Five stocks that gain from rate cuts

The wait for lower interest rates has finally ended and the rate cut cycle appears to have been kick-started. Drawing comfort from the falling consumer price inflation, the RBI has cut rates twice in the last three months reaffirming the downward trajectory in lending rates. With this, it appears to have set the ball rolling for a lower interest rate regime.

So, what does a lower borrowing rate mean to India Inc? Who will benefit from the gradual reduction in interest rates?

Companies sitting on a huge pile of debt and struggling to meet their interest payment obligation are the obvious beneficiaries. Companies with precariously low interest cover ratio (profit before interest and tax as a proportion of interest outgo) will be the first to see an improvement in their earnings as the rate cycle starts sloping downwards.

Here are five companies with sound fundamentals that can rake in higher profits with a fall in interest rates.

Economic recovery to spur sales South-based cement maker India Cements’ profit is expected to get a boost from lower lending rates.

Here’s why. Even as India Cements managed to achieve a modest growth in sales, its profitability took a beating in the last five years – thanks to the economic downturn and aggressive capex plans to augment cement capacity and acquire bulk carriers for its shipping division.

India Cements posted a loss of almost ₹117 crore at the consolidated level in 2013-14, compared with a profit of about ₹352 crore in 2009-10.

Even as the company’s debt to equity ratio, which measures the total borrowings as a proportion of its shareholders’ funds, remained comfortable at less than one time as of March 2014, there was barely any profit available to make interest payment to lenders.

India Cements’ interest cover ratio slipped from over three times in 2009-10 to 0.7 times in 2013-14 — implying that the company’s operating profits could cover only 70 per cent of the interest that was due to lenders. While weak operating performance also played a role, a ballooning interest burden that has more than doubled — from ₹143 crore in 2009-10 to almost ₹354 crore by 2013-14 — was the principal reason for the weak coverage ratio.

But now, the demand for cement is expected to pick up, given the Government’s focus on increasing investment in infrastructure. This, alongside a steady fall in interest rates, should aid India Cements’ profitability in the near term.

De-leveraging to aid growth Likewise, South-based commercial vehicle manufacturer Ashok Leyland is well poised to benefit from the downtrend in the rate cycle. The company’s interest cover ratio, which slipped from a comfortable five times in 2010 into negative territory at -0.01 in 2014, due to a two-fold rise in the interest outgo, is expected to improve with a moderation in the lending rates.

Ashok Leyland’s total loan has almost doubled in the last five years on two counts. First, the company borrowed more to fund its capacity expansion projects such as its greenfield plant at Pant Nagar, which was commissioned in 2010. Second, increased working capital requirement due to a slump in the economy led to an increase in the company’s borrowings.

Even as the company’s operating profit remained steady during the 2011-13 period, the sharp jump in interest outgo — which has more than doubled in the last five years — dragged Ashok Leyland’s interest coverage ratio. The company did not have any profit in 2013-14, to meet its interest obligation.

But now, with the economy gradually returning to the growth path, the demand for commercial vehicles has also improved in the past year.

For instance, sales of Ashok Leyland’s medium and heavy commercial vehicles have grown by 29 per cent during the April-February 2015 period compared with the same period last year.

Further, the company sold some of its non-core assets — physical assets such as land and investment in other ventures — to pare debt on its books. For instance, the company sold its Chennai property for ₹210 crore to tyre maker MRF. Likewise, it liquidated its holding in Hinduja Tech to Nissan International Holdings, the investment arm of the Japanese carmaker, in 2014, for an undisclosed amount. The company also plans to monetise its investment in group companies Albonair GmbH, Albonair India and Avia Ashok Leyland Motors in the near future, to reduce debt.

Improvement in the demand for commercial vehicles, fall in interest rates, coupled with the company’s efforts to prune debt should help Ashok Leyland return to profit.

Benefit from infra thrust Civil engineering and construction company Sadbhav Engineering will not only benefit from the government’s thrust on improving infrastructure but also from a moderation in the interest rate, given its appallingly low interest coverage ratio. The company’s aggressive project wins not only led to a sharp increase in assets but also its borrowings to fund these projects.

Sadbhav’s total debt more than tripled from ₹1,455 crore in 2010 to ₹5,714 crore by 2013-14.

As a result, Sadbhav’s interest outgo almost trebled from ₹141 crore in 2009-10 to ₹459 crore, leading to a sharp fall in the interest cover. From over 1.3 times in 2009-10, the interest cover ratio has almost halved to less than 0.8 times.

