18 Q3-18 Q2-18 Q1-18
Interest income 162,334 148,736 121,959 101,959 79,907 61,289
Fee income 11,614 400 2,064 6,054 3,237 2,505
Other income 2,187 2,339 2,806 3,391 2,956 1,650
Total investment income 176,135 151,475 126,825 110,485 86,100 65,444
Net investment income 119,622 96,005 82,896 71,608 52,341 38,677
Investments @ fair value 7,241 6,832 5,784 4,693 3,485 3,029
Wt Av Share Count 284,751 235,886 197,425 163,401 122,691 100,924
TII/share $0.6186 $0.6422 $0.6424 $0.6762 $0.7018 $0.6484
NII/share $0.4201 $0.4070 $0.4200 $0.4382 $0.4266 $0.3832
Rpt NII/share $0.41 $0.41 $0.41 $0.33
Div/share $0.35 $0.44 $0.36 $0.39 $0.34 $0.33
NAV/share $15.28 $15.26 $15.10 15.27 15.21 15.14
Port Wt Av Yield 9.1% 9.4% 9.4% 9.4% 9.4% 9.3%
Av Stated Yield on Debt 5.0% 4.7% 4.4% 4.3% 4.0%
3 month LIBOR 2.3% 2.6% 2.8% 2.4% 2.3% 2.3%
TII/Portfolio 9.73% 8.87% 8.77% 9.42% 9.88% 8.64%
NII/TII Ratio 67.9% 63.4% 65.4% 64.8% 60.8% 59.1%
# Portfolio Companies 90 81 73 65 51 47
Oil & Gas % of Port x.x% 5.0% 4.9% 5.9% 5.0% 5.1%
Energy Equip % of Port x.x% 1.4% 1.6% 1.4% 1.8% 4.6%
Rpt PIK Income-YTD 8,497 3,631 3,393 2,387 1,114 1,114
Rpt PIK Income-Qtr 4,866 3,631 1,006 1,273 0 1,114
Rpt PIK/TII 2.76% 2.40% 0.79% 1.15% 0 1.70%

I (or "we") learned from SunTrust analyst Mark Douglas Hughes that ORCC is waiving incentive fee for five quarters after its July IPO before charging competitive fees. The high NII/TII ratio strongly indicates that waiver has been going on since at least the beginning of 2018.

There is a fair amount of standard deviation in this NII/TII metric. The sector average is around 50%. Thus a decent estimate for "adjusted NII" that omits the fee waiver (a number that should be a better "run rate NII") would be roughly half of the TII. (And this is why I have highlighted those numbers - they are the evidence that an adjustment is needed in setting forward expectations.) Cutting the TII/share in half would produce adjusted NII of

0.3093 -- 0.3211 -- 0.3212 -- 0.3381 -- 0.3509 -- 0.3242

Looking only at those numbers -- a sustainable dividend that fits that number series would be $0.31/share per quarter. And $0.31/share per quarter just happens to be the current regular dividend.

The above content strongly suggests basing a valuation based on a $0.31 dividend as to 2020 projected dividends in the low 40s.

Owl Rock Capital Q2-19 Q1-19 Q4-18 Q3-18 Q2-18 Q1-18
Debt 1,570,621 2,769,805 2,567,700 1,974,629 1,485,464 1,338,495
Debt/share 5.5158 11.7421 13.0060 12.0846 12.1074 13.2624
Debt/share to NAV 36.10% 76.95% 86.13% 79.14% 79.60% 87.60%
Interest expense 36,858 34,729 26,229 21,386 17,102 12,057
Interest expense/share 0.1294 0.1472 0.1328 .1309 .1394 .1195
Interest expense/TII 20.93% 22.93% 20.68% 19.36% 19.86% 18.42%
Annualized Int exp/Debt 9.39% 5.01% 4.09% 4.33% 4.61% 3.60%
PWAY - Int exp/Debt -29 bps 439 bps 531 bps 507 bps 479 bps 570 bps

ORCC has filed with the SEC that it is considering raising capital by offering more shares - or offering preferred shares -- or by raising debt. The very low Debt/share to NAV/share ratio strongly suggests the next capital raise will not come from equity.

The debt ORCC already owes to others

2023 Notes $150 million Fixed Coupon: 4.75% matures 06/21/23

2024 Notes $400 million Fixed Coupon: 5.25% matures 04/15/24

Ignoring the Q2-19 numbers, the "Annualized Interest expense/Debt" ratio numbers produced in the above spreadsheet is a good fit with those numbers for the notes. The average has drifted higher as the percentage of debt from notes grows - and as the percentage of debt from the credit facility shrinks.

The Q2-19 earnings release supplement informs us that ORCC has a BBB- credit rating from Krolls and S&P. ORCC is positioned well to raise a boat lode of longer term debt at lower yields. But until that is done - there is uncertainty as to the cost of that upcoming debt.

Having an interest expense to TII ratio of around 21% is "not pretty". Having that high of a ratio (technically - "that moderate of a ratio") combined with the leverage being so low  . . . is a bit ugly.

Summation:

(1) Great trends on "gains" and NAV - which is bullish news when giving ORCC a correct Price/NAV assessment.

(2) Historical "Adjusted NII" suggests $0.31 is a good run rate dividend - and that is bearish news.

(3) There is uncertainty on the forward cost of debt - bearish news potential.

(4) All this supports the conclusion that the yield is (potentially) too dang low at the current price (15.94 - which is 1594/1528 or 104.32% of NAV). But I would not be a good investment writer if a failed to throw in an "on the other hand". ORCC clearly has an NAV trend that supports the expectation of it selling above its NAV. And five more quarters without an incentive fee is the recipe for continued increases in its NAV.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in ORCC over the next 72 hours.