The Zacks SBIC & Commercial Finance industry will continue to bear the brunt of higher prepayments as interest rates rise. This is likely to hurt the industry players’ profitability to some extent.
Yet, high interest rates, favorable regulatory changes and steady demand for personalized financing solutions are expected to support industry players in the coming days. Robust asset quality continues to act as a major tailwind. Hence, a few industry names, like Hercules Capital, Inc. HTGC, Golub Capital BDC, Inc. GBDC and BlackRock TCP Capital Corp. TCPC, are expected to gain from these favorable developments.
About the Industry
The Zacks SBIC & Commercial Finance industry comprises companies that provide finance to small and mid-sized privately held developing firms. These firms are typically underserved by traditional banks and other lenders. Additionally, firms suffering from financial distress are the primary target clients of these lenders. The industry players provide customized financing solutions, ranging from senior debt instruments to equity capital. This financing is provided for a change of ownership transactions, strategic buyouts, recapitalizations and growth initiatives in partnership with business owners, management teams and financial sponsors, among others. Some of the other products offered by the industry participants are mezzanine loans that typically pay high interest rates and could be converted into equity in the target firm.
3 Factors Shaping the Future of SBIC & Commercial Finance Industry
High Rates: The Federal Reserve aggressively raised interest rates last year, with the rates currently at a 22-year high of 5.25-5.50%. Also, the central bank has kept the door open for one more hike this year as “inflation remains elevated,” while signaling that the rates will remain high for a longer period. As the higher rates lead to a spike in prepayments and refinancing, this will keep benefiting SBIC & Commercial Finance industry players. The demand for products and services offered by these companies is likely to keep growing amid the challenging macroeconomic backdrop. Thus, the industry players are expected to witness a decent revenue improvement going forward.
Solid Asset Quality: Following the COVID-19 outbreak and a subsequent halt in business activities in 2020, the majority of sectors wherein SBIC & Commercial Finance companies provide loans were hit hard. This raised fears of a deterioration of asset quality for industry players. But the support from the administration in the form of stimulus packages, extensive vaccination drives and the re-opening of businesses supported economic growth and prevented a substantial rise in delinquency rates for the industry players. Even now, the industry players are not expected to witness much deterioration in credit quality, though high inflation and rates remain major near-term headwinds.
Regulatory Changes: In 2018, an amendment to the Investment Company Act of 1940 by the Small Business Credit Availability Act eased leverage limits for such companies, allowing them to increase their debt-to-equity leverage to 2:1 from 1:1. This helped these companies to reduce portfolio risks by investing in higher capital structures without foregoing current returns. Thus, the act provided extra funding flexibility to these companies and will continue offering more growth opportunities.
Zacks Industry Rank Indicates Brighter Prospects
The Zacks SBIC & Commercial Finance industry is a 34-stock group within the broader Zacks Finance sector. The industry currently carries a Zacks Industry Rank #29, which places it in the top 12% of more than 250 Zacks industries.
The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates outperformance in the near term. Our research shows that the top 50% of the Zacks-ranked industries outperform the bottom 50% by a factor of more than 2 to 1.
The industry’s positioning in the top 50% of the Zacks-ranked industries is a result of an encouraging earnings outlook for the constituent companies in aggregate. Looking at aggregate earnings estimate revisions, it appears that analysts are gradually gaining confidence in this group’s bottom-line growth potential. Over the past year, the industry’s earnings estimates for the current year have been revised 13.3% upward.
Hence, we are presenting a few stocks that are well-positioned to outperform the market based on a strong earnings outlook. Before that, let’s check out the industry’s recent stock market performance and valuation picture.
Industry Outperforms Sector and S&P 500
The Zacks SBIC & Commercial Finance industry has outperformed both the S&P 500 composite and its own sector over the past three years.
The stocks in this industry have collectively gained 37.9% over this period, while the Zacks S&P 500 composite and the Zacks Finance sector have rallied 26.5% and 25%, respectively.
Industry’s Current Valuation
One might get a good sense of the industry’s relative valuation by looking at its price-to-tangible book ratio (P/TBV), which is commonly used for valuing loan providers because of large variations in their earnings results from one quarter to the next.
The industry currently has a trailing 12-month P/TB of 0.90X. The highest level of 1.03X, lowest of 0.41X and a median of 0.89X have been recorded by the industry over the past five years. Also, the industry is trading at a significant discount compared with the market at large, as evident from the trailing 12-month P/TB for the S&P 500 composite of 9.79X.
