Hercules Capital, Inc. has been downgraded to a hold rating due to its premium valuation, leading to cautious investor sentiment. The business development company (BDC) focuses primarily on the technology and life science sectors and has shown strong portfolio performance. However, with a forward dividend yield of 10.3% and trading at a significant premium to net asset value, the stock is currently considered overpriced.
In the second quarter, Hercules Capital announced another increase in its regular dividend by 2.6% to $0.40 per share. The BDC’s portfolio performed well, maintaining perfect credit quality. However, investors are advised against chasing the stock price, as it has already recovered from the first quarter’s valuation shock related to the collapse of Silicon Valley Bank.
Hercules Capital’s investment portfolio was valued at $2.94 billion at the end of the second quarter, with 94% of investments in debt securities. The company also made additional investments in equity and warrants, which could potentially enhance its investment returns. However, its niche focus on the technology and life science industries means less portfolio diversification compared to other BDCs.
The BDC had a strong funding quarter, with $352.9 million in new debt investments. However, early repayments led to a decline in the overall portfolio value compared to the previous quarter. The main reason for a previous aggressive recommendation of Hercules Capital was its strong portfolio quality and solid investment performance.
Hercules Capital has consistently reported a 0.0% non-accrual ratio, indicating excellent credit quality. Additionally, due to rising interest rates, the BDC’s debt investment portfolio is currently producing a higher than average effective yield. In the second quarter, the effective yield reached 16%, resulting in a record total investment income of $116.2 million.
One of Hercules Capital’s notable features is its status as a serial dividend raiser, regularly increasing its regular dividend and paying supplemental dividends. The company recently announced an increase in its regular dividend to $0.40 per share and the payment of a $0.08 per share supplemental dividend. This translates to a forward dividend yield of 10.3%.
With a net investment income of $0.53 per share in the second quarter and a dividend coverage ratio of 136%, Hercules Capital’s base dividend appears to be safe moving forward. The company also reported a 1.3% increase in its net asset value, bringing it to $10.96 per share.
Despite its strong performance, Hercules Capital’s valuation has risen significantly since the market panic in March. With a premium of over 50% to its net asset value, the stock is considered one of the most expensive BDCs for passive income investors. This premium valuation has resulted in the downgrade of the stock to a hold rating.
As investors continue to monitor Hercules Capital’s dividend coverage ratio and non-accrual ratio, any deterioration in these key metrics could lead to a sell rating for the stock.
In conclusion, although Hercules Capital has demonstrated consistent performance and dividend growth, its current premium valuation raises concerns. While the BDC remains focused on the technology and life science sectors, the decision to hold the stock reflects cautious investor sentiment regarding its premium pricing.
