Interest rates have been so low for so long, investors have likely forgotten what interest actually looks like. The last time we saw rates above 5% was 5.25% in November 2008 – in the throes of the GFC, and en route to that year's low of 3%.
What's that got to do with investing?
First, higher interest rates make debt more expensive, and because rates have been so low for so long, many companies have been very comfortable with their borrowing.
Second, the number of alternative investment prospects increases. Right now, the only way to get a respectable yield on your investment is to own stocks. As interest rates go up, people will start to pull their money out of stocks in favour of bonds and savings accounts.
Third, because of both of these things, as interest rates rise, typically the value of stocks fall. Here are two companies I think will be hit particularly hard when rates rise:
Sydney Airport Holdings Pty Ltd (ASX: SYD)
Sydney Airport carries net debt of 6.8x its earnings before interest, tax, depreciation and amortisation (EBITDA), which is almost double the 3.5x that most listed companies are restricted to. While the average maturity is in 2024 and the company is largely hedged against rate rises, higher interest rates will rapidly make its 4.6% unfranked dividend less attractive, and I would expect shares to fall in this situation.
Transurban Group (ASX: TCL)
It's a similar story with Transurban, which carries $12.7 billion in net debt – ~8x EBITDA – which has a weighted average time to maturity (repayment) of 9 years. Over 99% of the debt is hedged against increases in interest rates, but Transurban's 4.3% dividend starts to look skimpy if rates rise by even 1%. To be sure, Sydney Airport and Transurban are companies less likely to struggle financially when rates rise, simply because their traffic is so reliable – which is one of the reasons they can carry so much debt.
However, a 4.3% unfranked dividend simply won't cut it if you could also get 4% in a term deposit, and today's share prices seem too high in a world where interest rates are reportedly going up. As a result, I'm not a buyer of either Sydney Airport or Transurban today.
