Ever wonder why does the stock market place an importance on any interest rate adjustment? Today’s write-up will deal with the effects of interest rate on the stock market.
What is interest rate
When a lender lends money to a borrower, the lender expects some form of payment, from the borrower. That form of payment is interest. The rate of interest is therefore the cost of borrowing money.
When interest rate is high, the cost of borrowing would increase, and vice versa.
Importance of interest rate
Interest rate affects every facet of our lives, to the extent that, monetary policymakers and central banks often adjusts interest rate to steer the growth of an economy.
When economic growth is lacklustre, interest rate could be lowered to spur growth. A low interest rate climate encourages consumers, investors and businesses to borrow. The spur of cheap credit would encourage consumers, investors and businesses, big and small, to increase spending on purchases. These purchases may encompass various assets including, real property, commodities and stocks. This inevitably means consumers, investors and businesses will take up more debt, sometimes more than they can afford (unfortunately). For example, consumers would be more inclined to purchase big ticket items, like houses and cars, when interest on the loans are low. This scenario is a normality in Japan where housing loans can be lower than 1% per annum.
On the other hand, higher interest rate would increase the cost of borrowing for consumers, investors and businesses, and would tend to deter people from borrowing and thus spending, because they would not be able to afford a higher cost of borrowing. As a result, economic growth moderates. More often than not, interest rate is increased to prevent an economy from overheating, or to decrease inflation.
So how does interest rate indirectly affect the stock market? To answer that, you must draw a relationship between interest rate and spending.
When interest rate increases, consumers and investors would have less money to spend than before. As a result, consumers and investors, already saddled with debt, would have to set aside more money towards the repayment of their loans. That leaves borrowers with less disposable income to spend on their needs and wants. Therefore, consumers and investors would buy less goods and services and the companies, which provide goods and services, make less money. When profits shrinks, the price of a listed company’s stocks would inevitably dip, and that causes a drag on the stock market.
In comparison, the stock market tends to perform better in low interest rate environment.
Companies which are already borrowing money from financial institutions would also have to bear the brunt from an increased cost of borrowing as a result of an interest rate hike. Companies would have to pay more to service their debts, leaving less money, as profits.
When interest rate is hiked, investors, who invest in the stock market on credit (margin), would soon find themselves having to close their positions, as any potential profits are offset by higher cost of borrowing. Hence, the stock market is subjected to selling pressures which would usher a slump in the market.
Any adjustment in interest rates, especially by the Feds, may have an impact on your equity portfolio. Being able to discern how the market would react to interest rate adjustments may give you an advantage, to either enter or exit the market. However, if you are investing in the long run, pay very little heed to any adjustments of interest rate.
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Oceancash Pacific Berhad (“Oceancash“) is a manufacturer of two product lines, being:
Oceancash has over 20 years of manufacturing experience and expertise, and is currently listed on the ACE market. It is, however, seeking a transfer to the Main Market in the next quarter of 2018 as it has met the requirements for a transfer. Such transfer will require the approval of shareholders. From the reading of its Q4 FY2017 report, the company had already incurred listing transfer expenses. Hence, it appears that the transfer is in motion.
Felts are textile materials which are made by interlocking the fibres through the process of compression, heating or chemical bonding (using resins) which causes the fibres to mat together, thus creating a textile. Felts can be made out of natural fibres such as cotton and other synthetic fibres.
The felts produced by Oceancash have many uses especially for:
heat insulation and sound insulation in automobiles;
noise insulation for compressors of split unit air conditioners;
roof insulation; and
Oceancash manufactures and supplies about 60% of felts into the local market, thus making it the biggest supplier of felts in Malaysia. Felts produced are mainly supplied to the automotive and air conditioning industries. This makes Oceancash’s earnings largely dependent on the performance of those industries.
Oceancash’s felts are also exported to overseas markets like Thailand, Taiwan, the Philippines and Australia. In terms of overseas market share, Thailand takes the cake for being the largest importer of felts. This comes as no surprise considering Thailand has Southeast Asia’s biggest automotive assembly industry.
The contribution from the insulation segment has been stagnated since 2012. In FY2016, the insulation segment only contributed to 27% of the company’s top line. And in FY2017, that contribution dropped to 23%. This stagnated pattern is a bleak reflection of a weaken automotive industry in Malaysia, Indonesia and Thailand. Consequently, the company postponed the transfer of one of its production lines from Malaysia to Thailand in 2016.
To soften the bleak outlook in the automotive industry, the company has been stepping up efforts in the air-conditioning industry for some reprieve.
Despite the shrouding negativity, the automotive industry in Southeast Asia is predicted to improve in 2018.
Nonwoven fabric is a broad categorisation of fabric where the fabric is manufactured without undergoing the process of weaving or knitting, unlike most textiles with which we traditionally associate. Like felts, nonwoven fabric can be made by bonding the fibers through a mechanical, thermal or chemical process.
