Strong Pressure on the Indian Rupee: Should You Buy Indian ADRs?
India is heading toward its worst financial crisis since 1991, as many of its stocks are dropping. In fact, most emerging markets started making a correction since the U.S. Federal Reserve began tapering its stimulus plan. Last Wednesday, this institution trimmed its monthly bond purchases by another $10 billion despite the turmoil in emerging markets. In response, the Reserve Bank of India tightened its monetary policy, trying to push down high consumer inflation and help restore confidence in the Indian rupee. Local currency has declined about 14% in the past year, adding to price pressures by raising the cost of imports.
Given the circumstances, let's take a look at three Indian ADRs.
Why net interest margins matter
First, here's one of the largest financial institutions in India, HDFC Bank .
Despite the outlook for the country, the bank's third-quarter core earnings grew 25% year over year, driven by 11.4% growth in non-interest revenue (32% of net revenue) and 16.4% growth in interest revenue (68% of net revenue).
HDFC is benefiting from scale advantages as its revenue growth exceeds its cost growth. But the key for this bank in particular are its net interest margins, or NIMs. This indicator was around 4.5% on average and 3% on a risk-adjusted basis during the past decade, much higher than its peers'.
However, this last quarter, interest revenue growth was predominantly volume-driven, with NIMs declining from 4.3% to 4.2%. The drop is not significant, but it could reflect a change in trends.
Changes in insurance product mix
Second, there's another institution to consider, ICICI Bank , which operates in India, Canada, and the U.K.
ICICI's earnings grew 18.9% year over year in the first nine months of fiscal 2014 thanks to the fact that net revenue grew 20.8% while operating expenses only grew 12.5%. Loans hiked 16%, supporting a growth in NIMs, which have a guidance of 3.3% for this year -- a bit above the 3.1% registered in fiscal 2013.
The main problem with ICICI is that its insurance business is not picking up -- its life insurance business grew only 3% last year. The bank is now shifting its product mix away from its popular Unit-Linked Insurance Plans, which still represent most of the schemes sold during the first nine months of fiscal 2014. Unfortunately, a recent change in regulations will make the company earn a lower margin per scheme. This is bad news, as ICICI's general and life insurance businesses put together accounted for 13% of its fiscal 2013 earnings.
Jaguar Land Rover driving results
Finally, here's the market share leader in India's domestic commercial vehicle segment, Tata Motors .
The currency impact from the weaker Indian rupee, along with the outperformance of its Jaguar Land Rover, or JLR, division helped Tata deliver good results for its second quarter. Revenue grew 31% year over year on the back of a 56% increase in JLR's revenue.
JLR's performance has been impressive, as it managed to increase revenue and expand margins even with a negative currency translation impact from the U.S. dollar to the British pound.
In addition, the JLR division has reversed Tata's domestic/international revenue mix to about 30%/70%, making for less exposure to India and greater profits when the rupee loses value.
Although the country might make a correction throughout this year, India still has attractive long-term growth prospects. However, the devaluation of the Indian rupee has a direct impact on the banks' fair-value estimate in U.S. dollars. As an example, a 10% decline in the exchange rate entails a 10% fall in the ADR price without any deterioration in the bank's fundamentals. In addition, you should keep in mind that financial institutions are usually the first ones to make corrections when turmoil occurs.
HDFC is set to profitably supply the financial resources needed for India's development. The drop in its interest margin is not yet something to worry about, but keep an eye on it.
Regarding ICICI, it is very exposed to India, which contributes nearly 85% of consolidated accounting profits. It will be important to monitor how its insurance business develop.
The devaluation of the rupee could be beneficial for Tata in the short term, as the company can make hard currency for its exports while many of its costs are denominated in local currency. However, if India's economic conditions deteriorate further, or if JLR's performance cools on an unexpected turn in U.S. demand, the stock will feel the impact.
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The article Strong Pressure on the Indian Rupee: Should You Buy Indian ADRs? originally appeared on Fool.com.Louie Grint has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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