OFS Capital Corporation (NASDAQ:OFSSH) Navigating Uncertain Times with Disciplined Investing

Published on September 24, 2024 | Ticker: OFSSH

OFS Capital Corporation (NASDAQ:OFSSH) is a business development company (BDC) that primarily invests in middle-market and larger companies in the United States. The company has a long-standing track record of disciplined investing, having invested over $1.9 billion since 2011 with a cumulative net realized loss of just 2.5% over the past 13 years.

Business Overview

OFS Capital's investment strategy focuses on debt investments, with a particular emphasis on first and second lien senior secured loans. As of June 30, 2024, approximately 100% of the company's loan portfolio at fair value was in senior secured positions. This positioning has been a key part of OFS Capital's investment discipline, as the company believes it provides greater downside protection in the current uncertain macroeconomic environment.

The company's portfolio is well-diversified, with its largest industry exposures being manufacturing (29.8% of the portfolio at fair value), healthcare and social assistance (20.6%), and wholesale trade (12.9%). This diversification, along with the company's focus on avoiding highly cyclical industries, has helped to mitigate risk in the portfolio.

OFS Capital is externally managed by OFS Advisor, a registered investment advisor with a $4 billion corporate credit platform and over 25 years of experience navigating multiple credit cycles. The company's management team and affiliates maintain a significant equity stake of approximately 23%, aligning their interests with those of shareholders.

Financials

For the first quarter of 2024, OFS Capital reported net investment income of $0.42 per share, a 20% increase over the prior quarter. This increase was primarily due to certain nonrecurring items, and the company was able to cover its $0.34 per share distribution during the quarter.

The company's net asset value (NAV) per share declined to $11.08 at the end of the first quarter, down from $12.09 at the end of 2023. This decline was largely attributable to unrealized depreciation in the company's equity investment in Pfanstiehl Holdings, a manufacturer of specialized products for the biopharmaceutical industry.

Despite the decline in NAV, OFS Capital's management remains confident in the overall health and positioning of the portfolio. As of June 30, 2024, the company had investments in 50 portfolio companies totaling $398.2 million at fair value. The weighted average performing investment income yield on the interest-bearing portion of the portfolio was 13%, down slightly from the prior quarter due to the placement of one borrower on non-accrual status.

Liquidity

OFS Capital's balance sheet positioning has been a key strength, with 100% of its outstanding debt maturing in 2026 or later and approximately 70% of its debt being unsecured. The company's nonrecourse $150 million senior loan facility with BNP Paribas matures in June 2027, providing additional flexibility.

In the first quarter of 2024, the company fully repaid its remaining $31.9 million in SBIC debentures, further strengthening its balance sheet. As of June 30, 2024, the company's debt-to-equity ratio was approximately 1.74x, and its regulatory asset coverage ratio was 157%, exceeding the minimum requirement of 150%.

Outlook

OFS Capital's management remains cautious about new originations, citing slow M&A activity during the first quarter. However, the company continues to support its existing portfolio companies, funding $12.3 million in new investments during the first half of 2024.

The company's focus on capital preservation and senior secured positions in the capital structure has served it well in the current environment.

Risks and Challenges

Risks remain, including the potential for further unrealized depreciation in the portfolio, particularly in the company's equity investments.

Additionally, the company's performance is closely tied to the overall health of the middle-market and larger companies in which it invests. A prolonged economic downturn or disruptions in the credit markets could adversely impact the company's portfolio and financial results.

Conclusion

OFS Capital's disciplined investment approach, diversified portfolio, and strong balance sheet positioning have helped the company navigate the current uncertain macroeconomic environment. While the company has faced some challenges, such as the unrealized depreciation in its Pfanstiehl Holdings investment, its management team remains confident in the overall quality and fundamentals of the portfolio.

As the company continues to support its existing portfolio companies and selectively pursue new opportunities, investors will be closely watching for signs of continued portfolio stability and the company's ability to maintain its attractive risk-adjusted returns. With its experienced management team, conservative financing, and focus on capital preservation, OFS Capital appears well-positioned to weather the current market conditions.

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