- At its September meeting, the Fed decided to raise interest rates again by 75 basis points to 3.25%.
- Highly leveraged companies tend to be more impacted by interest rate increases. Those with lesser debt loads and plenty of cash are less affected.
- GameStop’s current cash position is robust and should provide protection in the event of an eventual recession. However, investors need to keep an eye on GME’s cash flow.
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Fed Raises Interest Rates
The Federal Reserve made another large rate increase at its last meeting on September 21st. In a widely anticipated move, the Fed raised rates by 75 bp, putting the federal funds rate at the 3% to 3.25% range.
At a press conference, Chairman Jerome Powell reiterated that the Fed will do what is necessary to regain control of consumer prices. In effect - the Fed will raise interest rates for as long as it takes to beat down inflation.
Now, the Central Bank predicts that interest rates could reach 4.6% on average before finally stabilizing.
The market was not keen on this news. Major averages ended the Wednesday, September 21st trading session down 1.7%.
According to the Fed's own notes, high interest rates may be sticking around for quite some time.
One upshot of this is that more leveraged companies – companies with greater debt than average within their industries – will feel the most pain from these rising rates.
Indeed, as debt expenses eat away at these companies’ operating margins, many may have to live “hand to mouth.”
How Does This Affect GameStop?
GameStop (GME) - Get Free Report currently has a robust cash position of $908 million. This amount is considerably more than the $570 million the company had on hand during the worst of the Covid pandemic.
GME’s cash pile was bolstered by its issuing a whopping $1.67 billion in equity last year. Company execs looked to take advantage of the company’s sky-high valuation and firm up their reserves.
Thanks to the new share issuance, GameStop was able to pay off almost all of its outstanding debt position and still keep almost $1 billion in its cash.
GameStop doesn’t intend to just sit on its hands, though. The company has a plan to put capital to work by strengthening its fulfillment capacity and advancing its digital-focused turnaround plan.
The company’s considerable cash hoard will offer it some extra cushion should macroeconomic conditions sour further.
(Read more from Wall Street Memes: 3 Reasons Why GameStop Stock Investors Should Be Bullish)
Pay Attention To GameStop's Cash Flow Situation
Even though GameStop has plenty of cash at the moment, the company cannot afford to relax.
Cash raised through share issuance is quite different from cash produced by the company's operations. And unfortunately, GME’s latest quarterly results have put a spotlight on the company’s operational difficulties. Last quarter's data shows that free cash flow (FCF) per share was -$2.88. That’s the lowest it has been in a decade.
Last quarter, GameStop used about $380 million in cash to support operations. That’s a 15% reduction from the previous quarter, but the situation needs to improve further.
At the current pace, and if all else is held equal, GameStop could put its balance sheet in jeopardy and even run out of cash as soon as next year.
The good news is that many of the company's difficulties in producing operating cash flow appear to be linked to supply chain disruptions and external factors. Those factors may improve, helping to stabilize cash burn, in the coming quarters.
Even though GameStop stock’s trading activity has been heavily influenced by investor sentiment, sooner or later, the stock's performance will follow its earnings growth. In the short term, fundamentals may be neglected. But in the long term, it is shareholder returns that count.
GameStop executives are well aware of this. They have been 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."
(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 Wall Street Memes)