Fidus Investment: The Case Has Become More Attractive After Q1 2024 (NASDAQ:FDUS)

da-kuk I have been covering Fidus Investment (NASDAQ:FDUS) since December last year, when I issued my first bullish article on this business development company, or BDC. Since then, I have circulated a follow-up article assessing the Q4, 2023 results, where the conclusion was also clear – i.e., to maintain a buy rating. On a YTD basis, FDUS has delivered positive total returns, but to a lower extent as the overall BDC market. All in all, this is fairly logical given that there has been a notable systematic push in the BDC sector, where higher beta (i.e., more risky) BDCs have quite naturally responded in a more magnified fashion. YCharts As elaborated in the previous articles, the key advantage of FDUS is its defensive characteristics, which render it one of the most durable BDCs out there. Just to quickly remind this, the key aspects are the following: Strong focus towards very defensive and traditional businesses that have already reached a positive cash generation phase and also have established a notable market position in the segments, where they operate. Deep diversification, both at industry and single investment level. Average interest rate coverage among the underlying investment companies at 3x, which could be easily deemed as one of the highest (safest) levels in the BDC sector. With this being said, let’s now review the most recent earnings report published by FDUS to see whether the necessary defensive elements are still there and how the investment case looks from here. Thesis review The Q1 2024 performance was stable and continued to bring in solid cash flows that provide a huge surplus in the coverage of base dividend. Yet, in rate of change terms, the key metric – adjusted net investment income per share – came in at not so positive levels. While the debt portfolio generated adjusted NII of $18.1 million (which is an increase of 21.8% and compared to $14.9 million last year), if we adjust for the higher share count, on a per-share basis, the result came in lower by $0.01 – i.e., $0.59 per share compared to $0.60 per share for the same period last year. On the net asset value front there were similar dynamics, where in absolute terms the NAV base grew by 3.2% to $608 million compared to $589 million in Q1, 2023. However, the NAV per share here also declined by $0.01 ending the Q1 at $19.37. On top of this, an additional headwind on the adjusted NII generation stemmed from a slight yield compression, which has been the case for almost every BDC out there. In FDUS’s case, the decrease in the overall portfolio yield was, however, not that significant, dropping by only 20 basis points. Having said, we have to understand that the fact that the share count has increased so much is not a permanently diluting thing for the shareholders. As long as the Management issues the additional equity at a premium over NAV (which is has done) and then can put the fresh liquidity to work in investments that generate higher yields than the cost of capital, the shareholders should benefit. If we look at the M&A front, we will see how active the management has been in deploying the capital into new investments in a quite significant manner. Over the Q1 period, FDUS finally surpassed the $1 billion portfolio mark by conducting net investments in an amount of circa $86 million. To put the Q1 originations in the context, the gross funding amount that was achieved in Q1 nearly equaled the total amount invested in the first half of 2023. The proceeds from repayments and realizations totaled $60.2 million for the first quarter, which is in line with the average amount over the past four quarters. What this means is that a notable chunk of adjusted NII generation will actually kick in during Q2, contributing directly to the bottom-line. In addition, by growing the portfolio via the issuance of fresh equity, FDUS captures several secondary benefits such as enhanced portfolio diversification and better access to capital as a more established and more capitalized BDC. Plus, the lion’s share of the recent transactions were made at the first lien segment, which de-risks the portfolio even further. In this context, the commentary by Ed Ross – Chairman, CEO – fits nicely, where during the recent earnings call the CEO gave an encouraging color on seeing FDUS portfolio grow on a go forward basis as well: For us, this quarter, probably it’s going to be lighter than Q1 by a good bit. And that’s okay. We — what I would say is our portfolio continues to be acquisitive. So that’s part of our investments. And then new transaction activity, we’re working on a couple of deals very seriously right now. I don’t know if they’ll close or not, but that’s our hope. So we definitely are very busy, but it’s not like Q1. And so when I look out the rest of the year, I expect an increase in activity levels over Q2. Finally, the other benefit of growing through new equity issuance is the ability to keep the capital structure balanced without assuming unnecessary financial risk. For example, FDUS ended Q1 with a debt to equity of 0.8x, which is roughly by 0.35x lower than the sector average. The bottom line While on the surface it might seem that Q1, 2024 brought subpar results, if we assess the situation a bit deeper, we will understand that there is actually a solid momentum in the underlying fundamentals that should stimulate the future adjusted NII generation. In a nutshell, the investment amount executed in the Q1 should feed nicely into the future adjusted NII generation, while keeping the overall financial profile safe. Meanwhile, through this notable growth, FDUS is gradually becoming a more diversified and a de-risked BDC thanks to a larger size in combination with a more pronounced focus on the first lien investments. As a result of this, I am still keeping my bullish view on Fidus Investment and consider it a one of the strongest and most defensive dividend plays in the BDC space.