A High-Yield Finance Stock to Think About
With today’s ultra-low interest rates, most income investors would be pretty happy to earn a dividend yield of five percent.
After all, a 10-year U.S. government bond yields a measly 0.8%, while the average dividend yield of S&P 500 companies stands at just 1.7%. (Source: “S&P 500 Dividend Yield,” multpl.com, last accessed November 11, 2020.)
And yet, Horizon Technology Finance Corp (NASDAQ:HRZN) manages to offer an annual dividend yield above the double-digit mark. At the same time, it makes more frequent distributions than most companies.
Sound too good to be true?
Well, on November 3, the company announced that its board of directors declared monthly cash dividends of $0.10 per share, payable in January, February, and March 2021. (Source: “Horizon Technology Finance Announces Monthly Distributions for January, February and March 2021 Totaling $0.30 per Share,” Horizon Technology Finance Corp, November 3, 2020.)
With HRZN stock trading at $11.66 per share, those monthly dividends come out to an annual yield of 10.3%.
Of course, high-yield stocks are not really known for their dividend safety, especially in this year’s challenging economic environment caused by COVID-19. If you follow double-digit yielders, you’d know that, in recent months, dividend cuts have not been uncommon.
Horizon, though, did not reduce its payout. In fact, the monthly dividends it just declared are the exact same amount it was paying before the pandemic. (Source: “Dividend History,” Horizon Technology Finance Corp, last accessed November 11, 2020.)
Now, you may be wondering how this ultra-high yielder manages to maintain its payout.
Well, Horizon is a specialty finance company that invests in venture-capital-backed companies in the technology, life sciences, health-care information and services, and sustainability industries.
Headquartered in Farmington, CT, the company’s investment objective is to “maximize our investment portfolio’s return by generating current income from the debt investments we make and capital appreciation from the warrants we receive when making such debt investments.” (Source: “Fact Sheet,” Horizon Technology Finance Corp, last accessed November 11, 2020.)
With a strong focus on income generation, most of Horizon’s portfolio is invested in debt instruments. At the end of September, the company’s debt portfolio consisted of 34 secured loans, with an aggregate fair value of $298.9 million. (Source: “Horizon Technology Finance Announces Third Quarter 2020 Financial Results,” Horizon Technology Finance Corp, November 3, 2020.)
Meanwhile, the company had warrant, equity, and other investments totaling $12.9 million in aggregate fair value.
Lending to venture-capital-backed companies in fast-growing industries is very lucrative. In the third quarter of 2020, the annualized portfolio yield on Horizon’s debt investments was 15.1%.
Here’s the neat part: because Horizon is structured as a business development company (BDC), it must return at least 90% of its profits to investors through dividends. In exchange for meeting that mandatory distribution requirement, BDCs do not have to pay income tax at the corporate level.
In other words, the pass-through structure of BDCs is one of the reasons behind HRZN stock’s oversized dividends.
So, the big question now is: Can the company afford its current payout level?
Well, according to its latest earnings report, Horizon Technology Finance Corp generated net investment income of $0.34 per share in the third quarter of 2020. While the amount represented a decline from the $0.42 per share earned in the year-ago period, it was in excess of the company’s three monthly dividends totaling $0.30 per share paid for the quarter.
Furthermore, after earning $0.34 per share in net investment income and paying $0.30 per share in dividends for the quarter, Horizon still had $0.45 per share in undistributed spillover income as of September 30. Undistributed spillover income can be used to fund shareholder distributions in future periods, providing an additional level of dividend safety.
Commenting on the HRZN stock distribution policy, Horizon’s chairman and CEO, Robert Pomeroy, said, “It is our board’s policy to make distributions in amounts that can be covered by NII over time. The distribution level reflects our outlook for the remainder of 2020 and the beginning of 2021 and our spillover income at September 30. We have now covered our distributions with NII for the past 3 years.” (Source: “Horizon Technology Finance Corp (HRZN) CEO Robert Pomeroy on Q3 2020 Results – Earnings Call Transcript,” Seeking Alpha, November 4, 2020.)
Bottom Line on Horizon Technology Finance Corp
At this point, it’s important to remember that, as is the case with any stock, HRZN stock’s dividends are not carved in stone.
That being said, a covered 10.3% yield—combined with a monthly distribution schedule—makes Horizon Technology Finance Corp stand out among today’s dividend stocks.