OFS Capital Stock: 13.5%-Yielder Hiked Q3 Payout 17%
November 1, 2023
Why Investors Should Consider OFS Stock
The U.S. continues to show strong economic growth, despite a sharp rise in interest rates. For more than a year and a half, the Federal Reserve has been trying to get a handle on the decades-high inflation. Despite this, Americans continue to spend money, leading inflation to remain high.
This could result in more interest rate hikes. Even when the current rate hikes are over, the Fed says it expects interest rates to stay high longer. That’s bad news for consumers and cash-strapped businesses, but it’s great news for business development companies (BDCs) like OFS Capital Corp (NASDAQ:OFS).
Why is that?
BDCs operate much like traditional financial institutions. They borrow money at low interest rates and lend it out to businesses at higher interest rates. Their profit, called the spread, comes from the difference between what they pay to creditors and what they receive from borrowers.
Like traditional banks, BDCs tend to build nationwide operations. Unlike traditional banks, though, BDCs don’t serve the general public. Instead, BDCs have carved out a lucrative niche market: providing loans to small and midsized companies in various industries.
For BDCs, “small and midsized” companies are those that generate annual sales between $20.0 and $100.0 million. The big banks tend to shun these companies, as they aren’t large enough to go public. Moreover, these businesses need more funds than those typically provided by traditional bank loans.
So, BDCs fit right into the “sweet spot” of the U.S. economy: the huge gap between commercial and investment banks.
About OFS Capital Corp
OFS Capital is an externally managed BDC that specializes in direct and fund investments, as well as add-on acquisitions. The company’s goal is to provide its shareholders with income and capital appreciation, mostly through debt investments and, to a lesser extent, equity investments. (Source: “OFS Capital Corporation Announces Second Quarter 2023 Financial Results,” OFS Capital Corp, August 3, 2023.)
OFS Capital primarily invests in privately held middle-market companies in the U.S., targeting companies with annual earnings before interest, taxes, depreciation, and amortization (EBITDA) between $5.0 and $50.0 million. It doesn’t invest in operational turnarounds or start-up businesses.
OFS Capital Corp offers senior secured loans, including first-lien, second-lien, and unitranche loans. It also offers subordinated loans and, to a lesser extent, warrants and other minority equity securities.
As of June 30, based on fair value, 95% of OFS Capital’s loan portfolio consisted of floating-rate loans and approximately 99% consisted of senior secured loans. (Source: “Investor Presentation: August 2023,” OFS Capital Corporation, last accessed October 30, 2023.)
Note that “senior” debtholders stand first in line to get their money back in the event of a bankruptcy. “Mezzanine” lenders get paid second. “Preferred” and “equity” investors usually only receive a fraction of their original investments back (if anything at all) if the borrower declares bankruptcy.
With $4.3 billion of assets under management, OFS Capital Corp’s portfolio is diversified across 15 business sectors and 44 distinct loan obligations, with no material exposure to cyclical sectors. The manufacturing sector accounts for the biggest portion of its portfolio (26.9%), followed by health care and social assistance (17.5%); wholesale trade (13.2%); and professional, scientific, and technical services (12.5%).
The company’s experienced management team really believes in what it’s doing; company insiders own 22.5% of the outstanding shares of OFS Capital stock. The BDC sector’s median insider ownership is just two percent.
3rd Consecutive Quarter of Increases in Net Investment Income
For the second quarter ended June 30, OFS Capital reported net investment income of $0.38 per share, up from $0.37 per share in the first quarter but down from $0.47 in the second quarter of last year. (Source: Ibid.)
Its net investment income in the first six months of the year was $0.75 per share, up by 8.6% from $0.69 per share in the first half of 2022.
OFS Capital’s total investment income in the second quarter increased to $14.5 million, from $14.3 million in the prior quarter. The increase in the company’s interest income was primarily due to a rise in its portfolio’s weighted-average performing income yield to 13.8% in the quarter, from 13.0% in the prior quarter.
Commenting on the results, Bilal Rashid, OFS Capital Corp’s chairman and CEO, said, “Today we reported another increase in our quarterly net investment income, which rose to $0.38 per common share, and was the third consecutive increase in our quarterly net investment income.” (Source: Ibid.)
He continued, “We believe our balance sheet is well positioned in the current interest rate environment with the vast majority of our loan portfolio being floating rate and the majority of our debt being fixed-rate. At the end of the second quarter, approximately 86% of our outstanding debt matures in 2026 or later, and more than half of our outstanding debt is unsecured.”
Quarterly Dividend Increased to $0.34/Share
Thanks to its high cash flow, OFS Capital Corp has been able to reward buy-and-hold investors with reliably growing quarterly dividends. Management has increased OFS stock’s dividend 10 times since 2020.
On June 30, the company paid a quarterly distribution of $0.33 per common share. On September 29, it paid $0.34 per common share. That represents a three-percent increase quarter-over-quarter and a 17.2% increase year-over-year. (Source: “Distribution History,” OFS Capital Corp, last accessed October 30, 2023.)
It also translates to a yield of 13.5% (as of this writing).
Perhaps not surprisingly, OFS Capital stock’s dividend took a hit during the COVID-19 pandemic. Lending out money during one of the toughest economic climates in 100 years will do that. That said, OFS stock’s quarterly payout is now back to where it was before the pandemic.
OFS Capital Stock’s Price Recently Hit Record High
OFS Capital Corp’s share price has also recovered from the pandemic. On September 20, OFS stock hit a new intraday record high of $12.10 per share.
OFS Capital stock has pulled back a little from that level due to well-deserved profit taking, but it has still been trumping the broader market. As of this writing, OFS stock is up by 12.12% year-to-date and 37.7% year-over-year. In comparison, the S&P 500 is up by 10.4% year-to-date and 13.0% year-over-year.
Chart courtesy of StockCharts.com
The Lowdown on OFS Capital Corp
OFS Capital is a great BDC with a diverse investment portfolio that’s made up almost entirely of senior secured loans to high-quality, recession-resistant businesses. This helps the company provide OFS Capital stockholders with significant capital gains and reliable, ultra-high-yield dividends.
At a time when Americans are worried about inflation, high interest rates, rising personal debt, and a possible recession, it’s tough to beat a BDC like OFS Capital Corp. The company’s outlook is solid, thanks to its growing investment portfolio and the current high interest rates.
