FDUS - Fidus Investment: A Fat Double-Digit Yield

2023-10-18 11:15:49 ET

Summary

• Fidus Investment is currently paying out a huge 15.6% aggregate dividend yield from a base, supplemental, and special distribution.
• The BDC plans to pay out the special dividend throughout 2023 but has indicated that these will end in 2024.
• A small 2.9% discount to NAV per share sets the backdrop for a small starter position until NAV starts to grow.

Fidus is a Latin word that can be translated as loyal or trustworthy, hence it's clear why externally managed Fidus Investment ( FDUS ) chose it as its name. The business development company has become a juggernaut of income, with the current optimal macroeconomic environment driving its aggregate dividend distributions to record highs to build a nirvana for shareholders. The BDC last declared a base quarterly cash dividend of $0.41 per share , unchanged from its prior distribution and for an 8.9% annualized forward dividend yield. The BDC also announced a $0.21 per share supplemental and a $0.10 per share special dividend for a $0.72 per share aggregate dividend payout, a fat 15.6% yield when annualized.

BDCs are registered as Regulated Investment Companies so they must distribute 90% of their income to their shareholders to be exempt from federal taxes. This has meant record income for Fidus. The BDC intends to pay out the special dividend throughout this year to satisfy RIC requirements and to rightsize spillover income that was at $1.43 per share as of the end of its fiscal 2023 second quarter. Hence, I'd caution going heavy on the commons solely on the basis of the larger 15.6% dividend yield as Fidus has already indicated that the special payments will likely come to an end in 2024. The base dividend and supplemental are set to remain sticky on the back of a Goldilocks macroeconomic backdrop where higher for longer interest rates intersect with a resilient US economy.

Investment Income Growth, Leverage, And Net Asset Value

Fidus had a blockbuster second quarter with total investment income coming in at $30.6 million , up 44.3% over its year-ago quarter and beating consensus estimates by $1.4 million. The BDC's portfolio at fair value stood at $928.7 million and was spread across 79 companies across a diversified mix of industries. These came with a weighted average debt yield of 14.5% but with a 58.1% first lien weighting. While I'd have preferred a higher weighting toward first lien debt, which provides a primary claim on the assets of the borrower, this figure has progressively moved up with Fidus prioritizing investment at the top of the debt stack to de-risk its debt portfolio.

First lien debt has moved up from just 6% of the debt portfolio in 2017 to 65% as of the end of the second quarter. We could see this number come in at just under 70% as of the end of 2023. Fidus focuses on debt and equity financing solutions primarily to lower middle market US companies. The BDC went public in 2011 and has managed to grow NAV on both a nominal and per share basis over this time. Fidus has done this whilst keeping its debt to equity below the upper 1.5x threshold that infers more material gearing. Indeed, its debt to equity stood at 0.97x as of the end of the second quarter. This ratio has been going up though ever since the Fed embarked on raising rates to their highest level in over two decades.

NAV per share was $19.13 at the end of the second quarter, down around 26 cents sequentially from $19.39 in the first quarter. NAV per share has actually dipped for six consecutive quarters from $19.96 per share in the fourth quarter of fiscal 2021. Shareholders would likely want to see the upcoming third-quarter earnings reverse this trend. The BDC will definitely have to scrap the special dividend from next year as a baseline for reversing this. Critically, Fidus can be picked up for a 2.9% discount to NAV with the common shares currently trading for $18.58 per share.

Dividend Coverage And A Goldilocks Economy

There's a slight edge to buy BDCs at a discount to their NAV so I'm a fan of the current discount to NAV. This comes with second-quarter adjusted net investment income of $15.6 million, around $0.62 per share. This non-GAAP figure beat consensus by $0.03 per share and is calculated by excluding capital gain incentive fees from net investment income. Hence, the BDC paid out around 116% of its adjusted NII as an aggregate dividend. The base and supplemental dividends are 100% covered by adjusted NII. Hence, Fidus will likely maintain the supplemental close to its current level once the special is scrapped as it is currently overpaying on its RIC requirements. Spillover income should be able to support more than a year of the current supplemental at the current level.

Bears would be right to flag that the current macroeconomic backdrop is tumultuous. A recession would harm the ability of companies to service their loans and middle market companies would likely bear the brunt of any such recession. Fidus had around 1.6% of its portfolio at fair value on non-accrual status at the end of the second quarter, a low base that would of course balloon if a resilient economy unpinned by a strong labor market and healthy consumer spending gets inverted to the downside. Economic growth set within higher for longer but an end to further rate hikes forms a Goldilocks scenario for BDCs. Fidus forms a buy here.

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