DSIJ Mindshare

Depreciating INR: How To Gain From It?

Last seven years have been quite unique in the Indian history of economy and equity markets – the exchange rate of rupee fell about 55 per cent between two bull runs in the Indian stock market. While Sensex hit a then record high of 21200 in January 2008, the exchange rate was Rs.  39.40 against the USD. Once again, the Sensex has hit a fresh record high of 27355 in September 2014 while rupee has hit the mark of 60.90.

Weakened domestic currency discourages the inflows from the FIIs as every fall in domestic currency exchange rate brings down the value of investments by them in dollar terms. The same is true for the reversal of exchange rates – when the domestic currency recovers its lost values (i.e. when it starts appreciating against the dollar), the stock markets get into the rising mode as appreciation of local currency fetches more return on the past investments.

RUPEE FALL PROVIDING UNPRECEDENTED REWARDS TO THE INVESTORS OF IT AND PHARMACEUTICAL SECTORS

The traditional economic theories suggest currency crash helping the export sector, import substitutes and larger inflows of foreign direct investments chasing cheaper (in appreciating currencies) domestic assets. This, as expected got reflected in the stock markets as well – all of us know that this is evident in the export sectors like IT and Pharma.

While the Sensex moved up 29 per cent, the BSE IT & Pharma index has given returns of 133 per cent and 213 per cent respectively during the period between these two peaks.

MNCs CHASING THE INDIAN ASSETS IN THE LISTED SPACE

The crash in the exchange rate of rupee has also led to quite aggressive buying of Indian assets by the MNCs in the listed space. This trend has led to 188 per cent increase in the market cap of about 31 MNCs as compared to 86 percent increase in the market cap of Sensex companies since FY 2008.

EMERGING DOLLAR SQUEEZE: HOW TO PLAY ON THIS THEME?

We believe that rupee would be under pressure both in the short term as well as in the long term. Gradually the base of external debt has expanded in a big way in the recent years. At end of March 2014, external debt was placed at USD 440.6 billion (23.3 per cent of GDP) recording an increase of USD 31.2 billion (7.6 per cent) over the end of March 2013 level. India has to repay about USD 174 billion of external debt by March 31, 2015. This figure includes the short term debt as well as the long term debt which matures within the current fiscal. Further, it is quite certain that the US FED would phase out completely the pending USD 25 billion of monthly asset purchase program by end of this calendar year itself. It is also expected to commence the reversal of interest rate cycle in the last quarter of FY 2015. These developments would lead to some pressures on the rupee in the second half of current fiscal itself.

Again in the long term also, we would see a lot of pressure on rupee exchange rate due to emerging dollar squeeze. About 15 years ago, we used to import oil to the extent of around USD 12 billion per annum and import just USD 1 billion or USD 2 billion worth of gold. Today these two items alone account for about USD 190 billion. As the domestic economy picks up, the oil consumption would rise significantly. Similarly our import of edible oil and oil seeds has risen as high as USD 15 billion per annum. In August 2014, we imported the highest quantum of vegetable oil in the last two decades. In addition, our dependence on import of fertilizers and its inputs, coal and now we have started importing of iron ore slowly. As the economy improves its growth and our population also keeps growing, our import of all these items would grow substantially which would apply tremendous pressure on our demand for the dollar in the next 3 to 5 years. Hence, we believe that the IT, Pharma, and MNC stocks would once again find favor in the markets if rupee falls once again. In addition, import substitutes and traditional export segments would also gain in terms of business growth and market cap.

We give six stocks, which, in our view, would be thematic play on emerging dollar squeeze leading to further depreciation of rupee.

International Paper APPM Ltd:

We believe IP APPM provides tactical as well as fundamental opportunity to investors from medium to long term. Recently the International Paper has acquired the remaining 25 per cent of shares of Orsa International Paper Embalagens S.A. from its joint venture partner. With this transaction, International Paper takes full ownership. We believe, this provides tactical opportunity for Indian investors if management decides to delist the company. International Paper acquired 75 per cent of shares in the company in 2011. IP APPM was bought at Rs. 674 and at that time the rupee was trading at 45 vs dollar. However, since then the share price has fallen by 52 per cent and rupee by 35 per cent vs dollar. Considering these factors, we have “BUY” recommendation on the stock for target price of Rs. 400.

Mphasis Ltd:

It is surprising that Mphasis, part of USD 120-billion HP trades at single digit PE on one-year forward earnings. We believe there is a tactical opportunity in the Mphasis stock either in terms of buy-back or sale on the Indian company as globally the larger focus of HP is on hardware business. Further, the fall of rupee by 50 per cent over the last six years makes it more attractive for the MNC to think of complete buyout. At CMP, the stock is trading at 9x its FY2016 EPS of Rs. 53. Considering these factors, we have “BUY” recommendation on the stock for target price of Rs. 550 and the stock can give return of 27 per cent from CMP of Rs. 432.

Styrolution ABS (SABS):

SABS, which is a subsidiary of Styrolution, an MNC, which in turn was a joint venture between BASF and INEOS. Recently INEOS announced buying out 50 per cent stake held by BASF in Styrolution of Europe. This will be positive for the company which has come up with an open off er recently at a price of Rs. 499.81 per share. Considering the facts that its current market price is substantially more than the offer price, the company came out with open off er earlier in 2010 at Rs. 606.81 per share and since then rupee has fallen by 36 per cent. We believe that there is a possibility of revision of its offer price in the future. We expect the company to post an EPS of Rs. 43 for CY2015 and hence, we have a target price to Rs. 800 (based on 18.6x CY2015E EPS) which is 36 per cent upside from the current market price of Rs. 587. Hence, we suggest investors to accumulate the stock.

Seshasayee Paper:

Paper is an import substitute to some extent. There were hardly any major greenfield projects in the last 10 years. It is one of the cheapest and also the most efficient paper companies. The promoters hold 43 per cent which is thinly distributed across 15 entities and individuals. Its enterprise value to capacity is very attractive as compared to the valuation given to AP Paper in 2011. We have “Buy” recommendation on the stock for target price of Rs. 320 with an upside of 36 per cent return.

Gujarat Alkalies:

It makes caustic soda which is an import substitute. Caustic soda is used by a host of industries and the expected revival in the economy is also conducive for this product. Stock trades at 8.8x FY2014 EPS of Rs. 25.2. We recommend a “Buy” rating to the stock for target price of Rs. 280.

Sutlej Textiles:

In our view, rupee depreciation has not yet reflected in the textile sector earnings (major exporting sector). While rupee has fallen 54 per cent, the Chinese Yuan has appreciated 16 per cent during the period 2008-2014. Further there has been substantial increase in the labor costs in China during this period. China is also reducing its focus on cotton textiles as it plans to increase the focus on other value-added businesses. Also according to US Department of Agriculture (USDA) projections, India will be the world’s No. 1 cotton grower this year, ousting China from the top spot for the first time in over 30 years. This will be positive for the Indian textile companies like Sutlej Textiles and Industries Ltd. With structural changes taking place and decreasing debt levels, we believe the company is poised for future growth. We have “Buy” rating on the stock for target of Rs. 500.

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