Better to buy after the second quarter results: Main Street or Owl Rock? (MAIN) (ORCC)

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The two capital of the main street (NYSE: HAND) and Owl Rock Capital Corp (NYSE: ORCC) have investment-grade credit ratings (BBB-Stable from S&P), which puts them in the upper echelon of quality business development companies (i.e. BDCs) (BIZD). Both also offer mouth-watering dividend yields, with MAIN posting a dividend yield of 5.8% and ORCC a dividend yield of 9.7%.

In this article, we’ll review their Q2 results, then compare them side-by-side and offer our take on which is the better buy.

Q2 results

ORCC’s second-quarter results beat analyst consensus expectations with net investment income of $0.32 per share, up 6.7% year-over-year. That said, NAV declined year over year to $14.48 from $14.90. However, this was not due to deteriorating credit quality. As management explained during the earnings call:

I want to emphasize the importance of our valuation process to accurately mark every investment in our portfolio each quarter. As mentioned, our net asset value declined due to unrealized losses due to a widening credit spread environment and does not reflect the deterioration in credit quality in our portfolio.

MAIN also beat Wall Street expectations with net investment income of $0.78 per share, up 1.3% sequentially and 18.2% year-on-year. Net asset value per share also increased significantly year over year, from $23.42 to $25.37, although it was down sequentially from $25.89 at the end of the year. first trimester.

Balance sheet

As previously noted, MAIN and ORCC have the same credit rating and outlook as S&P, which puts them on equal footing in terms of perceived risk and access to capital.

MAIN has $518.4 million in total liquidity (~10.2% of its enterprise value) with a leverage ratio of 0.98x. Only 20% of MAIN’s debt is negatively exposed to the floating rate.

ORCC, on the other hand, has $1.7 billion in total liquidity (~14.5% of its enterprise value) and a leverage ratio of 1.2x. Only ~50% of ORCC’s liabilities are floating rate and exposed to rising rates.

While both appear to be in good health, MAIN appears to have the stronger balance sheet as its significantly lower leverage ratio and less exposure to floating interest rates outweigh ORCC’s greater liquidity.

Investment portfolio

ORCC’s portfolio is 88% senior secured debt and 99% of its debt investments are floating rate, meaning approximately 90% of the total portfolio is floating rate debt. ORCC’s portfolio is overweight in more defensive sectors, with its top five sectors being software, financial services, insurance, food and beverage, and manufacturing. Non-accruals were very low at 6/30/22 with only one non-accrual investment amounting to just 0.1% at fair value.

MAIN’s portfolio consists of approximately 69% senior secured debt and 73% of its debt investments are variable rate, meaning that approximately 59% of the total investment portfolio benefits from rising interest rates. interest. Similar to ORCC’s portfolio, MAIN’s portfolio is also mostly overweight in more defensive sectors, with its top five sectors being Software, Machinery, Construction, Business Services and Diversified Consumer Services. Defaults were very low at 6/30/22 at only 0.7% at fair value, although they were much higher at 3.2% on a cost basis.

Both companies appear very well positioned to benefit from rising interest rates, with ORCC management saying on its second quarter earnings call:

we will see significant benefit from higher rates starting in the third quarter. As you will recall, at the start of the second quarter, many of our borrowers reset their interest rate choice to three-month LIBOR, which was around 1% at the time and slightly above the average floor of our portfolio. So there was a limited benefit to our interest income in the second quarter.

The second quarter ended with three-month LIBOR at 2.3%, which significantly increases the base rate for these borrowers. All other things being equal, had our June 30 base rates been in effect for the entire second quarter, we estimate that the NII would have increased by $0.02 per share, to a total of $0.34 per share. action in the second quarter. Additionally, borrowers will continue to reset their interest rate choices throughout the third quarter, which will continue to benefit our portfolio performance and be accretive to NII.

