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Interest rates are on the up - here's the penny shares that are in trouble, and the ones that'll thrive…

by , 18 March 2016

Interest rates are up 100 basis points since May 2015. Since the start of May 2015 the JSE has dropped from its all-time highs around 54,640 points to its current 49,852 points.

Clearly investors are spooked - the markets are showing it.

But instead of reacting to interest rate increases like a mindless Zombie you should rather look at what they mean for investments…

And today I'd like to show you two shares I believe will suffer under higher interest rates and another two that'll thrive!

Two shares that could end up neck deep in trouble if interest rates continue rising…

Interest rate risk #1 – Ellies

Ellies took on a lot of debt to accelerate its growth. It was too aggressive and got into trouble. The company did a rights issue recently and raised cash to pay off some of its debt but it’s not out of the woods yet:
  • Ellies Electronics sit with R200 million in debt (overdraft facility)
     
  • Ellies Properties sit with R53 million debt and,
     
  • Megatron sits with R95 million in debt…
That’s R348 million in debt with the bulk being in an overdraft facility at the prime interest rate.

Now do the math yourself… A 1% increase in interest rate equals an additional R3.48 million interest per year. So a 3% increase in interest rates, which is possible in the next two years could mean at least R10 million less profit for Ellies.

Considering the company reported a R9 million loss in January it’s clear that higher interest rates could materially affect it going forward…

Interest rate risk #2 – Eqstra

Eqstra’s a large industrial equipment company. It sells and rents equipment and services it. It also does fleet management.

The company’s reasonably profitable and at a PE below 3 the company looks cheap.

But Eqstra has a lot of debt on its books… The company reported R7.519 billion in interest bearing debt in its results in September 2015.
 
That means at 1% extra interest it could end up paying as much as R75 million extra interest a year.  The company does fix debt in order to limit interest rate risk. But S&P Ratings agency recently downgraded its debt. So that means the future cost of debt will be increased.
 
Considering the company recorded a profit of R243 million when it recorded results in September 2015 I’d be slightly worried about the effect an additional R75 million or more in interest payments could have on its books this year…
 
High Interest beater #1 – Merafe
 
One year ago Merafe owed R189 million in short term debt and another R617 million in longer term debt with Standard Bank and Absa. Its sum total of all cash minus all debt was equal to –R1,251 million.
 
It’s paid off a lot of this in the past year using profits from its operations. Now its cash balances minus all debt is equal to –R660 million. It’s paid off the entire short term debt facility it had in place. It’s also reduced the Absa+Standard Bank debt facility to R559 million.
 
In short this means a lot less interest expenses. Let’s say the company reduced debt by R281 million. And it paid 10% on all of this debt. That translates to a R28.1 million reduction in interest payments for the coming year.
 
Considering the company grew profits in the past six months on the back of its Lion II plant reaching full production as well as the weak rand boosting profits I am excited about where this company is going in the midst of increasing interest rates…

High Interest beater #2 – Torre Industries

Torre Industries is a re-incarnation of SA French. A couple of years ago the company was in trouble because of too high debt levels.

When the company reported results in June 2015 it reduced interest bearing debt from R164 million to R56 million. It had reduced its debt:equity ratio from 73% to 9%!

Interim results will be out in March this year. The company will probably hit 16cps-18cps and full year earnings could hit 38cps, putting the company on a low forward PE of 8.95!

It’s important you analyse companies you invest in properly to see whether they are capable of mitigating interest rate risk properly or not.

On 27 February 2016 I’m hosting the Red Hot Penny Shares Bootcamp – and I’ll show you two simple ratios that I’ve effectively used in the past to predict how companies can handle interest rate changes. I’ve used these ratios to predict the fall of Lonmin and the fall of Highveld Steel. Make sure you’re there!
 
Here's to unleashing real wealth,


Francois Joubert
Investment Director, FSPInvest


Interest rates are on the up - here's the penny shares that are in trouble, and the ones that'll thrive…
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