Can Broad Shoulders Shake Off The Rate Hike?

by Debra Fiakas CFA

Some investors may be surprised by the repercussions of an increase in the Federal Reserve’s benchmark interest rate.  The Federal Open Market Committee is expected to take action next week for the first time in nine years to increase the rate from near zero.  Odds makers have pegged the magnitude of the rate increase by a quarter percentage point.

We decided to take a look at some of the companies in Crystal Equity Research’s Beach Boys Index composed of biofuel, ethanol, renewable diesel and other alternative fuel producers.  We looked to see which ones might be vulnerable to an interest rate increase by virtue of having large amounts of debt.

Top of the list is agriculture giant Archer Daniels Midland (ADM:  NYSE), which appears on our Beach Boys Index by virtue of its biodiesel and ethanol interests.  Of the five companies in this group, ADM uses the lowest leverage.  Eastman Chemical (EMN:  NYSE) is a specialty chemicals company that is attempting to transform its old-line petrochemical-based products with renewable materials.  Eastman is the most levered in the group.  Ethanol producer, The Andersons (ANDE:  Nasdaq) is the smallest of the group in terms of sales and assets and has the second lowest debt-to-equity ratio in the group.  Air Products and Chemicals (APD:  NYSE) is the most successful in the group at converting sales to operating cash flow.  Yet even with all that cash flowing in, debt is still an important element in the company’s capital structure.  The Praxair Group (PX:  NYSE), the second specialty gas producer in the group, has the higher debt-to-equity ratio in the group. 
 
For each of these companies, we estimated the incremental interest burden that might ensue with an quarter point interest rate increase.  Our calculation assumes all of the debt was either subject to variable rate interest rates or would need to be refinanced within the year.

Next the impact on earnings per share was calculated.  Then we used each company’s forward earnings multiple to determine the potential impact on price.  As ominous as an interest rate increase sounds, from a valuation standpoint, these large companies might not experience any significant price adjustment. 

It is also possible that the impact of rising interest burden has already been incorporated in stock valuations.  This particular decision by the Federal Reserve has been discussed for months.  It seems logical that equity investors have already taken increasing interest rates into consideration in completing forward projections and determining target prices.  For this group of five large companies, all of which have ample analyst coverage, the FOMC meeting and Janet Yellen’s announcement next week might be anti-climactic.  These ‘broad shouldered’ companies have appear ready to shake off an interest rate hike whenever it comes along. 

Debra Fiakas is the Managing Director of Crystal Equity Research, an alternative research resource on small capitalization companies in selected industries.

Neither the author of the Small Cap Strategist web log, Crystal Equity Research nor its affiliates have a beneficial interest in the companies mentioned herein.