This is an extract from an earlier article at Systematic Income Premium.
In this article we discuss the latest quarterly results from the Business Development Company Sixth Street Specialty Lending (TSLX). The company delivered a strong Q4 with a +3.6% total NAV return, continuing its sector outperformance. TSLX recently saw its valuation deflate relative to the sector average which we view as an attractive entry point.
Quarter Update
Adjusted net income (adjusted for accrued capital gain incentive fees) rose by 36% to $0.64 in Q4. It appears that there was a non-recurring +$0.12 item (Biohaven) in net income so recurring net income still rose a very respectable 11% in Q4.
The company increased the base dividend for the third consecutive quarter for a year-over-year increase of 12%. It also declared a supplemental dividend of $0.09.
Distribution coverage remains high. With the new base dividend of $0.46 coverage is 139% while, with the Q1 supplemental, it is 116%. As many other BDCs, the company is worried about a drop in short-term rates and therefore plans to run at a high level of coverage for the time being. Spillover income was estimated to be $0.77 or close to 2 months of the base dividend.
The NAV rose slightly, primarily as a result of retained income.
Income Dynamics
Net new investments remained positive for the third quarter in a row.
Leverage was not much different and remains in the 0.9x – 1.25x target range.
Portfolio yield increased by 1.2% over the quarter due to the impact of base rates. Cost of debt, however, increased by about the same.
TSLX is unusual in that all of its debt is floating-rate. Its fixed-rate unsecured debt is swapped to floating-rates via interest rate swaps. To our knowledge it’s the only BDC that swaps their entire bond issuance. OCSL has swapped one of their two bonds.
The company’s floating-rate debt profile translates into a relatively low net income beta to short-term rates that is 45% below the median BDC.
Portfolio Quality
Non-accruals remained near zero for a couple of years running now – an impressive profile.
Portfolio quality, as indicated by internal ratings, was flat.
The company had net realized gains for the fifth quarter in a row. There was only a single quarter of net realized losses in the last two years.
Return And Valuation Profile
TSLX features one of the strongest return profiles in the broader BDC sector with a total NAV return close to double the average company over the 3-7Y horizons.
The company has consistently outperformed the BDC sector with only one quarter of underperformance in the last 5 years. On a twelve-month trailing basis (yellow line) it has consistently outperformed. The level of outperformance has moved lower over the past couple of years and is worth watching. This is mitigated by the company’s relative valuation improvement and likely explained by a lower deal / exit level environment which leads to a more muted fee and equity upside profile. We expect outperformance to increase once the broader venture environment improves.
It can be difficult to compare performance and valuation at the same time. One way we like to do it is to produce a ratio of the 3Y total NAV return to the current valuation which combines the two key metrics into one, presenting a kind of total return per unit of valuation. On this metric we see that TSLX looks very strong.
TSLX valuation premium to the broader sector has fallen to around 15%. This sounds high, however, this is well below its average premium of around 24% over the last 5 years. And, as discussed above, its performance premium remains well above its valuation premium.
Takeaways
The recent valuation compression of TSLX relative to the sector provides an attractive entry point in our view. The company continues to generate strong returns and outperform the sector. Its higher-quality first-lien profile is also an asset in the current environment.
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