NCDL: The Data Is Too Good To Keep (NYSE:NCDL)

My previous article on Nuveen Churchill Direct Lending Corp. (NYSE:NCDL) was issued in May 2024 with a title – NCDL: Too Many Uncertainties To Go Long. The main conclusion from the analysis was that NCDL has a decent portfolio structure and the right types of assets on the balance sheet to generate sustainable income streams. However, at the same time, there were problems with abnormal leverage and spread compression, which introduced a relatively high degree of uncertainty, especially considering that the NCDL has only been public since the beginning of January this year (ie a set minimum data from which to evaluate the history). performance).

Since the publication of my previous article, NCDL has actually performed quite well, delivering a positive alpha of ~6.5% during a period when many BDCs reported subpar Q2, 2024 results.

come on Now take a look at NCDL’s recent earnings package to see if the thesis has become more attractive, which could warrant a rating upgrade.

Revision of the thesis

Looking deeper into Q2, 2024 revenue data, the overall conclusion is that NCDL managed to deliver relatively stable results, albeit with some areas of concern.

Net investment income per share came in at $0.57, an increase of $0.01 per share compared to the previous quarter. Posting a rising net investment figure for Q2 was not that common among many BDC peers.

If we measure this result against the total dividend paid in Q2, we arrive at a dividend coverage of ~104%, but adjusting for the additional distribution, which amounted to $0.1 per share, the underlying dividend coverage level would reaches 126%, which is certainly above the BDC sector average. Based on the core dividend alone, the forward yield for NCDL is ~10.3% – ie, an attractive level given the strong core dividend coverage statistic.

Speaking of positive aspects, it is worth highlighting the recovery in investment activity, where during the quarter NCDL captured $360 million in new originations of which more than 95% came in the form of senior secured loans. As a result, the fair value of NCDL’s portfolio increased by approximately $196 million, with new investments and originations clearly outpacing organic loan disbursements. In addition, after the significant addition of new and defensive investments, the total share of prime loan investments in the portfolio increased to nearly 91% (measured on a fair value basis).

Commentary during the Q2 earnings call from Kenneth Kencel – Chairman, President and CEO – provides decent color to this particular dynamic:

When we look at the second quarter results, there are two factors that help us to increase our performance. One was the level of implementation we experienced this quarter. The other was our discipline in managing NCDL’s leverage profile, which Shai will discuss in more detail. Capital deployment by NCDL in Q2 was very strong. This was a significant increase compared to Q1. In fact, Q2 represented one of the strongest lending quarters in our firm’s history. And that resurgence of activity, particularly in the senior lending area, which accounted for over 95% of our origination activity, has been responsible for a large part of our success.

An additional driver of earnings growth that Kenneth highlighted in the highlighted comment was the optimized use of external leverage. In other words, it just means that NCDL has taken on heavy loads of debt to enable the portfolio to expand – increasing it from a conservative 0.82x to 1.04x.

Now, as many of my followers have probably noticed, I’m not that comfortable recommending BDCs that currently have high levels of leverage. Overall economic conditions are too uncertain and the signals we are getting from many other BDCs is that there could be a slow emergence of structurally rising unemployment. The problem is that with high leverage, every negative aspect or outcome is significantly amplified in an unfavorable way.

In fact, we can already see the consequences of this by looking at some of the NCDL Q2 data points. For example, in Q2, NCDL was forced to recognize an unrealized loss of $0.20 per share that resulted from just two underperforming investments that were placed on non-accrued status.

However, there are three important mitigating factors:

1. As described above, NCDL’s portfolio is skewed towards inherently defensive investments (in Senior Secured First Collateral) of which 100% are backed by private equity sponsors. This is the best quality and best combination you can get in the BDC investment universe.
2. Core portfolio credit statistics are as strong as in the segment, with average net portfolio leverage of 4.8x and interest coverage of 2.2x.
3. While NCDL’s leverage has increased significantly, the current level is still below the sector average, which could be considered an advantage in itself.

The bottom line

After seeing the Q2 2024 earnings data, I decided to upgrade the rating from hold to buy. This is because Nuveen Churchill Direct Lending Corporation has demonstrated that it is able to grow its portfolio conservatively even during a period when M&A activity is constrained. Additionally, by growing the portfolio, NCDL was actually able to increase the portfolio yield by 20 basis points, which again goes against the average dynamics we’ve seen in the rest of the BDC space. Finally, while leverage has indeed increased, the combination of strong portfolio quality and a level of debt that is still below the sector average helps to derail the situation.

Finally, we must appreciate the presence of one of the strongest underlying dividend coverage levels in the sector, where given the underlying T2 distribution and NII generation, the coverage statistic is 126%, providing a large margin of safety .