This is an extract from an earlier article at Systematic Income Premium.
In this post, we catch up on Q3 results from the business development company (“BDC”) Fidus Investment (FDUS).
The stock remains one of our largest BDC holdings in the High Income Portfolio. Since we topped up the holding in October of last year, the stock has handily outperformed the rest of the space, as the following chart shows.
In our last update, we highlighted that, given its large income tailwinds and a huge spillover, the company was very likely to deliver dividend hikes across any of its base, supplemental and special dividends. This is indeed what happened – in fact, there was an increase across all three dividend components.
For Q4, the company kept its regular dividend the same at $0.36 but increased the supplemental from $0.07 to $0.15 while declaring a new special of $0.10. For 2023, the company has increased its base dividend to $0.39 and kept the $0.10 special.
Quarter Update
Total investment income jumped over Q3, supported by both interest income as well as a rise in fee income from relatively depressed levels.
Both GAAP and adjusted net income (adjusted net income excludes capital gains incentive fees) rose over the quarter and stand at the highest levels over the last few years.
Total dividend coverage rose to 119% in Q3, which explains the bumps in Q4 dividends.
FDUS NAV fell around 2% versus the median of around a 0.5% drop. The NAV was skewed lower due to an August declaration of the Q4 base and supplemental dividends totaling $0.43. In other words, the NAV bore the brunt of 2 quarters of dividends. This early declaration of a Q4 dividend was intended to satisfy the distribution requirement of 2021 income. Taking this into account, the NAV actually increased over the quarter, once again outperforming the broader sector on an apples-to-apples basis.
Income Dynamics
The company continues to rotate its equity securities into secured loan/income-producing assets. The portfolio allocation chart below shows that the proportion of secured loans has been growing at the expense of equity. During the quarter, the company monetized $40m of its equity portfolio as part of its broader strategy to cap its equity allocation at 10%. This rotation away from lower-yielding equity positions will increase the fund’s overall investment income, all else equal. Since the end of the year, the debt portfolio has increased by $197m or 35%. In terms of the NAV, it was a 42% increase. This will have a sizable impact on the company’s ability to generate a significantly higher level of income relative to its historic level.
Q3 was big for realized gains, with a net of $40m monetized from its equity portfolio. The company has been very successful on its equity holdings, generating a cumulative $242m of realized gains in the context of a current $857m portfolio.
New originations outpaced repayments, resulting in net new investments, creating a further income tailwind going forward.
Portfolio Quality
There were no new non-accruals during the quarter. The company’s non-accrual on fair value is about half the average and below the median sector level.
The weighted-average internal portfolio rating worsened for the second straight quarter. This is not out of line with the broader sector and makes sense in the context of slowing economic activity.
PIK remains well below sector-average levels.
Our previous allocation to FDUS was predicated in part on the combination of strong and consistent historic performance and low valuation relative to its strong performance. The chart below comes from our first article on the company almost exactly a year ago. It shows that among BDCs that have generated a total NAV return of 12-15%, FDUS was trading at the lowest valuation, with the next company with a similar track record, Ares Capital (ARCC), trading at a valuation of around 20% higher.
Since then, the valuations of FDUS and ARCC have converged from both ends as FDUS has gained and ARCC has fallen.
Overall, FDUS is very quickly turning from a higher-risk/higher-beta BDC to a lower-risk/lower-beta BDC. Its equity allocation is falling towards the broader sector average while its leverage remains unusually low in the sector. This increased focus on secured loans at the expense of equity may mean Fidus Investment’s impressive historic returns may not be repeated. This is certainly possible, however, we remain optimistic.
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