BUY (OFS, $10.75)
Low Leverage, Strong Growth Potential, and Sound Asset Quality - Initiating With A BUY Rating And $14 Price Target.
August 31, 2015
Christopher R. Testa
Investment Conclusion. We are initiating coverage of OFS Capital Ltd. (OFS) with a BUY rating and $14 price target. OFS Capital should be able to post strong NII/share (net investment income per share) growth through 2016 and increase its regular dividend, as we see it. OFS’s debt was entirely SBA (Small Business Administration) debentures as of 2Q15, putting regulatory leverage at zero. Thus despite the stock being at a substantial discount to NAV, the company has no need to issue equity to grow the portfolio significantly. A second SBIC (Small Business Investment Company) license has been applied for and would permit OFS to issue $75 million more in debentures not counted as regulatory leverage. The company has been rotating out of lower yielding club loans into more direct originations which have caused NIM (net investment margin) and effective yields to increase since 2013. While the dollar amount of club deals is relatively smaller at $28 million, OFS should be able to continue to improve effective yield going forward. Returns on equity (ROE) should also steadily improve as the company takes on more balance sheet leverage to grow the portfolio. OFS has solid asset quality with one small investment on non-accrual status as of 6/30/15, representing 1.6% of the portfolio at cost. Despite the sound asset quality and above average growth potential, OFS trades at 6.8x our $1.54 adjusted NII estimate for 2016 and at a 27% discount to NAV (net asset value). Our $14 price target implies an estimated 2016 P/ NII of 9.1x, dividend yield of 9.7%, and P/NAV of 0.94x compared to the BDC sector averages of 8.7x, 11.3%, and 0.88x, respectively.
*Adjusted net investment income = net investment income + write-off of deferred financing closing costs + incentive fee expenses associated with write-off
Source: S&P Capital IQ, National Securities Corporation Estimates
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