Fidus Investment Corp: “Alternative Bank” Now Pays 11.7%
A Special High-Yield Stock?
Fidus Investment Corp (NASDAQ:FDUS) hasn’t exactly been a market favorite this year. But for yield hunters, the stock offers the potential to earn an oversized payout.
Allow me to explain…
Fidus Investment Corp is structured as a business development company (BDC). If you’ve been following my column, you know that I like to call BDCs “alternative banks” because they make money in a way that’s similar to banks—lending money out at higher interest rates than they borrow at.
There are, of course, some differences, with a notable one being that BDCs don’t really serve retail customers like you and I; they tend to focus on lending to middle market businesses.
In the case of Fidus Investment Corp, the company provides customized debt and equity financing solutions primarily to lower middle market businesses in the U.S. In particular, FDUS targets firms with annual revenues of between $10.0 million and $150.0 million and annual earnings before interest, taxes, depreciation and amortization (EBITDA) of between $5.0 million and $30.0 million. (Source: “Investor Presentation,” Fidus Investment Corp, last accessed October 14, 2020.)
Note that the lower middle market is underserved by traditional capital providers. During the last financial crisis, many traditional banks stopped lending to lower middle market businesses, and the ongoing COVID-19 pandemic has only exacerbated the problem.
Because these businesses are underserved, they have to pay higher costs to obtain financing. As a result, lenders like Fidus Investment Corp have an opportunity to earn attractive returns.
At the end of June, the weighted average debt yield of Fidus Investment’s portfolio was 12%.
By earning oversized interest income from its lending business, Fidus Investment Corp has established a generous dividend policy. The company pays quarterly dividends of $0.30 per share, which at the current share price, comes out to an annual yield of 11.7%.
Of course, the COVID-19 pandemic has sent shockwaves across industries, and BDCs have certainly been impacted. Earlier this year, FDUS stock was dishing out bigger quarterly dividend checks—$0.39 per share. (Source: “Dividend History,” Fidus Investment Corp, last accessed October 14, 2020.)
So the big question now is, can the company maintain the current dividend rate?
Well, based on Fidus Investment Corp’s most recent financial results, the answer is yes.
The BDC reported second-quarter results on August 6. For the quarter, Fidus Investment Corp earned an adjusted net investment income of $0.37 per share. While the amount was lower year-over-year, it was more than enough to cover the company’s quarterly dividend payment of $0.30 per share. (Source: “Fidus Investment Corporation Announces Second Quarter 2020 Financial Results,” Fidus Investment Corp, August 6, 2020.)
Furthermore, Fidus Investment Corp had spillover income—also called taxable income in excess of distributions—of $27.4 million, or $1.12 per share, as of June 30, 2020. This was up from the company’s spillover income of $21.6 million, or $0.89 per share, at the end of March.
In other words, based on the results that are available right now, the company has left a margin of safety in its dividend policy.
Will Fidus Investment Corp Pay Investors Even More?
Now, keep in mind that BDCs are regulated investment companies (RIC), meaning that as long as 90% or more of a BDC’s profit is distributed to investors, it is not taxed at the corporate level.
And that means with excess coverage and accumulated spillover income, Fidus Investment Corp has the potential to return more cash to investors.
Looking back, we see that, since the company’s initial public offering (IPO) in 2011, it has declared 10 special dividends totaling $0.84 per share. Those were payments on top of FDUS stock’s regular quarterly dividends.
When asked about Fidus stock’s dividend level in the latest earnings conference call, the company’s chairman and chief executive officer, Ed Ross, said, “We do recognize from a dividend perspective, we may need to think about some things in the future. We do what we like the idea of waiting a little longer and finding a place have a little bit greater visibility. And then I would also say depending on how things go, we may need to make special distributions in order to meet some RIC spillover distribution requirements over the medium term. But quite frankly, we need to probably play a couple of more innings first to figure out the whole equation.” (Source: “Fidus Investment (FDUS) CEO Ed Ross on Q2 2020 Results – Earnings Call Transcript,” Seeking Alpha, August 7, 2020.)
If you are a yield hunter, you probably want to get paid as much as possible, especially since BDCs are pass-through entities. But given the uncertainties we are still facing, I think it’s a good idea for ultra-high-yielders like Fidus to operate with a conservative mindset. Plus, earning a relatively safe 11.7% yield isn’t too shabby in today’s environment.