Rate cut is a high probability event.......In the light of our expectations we enlist some of our top stock ideas which will directly or indirectly benefit from a low interest rate environment.

Dear All,

India has been plagued by high inflation for years. Its only since the second half of 2014, did we see inflation coming down consistently. Both the CPI and the WPI have been trending down since May 2014, the former a bit unevenly, and the latter consistently. The WPI has, in fact, been negative for six months in a row, and average wholesale inflation for the last 12 months is a 1.3%. The IIP in 2014-15 showed a modest revival over the year before (2013-14), but the industry is still struggling under an overload of past debt. Till this overload is lifted, it (i.e. the industry) cannot run faster and contribute to GDP growth. While RBI has its own sets of worries and data points to look at (like the US 10 Year Yield, CAD & Fisc situation, amongst others), right now growth is a bigger challenge than inflation and therefore the Government and the RBI needs to act fast.

 Given the latest print on both CPI and WPI, the case for interest rate in the next policy meet (2 June, 2015) has become very strong. Given the various macro economic variables, we believe that a series of rate cuts over the next few quarters cannot be ruled out. While an immediate rate cut is a high probability event, subsequent rate cuts though will be to some extent contingent on variables highlighted above.

 In the light of our expectations we enlist some of our top stock ideas which will directly or indirectly benefit from a low interest rate environment.

 ·         Indusind bank (CMP Rs834.0) is one of the major beneficiary of downward trending interest rate trajectory as it relies heavily on bulk deposits.  Majority of its deposits mature within 1 year which places the bank in a sweet spot in terms of lower cost of re-financing its deposits. Also, its 50% of retail book is fixed rate wherein yield pressure will be less. Overall, its NIM is set to improve from 3.7% now to ~3.9% which shall support healthy NII growth and 25%+ PAT growth for next couple of years. Valuation reasonable at 3.5x FY16E ABV for the bank with strong 1.9% RoA.

 ·         Dewan Housing finance (CMP Rs 434.2)- The borrowing mix of Dewan housing constitutes 61% in form of bank loans, 28% is Bonds, 8% is FDs and 3% is NHB. With interest rate trending south, Dewan has the higher lever to shift its borrowing mix from bank loans to bond which shall reduce its overall cost of fund. Also, the cut in base rate by banks shall keep its cost of fund under check. Besides, lower EMI shall translate into higher credit growth volume (20%+ expected till FY17E). Overall, steady PAT growth of 18-20% expected. Valuation cheap at 1.2x FY16E ABV.

 ·         L&T: (CMP Rs 1584) liquidity crunch  and slow pace of execution  has led to  deterioration of the company’s NWC to 25% of revenues one of the highest levels witnessed. Secondly, L&T gives away lot of work on sub-contract basis and any rate cuts going forward will ease the pressure of the sub-contractor (most of them under working capital stress) which in turn will indirectly benefit the company as well. Interest rate cuts will therefore lead to huge savings for the company and boost its profitability.

 ·         Kajaria Ceramics (CMP Rs 766): Indirect play on real estate sector. Housing sector will be one of the key beneficiary of rate cut, as EMI outgo for house aspirants reduces leading to increase in affordability. The increase in demand for housing will directly drive demand for ancillary industries like tiles and sanitaryware. Kajaria is market leader in vitrified tiles. Tiles industry is likely to grow by 15% in FY16E and we expect Kajaria to outgrow the industry growth by 250-300 bps. Currently, trading at consensus P/E of 28x and 22x FY16E and FY17E (Source: Bloomberg).

 ·         Ashok Leyland (CMP: Rs 70.3): Play on demand recovery for CVs, which is directly the function of recovery in mining activities (coal and minerals mining) and urban public transport. Moreover, any rate cut will lead to lower cost of ownership for CV owner and will make logistic/transport industry attractive. Majority of the CV business is on finance. Industry volumes are likely to grow by 10-15% in FY16E and the company is likely to outperform the industry growth.  Currently, trading at consensus P/E of 28x and 17x FY16E and FY17E (Source: Bloomberg).

 ·         Dalmia Bharat Ltd (CMP: Rs 501): DBL is the 3^rd largest cement player in India with capacity of 24.5 mn tonnes. The company’s profitability were under pressure till FY15 due to weak cement uptake and realization in Southern markets. DBL gets majority of the sales from Southern region. With likely improvement in pickup in infrastructure and housing activity, especially in Andhra region, coupled with cost optimization measures initiated by the company, we believe DBL’s profitability is likely to increase substantially over FY15-FY17E period.

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