Blackstone Secured Lending: High Quality BDC With Strong Dividend Coverage

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Blackstone Secured Lending stands out due to its strong portfolio strategy, low non-accrual rate, and consistent dividend coverage, making it a solid buy despite interest rate cuts.The BDC prioritizes...

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Roman Tiraspolsky Overview I truly believe that the golden era for business development companies has come to an end now that the first set of interest rate cuts have begun. BDCs will not be able to pull in the elevated levels of net investment income that we've seen over the last two years now that a lower interest rate means that borrowers will be paying less in interest on their existing loans. This shifting environment has exposed which BDCs stand out as high quality and which have been coasting by on the favorable market environment. I believe that Blackstone Secured Lending Fund (NYSE:BXSL) stands out as one of the BDCs that have proven how well put together their portfolio strategy and underwriting abilities are. I previously covered BXSL back in July and since then, the price has retracted a bit. However, I still believe that we have an attractive opportunity to continue accumulating shares of BXSL at its current level. From a price perspective, we can see that BXSL has retracted a bit from its high, but still delivers a 6.3% price growth on a YTD basis. The high dividend yield of 10.3% helps boost total returns up to about 16.2% when including the distributions. I believe that the main source of value is derived from a BDC's ability to continue paying its high distribution through all market cycles. After all, BDCs are best utilized as income vehicles since their investment structure prioritizes income generation above all else. Data by YCharts For context, BXSL operates as a business development company that generates its earnings through a portfolio of various debt investments. BXSL has a unique advantage of being relatively new in the sector, with an inception dating back to the tail end of 2021. Therefore, this BDC hasn't really had the opportunity to operate in what's considered a 'normal' market environment. Right after the launch of BXSL, interest rates started to get hiked to their decade high. This means that some investor caution may be clouding judgement here around the success of BXSL in a changing rate environment and thereby causing this BDC to trade at a very modest premium to NAV when compared against peers. However, lets first start by dissecting the aspects of BXSL's investment methods that entitles it to a buy rating. Portfolio Strategy & Risk Profile When it comes to structure, BXSL prioritizes making investments on a first lien debt basis. The latest overview confirms that first lien debt accounts for 98.6% of their portfolio. Senior secured first lien debt sits at the top of the corporate capital structure which means that this form of debt has the highest priority for repayment. This helps protect BXSL in cases where a portfolio company may be going through a bankruptcy and liquidating assets. This will help BXSL get a priority claim on assets over other forms of debt and can help soften the impact of a bad investment. We can also see that having a diverse range of industry exposure is a focus for BXSL. Weight to the software industry takes the majority spot, accounting for 18% of the portfolio at fair market value. This is followed by exposure to health care providers and professional services, accounting for 10% and 9% respectively. This diverse exposure helps mitigate any sort of vulnerability to any one specific industry. However, I would admittedly like to see a decreased weight towards software spend and have the allocation a bit more evenly distributed. BXSL Portfolio Overview While approximately 92.2% of their portfolio is concentrated in the US, BXSL does have some international exposure, with 5.3% of investments being Europe-based and 2.5% of investments based in Canada. The largest individual issuer only accounts for 3% of total assets, while there are about 231 different portfolio companies. Year over year, their criteria for investments have proven successful as revenue increased to $773M, up from $721M in Q2 of 2023. In addition, EBITDA increased up to $206M in Q2 of 2024 from a prior total of $183M in Q2 of 2023. The overall risk here remains low, and this is why I plan to continue accumulating shares. When it comes to assessing the risk factor of a BDC, I like to refer to the non-accrual rate. Non-accruals represent the rate of portfolio companies that are underperforming and can no longer keep up with the required debt payments. While a higher interest rate can help boost the level of net investment income generated, it can simultaneously put some stress on these underperforming borrowers that may have smaller operating margins. Borrowers with large amounts of debt on the balance sheet feel the weight of these higher rates, which is why it's important for the underwriting of management to be strong. For reference, when I previously covered BXSL, non-accrual sat at an extremely low level of 0.1% of cost. Thankfully, the underwriting ability of management remains strong as the non-accrual rate still remains low. As of the latest earnings call, the non-accrual rate slightly ticked up to 0.3% at cost and 0.2% at fair value. However, I don't believe this level of non-accruals is something to be worried about at all. This level of non-accruals is especially strong when compared to the non-accrual rate of some popular peers.  Ares Capital (ARCC): non-accrual rate of 0.7% at fair value. Main Street Capital (MAIN): non-accrual rate of 1.2% at fair value. Blue Owl Capital (OBDC): non-accrual rate of 1.4% at fair value. Capital Southwest (CSWC): non-accrual rate of 1.9% at fair value.  This extremely low non-accrual rate instills a lot of confidence here and leaves me with no worries about the underwriting abilities. If management can continue to find deals in such an elevated interest rate environment, they should have no problem continuing to find good opportunities for growth in a more favorable rate environment. Financials BXSL reported their Q2 earnings at the beginning of August and I believe the results to be solid. Most notable, net investment income landed at $0.89 per share for the quarter. Even though this missed expectations by $0.05 per share, this still fell in-line with a healthy range that fully supports the current distribution. A total increase in net investment income offsets this, as net investment income for the last twelve months as of Q2 sits at $672M, an increase from the prior year's total of $596M. Additionally, continued emphasis on new investment activity has successfully offset any decrease in interest income from lower interest rates and the rising non-accrual rate. BXSL pulled in $303M in interest income for Q2, representing a sizeable increase from the prior year's total of $274M. Management continues to grow the level of investment commitments quarter after quarter. BXSL was able to commit $1.28B towards new investment commitments and $891M of investment fundings. The increased level of commitments can contribute to more growth of their portfolio and earnings potential as they accumulate more portfolio companies.   