BDC Weekly Review: Price Jumps On Dividend Hikes Reveal Sector Inefficiency

This text was first launched to Systematic Earnings subscribers and free trials on Sep. 24.

Welcome to a different installment of our BDC Market Weekly Evaluate, the place we focus on market exercise within the Enterprise Improvement Firm (“BDC”) sector from each the bottom-up – highlighting particular person information and occasions – in addition to the top-down – offering an summary of the broader market.

We additionally attempt to add some historic context in addition to related themes that look to be driving the market or that buyers should be conscious of. This replace covers the interval by means of the fourth week of September.

You’ll want to try our different Weeklies – masking the Closed-Finish Fund (“CEF”) in addition to the preferreds/child bond markets for views throughout the broader earnings house. Additionally, take a look at our primer of the BDC sector, with a give attention to the way it compares to credit score CEFs.

Market Motion

It was a uncommon underperformance week for the BDC sector this 12 months. The clear nervousness round a “greater for longer” financial coverage atmosphere brought on higher-beta sectors like BDCs, MLPs, REITs and others to underperform sharply. That is although rapidly rising short-term charges have continued to ship dividend hikes for BDCs.

The sector was down round 7% this week. Solely BXSL is up over the month of September which is shaping as much as be the worst month for the sector since Mar-2020.

The BDC index under exhibits that the sector has now fallen under its June trough and stands roughly the place it was in early 2021.

The sector valuation is at its June trough ranges and never far off the earlier troughs in 2018 (Fed auto-pilot tantrum), 2016 (Power crash) and 2012 (Euro disaster). Durations the place the sector noticed considerably decrease valuations are these of the “world-ending” sort such because the GFC and the COVID crash. Whereas we’re more likely to enter a recession in our view a greater comparability set is the previous quite than the letter which means that present valuation appears to be like fairly engaging in combination.

Market Themes

The sharp rise in short-term charges amid a low default atmosphere has allowed many BDCs to hike their dividends in the previous couple of months. One clear sample that has emerged which is not going to shock many earnings buyers is that these BDCs that hiked their dividends have loved a worth increase as properly.

We are able to see this for BXSL the place the inventory’s worth jumped on the dividend hike announcement.

We see it for TRIN.

And for CSWC.

This all is smart, nevertheless, it additionally highlights that the sector is much from environment friendly. As an illustration, if the sector have been completely environment friendly it might commerce on a web earnings yield quite than a dividend yield. In different phrases, exterior of the every day market volatility, buyers would see a lot of the worth adjustment on quarterly earnings days when web earnings numbers are introduced. Finally, it is web earnings which is the fitting metric of BDC incomes energy, not their dividends.

The worth jumps on dividend hike days additionally highlights a market inefficiency as a result of the worth jumps reveal that the hike was a shock, no less than to some buyers. In our latest BXSL and TRIN protection, we explicitly highlighted a powerful probability of dividend hikes (we have not offered detailed protection of CSWC). This did not require any form of specialised or insider data – it was a easy reflection of only a handful of key metrics.

What this market dynamic suggests is that buyers who may be only a step forward can profit not solely with potential capital good points but additionally with a better degree of yield as a result of their decrease value foundation over buyers who chase the hike at greater costs.

Market Commentary

As indicated above, the Capital Southwest Company (CSWC) hiked its dividend to $0.52. The corporate has been often growing its dividend because the chart under exhibits. A part of that is because of the NAV accretion of latest shares choices given the inventory’s premium valuation.

The CEO of Carlyle Secured Lending (CGBD) Linda Tempo will step down however proceed to function the Chair of the Board. Tempo will likely be changed with Aren LeeKong in January who’s at the moment the corporate director. We do not see this as having a cloth affect on our outlook for the corporate which stays Purchase rated.

Stance And Takeaways

This week we improve the Fidus Funding (FDUS) in addition to the Oaktree Specialty Lending Corp (OCSL) from Maintain to Purchase.

Two of our different holdings have risen to valuations that look a tad costly although not exceedingly so. They’re the Blackstone Secured Lending Fund (BXSL)…

… and Trinity Capital (TRIN). We proceed to keep up positions in these shares in our Excessive Earnings Portfolio with a Maintain ranking.