INDIAN INFRASTRUCTURE SECTOR - PURE INTEREST RATE PLAY !!! Case study of GMR Infrastructure

This article explains how Interest rates affect share price of High leverage stocks in a profound way. This also applys to your Home loan.

Suppose I has Rs. 100, & I started business taking a loan of Rs. 1000 (D/E =10:1). Interest rate is 10% PA, If my profit is Rs. 100/- per annum on my total Investment,  my Net profit is Rs. 0 /- . (Earnings- Rs.100/-, Interest- Rs.100/- ; Net profit (PBT) = 0) 

If  the interest rate comes down to  Rs. 9.5%, the Net profit will be Rs. 5 as per the above calculations. 

This Net present value of This Rs.5 profit over a 25 year period is @ 9.5% interest rate over a 20 year period is Rs.45. So My Rs. 100 equity value becomes Rs. 145 with a 0.5% reduction in interest rates.

This , analogy apply best for your home loan too. People buys a home with about 90% of debt. Not that , as it seems Indian Interest rates have peaked, it may be time to take high leverage.

This may well mean that stocks with real D/E of about 1:10 , Like Indian Infrasturcture stocks, will appreciate typically by 40-45% for every 0.5% reduction in Interest rates. 

Let us take a major infrastructure player  in the market - GMR INFRASTRUCTURE .   The stock has actual D/E of 5:1, real D/E of more than 10:1 . This is because, the invesments are mostly made in the SPV route. The parent company will have an Debt and equity component. It will again invest in Individual projects , which are treated as separate business, which will further have D/E of about 70:30. 

Let us look at the share price of  typical infrastructure stock GMR INFRASTRUCTURE  over the last 3 years, 

Change Date	RBI REPO RATE	GMR INFRA STOCK PRICE
March 19 2013	7.500 %	22
January 29 2013	7.750 %	19.8
April 17 2012	8.000 %	21
October 25 2011	8.500 %	18.75
September 16 2011	8.250 %	25.9
July 26 2011	8.000 %	26.5
June 16 2011	7.500 %	29.8
May 03 2011	7.250 %	34.25
March 17 2011	6.750 %	37.45
January 25 2011	6.500 %	39.4
December 1 2010	6.250 %	43.7
October 1 2010	6.000 %	53.6
October 1 2010	6.000 %	53.6
August  1 2010	5.500 %	63
July 1 2010	5.000 %	55

This leaves us , with strong proof that the stock has correlation with Interest rates.  Every 0.5 to 1% increase in interest rate - is reflected as about 50% increase in the stock price, Every  0.5 to1% decrease in Interest rate gave about -33% decrease  in Stock price. 

So in the current macro economic trend, where interest rates are slated to come down , The typical Infrastructure stocks are bound to increase. D/E ratio of 5:1 - The rate of increase will be atleast 50% for every 1% decrease in interest rates. So , come on now and buy the infra names. Its right time to buy.

In the next blog , we will analyze when to invest in the real estate with debt, It is another leverage play that depends on Interest rates purely.