Hercules Tech Stays Neutral - Analyst Blog

We reaffirm our Neutral recommendation on Hercules Technology Growth Capital Inc. (HTGC) based on the gradual recovery of the overall economy with an improvement in the valuation of its portfolio companies.

 

 

In May 2010, Hercules had reported its first quarter change in net assets of 16 cents per share, which was slightly lower than the Zacks Consensus Estimate of 19 cents. However, results improved marginally compared with the prior-year quarter. Results for the quarter benefited mainly from lower operating expenses, partially offset by a decrease in top line. Hercules ended the quarter with a much stronger balance sheet and a high level of liquidity.

 

Hercules provides venture capital to technology and life-science related companies, which are in general underserved by traditional lending sources. Hence, Hercules can receive attractive returns by providing finance to such companies.

 

Though Hercules is a small participant in a market with huge growth potential, we are encouraged by its focus on its credit performance. The company continues to experience an increase in new investment origination activities and expects the trend to persist in the near future.

 

As a result of its regulated investment company (RIC) status, Hercules will be required to pay a majority of its earnings as dividend every year. The company’s dividend growth story has been fairly decent so far and is likely to grow over time. In June 2010, the company paid its nineteenth consecutive dividend of 20 cents per share since its initial public offering (IPO).

 

One of the biggest setbacks for Hercules is its inadequate experience as the company had commenced its operations in late 2004. So there seems to be few records to validate its investment approach.

 

Although Hercules has an experienced investment team to its credit, its business model largely depends on its client relationships and loss of any personnel may considerably impede its operations.

 

To comply with regulatory requirements, Hercules invests mainly in U.S. based companies and, to a lesser extent, in foreign companies. Though the U.S. economy is showing signs of recovery in the recent quarters, a further deterioration may lead to an increased cost of funding and limit the access to capital market. The company’s foreign investment will be too limited to support its overall financials.

 

 

Over the last 30 days, 1 of the 8 analysts covering the stock has downgraded the estimate for the second quarter of 2010 and full year 2010, while no upward revisions were witnessed. Currently, the Zacks Consensus Estimate for the second quarter is operating earnings of 19 cents per share, a sharp increase of 149.34% from the year-ago quarter. Similarly, the Zacks Consensus Estimate for full year 2010 is operating earnings of 85 cents, which would be down by 30.79% from the prior year.

 

The absence of upward estimate revisions for the second quarter and full year 2010 indicates a likelihood of downward pressure on the stock’s performance in the near term.

 

With respect to earnings surprises, the stock has been volatile over the trailing four quarters, with two negative surprises. The average remained negative at 68.69%, implying that Hercules has missed the Zacks Consensus Estimate by the same magnitude over that period.

 

The downside potential for the second quarter and full year 2010 Zacks Consensus Estimates, essentially a proxy for future earnings surprises, currently stand at 21.05% and 8.24%, respectively, for Hercules.

 

The estimate revision trends clearly reflect the potential for a slight downward pressure on the stock over the near term. This justifies the current Zacks #4 Rank (Sell) for Hercules.