Five analysts have increased their EPS forecasts in the past 30 days, for our first recommendation, a lending company. And the shares were just upgraded to ‘Outperform’ at Keefe Bruyette & Woods. Our second idea is taking some profits in a previous pick.
Buy: Oaktree Specialty Lending Corporation (OCSL)
From The Turnaround Letter
Oaktree Specialty Lending Corporation (OCSL) provides customized lending to companies with limited access to public or major bank-loan markets. Its $1.4 billion in investments are spread across 115 companies from a wide range of industries, producing a diversified portfolio. The company’s leadership comes from the highly regarded (and Turnaround Letter recommended) Oaktree Capital, a premier credit-oriented investment manager with $121 billion in assets under management. As a business development corporation (“BDC”), it does not pay corporate
taxes, similar to a REIT, as long as it pays out most of its income to shareholders.
Oaktree Specialty Lending wasn’t always in such good hands. Until being taken over by Oaktree in October 2017, the company, then-named Fifth Street Finance Corp (FSC), was a poorly-managed BDC with a reputation for undisciplined lending and recurring regulatory issues. Fifth Street shares, which reached nearly 14 in 2011, fell below 4 by mid-2017. By September 2017, as much as 4.7% of its loans were not accruing interest.
On October 17, 2017, Oaktree Capital acquired the rights to Fifth Street’s investment contracts, paying $320 million to the former management company. Little else was retained, as Oaktree changed the name of the company, replaced nearly the entire leadership and analyst team with Oaktree veterans and moved OCSL onto Oaktree Capital’s accounting, management and credit analysis platforms. Essentially, the business is now an arm of Oaktree Capital.
At its most basic level, Oaktree Specialty Lending’s strategy is to improve its return on equity, then pay out most of that return as dividends. The first step: getting a handle on the investment portfolio. In the six months since the changeover, the company has marked each investment to a more appropriate value, which initially reduced the net asset value (“NAV”) but will now allow cleaner financial results. Substandard loans, and loans that don’t fit the Oaktree Capital criteria, are being sold (a process well on its way to completion) at very respectable prices.
Another step: improving the portfolio’s yield by making smart new investments, in many cases side by side with Oaktree Capital. Other improvements, including boosting its risk controls, lowering its own borrowing costs and trimming its operating expenses, will help to improve Oaktree Specialty Lending’s return on equity. Overall, the company is now being managed in the same conservative, highly-skilled manner as Oaktree Capital.
Yet, investors remain on the sidelines. OCSL shares currently trade at only 84% of NAV, a sizeable and unwarranted discount to other high-quality BDCs that trade at premiums to their NAVs. While the direct lending market is currently highly competitive with new participants offering increasingly aggressive terms, Oaktree Specialty Lending’s near-term improvements and superior long-term focused platform are well-positioned to provide attractive returns to shareholders. The generous dividend may fluctuate with OCSL’s investment income but should provide an appealing cash return as the company advances its turnaround. Taxable investors may want to familiarize themselves with the tax nuances of BDC dividends at the individual level before investing.
We recommend PURCHASE of shares of Oaktree Specialty Lending (OCSL) up to 7.
George Putnam III, The Turnaround Letter, www.turnaroundletter.com, 617-573-9550, August 2018