Block: Analysis Under Current Economic Conditions (NYSE:SQ)

Block, Inc. (NYSE:SQ) has of course taken a big hit in light of the policies of the Federal Reserve and the impact of higher interest rates on what is considered a high-growth tech company.

With the Fed expected to continue to raise rates going forward, it’s highly probable the share price of SQ will come under more pressure, the level of which will depend upon how high and how quickly the Fed boosts interest rates in the months ahead.

The big question at this time is whether or not the market has already priced in the upcoming increase in interest rates, or it’s waiting to see if the Fed does implement an increase of 25 basis points, and what the commentary is at that time in regard to future increases.

I’ve been on record for some time saying the Fed will probably not exceed an interest rate level of 5.25 percent. While I still think that’s a possibility, if inflation remains high and the U.S. economy remains hot, the result could mean rates could rise to 5.50 percent, and possibly as high as 5.75 percent.

That said, that is going be a tough level to maintain because of the consequences it would have on the U.S. government and its $31-trillion-plus debt load.

As it relates to SQ, it’s not really good news no matter what the Fed does. Higher interest rates usually hit tech stocks like SQ harder, and that, combined with the inevitable slowdown of the U.S. economy will probably hit the stock fairly hard.

In this article we’ll look at some of its recent numbers, but mostly at how the share price of Block is likely to respond to near-term headwinds, and how investors should consider the implications in regard to entry points or adding to positions.

Some of the numbers

Total net revenue in the fourth quarter of 2022 was $4.65 billion, up 14 percent year-over-year. Full year net revenue for 2022 was $17.53 billion, down one percent year-over-year.

Gross profit in the reporting period was $1.66 billion, compared to gross profit of 1.18 billion in the fourth quarter of 2021, a gain of 40 percent. Gross profit for full year 2022 was $5.99 billion, up 36 percent from last year in the same quarter.

The company had an operating loss of -$(135.00) million in the fourth quarter of 2022, and an operating loss of -$(625.00) million for full year 2022.

In the fourth quarter of 2022, Block had a net loss of -$(114.00) million, or -$(0.19) per diluted share. For full year 2022, SQ had a net loss of -$(541.00) million, or -$(0.93) per diluted share.

Operating expenses in the quarter were $1.80 billion, up 45 percent year-over-year.

At the end of calendar 2022 the company held cash and cash equivalents of $6.9 billion, with $7.5 billion in overall liquidity.

My main focus for the purpose of this article is on the losses of the company, increased spend, the higher cost of capital, and how that will have an impact on the performance of the company in the near term, and why it’s important to take into consideration if considering taking a position in SQ.

Share price considerations

I want to look at the share price of Block over the last several years to get a look at where the bottoms have been during that time, and how that aligns with what the recent bottoms have been, and what that could mean for a possible entry point.

Over the last five years the share price of SQ fell to a brief low of approximately $31.50 per share on March 16, 2020, and moved up from there to about $37.00 per share for a couple of weeks, beginning a prolonged run from that time on to its 5-year high of around $289.00 per share on August 2, 2021, afterwards descending to a 52-week low of $51.34 on October 10, 2022.

Excluding the very short 5-year low, since May 7, 2018, the company has had a triple low of approximately $50.00 per share, and a triple top of about $91.00 per share. Since June 13, 2022, the stock has traded in a range of about $51.00 per share to approximately $90.00 per share.

Currently it’s trading almost in the middle of those numbers at $71.00 per share. If you went back to July 16, 2018, the share price of SQ would have been higher than it is trading today.

Why it matters

The reason for going through the history of Block’s share price is to show, first of all, that it has traded as much on the low side as it has on the high side, and when considering taking a position in the company in light of the fact the Federal Reserve is going to continue to raise interest rates, there is a much higher probability the stock is going to trade lower in conjunction with the increase in interest rates, at least for much if not all of 2023. The level of that will be determined by how inflation responds to the boost in interest rates.

At this time the question that has yet to be answered is how high the Fed will raise rates before pivoting. I think it’s going to raise rates, probably pause to wait to see the results, and respond accordingly.

If my thesis is correct, it would mean a prolonged period of uncertainty during 2023, with the result being investors holding back on taking positions in high-tech companies like SQ. Under that scenario, the stock would probably either trade level or down; I don’t see any catalysts that could possibly overcome the Fed factor – at least in the near term.

In thinking terms of a bottom, assuming the Fed stays below the 6 percent mark in interest rate levels, around $45.00 to $50.00 would be what I would look for on the low side.

For those that like the company but want to get in because of FOMO, the best way to play it would be to use dollar-cost averaging. Where the share price stands today isn’t bad, and taking a position here and averaging down if the stock goes down, would still result in an attractive cost basis for those in Block for the long term.

The other thing to consider would be to position size with discipline. I think for those in the stock for the long term, there is plenty of upside left in the share price. The big mistake is to take too big of a position based upon investment capital available.

Conclusion

In the sector SQ competes in it takes a lot of invested capital to ensure being competitive with its peers, and with the cost of capital climbing and the company being unprofitable, the outlook in the near term isn’t that good.

For that reason, I see the share price coming under further pressure in the months ahead, based upon the actions of the Federal Reserve, cost of capital, and the need to continue spending in order not to fall behind its competitors.

Under that scenario it means losses will continue for now, and investors and shareholders will have to remain patient in either waiting for a good entry point to take a new position in the firm, or in adding to a position.

I believe it’s going to take some time to climb out of the hole the company is in, and those taking a position will have to wait until the Fed signals it’s going to pivot, while waiting for interest rates to reverse direction and inflation to recede before starting to be rewarded with some profits from the company.