However, the diversified nature of the company’s business — it has presence across key segments such as roads and mining — should help sustain growth in the medium term. Sadbhav’s healthy order book and good execution capabilities can give it an edge over competitors.

The company is consolidating its project portfolio by buying out its partner’s stake in projects that have been stalled due to its partner’s inability to infuse funds. These should provide a leg-up to the company’s revenues and profitability in the near term. In addition to improving fundamentals, lower interest outgo in the light of a moderation in bank lending rates should boost the company’s bottom line.

Investments to pay off Having started off as a cycle maker, Tube Investments, over the years, has gradually expanded into the engineering and value-added steel components space.

The company has invested aggressively over the last five years to scale up presence in new product segments, such as large diameter tubes, to meet growing demand from the auto and infrastructure sectors. Tube Investments has added assets worth about ₹1,500 crore in the last five years through greenfield and brownfield expansions. This has led to a multi-fold increase in borrowings.

From about ₹2,450 crore in 2009-10, Tube Investment’s total debt has swelled by over nine times to about ₹19,460 crore in 2013-14. Of this, the company’s secured borrowings, which was predominantly used to fund its capex, witnessed a five-fold rise. The steep jump in borrowings was primarily due to higher working capital borrowings by the company, following a slowdown in the economy during 2011-13.

The sharp rise in borrowings led to a whopping increase in the company’s gearing (debt/equity ratio) from about 2.8 times in 2009-10 to seven times by 2013-14. Despite a strong operating performance, the full benefit did not flow to the bottom line. And this was largely on account of a massive jump in the interest outgo. While the company’s operating profit rose eight-fold during the five-year period, its interest expenses saw a faster 10-fold increase in the last five years to ₹1,897 crore. Tube Investments pays out almost two-thirds of its profit as interest costs and charges, hence, progressive cuts in lending rates by the RBI can benefit the company.

Profit from lower interest Similarly, investors in the country’s leading power distributor Tata Power may have some reason to cheer, should the lending rates continue to head down. Reason: The company is sitting on a huge pile of debt — its total debt as a proportion of its total equity shareholder funds has swelled from 1.5 times five years back to over three times now. In addition to this, Tata Power’s operating profits are just about enough to make interest payment to its lenders. Its interest coverage ratio has fallen from about four times to a little over one time, over the last five years. Given that the sharp rise in interest expenses has eaten into the company’s profits, a moderation in interest rates should augur well for the company.

Sector trends In addition to these, there are a host of other companies across sectors with leveraged balance sheets and low interest cover ratios that can benefit from the downward movement in interest rates. Of the 418 companies (excluding financials) that constitute the BSE 500 Index, 181 companies had an interest cover ratio of less than four times as of March 2014. The aggregate interest cover for these companies stood at 3.7 times.

Are there any sectoral trends? Well, rate-sensitive sectors such as banking and financials, realty and auto are set to benefit the most from a falling interest rate regime.

Consider banks and financial companies, for instance. Lower interest rate, coupled with improvement in the macro fundamentals, can encourage India Inc to reconsider its capex plans, which were stalled for the last two-three years.

So also, individuals who were waiting on the sidelines to take a loan for big-ticket purchases such as home, luxury car, etc, may seize the opportunity and borrow now.

This should spur credit growth for banks and financial companies.

Similarly, a cut in interest rate will provide banks and other deposit-taking, non-banking financial companies with access to low-cost funds as deposit rates will also be revised downwards.

Hence, lower interest rates should boost the profitability of companies in the financials space. For realty companies, cheaper loans could translate into better demand for homes, which can boost sales and profits. Likewise, lower borrowing rate can encourage customers to make discretionary purchases, such as two-wheelers and cars.

Apart from the rate-sensitive themes, companies in the engineering and infrastructure projects space that had borrowed to fund projects may get some respite from falling interest rates.

For instance, the interest cover ratio of companies such as IVRCL, Lanco Infratech and Punj Lloyd, which were bogged down with high-cost borrowings, can improve from the current less than 0.5 times, if banks lower their lending rates.

Similarly, sugar companies, which are struggling to make their interest payments, can expect some relief from rate cuts.

Even as structural problems such as irrational sugarcane pricing mechanism, global sugar supply glut and downturn in the domestic sugar market stay put, lower interest outgo can help sugar makers narrow their losses. For instance, the interest coverage ratio for companies such as Bajaj Hindusthan and Shree Renuka, which is currently negative, can improve with a drop in interest expenses.

Also read: Those that lose from rate cuts

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