It may have been only a 25 basis point increase in the reserve rate to 0.5%, but the Bank of England’s decision to hike interest rates for the first time in a decade will still have repercussions for the broader economy, investors and many stocks. Two that will benefit from rising interest rates are share registrar Equiniti (LSE: EQN) and challenger bank Metro Bank (LSE: MTRO).
Equiniti should benefit as, aside from its core share registration business, it also offers a bevy of related critical but non-core technology applications to more than half of the FTSE 100. That includes pension administration, employee share plans, regulatory compliance software and payroll solutions.
Some of its many offerings mean it holds a significant amount of cash for clients. In H1 2017 it held some £1,700m of client cash on its balance sheet and received £4.7m in income from investing this cash in short-term securities. This income was 19% lower than the year prior due to the BoE’s rate cut in August 2016 following the Brexit vote. And while two-thirds of this cash is invested in fixed rate securities, Equiniti will see rising income from the rest as we go forward.
Now, Equiniti also has roughly £450m in debt, so it will see interest payments rise for any portion of this debt that has a floating rate. However, this debt level is comfortable for the firm due to its steady recurring revenue, high cash flow and the fact that £120m of it is related to the recent acquisition of Wells Fargo Share Services. This deal has made Equiniti the third largest provider of such services in the US and marks its entry into the world’s largest market for them.
Equiniti’s share price has risen by 55% over the past year and its shares are now priced at a full 19 times forward earnings. That said, I see plenty to like about the firm and believe it has stellar growth prospects as it cross-sells its array of services into the US and builds on its dominant market position in the UK.
A most welcome surprise
As a pureplay retail bank, interest rates are very important for Metro Bank (LSE: MTRO) as it gives the company more room to increase the spread between the interest rate at which it borrows money, ie deposits or corporate borrowings, and the rate at which it lends it out.
Taking the difference between these two and then dividing by the bank’s total interest-bearing assets is referred to as the net interest margin (NIM), and with interest rates at rock bottom levels for years, banks’ NIM have been very low. Indeed, in the quarter to September, Metro Bank’s statutory net interest margin fell from 1.95% to 1.94% year-on-year.
However, this figure is a bit distorted by the BoE’s own term funding scheme. The bank’s underlying NIM based purely on its main source of funding going forward, actual customer deposits, was a heartier 2.22% and was growing even without the interest rate hike. Needless to say, this semi-unexpected rate hike should further benefit this metric.
There’s plenty of other moving parts to consider with fast-growing Metro Bank, but with interest rates rising and a compelling rollout plan, I’ll follow the challenger bank closely, even if its 3.92 price/book ratio has it very, very highly valued.
A more sanely valued stock I have my eye on is the Motley Fool’s Top Small Cap of 2017, which trades at under eight times forward earnings. But fret not, because this bargain basement valuation doesn’t mean low growth as the company has increased earnings by double-digits four years in a row.
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Ian Pierce has no position in any of the shares mentioned. The Motley Fool UK owns shares of Equiniti. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.