Scott Kennedy’s BDC Earnings Series: Assessing Ares Capital’s And Sixth Street Specialty Lending’s Performance For Q1 2024
Summary
This earnings assessment article reviews ARCC’s and TSLX’s NAV and core earnings/adjusted NII performance during Q1 2024 and compares results to expectations. Earnings remain a driver to stock performance.
ARCC’s NAV slightly outperformed my/our expectations (within range). ARCC’s core earnings slightly underperformed expectations (at the low end of my/our range).
ARCC’s non-accruals very slightly increased (correctly anticipated). No change in ARCC’s percentage recommendation ranges or risk/performance rating. ARCC is deemed appropriately undervalued (HOLD).
TSLX’s NAV basically matched my/our expectations (well within range). TSLX’s adjusted NII slightly underperformed expectations (within range). TSLX had 1 new non-accrual portfolio company (correctly anticipated).
No change in TSLX’s percentage recommendation ranges or risk/performance rating. TSLX is currently deemed appropriately undervalued (HOLD) but is very close to my/our price target.
Formatting Change to this Article Series
We have recently changed the format of this earnings-related article series (less wording, more visual images). This process remains ongoing and future changes will likely occur.
1) ARCC:
Commentary
Quarterly NAV Fluctuation: Minor Outperformance (1.2% Variance).
Core Earnings: Minor Underperformance ($0.023 Per Share Variance).
A minor outperforming quarter regarding Ares Capital’s ARCC 0.00%↑ NAV in my opinion. ARCC generated a slightly more enhanced quarterly NAV increase when compared to my expectations. As such, ARCC’s underlying portfolio company valuations (mainly unrealized fluctuations) slightly exceeded expectations. ARCC reported a combined net realized loss and unrealized appreciation (including foreign currency FMV fluctuations) of $138 million during Q1 2024. In comparison, I projected a combined net realized loss and unrealized appreciation (including foreign currency FMV fluctuations) of $25 million. When calculated, this directly led to a NAV outperformance of $0.19 per share. This outperformance was largely scattered amongst ARCC’s 510 portfolio companies as of 3/31/2024. It will take some time to fully reconcile the entire investment portfolio regarding quarterly valuation fluctuations. The remainder of ARCC’s NAV outperformance was directly in relation to the accretive equity issuance of 25.5 million shares of common stock during Q1 2024 (mainly due to the redemption/conversion of the 2024 Convertible Notes). This was simply larger than I anticipated.
A slightly underperforming quarter regarding ARCC’s core earnings in my opinion. Due to the fact ARCC continually accrues for GAAP capital gains incentive fees (or reversals), I continue to believe the company’s core earnings is the best metric to track regarding operational performance (not NII; more indicative of net ICTI). Let us briefly discuss this minor underperformance.
First, when including the impact of quarterly FMV fluctuations, amortization, and principal paydowns, ARCC increased the company’s investment portfolio size by $250 million or 1% during Q1 2024. Just know some of this increase was directly in relation to equity investments that currently do not provide dividend income (but could in the future). In comparison, I projected an increase of $300 million. As such, a very slightly smaller investment portfolio size when compared to my expectations.
Second, ARCC reported a weighted average annualized yield of 12.50% and 12.40% during Q4 2023 and Q1 2024, respectively ((0.1%) decrease). This past quarter, this was a (0.1%) underperformance when compared to my expectations. This was mainly the result of investment portfolio compositional changes whereas ARCC lowered the company’s exposure of 2nd lien loans (decrease of ($0.6) billion) and increased its exposure of 1st lien loans (increase of $0.6 billion). This shift directly resulted in slightly lower effective interest rates/yields regarding this portion of ARCC’s investment portfolio. As correctly stated 2 quarters ago, this metric began to plateau towards the end of 2023. In addition, it should be noted the higher LIBOR/SOFR/PRIME rose (over 500 basis points [bps] in 1.5 years), the more underlying credit risk (non-accruals) needs to be respected (and monitored). This will have heightened importance as we head through 2024.
When combining these 2 factors, ARCC reported core earnings (which includes interest, PIK/deferred, fee, and dividend income less operational expenses) of $350.0 million during Q1 2024. In comparison, I projected ARCC would report core earnings of $362.5 million. When calculated, a ($12.5) million underperformance.
ARCC reported another good quarter overall. Underlying portfolio company interest coverage remains fairly strong and the average LTV ratio remains very attractive below 50%. A risk/performance rating of 3 for ARCC remains appropriate in the current environment/over the foreseeable future.
Change or Maintain
NAV Adjustment: Our projection for current NAV per share was adjusted: Up $0.20 (To Account for the Actual 3/31/2024 NAV Vs. Prior Projection). Price targets have already been adjusted to reflect the change in NAV. The update is included in the card below and the subscriber spreadsheets.
Percentage Recommendation Range (Relative to CURRENT NAV): No Change.
Risk/Performance Rating: No Change. Remains at 3.
Earnings Results
Note: NAV at the end of the quarter. Subscriber spreadsheets and targets use current estimates, not trailing values.