Retirees more than anyone benefit from high sustainable yields. The reasons for this are clear:
- While the stock market tends to be unpredictable over short to medium periods and can at times be extremely volatile, dividend payments tend to be quite dependable with market volatility seldom having an impact on the cash distributions of quality businesses with defensive positioning and strong balance sheets. This is important because it reduces the sequence or returns risk for retirees. If you do not need to tap into your investments to meet living expenses for many years to come, volatility is relatively meaningless. However, if you are retired and counting on passive income from your portfolio to survive for an extended period of time, market volatility can significantly impact your retirement plans. However, if you remove the need to actually sell shares of stock on a consistent basis and instead just live off of the dividend income that your portfolio generates, market volatility then means little to nothing to retirees similar to non-retirees.
- It then stands to reason that a high yield – that perhaps does not grow as fast – is much more useful to a retiree than a lower yield that comes with more dividend growth. This is because retirees have a much greater need for cash flow today and have less of a need for rapidly increasing cash flow down the road since they are living off of their savings now. This is why fixed-income funds and high-yield stocks are generally much more attractive to retirees than lower-yielding dividend growth funds (VIG)(SCHD).
Recently I discussed two 9%+ Yields Growing Faster Than Inflation For Retirement Passive Income – namely Energy Transfer (ET) and MPLX (MPLX) – and in this article, I will discuss another 9%+ retiree-friendly yield from Blue Owl Capital Corporation (NYSE:OBDC).
1. OBDC Stock’s Business Model Is Defensively Positioned
First and foremost, OBDC’s 9.5% yield is retiree-friendly because its business model is defensively positioned. As a BDC (BIZD), OBDC specializes in providing capital to middle-market businesses. However, the following qualities set it apart as one of the most defensively-positioned BDCs in the market today:
- It is managed by Blue Owl Capital (OWL), which – along with the likes of Oaktree (BN)(BAM), Blackstone (BX), KKR (KKR), and Ares Management (ARES) – is one of the world’s pre-eminent experts in direct lending and private credit underwriting. This platform has over 110 direct lending investment professionals and an extensive network of over 675 financial sponsor relationships with an average annual net loss rate of just 6 basis points since inception in 2016.
- It has significant exposure (82.6%) to senior secured debt, including 68.8% exposure to 1st lien loans, significantly exceeding the senior secured debt exposure of some of the most popular BDCs today like Ares Capital Corp (ARCC) (65.1%) and Main Street Capital (MAIN) (68.8%).
- Its top three segments by exposure in its portfolio are defensive in nature (consumer products and services, software, and healthcare) and the portfolio as a whole is very well-diversified across 187 companies.
- Its underwriting performance has been very strong, with non-accruals only totaling 0.9% on a fair value basis and 1.1% on an at-cost basis.
This means that its earnings stream should hold up fairly well during an economic downturn, thereby supporting the sustainability of its dividend.
2. OBDC Stock’s Balance Sheet Is Investment Grade
Another reason why retirees should feel pretty good about OBDC’s dividend is that its balance sheet is in strong shape, with investment-grade credit ratings from all four rating agencies and either positive or stable outlooks from each of them.
Moreover, with $1.9 billion in total liquidity, a modest debt-to-equity ratio of 1.13x (well within its target range of 0.9x-1.25x), 58% unsecured debt, and a weighted average debt maturity of 5.1 years, OBDC’s balance sheet affords it plenty of financial flexibility to continue focusing on creating value for shareholders, including paying its attractive dividend.
3. OBDC Stock’s Dividend Is Very Well-Covered
Perhaps most importantly of all, OBDC’s payout ratio is one of the lowest in the BDC sector, especially among BDCs with such a defensive orientation in their investment portfolio. In its latest reported quarter, OBDC’s base quarterly dividend of $0.33 was covered 1.5x by net investment income per share and 1.6x by net income per share. Even when including its substantial supplemental dividend of $0.08, its NII coverage ratio was a healthy 1.2x and its net income coverage ratio was a conservative 1.3x.
This means that OBDC has a significant cushion to maintain its dividend even if non-accruals spike in the event of an economic downturn and/or declining interest rates weighing some on its interest income (which is partially hedged by the fact that 52% of its debt is floating rate).
4. OBDC Stock’s Valuation Is Discounted
Another reason to like OBDC is that its valuation remains discounted. Despite its strong aforementioned metrics and qualities, OBDC stock trades at a 3% discount to its book value even as peers like ARCC trade at a premium to book value. Moreover, its NTM price-to-earnings ratio of 7.86x is well below ARCC’s 8.52x price-to-earnings ratio.
The discounted valuation was highlighted a few quarters ago when OBDC management executed a buyback, something that is quite rare for a BDC.
5. OBDC Stock’s Insiders Are Aligned
Last, but not least, OBDC insiders are well-aligned with shareholders. As pointed out in its most recent earnings call:
We were pleased to complete our previously announced repurchase target of $75 million through the combined buying power of the company’s [$50 million] share repurchase program and the [$25 million] Blue Owl employee investment vehicle.
This harkened back to its Q3 2022 earnings call where management stated:
Blue Owl employees have opted to participate in an investment vehicle that intends to buy an additional $25 million of [OBDC’s] stock. In the near term, the company plan and the investment vehicle intend to purchase $75 million of stock in aggregate, a portion of which will be executed under programmatic 10b5-1 plans so they are able to continue buying after the trading window closes. Our Board and the Blue Owl employees believe it is an attractive time to be buying ORCC shares, and we value this alignment between the company to allow our employees and our shareholders.
While OBDC is externally managed by OWL, this significant alignment between shareholders and management helps to ensure that management puts OBDC’s shareholder interests first.
OBDC Stock’s Risks
The BDC sector as a whole faces two big headwinds right now:
- Short-term interest rates are likely at their peak. Given that most BDC investments (including the overwhelming majority of OBDC’s) have yields that float with short-term rates, this means that BDC investment income is likely at its peak too. As short term rates likely come down at some point this year, so too will OBDC’s income.
- Many BDC counterparties are finding their balance sheets stretched increasingly thin due to a prolonged period of elevated interest rates and inflation. As a result, non-accruals and even defaults may increase significantly this year. As ARCC’s management stated on their most recent earnings call:
we’re likely to see defaults in the industry increase this year… you have some companies that are making interest payments but continue to live off revolver availability, cash, et cetera, but the liquidity is getting tighter and tighter.
The good news for OBDC is that – as we have already mentioned – its portfolio and balance sheet are positioned to withstand these headwinds better than many of its peers. Moreover, its dividend is very well covered by earnings, so even if earnings fall some this year, the dividend should still be in excellent shape. Finally, while it would not shock us at all if OBDC’s book value per share declined this year, it does have at least a small margin of safety on that front built into its valuation, so the headwind it faces from that should not be as great as that experienced by peers like ARCC that currently trades at a premium to NAV.
Investor Takeaway
We rate OBDC a Hold given the aforementioned headwinds facing the sector. That being said, it could very possibly outperform the sector given its slightly discounted valuation and more defensive positioning. Moreover, its dividend is well covered by earnings, positioning it to continue to pay out a hefty yield to retirees dependent on it for passive income even if the economy falters, short-term rates decline, and defaults pick up.
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