Horizon Technology Finance: High 10.1% Yield With Low Leverage (NASDAQ:HRZN)

The current macroeconomic environment presents a conundrum for retirees and income-oriented investors, with bank interest rates near zero, and the S&P 500 (SPY) yielding a paltry 1.6%. While harvesting capital gains on investments is nice, most investors may find it hard to time the market. Also, selling stocks can lead to FOMO (fear of missing out).

This leads me to Horizon Technology Finance (HRZN) which provides a covered, high dividend yield for income-oriented investors. The last time I visited this stock, I was somewhat neutral on it. However, I’m starting to warm up to it, given its focus on attractive industry focus. In this article, I evaluate what makes Horizon an attractive buy for dividend investors, so let’s get started.

(Source: Company website)

A Look Into Horizon Technology Finance

Horizon Technology Finance is an externally-managed BDC that is focused on lending to life sciences and technology companies. Since its founding in 2004, Horizon has originated and invested more than $2 billion in venture loans to over 235 companies. At present, Horizon has a portfolio size of $356M, and in 2019, it generated over $43M in total revenue.

What I like about Horizon is that its industry focus on technology, life sciences, and healthcare information services makes it well-positioned to weather the effects of COVID-19. This compares favorably to other BDCs that have exposure to the more affected sectors, such as hospitality and energy.

As seen below, just over half of Horizon’s investments, at fair value, are associated with Life Sciences, with much of the remaining half being related to technology. Management estimates an addressable market of $12 billion for venture debt, in its core industries.

(Source: Q3’20 Investor Presentation)

Horizon also adopts a rather conservative investment strategy. As seen above, only 10% of its investments are in early stage companies, with 56% and 34% of its investments being made at the expansion and later stages of its portfolio companies’ development. Its portfolio companies are also well-diversified geographically, with the west coast and northeastern regions being the top two.

Horizon posted decent Q3 results, as it continued to out-earn its dividend during the third quarter, with NII (net investment income) of $0.34, equating to a dividend coverage ratio of 1.13. Total investment income increased by 8% YoY, to $12.3M, and onboarding yields on new investments increased by 80 bps QoQ, to 11.9%. In addition, Horizon also has ample dry powder to make add-on investments, with $254 million in available investment capacity. This includes $56.9M in cash, and $196.8M in undrawn capacity on line of credit.

As such, I see Horizon as being in a position to capitalize on market dislocations, which may arise as we continue to see economic uncertainty with surging COVID-19 cases around the country. This is supported by strength in certain technology investments in Horizon’s portfolio, and continued deal-making activity in the latest quarter, as management noted during the recent conference call:

On our last call, we noted that we were beginning to see positive developments in certain technology sectors that are benefiting from the impact of COVID-19, and that trend continued into the third quarter. Utilizing our strong brand, we originated quality investments to 2 tech-oriented companies that provide software platforms.

Both companies have strong management teams, committed investors, ample liquidity and have demonstrated growth even through the current uncertain economic cycle. We made a total of $16 million in investments to the 2 new technology companies I just mentioned as well as to existing life science portfolio companies. The onboarding yield for such investments was 11.9%.”

Looking forward, I see no signs of Horizon slowing down. This is supported by the $96M in committed backlog, of which $60M is committed to current life science portfolio companies as they meet key milestone value drivers in their development. Total pipeline of new opportunities as of November is $372M. As such, I see ample opportunity for Horizon to grow in Q4 and beyond.

One risk to consider is the 4% drop in NAV/share, from $11.64 in Q2’20, to $11.17 at September 30^th. This was due to a downgrading of 3 portfolio companies, which management has since placed on non-accrual status in the current quarter, Q4. However, I’m willing to give the company a pass, as this was offset by some positives, including seven portfolio companies that raised new equity, including one successful M&A exit.

Year-to-date, Horizon’s portfolio companies have raised over $500M in new capital. This is a positive for Horizon, as the cash infusion helps to ensure sufficient capital for debt payments, and signals a vote of investor confidence in further expansion. Plus, management noted that 89% of portfolio companies are performing well or better than expected at the time of underwriting.

Meanwhile, I find Horizon’s debt profile to be safe, with a debt to equity ratio of 0.81 to 1. This sits well below the 1.25 to 1 ratio that I generally prefer to see for BDCs. Horizon also has $0.45 per share in spillover income, which provides further support to the currently high 10.1% dividend yield, with a 113% Q3 NII to dividend coverage ratio.

Turning to valuation, Horizon is currently trading at a 6% premium to book value. I see this premium as being warranted, given Horizon’s attractive industry focus, its strong track record, and the fact that it traded above book value for most of 2019, and early 2020, before the pandemic.

(Source: YCharts)

Long-term investors have done well. Since its IPO in 2010, Horizon has returned $13.87 in cumulative dividends to its shareholders. This means that the initial investors who have held one, have gotten over 95% of their initial investment capital back in the form of dividends alone. As seen below, Horizon’s total return since September of 2015 has far outpaced the broader BDC industry, with a 135.1% total return, compared to the 16.5% return of the Wells Fargo (WFC) BDC index.

(Source: Q3’20 Investor Presentation)

Investor Takeaway

Horizon posted decent Q3 results, with a sequential increase in onboarding yields, and an increase in total investment income. It also continues to out-earn its dividend, with 113% NII to dividend coverage. I like Horizon’s focus on technology, life sciences, and healthcare information services, as these sectors appear to be relatively immune to the effects of COVID-19. Plus, these are growing sectors, and I’m encouraged by the $12 billion addressable market for venture debt in relation to these industries.

Horizon has a strong track record of shareholder returns in the past 5 years, and I see continued growth ahead, given the active deal pipeline. I see potential for price appreciation from the current level, but I believe investors should focus more on the 10%+ dividend yield. Buy for income.

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Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in HRZN over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: This article is for informational purposes and does not constitute as financial advice. Readers are encouraged and expected to perform due diligence and draw their own conclusions prior to making any investment decisions.

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