Sixth Street: You Can Still Get A 10% Yield On Your Purchase (NYSE:TSLX)

Sixth Street Specialty Lending, Inc. (NYSE:TSLX) is a high-quality, well-managed business development company (“BDC”) that income investors should consider adding to their portfolios.

The business development firm specializes in First Liens and has exceptional credit quality. Despite a conservative portfolio, the BDC has consistently produced high returns on equity.

Sixth Street Specialty Lending’s dividend is fully covered by net investment income, and the stock is currently trading at a 10% premium to net asset value.

Portfolio Composition, Double Digit Equity Returns, Credit Quality

Sixth Street Specialty Lending is a well-managed business development firm that specializes in high-quality First Lien Debt investments.

The BDC invests approximately 90% of its capital in secure first liens with low loss ratios, providing passive income investors with a high level of security. 87% of Sixth Street Specialty Lending’s new investments in the third quarter were in secure first liens.

The BDC follows a disciplined investment strategy and ensures that its investments are secure in order to protect investors from capital losses.

Despite its First Lien focus, Sixth Street Specialty Lending has historically produced attractive, double-digit equity returns. The BDC’s return on equity (measured as ROE on adjusted net income) was at least 10.8% between 2014 and 2021, and Sixth Street Specialty Lending performed well even when the Covid-19 pandemic impacted portfolio companies and valuations in 2020. Sixth Street Specialty Lending did not achieve a double-digit ROE until 2015.

Sixth Street Specialty Lending has significantly less investment risk than the average large business development company because its First Lien percentage is 20 percentage points higher.

Sixth Street Specialty Lending achieves high double-digit ROEs while assuming less risk than other business development firms in the sector.

Sixth Street Specialty Lending reached a record portfolio value (based on fair value) of $2.81 billion in the third quarter, and the BDC has significantly reduced its exposure to volatile business sectors over time.

Currently, the BDC has approximately 12% of its investment portfolio invested in cyclical names, including energy exposure.

Top Portfolio Quality

Sixth Street Specialty Lending’s portfolio quality is very high, comparable to Oaktree Specialty Lending Corporation (OCSL), which I consider to be the gold standard in the BDC industry.

As of September 30, 2022, Sixth Street Specialty Lending had only one non-accrual investment, which represented less than 0.1% of the company’s investments based on fair value. The non-accrual ratio has remained low over the last year, attesting to the overall portfolio quality and superior management style of Sixth Street Specialty Lending.

10% Premium To Net Asset Value

Given Sixth Street Specialty Lending’s high portfolio quality and ability to cover its dividend with net investment income (the dividend payout ratio in the third quarter was 89.4%), the BDC’s stock should not be trading at a 10% premium to net asset value.

Sixth Street Specialty Lending is a very high-quality business development company that deserves a higher net asset value multiple, especially given how well its credit is performing right now.

Why Sixth Street Specialty Lending Could See A Lower Valuation

Sixth Street Specialty Lending’s portfolio quality could suffer if the company experiences an increase in non-accruals, which is theoretically possible.

Because Sixth Street Specialty Lending has a higher-than-average percentage of First Lien Debt in its portfolio, I believe TSLX is less likely to experience an increase in the non-accrual ratio.

A rise in non-accruals during a recession, when more borrowers face financial difficulties, could cause the market to apply a net asset value discount to TSLX.

My Conclusion

Sixth Street Specialty Lending is a well-managed business development company with a strong First Lien focus that helps to limit capital risks during a downturn.

Sixth Street Specialty Lending is a strong potential BDC investment for tougher times due to its distinct First Lien focus and top-rated credit quality.

The 10% dividend yield, which is covered by net investment income, and the fact that the stock is currently trading at a 10% premium to net asset value are two additional reasons to consider TSLX for a passive income-oriented investment portfolio.