Carlyle Secured Lending: Recent Pullback, Merger And Discount To NAV Makes Them A Buy

Introduction

Carlyle Secured Lending (NASDAQ:CGBD) is a business development company that has been one of my favorite smaller cap BDCs for a while. The stock has performed well in a high-interest rate environment, but their portfolio companies have faced some headwinds recently.

Additionally, they recently announced a merger with Carlyle Secured Lending III that is expected to provide benefits such as increased liquidity, size and scale for the company moving forward. With the share price experiencing an 8% pullback in the past month, I think Carlyle Secured Lending is worth buying at its current price.

Previous Hold Rating

I last covered Carlyle Secured Lending this past June, assigning the stock a hold rating due to the company’s valuation. However, their share price has seen a pullback like others in the sector. A likely result of declining interest rates already priced in. Since then, CGBD is down nearly 7% while the S&P is up slightly above 3%.

During the company’s Q1 earnings, the BDC managed to beat on their bottom line by $0.02 with net investment income of $0.54. Total investment income declined from the prior quarter by roughly $600,000 coming in at $62 million.

Their NAV also saw an $0.08 increase to $17.07. Their dividend coverage was also strong at 115%. This was even higher than peers Blackstone Secured Lending (BXSL) and Ares Capital’s (ARCC) 113% and 114% respectively.

Disappointing Quarter

CGBD reported their second quarter earnings earlier this month, with a miss on both its top and bottom lines. The quarter was a not so great one for the BDC in my opinion with net investment income declining to $0.51, missing analysts’ estimates by $0.01.

This was a 5.5% decline from $0.54 in Q1. Total investment income also experienced a decline from the previous quarter’s $60.2 million to $58.3 million. The company’s financials dropped as a result of their portfolio’s fair value declining 2.8% during the quarter to $1.73 billion.

Year-over-year, their portfolio value also declined from $1.90 billion. But the good news is the company announced a merger on August 5th with Carlyle Secured Lending III.

The merger is expected to increase the company’s liquidity and scale, giving the BDC better access to capital. This is expected to close during the first quarter of 2025 and increase net assets to $2.5 billion. With the announcement, this puts CGBD in a favorable position to better navigate a declining interest rate environment.

Dividend Coverage

As mentioned in my previous thesis, I like the fact that the BDC operates similarly to an internally managed BDC with its shareholder friendly dividend payouts. During the quarter, dividend coverage remained strong even with the decline on their bottom line. This stood at 109% in comparison to 115% in the previous quarter. Base dividend coverage was significantly higher at 128%.

This was in comparison to base dividend coverage of 133% for Fidus Investment Corp (FDUS). Their non-base dividend coverage was 100%. For Carlyle Secured Lending, the merger should add to the company’s bottom line and is expected to reduce costs, translating to NII growth for the BDC going forward.

One metric I would’ve liked to see from the company is a reduction in its fees when they announced the merger, similar to Golub Capital BDC (GBDC) who lowered its base management fee from 1.375% to 1.0% following the merger with Golub Capital BDC III.

Furthermore, management expects this to provide $0.13 accretion to their bottom line on an annualized basis. This is a possibility for CGBD’s management to announce later in the year, but honestly don’t see it happening. But if so, this would likely benefit shareholders, especially with anticipated lower interest rates in the foreseeable future.

NAV & Balance Sheet

Carlyle Secured Lending also saw a drop in NAV from the previous quarter. This stood at $16.95, down $0.12 from March as a result of unrealized depreciation.

However, it is still up slightly from $16.78 from the year prior. But with the merger, this should also be accretive to the BDC’s NAV as well. Golub Capital BDC’s merger was accretive to their NAV following the completion. This was up 1.3% from March.

One thing that did see improvement during the quarter was the CGBD’s leverage. Statutory leverage was 1.1x, while net financial leverage was just 0.9x. These were 1.13x and 0.95x respectively in the previous quarter. Aside from $190 million worth of debt maturing at the end of this year, CGBD’s debt is well-staggered, with none due until 2028.

They also extended the maturity date and reinvestment period of their 2015-IN debt by four years and reduced the debt cost by more than 20 basis points. So, from a balance sheet standpoint, Carlyle Secured Lending is in a good position to take advantage of an uptick in investment activity, likely in the coming months.

Valuation

At the time of writing, CGBD is trading at a slight discount to its NAV at a price of $16.65, giving them a P/NAV ratio of 0.98x. In my opinion, due the merger likely being accretive to earnings going forward, and their quality, I think the BDC is worth buying at current levels.

Additionally, at least 2 rate cuts are already priced in the market in my opinion, so unless something drastic happens, I don’t foresee a huge drop in share price. For comparison purposes, here’s how Carlyle Secured Lending stacks up in terms of valuation to some of their peers:

Golub Capital BDC: 0.99x

Fidus Investment Corp: 1.02x

Monroe Capital Corp (MRCC): 0.84x

Ares capital (ARCC): 1.07x

Although the current discount is not low as their 3-year average of 13.24%, with the merger improving their size, liquidity, and scale, I think a smaller discount is justified investor’s buying at the current price. Moreover, if you’re looking to start a sizable position, you may want to consider waiting for a few rate cuts to happen as I anticipate the BDC could see a further drop in the next 6–12 months.

Risks & Conclusion

One risk investing here is CGBD did see a rise in non-accruals during the quarter. But management stated during earnings they expect this to drop back below 1% in the upcoming quarter. During Q2, non-accruals rose to 2.8% at cost and 1.8% at fair value as the lender added two additional companies to non-accrual status.

These were only 0.2% at cost and fair value during the previous quarter. But as previously mentioned, the merger should provide some relief going forward. And unless the economy experiences a sudden downturn, I expect these to improve over the coming quarters. But with a weakening economy, a potential further rise in non-accruals is something potential investors and shareholders should keep a close eye on.

With the merger expected to close in Q1 2025, this will increase Carlyle Secured Lending’s size and scale, positioning the BDC more favorably moving forward. Additionally, this should be accretive to their financials as management expects cost savings of $2.5 million annually.

So, for potential investors and current shareholders, CGBD looks to position themselves as one of the major players in the sector with net assets anticipated to be $2.5 billion at close of the transaction. As a result of this along with their current discount to NAV, I am upgrading Carlyle Secured Lending to a buy.