IvelinRadkovBlue Owl BDC Benefits From A Higher-For-Longer Fed Blue Owl Capital Corporation (NYSE:OBDC) investors suffered downward volatility over the past month, as OBDC lost all its gains for May 2024. OBDC topped in early June 2024, as the market likely reacted to a higher possibility of lower interest rates by the end of 2024. As a result, potential interest rate growth headwinds have likely impacted business development companies. Blue Owl Capital maintained its confidence in a higher-for-longer Fed at OBDC’s Q1 earnings release in early May 2024. Management articulated that OBDC anticipates a hawkish Fed “with expectations of elevated rates and limited to no Fed cuts anticipated for the year.” Given OBDC’s mainly first-lien floating rate portfolio, the company is well-positioned as interest rates are still expected to remain high. However, a potentially more dovish Fed has likely lowered confidence in OBDC’s ability to replicate its 2023 performance this year. Blue Owl Capital NII per share estimates (TIKR)Wall Street has started downgrading OBDC’s earnings projections. As seen above, OBDC’s net investment income per share likely peaked in Q4, as Blue Owl Capital reported an NII per share of $0.47 in Q1. While NII per share is still expected to remain elevated, a growth normalization phase must be anticipated, resulting in lower YoY comps. Blue Owl BDC Has The Scale To Compete Effectively Private credit fund raising (Bloomberg, Deutsche Bank)Moreover, there are concerns that the return of the public syndicated lending market could hamper the near-term growth dynamics of private credit. As a result, higher competition between lenders could narrow the spread and further affect the growth normalization of OBDC’s NII per share. In addition, private credit has raised funds aggressively in the first half of 2024, corroborating concerns about a potential demand/supply overhang. Blue Owl Capital management provided keen insights into the market environment in Q1. OBDC indicated “lighter activity than expected in the market overall.” In addition, M&A activity has remained lower than anticipated. Coupled with the “more active” public loan markets, Blue Owl Capital also observed “noticeable pressure on loan spreads” this year. Notwithstanding OBDC’s cautious commentary, the prospects for increased M&A activity in the second half could bolster the demand dynamics for private credit. Blue Owl Capital has a leadership position as one of the top three BDCs by market cap. Therefore, I assess that OBDC has the necessary scale to compete effectively against a resurgent public lending market. OBDC Stock Is Still Cheap OBDC Quant Grades (Seeking Alpha)OBDC receives top marks for valuation and is assigned an “A” valuation grade by Seeking Alpha Quant. However, growth is expected to normalize, as seen with the deterioration of OBDC’s growth grade from “A-” to “C” over the past six months. However, OBDC’s momentum has remained robust (“B” momentum grade). OBDC seems to be in a solid position to capitalize on a more competitive lending environment ahead of its smaller peers. It has the potential to raise funds at a lower rate, which could be increasingly critical as spreads possibly narrow further. In addition, investors should carefully consider JPMorgan (JPM) CEO Jamie Dimon’s caution about private credit’s “bad actors within the industry.” As a result, “potential turmoil in the private credit market” could lead to “serious consequences,” affecting the whole BDC industry. Dimon’s commentary suggests BDC investors should consider focusing their capital allocation on the leading private credit lenders with robust liquidity, solid external advisors, and a healthy balance sheet. OBDC possesses such characteristics. It has $2.4B in liquidity and a debt-to-equity ratio of 1.04x (down from 1.09x in Q4’23). OBDC also has favorable credit ratings from the respective rating agencies. OBDC is affiliated with Blue Owl Capital Inc. (OWL), corroborating the strength of OBDC’s origination and advisory platform. Bolstered by OBDC’s highly attractive forward dividend yield of 10.4%, income investors will likely continue to favor its bullish thesis. Is OBDC Stock A Buy, Sell, Or Hold? OBDC price chart (weekly, medium-term, adjusted for dividends) (TradingView)OBDC’s price action suggests it suffered from pretty steep downward volatility over the past three weeks since topping in early June 2024. Although OBDC remains in a medium-term uptrend, I have not assessed a bullish reversal yet. Therefore, investors must anticipate potential further near-term downside. OBDC’s bullish thesis is predicated on its ability to benefit from a higher-for-longer Fed while fending off higher default risks from its borrowers. Based on OBDC’s earnings commentary, I have not assessed significantly elevated risks emanating from such downside possibilities. OBDC’s non-accrual rate of 1.8% (based on portfolio fair value) in Q1 underscores my assessment. Moreover, its healthy balance sheet should lend credence and assure investors about unanticipated challenges in the BDC industry. Notwithstanding my caution, a severe economic downturn isn’t assessed to be my base case in the near term. OBDC’s bullish bias suggests investors have also not fled in a hurry. Therefore, I view OBDC’s recent pullback as a solid opportunity for investors to consider adding exposure, even as they need to navigate a growth normalization in OBDC’s NII per share. Despite that, OBDC’s relatively attractive valuation suggests it has likely been priced in, lowering significant downside risks unless a severe recession is anticipated. Rating: Maintain Buy. Important note: Investors are reminded to do their due diligence and not rely on the information provided as financial advice. Consider this article as supplementing your required research. Please always apply independent thinking. Note that the rating is not intended to time a specific entry/exit at the point of writing unless otherwise specified. I Want To Hear From You Have constructive commentary to improve our thesis? Spotted a critical gap in our view? Saw something important that we didn’t? Agree or disagree? Comment below with the aim of helping everyone in the community to learn better!
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