Hercules Capital: Double Your Income With This 9% Yield (NYSE:HTGC)

The market is up one day and down another, and there’s no telling what it will do tomorrow. That’s why I maintain good-sized exposure to dividend payers that can help to buffer the effects of a downturn in a bear market, and boost returns in a bull market. That’s why I don’t mind down markets as much, since they give better buying opportunities.

This brings me to Hercules Capital, Inc. (NYSE:HTGC), which has impressed with strong results in the latest quarter while giving a dividend bump as icing on the cake. In this article, I highlight what makes HTGC a great income stock to buy at present, so let’s get started.

Why HTGC?

Hercules Capital is a business development company (“BDC”) that’s focused on emerging technologies and life sciences, and like peer Main Street Capital (MAIN), it’s one of just a few that are internally managed. Since inception in 2003, Hercules has deployed $14.6 billion in investment capital across 590 companies, and is in many cases, a lender of choice for entrepreneurs and venture capital firms seeking growth capital financing.

It’s generally the only lender on its debt investment, with 74% of the debt portfolio comprised of first lien senior secured loans, and 23.6% of its remaining loans are second lien with Hercules maintaining the right to buy out the first lien holder.

The company’s headquarters are located at the heart of Silicon Valley, in Palo Alto, California. This puts HTGC where the action is, with close proximity to many emerging technology and life sciences companies, as well as leading research institutions such as Stanford University and UC-Berkeley. This ease of conducting impromptu face-to-face engagements puts HTGC at an advantage even in today’s video conferencing environment.

HTGC just closed a strong Q2 with record originations across debt and equity commitments that amounted to $1.04 billion, making it the first time in history that it exceeded $1 billion in a single quarter. This brings the total originations during the first half of the year to $1.66 billion, a record for the company. Meanwhile, HTGC’s portfolio companies have delayed exit events such as IPOs and buyouts, resulting in low early loan payoff. This resulted in record $360 million net debt investment portfolio growth in the first half of this year.

Moreover, HTGC is generating a respectable 11.5% effective yield on its debt investment portfolio and holds equity or warrant positions in 103 portfolio companies with a fair value of $165.7 million. While this is worth less than the $181.6 million cost basis, this has more to do with equity market volatility resulting in lower valuations for the growth state companies that HTGC invests in. The loan portfolio appears to be in good shape, as only 1 new nonaccrual was added during Q2, bringing total nonaccruals to just 2 investments representing just 0.1% of portfolio fair value.

As such, I’m not concerned about the drop in NAV per share from $11.22 at the end of 2021 to $10.43 at present, as NAV/share should recover with a normalization of tech valuations, whenever that may be. At the same time, HTGC is well positioned in a rising rate environment, as 94.9% of its debt portfolio are floating rate loans with interest rate floors.

Looking forward, HTGC has plenty of dry powder to fund its deal pipeline, with $780 million in available liquidity and regulatory leverage of 101%, sitting well below the 200% limit. Moreover, the venture capital ecosystem appears to be healthy as outlined by management during the conference call:

Thanks to the tremendous and timely efforts of our broader finance team, we ended Q2 with strong liquidity of $780 million, which provides us with ample coverage of our available unfunded commitments of $489 million and the ability to fund our ongoing anticipated business activity.

The venture capital ecosystem continued its healthy pace for the first half of 2022, with fundraising activity at $121 billion and investment activity at $144 billion, according to data gathered by PitchBook and the National Venture Capital Association.

Importantly, Hercules recently raised its regular dividend by 6% to $0.35 per quarter and declared another special dividend of $0.15. While the regular dividend is currently not covered by net investment income of $0.32 during Q2, I see potential for better coverage in the coming quarters as it funds its new originations. Plus, HTGC has $1.18 per share in spillover income, which gives further support to the regular and special dividends.

While BDCs are generally measured on a Price-to-NAV basis, I believe internally managed ones with a strong track record of growth should be valued on a Price-to-Earnings basis. At the current price of $15.91, HTGC trades at a forward P/E of 11.9, which I find to be reasonable for a growing enterprise.

Sell side analysts have a consensus Buy rating with an average price target of $17.17. This translates to a potential one-year 17% total return including the regular dividend, and continued special dividends should boost the total return.

Investor Takeaway

Hercules Capital is a well-run internally managed BDC with a strong track record of growth. It’s seeing record levels of deal originations as tech companies delay liquidity exit events due to market volatility, and is seeing healthy activity from private equity sponsors.

While the NAV per share dropped since the end of last year, I see this as being temporary due to lower tech valuations rather than signs of material weakness in its debt portfolio. Meanwhile, income investors get paid an 8.8% regular dividend yield with plenty of room for continued special dividends as an added bonus. HTGC is a buy for income investors.