Is this high yield dividend stock a buy?

Dividend stocks are good investments for retirees and others looking for predictable portfolio income, especially when they also offer the potential for long-term growth. Many large established companies pay regular dividends on a quarterly basis. Companies like Procter & Gamble, Coca Cola, and Real estate income yield in the range of 2% to 4% on an annualized basis.

And some stocks pay more for investors willing to take additional risk. Owl Roche Capitale (NYSE: ORCC) is a middle market lender with an 8.5% dividend yield at Friday’s closing price. The lender has only been publicly traded for a few years and its high yield makes it hard to ignore. Is Owl Rock Capital’s high return worth the risk?

A lender in a neglected market

Owl Rock Capital provides loans to middle market companies in the United States and is organized as a Business Development Company (BDC). A BDC is simply a fund that grants loans or buys shares in private companies that banks may consider too risky. Like real estate investment trusts (REITs), BDCs are subject to tax rules that require them to pay 90% of their income in the form of dividends. While BDCs can offer a high return, they are also riskier investments due to the nature of their investments and their use of leverage.

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Owl Rock Capital seeks opportunities in the middle market lending space. The company sees this space as underserved, as large institutional investors are bogged down by liquidity needs, leading them to invest in large corporate bonds. Owl Rock Capital seeks to make this an advantage of its stable capital base and ability to invest in illiquid assets.

BDCs are risky because of the nature of their investments. Since many of their investments are in illiquid securities, they could suffer rapid losses in the event of defaults or series of defaults on loans. Additionally, BDCs tend to use leverage, which can further magnify potential losses.

Owl Rock Capital uses a leverage ratio of 1.0 times debt-to-equity, within its range of 0.9 and 1.25 leverage targets.

A solid backdrop for lending to mid-market companies

Second quarter builds were strong for Owl Rock Capital. New investment commitments in the quarter were $ 1.6 billion, up from $ 401 million in the same quarter last year, and nearly double the $ 864 million posted in the first quarter of this year. .

Investment performance has been robust, aided by strong M&A activity which has seen private equity firms choose direct loans for many of their larger transactions. Direct lending seeks to pool capital to make loans, rather than raising capital from investors, thus playing on the strengths of Owl Rock Capital. During the year, the company evaluated 20 opportunities valued at over $ 1 billion, investing in eight of them.

As of June 30, he has investments in 129 companies with a fair value of $ 11.9 billion and the average return on his portfolio was 8.1%. Its investments consist primarily of senior secured debt instruments, representing 76% of its total debt. Senior secured debt means Owl Rock Capital would have the primary claims on the assets of the company in the event of bankruptcy, and means debt tends to be less risky than unsecured debt.

Owl Rock Capital is exposed to a wide range of industries, with no more than 11% investments in any one. The sectors it serves include internet services, insurance, food and beverage, distribution, and healthcare providers.

A risky investment, but its high return may be worth it

Owl Rock Capital doesn’t have a long history, given that it has only been publicly traded for a little over two years now, so we can’t say much about its history of dividend distribution. However, management expects the third quarter to be another solid period of creations and has already declared another dividend of $ 0.31.

One thing investors should note is that Owl Rock has failed to cover its quarterly distributions when you break them down by net interest income per share. In the second quarter, it hedged 97% of its dividend payment, based on a dividend per share of $ 0.31 and net interest income per share of $ 0.30 for the quarter. Management said their goal is to fully cover the distribution in the second half of 2021.

Owl Rock Capital is a high yield dividend stock which can be viewed in the same way as a REIT. Its high yield is attractive, but it carries additional risk due to potential defaults or risk if the economy as a whole is struggling. However, given the strength of the economic recovery and lending markets, Owl Rock Capital looks like a solid, high yield dividend stock that is worth the risk.

This article represents the opinion of the author, who may disagree with the “official” recommendation position of a premium Motley Fool consulting service. We are motley! Challenging an investment thesis – even one of our own – helps us all to think critically about investing and make decisions that help us become smarter, happier, and richer.

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