As finance stocks typically have a low P/TB ratio, comparing SBIC & commercial loan providers with the S&P 500 may not make sense to many investors. However, comparing the group’s P/TB ratio with that of its broader sector ensures that the group is trading at a solid discount. The Zacks Finance sector’s trailing 12-month P/TB of 4.19X is also way above the Zacks SBIC & Commercial Finance industry’s ratio.
3 SBIC & Commercial Finance Stocks Worth Betting on
Hercules Capital: Headquartered in Palo Alto, CA, HTGC is a specialty finance company that provides venture capital to technology and life science-related companies. Its investments are generally between $15.0 million and $40.0 million, and it expects these to generate revenues within at least two to four years.
Despite the tough macroeconomic scenario, Hercules Capital is expected to continue witnessing the growing demand for customized financing from private equity firms and venture capitalists. Driven by the rise in the demand for customized financing and a robust deal pipeline, total new commitments are expected to keep increasing.
As of Jun 30, 2023, it had $670.7 million in liquidity. Also, the company has long-term issuer ratings of BBB- and Baa3 from Fitch and Moody’s, respectively, along with a stable outlook, which renders it favorable access to the debt market. At the end of the second quarter of 2023, the weighted average cost of debt, comprising interest and fees, was 4.8%.
The fair value of Hercules Capital’s total investment portfolio was $3.11 billion as of Jun 30, 2023. Net asset value (NAV) was $10.96 per share on the same date.
Hercules Capital has a market cap of $2.43 million. Shares of this Zacks Rank #2 (Buy) company have rallied 27.6% over the past year. The Zacks Consensus Estimate for 2023 earnings has remained unchanged at $1.99 over the past month.
Golub Capital BDC: This Zacks Rank #1 (Strong Buy) stock makes investments mainly in one stop (a loan that combines characteristics of traditional first lien senior secured loans and second lien or subordinated loans) and other senior secured loans of middle-market companies. Based in New York, the company invests roughly $10-$75 million of capital.
Following the acquisition of Golub Capital Investment Corporation in September 2019, Golub Capital became the fifth largest externally managed, publicly traded business development company in the United States in terms of assets. The deal continues to support the company’s financials.
As of Jun 30, 2023, Golub Capital had total investments (fair value) of $5.53 billion in 333 portfolio companies and NAV per share of $14.83. As of the same date, the company had cash, cash equivalents and foreign currencies of $91.7 million and restricted cash and cash equivalents of $79.3 million.
Further, at June 2023-end, GBDC had $3.2 billion in outstanding debt and $100.0 million of remaining commitments and availability on its unsecured line of credit with GC Advisors.
The company’s shares have rallied 9.1% over the past year. The Zacks Consensus Estimate for earnings has been unchanged at $1.73 for fiscal 2024 over the past month. GBDC has a market cap of $2.42 billion.
BlackRock TCP: This is a specialty finance company that is mainly focused on direct lending to middle-market companies and small businesses. Carrying a Zacks Rank #2, TCPC lends largely to companies with solid market positions, strong regional or national footprints, differentiated products and services and sustainable competitive advantages.
As of Jun 30, 2023, BlackRock TCP had total investments (fair value) of $1.6 billion (in 143 portfolio companies). Of the total investment value, 88.4% was senior secured debt. As of the same date, NAV was $12.94 per share.
BlackRock TCP has been witnessing growth in total investment income over the last few years. The company is expected to continue witnessing a rise in investment income in the quarters ahead, given the regulatory changes and rising demand for customized financing. Also, its investment commitments to new and existing portfolio companies have been steadily rising.
As of Jun 30, 2023, TCPC had a debt of $10.2 billion and available liquidity of $333 million. At the end of the second quarter of 2023, the weighted average cost of debt outstanding was 4.28%.
BlackRock TCP has a market cap of $645.3 million. Over the year, the company’s shares have lost 4%. The Zacks Consensus Estimate for earnings has remained unchanged at $1.84 for 2023 over the past 30 days.
Hercules Capital, Inc. (HTGC): Free Stock Analysis Report
Golub Capital BDC, Inc. (GBDC): Free Stock Analysis Report
BLACKROCK TCP CAPITAL CORP. (TCPC): Free Stock Analysis Report
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