Buy Hold Sell: 5 stocks that surprisingly benefit from rising rates

Buy Hold Sell

Livewire Markets

It's clear that rising rates haven't been great for local and global share markets. High P/E names, those that have led the world's major bourses over the past few years, have run and tripped off a cliff, and look to be heading for an awkward and uncomfortable belly flop in the dark waters below. 

Either way, the next few months are likely to be painful for investors. But they don't have to be. In fact, there are some stocks, other than banks and commodities companies, that can surprisingly benefit from the rising rate cycle. 

So in this episode, Livewire's Ally Selby was joined by Tribeca Investment Management's Jun Bei Liu and TMS Capital's Ben Clark for a look at three stocks that profit from rising rates and inflation. 

Plus, they also both name one company with surprising upside ahead as the RBA continues on its aggressive rate hike cycle. 

 Note: This episode of Buy Hold Sell was shot on Wednesday 11th May 2022. You can watch the video, read an edited transcript or listen to the podcast below.

Edited Transcript 

Ally Selby: Hey, how are you doing? And welcome to Livewire's Buy Hold Sell. I'm Ally Selby, and with the RBA raising the cash rate to 0.35% and more hikes expected over the coming years, we thought we'd take a look at some of the non-bank stocks that benefit from a rising cash rate cycle. To do that, we're joined by Ben Clark from TMS Capital and Jun Bei Liu from Tribeca. 

First off the ranks today, we have Coles. I'm sure you've been noticing that your groceries have been costing more at the checkout. I sure have. Jun Bei, I might start on you. Is it a buy, hold, or sell?

Coles (ASX: COL) 

Jun Bei Liu (HOLD): Coles is a hold for me, even though at the moment the operating environment is great for these guys. People still stay at home somewhat, and they still continue to shop at grocery stores. And then with high inflation, these supermarkets, Coles and Woolworths, have very strong pricing power. They push through prices, what you pay in your basket size, and then they get a bigger cut, so the profit margin grows as a result of that.

At the same time, there were a lot of costs that were put into the business during the pandemic, and these costs will continue to unwind. And the same goes for Woolworths. So for this environment, earnings are doing great. Now, the only thing that's holding me back to put it as a buy, is it's very expensive relative to the market right now. It's cheaper than Woolworths, so we probably prefer this one to Woolworths, but it's still trading on a mid-20s multiple for the growth it's going to deliver.

Ally Selby: Its share price has risen around 4% since the beginning of the year. Ben, over to you. Is it a buy, hold, or sell?

Ben Clark (HOLD): I'm going a hold as well for very similar reasons. The supermarkets have wanted some inflation for years now. It feels like they keep talking about it in every result, and there was never any. Suddenly, there's plenty. I guess one of the big things for them will be trying to make sure that they can contain the cost side of their business with their suppliers and get that widening margin, but I don't think they'll have too much problem doing that. I agree with Jun Bei. You're probably going to see normalisation in volumes over the next 12 months. But at 25 times, it feels like the part of the market that everyone retreated to while they've waited for the carnage that's happened in other areas to play out, so it's maybe a crowded area to be in now.

Medibank Private (ASX: MPL) 

Ally Selby: Okay. Next up, we have private health insurance provider Medibank. Ben, why does this stock benefit from rising rates and is it a buy, hold, or sell?

Ben Clark (HOLD): It can benefit from rising rates, as potentially, it can put up policy prices faster than the cost side of the business. But it also has a pretty big investment portfolio. And if it can get a higher return on the bonds and fixed interest that it owns there, where it parks money while it waits to pay out premiums, then it keeps that money effectively afloat. 

I'm going a hold on this one as well. And the reason for that is during COVID, these guys had an unexpectedly good time, because none of their policyholders could make claims in many cases because they couldn't actually get into hospitals to get an operation that they might have needed. I think you want to keep an eye on the normalisation of the claims environment. We've seen Bupa has just announced a major stoush with Ramsay (ASX: RHC), so I think the private hospitals are going to want to make sure that they get some cost inflation as well. How that arm wrestle plays out will be interesting to watch.

Ally Selby: Its share price has fallen around 7% since the beginning of the year. Jun Bei, is it a buy, hold, or sell?

