The UK shares to own as interest rates fall

The rate-sensitive stocks and sectors that investors need to watch as the Bank of England begins to loosen monetary policy have been highlighted by a leading City firm.

Peel Hunt’s analysis assumes that UK interest rates will end 2025 at 3.75%, which compares with the current level of 5% after the central bank’s first cut in the cycle on 1 August.

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Hopes of a back-to-back move at the Bank’s next meeting on 19 September diminished earlier today when figures showed a tighter labour market, offsetting softer wage growth.

City economists expect the next downward interest rate move to happen in November, providing a tailwind from lower finance costs for firms across a range of sectors.

There will also be the longer-term benefit from increased demand and affordability, particularly in housebuilding and real estate.

Peel Hunt sees one of the biggest impacts being in healthcare and life sciences, where valuations are built on future cash flows. The run of rate rises has diminished their appeal, leading to one of the sector’s most testing periods since the financial crisis.

The bank said: “As we turn the corner, it would be reasonable to assume that a more stable inflationary environment will also see some risk-appetite return for higher growth companies.”

In Peel Hunt’s coverage, the Buy-rated stocks that could see support include FTSE 250-listed PureTech Health (LSE:PRTC) and Syncona Ord (LSE:SYNC) and the smaller duo of Oxford BioMedica (LSE:OXB) and hVIVO (LSE:HVO).

In terms of debt and leverage, the most exposed to upside risk is Spire Healthcare Group (LSE:SPI) based on the potential benefit relating to £18.5 million of interest cost on its bank facilities.

Leverage in the consumer space has reduced materially over the past two years as companies in the sector have focused on profit improvement and debt reduction rather than acquisitions.

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The balance sheet of McBride (LSE:MCB) is among those now in a better place, but given a forecast £14 million of interest charges in the current year the bank said there is “potentially a major saving to come”. It has a price target of 175p on the own-brand household goods supplier.

In contrast, most of the debt facilities of Premier Foods (LSE:PFD) are based on fixed rates so the benefit of the declining interest rate environment is limited.

In financial services, Peel Hunt believes that management guidance and consensus estimates are broadly up to date with the changing yield curve and base rate expectations.

UK lenders typically experience lower yields on their lending portfolios, which typically re-price more rapidly than liabilities when interest rates decline.

This leads to shorter-term pressures on net interest margins, which will correct as funding costs subsequently re-price downwards over time.

Real estate shares have been highly correlated to interest rates in recent years, with stocks such as Primary Health Properties (LSE:PHP), Tritax Big Box Ord (LSE:BBOX) and Assura (LSE:AGR) perceived as bond proxies given their long leases and secure income streams.

Their shares are down by between 30% and 40% over the past two-and-a-half years and offer the potential of share recovery as rates fall.

Peel Hunt said Primary Health, which trades on a 10% discount to net asset value and offers a 7% dividend yield backed by the sector’s most secure income stream, looked attractive.

As interest rates have risen, investors have increasingly compared property yields to debt costs, and have been cautious on companies with low or negative yield spreads.

While it points out that rental growth can often justify such yields, Peel Hunt expects renewed interest in stocks including Shaftesbury Capital (LSE:SHC), Grainger (LSE:GRI), Derwent London (LSE:DLN), Great Portland Estates (LSE:GPE) and Helical (LSE:HLCL).

The vast majority of housebuilders sit with either net cash or modest levels of debt.

Peel Hunt said: “Even if we include land creditors in as debt, the housebuilders’ direct sensitivity to falling interest rates is modest albeit they should benefit from increased affordability, and hopefully demand, from their customer base.”

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The situation for the building materials and merchant companies is more varied, with one of the highest leverage ratios being SigmaRoc (LSE:SRC) after its acquisition of CRH’s lime assets.

Peel Hunt, which has a Buy rating and 109p target price, estimates a 1% fall in interest rates would be worth as much as £6 million across a full year and equate to a 4% boost to profits.

In many other sectors, companies either operate with net cash positions or have long-term fixed debt instruments. In retail, the bank picks out DFS Furniture (LSE:DFS) for attention as it says the market leader’s debt position is manageable even off lower profitability.

It said: “Clearly a reduction in rates would be helpful here from an interest charge perspective, but it would also help the cost of offering interest free credit on purchases.

“More than half of sales go through with this offer attached, and every 1% change in the BoE rate changes the cost of offering interest free credit by £6 million.”