GSBD - BDCs: Fidus Investment Looks More Attractive Than Goldman Sachs BDC

Summary

• Business development companies could be an attractive option to beat broader market trends in 2023 due to their high dividend yields and low price volatility.
• Fidus Investment is one of the BDCs poised to generate high total returns for shareholders as a result of its portfolio management strategy and strong investment income growth trends.
• Goldman Sachs BDC has a double-digit dividend yield, but its negative earnings growth trend and poor share price performance make it less appealing than Fidus Investment.

Business development companies ("BDCs") may be an appealing option for investors looking to outperform broader market trends and produce healthy total returns in 2023. This is a year with the bleakest outlook in the last two decades due to recession fear, declining earnings, and tightening monetary policy.

Increasing demand for alternative financing and floating-nature portfolios is helping high-yield business development companies grow their investment income and provide investors with sizable cash returns. Regardless of the industry's upbeat outlook, it is prudent to choose a BDC that offers a high risk-adjusted total return. This is because some BDCs provide better returns than others, while some underperform despite having double-digit yields.

Goldman Sachs BDC ( GSBD ) is one that pays a double-digit dividend yield but has failed to outperform broader market trends. Fidus Investment ( FDUS ), on the other hand, is a top-rated small-cap BDC that can help investors generate double-digit price and dividend returns.

Why is Fidus Investment Set to Generate Lofty Returns in 2023?

Fidus Investment outperformed the S&P 500 Index (SP500) in 2022, with a 16% positive total return. Its stock price increased by about 7% in 2022, compared to the S&P 500's drop of 20%. Its total returns in 2022 were 16% thanks to a $2 per share dividend that included a base dividend of $0.36 per share, a supplementary dividend, and a special dividend. The stellar returns from a small-cap business development company focused on lower middle-market companies are likely to continue in 2023. This is reflected in the company's strategy of increasing its quarterly base dividend by 10% to $0.39 per share for 2023 and announcing a special dividend of $0.10 per share.

Furthermore, supplementary dividends are likely to continue in 2023 as a result of three key factors: portfolio expansion, higher portfolio yield, and net realized gains from monetizing the equity portfolio. These three elements enabled the business to increase its adjusted NII by 27% in the third quarter and accrue spillover income per share of $2.86.

In the coming quarters, the company's portfolio expansion strategy, which prioritizes high-yielding debt investments and the rotation out of equity stakes, is likely to contribute to long-term earnings growth. In the third quarter of 2022, the company invested $107 million in new opportunities, in line with its strategy of increasing debt investments and rotating out of equity. Its portfolio yield increased to 12.9% from 11.9% in the previous quarter. Furthermore, 72.0% of its debt investment portfolio is subject to floating rates, implying that additional rate hikes will certainly contribute to investment income.

Fidus' investment potential has also increased as a result of substantial spillover income and proceeds from equity realizations. During an earnings call , the chairman and chief executive officer stated they would deploy some spillover income into growth activities and distribute the rest to shareholders as supplementary dividends. The company's portfolio also appears secure, owing to its emphasis on increasing first-lien investments and strategy of investing in high-quality companies in the lower middle market. As of the end of September, the company's portfolio consisted of 65% first-lien investments and 12.9% second-lien investments.

Core middle market companies are perceived as riskier by markets, but data shows that they have higher growth rates, lower default rates, and higher recovery rates than companies with higher EBITDA. Moreover, companies with EBITDA of around $20 million actually provide significantly safer returns than those above this level. In the case of Fidus, the company targets lower middle market companies with annual EBITDA of $5 to $30 million. This is among the reasons its non-accruals stood at less than 1% of its total portfolio on a fair value basis as of the end of the third quarter of 2022.

Fidus Investment's earnings outlook also appears promising based on the Wall Street earnings forecast and analyst projections. The company received a B-plus grade on earnings revisions according to the Seeking Alpha quant system, because six out of six analysts increased their earnings forecasts in the previous ninety days. Wall Street analysts expect Fidus to earn more than $0.50 per share in the fourth quarter of 2022, finishing the year at around $1.90 per share, with expectations for earnings exceeding $2 per share in 2023.

The quantitative analysis aids in eliminating emotions from investment decisions, which is why it's important to use it when evaluating an investment. According to Seeking Alpha's quant rating, FDUS is the third-best business development company in the industry, with a quant score of 4.88 and a strong buy rating. Fidus received high quant scores on all five factors. In particular, an A grade on profitability reflects solid earnings and dividend growth potential. Moreover, an A+ on valuation and a negative B on momentum indicate that the stock is trading at attractive valuations and that there is still room for upside.

Goldman Sachs BDC Looks Less Attractive

Goldman Sachs BDC is a popular business development company, with a $3.6 billion investment portfolio. It has created one of the safest investment portfolios, consisting primarily of 97.7% senior secured debt investments in 133 companies with an average weighted average yield of more than 10%. Despite this, the company has so far failed to protect its shareholders from bearish broader market trends. Its shares fell by more than 25% in 2022, but thanks to a high dividend yield, the total losses were only 20%, as opposed to a negative 18% total return for the S&P 500. Its double-digit dividend yield appears attractive, but dividend returns lag behind many other BDCs that have paid special and supplementary dividends along with substantial increases in base dividends.

Goldman Sachs BDC has maintained its quarterly dividend of $0.45 per share in 2022, with no special or supplementary dividends. The share price and dividend performance of the company has been adversely affected by factors such as declining earnings potential, high debt leverage, and the risk of putting more companies into non-accrual status.

The company's earnings per share for fiscal 2022 are expected to be around $2.05, a 12% decrease from the previous year. Furthermore, the downtrend is expected to continue in the coming years, implying that the company may face challenges in increasing dividends. However, I see no risk to its current quarterly dividend of $0.45 per share, which is expected to be fully covered by its earnings forecast. The drop in earnings is attributed to a decrease in accelerated accretion related to repayments, as well as slowing portfolio growth trends.

The company's high net debt-to-equity ratio of 1.34x as of September , which is slightly higher than its target level of 1.25x, limits its investment potential. Another threat to its earnings growth is a decline in the weighted average interest coverage ratio, which means its portfolio holdings are losing their interest payment potential. The company's portfolio ended the third quarter with a weighted average interest coverage ratio of 1.8x, down from 2.1x the previous year. The company has placed four additional investments across three portfolio companies on non-accrual status, amounting to 1.4% of the total investment portfolio at amortized cost.

According to the Seeking Alpha quant system, the company received a quant score of 3.45 and a hold rating, owing to poor grades on growth and momentum factors. The company received a D-plus for growth and a D-minus for momentum. A low growth grade indicates that the company is having difficulty producing positive investment income, earnings per share, dividends, and cash flows. The company is ranked 23 out of 93 BDCs, according to Seeking Alpha's quant ranking.

In Conclusion

It makes sense to look for high-yielding stocks that can provide investors with high cash returns, given the most pessimistic outlook for the S&P 500 in the last two decades and the high risk of recession. However, a high yield in the absence of strong share price momentum does not bode well for total returns.

Although Goldman Sachs BDC has a high yield, its poor share price performance makes it a weak candidate to outperform the S&P 500. Fidus Investment, on the other hand, seems like a wise choice to produce healthy returns despite bearish broader market trends. The company's shares are likely to remain in high demand due to its aggressive growth strategies, solid earnings growth prospects, and robust investment potential. Furthermore, regular, special, and supplementary dividends in 2023 would aid in improving investor sentiment and total returns.

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