BXSL Q2 Presentation Liquidity has also improved here, which increases the likelihood that BXSL maneuvers through a changing rate environment successfully. Cash and equivalents have grown to $291.3M, which is now the highest level ever since BXSL's inception. However, their long-term debt also sits at its highest level ever, totaling $6B. Liquidity is so strong that BXSL has also announced a $400M public offering of unsecured notes. It was stated that this is going to be used towards general corporate purposes, but it can also go towards debt repayment and new investment activity. Dividend As of the latest declared quarterly dividend of $0.77 per share, the current dividend yield sits at 10.3%. While the history here is short, the dividend history has remained very consistent and has never been reduced. This is reassuring for income investors that are looking for a source of income that is at no threat of being reduced. As mentioned, net investment for the quarter landed at $0.89 per share. This means that earnings cover the distribution at a rate of 116% and instills confidence that this cushion is strong enough to offset any negative impacts to net investment income that may be caused from a fall rate environment. Seeking Alpha However, if interest rates continue to fall, this may result in a lack of supplemental distributions that early investors were able to enjoy during 2022. In my opinion, I'd rather say the management to maintain a greater amount of earnings to help build up a larger coverage cushion, so I am okay with a lack of supplementals. Not to mention, lower interest rates could actually improve the distribution coverage, as the struggling portfolio companies see improved margins when the cost of their debt is reduced. It's also worth noting that the distributions received from BXSL are classified as ordinary dividends. Ordinary dividends have less favorable tax consequences compared to the qualified dividends you would receive from a more traditional dividend paying stock. Based on your personal situation, BXSL may be best utilized inside of a tax advantaged account to offset the possible tax burden received with large positions. Positive Valuation Outlook Since BXSL operates as a business development company, the price can vary from the actual value of underlying net assets. As a result, the price trades at a slight premium to NAV of 9.53%. We can see that the premium to NAV sat closer to 24% at its recent peak in 2023 and as high as a 35% premium to NAV shortly after inception. However, I believe that the strong portfolio structure, low non-accrual rate, and strong dividend coverage entitle BXSL to trade at a much higher premium than this. For instance, one of my favorite BDCs, Main Street Capital (MAIN), currently trades at a premium to NAV of over 70% and has consistently traded at a premium to NAV over 50% over the last three years because of its high quality. Once investors realize that BXSL can comfortably sustain the distribution through a lower interest rate environment, perhaps the value will be fully recognized and investors will pile in. For now, I take this under appreciation as an opportunity to accumulate shares for now. BXSL has been able to consistently capture NAV growth as well, with NAV per share rising up to $27.19 over the last quarter, an improvement from the prior quarter's NAV of $26.87. Wall St. agrees with this assessment as their average price target sits at $32.35 per share, indicating a potential upside of 9.7% from the current levels. CEF Data I believe that future interest rate cuts may actually be a positive catalyst for growth over the long term. The Fed implemented its first set of rate cuts, totaling 50 basis points. While this may negatively impact net investment income in the short term, I believe that future growth of the portfolio companies can offset this. For instance, a lower interest rate directly translates to borrowers having more affordable access to debt financing. This will likely increase the volume of borrowers that enter the market seeking capital to fund different forms of operational growth such as acquisitions, product research and development, or construction of new locations for expansion. The good news is that I believe there will be additional interest rate cuts to follow based on recent economic indicators. For instance, the unemployment levels in the US continue to trend upward and now sits at 4.1%. As more households are out of work and have less income, this may cause spending levels to be suppressed. This is also accompanied by inflation levels that remain above the Fed's targeted 2% level. Although inflation has been cooling over the last few months, it now sits at 2.5%. The combination of these two factors may be enough to incentivize the Fed to continue reducing interest rates as a way to stimulate the market. Takeaway  In conclusion, I maintain my buy rating on BXSL as the portfolio of investments is solid and has an extremely low non-accrual rate. New investment commitments continue to grow quarter over quarter, which can offset any short-term impacts to net investment income. Lower interest rates, supported by a growing unemployment rate and higher inflation, can produce a more favorable environment for borrowers, which BXSL may be able to capitalize on by growing their portfolio more rapidly. Likewise, future interest rate cuts can provide existing non-accrual companies with some relief and improve the overall quality of BXSL's portfolio. The distribution remains well-supported, and the price trades at a modest premium when compared against other parallel peers.","kind":null,"is_publish_news":true,"is_publish_highlight":false,"is_publish_live":false,"is_publish_wemedia":null,"editions":null,"column":"","sentiment":"0","news_tag":"analysis","news_rank":0,"symbols":[],"gpt_button":1},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.29.1","shortVersion":"4.29.1","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2474606786"}