Hercules Capital Stock: Grab its 13% yield as weak holders capitulate (NYSE:HTGC)

Thesis

Hercules Capital, Inc. (NYSE: HTGC) is a leading internally managed business development firm, specializing in venture debt financing, focused on late-stage expanding or high-growth businesses.

His portfolio is primarily focused on technology and life sciences companies, and he has invested in companies that growth and technology investors should know about. Its publicly traded portfolio companies consist of household names such as Fastly (FSLY), DocuSign (DOCU), Enphase (ENPH) and Proterra (PTRA).

The company is focused on “higher quality” companies in its underwriting process and derives most of its income from interest (>95% in Q2). Additionally, nearly 95% of its debt investments are floating rate with a fixed floor, allowing the company to take advantage of aggressive Fed rate hikes.

However, the value of his portfolio was also significantly affected due to the bear market in equities, leading to a compression in the value of the companies in his portfolio. As a result, HTGC crashed almost 40% from its April 2022 highs, while its NTM dividend yields hit 13.3%.

Our assessment suggests that HTGC remains precariously set up in the near term, with the potential for greater downside volatility in the near term. However, we also understand that its valuation has likely been reduced enough that long-term investors will consider adding exposure at current levels, supported by a robust dividend yield.

Therefore, we postulate that HTGC’s reward-risk profile is attractive at current levels, but urge investors to add to it over time, taking advantage of market pessimism to increase exposure.

As such, we rate HTGC as a buy, with a medium-term (PT) price target of $15 (an implied 30% upside).

Hercules should benefit from the Fed’s hawkish push

Hercules Change in interest income % (company deposits)

Hercules pointed out that it was benefiting from the Fed’s aggressive rate hikes, as it significantly increased its interest income in the second quarter, as shown above. The company has released a 12.1% year-over-year increase in interest income in the second quarter, supported by its strong origination volumes.

Although we are potentially approaching the current Fed median terminal rate (4.6%), Hercules Capital’s funding conditions are embedded in a base floor to mitigate the impact of rate reversion going forward .

% change in total Hercules investment income and % change in net investment income per share consensus estimates

Hercules Change in total investment income in % and change in net investment income per share % consensus estimates (S&P Cap IQ)

Additionally, the company pointed out that it continues to see high-quality investment opportunities as its average credit underwriting score rose in the second quarter despite the market downturn. As a result, it has tightened its scope of companies but does not expect a significant slowdown in origination opportunities.

Consensus (bullish) estimates suggest that Hercules Capital’s total investment income (TTI) growth should remain robust through 2023 amid the Fed’s hawkish push, as noted above. Additionally, it is also expected to increase its net investment income (NII) per share growth in the first quarter of 2023 before declining.

But the market is concerned about value compression

Hercules Share of industry in the fair value of the portfolio %

Share of Hercules Industry in the fair value of the portfolio % (documents filed by the company)

Hercules Capital invests mainly in technology and life sciences companies, which have consistently represented more than 80% of the fair value of its portfolio over the past two years.

Consequently, the blows in the public market did not spare the valuations of the companies in its portfolio either, the net asset value (NAV) per share of Hercules Capital having collapsed.

Change in NAV per Hercules share % consensus estimates

Hercules NAV per share change % consensus estimates (S&P Cap IQ)

Nonetheless, consensus estimates suggest that the drop in Hercules Capital’s net asset value per share could have reached a nadir in the second quarter after falling nearly 11% year-on-year. However, the recent hits to HTGC suggested that the market might have changed its outlook.

We postulate that the market is likely anticipating a global recession which could further impact its portfolio companies. Hercules Capital hinted that it has not yet seen significant deterioration in credit or significant challenges in its portfolio companies seeking funding in its second-quarter call.

However, we infer that the market has likely devalued HTGC further to account for larger stumbles if the global economy enters a deeper recession in 2023. As a result, we believe its Q3 estimates could be at risk, with an NAV down the share will likely move further towards Q3/Q4. Therefore, investors should be prepared for a likely decline in Hercules Capital’s NAV per share estimates going forward, but this should have been reflected in the recent downward move.

Is HTGC stock a buy, sell or hold?

Trend in the valuation of multiples per share of HTGC NTM NII

HTGC NTM NII per share multiple valuation trend (koyfin)

As seen above, HTGC’s P/NII per share has been sent well below its long-term average, in line with the zone of two standard deviations below its 10-year average.

Barring the dramatic collapse in its earnings estimates seen during the COVID 2020 pandemic, we posit that the market has sufficiently de-risked HTGC. We believe the market is pricing in further declines in the valuation of its portfolio companies, given the specter of a global recession.

HTGC TTM P/TBV valuation trend

Valuation trend of HTGC TTM P/TBV (koyfin)

In addition, its TTM tangible book value (TBV) multiples have moved closer to the area of ​​two standard deviations below its 10-year average. Despite the potential for additional downside volatility if the market decides to further de-risk HTGC, we see an attractive opportunity for an average upside return at these levels.

HTGC Price Chart (Weekly)

HTGC Price Chart (Weekly) (TradingView)

As seen above, HTGC remains in medium-term bearish flux, but the recent move lower forming its September lows is emblematic of a quick capitulation to force a bottom.

Therefore, we believe the decline in sales may ease over the next five to eight weeks if it can form a basis for consolidation.

However, investors should be prepared for near-term downside volatility as the market could use the current pessimism to force weaker holders before reversing its momentum.

Consequently, we rate HTGC as a buy with a mid-term PT of $15.

Sallie R. Loera