NEWS

On Thursday July 18, 2024, Oaktree Specialty Lending (OCSL)’s stock price reached a new 52-week low of $17.67, before closing at $17.73. This is also the lowest price the BDC has traded since early 2021, as this 5 year chart shows:

OCSL’s decline actually began in early 2022 when the stock closed at a peak of $23.04. Two and a half years later, OCSL has dropped (23%) in price.

Since the end of 2021, the NAV Change Table shows that the BDC’s Net Asset Value Per Share (NAVPS) has decreased by (15%) – placing OCSL in the bottom quartile of the public BDC universe.

ANALYSIS

Some Time

As the NAV data above shows, OCSL has been under-performing for several quarters now, so the drop in the stock price to a new low is not a great surprise.

We had hoped to write up a full performance review as of the IQ 2024 – as we’ve done for many other BDCs – but we’ve run out of time with IIQ 2024 earnings season right round the corner.

Instead, we’re going to analyze the BDC’s key metrics and its outlook to determine as best we can what might be causing investor anxiety.

As recently as January 21, 2024 OCSL’s stock was on the rebound but has since fallen pretty consistently over the last 6 months to reach this most recent nadir:

Earnings

Back in calendar year 2021, OCSL’s Adjusted Net Investment Income Per Share (ANIIPS) was $1.98. Despite multiple credit problems since then, ANIIPS – helped by the higher income from raised interest rates – increased to $2.20 in 2022 and $2.43 in 2023. That’s a 22% increase in two years.

In the IQ 2024, ANIIPS came to $0.56, only (1.8%) lower than the quarter before and in-line with the analysts estimate. In the IIQ 2024, those same analysts are projecting OCSL will earn $0.56 again. Management argued strongly on the last quarter that new deals were booked late in the period and would pay off in the April-June period. BDC Best Ideas does not undertake quarterly projections but expects 2024 as a whole to result in ANIIPS of $2.25, much in line with actual results annualized. The fiscal year analyst estimate is $2.27. Or, in other words, OCSL has managed to increase its ANIIPS in recent years but is now expected to be on a decreasing path (7% lower in 2024 vs 2023). However, there is no surprise in these earnings numbers and are unlikely to be the reason for the price decline.

Credit

There’s no way to sugarcoat this: in the last two fiscal years OCSL has booked realized and unrealized losses hand over fist. In those twenty four months ended September 2023, losses amounted to ($182mn). To put that into context, Net Investment Income came to $330mn. 55% of what was earned on the swings was lost on the roundabouts. In the IVQ 2023 matters did not get any better as losses came t0 ($34mn) and hardly improved in the IQ 2024 at ($32mn). Even for a BDC with $3.0bn in assets those are not sustainable losses.

Under Control

Management’s answer is that i) the number of deeply troubled companies on its books is relatively small; ii) Oaktree is utilizing its well known skills at turning round failing companies to maximize ultimate recovery.

We view recent challenges faced by companies placed on nonaccrual as idiosyncratic and not indicative of broader or systemic issues within the portfolio… I would just say that ex the NPAs, [Non-Performing Assets] the portfolio was relatively flat quarter-on-quarter. You’re right to point out that, that really was the driver.Predominantly, the write-downs during the quarter were in Thrasio, Impel and OTG, all of our nonperforming assets from 12/31…

Extracts from OCSL IQ 2024 Conference Call

In The Weeds

Thrasio is emerging from bankruptcy in a debt-for-equity swap and has already been written down (45%) by OCSL as of March. OTG has already undertaken a debt for equity swap and what debt is left (one-third of what was outstanding previously) is back to performing. Impel’s assets have been sold to a “JN Holdco” – the only bidder. OCSL had already written its investment down by two-thirds.

More

If these were the only credit hot spots OCSL has, the worst could be said to be behind them and recoveries might occur down the road for Thrasio and OTG. Unfortunately, the review of the BDC’s portfolio by our sister publication – the BDC Credit Reporter – indicates that’s not the case.

By our count, there are 7 other “Important Underperformers” which OCSL has to contend with. Most have been around for some time. We don’t have time to get into the back story of each company but here are some of the names: Let’s start with Astra Acquisition, underperforming since 2022 and where Sixth Street Specialty (TSLX) ominously placed its second lien on non-accrual in the IQ 2024. OCSL’s first lien debt is performing, but is written down by (23%). We hear Astra just restructured its debt which might be good news or bad news.

Then there’s Averys SA – non-performing for several quarters but written down only modestly. Next is the famous Singer Sewing Company, also a non-accrual discounted (38%) and where there is no word of any resolution. All Web Leads was partially restructured last quarter but one of OCSL’s loans to the company remains non-performing. OCSL has already booked a significant realized loss on this company.

Torn From The Headlines

More famously, OCSL also holds $71mn in first lien loans to Pluralsight – a company much in the news these days. This was valued at $65mn at March 2024. We’re pretty sure the IIQ 2024 valuation will be lower and there’s a very good chance some portion of the debt will be converted to equity in yet another debt-for-equity swap. That would erode earnings as was the case with All Web Leads and Thrasio. Unfortunately, we are not done. Also worrying us is FinThrive Software Intermediate Holdings. OCSL holds a second lien loan already discounted (31%). Fitch rates the company B-.

Summary

In total, the Important Underperformers have an aggregate cost of $458mn and an FMV of $347mn. The BDC Credit Reporter estimates OCSL could lend up booking ($200mn) more in realized losses and – most important – ($85mn) of incremental write-downs from the level at March 31, 2024. That amounts to ($1.04) per share and would bring the NAVPS from $18.72 to $17.68 – a (5.6%) drop. However, these are just estimates and the ultimate result could be much different.

Keep In Mind

Not to rub things in but when we add up all the companies that the BDC Credit Reporter rates a 3 on their 5 point scale, there are 10 more, bringing the count of all underperforming entities to 19, or 13% of the 151 companies with which the BDC is involved.

Reason Why

This is on the high side and suggests that investors skepticism – as reflected in the recent price drop – is related to concerns that credit things might get worse before they get better. We wouldn’t be able to say otherwise looking at the data, but credit outcomes are a curious thing and with so many moving parts much could yet happen.

VIEWS

Right Now

By our standards, OCSL’s credit performance is BELOW NORMAL and could yet get worse.

On the other hand, the BDC is managed by a famous and reputable asset manager which has proven its ability to restructure numerous troubled companies.

Debt to equity is modest, leaving room to grow earnings by adding new assets even if losses cause some loans not to get paid.

Mild

To date – despite reaching today’s 52 week low – one could argue investors have not punished the stock very much.

OCSL is trading at a still high-ish 7.8x multiple of its projected fiscal year ANIIPS and at a not-so-dramatic (5%) discount to net book value.

This suggests the market is taking a measured approach to the BDC’s challenges.

The question everyone must be asking themselves is whether this tempered approach will subsist if losses continue to mount and NAVPS drops even more.

OCSL’s IIQ 2024 results – especially on the credit side – will need to be watched carefully.