Specialty Lending on Sixth Street Maintains Elevated Net Asset Value Premium
** Straight-Up Talk About TSLX: A Sizzling Business Development Company**
Sixth Street Specialty Lending Inc. (NYSE:TSLX) is an exceptional business development company (BDC), bucking the trend by growing its net investment income and garnering investors' attention with a premium valuation based on net asset value. It's a rare pearl in the crowded BDC market.
While most BDCs are grappling with mounting pressure on their portfolios due to hefty repayments in high-interest environments, TSLX manages to expand its originations, and consequently, its net investment income. This growth results in a better-covered dividend and a higher margin of safety for investors.
Despite the risks of short-term rate cuts amid escalating geopolitical turmoil, making the BDC's floating-rate credit portfolio vulnerable, TSLX is still, in my opinion, a solid 'Buy', and the premium to net asset value is well-deserved.
The Lowdown on TSLX's Portfolio
TSLX is a specialty finance company that focuses on lending to middle-market companies with a significant emphasis on first lien loans, making it a high-quality BDC. The high percentage of first lien loans—93% in the March quarter—underscores BDC's focus on risk mitigation and high credit quality. As of March 31, 2025, TSLX's portfolio was valued at $3.4 billion, up 1% year-over-year thanks to originations growth.
TSLX's 8-quarter trend in originations and fundings demonstrates positive average origination activity over the past two years. The BDC typically originated around $17 million in new investments per quarter, with variations from quarter to quarter in net new investments.
TSLX's non-accruals as of March 31, 2025 stood at 1.2%, a 0.7 percentage point improvement compared to 3Q24 when non-accruals peaked at 1.9%. TSLX has indeed enjoyed two consecutive quarters of enhancing credit quality.
It's worth noting that TSLX's non-accrual ratio is slightly higher than some of the best BDCs in the sector, such as Ares Capital Corp. (ARCC) and Blackstone Secured Lending Fund (BXSL), but the peer group average non-accrual ratio is still 0.3 percentage points better.
TSLX's Booming Net Investment Income (NII)
TSLX's net investment income soared 11.5% year-over-year to $59.3 million in 1Q25. The positive trend is backed by originations and NII growth in the BDC's portfolio as well as lower interest expenses (lower operating costs).
Safer Dividend Yield for TSLX Shareholders
TSLX's dividend coverage has significantly improved over the past year. In the first quarter, the BDC earned $0.62 per share in net investment income, up 5.1% year-over-year. Consequently, the dividend pay-out ratio was 86%, reflecting a 6 percentage point decrease compared to the previous year.
Premium to NAV
TSLXtrades at a substantial 34% premium to its latest reported net asset value, which as of March 31, 2025, stood at $17.04 per share. Despite the high premium, TSLX isn't alone in the market; other BDCs sell for even higher multiples.
In the BDC peer group, TSLX has the second-highest Price-To-NAV ratio, trailing Hercules Capital Inc. (HTGC), and enjoys the highest net asset value premium of 52%. Blue Owl Capital Corp. (OBDC) and FSK KKR Capital Corp. (FSK) sport the biggest net asset value discounts and also the lowest Price-To-NII ratios.
These BDCs present interesting opportunities for passive investors tolerant of higher risk: Blue Owl Capital recently completed a merger, while FS KKR Capital boasts a non-accrual ratio exceeding 2.0%. These factors could trigger discounted valuations and stock re-rating potential if investor sentiment turns positive.
In terms of Price-To-NII, TSLX is selling for 9.2 times its 1Q25 annualized net investment income, which equates to the peer group average multiple of 9.1x.
Considering the well-covered dividend and TSLX's tendency to distribute excess income as supplemental dividends, the BDC merits the above-average Price-To-NAV and Price-To-NII ratio.
Fears About Interest Rates
Three-quarters of TSLX's credit portfolio is exposed to floating-rate investment loans, which means the BDC is vulnerable to potential interest rate cuts due to a moderating inflation trend and growing concerns about a new war in the Middle East. The interest rate cuts could negatively impact TSLX's net investment income in a falling-rate environment, potentially lowering the margin of safety for passive income investors.
My Verdict
TSLX is an attractive BDC for passive income investors prepared to pay a significant premium for a relatively low-risk dividend. The BDC offers passive income investors a secure 8% dividend yield that is well-covered by net investment income and supported by positive originations trends.
While TSLX exhibits an above-average non-accrual ratio and high-floating rate exposure, which could reduce the BDC's net investment income in the event of short-term interest rate cuts, TSLX remains a compelling yield play. The BDC manages to grow its net investment income while many other BDCs face pressure on their portfolios and lower NIIs.
- TSLX's high-quality focus on first lien loans, which accounts for 93% of its portfolio, demonstrates a strategic emphasis on risk mitigation and high credit quality.
- The growth in TSLX's net investment income, bolstered by originations and lower interest expenses, offers a secure 8% dividend yield for passive income investors, making it an attractive choice despite the moderate inflation trend and geopolitical uncertainties that could trigger interest rate cuts.
