Declining Core Yields And Rising Risk Will Spur Future Opportunities

Key Takeaways

• Hercules Capital may struggle with revenue growth due to declining core yields and strategic avoidance of higher-risk assets.
  
• Increased GAAP leverage and macroeconomic shifts may elevate financial risk, impacting earnings stability and credit quality.
  
• Hercules Capital's strong financial performance, strategic growth, and robust liquidity position enhance its potential for increased revenue and earnings.

Catalysts

A business development company.

• Hercules Capital may face pressure on future core yields, which have already declined from 12.9% in Q4 to 12.6% in Q1, due to declining base rates and spread compression, potentially impacting revenue growth and net income.
  
• The company's focused origination strategy, avoiding higher-yield assets due to perceived risk, may limit top-line growth if market conditions improve, which could also affect net margins as they may forego potentially lucrative investments.
  
• Increased GAAP leverage from under 90% in Q4 to just under 100% in Q1, while below historical targets, could signal a shift towards higher financial risk in a volatile market, impacting future earnings stability.
  
• Hercules Capital is seeing a shift in macroeconomic conditions with potential equity scarcity, which could increase debt demand but also elevate risk profiles for borrowers, potentially leading to credit quality issues and affecting net income if defaults rise.
  
• The evolving trade environment and tariff concerns pose indirect risks to Hercules Capital's portfolio companies, potentially leading to slower economic growth and impacting revenues from fees and interest if borrowers face operational challenges.

Hercules Capital Future Earnings and Revenue Growth

Assumptions

• This narrative explores a more pessimistic perspective on Hercules Capital compared to the consensus, based on a Fair Value that aligns with the bearish cohort of analysts.
• The bearish analysts are assuming Hercules Capital's revenue will grow by 8.0% annually over the next 3 years.
• The bearish analysts assume that profit margins will increase from 44.8% today to 60.1% in 3 years time.
• The bearish analysts expect earnings to reach $372.5 million (and earnings per share of $1.88) by about June 2028, up from $220.3 million today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the price target of the more bearish analyst cohort, the company would need to trade at a PE ratio of 11.7x on those 2028 earnings, down from 14.2x today. This future PE is lower than the current PE for the US Capital Markets industry at 27.3x.
• Analysts expect the number of shares outstanding to grow by 7.0% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 8.87%, as per the Simply Wall St company report.

Hercules Capital Future Earnings Per Share Growth

Risks

• Hercules Capital has experienced record operating performance and platform expansion with strong originations and net debt portfolio growth, which may lead to increased revenue growth and earnings.
  
• The issuance of $287.5 million of convertible unsecured notes at a low interest rate of 4.75% strengthens Hercules' balance sheet and liquidity position, potentially positively impacting net margins and earnings.
  
• With over $1 billion of assets under management and substantial liquidity, Hercules Capital is well-positioned to capitalize on favorable new business opportunities, supporting potential revenue and earnings growth.
  
• Hercules' investment-grade credit rating and low cost of debt allow it to compete aggressively on quality transactions, which could enhance revenues and earnings through strategic growth.
  
• The continued execution of high-quality origination strategies and focus on diversified sectors less affected by trade policy may support Hercules' stable credit quality, leading to sustained earnings.

Valuation

• The assumed bearish price target for Hercules Capital is $16.0, which represents the lowest price target estimate amongst analysts. This valuation is based on what can be assumed as the expectations of Hercules Capital's future earnings growth, profit margins and other risk factors from analysts on the more bearish end of the spectrum.
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $25.0, and the most bearish reporting a price target of just $16.0.
• In order for you to agree with the bearish analysts, you'd need to believe that by 2028, revenues will be $619.4 million, earnings will come to $372.5 million, and it would be trading on a PE ratio of 11.7x, assuming you use a discount rate of 8.9%.
• Given the current share price of $18.08, the bearish analyst price target of $16.0 is 13.0% lower. Despite analysts expecting the underlying buisness to improve, they seem to believe the market's expectations are too high.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.