Stock Analysis & Ideas

Which Stock Picks Could Profit from Rising Interest Rates?

Tech shares have taken a beating in 2022 as higher interest rates decreased the present value of future earnings growth. Investors are thinking twice before paying above-market multiples, and are focusing on value stocks instead.

However a somewhat overlooked fact is that technology companies often have a very conservative capital structure. Most big technology companies, such as Apple (AAPL), are sitting on a net cash position. This is in contrast to utility and real estate companies, which often use leverage to juice up returns.

Avenues to Deploy Excess Capital

There are several different ways companies can deploy this excess cash. First, they can invest it in their core businesses and grow organically. Second, they can use it for acquisitions. Third, they can return it to shareholders via dividends and buybacks. Lastly, they can keep their options open, and keep the dry powder on their books.

The last option allows companies to exploit periods of market turmoil to boost returns. This is what Warren Buffet does at Berkshire Hathaway (BRK.B). Berkshire ended Q1 2022 with around $103 billion in cash, down from $144 billion at the end of Q4 2021. In essence, Berkshire deemed the opportunities in Q1 2022 worth deploying some 28% of its cash pile.

It is likely that dropping share prices will prompt corporate treasurers to deploy the excess cash reserves accumulated in the good days. Nevertheless, as we have seen at Berkshire, some of the cash will remain on the books.

In this article I will explore what effects rising rates will have on corporate profits for some of the tech companies sitting on the largest cash pile.

Apple

At the end of Q1 2022 — which for Apple is Q2 given the September financial year — the interest-sensitive portions of Apple’s balance sheet were as follows:

Balance sheet item, USD billionAssetsLiabilities
Cash and equivalents$28.1
Marketable securities$164.6
Commercial Paper$7
Term debt$113
Total$192.7$120
Selected Balance Sheet Items, Author’s calculations based on Q1 2022 disclosure

In total, Apple is sitting on a net cash position of about $72.7 billion, which could fetch an extra $2 billion a year in pre-tax profits if reinvested at the 3% Fed funds rate currently expected by the market over the medium term.

The impact from the extra income largely depends on Apple’s product cycle. I think the effect will be more noticeable in years without major product releases. Overall though the impact should be a boost to earnings by 2-3%.

Alphabet (GOOGL)

At the end of Q1 2022, the interest-sensitive portions of Google’s balance sheet were as follows:

Balance sheet item, USD billionAssetsLiabilities
Cash and equivalents$20.9
Marketable securities$113
Long-term debt$14.8
Total$133.9$14.8
Selected Balance Sheet Items, Author’s calculations based on Q1 2022 disclosure

Overall, Google has at its disposal some $119.1 billion net for reinvestments, which could boost pre-tax income by some $3.3 billion over the medium term. Given the more conservative balance sheet of Google as compared to Apple, the boost to earnings should be around 4%.

Meta Platforms (FB)

At the end of Q1 2022, the interest-sensitive portions of Facebook’s balance sheet were as follows:

Balance sheet item, USD billionAssetsLiabilities
Cash and equivalents$14.9
Marketable securities$29
Total$43.9
Selected Balance Sheet Items, Author’s calculations based on Q1 2022 disclosure

Curiously, Facebook has no debts. As the company moves into a more mature phase, this may prompt the corporate treasurer to diversify the capital structure.

This should allow debt investors to have an allocation towards Facebook, and at the same time potentially lower the cost of capital.

As things stand, the net cash position of around $43.9 billion should bring an extra $1.2 billion in pre-tax income over the medium term. The overall boost to pre-tax income should be around 3%.

Amazon (AMZN)

At the end of Q1 2022, the interest-sensitive portions of Amazon’s balance sheet were as follows:

Balance sheet item, USD billionAssetsLiabilities
Cash and equivalents$36.4
Marketable securities$30
Long-term debt$47.5
Total$66.4$47.5
Selected Balance Sheet Items, Author’s calculations based on Q1 2022 disclosure

Amazon recorded a sharp drop in marketable securities in Q1 2022 to $30 billion, down from $59.8 billion in Q4 2021. This was partly the result of a $8.2 billion valuation loss, of which $7.6 billion was due to a writedown in the value of Rivian (RIVN).

