High Yield Income Keeps Your Fire Burning

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Co-produced with Treading Softly

The FIRE movement (Ffinancially Iindependent Rstretch Early) has always been the one I have watched with great interest. I find it encouraging and inspiring to see people putting their financial and health at the forefront of their planning and to see them highly motivated to achieve their goals.

I also find it curious how many of them are saving, investing, reinvesting, and continuing to plug in – all while failing to reach the high-yield sector. Sure, they invest in REITs, or even CEFs and ETFs, but they stay in the “low yield” or shallow end of the pool.

This leaves a lot of potential on the table.

I read some of their blogs or watch their YouTube videos and the reason quickly becomes apparent. They are not shrewd investors by nature or profession. Many of them are exceptionally qualified, talented and hardworking people who know that investing is the surest way to develop and grow their wealth, but have not taken the time to discover that investing income can easily speed up their methodology.

FIRE followers can often be scared when they reach the “retirement” stage of the process due to their reliance on very low returns to generate their needed income. We’ve seen time and time again that “low yield” is no guarantee that a dividend cut won’t occur. During the Great Financial Crisis, more than half of the famous dividend aristocrats disappeared from the list due to suspensions, reductions or no increase in dividends.

So today I want to highlight two high-yield income generators that also have a strong possibility of dividend growth on the horizon. Investments like these make your FIRE even brighter and keep it going longer.

Let’s dive into it.

Choice #1: ORCC – Yield 9.2%

Owl Rock Capital Corporation (ORCC) boosted its earnings with net investment income of $0.32/share, covering its dividend of $0.31. There are still better days ahead, as management announced during the earnings call. Here’s the silver line and why BDCs have been so strong throughout earnings:

The second quarter ended with three-month LIBOR at 2.3%, which significantly increases the base rate for these borrowers. All things being equal, if our June 30 base rates had been in effect for the entire second quarter, we estimate that NII would have increased by $0.02 per share, reaching a total of $0.34 per share in Q2. Additionally, borrowers will continue to reset their interest rate choices throughout the third quarter, which will continue to benefit our portfolio performance and be accretive to NII.

We know that since June 30, interest rates have continued to rise. The Fed remains committed to raising rates further, so we can expect them to continue to rise.

Rising interest rates are great for BDC’s business model since the majority of its loans are variable rate.

Over the past year, ORCC has been working on leveraging. Not intermittently covering the dividend and relying on prepayments and other one-time charges rather than interest. Over the past two quarters, ORCC has managed to cover the dividend with recurring interest income. Here’s a look at ORCC’s revenue breakdown. (Source: ORCC Quarterly Presentation)

Owl Rock Capital Investment Income

ORCC quarterly presentation

Note that “other expenses” and “other income” have been very low over the past two quarters. Yet ORCC hedged its dividend in Q1, hedged it more in Q2, and will easily hedge it as interest rates continue to rise. In short, we can now see a path to an eventual dividend hike as recurring interest income continues to climb. It’s something we couldn’t see with confidence even a quarter ago.

If we compare to other BDCs, ORCC is most comparable to a young Ares Capital (ARCC). It is the third largest publicly traded BDC, and it uses this scale to invest in “upper middle market” companies. The average ORCC borrower has an EBITDA of $151 million per year.

Owl Rock Capital Overview

ORCC quarterly presentation

With a portfolio of $12.6 billion, ORCC aims to have only 2-3% in a single company.

The credit quality of the portfolio remains high, with a single non-recognized company representing only 0.1% of the portfolio.

Owl Rock Capital Portfolio Highlights

ORCC quarterly presentation

ORCC is becoming a stronger BDC day by day. Its profits are increasing, its ability to cover the dividend is improving, and it is doing it without taking huge risks.

As shareholders, we can buy ORCC at less than book value. Get a great return now, and we’ll likely see a dividend hike by the end of the year or early next year. Here’s what management said about the dividend:

I think obviously it’s all on the table to just look at increasing the base dividend, or we could go to more special dividends based on increases. This is going to be so specific to the situation at the time slightly. It’s hard to really, totally speculate. Right now everyone is rightly looking at this rate environment and this rate environment staying here for the foreseeable future and it’s entirely possible by the end of the year. There is a different vision of the pricing environment.

