- U.S. companies still may need to move toward fixed-rate debt
- AutoNation CEO says eventual boost will be sign crisis is over
The Federal Reserve’s decision to keep interest rates unchanged is delaying the inevitable for companies that will have to adjust the ways they save, borrow and invest, when money isn’t quite so free.
Futures markets are now pricing in a 45 percent chance that Fed policy makers will raise their benchmark rate by a quarter-point by year-end, from near zero, where it’s stood since late 2008 to try to stimulate growth.
When that day comes, chances are that the initial changes at corporate treasuries won’t be as dramatic as the build-up. Still, the prospect of rising rates may make executives more circumspect about acquisitions and capital spending, strategists and analysts said. They’re also likely to shift more borrowing to fixed-rate instruments from those that float up or down.
“When rates are going up, you need to go back and look at the closet of fixed-income securities and make sure that you are funding your business as efficiently as you can,” said Robert Hoglund, the chief financial officer of Consolidated Edison Inc. The utility provides electricity for most of New York City.
Companies such as Ford Motor Co., McDonald’s Corp. or Johnson & Johnson may be more vulnerable to rising borrowing costs because they carry proportionately larger slices of floating debt, according to a Sept. 14 analysis by Goldman Sachs Group Inc.
“We manage our business for the long term and recognize that changing interest rates are part of the normal course of doing business,” said Alex Gorsky, chairman and chief executive officer of the pharmaceutical giant. “In the near term, an initial small change in interest rates will not have a significant impact on our business.”
Representatives from Ford and McDonald’s declined to comment.
Stocks were hurt in recent weeks in part because of anxiety over what the Federal Open Market Committee would or wouldn’t do, said Jim Paulsen, chief investment strategist at Wells Capital Management. Market volatility surrounding rate decisions take a toll on executives, he said.
“That might be the biggest fundamental impact this has had so far on companies,” Paulsen said. “It affects what they do with debt raising, it affects what they do with issuance of equity, it affects cash holdings, it affects their attitudes about capital spending.”
Many executives who manage corporate finances have never done so in an era when the Fed is raising rates. Only about one in seven chief financial officers of Standard & Poor’s 500 companies was even in her or his job when the Fed last had an increase, in 2006, according to data compiled by Bloomberg.
“Over the last seven, eight years we’ve had an unprecedented business cycle,” said Kurt Abkemeier, CFO of Inteliquent Inc., a Chicago-based provider of voice, data and other hosted services. He said the change could unnerve CFOs at companies that have taken on too much debt. Inteliquent, with no debt and a solid cash cushion, shouldn’t experience much impact, he said.
Corporate debt issuance has increased this year as companies sought to get ahead of the possibly higher borrowing costs, said Jack Ablin, chief investment officer at BMO Harris Bank. The Fed’s first move “could send a message to the financial community that the cost of risk-taking is going to go up,” he said.
Companies based outside the U.S. are watching closely, with the prospect of higher rates adding to the recent volatility in global markets.
“We’re focusing on maintaining our financial flexibility,” said Bodo Uebber, Daimler AG’s CFO, on the sidelines of a company event at this week’s Frankfurt Auto Show. Daimler’s 18 billion euros ($20.3 billion) in cash or equivalents at the end of the second quarter is “a good liquidity cushion to be able to deal with volatile market,” Uebber said. “At the same time, we’re seeking ways to broaden our financing options,” such as buying more Panda bonds sold in China.
Higher rates, when they come, also eventually could damp consumer confidence, said Ian Robertson, sales chief for automaker BMW AG, owner of last year’s best-selling luxury brand in the U.S. Robertson considers it a step that has to happen “sooner or later,” even though rates will probably rise slowly.
Goldman Sachs in a separate report identified 25 Asian companies that could be vulnerable because of their high exposure to U.S. debt, including China Southern Airlines Co. and phone operator Bharti Airtel Ltd. The report said China Southern has 93 percent of its debt denominated in U.S. dollars while Bharti has 77 percent.
Firms that sell heavily in emerging markets will focus on how the U.S. rate affects foreign currencies. Royal Philips NV CEO Frans van Houten told journalists in London on Tuesday that higher U.S. rates could siphon money out of emerging markets. That could devalue currencies in those countries, which would cost the seller of medical gear and lighting equipment revenue as those sales are converted to euros.
“We will raise prices in the end,” van Houten said. “We’re in the business of making money and not giving it away.”
The increase could offer benefits for some companies. For instance, health and life insurers that set aside reserves to pay claims may get higher interest payments on those funds, which are frequently invested in short-term vehicles.
“Back in the day when we had higher interest rates, (insurers) made money on it because they’re sitting on so many reserves,” said David Heupel, senior health-care analyst at Thrivent Asset Management. Even if yields go up by just 25 or 50 basis points, Heupel said, the added income for health insurers is “not an inconsequential sum of money.”
Mike Jackson, the CEO of AutoNation Inc., the largest automotive retailer in the U.S., also supports the Fed raising interest rates before the end of the year.
“It’s almost a message to America that the economic crisis is over, and that’s an important message,” Jackson said Thursday, before the Fed announcement. “This is nothing drastic. It’s baby steps.”