- As the markets had anticipated, the Fed made another big interest rate hike - 75 bps this time - and indicated that it will eventually need to raise interest rates above 4.6%.
- GameStop, and the broader markets, took the news badly, making significant declines right after the Fed's announcement.
- Because it has almost no debt and is sitting on a sizable cash pile, GameStop may be much less impacted than other, more highly-leveraged companies.
Read more from Wall Street Memes: GameStop Stock: Outperforming the Tech Giants in 2022
Another Widely-Expected Interest Rates Hike
The Federal Reserve made another large rate increase at its last meeting on November 2nd. In a highly anticipated move, the Fed raised rates by 75 bp, moving the federal funds rate to the 3.75%-4% range. This is the highest level it has been at since January 2008. And it follows the most aggressive monetary policy the Fed has had since the 1980s.
While Fed Chair Jerome Powell hinted at potentially slowing the rate hike pace in the future, he also made clear that the Fed still has a long way to go.
"It is very premature, in my view, to think about or be talking about pausing our rate hikes," Powell stressed. "We have a ways to go. Our policy, we need ongoing rate hikes to get to that level of sufficiently restrictive [territory] - and of course, we don't know exactly where that is. ... I would expect us to continue to update it based on what we're seeing with incoming data."
Perhaps the least encouraging news came from the Central Bank’s projection that interest rates will now need to move above 4.6%. Previously, 4.6% was seen as the leveling-off point for rates.
While news out of the Fed meeting was not particularly surprising, the markets were not pleased. The Dow Jones Industrial Average, S&P 500, and the Nasdaq ended the November 2nd trading session down 1.6%, 2.5%, and 3.4% respectively.
What about GameStop?
According to the Fed, there is still little clarity concerning how long high-interest rates will have to stick around. What is known is that the longer interest rates remain high, the more leveraged companies – i.e., those with debts larger than the average for their industry – will have to deal with the pinch of high-interest rates.
Debt expenses will gradually squeeze the operating margins of these companies, and many may be forced to run their businesses “hand-to-mouth”.
The good news for GameStop investors is that the video game retailer currently sits in a robust cash position - about $909 million. This amount is $570 million more than the company had during the worst trough of the pandemic.
The company's considerable cash hoard will offer it some extra cushion should macroeconomic conditions sour further.
However, it is necessary to point out that most of this amount did not come exclusively from the company's operations. Rather, the bulk of it came from $1.67 billion issued in equity last year, when the board took advantage of GME’s extremely elevated share price.
Even though the cash raised did generate float dilution, GameStop's management was able to use that cash to clear almost all of its debt.
GameStop's operations, importantly, are still not profitable. The company has reported operating losses greater than $100 million in each of the last four quarters. GameStop has plans to put its capital to work on its turnaround plan, led by Chair Ryan Cohen and CEO Matt Furlong, which is aimed at transforming the company into a digital-focused business.
Not All That Glitters Is Gold
A sizable cash hoard does not necessarily mean that GameStop is in a situation of privilege or comfort.
GameStop's operational difficulties are a worrying factor for the long term. Even though in the last quarter, Q3, the company reduced income loss by $50 million, there is still no clarity on when profitability will return for the video game retailer. GameStop had to use about $380 million in cash to support operations last quarter.
GameStop's Q3 operating cash was negative $103 million. In the last twelve trailing months, the company recorded negative $811 million in operating cash flow, indicating expenses are far outstripping inflows.
This rate of spending is simply unsustainable for GameStop. If it stays on the same course, its entire cash pile will dry up in a matter of time.
The good news is that GameStop's management is prioritizing this very issue. Executives are mobilizing with the primary objective of returning to profitability, as CEO Matt Furlong's recent speech attests:
"After spending a year strengthening our assortment, infrastructure, and tech capabilities, we're now focused on achieving profitability, launching proprietary products, leveraging our brand in new ways, and investing in our stores."
Even though GameStop's stock trading performance is heavily influenced by socially- mobilized investing, sooner or later the stock's performance will more closely track earnings growth. In the short term, business fundamentals may matter less. But in the long term, the market’s focus will likely be on GME’s return to its shareholders.
(Disclaimers: this is not investment advice. The author may be long one or more stocks mentioned in this report. Also, the article may contain affiliate links. These partnerships do not influence editorial content. Thanks for supporting the Wall Street Memes)