Housing Scam -CBI investigation: BUY on HDIL, Orbit and Puravankara: Ambit

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The CBI investigation: Market over-reaction creates good entry points into select realty stocks; Reiterate BUY on HDIL, Orbit and Puravankara

Event: A CBI investigation into bribe taking at the highest echelons of  Public Sectors Banks (Central Bank of India, Punjab National Bank , Bank of India) and public sector financial institutions (LIC, LIC Housing Finance) has led to several arrests of senior management personnel. Though media reports suggest that the main beneficiary of the largesee of bribed senior management has been the real estate sector, the CBI has not named any real estate company as an accused

The allegation relate to corporates availing General Corporate Loans through Financial Intemediaries (FIs). A specifc  FI, Money Matters,  has allegedly bribed senior officials in these public sector financial institutions and thereby procured loans for corporates. Besides sanctioning the loans, the bribed senior officials are also alleged to have passed on confidential competitive information to corporate through the named FI.

We had collected some data points from the website of  Money Matters for some of the Debt Syndication they have done for the real estate companies. We have also referred to some excerpts from their Annual Report. Some of Money Matters' clients are exhibited in Table 1. We reiterate that the CBI has not implicated an real estate company at this juncture.

Our discussions with our Real Estate coverage universe

• DLF - Management said that DLF raises corporate loans directly with minimal intermediary interference and have not dealt with Money Matters
• HDIL - HDIL has issued a NCD of Rs8.5bn through Money Matters. The NCD was financed by LIC & other institutions. Since this NCD was issued in Jun-08, most of the amount has been repaid .
• Unitech - it has dealt with Money Matters earlier but has not done a transaction with them for the past 2 years.
• Puravankara - has not dealt with Money Matters
• Orbit - has sanction of Rs2.5bn from LIC Housing Finance. It has availed about Rs1.6bn of this loan and it has to be repaid over next 2-2.5 years. They had earlier dealt with Money Matters.

The Ambit view on the impact of this scam in real estate stocks

1)  Debt levels will go up, the cost of borrowing will rise, execution will be impacted 

Table 3 clearly shows that the net debt of our coverage universe has gone up over H1FY11 vs FY10 end despite a recovery in the real estate sector. Inspite of strong sales and robust prices, real estate firms have not been able to reduce debt & interest repayments. Instead, the debt has been refinanced. Out discussion with the coverage universe suggests that none of the above companies will generate positive cashflows in FY11 basis and net debt will go up by FY11 end. The only exception is HDIL which has raised money through a QIP.

We believe debt restructuring / refinancing would go through increased scrutiny and the required asset security will go up. This will result in delays in refinancing and will push up the higher cost of borrowing. The cascading negative effect will be on execution of the development land bank. That in turn will generate more upward pressure on real estate firms' debt:equity levels. To give a sense of the downside impact of this negative dynamic, we analyzed the impact of a 100-200 bps rise in WACC to our model. The senstivities are highlighted in the Table 4

2) We expect a 10-20% correction in property prices 

Developers will have to now rely more on internal business cash flows to service debt and improve execution. This will have to be funded by increased sales and new launches at attractive prices. We expect prices in metros to correct by 10-15% with Mumbai seeing a sharper correction at 15-20%. SEBI has already asked Mutual Funds to keep real estate companies under the "Negative List:"  for short to medium term liquidity. The RBI has increased risk weightages for retail housing loans above Rs7.5mn. The only window which was left for developers to encash was Bank Financing and we expect this to now go through even more extensive screening & approvals.
Our view on stocks
We would recommend investors to look at low D/E equity companies with a focus on execution & reasonable product pricing. Though even in a bear case scenario of WACC was increasing by 200bps, our coverage universe offers healthy upside. We believe that tnhe recent 2G scam coupled with this Loan scam presents a good opportunity to enter stocks not exposed to these factors.  HDIL (HDIL IN, 55% Upside) , Puravankara Project (PVKP IN, 60% