The BDC sector has been among the harder-hit industries since the start of the pandemic. Amidst the rubble, I believe there are some value opportunities to be had. One BDC company that has been left behind is Fidus Investment (FDUS). Looking at the stock chart below, it’s clear that shares have widely underperformed the broader market by 35% on a YTD basis. In this article, I evaluate this stock from a fundamental perspective and will show why I believe the stock is attractive at the current price, so let’s get started!
(Source: Yahoo Finance)
A Look Into Fidus Investment
Fidus Investment is one of the smaller BDCs in the sector, and is externally managed by Fidus Investment Advisors, LLC. It invests primarily in the lower middle market-companies based in the United States. At present, it has $733 million worth of investments at fair value, which is diversified across 67 portfolio companies.
One of the key risk factors for Fidus is its higher focus on second-lien and subordinated debt. Currently, just 19% of its investments are in the form of first-lien debt, with 71% of its portfolio comprised of second-lien and subordinated debt, and the remaining 10% in equity-related securities. This portfolio structure offers Fidus less protection in the event of a borrower default, compared to its first-lien focused peers, such as Main Street Capital (MAIN) and Solar Senior Capital (SUNS).
Another risk for Fidus is declining interest rates, which have negatively impacted its portfolio yield. As seen below, the weighted average portfolio yield has steadily dropped from above 15% in 2013 to 12% in the latest quarter. This was a key factor in why Fidus had to cut its dividend from $0.39 to $0.30 per share. This shouldn’t come as a surprise, as the dividend coverage ratio trended from the 100-110% range in 2016 and prior, to just 92% in 2019.
(Source: August Investor Presentation)
Despite these risks, management has maintained discipline with a highly-selective and credit-based approach to making its investments. As seen below, I’m impressed by the Net Asset Value (NAV) preservation over the past decade. Had an investor purchased shares back in 2011, those shares would have a total intrinsic value of $29 today, based on the combination of accumulated dividends and the current NAV.
(Source: August Investor Presentation)
Additionally, through its SBIC (small business investment company) subsidiary, Fidus is able to access fixed-rate, long-term funding at attractive interest rates from the SBA (Small Business Administration). What I like about this form of funding is that they are interest-only and come with no financial covenants. In addition, SBA debentures are excluded from debt, for purposes of BDC asset coverage requirements. This gives Fidus the financial backing to invest in the fragmented lower middle-market, which has more than 100,000 companies. This high number of opportunities also allows management to be selective in choosing to fund the best credit-risks.
I’m also encouraged by the strong Adjusted NII (Net Investment Income) of $0.37 per share that the company generated in the latest quarter, which represents a 9% YoY increase. This was more than enough to cover the new dividend rate of $0.30 per share, with a dividend coverage ratio of 123%. As such, I find the current dividend rate of 11.7% to be both safe and attractive. Further protecting the new dividend rate is the $1.12 worth of spillover income that the company has on hand. For reference, spillover income is defined as NII that the company generated in excess of the dividend in prior quarters.
I also like the fact that NAV increased slightly, by $0.02, on a quarter-on-quarter basis to $15.39 per share, after the management wrote down the fair value of its portfolio by 5.7% during Q1. I see further risks to its NAV as being mitigated by the company’s low exposure to highly impacted industries. This is supported by the fact that Fidus only has a combined 7% exposure to energy and retail, and no exposure to restaurants or hospitality other than one equity investment with a fair value of less than $300K.
Lastly, Fidus Investment’s balance sheet is in good shape, as the debt-to-equity ratio is at 0.6x statutory leverage, when excluding exempt SBA debentures. For reference, BDCs are generally required to have 1x debt-to-leverage ratio, which equates to a 200% asset coverage ratio as required by the 1940 Act. This means the company’s leverage is well within statutory limits.
Turning to valuation, I see the shares as being deeply discounted. The current share price of $10.30 means that shares are trading at a low 67% Price-to-NAV ratio. In the chart below, I calculated the historical Price-to-NAV, by using the company reported NAV figures in the earlier slide, and the share price at the end of each respective year. As seen below, the Price-to-NAV ratio has trended between 87% and 100%, excluding the 73% Price-to-NAV in 2018 as a result of the December correction that year. This tells me that the shares have potential for strong double-digit returns based on share price appreciation alone.
(Source: Created by author)
Fidus Investment is a well-managed BDC that invests primarily in the fragmented, lower middle-market. While the majority of the company’s loan portfolio sits below first-lien, management has shown its competency, with a steadily improving NAV in the years leading up to 2020.
The current recession has presented the company with risks, as evidenced by the write-down in fair value of its assets during Q1. However, I see most of the risks as already having been baked in, as evidenced by the steady NAV performance during Q2.
I find the current 11.7% dividend yield to be both safe and attractive. Shares are also trading at a deep discount to NAV, especially when compared to historical measures. As such, I have a Buy rating on shares at the current price of $10.30, with potential for strong share price appreciation through a narrowing of the discount to NAV.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.