Meanwhile, the CEO of MAIN said in his earnings call:

An additional element I wanted to address is the impact of rising interest rates. During the quarter, LIBOR rates increased by approximately 130 basis points from those in effect from March 31 to June 30. At the end of the second quarter, 80% of our outstanding debt securities maintained fixed interest rates. On the other hand, approximately 75% of Main’s debt investments for floating rate interest rates with a weighted average contractual interest rate floor of low current market index rates. Therefore, in a rising interest rate environment, our exposure to higher interest expense is largely mitigated and, over time, increases in our interest income will exceed increases in our interest expense. interests. It is important to note that the majority of our variable interest rate investments are based on contracts that reset quarterly, while our credit facility resets monthly. Accordingly, we will generally have a quarterly lag in realizing the benefits of rate increases in our interest income and net investment income.

ORCC’s more favorable exposure to rising interest rates, its more defensive positioning with greater exposure to debt rather than equities, and its much lower no-book rate combine to make it appear its portfolio much more favorable than that of MAIN in the current environment.

Dividend Security

ORCC generated $0.32 of net investment income per share in its most recent quarter while paying out $0.31 in dividends. While dividend coverage was tight, management noted this was likely a short-term issue given it had very little redemption income due to a seasonal M&A environment. calmer as well as the fact that revenues are expected to increase with higher interest rates in the third quarter. . That said, ORCC’s management was not prepared to steer towards significantly higher earnings in the future and would not commit to increasing the dividend or paying out a special dividend in the near term.

MAIN’s dividend coverage was quite strong in the second quarter, with distributable net investment income covering monthly dividends by 1.21x. As a result, management declared a special dividend, stating:

Based on our second quarter results and the positive performance of our existing portfolio of companies, combined with our favorable outlook in each of our main investment strategies and for our asset management business and the advantages of our operating efficiency, earlier this week our board declared an additional dividend of $0.10 per share payable in September and an increase in monthly dividends for the fourth quarter of 2022 to $0.22 per share payable in October, November and December. These monthly dividends represent a 4.8% increase from the fourth quarter of 2021 and a 2.3% increase from the third quarter of 2022.

The additional September dividend is due to our strong performance in the second quarter, which translated into a DNII per share, it was $0.13 or 21% higher than the monthly dividends paid during the quarter. This represents our fourth consecutive quarter of paying an additional dividend and translates to total additional dividends paid over the past year of $0.35 per share, representing an additional 13% paid on top of our dividends monthly and an increase in total dividends paid for the last 12 months. period of 18.5% compared to the previous year. We are pleased to have been able to bring this significant added value to our shareholders.

Although ORCC’s portfolio is positioned more conservatively at the moment, MAIN’s regular dividend coverage still looks stronger at the moment, so we give them the edge here.

Track record

MAIN has an excellent track record, as it has crushed the market since its IPO:

Chart
PRINCIPAL total return price given by Y-Charts

Meanwhile, ORCC has underperformed both SPY and MAIN since its IPO:

Chart
ORCC Total Return Price given by Y-Charts

As a result, MAIN clearly wins the record competition.

Evaluation

ORCC does, however, have significant valuation elements. First and foremost, its dividend yield is 374 basis points higher than MAIN’s. Second, MAIN is currently trading at a huge 74.93% premium to NAV, while ORCC is trading at an 11.4% discount to NAV. On the other hand, however, according to CEFdata.com, MAIN’s expense ratio is well below 5.94% compared to ORCC’s expense ratio of 10.18%. While MAIN’s lower expense ratio certainly justifies a higher valuation, the valuation gap between the two is simply huge.

Key takeaway for investors

Choosing MAIN is certainly difficult, given its impressive long-term track record, strong balance sheet and low expense ratio. However, ORCC has a more favorable exposure to rising interest rates, a more conservatively positioned investment portfolio and, most importantly, a vastly higher dividend yield and a much more favorable valuation relative to NAV. Overall, the valuation discount is just too big for us, and ORCC’s better positioning in a recessionary and/or rising interest rate environment is another important factor. So we think ORCC is a much more attractive BDC at the moment. We rate ORCC as a buy and MAIN as a hold.

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