Fidus Investment Corporation (NASDAQ: FDUS) is a high-quality business development firm with a well-managed investment portfolio and excellent credit ratings.
A BDC invests much of its funds in secured debt, but also holds equity positions for higher profits.
Fidus Investment’s dividend payout is covered by net investment income and the shares continue to trade at a discount to net asset value.
High quality BDC with a unique flavor
Fidus Investment serves the lower middle market by providing companies with money to help them grow. While a BDC invests in equity, its main concentration is on first and second liens (the safest type of debt for investment companies).
Fidus Investment typically invests in companies with proven business concepts and debt servicing experience: The company seeks businesses in the United States with annual revenues of $10 to $150 million and EBITDA of $5 to $30 million. Fidus Investment typically invests in private businesses that have limited access to cash and need growth capital from private lenders.
As of March 31, 2022, Fidus Investment has $812 million in active portfolio companies. The majority of investments (59.1%) were in first lien, and the remaining 24.7% were in second lien.
The entire secured debt investment ratio now stands at 83.8%. In addition, Fidus Investment allocated 7.4% of its assets in subordinated debt and 8.8% in equity. All percentages given here are based on cost.
The portfolio is also performing well: at the end of March, only 1.1% (cost) and 0.3% (fair value) of the company’s investments were not accrued.
In terms of industry exposure, Fidus Investment seeks to invest in companies with an established business plan, consistent earnings and cash flow and less cyclical exposure to the economy. With a 32.1% stake, Fidus Investment is most exposed to the IT services business.
Fidus Investment’s portfolio has seen a decade of continuous expansion, resulting in the most portfolio investments and the highest ever BDC portfolio fair value on March 31, 2022. Since the company’s inception more than a decade ago, the portfolio’s value has risen 316 % based on costs.
There is a unique twist with Fidus Investment
Despite its focus on debt, Fidus Investment has seen significant success with equity deals over the past decade. On a fair value basis, Fidus Investment’s equity investments were valued at $161.2 million, representing 19.8% of BDC’s total portfolio.
Fidus Investing has generated $183.4 million in realized net cumulative capital gains since its IPO, demonstrating that the company’s capital investment philosophy has paid solid dividends to BDC and its shareholders.
Dividends to cover adjusted NII
Fidus Investment’s dividend payment is covered by adjusted net investment income. BDC now pays a quarterly core dividend of $0.36 per share, but it also pays special dividends, resulting in a changing total dividend payout.
Over the trailing twelve months, the company’s business development investments generated $1.74 per share in adjusted NII, compared to $1.75 per share in total dividends.
The payout ratio in 1Q-22 was 84% based on the basic dividend only, meaning that the current regular payout of $0.36 per share is covered by the adjusted NII. The variable dividend varies depending on the BDC’s investment performance, allowing Fidus Investment to pay out additional income.
The stock has a 7.8% yield based on a base payout of $0.36 per share ($1.44 per share annually). Because management regularly declares special dividends to share excess portfolio income, the effective dividend yield is likely to be significantly greater than this.
Multiple book value
Fidus Investment currently trades at an 8% discount to net asset value, but the BDC has historically traded at a premium to net asset value. The stock market correction in June, which was mainly driven by rising inflation, higher projected interest rates and growing recession fears, is to blame for the company’s valuation decline. Fidus Investment could once again trade at a premium to book value if the BDC maintains its book value growth while maintaining low defaults.
Why Fidus Investment could see a lower valuation
Market expectations of future economic growth and the possibility of credit losses in a weaker market drive the valuation of business development organizations.
Fidus Investment’s credit quality was strong in the first quarter, but an increase in non-accruals in the coming quarters is likely to raise concerns about the sustainability of the BDC’s book value. Increasing loan losses and declining book value may allow BDC shares to trade at an ever-increasing discount to net asset value.
Fidus Investment is a higher quality business development company with a diversified debt portfolio and a track record of strong equity returns that contribute to the BDC’s overall returns.
The equity component of Fidus Investment’s portfolio makes the BDC more attractive than more conservative BDCs, but also makes the BDC potentially riskier if the market experiences another downturn.
FDUS is a great passive income earning stock because it has high portfolio quality (low accruals) and the company covers its dividend payout with net investment income.