As of the end of Q1 2022, Amazon held a circa 18% stake in the electric car maker. Overall, the benefit to pre-tax profit from the reinvestment of the spare cash would be in the 1%-2% range.

Microsoft (MSFT)

At the end of Q1 2022 — which for Microsoft is Q3 given the June financial year — the interest-sensitive portions of Microsoft’s balance sheet were as follows:

Balance sheet item, USD billionAssetsLiabilities
Cash and equivalents$12.5
Short-term investments$92.2
Long-term debt$50
Total$104.7$50
Selected Balance Sheet Items, Author’s calculations based on Q1 2022 disclosure

The reinvestment of the net cash position of Microsoft at circa $54.7 billion would results in a pre-tax earnings boots of close to 2%.

Intel (INTC)

At the end of Q1 2022, the interest-sensitive portions of Intel’s balance sheet were as follows:

Balance sheet item, USD billionAssetsLiabilities
Cash and equivalents$6.2
Short-term investments$32.5
Debt$37.25
Total$38.7$37.25
Selected Balance Sheet Items, Author’s calculations based on Q1 2022 disclosure

Despite boasting a large absolute cash pile, Intel’s actual net cash position is negligible when the debt is taken into account.

Tesla (TSLA)

At the end of Q1 2022, the interest-sensitive portions of Tesla’s balance sheet were as follows:

Balance sheet item, USD billionAssetsLiabilities
Cash and equivalents$17.5
Short-term investments$0.5
Debt and finance leases$4.8
Total$18$4.8
Selected Balance Sheet Items, Author’s calculations based on Q1 2022 disclosure

Automakers have traditionally relied on having a sizable cash pile to ride out industry downturns. Tesla’s $13.2-billion net cash position could boost pre-tax profits by $350 million, or 5%-6%, which is quite significant in percentage terms.

In absolute terms, however, given the market capitalization of the company, the effect would be negligible.

Nvidia (NVDA)

At the end of January 2022, the interest-sensitive portions of Nvidia’s balance sheet were as follows:

Balance sheet item, USD billionAssetsLiabilities
Cash and equivalents$2
Short-term investments$19.2
Long-term debt$10.9
Total$21.2$10.9
Selected Balance Sheet Items, Author’s calculations based on January 2022 Annual report

Nvidia boasts a net cash position of around $10.3 billion. A reinvestment at the expected 3% Fed funds rate could boost pre-tax returns by $275 million, or close to 3%.

Summary

When it comes to the cash pile of tech companies, the devil is in the details. Overall, the group will be a net beneficiary of higher rates.

Older tech companies, such as Intel, Microsoft, and Apple, have a more diversified capital structure, and a sizable debt component.

Over the short term, Tesla looks like the biggest winner of higher rates. However, this is the result of a small pre-tax profit relative to the net cash position.

I expect the effect to diminish as car production increases in the future, boosting pre-tax profits. Over the medium term, Google parent Alphabet should be the biggest beneficiary of higher rates, given its meaningful $119.1 billion net cash and cash equivalents position.

All in all, while higher rates will by no means be a main driver for tech earnings, most names should experience an earnings per share bump of several percentage points.

The effect may end up being slightly larger over the very short term. This is due to the fact that the debt companies have issued is usually with a fixed interest rate.

Eventually, these bonds will have to be refinanced at higher rates. In the meantime, however, their immediate cash reserves can be redeployed very quickly at the higher Fed funds rate.

Of course, this is offset by the fact that companies themselves have invested a portion of their marketable securities into longer-duration instruments.

At the end of the day, there is still a silver lining for tech shares when higher rates are concerned.

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