The specter of high and rising interest rates is upon us, and in its wake, astute investors should consider stocks with a robust financial backbone. The narrative of higher interest rates orchestrated by the Federal Reserve is not necessarily one of doom, but a call to action for investors to realign their portfolios with stocks capable of thriving in such a milieu.
So we assembled three of The Motley Fool's eminent tech writers to examine the financial fabric of three world-class cash-cow companies. Our experts will explain why these tech giants are poised to navigate the high-interest rate terrain with confidence, making them sterling picks for investors in these challenging times.
NASDAQ: MQ
Key Data Points
Cash makes up nearly 50% of this fintech's market cap
Billy Duberstein (Marqeta): Card issuing technology platform Marqeta (MQ 0.50%) is relatively new on the scene, having gone public just in June 2021.
The good news about that is that was pretty much the top of the tech and software bubble, which allowed this innovative fintech to raise $1.2 billion at $27 per share at that time. Flash forward to the present day, which has seen a dramatic sell-off in software and fintech, and Marqeta trades at just $5.88 per share. However, about $2.57 per share of that, or $1.38 billion, is made up of cash on the balance sheet, against no debt -- good for 44% of Marqeta's market cap.
But besides its bountiful cash hoard, which is allowing the company not just to invest in growth but also repurchase stock -- a rarity for an earlier-stage growth stock -- Marqeta has also been the recipient of some good news lately.
Last quarter, Marqeta announced it renewed its contract with Block (SQ 0.13%) for another four years. That was super-important, as Block had accounted for a whopping 78% of Marqeta's revenue last quarter.
Now, of course, with a customer concentration like that, the renegotiation will greatly lower the fees Block's Cash App card will pay Marqeta. In addition, because of an accounting change associated with the renewal, Marqeta will see a huge drop in revenue starting next quarter -- but a huge drop in costs, too.
Still, after this "reset," along with other major contract renewals made earlier this year and 2022, Marqeta's results will rebase, and probably grow a lot from there. New CEO Simon Khalaf, who took over in early 2023, has already implemented a lot of go-to-market changes, and Marqeta has just fully integrated its Power Finance acquisition, which will give Marqeta industry-leading virtual credit card capabilities.
To assess the underlying growth of the business aside from these contract resets, it may be helpful to look at total processing volume (TPV) growth, which grew a healthy 33% last quarter, even in a very tepid economic backdrop. And thanks to Khalaf's recently implemented changes, management noted that bookings grew a whopping 60% quarter over quarter and 150% for the three previous quarters compared with the same period in the prior year. Bookings typically translate into revenue between six and 12 months later, since it takes that long for these programs to launch after a customer deal is signed. And since Marqeta's revenue is based on usage, it can take even longer for that to ramp up into meaningful revenue.
So last year's mere 24% revenue growth reflected contract renewals and rather tepid bookings made before Khalaf took over. But with the strong bookings over the past three quarters, revenue should see a material pickup in 2024 as the new deals begin to translate into revenue and gross profit. At least one insider expects as much, with director Judson C. Linville buying about $200,000 worth of stock in the open market in August at $5.86, after the Block deal was announced.
Marqeta enables much more flexibility in physical and virtual cards than static and inflexible legacy alternatives, allowing businesses of all types, and not just financial institutions, to manage their own flexible card programs. Other use cases include delivery platform providers, seller financing, buy-now-pay-later, accelerated wage access for gig workers, fleet management programs, and general card-based corporate expense management. These use cases are growing by leaps and bounds, as should Marqeta in the quarters and years ahead.
NASDAQ: NFLX
Key Data Points
The new and improved Netflix: Cash-earning, not cash-burning
Anders Bylund (Netflix): This would have sounded ridiculous a couple of years ago, but Netflix (NFLX +1.15%) is transforming from a cash-burning growth phenom into an efficient cash machine. The company is not likely to take on additional debt at this point. Therefore, interest rates on new debt shouldn't have any direct effect on Netflix's financial results for the foreseeable future. The Albanian army of yesteryear has become a formidable force in the entertainment industry, fully funded by fresh cash profits.
I'm not kidding. Netflix's free cash flows were slim in the first few years of video-streaming operations, shifting into a deeply negative mode as the production of Netflix originals accelerated. The company consumed as much as $3.1 billion of free cash in 2019, for example. But management has changed gears in recent years, moving the business plan away from subscriber growth at nearly any cost to focus on profitable revenue growth instead.
Equipped with new tools such as ad-supported subscription plans and a crackdown on password-sharing accounts, Netflix now generates reliably positive cash flows and hasn't taken on any debt since 2020. Instead, it paid down $500 million of long-term debt in 2021 and another $700 million last year. The free cash profits added up to $4.3 billion over the past four quarters:
NFLX Free Cash Flow data by YCharts
It's a beautiful thing. Netflix has more incoming cash profits than it needs to run the business. The management team has set up a target range between $10 billion and $15 billion for its long-term debt balance, while funneling excess cash back to shareholders in the form of stock buybacks.
That's a shareholder-friendly policy, and already a very active one. Netflix has invested $974 million in retiring stock stubs over the past year. The buyback program should also accelerate in the second half of 2023, according to the second-quarter earnings report.
Furthermore, Netflix's stock looks affordable at 5.2 times sales and 24.6 times forward earnings projections. The buybacks are a nice bonus, but I would recommend buying Netflix stock right now if that commitment to cash-sharing weren't there.
So if I had to pick one stock to buy in a market with high and potentially rising interest rates, I wouldn't hesitate to reach for Netflix. Its financial platform has never been this robust, and I can't wait to see how Netflix puts its cash profits to work in the long run.
NASDAQ: AMAT
Key Data Points
Cash is still flowing to this critical industry niche, higher interest rates or not
Nicholas Rossolillo (Applied Materials): The Federal Reserve may be signaling higher interest rates for longer, putting the risk of recession back on the table in the minds of many investors. But Fed interest rate moves or not, money is still flowing to the semiconductor manufacturing industry.
The U.S., Europe, South Korea, Japan, China, even India (not historically a big hub of chipmaking) and countries in Southeast Asia, have all launched funding initiatives to bolster their own domestic semiconductor manufacturing industry. Dozens of new chip fabs -- facilities that make silicon wafers and the chips cut from them -- are under construction around the world, and dozens more are being upgraded or expanded.
Applied Materials (AMAT +1.05%) will thrive in this higher-interest-rate environment, as it has been in the past year and a half, owing to this trend toward chip manufacturing. Applied is the big manufacturing equipment generalist that supplies big expensive machines, parts, and services to everyone, all over the world, no matter what kind of chip they're manufacturing -- processors for PCs and smartphones, data centers, electric vehicles, power grid infrastructure, and more.
Data by YCharts.
All of those new and expanded fabs are going to need billions of dollars of additional equipment in the next two to three years, which could create a floor for Applied during a tough period because of interest rate concerns. Besides growth, the company also has a solid balance sheet, with $6.5 billion in cash and short-term investments, $2.2 billion in long-term investments, and just $5.7 billion in total debt.
Applied uses this financial strength to pay a rising dividend, currently yielding nearly 1% a year, and to repurchase ample amounts of stock -- $439 million in the last quarter, an annualized dividend yield equivalent of 2.3% based on the current market cap of $74.7 billion.
Applied Materials stock trades for 18 times trailing-12-month earnings per share, and 16 times free cash flow. I'm a biased longtime shareholder, but I think shares can do very well from here in a higher Fed interest-rate environment.
