FDUS - Fidus Investment: This High Yield Packs A Punch

• Fidus Investment Corp. is a BDC that offers attractive risk-adjusted returns.
• It has a diversified portfolio across defensive industries in the fragmented lower middle market space.
• It continues its strong track record of generating healthy gains on its equity investments.

Most investors in their working and retirement years have likely heard about the 4% rule, in which a retiree should target drawing 4% from their investment balance each year. The question remains, however, on what types of investments one should target in the first place.

For one thing, the S&P 500 ( SPY ) still yields just 1.6%, hardly enough to fulfill the 4% rule without one having to touch their principal, and we all know that selling the principal can be detrimental to a portfolio when the market is having a down year, as we find ourselves in so far.

This brings me to Fidus Investment ( FDUS ), which is a well-run BDC that throws off a high yield that one can use to fund living expenses. This article highlights what makes the recent sell-off a good opportunity to layer into this name, so let's get started.

Why FDUS?

Fidus Investment is an externally-managed BDC that invests primarily in lower middle-market, as defined by U.S. companies with annual revenues between $10M and $150M. It was founded in 2007 as a Small Business Investment Company and went IPO as a BDC in 2011.

Fidus targets companies in niche markets with defensible market positionings, diversified customer and supplier bases, and strong free cash flows with significant equity cushions. Like a few of its bigger peers such as Main Street Capital ( MAIN ), FDUS invests primarily in the lower middle market space, which is highly fragmented with more than 100,000 companies and offers attractive risk-adjusted returns.

At present, it has a diversified portfolio totaling $812 million spread across 74 companies. 84% of Fidus's investments are in the form of secured debt (59% first lien, 25% second lien), with the remainder comprised of higher yielding subordinated debt (7%) and equity (8.8%) for a growth kicker.

As shown below, the portfolio is mostly defensive in nature, with IT, Business Services, Component Manufacturing, and Specialty distribution comprising 62% of the portfolio.

Fidus maintains equity investments in 82% of its portfolio companies. This strategy has worked out well for Fidus, as equity represents 19.8% of the portfolio fair value, comparing favorably to the aforementioned 8.8% portfolio cost. Since IPO, FDUS has an impressive track record of $183 million in realized net cumulative capital gains. As shown below, FDUS had equity gains every year since 2011 except for 2013.

FDUS has continued to demonstrate strong underlying fundamentals, with NAV per share growing by $0.48 YoY to $19.91 in the first quarter. While NII per share was down by $0.03 YoY $0.42, it amply covers the regular dividend of $0.36 per quarter with a 1.17x dividend coverage ratio. Investments on non-accrual remain low, at just 0.3% of portfolio fair value.

Looking forward to Q2 results and beyond, would expect for NII per share to improve as Fidus maintains a very strong balance sheet, with a regulatory debt to equity ratio of just 0.6x , sitting well below the 2.0x statutory limit.

Risks to FDUS include potential conflicts of interest due to external management, and a slowdown in economic activity. Management, however, noted record levels of private capital sitting on the sidelines as being a potential backstop, as noted during the recent conference call :

So the market today seems to be primarily focused on companies that that have not been meaningfully impacted by COVID-19 or the supply chain issues and overall inflation dynamics that obviously many companies are experiencing and facing.

And, in fact, what we're, we're continuing to see a premium paid for those businesses that are operating without meaningful incident or concern of those issues. There's obviously a fair bit of pent up demand and a lot of liquidity designed to invest in high quality assets.

In fact, I would say private equity and private debt, war chest for lack of a better word, are near record levels today. So, as I would, as I sit here today, I would suggest activity levels are still reasonably solid in the lower middle market, but obviously, nowhere near last year.

Lastly, I find the current share price of $17.83 to be attractive, especially after its drop from the $20-level as recently as early June. This equates to a price to book value of just 0.9x, sitting at the low end of its trading range over the past year.

Sell side analysts have a consensus Buy rating with an average price target of $20.90. This implies a potential one-year 25% total return including regular dividends. This could be higher considering that FDUS paid $0.24 per share worth of special dividends in the first half of this year alone.

Investor Takeaway

Fidus Investment Corporation is a BDC that offers attractive risk-adjusted returns. It has a diversified portfolio across defensive industries in the fragmented lower middle market space, and continues its strong track record of generating healthy gains on its equity investments. I find the shares and the well-covered dividend to be attractive, especially after the recent drop in share price.

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