FDUS - Fidus: Q1-Update - A Net Income And Dividend Boost With Stable NAV

2023-05-10 12:08:48 ET

Summary

• We discuss quarterly results from the BDC Fidus Investment and highlight key income dynamics of the portfolio.
• FDUS had a strong net income rise in Q1, which translated into a dividend boost given its mechanical dividend rules.
• The NAV was stable. Non-accruals rose slightly.
• FDUS continues to have a very low level of interest expense, giving it a material competitive advantage in the current environment.
• We cut our FDUS exposure in March on expensive valuation. Now that the valuation has cheapened considerably, we marginally added back to our position.

This article was first released to Systematic Income subscribers and free trials on May. 5

In this article, we catch up on Q1 results from the Business Development Company Fidus Investment ( FDUS ). FDUS trades at a 15.5% total dividend yield (9.1% regular dividend yield) and a 93% valuation.

As FDUS investors know, the company's dividend is composed of three parts. The base dividend targets the floor the company expects to generate in net income. The supplemental covers the gap between net income and the base dividend. The special dividend is there to gradually push the spillover lower, so it is closer to its target of three-quarters of the base dividend.

Last quarter the company paid a base dividend of $0.41, a $0.15 supplemental dividend, and declared a series of $0.10 quarterly special dividends for each quarter in 2023 for a total Q1 dividend of $0.66.

For Q2, the company declared total dividends of $0.70 or a 6% raise, composed of the same $0.41 regular dividend and the same $0.10 special, but a higher supplemental dividend of $0.19.

The company also paid a deemed dividend of $1.65 which brought the spillover down to $1.55 per share. Many tax-deferred investors have struggled to get the refund from the IRS because of the general lack of familiarity with this issue by custodians who have to file a form 990-T with the IRS.

Quarter Update

FDUS put together a strong quarter for a 3.3% total NAV return.

The NAV fell 0.2% and has been relatively stable for the last two quarters.

Core net income rose by 18% (GAAP net income rose by about the same).

Coverage of the regular dividend is around 146%. The supplemental brings coverage down to 100% given how it's defined. The company's core net income NAV yield is 12.4% - not far from the sector average, despite its relatively low leverage.

Income Dynamics

Net investment activity was pretty strong with a 4% rise during the quarter.

Portfolio yield increased further to 14.3%. The gap between the company's asset and liability yield is a hefty 10.2%, well above the 7% average of the BDC sector. This wide gap is due to both a high asset yield and a low level of interest expense.

FDUS boasts one of the very lowest interest cost profiles, even below the highest-rated BDCs, due to its opportunistic bond issuance, almost entirely fixed-rate profile, and significant SBIC issuance. Its earliest unsecured debt maturity is in 2026. The company recently tapped a line of credit which represents its highest interest expense, however, it is only about 3% of its total debt versus around 50% for the broader sector.

Credit facility interest expense across the sector is very elevated due to the high level of short-term rates, so having nearly all of its debt in fixed-rate format is a huge competitive advantage for FDUS. The company did issue new SBA debentures recently at interest rates above 5%, however, this is still well below the interest expense of a credit facility.

Leverage rose over the quarter to 0.9x - a level that is still well below the sector average.

The company's sensitivity to a 1% drop in short-term rates is about 7% - below the sector average of about 10%. While this was a liability as short-term rates went up, it will be an asset if they start coming down.

Portfolio Quality

Non-accruals rose for the second quarter - a trend we have seen elsewhere in the sector. FDUS non-accruals are currently around the sector average level.

PIK income rose but remains well below the sector average.

Portfolio quality, as gauged by internal ratings , remained fairly stable. The lowest-rated buckets have remained at the same level over the last few quarters.

The company had positive though small net realized gains - a run of eight quarters of positive net realized gains in a row. These gains mostly come from the equity portion of the portfolio, which has doubled on a fair-value basis relative to its cost. The company has been using these gains to roll the capital into first-lien assets, though this process has stalled recently.

Return And Valuation Profile

FDUS is one of the best-performing BDCs in our coverage. What's also important about BDC performance is consistency. In other words, it's easy enough to find BDCs with strong overall performance but whose performance was stellar several years ago, having come down to earth more recently. That isn't the case with FDUS. As the following chart shows, it has consistently outperformed the sector.

FDUS is not alone in a strong performance. However, what sets it apart from other double-digit return performers like TSLX, HTGC, and MAIN is its still reasonable valuation.

The company's valuation relative to the sector rose over 2022, however, it has dropped off recently, currently trading about 5% above the sector average level.

Stance And Takeaways

FDUS continues to outperform the sector while growing its net income and raising the dividend.

The chart below shows our initial allocation to the stock plotted in terms of valuations. We first allocated to FDUS when it traded at a substantial discount to the sector average (green lines) and exited when it moved to trade at a significant premium (red lines).

The chart below shows this a bit better by plotting the valuation differential between FDUS and the sector. Specifically, we added FDUS when it traded at a valuation between 10-15% cheaper than the sector average and reduced our holdings when it traded at a valuation 5-10% above the sector average.

Our recent position reductions were into a Municipal CEF ( NMCO ) and another BDC ( GBDC ). From the time of the rotation (marked by a red line), NMCO has outperformed FDUS. The chart below normalizes the two securities to 100 at the time of the switch.

GBDC also outperformed FDUS from the moment of rotation from FDUS to GBDC in March.

As FDUS has cheapened recently, in absolute terms as well as relative to our recent rotations, we reversed the FDUS to GBDC switch, adding to our FDUS position. The 5% valuation premium to the sector, 7% discount to book, and a 15.5% total dividend yield are attractive in the context of the company's strong performance.

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