Outlook for 11%-Yield Oaktree Specialty Lending Stock Is Bullish
April 19, 2024
OCSL Stock Benefiting From Elevated Interest Rates
The Federal Reserve is expected to lower its key lending rate at least three times in 2024. Initially, analysts thought the cuts would be deep, but thanks to solid economic growth, they’re expected to be shallow.
Because of sticky inflation, the Fed said it was willing to maintain high interest rates for as long as necessary. Even when the rates do start to fall, they’re expected to remain well above pre-pandemic levels.
That’s good news for business development companies (BDCs) like Oaktree Specialty Lending Corp (NASDAQ:OCSL).
Why? BDCs, or what we at Income Investors like to call “alternative banks,” operate in much the same way as traditional financial institutions. They borrow money at one interest rate and then lend it out at a higher interest rate.
Unlike traditional banks, though, BDCs don’t serve the general public. They have no branches and no ATMs. They don’t provide mortgages, checking accounts, or credit cards.
Instead, they loan capital to small and midsized companies. These companies aren’t exactly what some people might consider small, however; they generate annual sales between $20.0 and $100.0 million.
Bank loans to “small” businesses are at their lowest level in a decade. This tightening, which is a result of the March 2023 collapse of Silicon Valley Bank, has led to more companies turning to BDCs for financing.
The current economic environment of high interest rates, lower bank lending, and low default rates is a compelling combination for BDCs like Oaktree Specialty Lending Corp.
Oaktree Specialty Lending loans capital to companies that have limited access to public or syndicated capital markets. As of the end of 2023, the BDC had $189.0 billion in assets under management in “contrarian, value-oriented, risk-controlled investment strategies across a variety of asset classes.” (Source: “Investor Presentation: First Quarter 2024,” Oaktree Specialty Lending Corp, last accessed April 16, 2024.)
Since the company was founded in 1995, that number has been growing. The company’s history of assets under management includes the following:
- 1995: $5.0 billion
- 2000: $18.0 billion
- 2005: $30.0 billion
- 2010: $84.0 billion
- 2015: $114.0 billion
Oaktree Specialty Lending Corp’s portfolio is made up of first-lien loans (78%), second-lien loans (eight percent), unsecured debt and equity debt (eight percent), and joint ventures (six percent). By interest rate type, 84% of the loans in the portfolio have floating rates.
As of the end of 2023, the BDC’s portfolio was made up of 146 companies.
The five biggest industries represented in the portfolio were software (15.2%), biotechnology (4.2%), data processing and outsourced services (4.2%), health-care services (4.0%), and health-care technology (3.6%). Three other industries represented in the portfolio are industrial machinery, pharmaceuticals, and interactive media.
Since 2005, Oaktree Specialty Lending Corp has invested more than $49.0 billion in more than 675 directly originated loans.
Strong Loan Origination Activity in Fiscal 1st Quarter
For the first quarter of fiscal 2024 (ended December 31, 2023), Oaktree Specialty Lending reported total investment income of $98.0 million, or $1.26 per share. That was down from $101.9 million, or $1.32 per share, in the fourth quarter of fiscal 2023. (Source: “Oaktree Specialty Lending Corporation Announces First Fiscal Quarter 2024 Financial Results and Declares Quarterly Distribution of $0.55 Per Share,” Oaktree Specialty Lending Corp, February 1, 2024.)
The company’s generally accepted accounting principles (GAAP) net investment income in the first fiscal quarter was $44.2 million, or $0.57 per share. That’s compared to $47.5 million, or $0.62 per share, in the prior quarter.
During the first quarter of fiscal 2024, Oaktree Specialty Lending Corp originated $370.3 million worth of new investments and received $213.5 million from prepayments, exits, and other paydowns and sales.
At the end of the quarter, the BDC had $112.4 million in unrestricted cash and cash equivalents, as well as $907.5 million of undrawn capacity under its credit facilities.
Commenting on the results, Armen Panossian, Oaktree Specialty Lending Corp’s CEO and chief investment officer, said, “Our first quarter results were highlighted by strong origination activity and adjusted net investment income that supports our cash distribution.” (Source: Ibid.)
He continued, “We leveraged the breadth of the Oaktree platform to invest $370 million across sponsor, non-sponsor and discounted publicly traded credit investments, generating net portfolio growth with a diverse set of attractive opportunities.”
Management Declared Q1 Dividend of $0.55 Per Share
As a BDC, Oaktree Specialty Lending Corp is legally required to distribute at least 90% of its taxable income to investors. This helps explain its reliable, high-yield distributions.
In March, Oaktree Specialty Lending stock paid a cash distribution of $0.55 per share. (Source: “Dividends,” Oaktree Specialty Lending Corp, last accessed April 16, 2024.)
As of this writing, that works out to a dividend yield of 11.44%.
OCSL stock has also paid special dividends over the last two years. Most recently, in December 2023, it paid a special distribution of $0.07 per share (in addition to a regular quarterly distribution of $0.55 per share. (Source: “Oaktree Specialty Lending Corporation Announces Fourth Fiscal Quarter and Full Year 2023 Financial Results and Declares Quarterly Distribution of $0.55 Per Share and Special Distribution of $0.07 Per Share,” Oaktree Specialty Lending Corp, November 14, 2023.)
Outlook for Oaktree Specialty Lending Stock Is Robust
Like most BDC stocks, OCSL stock began to climb in early November 2023 after the Fed announced it was holding its key lending rate. It kept climbing after the Fed said in December that it would be cutting the rate in 2024.
From the beginning of November 2023 through January 30, 2024, Oaktree Specialty Lending stock rallied by an impressive 17.5%. OCSL stock even hit a new all-time high of $21.04 on January 24.
Shares of alternative banks, including Oaktree Specialty Lending Corp, took a hit on January 31 after the Fed said interest rate cuts weren’t imminent. The S&P 500 went down by 1.6%, the Nasdaq fell by 2.2%, and the Dow Jones Industrial Average slipped by 0.8%.
While the broader market rebounded the next day, interest rate-sensitive BDC stocks continued to feel downward pressure. That could change if the Fed introduces its first rate cut in June.
Chart courtesy of StockCharts.com
The Lowdown on Oaktree Specialty Lending Corp
Oaktree Specialty Lending is a terrific BDC with a growing and diverse lending portfolio, a conservative balance sheet, strong liquidity, and flexibility.
As mentioned earlier, its portfolio currently contains 146 companies. Moreover, 86% of the portfolio comprises senior secured (first-lien and second-lien) loans and, 84% of the portfolio’s loans have floating interest rates.
This has helped Oaktree Specialty Lending Corp perform well in the current high-interest-rate environment, which is expected to stick around for years.
