10.3%-Yielding Hercules Capital Is A Buy Right Now
Summary
- Hercules Capital makes an attractive value proposition as a BDC income play.
- Strong portfolio yields and dividend coverage stats support an investment in Hercules Capital.
- Positive interest rate sensitivity is an attractive property, improving the investment thesis further.
- An investment in HTGC yields 10.3 percent.
Hercules Capital, Inc. (NYSE:HTGC) continues to make a good value proposition for income investors seeking high, stable dividend income from a tech-focused BDC play. Hercules Capital has covered its dividend payout, on average, with net investment income and distributable net operating income. Hercules Capital continues to exhibit positive interest rate sensitivity, making it a promising income vehicle during the current rate hiking cycle. An investment in Hercules Capital currently yields 10.3 percent.
Like most BDCs, Hercules Capital has not been an investors' favorite lately. Income investors are selling high-yield income vehicles in light of surging bond yields and higher inflation expectations which tend to be viewed as negatives for dividend-paying stocks. That said, though, with interest rates expected to go up this year, it makes sense to put money into stocks that have interest rate upside. Hercules Capital is one such BDC play.
Source: StockCharts
Hercules Capital - A Tech-Focused BDC
Hercules Capital is a tech-focused BDC. The business development company primarily invests money in the technology and life sciences sectors, among others.
Source: Hercules Capital Investor Presentation
Hercules Capital's niche-strategy has been successful as the company has seen consistent growth over the last couple of years. Net investment income and total investment income have both grown at a fast clip since 2011.
Source: Hercules Capital
Double digit income growth is a reflection of Hercules Capital's growing asset base over time.
Source: Hercules Capital
One of the most attractive features of an investment in Hercules Capital is that the business development company has consistently produced stable results for shareholders. For instance, Hercules Capital's effective yields on its debt investments as well as its core portfolio yields have been in a narrow range in the last ten quarters.
Source: Achilles Research
Positive Interest Rate Sensitivity
Another attractive property is that the BDC has positive interest rate sensitivity.
Management expects that each 25 basis point rate hike by the Federal Reserve will result in a $3.2 million increase in net interest income annually or $0.04/share. The higher interest rates go, the better for Hercules Capital and its shareholders, obviously. Hence, rising interest rates are a reason to buy Hercules Capital, they are not a reason to sell in my view.
Source: Hercules Capital
The Dividend Is Covered
As a business development company, Hercules Capital is required to pay out most of its earnings to shareholders, which is why shares yield more than ten percent right now.
Hercules Capital has covered its steady dividend payout of $0.31/share with both net investment income and distributable net operating income, on average, in the last ten quarters.
Hercules Capital pulled in $0.31/share in net investment income and $0.34/share in distributable net operating income, on average, in the last ten quarters.
Here's Hercules Capital's dividend coverage, graphically.
Source: Achilles Research
One of the biggest risks for Hercules Capital is that one of its portfolio investments turns sour and that the company will be forced to write it off, potentially negatively affecting the dividend. Since Hercules Capital produced stable portfolio yields and dividend coverage stats over time, I think the probability of such an event is rather low. Another risk factor would be the externalization of management, which the company proposed last year (it withdrew the proposal later).
Reasonably Valued
Hercules Capital's shares sell for ~10.4x Q4-2017 run-rate NII and ~9.7x Q4-2017 run-rate DNOI. The BDC's shares are also priced at a ~22 percent premium to Net Asset Value.
Hercules Capital's shares have consistently changed hands at a premium to book value over time.
Source: Hercules Capital
Your Takeaway
Hercules Capital is a better income play than I think many investors realize. Rising interest rates would be a reason to buy the BDC, not to sell it. The business development company has covered its dividend with both NII and DNOI, on average, in the last ten quarters. Positive interest rate sensitivity and stable portfolio yields are two of the most attractive properties of an investment in Hercules Capital. Shares are affordable on a run-rate NII and DNOI basis. Buy for income and capital appreciation.
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Analyst’s Disclosure: I am/we are long HTGC. 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.
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Comments (24)
Of course, if we see lower earnings the opposite would be true, but since you asknowledged you're a holder I'm guessing that (like me) you don't generally expect this anytime soon.Just my 2c.
