Sixth Street Specialty Lending: Best Of Breed In BDC Space (NYSE:TSLX)

Sixth Avenue Specialty Lending, Inc. (NYSE:TSLX) is a specialty finance targeted enterprise growth firm (or BDC), which gives a diversified set of financing choices to small and medium measurement enterprises domiciled within the U.S.

Trying again on the previous 3-year interval, TSLX has underperformed its friends, which have managed to profit extra from the elevated demand for personal credit score.

If we glance deeper into how TSLX is structured, we are able to rapidly perceive what has been the primary causes for the lagging efficiency. In essence, TSLX’s conservative capital allocation coverage has capped the expansion momentum, leading to extra flattish returns relative to the direct friends.

But, for my part, this has created a horny entry level, the place on a relative foundation TSLX seems to be now extra attention-grabbing and contemplating the unsure macroeconomic backdrop, TSLX’s conservatism ought to turn out to be useful.

Under I’ve outlined three key the explanation why I believe that TSLX is a strong funding, which is price incorporating within the portfolio.

#1 – Minimal idiosyncratic exposures and comparatively secure exposures

TSLX’s funding focus within the first lien, which as of Q2, 2023 accounted for 91% of the full asset base. The remaining half is cut up amongst second lien, structured credit score, mezzanine, and fairness investments.

Being uncovered to a primary lien construction inherently comes with a good diploma of security as within the occasion of default, TSLX could be one of many first in line to seize the remaining worth. Often, when corporations wrestle and must decide the place to optimize money flows, dividends, and distributions to most popular and mezzanine holders are lower. In different phrases, first-lien collectors are virtually all the time served first.

An extra security issue, which is necessary to bear in mind is the web LTV (or mortgage to worth) ratio of TSLX’s underlying investments. The businesses to which TSLX has supplied credit score or fairness proceeds are one common carrying very sound steadiness sheets with a median web LTV of 31%. It will depend on the trade, however the common rule of the thumb is {that a} web LTV of fifty% is taken into account considerably dangerous particularly within the context of the prevailing rate of interest dynamics. TSLX is nowhere near that.

Furthermore, as TSLX has expanded its asset base, the diversification impact has kicked in contributing to a extra de-risked publicity. The nice factor right here is that cyclical entities (excluding vitality), which are inclined to expertise hardships throughout environments of financial misery represent solely ~ 8% of the full TSLX’s asset base.

The presence of a strong diversification is properly captured by the above-reflected graphs. The one largest safety (or firm) publicity of TSLX accounts just for 2.5% of the full portfolio. On the similar time, the most important sector publicity consumes solely 15.7% of the full portfolio, which is rare within the BDC area (i.e., often, the one sector exposures focus round 25% of the portfolio).

#2 – Prudent funding

Within the personal credit score enterprise, sources of funding and their buildings play a essential position for creating worth for shareholders.

In TSLX’s case we are able to see that the administration has assumed a fairly conservative method in sourcing exterior funding to cowl the incremental mortgage proceeds (i.e., investments).

To start with, TSLX has by no means issued further fairness beneath the NAV.

Because the IPO, TSLX has 98% of the all buying and selling days traded above the NAV, which has inspired the administration to challenge recent fairness in a worth accretive method for the prevailing shareholders.

This extra capital has helped TSLX speed up diversification and finance high-yielding initiatives.

As well as, the assumed leverage of TSLX is properly structured permitting the Fund to not fear about main refinancings till 2028. A lot of the attracted debt is predicated on a variable price to align the asset and legal responsibility threat exposures. In different phrases, a lot of the issued financing by TSLX is predicated on a floating or variable price. Subsequently, having a variable price funding permits TSLX to mitigate the rate of interest threat with out expensive derivatives.

Lastly, the prevailing liquidity is robust, amounting to $965 million. That is greater than enough to completely repay the maturing borrowing till 2028 and put money into new alternatives.

#3 – Juicy money flows

The present rate of interest dynamics warrant an interesting fairness story of the personal credit score autos like TSLX.

Within the chart above, we are able to see how TSLX’s lending and funding method has led to a strong unfold between the price of financing and the yield at which the credit score has been issued to the underlying corporations. For buyers because of this the returns transfer in keeping with the rates of interest, thus offering stability in the actual return part (which isn’t that widespread within the general funding universe area).

Taking a look at TSLX’s means to cowl dividends, we are able to safely conclude that there’s enough headroom for buyers to not fear about potential dividend cuts. Actually, even on a money movement foundation, TSLX stays web constructive after dividends, which gives further funding to develop internally.

Final however not least, TSLX’s valuation on a P/E foundation as measured by web curiosity revenue adjusted for historic dilutions, places the Fund in a fairly engaging place. The important thing driver for the delta within the mirrored valuations is the aforementioned facet pertaining to TSLX’s fairness funding precept. Particularly, the truth that TSLX can challenge further fairness at premium to NAV accommodates a sound worth creation for the prevailing shareholder base.

The underside line

In my humble opinion, TSLX is the very best of breed with regards to personal credit score BDC section. The latest underperformance has been attributable to the prudent funding and financing coverage, which within the context of a looming recession ought to compensate buyers by offering a extra pronounced draw back safety.

The present dividend of ~ 9.1% coupled with the aforementioned parts of security makes the funding case engaging.