If you are looking for a high-yield investment that will benefit from rising interest rates, you should consider the enterprise development business (“BDC”) industry.
BDC offers retail investors high-yield exposure to private companies and some of them, such as Hercules Capital, Inc. (NYSE: HTGC) focus on companies that are already backed by venture capital firms. These other companies do not want to lose their investments and will continue to support these companies. This has been crucial during the pandemic.
HTGC focuses primarily on pre-IPOs and M&A, high-growth innovative companies supported with venture capital in their expansion (risk growth) and established stages in a widely diversified variety of technology, life sciences, and technology industries. sustainable and renewable.
HTGC has a portfolio of $ 2.41 million, with a market capitalization of more than $ 2 million and $ 430 million in liquidity.
HTGC’s debt investment portfolio has 94.7% in variable rate loans, with minimum interest rates. Their debt investments have short-term repayment maturities (36-48 months), and most of them also have warrants for a possible additional total return.
Management estimates that a 100 basis point increase in the preferential rate would add $ 0.16 per share to HTGC’s EPA, while a 200 basis point increase would add $ 0.35 per share. The current preferential rate is ~ 4.38%, up from 3.25% a year ago.
92.2% of the portfolio is in debt investments, 6.2% in equity investments and 1.5% in warrants:
There are 103 warrants, showing an unrealized gain of ~ 25%; and 76 shares in shares, with an unrealized gain of ~ 11.5%, at 31/03/22.
The illustration of the direction of the potential earnings of the guarantee assumes that 50% will be false, but, nevertheless, the potential gains can go from $ 0.47 to $ 1.06 per share:
The delivery of medicines, software and business and consumer services on the Internet make up 81% of the exposure of the portfolio sector, much more concentrated than other BDCs we have covered:
A key factor in volatile times is the quarterly rating of the underlying holdings of a BDC, that is, the private companies to which it lends. BDC management uses a scale from 1 to 5, where 1 is the healthiest grade and 5 is the lowest.
Higher grades 1 and 2 made up 73% of the portfolio, as of 31/03/22, compared to ~ 80% a year ago, and grade 3 increased from 19.5% to 26.4 %. There were no investments with grade 5 rating, the lowest level, the first quarter of the 22nd.
While total investment income fell -5% in 1Q ’22, NII increased 3.56% from 1Q’21, due to lower net operating expenses. NII / share remained stable at $ 0.30, and NAV / share fell -4.75%, due to a portion of the distribution from previously undistributed assets.
HTGC had a lower weighted average cost of loans consisting of interest and commissions, 4.0% in the first quarter of 22, compared to 5.5% in the first quarter of 21, with interest expenditure falling by 21 %. The decrease is mainly due to the refinancing completed in 2021 and early 2022 and the increased use of lower cost SBA loans.
Gains realized Q1 ’22 were -2.38 million, due to a non-recurring loss on debt settlement of $ 3.7 million.
Total investment income in 2021 fell -2%, with NII falling -4.5% and NAV / Action ~ flat. Interest expense fell -8.7% in 2021:
This management chart shows that HTGC has a higher performance history compared to its BDC peers over the past few years:
HTGC has had 3 companies that complete their IPOs by 2022, and 5 companies that have registered for their IPOs or signed agreements to go public through merger or SPAC transactions.
HTGC had record the total gross of new debts and capital commitments for a total of $ 615.2 million and new gross funding for a total of $ 351.6 million in the first quarter of 22. This record-breaking activity in the first quarter was driven by the technology and science teams of the life of HTGC. HTGC financed capital to 26 different companies during the first quarter, of which 10 were new borrowers.
Early loan repayments were $ 84.9 million, which, along with the normal scheduled repayment of $ 11.3 million, resulted in total debt repayment of $ 96 million. , well below the target of $ 150 million to $ 250 million, and a reduction from $ 426 million in the fourth quarter of 2021. This hampered NII somewhat, leading to a record increase in the net debt investment portfolio. of $ 190.7 million.
HTGC has a payment history for additional distributions, in addition to your basic payments. It has paid $ 0.36 on these additional distributions over the last quarter, with the second quarter amounting to $ 0.15.
HTGC’s regular dividends have a return of 9.82%, while its supplementary dividends give an additional return of 4.46%, with a total return of 14.28%. The next 8/10/22 should be ex-dividend. Management generally declares the distribution from August to the end of July, so it will be some time before they know if they will pay another additional payment.
The usual $ 0.33 dividend coverage was less than 1X in the first quarter of 22, at .91X, but has averaged 1X in the next 4 quarters. The $ 0.03 deficit and the $ 0.15 additional payment per share were covered by UNII. HTGC had an overflow of retained earnings of more than $ 171 million or $ 1.39 per share, as of 03/31/22.
Profitability and leverage:
The ROA and ROA were relatively stable, but slightly below the BDC average, while the debt / NAV of .99X is slightly below average. HTGC’s EBIT margin of 75.78% was well above its industry average.
4.09X’s EBIT / Interest Coverage is among the highest ratios we’ve seen in the BDC industry, while its asset / debt ratio is online.
Debt and liquidity:
Management uses a variety of debt sources to capitalize HTGC: ~ 50% in equity, 37% in institutional notes, 6.5% in SBA loans and ~ 5% in credit facilities. Its debt is rated Baa3 by Moody’s.
Its debt looks well-scaled for the future, with its first maturity of $ 105 million in notes, which will mature in 2024:
HTGC had $ 430 million in cash on 31/03/22.
It’s a combination of yields: HTGC has outperformed the BDC industry and market over the past month, but has outpaced them over the past quarter and year. So far in 2022 it has outperformed the market, but has pursued its industry, probably due to its higher concentration in technology: the technology sector has fallen by 30% in 2022.
At its closing price of $ 13.44 on 06/29/22, HTGC was trading at a premium of 24.2% over its first quarter NAV / Share of $ 10.82, compared to the BDC sector average of -3%. However, as the NAV is affected by dividends and does not always tell the whole story, Price / NII should also be investigated.
HTGC is actually selling at a much lower P / NII of 10.42X, compared to the industry average BDC of 13.17X. Your supplemental dividends also give you a higher dividend yield:
HTGC has a history of selling with a premium to the NAV in recent years: its average premium to the NAV in 2017-2021 is ~ 1.30X, ranging from 1.11 to 1.47X.
Analysts’ price targets:
At its closing price on 06/29/22 of $ 13.44, HTGC was 18.5% below analysts ’lowest price target of $ 16.50 and 27% below target price average $ 18.44.
We consider HTGC to be a long-term PURCHASE: it is 6% above its 52-week low and could of course go down from here, but its relative P / NII undervaluation and its UNII cushion for its dividends give us confidence in its long-term prospects as a worthy high-yield investment vehicle.
If you are interested in other high performance vehicles, we cover them every weekend at our items. All tables provided by Hidden Dividend Stocks Plus, unless otherwise noted.