OFS Capital: Trading At A Discount To Net Asset Value (NASDAQ:OFS)

OFS Capital (NASDAQ:OFS) trades at a $131 million market cap and is among the many smallest publicly traded enterprise improvement firms. Externally managed by Chicago-based OFS Capital Administration with $4.1 billion in property below administration, the BDC has returned round 10% to its shareholders on a complete return foundation during the last yr. It final declared a quarterly money dividend of $0.33 per share, in keeping with its prior cost and for a 13.5% ahead annualized dividend yield. The yield is broadly on the similar stage as its pre-pandemic payouts as a quarterly distribution that was minimize by $0.17 has step by step recovered during the last three years. In view of shareholders is extra progress and a break from the predictable stagnation of the present distributions. Certainly, the payout has stayed the identical because the BDC began buying and selling in 2012.

Critically, with the BDC’s frequent shares at present swapping palms for $9.78, it is buying and selling at a 27% low cost to NAV per share of $13.42 as of the tip of its fiscal 2023 first quarter. Solely a slender band of BDCs commerce at such a marked low cost to NAV, a band extremely outlined by dividend cuts through the pandemic and the precarious intervals of protection that adopted within the years after. Is OFS a purchase on the again of what is successfully a inventory buying and selling for 73 cents on the greenback? It relies upon. BDCs that commerce on a reduction to NAV achieve this for a purpose as any such low cost could be closed by a inventory worth declining additional. Additional, the inventory worth might meander to the inherent oscillations of NAV while nonetheless buying and selling at a reduction in perpetuity. Nonetheless, OFS has carried out a very good job of managing NAV during the last decade with the present low cost being bigger than its pre-pandemic common.

Twin Beats As Dividend Protection Spikes Up

OFS reported a complete funding earnings of $14.28 million, up 30.5% from $10.95 million within the year-ago comp and a beat by $105,500 on consensus estimates. The expansion was pushed by floating charge loans that benefited from a Fed funds charge that has now been hiked to its highest stage since 2008. This now sits at 5% to five.25% following a pause on the June FOMC assembly. Floating charge loans comprised 94% of OFS’s mortgage portfolio as of the tip of their first quarter. The BDC has a concentrate on middle-market firms and sometimes makes investments that vary from $5 million to $35 million per transaction. The portfolio had a weighted common realized earnings yield on interest-bearing investments of 11.8% through the first quarter.

Critically, while the mortgage portfolio has an solely senior mortgage focus this shaped 62% of the BDC’s funding portfolio with frequent and most well-liked fairness and warrants forming 21% of the portfolio and 17% being in structured finance securities. These are primarily collateralized mortgage obligations from debt to subordinated notes and mortgage accumulation facility positions. An funding portfolio with solely a 62% concentrate on loans quickly ramps up the chance profile of the BDC and exposes shareholders to extra volatility, particularly with the debt tranche of CLOs which, while diversified throughout a pool of sub-investment grade company loans, are extremely levered and extremely delicate to charge rises.

Whole bills elevated by 17.5% for a web funding earnings of $4.95 million, a 65% improve over the year-ago comp. This meant NII per share of $0.37, a beat of $0.02 on consensus estimates and progress of $0.15 over the year-ago quarter. This meant the BDC was capable of cowl its dividend by 112% through the quarter.

Will The Quarterly Dividend Be Raised Above $0.33 Per Share?

The BDC is paying out round 90% of its NII per share as a dividend. The dichotomy between the 11.8% yield realized by OFS on its interest-bearing investments, earlier than charges, and the bigger 13.5% yield paid out to shareholders is because of its marked low cost to NAV. This presents the core funding pitch for the BDC in opposition to an earnings set to be supported by what’s anticipated to be an prolonged interval of elevated rates of interest. The market now expects the Fed to boost charges by not less than 25 foundation factors at their upcoming July twenty sixth FOMC assembly with the CME FedWatch Software inserting this at a 93% chance, up from 86.8% only a week in the past.

Therefore, the floating charge allocation of the BDC will assist to proceed to reel in sturdy year-over-year NII progress via to mid-2024 when charges are anticipated to start to say no. This assumes the US financial system skips a tough touchdown that may more than likely pull up investments on non-accrual standing. These shaped 2.3% of the BDC’s whole funding portfolio as of the tip of the primary quarter. OFS is a maintain in opposition to what’s set to be an elevated rate of interest surroundings.