Google profit

What stock picks could benefit from rising interest rates?

JThese stocks have taken a hit in 2022 as rising interest rates have lowered the present value of future earnings growth. Investors think twice before paying multiples above the market and instead focus on value stocks.

However, a somewhat overlooked fact is that technology companies often have a very conservative capital structure. Most major tech companies, like Apple (AAPL), are sitting on net cash. This contrasts with utility and real estate companies, which often use leverage to increase returns.

Ways to deploy excess capital

There are several ways companies can deploy this excess cash. First, they can invest it in their core business and grow organically. Second, they can use it for acquisitions. Third, they can return it to shareholders through dividends and buyouts. Finally, they can keep their options open and keep the powder dry in their books.

The last option allows companies to exploit periods of market turbulence to increase returns. That’s what Warren Buffet does at Berkshire Hathaway (BRK.B). Berkshire ended Q1 2022 with approximately $103 billion in cash, compared to $144 billion at the end of Q4 2021. In essence, Berkshire estimated Q1 2022 opportunities were worth deploying about 28% of its cash.

Falling stock prices are likely to prompt corporate treasurers to deploy accumulated excess cash reserves on good days. Nevertheless, as we saw in Berkshire, some of the money will stay on the books.

In this article, I’ll explore the effects of rising rates on corporate earnings for some of the tech companies that have the largest cash stack.

Apple

At the end of the first quarter of 2022 – which for Apple is the second quarter given the September fiscal year – the interest rate sensitive parts of Apple’s balance sheet were as follows:

Balance sheet item, in billions of dollars Assets Passives
Cash and cash 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 about $72.7 billion in net cash, which could yield an additional $2 billion a year in pretax profits if reinvested at the currently expected 3% federal funds rate. by the market in the medium term.

The impact of incremental revenue largely depends on Apple’s product cycle. I think the effect will be more noticeable in years without major product releases. Overall, however, the impact should be a 2-3% increase in profits.

Alphabet (GOOGL)

At the end of the first quarter of 2022, the interest rate sensitive parts of Google’s balance sheet were as follows:

Balance sheet item, in billions of dollars Assets Passives
Cash and cash 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 about $119.1 billion net for reinvestments, which could increase pre-tax income by some $3.3 billion over the medium term. Given Google’s more conservative balance sheet compared to Apple, the profit increase should be around 4%.

Meta platforms (Facebook)

At the end of the first quarter of 2022, the interest rate sensitive parts of Facebook’s balance sheet were as follows:

Balance sheet item, in billions of dollars Assets Passives
Cash and cash 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 debt. As the business enters a more mature phase, this may prompt the corporate treasurer to diversify the capital structure.

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

As it stands, the net cash position of approximately $43.9 billion is expected to provide an additional $1.2 billion in pre-tax profit over the medium term. The overall increase in pre-tax profit should be around 3%.

Amazon (AMZN)

At the end of the first quarter of 2022, the interest rate sensitive portions of Amazon’s balance sheet were as follows:

Balance sheet item, in billions of dollars Assets Passives
Cash and cash 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 saw a sharp decline in marketable securities in Q1 2022 to $30 billion from $59.8 billion in Q4 2021. This was partly the result of an $8.2 billion impairment loss , of which $7.6 billion was due to a write-down in the value of Rivian (SHORE).

At the end of the first quarter of 2022, Amazon held a roughly 18% stake in the electric car maker. Overall, the benefit to pre-tax earnings from reinvesting excess cash would be in the range of 1% to 2%.

Microsoft (MSFT)

At the end of the first quarter of 2022 – which for Microsoft is the third quarter given the June fiscal year – the interest rate sensitive parts of Microsoft’s balance sheet were as follows:

Balance sheet item, in billions of dollars Assets Passives
Cash and cash 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

Reinvesting Microsoft’s net cash to approximately $54.7 billion would increase pretax profits by nearly 2%.

At the end of the first quarter of 2022, the interest rate sensitive portions of Intel’s balance sheet were as follows:

Balance sheet item, in billions of dollars Assets Passives
Cash and cash 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 significant absolute cash, Intel’s actual net cash position is negligible when debt is taken into account.

At the end of the first quarter of 2022, the interest rate sensitive portions of Tesla’s balance sheet were as follows:

Balance sheet item, in billions of dollars Assets Passives
Cash and cash equivalents $17.5
short term investments $0.5
Debt and leasing $4.8
Total $18 $4.8
Selected balance sheet items, author’s calculations based on Q1 2022 disclosure

Automakers have traditionally relied on ample cash 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 rate sensitive parts of Nvidia’s balance sheet were as follows:

Balance sheet item, in billions of dollars Assets Passives
Cash and cash 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 has a net cash position of around $10.3 billion. Reinvestment at the expected federal funds rate of 3% could increase pre-tax returns by $275 million, or almost 3%.

Summary

When it comes to tech company cash, the devil is in the details. Overall, the group will be a net beneficiary of the rate increase.

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

In the short term, Tesla appears to be the big winner from higher rates. However, this is the result of a small profit before tax compared to net cash.

I expect the effect to diminish as auto production increases in the future, which will increase pre-tax profits. In the medium term, Alphabet, Google’s parent company, is expected to be the biggest beneficiary of higher rates, given its net cash and cash equivalent position of $119.1 billion.

Overall, while higher rates will by no means be a primary driver of tech earnings, most names are expected to experience an increase in earnings per share of several percentage points.

The effect may end up being slightly greater in the very short term. This is because debt issued by corporations usually comes 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 the companies themselves have invested some of their marketable securities in longer duration instruments.

Ultimately, there’s always a silver lining for tech stocks when it comes to higher rates.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.