Better Blue-Chip High-Yield Buy: Main Street Or Blackstone Secured Lending?

Both Blackstone Secured Lending Fund (NYSE:BXSL) and Main Street Capital (NYSE:MAIN) are high-yield business development companies (i.e., BDCs) (BIZD) with investment grade balance sheets. While BXSL is externally managed by alternative asset management giant Blackstone Inc. (BX), MAIN is internally managed and has an impressive track record as a long-term wealth compounding machine:

While BXSL has a poor track record since going public a relatively short time ago:

its parent manager has a very strong track record in private credit and direct lending. In fact, it recently promoted its direct lending leader and the current CEO of BXSL – Brad Marshall – to Global Head of Private Credit Strategies. He has been very effective at delivering strong results for clients in BX’s private credit strategies, resulting in growing Blackstone Credit’s assets under management by 135% over the past five years alone.

Furthermore, BXSL benefits from the considerable competitive advantages provided by its affiliation with a nearly $1 trillion-dollar alternative asset management firm. BX’s vast amount of data, experience, and deal flow that comes from being the world’s largest alternative asset manager will give BXSL an edge over peers. As a result, it is unsurprising that thus far BXSL boasts excellent underwriting results, including a 0% non-accrual rate at present. As a result, we have reasons to be optimistic about BXSL’s long-term potential and consider it to be a blue-chip BDC alongside MAIN.

In this article, we will compare them side by side and offer our take on which one is a better buy at the moment.

Main Street Capital Vs. Blackstone Secured Lending – Balance Sheet

Both MAIN and BXSL have some of the stronger balance sheets in the BDC sector, enjoying investment grade credit ratings and plenty of access to capital at a reasonable cost.

MAIN’s leverage ratio is on the low end of the spectrum at 49.30% and also enjoys sufficient liquidity of $420 million.

BXSL’s balance sheet has considerably more leverage at a debt-to-equity ratio of 55.54%. However, management has emphasized that moving forward deleveraging is a top priority for them, since in recent quarters they were buying back stock aggressively to take advantage of the substantial discount to NAV that they felt was unwarranted. Furthermore, the company has plenty of flexibility, with total liquidity of approximately $1.1 billion and a weighted average maturity of approximately 4 years.

Overall, we rate this category as a draw, given that MAIN has a meaningfully lower leverage ratio while BXSL has much greater liquidity.

MAIN Vs. BXSL – Investment Portfolio

As BDCs, MAIN and BXSL employ very similar business models. That said, BXSL is laser-focused on senior secured debt (97.3% of its investment portfolio) and floating rate debt (99.5% of its debt is floating rate), whereas MAIN has a greater relative exposure to equity and unsecured debt (only 71.8% of its investment portfolio is in 1st and 2nd lien debt) and only 66.8% of its debt is invested in floating rate loans.

As a result, BXSL is poised to outperform in an environment where economic growth is slower and interest rates are higher, whereas MAIN will outperform if interest rates decline and the economy grows rapidly again like we have seen for much of the past decade. A severe economic downturn will likely hurt both businesses, but MAIN definitely has the greater downside risk in such a scenario.

While MAIN’s internally managed format gives it a cost advantage over BXSL, it is only a minor edge given that BXSL has pursued a lower cost structure than most externally managed BDCs. Furthermore, BXSL has superior underwriting with zero non-accruals in its portfolio, whereas MAIN has a 3.7% at cost non-accrual ratio.

MAIN Vs. BXSL – Dividend Outlook

Rising interest rates and strong underwriting performance are combining to deliver strong earnings growth for both businesses. As BDCs are required to pay out 90% of taxable income to shareholders, this means that their dividend payouts are surging as well.

MAIN’s management recently announced that it would be increasing its regular dividend while also paying out a special dividend, and stated:

We are pleased to be able to deliver this significant additional value to our shareholders. We currently expect to recommend that our Board declare future supplemental dividends to the extent DNII significantly exceeds monthly dividends paid in future quarters and we maintain a stable to positive net asset value. Based upon our current expectations for continued favorable performance in the fourth quarter, we currently anticipate proposing an additional supplemental dividend in the first quarter of 2023.

