FDUS - Fidus Investment Looks Better Than Other High Yielding Dividend Options

2023-08-16 18:30:04 ET

Summary

• Popular dividend categories, particularly high yield, have underperformed in 2023 as a result of challenging conditions in key sectors such as healthcare, energy, financials, and real estate.
• In these circumstances, investors must conduct more research to identify dividend options with strong fundamentals.
• Fidus Investment is one of the best options for investors looking for consistent share price growth and healthy cash returns.
• It has the potential to perform well both in the bull and bear markets due to robust fundamentals for alternative financing in the lower middle markets.

In my previous article in early 2023, I praised Fidus Investment's ( FDUS ) business model, investment income growth potential, and stellar returns for shareholders in both bull and bear markets. In this article, I will explain why Fidus Investment is a better investment than many well-known high dividend-yielding options. The theme of the article is how cash-hungry investors can still generate robust total returns in an environment where a large number of high-yielding dividend categories have underperformed significantly.

A Look at Fidus Investment's Business Model

Although the entire BDC industry has been shining , I picked Fidus because of the attractiveness of its targeted end market. Unlike Crescent Capital ( CCAP ), MidCap Financial ( MFIC ), SLR Investments ( SLRC ), Trinity Capital ( TRIN ), and TriplePoint Venture Growth ( TPVG ), which target middle and upper-middle markets, the company focuses on the lower-middle market. The lower middle market typically refers to businesses with annual EBITDA between $5 million and $35 million. In fact, PennantPark Investment's ( PNNT ) data shows that companies with less than $20 million in EBITDA have higher growth potential than companies with greater EBITDA. Moreover, lower defaults and higher recovery rates make the lower middle market attractive than the middle and upper markets. This trend is also reflected in Fidus Investment's portfolio yield, which increased to 14.5% at the end of the June quarter, with non-accruals of only 1.6% at a fair portfolio value of approximately $930 million, down from Crescent Capital's 1.7%, Trinity's 2% and industry median of 2%. Since private companies in the lower middle markets have limited access to larger capital markets, a higher portfolio yield indicates a strong demand for financing in this sector.

In addition to higher portfolio yield, the company's strategy of steadily increasing portfolio value is adding to investment income growth. Fidus Investment generated year-over-year growth of 48% and 50% in net investment income and adjusted net investment income per share in the June quarter, respectively. Moreover, with around 60% of debt investments at a floating rate, the company has yet to fully realize the impact of a 0.50% rate increase in the June quarter and a 0.25% increase in July. Therefore, the extension of earnings growth momentum into the second half is highly likely. For the entire year, Wall Street projects its adjusted net investment income per share in the range of $2.45. If adjusted net investment income stands around $2.45 per share for the full year compared to the annual base dividend of $1.64 per, there is significant room for healthy supplemental dividends in the rest of 2023 in my view.

Cash Returns are Likely to Mark a New Record

Fidus Investment was among the few companies that have outperformed the S&P 500 by a large percentage both in the bear and bull markets. In the past three years, Fidus returned 150% to shareholders compared to the S&P 500's total return of 33%. It is worth noting that the US stock market has experienced two bull markets and one bear market in the last three years, and Fidus has outperformed the broader market index by a significant margin each year. In addition to a steady share price growth, healthy dividends have been adding to its outperformance. Fidus Investment's shares have surged by nearly 6% year to date in 2023 while the company has returned $1.36 per share in dividends including supplemental dividends of $0.34 per share and special cash dividends of $0.20 per share. Currently, Fidus Investment's dividend yield hovers around 13% including special and supplemental dividends.

Fiscal 2022 was a record year for Fidus shareholders in terms of cash returns. However, I believe 2023 will be another record-breaking year, with significantly higher returns than 2022. As shown in the chart above, the company has already paid a total dividend of $1.36 per share in the first half of 2022 while the net investment income outlook and a healthy amount of $1.43 per share in spillover income signals that returns could be much higher in the second half. Therefore, total cash returns may reach around $3 levels for the full year. On the other hand, shares are also likely to gain momentum because key share price drivers such as net investment income growth and dividends are providing solid support to the upside momentum.

Where Do Popular High-yielding ETFs Stand?

High-yielding ETFs are regarded as one of the best options for investors seeking safe and higher cash returns. Indeed, this investment strategy has helped investors earn healthy cash and share price returns over the years. However, the current and near-future markets do not appear to be favorable for high-yielding ETFs. This is because of deteriorating fundamentals of sectors like healthcare, real estate, finance, and energy, which are hubs of dividend stocks. Fundamental challenges have hampered their earnings potential and shareholder returns.

For example, the iShares Core High Dividend ETF ( HDV ), which primarily consists of the highest-yielding large-cap stocks from the energy, health care, and financials sectors with established historical track records, produced a total return of 6% in 2022 and only 0.84% so far in 2023. Furthermore, the weak fundamentals of its portfolio holdings make the outlook appear unfavorable. For example, lower crude oil prices compared to 2022 will have a significant impact on the earnings potential of energy companies. Data shows that the energy sector's earnings plunged 50% in the June quarter compared to the previous year. On the other hand, FactSet data indicates a 27% earnings decline for the healthcare sector in 2023. The financial sector, in particular regional banks and consumer finance companies, have also been struggling due to declining deposits, higher default rates and tightening market conditions.

Let's now look at a different kind of portfolio that has a higher yield than HDV. The Invesco High Yield Equity Dividend Achievers ETF ( PEY ) invests in 50 top high-yielding stocks from the NASDAQ US Dividend Achievers Index. Companies that have increased their dividends for the past ten years in a row are the only ones included in the NASDAQ US Dividend Achievers Index. PEY's portfolio is dominated by small and mid-cap regional banks, healthcare, consumer defensive, and consumer cyclical stocks. However, despite focusing on high yields from companies with a proven track record, PEY has underperformed significantly in 2023, with a total return of 0.10%. The underperformance is attributed to challenging conditions for regional banks and healthcare companies. Read in detail about PEY by clicking here .

The real estate sector is also one of the high-yielding options that are experiencing significant volatility in the current market conditions. For instance, the Global X SuperDividend® REIT ETF ( SRET ) and the iShares Mortgage Real Estate Capped ETF ( REM ) both slashed their dividends compared to the same period last year. The iShares Mortgage Real Estate Capped ETF paid a quarterly dividend of $0.54 per share for the June quarter, as opposed to $0.65 in the same quarter last year. The monthly dividend of the Global X SuperDividend® REIT ETF reduced twice so far in 2023. The real estate sector has been witnessing the negative impact of rising interest rates, falling demand, and growing supply. Both ETFs earned a strong sell rating from SA's quantitative analysis.

In Conclusion

Chasing underperforming stocks and ETFs with bleak future fundamentals does not bode well for investors seeking high cash returns and consistent price appreciation. Due to the challenging market conditions in the healthcare, energy, financial, and real estate sectors, the majority of high-yielding ETFs are currently struggling to generate promising returns. On the other hand, Fidus Investment appears to be a solid alternative due to its potential to generate robust cash returns and steady price appreciation. Its outlook also appears strong given the growth trends for alternative financing, high investment yields in lower middle markets, and low risk of non-accruals.

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