This 10%-Yielding “Alternative Bank” Pays More Than You Think
A High-Yield Stock to Think About
Very often, what yield-hunters do is use a stock screener to find companies that offer the highest dividend yields. I’m not a particular fan of that method, for the simple reason that there’s much more for an income investor to consider about a company than merely its dividend yield. Moreover, in the case of some dividend stocks, the companies might be paying more than the stated yields you find on financial web sites.
For instance, if you look up Owl Rock Capital Corp (NYSE:ORCC) on Yahoo! Finance or MarketWatch, you’ll see that the company has an annual dividend yield of about 10%. That’s an extremely generous amount considering that, in the current market, most stocks don’t even pay half as much.
However, if an investor buys shares of ORCC stock today, they could earn a yield that’s even higher.
Allow me to explain.
Owl Rock Capital Corp is a business development company (BDC) headquartered in New York City. I consider it an “alternative bank” because it is in the lending business, but does not serve retail customers like you and I. Instead, it provides direct lending solutions to middle-market companies.
Right now, the average customer of this alternative bank generates $449.0 million of annual revenue and $93.0 million in annual earnings before interest, tax, depreciation, and amortization (EBTIDA). (Source: “Quarterly Earnings Presentation,” Owl Rock Capital Corp, June 30, 2020.)
If you’ve been following this column, you’d know that I’m a big fan of alternative banks because of their pass-through structure. In particular, as long as a BDC distributes at least 90% of its profits to shareholders through dividends, it pays little to no income tax at the corporate level.
In the case of Owl Rock Capital, it has a quarterly dividend rate of $0.31 per share at the moment. With Owl Rock Capital stock trading at $12.26 per share, that quarterly payout translates to an annual yield of about 10%—and that’s the figure you see on financial web sites.
However, other than paying a generous quarterly dividend, the BDC also dishes out special dividends. In fact, the company has already paid four special dividends since its initial public offering (IPO) in July 2019. (Source: “Dividends,” Owl Rock Capital Corp, last accessed August 27, 2020.)
Of course, with the COVID-19 pandemic, a lot of businesses have been struggling, and we’ve seen plenty of dividend cuts across industries.
And that’s where Owl Rock Capital stands out. At the time of this writing, the company’s board of directors has already declared a regular quarterly dividend of $0.31 per share to be paid in November 2020, a $0.08-per-share special dividend also to be paid in November, and another $0.08-per-share special dividend to be paid in January 2021. Management also intends to pay a regular quarterly dividend of $0.31 per share in January 2021, subject to approval from the board of directors. (Source: “Owl Rock Capital Corp, June 30, 2020, op. cit.)
The reason the company managed to pay those special dividends and declare two more was that its advisor put in a fee waiver in connection with its IPO. The fee waiver will expire in October 2020 and ORCC’s advisor is not extending or renewing it.
Looking at the financials, we see that Owl Rock Capital generated net investment income of $0.34 per share in the second quarter of 2020. While the amount was down both quarter-over-quarter and year-over-year, it was more than enough to cover the company’s regular quarterly dividend payment of $0.31 per share. (Source: “Owl Rock Capital Corp. Reports Second Quarter Net Investment Income Per Share of $0.34 and NAV Per Share of $14.52,” Owl Rock Capital Corp, August 4, 2020.)
Given the impact of the pandemic, you are probably wondering how the BDC’s lending portfolio is doing.
Well, the first thing to note is that Owl Rock has a strong focus on senior secured lending. In fact, more than 80% of the company’s portfolio by fair value was made up of first-lien debt investments as of June 30. If you are lender of first lien, you stand first in line to get paid in the event of a borrower liquidation.
Second, the portfolio is well diversified across 102 companies in 27 different industries. Owl Rock’s top 10 positions represented just 24% of the portfolio by fair value at the end of June. (Source: “Owl Rock Capital Corp, June 30, 2020, op. cit.)
Third, the BDC has not experienced any loss of original principal since its inception. The non-accruals—loans that are not generating their stated interest rates due to non-payment from the borrower—represented less than two percent of the total fair value of Owl Rock’s portfolio.
Furthermore, the BDC continues to be investment-grade-rated by Standard & Poor’s Financial Services LLC, Fitch Ratings, Inc., Moody’s, and Kroll Bond Rating Agency, LLC.
Will Owl Rock Capital Corp Keep Delivering Oversized Dividends?
Now, as I mentioned earlier, the fee waiver—the main reason behind ORCC stock’s special dividends—will come to an end in October. Will that impact the company’s regular dividend policy?
Well, in Owl Rock Capital’s August earnings conference call, Chief Executive Officer Craig Packer said, “[W]e would expect net investment income to trail our regular dividend level upon the expiration of our fee waiver in the fourth quarter.” (Source: “Owl Rock Capital Corporation (ORCC) CEO Craig Packer on Q2 2020 Results – Earnings Call Transcript,” Seeking Alpha, August 5, 2020.)
The company plans to address the shortfall by ramping up its portfolio to its target leverage level, which should help boost the company’s earnings power. Management expects the BDC to be operating in the target leverage range and generate enough net investment income to cover the regular payout by the second half of 2021.
Packer added, “Until then, we expect to be able to continue to pay our regular dividend of $0.31 per share as well as our previously declared special dividends.”
So if things go as planned, investors will get two more $0.08-per-share special dividends and four $0.31-per-share quarterly dividends in the next 12 months. That adds up to $1.40 per share. Based on a share price of $12.26, Owl Rock stock has the potential to deliver an actual yield of 11.4%.