Executives are aggressively paying down debt as higher interest rates increase the cost associated with debt and businesses face the prospect of a recession.
Finance chiefs across industries are feeling the pinch of rising borrowing costs as the Federal Reserve continues to hike interest rates to fight inflation still high. The U.S. central bank last week raised its benchmark federal funds rate by 0.75 percentage points for the fourth time this year, bringing it within a range between 3.75% and 4%.
The London three-month interbank offered rate, a benchmark rate used for commercial lending, stood at 4.56% on Tuesday, down from just under 0.15% a year earlier, according to the data provider.
The costs of the one-month shorter duration Libor also increased. The three-month guaranteed overnight rate – the Libor replacement favored by US regulators – traded at 4.22% on Tuesday, down from 0.04% a year earlier.
Against this backdrop, companies across all industries and credit ratings are accelerating their preparations for a potential economic downturn, analyzing how a shortfall could affect their finances. As a result, some are taking steps to rein in spending and reduce interest charges, while others are looking to grow their cash reserves as their bank deposits continue to generate minimal returns.
DuPont de Nemours Inc.
on Tuesday announced plans to retire $2.5 billion of senior notes due in 2023, resulting in annualized pre-tax savings of $100 million. Additionally, the company expects to pay off its outstanding commercial paper balance of $1.3 billion during the fourth quarter. “Prepayment reduces rollover risk in a rising rate environment,” Edward Breen, chief executive of the Wilmington, Del.-based company, said on an earnings conference call.
elf beauty Inc.
expects to repay approximately 25% of its outstanding term loan during the quarter. The Oakland-based company had $88.3 million in long-term debt on its balance sheet as of Sept. 30, all of which was a floating-rate term loan.
Prior to the Fed’s latest rate hike, elf Beauty was paying an annual interest rate of 4.9% on the loan, according to Mandy Fields, the company’s chief financial officer. That rate, which adjusts quarterly, is expected to increase to nearly 6% in the current quarter, she said. “It was a good time to step back and say, ‘We’ve built up this great cash balance. How can we best use it?'” Ms Fields said.
Elf Beauty’s had $85.3 million in cash and cash equivalents on its balance sheet as of September 30, more than double from a year earlier. The company’s sales were strong despite fears of a slowdown as the company, whose consumer products include $3 lipstickenjoyed strong demand.
Lower-quality companies, and especially those with variable-rate debt, are more urgently looking for ways to reduce interest costs than higher-rated companies, which have ample liquidity and access to markets. capital, said David White, a senior managing director who advises CFOs at
FTI Council Inc.
“If I’m closer to an undesirable rating, that’s a game-changer. It’s a matter of the here and now,” Mr White said, describing the sense of urgency among these companies.
Total debt for S&P 500 companies that reported third-quarter earnings through Nov. 4 remained roughly flat in the quarter from a year earlier, rising 0.3% at the median to reach just over $9.3 trillion, according to S&P Global Market Intelligence. Sectors such as healthcare, consumer staples and information technology reduced their total debt by median values of 5%, 2% and 1%, respectively. Others, including consumer discretionary and real estate, increased their leverage, S&P said.
KAR Auction Services Inc.,
which operates a digital marketplace for used cars, used the net after-tax proceeds of $1.7 billion it generated from the May sale of its ADESA wholesale auction business in the United States to pay off its debt ahead of schedule.
KAR, which has an junk rating, is looking to cut spending as it forecasts a macroeconomic slowdown and aims to operate as a lean digital business, said Eric Loughmiller, the company’s chief financial officer. “I would much rather, given the choice, reduce my interest load and keep my technology team at full capacity,” he said.
During the third quarter, KAR completed a tender offer, buying $600 million of its $950 million of outstanding bonds. The debt bore a coupon of 5.125% and was due in 2025. In addition, KAR three months earlier had repaid a term loan of approximately $900 million. About two-thirds of the loan carried an interest rate of 5% fixed by a swap, which was due to expire in 2025. The rate was expected to rise to at least 7%, according to Mr Loughmiller.
The two transactions reduced KAR’s annual interest costs by $70 million, to about $15 million a year, Loughmiller said.
Small businesses make similar calculations. Toy and Costume Company
JAKKS Pacific Inc.
during the third quarter, made a $17.5 million prepayment on its floating rate term loan, Chief Financial Officer John Kimble said. The interest rate on the loan was around 7.5% in June, when the company refinanced, and in the current quarter it has increased to 10.2%, Mr Kimble said.
Sales for the Santa Monica, Calif.-based company rose 36% in the quarter ended Sept. 30 from a year earlier to $323 million, in part due to the early purchase of inventory by retailers, as well as the popularity of movie-related toys, including Disney’s Encanto. Profit fell 16% to $30.3 million.
It made sense to use cash to pay off the debt, since the company was not earning interest on its bank deposits. It was also worth incurring the $525,000 reimbursement fee, as the company found additional savings that could be spent elsewhere internally, Kimble said.
Three years ago, JAKKS was recapitalized after struggling following the bankruptcy of Toys ‘R’ Us, one of its biggest suppliers at the time. As JAKKS increases sales and builds its business on a solid footing, it aims to improve the quality of its balance sheet, Kimble said. “We’re kind of like a consumer household that has too much credit card debt,” he said.
—Nina Trentmann contributed to this article
Write to Kristin Broughton at [email protected]
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