SWINGING BY AN ‘INTEREST’ CHAIN

Rate sensitive stocks are those stocks whose financial performances have a direct bearing on account of changes in interest rates. There are various sectors which are impacted on account of interest rate changes like banks and NBFCs, automobiles, real estate, capital goods, infrastructure, and construction. Previously, the RBI for a long time has been on a war footing to tame inflation which was raising its head high and for this there had been 13 successive rate increases since March 2010. The previous RBI governor towards the end of his tenure had cut interest rates to boost economic growth but this resulted in inflation moving out of control. Hence, hence the new RBI governor again took a bold step and adopted a hawkish stance by increasing the interest rate before actually cutting it down by 25 bps in a surprise move in January 2015.

The successive rate increase has hurt many companies with regards to their financial performance as the revenue growth visibility slowed on one hand (automobiles, consumer durables and real estate) and higher interest expense impacted the profitability while on the other hand (construction, infrastructure and real estate) resulting in an adverse impact on the respective stocks’ performance on the stock exchange.

India is currently in a sweet spot as lots of factors are in its favour. Lower commodity prices (crude in the range of USD 45-55/barrel) and stable currency (Rs 60-62/USD) along with signs of revival in economic growth (GDP 5-5.5 per cent), lower fiscal deficit (less than 4 per cent) and contained inflation (CPI in the range of 4.5 – 5.0 per cent) have created room and space for a reversal in the rate cycle, which has been prolonged for one reason or the other as stated earlier. The RBI has provided an indication of a reversal in rate cycle by cutting interest rate by 25 bps in a surprise move in January 2015 after a long gap (last one being in May 2013) as its hands were tied to keep inflation within a comfortable zone for a sustained period of time.

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The market is convinced that the RBI with this move has sent a signal that it has been successful in taming inflation and is confident that the government is taking the right steps to keep fiscal deficit under check on a sustainable basis.

During its regular policy meet in February 2015, the RBI kept the interest rate unchanged but increased liquidity into the system by cutting SLR. It is expected that the RBI would consider further rate cut action after reviewing the Economy Survey Report, Railway Budget and Union Budget, all to be out in the current month. Also, the RBI will be monitoring government guidance to contain fiscal deficit and their actions, which is expected to boost economic growth activity. The rate cut is mostly considered as a positive sentiment for the markets as it helps to boost confidence and pushes economic growth to a higher trajectory based on higher credit off-take as a result of reduction in interest rates.

Usually the end-user waits for a reduction in interest rate so as to take a final decision with regards to big and medium (home, vehicle, consumer durables) ticket purchases (for individuals) and capex (for corporates). This sets the ball rolling as the increased demand in various sectors starts progressing, thereby giving a push and accelerating credit growth for banks, both on the personal as well as on the corporate front.

There are a lot of companies in different sectors which are highly sensitive to interest rates, as mentioned earlier. These companies can be classified into three categories. The first set is of companies in the banking and NBFC space, the second set is of those which have robust revenue visibility and high earnings’ potential with low debt such as companies in the automobile and consumer durable space, and the third set comprises companies with high revenue visibility and improved margin profile with higher debt as in real estate, infrastructure and construction space.

Interest Rate

We have tried to showcase below the key rate-sensitive sectors and their indices’ performance along with key companies’ financial performance for the last five years in each sector respectively with key indicators to justify our stand.

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Banks & NBFCs

The growth of the banking and NBFCs sector is dependent on both corporates and retail and hence in an economy where the growth rate is expected to accelerate, banking stocks are considered to be the safest bet as their performance improves sharply. Banks and NBFCs are considered to be the biggest beneficiaries of any reversal in the interest rate cycle. This is because of the fact that when the interest rates are on a downward trend, it is expected that the economic growth rate will accelerate, thus resulting in increased credit growth both on the corporate front (on account of revival in capex cycle along with higher working capital demand) and retail front (improved consumer sentiment resulting in higher consumer spending).

This leads to robust growth in NII as a result of increase in credit off-take and lower passing on of interest rate cut to customers and reduction in NPAs. Hence this leads to a robust financial performance by the banks on account of higher earnings as well as improved asset quality.

Automobiles

Though the growth of automobile companies is dependent on new product launches and the success rate of its existing product base, reversal in interest rate changes plays a key role in the performance of automobile companies. It changes the mindset of the buyers who had been deferring their big ticket purchases as a result of higher EMIs. With reduction in interest rates it is expected that the demand for commercial vehicles and four-wheelers will rise substantially, thus resulting in better growth visibility in the topline. Also, the discount and freebies offered during the dull period to revive or boost sales no more exists, which helps in margin expansion to an extent.

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Real Estate

The growth of the real estate sector is dependent on new project launches and the ticket size in which the projects are being launched in different cities. Here interest rates do play an important factor in the growth of the real estate industry, which has been one of the worst hit sectors on account of high interest rate regime since liquidity remains a concern, both for the corporates on project funding (land acquisition cost and working capital) and for retail participants on the home loan front. For corporates, a substantial part of the project cost gets locked in the form of land acquisition which is required upfront and higher interest rate further increases the total cost of a project as it generally takes more than three years to complete a project.

Hence during a high interest rate regime new project launches are lower and freebies are given to boost bookings as the real estate market sentiments’ remain low. For individuals, higher interest rate means higher monthly outgo in the form of EMIs in case of new purchases or increase in loan repayment tenure in case of existing home loans; hence people generally defer their plans to buy a house in anticipation of a reversal in the interest rate cycle. With signs of reversal in the interest rate cycle the real estate sector is hopeful of a revival as the economy is also expected to improve and that will bring the buyers back into the market.

Capital Goods

The last few years have been dull for the capital goods sectors as there were no new major projects announced by the corporates to boost the order book for companies in this space. The key reasons which could be attributed to such a performance by the sector include a high inflation regime resulting in high interest rates coupled with the government’s policy paralysis due to various scams, resulting in an overall slowdown in Indian economy. However, things have changed since the start of 2014 as the sentiment has improved quite significantly and things are falling in place after the formation of the new government. The ‘Make in India’ concept by the central government to boost manufacturing activity is also expected to rejuvenate the order book position of the companies in the capital goods sector.

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Infrastructure & Construction

The growth of the infrastructure and construction sector is related to the spending made by both the public (government) and the private (corporates) sector. The spending by both have been on a downward trend on account of slowdown in economy during the last few years, which has impacted the performance of this sector in addition to the real estate and capital goods’ sectors. That’s because infrastructure and construction is linked to capital goods and real estate to an extent. Interest rate also plays a key role in the performance of this sector as there are long-tenure projects and the viability of any such project comes under threat if the interest rate moves upwards sharply from its starting phase. The current scenario seems to have improved for the sectors with the new government taking measures to revive the economy. Also, the corporates seem to be confident that the new government is taking the right steps, which will bring traction in these sectors.