Oaktree Specialty Lending: A Sustainable 10.3% Dividend Yield (NASDAQ:OCSL)

The journey to build a sustained and sustainable dividend income stream is arduous with yield traps, dividend cuts, and collapsing stock prices forming some of the many mines to avoid. Business development company Oaktree Specialty Lending (NASDAQ:OCSL) seeks to generate investment income and capital growth by providing financing to companies. OCSL invests across all parts of the capital structure in companies operating in a range of industries from software to biotechnology and broadline retail.

The BDC’s portfolio at fair value was $2.9 billion at the end of its last reported fiscal 2023 fourth quarter, this was across 143 portfolio companies. It includes investments like a $25.3 million principal first lien term loan owed by Acquia, a software-as-a-service company operating out of Boston, that’s priced at LIBOR plus a 7.00% spread. There’s a lot to like here. The BDC last paid a quarterly base cash dividend of $0.55 per share, kept unchanged sequentially for a 10.3% annualized forward dividend yield. There was also a year-end special cash distribution of $0.07 per share. This double-digit dividend yield comes with a “BBB-” investment grade rating from Fitch and net asset value that has been on the up on a nominal basis.

The 12.7% weighted average yield on debt investment is high and reflects the elevated credit risk of OCSL’s investments. Biotechnology and pharmaceutical investments, which constitute 4.3% and 2.8% of OCSL’s investment portfolio respectively, have a high degree of clinical-stage firms like BioXcel Therapeutics (BTAI). Further, around 86% of OCSL’s portfolio is floating rate at mainly SOFR plus a spread that reflects the risk profile of the underlying company.

NAV, Investment Performance, And Dividend Coverage

OCSL’s NAV, total assets minus total liabilities, at $1.52 billion at the end of its fourth quarter has been on an upward trend for over five years. However, NAV per share at $19.63 was up 5 cents sequentially but was down by 3.7% over its year-ago comp.

The dichotomy between NAV on a nominal and per share basis has been created by consecutive sales of new equity with dilution running at roughly 12.8% per year over the last five years. OCSL had 77,225,329 shares of common stock outstanding as of November 10, 2023. Total investment income during the fourth quarter was $101.91 million, up 45.4% over its year-ago comp but missed consensus estimates by $1.54 million.

Growth was driven by higher base rates which pushed up its weighted average yield on debt investments by 40 basis points sequentially. However, adjusted net investment income at $0.62 per share, was broadly flat versus the prior quarter despite NII on a nominal basis at $47.8 million being marginally ahead of $47.6 million in the third quarter. NII per share of $0.62 meant OCSL covered its dividend by 113%. There was also $33.5 million, around $0.43 per share, of undistributed ordinary income at the end of the fourth quarter.

Investment Activity And Non-Accrual Investments

There was $117 million in newly funded investments against $364 million of investment exits, repayments, and sales during the fourth quarter. Exits exceeded funded investment activity by $247 million, a record difference to drive a drastic expansion in OCSL’s cash and equivalents position by 480% year-over-year to $136.5 million at the end of the fourth quarter.

These new loans were underwritten at a 12% weighted average yield and were 100% first lien. Critically, OCSL ended the fourth quarter with $1 billion in liquidity with the inclusion of $908 million of undrawn capacity on their credit facilities. This more defensive positioning likely reflects angst over possible elevated macroeconomic volatility in 2024 as the Fed looks to cut rates and the lagging effects of the most intense monetary tightening cycle in a generation reverberates through the economy.

OCSL’s debt-to-equity ratio at 1.1x at the end of the fourth quarter maintained a dip in place since the start of calendar 2023. This should continue to reduce if the BDC lets investment exits run ahead of newly funded investments in future quarters. A reduction of the broad portfolio needs to be contextualized against expectations that base rates will be cut by at least 75 basis points this year. The market is currently pricing in cuts beginning from the 20th March 2024 FOMC meeting with the probability of a 25 basis points cut currently at 75.4% according to the CME FedWatch Tool. It comes as non-accrual debt investments as a percentage of debt investments at fair value fell to 1.8% during the fourth quarter from 3.1% in the prior quarter. OCSL is a hold on the back of the double-digit dividend and its broadly stable NAV per share profile.