HRZN - 11.4%-Yielding Horizon Technology Finance: Monthly Pay With Upside Potential

2023-03-27 15:50:14 ET

Summary

• HRZN is a high-yield BDC with a solid portfolio of debt and equity investments in the life science, tech, and sustainability industries.
• It's benefitting from higher interest rates and pays a well-covered dividend.
• I also highlight the balance sheet, outlook, valuation, and other important points.

Stocks are generally considered to be inflation resistant, as some believe that a company can simply raise prices to combat inflation. It's not that simple, however, as higher prices also come with higher input costs (think margin pressure) and higher interest on debt, which can greatly eat into the bottom line.

That's why it may be a better idea to also own higher-yielding income vehicles that are designed to benefit from higher interest rates on debt. This brings me to Horizon Technology Finance ( HRZN ), which currently pays a yield that's way ahead of inflation.

Since I last covered HRZN back in November here , the stock has dropped by 7.7%, but thanks to dividends, the total return was only -4.3%. In this article, I provide an updated valuation and highlight recent developments, so let's get started.

Why HRZN?

Horizon Technology Finance is an externally managed BDC based out of Farmington, Connecticut. It provides secured loans to private equity-backed growth companies based in the life science, tech, and sustainability industries.

At present, HRZN has 160 debt and equity investments, with a fair value of $720 million. The portfolio is structured to be lower risk in that 95% is in debt investments, 4% is in warrants, and just 0.4% is related to equity. Moreover, 90% of the debt portfolio is in the form of senior secured loans.

As shown below, HRZN's portfolio is geared towards high-growth industries, led by life science and technology, followed by sustainability and healthcare information and services.

Meanwhile, it appears that HRZN is benefitting from a fickle market, as a soft IPO/M&A environment combined with a pullback from traditional bank financing has led to a record $403 million in originations by HRZN in 2022. Additionally, HRZN has a strong backlog of $250 million in its pipeline. These factors drove an impressive 57% increase to HRZN's total portfolio value to $720 million.

Importantly, HRZN's portfolio health remains in good shape, as 95% of its investments carry a 3 or 4 credit rating (on a scale from 1 to 4, with 4 being the lowest risk). Higher interest rates have pushed up HRZN's debt portfolio yield to 14.5%.

This helped HRZN to generate $1.46 in NII per share in 2022. This equates to a 1.11x dividend coverage ratio after management recently raised the monthly dividend rate by 10% to $0.11 per share. Plus, HRZN has $0.68 per share of spillover income, which further protects the dividend rate.

Looking ahead, HRZN is reasonably well positioned with a debt to equity ratio of 1.28x, sitting well below the 2.0x statutory limit. While the deal environment may be less certain due to general economic volatility, HRZN's overall portfolio health should enable its borrowers to sustain higher rates, considering the recent quarter-point increase by the Fed this month. This was noted by management during the recent conference call :

As we've consistently noted, 100% of our outstanding principal amount of our debt investments, their interest at floating rates with coupons that are structured to increase as interest rates rise with interest rate floors. As of December 31, 97% of our debt investments will benefit from additional increases in their applicable base rates.

Lastly, I see value in HRZN at the current price of $11.55, which trades at a price to NAV of 1.0x. As shown below, HRZN is back to trading at the low end of its valuation range over the past three years. Analysts have an average price target of $12.61, which equates to a potential 21% total return over the next 12 months.

Investor Takeaway

In summary, HRZN is a high-yield BDC with a solid portfolio of debt and equity investments geared toward high-growth industries. Management is focused on maintaining a low-risk portfolio, as evidenced by its well-diversified asset mix and strong credit ratings. Plus, the recent increase in interest rates should support portfolio yield growth and provide ample cushion for the dividend rate. Lastly, with a strong deal backlog, and a price to NAV of 1.0x, I believe HRZN is trading at an attractive valuation while paying an 11.4% yield.

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