Interest rates: Fed hikes set to hit smaller companies harder

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US interest rates are at their highest level since the financial crisis. In recent months, the inflation-fighting Federal Reserve has increased the cost of money as much as it has in the span of a few years. The central bank’s aggressive tone at the Jackson Hole meeting draws steam from a premature rally in US stocks.

Higher rates would hurt the most for companies whose balance sheets have ballooned during the long period of low rates. High energy prices and supply chain disruption will exacerbate the problem.

A stagflationary scenario of rising prices, higher interest rates and slowing growth represents the worst of all possible outcomes in the worst of all possible worlds. According to a data screening from Lex, the resilience of one-fifth of the S&P 500 non-financial companies would be tested. Companies hardest hit during the pandemic, such as cruise operator Carnival, American Airlines and casino group Caesars Entertainment, are all back in danger.

The findings reflect a screening of European companies. Here, the interest coverage for one-fifth of the large publicly traded companies would fall below double the corporate profit. We assumed interest costs would rise by half and profits would fall a quarter from current projections.

However, free money handed out during the pandemic — with the eager help of Wall Street — would dampen balance sheets. American Airlines may not be able to cover its interest payments from income. But $12 billion in cash and equivalents represents five years of interest coverage, even after adjusting for higher rates.

Carnival is in the same boat. The cruise line has enough money to pay the interest payments at past rates for more than four years. Its rival Royal Caribbean, meanwhile, can only cover last year’s interest charges 1.5 times with cash.

Smaller companies are most at risk. A stress test of S&P 400 mid-caps showed that a quarter in our severe scenario would fall below double the interest coverage. Available liquidity was also lower as a share of current assets. The little guys always end up with the depreciating money.

The Lex team would like to hear more from readers. Tell us how dangerous you think higher rates are for leveraged companies in the comments section below.