Nonwoven fabrics are supplied to manufacturers of diapers, sanitary napkins, wet wipes and surgical caps, masks and gowns. The trend overseas is heading towards a more comfortable and softer fabric for diapers and sanitary napkins which require air-through nonwoven fabrics. Better margins can be obtained from air-through nonwoven fabric too. Oceancash is hopeful that the overseas trend would compel local diapers and sanitary napkin manufacturers to follow suit.
More than 80% of its nonwoven fabrics are being exported overseas to Japan, its biggest export market, followed by Thailand, South Korea, China and Indonesia.
In FY2017, the hygiene segment contributed 67% of the company’s revenue. This is an increase from 63%, in FY2016. Overall, the hygiene segment has enjoyed strong performance since 2012.
The focus of the company lies with its hygiene segment. That segment is expected to be a main driving force behind revenue and earnings in the foreseeable future. Hence, the company, in 2016, acquired spooling machines to increase its capacity to manufacture premium grade nonwoven fabrics, at longer length. This will contribute to better margins.
OPERATING PROFIT (RM’000)
PROFIT TO SHAREHOLDERS (RM’000)
SHAREHOLDERS’ EQUITY (RM’000)
DEBT TO EQUITY RATIO
OPERATING PROFIT MARGIN (%)
PROFIT MARGIN (%)
EPS (ADJUSTED) CENTS
DIVIDEND PAY OUT (%)
The top line of the company experienced a steady increase from RM58 million, in FY2012, to RM83 million, in FY2016. In FY2017, revenue increased to RM89 million – another milestone for the company.
There is an overall increasing trend, in profitability and profit margin, which is in line with the company’s increasing revenue. Do note that profit fell from RM10.1 million, in FY2016, to RM9.8 million, in FY2017. Further profit margin fell from 12.1%, in FY2016, to 11%, in FY2017. The reasons for the decrease are higher operating costs and transfer listing expenses.
The company’s operating cash flow ratio, within the range of 0.50 to 0.60, is sufficient to manage its debt to equity of about 0.40.
Return on equity is respectable, at about 13%.
Cash balance and retained profits are also on the increasing trend, as per balance sheet.
The disposable nature of hygiene products allows for a high turnover and recurring revenue. Products such as adult diapers are fast becoming modern day necessity. They are popular in Japan due to the hectic lifestyle of young carers, and the increasing aging population. The aging population in China and India could also potentially contribute to revenue in the future. However, there may be a certain social stigma attached, in societies outside of Japan, to the idea of using adult diapers. On the other hand, infant disposable diapers are already essential modern day necessity.
In the automotive front, the marriage between Geely and Proton is touted to potentially jump start the production of Proton and other Geely-related brands of cars. This collaboration is positive for Oceancash especially when Geely is planning to utilise Proton’s Tanjung Malim, as its manufacturing hub, for its cars, for exports within the Southeast Asian region. Tanjung Malim has a capacity to manufacture 1 million cars per annum and is greatly underutilised at the moment. Whatever it is, I don’t think that there will be much profit to be made in supplying parts to Proton especially when Proton had specifically requested suppliers to reduce their prices by 20%.
The general outlook in the Southeast Asian automotive industry, at least in 2018, looks bright.
Being such an export-oriented company, Oceancash’s business is affected by currency exchange fluctuations, especially USD/MYR, albeit minimal.
Further its business, especially the insulation segment, is highly dependent on the business cycle of the automotive industry.
In the Western world, makers of nappies are leaning towards biodegradables which have a smaller environmental impact than regular nappies. As the market caters to more environmentally conscious consumers, biodegradables would, in the future, be a preferred choice over regular nappies. A failure to put emphasis on biodegradable R&D would be detrimental to the company. Currently, the company has no biodegradable properties in their nonwoven fabric, as per their website.
Overall, I think the business-side of the company is intact and viable because of its association with modern day necessities such as cars and hygiene products.
When news broke out that Proton were to be merged or acquired by a foreign car company, the share price of Oceancash rallied in April 2017 and peaked at RM0.78 in November 2017. However, the rally has since fizzled. Share price is steadily declining, currently range-bound between RM0.51 to RM0.54. Further, last quarter’s (Q4 FY2017) lower-than-expected result added salt to injury. Nonetheless, Oceancash’s share price has declined about 35% from its peak, thus presenting an opportunity to take up a position in this company. However, I’m sticking to a wait-and-see approach and would only consider buying when its share price drops lower.
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I do not own shares in this company.
This analysis is published for your casual and leisurely reading and is not a recommendation to buy, sell or hold shares and must not be relied upon as a financial advice. You are encouraged to seek your own financial advice.