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Both the Owl Rock Capital Corporation (NYSE:ORCC) and FS KKR Capital Corp (NYSE:FSK) are high-yield business development companies (i.e. BDCs) (BIZD). Both also boast investment grade ratings as well as support for world-class alternatives Asset manager of Blue Owl Capital (OWL) and KKR & Co. (KKR). We compare them side by side and share our opinion on which is the better buy today.
FS KKR vs Owl Rock Record
Both FSK and ORCC have some of the stronger balance sheets in the BDC sector, as evidenced by their investment grade ratings.
FSK’s debt-to-equity ratio is currently 1.19x and its balance sheet is very flexible with $2.75 billion in total available cash (19.8% of enterprise value).
ORCC’s debt-to-equity ratio is roughly the same as FSK’s at 1.18, and the company also has ample cash of $2.1 billion (18.3% of its enterprise value).
Both companies have similarly constructed balance sheets, with similar leverage ratios and cash pools relative to their enterprise values.
FS KKR vs. Owl Rock – Business Models
A key point for FSK to keep in mind is that it previously waived a significant portion of its management fees to help create value for shareholders. Starting this year, however, the manager will reintroduce its full incentive fee. While this isn’t a deal breaker and shouldn’t even come close to jeopardizing the quarterly base dividend, it will no doubt result in lower special/extra dividends.
Both companies have had pretty good underwriting performances lately. ORCC’s accrual rate is currently 1.0% of the total portfolio at cost, while FSK’s overall accrual rate was 4.9% at cost. While ORCC’s non-cash rate is far superior to FSK’s, it is important to note that none of FSK’s non-cash interest comes from loans underwritten since new FS/KKR advisor took over in April 2018, according to the Journal, FSK’s non-demarcation rate is declining and should continue to improve.
In constructing the investment portfolio, FSK has 45% exposure to senior secured loans while ORCC has 72% exposure to senior secured loans. FSK has 18% exposure to senior secured second lien loans and ORCC has 14% exposure to senior secured second lien loans. 73% of FSK’s investments are in floating rate notes, while 86% of ORCC’s investments are in floating rate notes.
FSK’s industry exposure favors more defensive business models, including a 23% exposure to software and a 10% exposure to healthcare as its top two verticals. ORCC’s largest industry exposure is 13% software, 10% financial services, 9% insurance, and 7% food and beverage companies.
Overall, ORCC’s investment portfolio appears much better suited to the current environment, with its greater emphasis on conservatively positioned and adjustable rate loans, a better underwriting track record and an equivalent superior exposure to defensively positioned industries.
FS KKR vs. Owl Rock – Dividend Outlook
In their recent earnings calls, both management teams highlighted how rising interest rates have allowed them to grow earnings and dividends in the current environment.
The FSK management announced:
Recent interest rate hikes have had a positive impact on our net investment income. And as Brian mentioned, we are well positioned to continue to benefit from the Fed’s recent actions as 89% of our debt investments are in variable interest rates. Beginning September 30, a 100 basis point move and higher and short-term interest rates will ultimately increase our net investment income by approximately $0.25 per share per year, which translates to approximately $0.06 per share per quarter.
Speaking of ORCC:
We’re increasing our regular quarterly dividend. Our board of directors declared a dividend of $0.33 per share for the fourth quarter, which is $0.02 higher than our third quarter dividend of $0.31 per share. We also want to ensure that our shareholders benefit from the consistent income that we expect to receive in addition to our regular dividend. That’s why we’re introducing a new quarterly bonus dividend on top of our regular dividend. For the third quarter, our board of directors declared a supplemental dividend of $0.03 per share… The increase in our regular dividend reflects our confidence in the portfolio’s earnings potential and positions us to consider further increases in the future while the additional dividend provides shareholders with additional predictable cash flow.
FS KKR vs. Owl Rock – Review
Both BDCs currently appear to be severely undervalued:
| evaluation metric | ORCC | FSK |
| Price to normalized NTM profit | 7.17x | 5.95x |
| NTM Dividend Yield | 12.4% | 14.3% |
| P/NAV | 0.80x | 0.70x |
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FSK continues to gradually buy back shares at a steep discount to NAV, but we haven’t seen any aggressive movement on this front. However, they pay hefty dividends and seem poised to continue doing so for the foreseeable future, so shareholders will definitely benefit from buying the stock at a deep discount to NAV.
As for ORCC, management is pursuing several options to try to close its massive discount to NAV and highlighted this on its recent conference call:
ORCC’s Board of Directors approved a new $150 million buyback program replacing our previous program. Second, Blue Owl employees have decided to participate in an investment vehicle that intends to purchase an additional $25 million in ORCC stock. In the near term, the corporate plan and investment vehicle intends to purchase a total of $75 million in shares, a portion of which will be executed under 10b5-1 programmatic plans for continued buying after the trading window closes. Our board and employees at Blue Owl believe it is an attractive time to purchase ORCC stock and we appreciate this alignment between the company to enable our employees and our shareholders…
We’re really frustrated with where the stocks are trading. Hopefully that shows in what we do and what we do. And we have made the earnings development visible. And while there are attractive investment opportunities, we think it’s important that we also look at the stock price, and share buybacks are one way to do that. So we don’t shy away from that either. I would also like to add that, as I said, we have Blue Owl employees who will also be buying shares of the stock. And there are many – it was a totally optional program that we had a very high participation rate in and they obviously know the portfolio pretty well. Hopefully this is all a sign of confidence in what we do…
I will tell you that I think the portfolio and the companies are doing significantly better than the way our stocks are being traded. Our stock is trading as if we have a lot of problems in our portfolio, and we don’t.
Investor Takeaway
Overall, we believe these two BDCs offer a comparable risk/reward trade-off. FSK trades at a significantly larger discount to NAV than ORCC while offering a significantly higher earnings and dividend yield. However, ORCC’s investment portfolio is much more conservative, which is important in the current environment.
We think both are strong buys at the moment and worth holding. However, as we are very bullish on ORCC’s parent OWL (which, as a fee-based manager, has significant indirect exposure to ORCC’s credit) and already hold it in our portfolio, we have chosen to simply hold FSK versus ORCC. You can read our full FSK investment thesis here and our full OWL investment thesis here.
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