BXSL has also recently raised its dividend and anticipates continued strength in earnings and dividends moving forward, stating on its latest earnings call:

we believe BXSL is well positioned to deliver high and growing income and dividends for our investors, given our deep platform, positive NII tailwinds and defensive portfolio positioning…the third quarter represents the beginning of a material expansion of our earnings, BXSL out earned its dividend by 33% driven by a favorable asset liability profile, with virtually 100% floating rate investments and 58% fixed rate debt at an average coupon of less than 3%. We expect additional NII growth over the near-term as the portfolio more fully incorporates recent rate increases. Our average base rate was 1.1% in the second quarter 2.5% in the third quarter and would have been 3.5% at quarter end, if all the loans reset on September 30. With 76% of our assets based on LIBOR, the blended base rate would have been 4.3%, if all loans were to reset yesterday. September 30, base rate of 3.5% had been in effect for the entire quarter, we estimate that third quarter NII would have been 13% higher or an additional $0.10 per share.

Moving forward, it will be interesting to see how both businesses walk the fine line between benefiting from higher interest rates and sustaining their strong underwriting performance.

After all, there are significant concerns about a deteriorating credit environment given the Federal Reserve’s insistence on raising rates aggressively, persistent inflation, and numerous recession indicators flashing. With many prominent economists and businessmen expecting a U.S. recession to hit sometime in 2023 (which happens to be our outlook as well), there is concern that this will be the straw that breaks the camel’s back for some BDC counterparties, with many already facing stressed interest coverage ratios due to higher interest rates and market volatility.

Even worse, it appears that the Federal Reserve is not quite finished tightening, either. As a result, there is the very real possibility that BDC loan counterparties will continue to be squeezed from both directions with interest rates rising further for at least the beginning of 2023 even as the economic backdrop deteriorates, resulting in weaker and weaker interest coverage ratios.

Another important risk factor to keep in mind is that interest rates have risen rapidly over the past year, so the shocks to the economy have not yet been fully absorbed and – perhaps even more dangerous – the vast majority of loans in BDC portfolios were underwritten when interest rates were far lower than they are today in a highly competitive environment with fewer and looser covenants, higher leverage, and weaker lender flexibility. This means that there are numerous catalysts for meaningful declines in underwriting performance in 2023.

MAIN Vs. BXSL – Valuation

Based on the numbers below, BXSL is significantly cheaper than MAIN is. Its dividend yield is 410 basis points greater than MAIN’s, its price to earnings ratio is 62% that of MAIN’s, and its price to NAV ratio is also 62% that of MAIN’s. As a result, investors literally get significantly more BDC for their money with an investment in BXSL than they do with an investment in MAIN:

Valuation Metric	MAIN	BXSL
Price to NTM Normalized Earnings	10.44x	6.48x
NTM Dividend Yield	7.2%	11.3%
P/NAV	1.45x	0.90x

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Investor Takeaway

Main Street Capital certainly is about as good as it gets when it comes to track record. MAIN also wins the competition when it comes to lower management cost due to its internal structure.

That said, Blackstone Secured Lending Fund – with its near-maniacal focus on investing in senior secured floating rate debt – is much better positioned for the current weakening economic environment with higher interest rates. On top of that, its underwriting performance is stronger than MAIN’s, and it benefits from the competitive advantages that being managed by BX offers.

Last, but not least, BXSL is clearly undervalued relative to NAV, whereas MAIN trades at a large premium to NAV. While it is possible that MAIN’s superior management and lower cost structure justifies that premium, it is hard to know, especially given where we find ourselves in the economic cycle.

In contrast, buying BXSL right now seems like a much simpler decision, given that the market is pricing in the assumption that BX management will be destructive to earnings. In reality, we believe it will turn out to be just the opposite, and BX’s competitive advantages will turn out to be a huge boon to the BDC. As a result, we favor BXSL right now and rate it a Buy, whereas we rate MAIN a Hold. We also hold BXSL as our second-largest single BDC holding among several in our Core Portfolio: