Fidus Investment Corporation (NASDAQ: FDUS) is a high-quality business development company with a well-managed investment portfolio and excellent credit ratings.
BDC invests a large portion of its funds in secured debt, but it also holds equity positions for higher profits.
Fidus Investment’s dividend payout is covered by net investment income, and the stock continues to trade at a price below net asset value.
A high-quality BDC with a unique twist
Fidus Investment serves the lower middle market by providing businesses with money to help them grow. While BDC invests in stocks, its primary focus is on first and second lien (the safest type of debt for investment companies).
Fidus Investment typically invests in companies with proven business concepts and a track record of servicing debt: the firm seeks companies in the United States with annual revenues of $10-150 million and EBITDA of $5-30 millions of dollars. Fidus Investment typically invests in private companies that have limited access to cash and need growth capital from private lenders.
Fidus Investment held $812 million in active portfolio companies as of March 31, 2022. The majority of investments (59.1%) were senior debt, with the remaining 24.7% being junior debt.
The total percentage of investments in secured debt now stands at 83.8%. In addition, Fidus Investment allocated 7.4% of its assets to subordinated debt and 8.8% to equity. All percentages shown here are cost based.
The portfolio is also doing well: at the end of March, only 1.1% (cost) and 0.3% (fair value) of the company’s investments were unaccounted for.
In terms of industry exposure, Fidus Investment seeks to invest in companies with an established business plan, consistent revenue and cash flow, and less cyclical exposure to the economy. With a 32.1% stake, Fidus Investment is the most exposed to IT services businesses.
Fidus Investment’s portfolio has enjoyed a decade of continuous expansion, resulting in the highest number of portfolio investments and the highest fair value ever of BDC’s portfolio as of March 31, 2022. Since the inception of company over ten years ago, portfolio value has grown 316% based on cost.
There is a unique touch with Fidus Investment
Despite its focus on debt, Fidus Investment has had significant success with equity transactions over the past decade. Based on fair value, Fidus Investissement’s equity investments were valued at $161.2 million, which represents 19.8% of BDC’s overall portfolio.
Fidus Investing has generated $183.4 million in cumulative net realized capital gains since its IPO, demonstrating that the firm’s equity investment philosophy has paid strong dividends to BDC and its shareholders.
The adjusted NII covers the dividend
The payment of dividends from Fidus Investment is covered by the adjusted net investment income. BDC now pays a basic quarterly dividend of $0.36 per share, but it also pays special dividends, which causes the total dividend payout to vary.
Over the past twelve months, the business development company’s investments have generated $1.74 per share in adjusted NII, compared to $1.75 per share in total dividends.
The 1Q-22 payout ratio was 84% based on the base dividend alone, implying that the current regular payout of $0.36 per share is covered by the adjusted NII. The variable dividend varies according to the performance of BDC investments, allowing Fidus Investissement to pay out additional income.
The stock has a yield of 7.8% based on a base payout of $0.36 per share ($1.44 per share per year). Since management regularly declares special dividends to share excess portfolio income, the effective dividend yield is likely to be significantly higher than this.
Multiple of book value
Fidus Investment is currently selling at an 8% discount to NAV, but BDC has historically traded at a premium to NAV. The stock market correction in June, which was mainly driven by higher inflation, higher expected interest rates and growing fears of recession, is behind the decline in the company’s valuation. Fidus Investment could trade again at a premium to book value if BDC maintains book value growth while keeping defaults low.
Why Fidus Investment might see a lower valuation
Market expectations about future economic growth and the possibility of credit losses in a weaker market determine the valuation of business development agencies.
Fidus Investment’s credit quality was strong in the first quarter, but an increase in non-bookings in the coming quarters is likely to raise concerns about the sustainability of BDC’s book value. An increase in loan losses and a decline in book value could allow BDC shares to trade at an increasingly deep discount to net asset value.
Fidus Investment is a top-quality business development firm with a diversified debt portfolio and a track record of strong equity returns that contribute to BDC’s total returns.
The equity component of Fidus Investment’s portfolio makes BDC more attractive than more conservative BDCs, but it also makes BDC potentially riskier if the market experiences another downturn.
FDUS is a wonderful stock for earning passive income because it has a high quality portfolio (few non-regularizations) and the company covers its dividend payment with net investment income.