Stock Watch: OFS Capital Reaches New Low
With the BDC news feed as slow as molasses – see the bare pickings on the BDC Daily News Table in Tools – and the year end Earnings Season very close at hand, the BDC Reporter – who watches such things with an eagle’s eye – noted that several well known funds are scraping along or even breaching their 52 Week Lows. Investors like to position themselves in advance of the earnings releases, seeking to jettison BDCs that MIGHT be candidates for Bad News, and thus for those gut wrenching elevator drops down. Then there are investors speculating on the opposite: BDCs who might report better-than-everyone- expected news. Let’s have a look at a smaller sized BDC with market confidence problems: OFS Capital (OFS).
OFS Capital (OFS), ever since raising new capital in 2017, has been on the down escalator. The secondary was priced at $14.57 in March 2017 by some of the top investment bankers in this field. The BDC did not seem to NEED the capital, but this was the last month of the BDC Rally and most investors didn’t ask too many questions. After all, you can never be too rich, or too whatever. Unfortunately, ever since then the OFS stock price has been headed downwards:
What A Difference Ten Months Makes
Today – January 26, 2018- OFS reached $11.58, both a new 52 Week Low and the lowest level achieved since March 2016, and only 10% above the lowest price level the BDC has ever reached in its 6 year history as a public company. Most surprising of all is that OFS has continued to pay the same unchanged distribution for 20 quarters in a row and its IIIQ 2017 results were relatively decent. Let’s revisit the highlights: Net Investment Income Per Share was at $0.33, just 1 cent below its dividend and not surprising given the dilution that accompanies the initial 6 months after a secondary raise. The BDC still had $36mn to spend in cash at September 30, 2017. From a credit standpoint, OFS had “only” one loan on non-accrual.That’s Community Intervention Services, which has been non-performing since the IIQ of 2016. Admittedly, there was a medium sized Realized Loss in the quarter and NAV has slipped from $14.82 at the end of 2016 to $14.15 nine months later. OFS was in the wrong place at the wrong time when My Alarm Center, LLC got itself into trouble and its junior lenders got hammered in the Oaktree-led restructuring. However that loan was restructured in record time and what was left of the capital returned as a small amount of Preferred.
There are two notable borrowers in our Worry category, both of which have been know about for some time. Master Cutlery LLC, in which OFS has invested $8.8mn at cost was downgraded last quarter in the BDC’s risk monitoring system from Category 5 to Category 6 in their 7 level scale. Since the IIQ of 2017, OFS has not been recognizing PIK income on the $3.5mn of Preferred to the company. Maybe markets have learned of a further deterioration which might put the $5.3mn in Senior and Subordinated debt (mostly in the latter) into question. If that’s the case, OFS could lose $0.7mn in Investment Income from this source. Then there’s Southern Technical Institute, which OFS has invested $5.6mn in. The investment consists of debt, Preferred and common. However, the $2.1mn in Preferred is non-income producing. Should the debt go on non accrual, OFS could lose out on just under $0.50mn of annual Investment Income.
Doing The Numbers
That’s $1.2mn of annual Investment Income at risk in a BDC which last quarter had annualized revenues of over $36mn and Net Investment Income of $17.6mn. Net of lower management fees and Incentive Fees that would result, the POTENTIAL LOSS from the known unknowns of these two credits is probably $0.800mn or 5% of Net Investment Income . That’s about 6 cents a share for a year or 1.5 cents a quarter.
Other Side Of The Ledger
As we’ve said that would be partly offset by any increase in the portfolio from deploying the BDC’s liquidity which might increase Investment Income by up to $4mn and Net Investment Income by as much as $3mn.
Moreover, OFS – like many other BDCs before them – might look to selling equity stakes at a profit to offset any credit and income losses. In this regard, OFS has over $11mn in various common equity investments that might console them for losses elsewhere.
Scratching Our Heads
However, this is all public information and not very hard to find. So the BDC Reporter wonders if there is some other credit problem or other issue that has not yet come fully to light, and which is driving the stock price downwards. Or are investors just marking down all BDCs with a major presence in Subordinated/Mezzanine lending following the continuing blow-ups at peers like Triangle Capital (TCAP); Capitala Finance (CPTA); Alcentra Capital (ABDC) and THL Credit (TCRD), to name a few ?
DIVIDEND OUTLOOK: Without any new information at hand -besides a dropping stock price – the BDC Reporter maintains its Dividend Outlook for 2018 as UNCHANGED.
INVESTMENT APPROACH: We’ve been invested in OFS – as part of our Long Term Income strategy – since April 2017 and have been dollar cost averaging on weakness on three subsequent occasions, most recently on January 4, 2018. Our average cost of the stock is $13.45 or (5%) below IIIQ 2017 book value and yielding over 10.0%. (After netting out distributions received our net cost is $12.81). Given our Long Term approach we’ve been holding rather than bolting, and may buy more at these much lower prices, before or after the next earnings release, whose date is not yet fixed. We don’t enjoy “fighting the tape” in this manner but what’s the point of spending all those hours researching BDCs to jump out when the market goes in another direction ? Given that we have no reason at this stage to envisage an earnings catastrophe, we take comfort that even if the stock price bottoms out at this level, we will be back in the black in just over a year with the receipt of more distributions, assuming the $0.34 a quarter payout holds. Of course, if OFS begins a credit slide similar to those that occurred to OHAI, OCSL (FSC), BKCC and TCRD then we’ll have to re-calculate.
With OFS trading at a (24%) discount to its 5 Year High and (11%) off book value and yielding 11.6%, the stock – ironically – is more attractive to True Believers such as the BDC Reporter’s principal than at any time in a long while.
2018 should be a very interesting year.
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