Stabilizing Deal Spreads And Rising Credit Risks Will Limit Future Upside

Catalysts

About Fidus Investment

Fidus Investment Corporation provides debt and equity financing to lower middle market companies, focusing on first lien loans and selective equity stakes.

What are the underlying business or industry changes driving this perspective?

• Stabilizing but not expanding deal spreads in the lower middle market limit upside from repricing risk, which could cap growth in investment income and slow adjusted net investment income expansion.
• Heavy reliance on add-on and sponsor backed M&A to drive portfolio growth exposes Fidus to any slowdown or disruption in transaction activity. This could potentially constrain originations and future revenue growth.
• High weighting to first lien loans enhances credit quality but reduces optionality for outsized equity gains. This may moderate long term net asset value growth and pressure total return if equity realizations remain modest.
• Incremental leverage capacity and recently upsized credit facilities could tempt faster balance sheet growth in a competitive environment. This raises the risk of lower quality originations and future compression in net margins.
• Limited but concentrated exposure to import sensitive and government related borrowers leaves earnings vulnerable to policy or tariff shocks. This could increase credit costs and weigh on future earnings stability.

Assumptions

How have these above catalysts been quantified?

• Analysts are assuming Fidus Investment's revenue will grow by 3.7% annually over the next 3 years.
• Analysts assume that profit margins will shrink from 54.0% today to 38.6% in 3 years time.
• Analysts expect earnings to reach $65.1 million (and earnings per share of $1.75) by about December 2028, down from $81.7 million today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the price target of the analysts, the company would need to trade at a PE ratio of 19.9x on those 2028 earnings, up from 9.0x today. This future PE is lower than the current PE for the US Capital Markets industry at 25.2x.
• Analysts expect the number of shares outstanding to grow by 7.0% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 9.77%, as per the Simply Wall St company report.

Risks

What could happen that would invalidate this narrative?

• A prolonged upswing in lower middle market M&A and healthy deal flow, which management already describes as busy and relatively decent, could allow Fidus to deploy its sizeable liquidity and expanded credit facilities more aggressively, driving faster than expected portfolio growth and higher recurring investment income, supporting higher earnings.
• Stable deal structures with covenant protection and largely unchanged leverage metrics, combined with a portfolio that is over 80% first lien and currently has less than 1% of assets on nonaccrual at fair value, may sustain low credit losses for longer than anticipated, preserving high net interest margins and supporting continued growth in net asset value.
• Broad exposure to resilient, recurring revenue business models and the ability to generate capital gains from a growing equity portfolio that already stands at 12% of total investments could translate into more frequent and larger equity realizations, boosting total investment income and net income beyond current expectations.
• Refinancing of debt and extension of maturities, including the upsized 6.75% notes due 2030 and an enlarged revolving credit facility to 2030, enhance financial flexibility and reduce refinancing risk through the cycle, which may improve return on equity and support a higher valuation multiple and share price appreciation.
• Increasing shareholder payouts supported by adjusted NII consistently covering the base dividend, together with supplemental dividends funded from surplus income, could lead investors to re-rate the stock as a reliable income vehicle, compressing the yield and pushing the share price above current levels as dividend sustainability and earnings power become more evident.

Valuation

How have all the factors above been brought together to estimate a fair value?

• The analysts have a consensus price target of $22.0 for Fidus Investment based on their expectations of its future earnings growth, profit margins and other risk factors.
  
• In order for you to agree with the analysts, you'd need to believe that by 2028, revenues will be $168.6 million, earnings will come to $65.1 million, and it would be trading on a PE ratio of 19.9x, assuming you use a discount rate of 9.8%.
  
• Given the current share price of $20.11, the analyst price target of $22.0 is 8.6% higher. The relatively low difference between the current share price and the analyst consensus price target indicates that they believe on average, the company is fairly priced.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.