Looming end to low interest rate era: Which tech stocks are at risk?

Looming interest rate hikes is already causing a divergence in ASX sector performance in 2022.

Across the 11 S&P/ASX 200 sectors: 

• Materials: 4.8%

• Energy: 4.6% 

• Utilities: 4.2%

• Financials: -1.2%

• Communication services: -2.55%

• Industrials: -3.8%

• Consumer discretionary: -5.4% 

• Real estate: -5.9%

• Consumer staples: -6.9%

• Healthcare: -7.4%

• Information Technology: -12.4%

The ASX 200 is down -2.6% year-to-date. 

Tech and healthcare immediately stand out with relatively high price-to-earnings (P/E) ratios, averaging 51 and 36 according to Morningstar data. 

This is a way off from the winning end of town, where P/E ratios sit at 29 and 11.5 for materials and energy, respectively. 

The prospect of higher interest rates greatly shifts the opportunity cost for investors betting on fast growing, and at times, loss making companies that may only turn a profit in the distant future. 

When interest rates are near zero, investors are both happy to pay a premium for potential future profits and hold out the near-term loss making period. 

As interest rates, or risk-free returns begin to rise, those risky bets begin to look far less appealing.

Stocks are at risk

Buy now, pay later (BNPL) stocks have benefited immensely from cheap cash.

As interest rates begin to increase, so will the funding costs for BNPLs. Unless these costs can be passed onto merchants, this could put pressure on BNPL margins. 

According to Macquarie (March 2021), a 10% increase in financing costs is most sensitive to Openpay (ASX: OPY), given its “combination of high cost of borrow and relatively low receivables turnover”. 

Humm (ASX: HUM) and Zip (ASX: Z1P) fared slightly better, but both BNPLs offer services to big ticket items with flexible payment options. 

Afterpay (ASX: APT) remains least sensitive, given its stock standard ‘pay in four’ business model.

Materials, energy, utilities and financials are typically characterised as businesses that generate strong cash flows. But what about the businesses that don't?

As interest rates rise, capital-intensive and loss making businesses might find it difficult to raise funds. After all, why invest in a risky, loss making company when risk-free returns are on the rise? 

Bookmaker PointsBet (ASX: PBH) fits into this loss making, high growth narrative. 

In FY21, PointsBet delivered 159% revenue growth to $194.7m, with an equally impressive 314% increase in losses to $164.3m. 

To fund its growth story, the company has raised capital on three separate occasions since October 2019 for $122.1m, $303m and $400m. 

PointsBet shares are down -14.8% year-to-date and -54% in the past 12 months.

Near-term considerations

Reporting season is right around the corner, and what better way for a beaten up tech stock to prove the market wrong by exceeding expectations.

During August reporting season, WiseTech Global (ASX: WTC) rose up to the occasion, driving a one-day gain of 28% on 25 August 2021.

Altium (ASX: ALU) on the other hand, hit another speed bump, with its shares tumbling -14% on 30 August 2021.

Here is a list of things investors should look out for ahead of the upcoming February reporting season.