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Indian Stocks—Especially Shares of HDFC Bank—Look Like the Best Way to Produce Profits from Falling Oil Prices
11/18/2014 6:42 pm EST
Lower oil and fuel prices would give a big boost to the Indian economy and MoneyShow's Jim Jubak can't think of an individual stock with more upward leverage than this Indian bank, so he's adding shares as of today, November 19.
In my search for stocks that will go up as oil prices go down, I can't think of a market with more leverage to the downward movement in oil prices than the Indian stock market. And I can't think of an individual stock in that market with more upward leverage to falling oil pries than Indian bank HDFC Bank (HDB), which is why I will be adding the bank's New York traded ADRs to my Jubak's Picks portfolio today, November 19.
The structure of the Indian economy—the country imports 80% of its fuel—and the Indian fiscal and financial cycles are powerfully concentrating the effects of falling oil prices. For example, the government of Prime Minister Narendra Modi has used falling oil prices as an opportunity to end price controls and subsidies to consumers on diesel fuel and natural gas. That's had the effect of reducing the government's budget deficit at the same time as the falling cost of fuel imports has reduced the country's current account deficit. India's current account deficit has dropped to its lowest level in six years. Expectations are that the Reserve Bank of India will see enough of a decline in inflation (from lower fuel prices) and enough of an improvement in the national accounts to start lowering interest rates around the end of the fiscal year in March 2015. (Consumer price inflation dropped to 5.52% year over year in October, below the central bank's target of 6%. The Reserve Bank next meets on December 2.) The central bank's short-term benchmark repo interest rate is at 8%.
Lower oil and fuel prices, plus a cut in interest rates would give a big boost to an Indian economy that the State Bank of India, the country's biggest bank, estimates will grow by 5.8% in fiscal 2015. The Modi government has set a target to increase the growth rate to 7% to 8% within two to three years.
You can get exposure to that story through a broad-based India ETF such as the iShares MSCI India ETF (INDA). That ETF has gained 31.8% from November 18, 2013 through the close on November 17, 2014.
Or you can look for an individual stock that is likely to leverage those trends even further.
A bank such as HDFC Bank, one of the largest privately owned banks in India, will benefit from a general recovery of growth in the Indian economy and from any interest rate cuts from the Reserve Bank of India. And it will benefit more than almost any other Indian bank. Almost 50% of the bank's loan book is made up of retail loans—demand for retail loans is likely to pick up with the economy at a faster pace than corporate loan demand—and retail loan interest rates tend to come down relatively more slowly than the benchmark, so HDFC should see rising net interest margins. The bank has done a good job of keeping lending standards high during the economic slowdown—the gross bad loan ratio is just 1%—and the bank's capital ratios are in good shape with a capital adequacy ratio of 15.7% as of September 30.
The bank also looks to be positioned to benefit as well from a more relaxed attitude from the Reserve Bank of India and the Modi government as growth picks up and as the country's fiscal posture improves.
On November 14, India's Foreign Investment Promotion Board approved an increase in permitted foreign ownership for HDFC Bank to 74% from a previous limit of 49%. That will let the bank go ahead with a 100 billion-rupee ($1.6 billion) sale of shares that will boost the bank's capital available for lending just as the economy starts to speed up.
That approval is likely to revive talk—and maybe even actual negotiations—of a merger between HDFC Bank and mortgage lender and parent HDFC. The recent scrapping of tough reserve requirements and the recent increase in permitted foreign ownership remove two of the biggest obstacles to a deal which would create India's largest privately owned lender. A deal, depending on its structure, could lower the cost of funds for HDFC's mortgage business at the same time as it allowed HDFC Bank to escape current high reserve and restrictive lending allocation requirements. I'd put the merger talk in the buzz category of rumors, but a little buzz never hurt a stock price either.
I calculate a target price of $62 for the ADR as of August 2015. That's roughly a 20% gain from the November 17 closing price of $51.93.
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