I have four Business Development Companies (BDCs) on the list of Dividend Hunter recommended stocks. The Fed’s interest rate hikes have proven to be a huge benefit for BDCs. These companies lend using adjustable-rate loans and carry low debt loads of their own. Hercules Capital (HTGC) will continue to be an excellent income investment, writes Tim Plaehn, editor of The Dividend Hunter.
Hercules is one of the oldest BDCs, founded in 2003 and available to investors as of a 2005 IPO. The company is internally managed with a $1.9 billion market cap. In the BDC world, a $2 billion market cap with a $3.3 billion enterprise value (market cap plus debt) means it is one of the larger companies.
What sets Hercules apart from its peers is its client focus: it works with venture capital and private equity firms to fund pre-IPO companies or ones being groomed for mergers or acquisitions. The BDC lives up to its name, primarily providing financing to various technology-related companies.
To assist its client companies and their venture capital backers, Hercules makes only senior debt loans with maturities of 3 to 3 1/2 years. About 90% of Hercules’ assets are loans, with 10% as equity positions that can pay off very well when a client goes public or is acquired.
The loans made by Hercules carry an effective yield of 14.7% — up 2% compared to when I last wrote it up, in 2021. The typical loan has an 11% to 12% coupon rate, and the effective yield gets boosted by commitment and origination fees. Equity profits and early termination fees have increased Hercules’s average returns to above 15%.
The company’s relationships with more than 500 venture capital firms have allowed Hercules Capital to grow its book of business steadily and increase its annual dividend step-by-step. Since 2010, the annual dividend has increased from $0.80 per share, to $1.56 currently. The regular quarterly rate increased by a penny in October 2021.
The Hercules Capital share price has suffered through a year-long bear market. HTGC now trades for just under $13, compared to around $18 a year ago. The regular dividend gives a current 12% yield. That is an excellent return from one of the very best BDCs. The supplemental dividends will add additional annual income.
All of the HTGC customer loans carry floating interest rates. As rates rise, so will the net investment income earned. In a recent presentation, Hercules noted that the annual net investment income would grow by $0.18 per share for each one percent increase in interest rates.
Recommended Action: Buy HTGC.