I can therefore promise that the Board of Directors is very committed and that we want to continue to deliver excellent returns to shareholders. And if we are confident that earnings will continue to be good, we will seriously consider ways to share them with shareholders. So I hope that answers your question.

You can’t book a dividend hike until it’s actually raised, but I love it when my 9%+ producers discuss dividend hikes! Who says you have to choose between high yield and dividend growth?

Choice #2: TPVG – Yield 10.7%

When a company I own issues shares, my instinctive reaction is to buy. The reason is simple: companies issue shares to grow. In the case of “RICs” (regulated investment companies) such as REITs, BDCs and CEFs, equity issues are their main lever for expansion. RICs are required to distribute the majority of their taxable income in order to maintain their tax status. This means they cannot be greedy like tech companies and withhold all the money by investing in “growth” projects that may or may not create value, without even consulting shareholders.

I was watching a new TV show “Me Or The Menu” which follows couples who own a new start-up restaurant together. In one scene, the restaurant operator sits down with investors and tells them that they will not receive distributions this year. The operator decided to reinvest all profits in the construction of a new dining room in the basement. Notice the investors were about 1.5 years old and hadn’t seen a dime. Maybe the investors were nice because they were taped on TV. Me? I would have gone through the roof. Pay me for my distribution, then come tell me about your big expansion plans and I’ll decide if I want to make more money. Don’t spend it and tell me afterwards!

RICs pay above-average dividends, distributing cash to shareholders as they earn it. If they want to grow, they have to go back to shareholders and raise new capital. The company cannot just hoard capital and do whatever it wants. I get my dividend, then I decide if I want more from the company. Since I still own stock, that’s usually a pretty good indication that I want more from the company, so more often than not I’m investing.

TriplePoint Venture Growth (TPVG) is the last security in my portfolio to make a secondary offer. Raise capital to pay off the revolver and invest in new opportunities. The best part is that TPVG did it right after earnings, allowing me the luxury of seeing how it performs right now before hitting the market for more capital.

TPVG’s income corresponded to what I expected of them. $0.41/share in net investment income, well above their $0.36 dividend. TPVG has $0.46/share in “squeeze” income, which is undistributed taxable income that will eventually need to be distributed to shareholders.

TPVG continues its strong performance with strong borrowing demand, as management announced last quarter. TPVG closed deals for $260 million and signed term sheets for $804 million during the quarter. (Source: TPVG Investor Presentation)

TPVG performance

Presentation Investors TPVG

Notably, TPVG’s yield on debt before prepayments has risen from 12% to 12.8% over the past year. Compare 2022 to 2021: TPVG has larger portfolio, receives higher return, has more origins (future growth), has NII of $0.41 vs. $0.30, NAV is 13.01 $ versus $13.03, but its stock price is lower!

TPVG is firing on all cylinders, making more money today and positioning itself to do even more in the future. So when TPVG comes knocking and asking for more capital, I’m happy to buy more shares. I also appreciate investing in a company that has the decency to ask instead of just keeping money and never handing it out to me.

The time of dreams

The time of dreams

Conclusion

With ORCC and TPVG, we get heavily hedged dividends from blue chip BDC. Both companies are firing on all cylinders and delivering valuable dividend dollars to my coffers.

If you’re trying to follow the FIRE movement, I support your focus and dedication. Top quality income choices will help your invested dollars accumulate and grow quickly. They also help you see more clearly how much income you are passively generating. This provides an easy litmus test of whether you are nearing the goal, past it, or still have a way to reach it.

For those of us who are not FIRE enthusiasts, the demands for retirement income are always there. We need retirement income and a plan for it when we save for retirement. Investing in companies like ORCC and TPVG is particularly wise.

This way we all have the money we need when we need it most. That’s the beauty of income-driven investing and the goal of our income method.

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