Sixth Street Lending Inc. (TSLX) is a well-managed business development company (BDC) known for its First Lien-centric, floating-rate investment portfolio. The company has shown strong originations in the first quarter and offers a dividend yield of 9%, which is supported by the BDC’s net investment income.
The recent guidance from the central bank for a higher-for-longer rate environment could benefit TSLX in the short term. However, the long-term growth in net investment income might be limited.
Considering that Sixth Street Lending is trading at a 23% premium to its net asset value (NAV), the risk/reward relationship appears less compelling despite the central bank’s stance of only one rate cut in 2024.
Portfolio Review and Performance
As of March 31, 2024, Sixth Street Lending’s investment portfolio was primarily composed of First Lien investments, which accounted for 92% of the portfolio, up by 1 percentage point from the previous quarter. In the first quarter, 95% of new investments were also made in First Liens.
The company funded $163 million in new investments during this period, with a net funding of $54.2 million after accounting for investments sold or repaid, bringing the portfolio value to $3.38 billion.
Portfolio Composition and Originations
- First Lien Investments: 92%
- New Investment Fundings: $163 million
- Net Fundings: $54.2 million
- Portfolio Value: $3.38 billion
Interest Rate Sensitivity and Yield
Sixth Street Lending’s focus on floating-rate loans makes it highly sensitive to changes in interest rates. The longer the central bank maintains high interest rates, the stronger the NII tailwind for the company.
In the first quarter of 2024, the BDC achieved a yield of 13.5% on its income-generating investments, consistent with the previous year.
Dividend Coverage
Despite a challenging environment, Sixth Street Lending has maintained decent payout metrics, consistently covering its dividend with net investment income. Over the past year, the company had a dividend payout ratio ranging from the mid-80s to the low-90s, with an annual average NII-based dividend coverage ratio of 122%.
Historically, the BDC has under-earned its dividend only once in 2014, demonstrating strong dividend sustainability.
Valuation and Comparison with Peers
Sixth Street Lending is currently valued at a 24% premium to its net asset value (NAV) as of March 31, 2024, which stands at $17.17. In comparison, peer BDCs such as Goldman Sachs BDC Inc. (GSBD) and Golub Capital BDC Inc. (GBDC) are trading at much lower premiums of 7% and 3%, respectively.
Risks and Considerations
Sixth Street Lending’s exclusive focus on floating-rate loans means that any future cuts in interest rates could diminish its net investment income growth prospects. This scenario could pressure the BDC’s NAV premium and impact the dividend’s margin of safety.
However, if the central bank maintains higher rates for an extended period, TSLX could experience substantial upside in net investment income, potentially supporting its premium valuation.
Conclusion
Sixth Street Lending has demonstrated strong performance by consistently covering its dividend with net investment income and maintaining a focus on First Lien investments.
While the current higher-for-longer interest rate environment benefits TSLX, the potential for future rate cuts poses a risk to its growth prospects. The 24% NAV premium also suggests that the stock might be overvalued compared to its peers.
Therefore, while the BDC remains a solid option for income-focused investors, the prospects for significant capital appreciation appear limited given the current market conditions.
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