Why I Am Buying Blue Owl Capital At 1-Year Highs (NYSE:OBDC)

Shares of investment company Blue Owl Capital (NYSE:OBDC) hit fresh 1-year highs last week as dividend investors continue to seek out high-quality BDC income plays with a reliable performance history. Blue Owl Capital’s non-accrual percentage increased quarter over quarter, yet the BDC supported its dividend with net investment income (including the payment of a non-regular $0.05 per-share dividend in Q1’24). Although shares of Blue Owl Capital now trade above the longer-term P/NAV ratio, I believe that OBDC is a solid BDC play for dividend investors seeking recurring, high-quality dividend income!

Previous rating

I rated shares of Blue Owl Capital a buy in early March as the BDC supported its handsome dividend with net investment income and shares traded at a less than 1.0X P/NAV ratio at the time. Although shares are now trading at a 7% premium to NAV and hit a new 1-year high last week, I continue to believe that the value offer here is especially strong. I see catalysts for an upside revaluation if the BDC works through problematic loans and improves its non-accrual percentage. Since OBDC still had very good dividend coverage in Q1’24, I believe the 9% yield will remain in high demand by income investors.

A top, 9%-yielding BDC income play for dividend investors

Blue Owl Capital remains the number two BDC in the market, after Ares Capital (ARCC), with a market cap of $6.5B. Blue Owl Capital chiefly runs a First Lien investment strategy, meaning the BDC is focused on highly collateralized debt investments. At the end of the March quarter, Blue Owl Capital had an investment portfolio worth $12.4B and first lien investments represented 73% of all investments. Including second liens, the senior secured lending percentage was 81%.

Blue Owl Capital continues to provide new investment fundings chiefly for the first lien segment. In Q1’24, the BDC originated 92% of new investments in first liens with joint ventures and common equity representing much smaller investment shares of 1% and 8% respectively. The first fiscal quarter was also the second quarter in a row in which investment repayments and sales amounted to more than $1.1B, indicating that portfolio companies are still using the opportunity to repay high-cost loans quickly.

Blue Owl Capital’s non-accrual percentage, a key ratio that indicates the extent of loan problems, was 1.8% (based off of fair value). In Q4’23, the BDC had four portfolio debt investments on non-accrual, which reflected a non-accrual percentage of 1.1%. Currently, loans to five portfolio companies were counted as non-accrual, as opposed to four in the previous quarter. Blue Owl Capital, however, is experienced in working out financing solutions and should be able to work out through these loan issues as well. The BDC said in its 10Q filing that its annual loss ratio on loans is very low, 0.14%, so there is a good chance that Blue Owl Capital will see lower non-accruals in the future.

Distribution coverage analysis

Blue Owl Capital’s first fiscal quarter distribution coverage ratio was 1.12X, compared to 1.19X in the preceding quarter. In the last four quarters, the BDC’s total distribution coverage ratio calculates to 1.17X, so the dividend has been consistently well-supported by the company’s net investment income. The calculation of the distribution coverage ratio includes the payment of non-regular dividends, which amounted to $0.07 per-share quarterly in the last year, on average. With these metrics in mind, I believe dividend investors don’t have to sweat the quarter-over-quarter increase in the non-accrual roster.

Why I am buying OBDC even at 1-year highs

Often, dividend investors focus on a BDC’s net asset value in order to make a buy or sell decision, and I would make the argument that those BDCs with consistent dividend coverage, good balance sheet quality and low non-accrual percentages are especially deserving of a NAV premium. This is because dividend continuity ranks very high as a priority for investors that buy BDCs: the main goal is the generation of a reliable income stream that can, ideally, grow in the long run.

Shares of Blue Owl Capital currently trade at a 1.07X P/NAV ratio, which is above the investment firm’s longer-term average P/NAV ratio of 0.93X. The mark-up to net asset value is due chiefly because Blue Owl Capital invested in a forward-looking manner into variable rate loans in the past, which generated strong growth in total investment income for the BDC in 2023… and which resulted in the payments of non-regular dividends.

For context, Ares Capital, the leading BDC in the industry by market cap, is currently priced at a price-to-NAV ratio of 1.11X… and shares also just hit a fresh 1-year high. I recommend both Ares Capital and Blue Owl Capital to dividend investors with a desire to generate recurring dividend income, as both companies have long, stable performance track records.

Ares Capital has slightly better balance sheet quality (0.7% non-accrual percentage in Q1’24) than Blue Owl Capital, but marginally weaker distribution dividend coverage as well (1.15X): Ares Capital’s 9% Yield Is A No-Brainer.

Risks with Blue Owl Capital

Blue Owl Capital is mostly invested in variable rate loans, meaning the BDC has net investment income upside if inflation remains a headache for markets in the second half of the year. Inflation has seen a bit of a comeback in early 2024 which has led to speculation that the Federal Reserve might avoid cutting the federal fund rate this year altogether.

In my opinion, inflation could go either up or down this year, so I believe the odds of a Fed pivot in 2024 are about 50-50. With a 97% variable loan percentage as of Q1’24, Blue Owl Capital would be one of those BDCs that could handsomely benefit from the Fed pivoting a little bit later. Should the Fed change course and end its tightening policy faster, Blue Owl Capital would surely see weaker net investment income prospects.

Final thoughts

In my opinion, Blue Owl Capital remains a top-notch income play for dividend investors… and I am willing to pay a premium for the BDC knowing that the dividend is quite well-supported by net investment income. Blue Owl Capital is well-run BDC and has two levers for NII growth: 1) The improvement of its balance sheet quality through lowering of the non-accrual percentage, and 2) A variable rate-adjusted investment portfolio that is set to benefit from the Federal Reserve postponing cuts to the federal fund rate. The distribution coverage analysis also reveals that investors should have no fear about the stability and continuity of the current $0.37 per-share quarterly dividend. Shares of Blue Owl Capital have gotten a little more expensive as of late, but I am always willing to pay a little bit more for a quality BDC pick!