Jun Bei Liu (SELL): Medibank to me is a sell. It's been a big beneficiary of no one claiming or going to the private hospitals, and now we will start seeing a reverse of that. It's still not happening because volumes are still reasonably weak at private hospitals, but we will eventually see that come through. At the same time, private health insurance member numbers were on the decline for many years before the pandemic hit. When the pandemic first hit, we saw more people become more health conscious, so a lot of people were actually signing up for it. So they actually saw top line growth, while costs stayed low, so they had this enormous margin. Now, of course, a lot of that has gone back into pricing, but when that reverses, it is going to be pretty tough.

Atlas Arteria (ASX: ALX)

Ally Selby: Okay. Our third stock for today is Atlas Arteria. Jun Bei, why can this stock benefit from rising rates and is it a buy, hold, or sell?

Jun Bei Liu (HOLD): This is more of a hold. It benefits and it also is hurt by rising interest rates. So let's explore the benefit first. In its contract, its toll prices are actually linked to inflation, so as inflation goes up, its revenue goes up. That's one side. So in terms of revenue, it's linked directly to higher inflation numbers. 

Now, the challenge is, like any infrastructure asset, they borrow a lot of debt and then that debt is used to fund those assets. Now, those debts are very sensitive to rising interest rates. Of course, they hedged these out a little bit. But as rates go higher, when they need to roll their debt, it actually hurts their margin. 

So net-net, I would say this company is more neutral in terms of whether it's a beneficiary or not. But I would put this company as a hold, just because it's experiencing that reopening of toll roads in regions where lockdowns have been very prolonged.

Ally Selby: It's been a pretty volatile ride for Atlas Arteria shareholders in 2022, but now, its share price is down around 2%. Ben, is it a buy, hold, or sell?

Ben Clark (BUY): I'm going to go a buy on this one, Ally. We own it. If you look at the passenger numbers, they're now back to where they were in 2019, so we've seen a full resumption of volumes. As Jun Bei was saying, inflation in France is almost double what it is in Australia at the moment, so those tolls are going to go up at quite a decent clip. We should get the resumption of tourism this summer. The main toll road they own connects Paris to Leon, so it's a very frequently travelled road by tourists.

I think infrastructure CFOs, not just of Atlas Arteria, but of a number of infrastructure companies, have done a great job of using the low rate environment to lock in some of those borrowing costs, so it's going to be a while until they start to move higher. The only question I've got on it is that the duration of the concession in France is starting to look a little bit skinny. They need to try and push that out. I think that might be causing a bit of investor hesitancy, but it's on a yield of nearly 7%. So it looks pretty attractive.

Ally Selby: How many years are left?

Ben Clark: I think it's about 13.

Ally Selby: Well, we asked our guests to bring along one stock that surprisingly benefits from rising rates today. Ben, what have you brought for us?

Challenger (ASX: CGF) 

Ben Clark (BUY): I'm going to go with Challenger, which has been a really malign stock. To be honest, it's been one I've got wrong in the past. But this company was blown apart, particularly by the Royal Commission. It's effectively Salesforce with financial planners pushing their products, particularly bank-employed financial planners, but it was also impacted by the move in cash rates to zero. Annuities don't sound particularly attractive when you're locking in a 1% rate for the rest of your life.

I think during this period, the management team's done a great job at pivoting away from retail, and it's much more closely aligned to institutional solutions for annuities, particularly things like inflation linked to annuities and more boutique solutions to problems in big LICs. It feels like there's earnings momentum coming back to this business. And I think the retail side will start to pick up once you can start to lock in much more attractive yields. For the first time in what feels like years, we've also seen the financial advice industry start to calm down. People aren't moving around as much, so potentially, that could work for them as well.

Ally Selby: Okay. Over to you, Jun Bei. Your time in the hot seat. What stock surprisingly benefits from rising rates?

Computershare (ASX: CPU)

Jun Bei Liu (BUY): In my mind, there is a group of them, but I would say Computershare. That's the number one beneficiary of higher interest rates. Actually, surprisingly, a lot of people say, "Well, it's a registry business. How would they benefit?" Well, they hold a lot of cash, so their earnings are actually extremely sensitive to high rates. With every 50 basis point increase, their earnings will lift by double digits. Now, over the last few years, during the pandemic when rates were going down, the company put some hedges in place. So it's going to take some time to play through, but earnings are going to be significantly upgraded. Even at the current spot or consensus expectations for the bond yield, this company's earnings could be upgraded somewhere between 30% to 40%.

Ally Selby: Okay. Well, that's all we have time for today. What a great way to end that episode. If you enjoyed that, give it a like. And remember to subscribe to our YouTube channel. We're adding so much great content every single week.

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