IC Market Espresso 27 Jun 2022

 
Let’s Stop and Zoom Out A Bit – Back to Basics 101

Keeping things simple, higher interest rates mean higher costs for ANYONE borrowing money. Driven by pure logic, that HAS to be bad for equity, right? In this article, we will put equity in the current market perspective.

After over a decade of rock bottom interest rates in most of the developed countries – rates are rising. Last week all eyes were watching closely what the Fed, the central bank of the USA, will do. We saw Fed hike its benchmark interest rate by 75bps (0.75 percentage points), which is the largest amount since 1994. Rates hikes are referred to as central banks policy rates (federal funds rate in the US, controlled by FED or deposit facilities rate from ECB). This is the rate at which banks lend money to one another.  What does that mean? When this referent rate hikes (like what we have at the moment!), it pushes all other interest rates in the economy (like mortgage rates, and bonds yields..). A higher interest rate simply means higher costs for ANYONE that borrow money (banks, consumers, companies..).

Federal funds effective rate & ECB’s deposit facilities

As can be seen from the graph above, we have had more than a whole decade of low interest rates. Both Fed and ECB kept rates their reference rates at historically low rates. But a fundamental shift starts to happen. As said above, last week Fed raised their reference rate – the federal funds rate. The key thing to point out here is, that the rate hike was higher than expected. Numerous expectations were put at 50bps or 0.50 percentage points. Also, according to the target range of individual members’ expectations, Fed’s benchmark rate is further expected to reach 3.4% as Fed vows to raise rates steadily over the next year.

But why now? What is different?

This is pretty easy to conclude – inflation. Inflation makes a completely different environment. We’ve had the longest-lasting bull run up to date, but inflation started to boil as a result of inflationary pressures and long-lasting easing monetary policy as money lifted the value of asets. Inflation is the „enemy“ that should be fought under every cost – even a recession. The primary goal of most central banks is this exactly – to keep inflation low and steady. This is an answer to why we expect further contractionary monetary policy and the continuation of rising reference rates. Because inflation happened and it just has to be controlled, simple as that.

What does all this imply?

In the world of fixed income (primary bonds) – there is a clear negative relation. As interest rates rise, bond prices fall. This simply happens as the return on those bonds becomes less attractive, due to higher current interest rates – and to compensate, the price of the bonds will have to decrease to have a higher implied yield.

What about equity?

How is equity’s value derived – what’s the first domino? Of course, sales. Now, in the rising rates environment, what can we expect sales-wise? Consumers will definitely see their budgets shrink. Car loans or mortgage payments will increase. Further borrowing via bank loans will also be more expensive and so, we can justify the expected demand for most products to decrease. In other words – lower sales are to be expected. Companies could, consequently, report lower margin and their profits reduced.

Let’s get into the stocks in a bit more detail.  This will be of high importance for each investor to know the classification of the company he invests in and believes in. As every investor probably knows, the most general stock division is on „growth“ and „value“ companies.

„Value“ stocks tend to perform better during the rising interest rate times, as they mostly sell price inelastic products – something consumers will buy regardless if, for example, their income falls. A good example of this would be a food company, like Podravka. People will buy Podravka’s products anyhow. What about the other side of the coin? So-called „growth“ companies. Those companies should experience harder hits by money being more expensive. Tech companies are a good example. They should be more affected as growth companies derive their value from future expected growth in cash flows, which in times of higher rates, carry more intrinsic risk within them.

Valuation-related reasons for lower valuations

There is also a pure mathematically-derived reason why companies become less attractive during said times. Stocks are often valued on the return they offer, compared to other opportunities in the market, like of course, bonds. Considering the risk/reward, higher-income yields could decrease stock prices via lower demand for stocks, as bonds could offer comparable yields with a much lower risk.

Also, the reason why growth companies should expect a higher downturn lies within the valuation assumptions that the equity market lies onto. Growth companies derive more of their value from expected future cash flows, in relative terms, compared to value companies. This said those expected cash flows will now be discounted by higher interest rates to come up to their present value of them. This effect should decrease the valuation of growth companies more noticeably.  But nonetheless, the whole equity should feel a lower valuation as reference rates increase.

As a cherry on top – we might see the self-fulfilling prophecy. Black-on-white, the USA might end up in a recession. To enter a recession, the USA needs to report two consecutive YoY quarter decreases. Last quarter decrease was already reported. If the following quarter also falls on a YoY basis, there will be an official recession – and the data comes out soon. Then, potentially this self-fulfilling prophecy might occur, as each headline will read „We are in a recession“. Not much of a sentiment boost, right? But nonetheless, we should not rush ahead of anything.

Končar Signs EUR 65m Agreement for the Revitalization of HPP Haditha in Iraq

On Friday, Končar announced the signing of an agreement worth EUR 65m with Iraq’s Ministry of Electricity, for the revitalization of HPP (Hydropower Plant) Haditha.

This agreement refers to the hydropower plant that was first built in the 1980s, with an installed capacity of 6×128 MVA, making it one of Končar’s flagship projects. The total value of the project is EUR 65m and will be led by Končar – Engineering (KET), as well as several other members of the Končar Group.

Under this agreement, Končar will carry out a partial revitalization of generation units, replace parts of the MV (medium voltage) and HV (high voltage) equipment, the entire plant management systems, the excitation system, and the electric protection system, as well as upgrading the mechanical subsystems and hydromechanical equipment.

The consultations for the project were continued after 10 years, following an 18-month round of negotiations in a completely new political environment. During the last 10 years, Končar performed a series of smaller agreements for the plant, and similar other facilities such as HPP Hemren, mainly pertaining to the delivery of equipment and spare parts.

This latest agreement marks the return of Končar to the Iraqi market, a historical step that secures Končar’s position as one of the leading Croatian exporters.

Končar Went Ex-date

As a reminder, Končar’s shareholders approved the dividend payment of HRK 13 per share at its GSM meeting held on 10 June 2022, with a DY of 1.4%.

On Friday, Končar’s shares went ex-date, referring to the previously approved dividend of HRK 13 per share, with a DY of 1.4% (at the price before the dividend’s proposal). During the day, the share price increased by 1.2%, and the Company’s stock ended the day at HRK 880. It should be noted that this is contrary to what usually happens on an ex-date, as without the dividend payment incentivizing investors to invest in a stock, the stock price usually decreases, by approximately the dividend yield. However, on the same day, Končar also announced a new agreement with the Iraqi Ministry of Electricity worth EUR 65m, which also influenced the price movement. To read more about this news, click here.

The payment date for the dividend is set for 10 July 2022. Below we provide you with a historical overview of Končar’s dividends per share and dividend yields.

Dividend per share (HRK) and dividend yields (%) (2015 – 2022)

NLB Went Ex-date

As a reminder, at the last GSM meeting, the shareholders of the Company approved the payment of EUR 50m of the distributable profit, which would amount to a dividend of EUR 2.5 per share or a DY of 3.8%.

On Friday, NLB went ex-date, meaning that the approved dividend payment of EUR 2.5 per share would no longer be accessible to new investors. During the day, the stock decreased by -3.46%, ending Friday at EUR 61.40 per share. The payment date for the dividend is set for 28 June 2022.

It should be noted that this dividend payment is half of the EUR 100m the Company expects for 2022, as outlined in their 2022 outlook in the FY 2021 report. As such, there should be a 2nd dividend payment happening, somewhere in the 2H 2022.

Below we provide you with a historical overview of the Company’s dividends per share and dividend yields.

NLB Dividend Per Share (EUR) and Dividend Yield (%) (2019 – 2022)

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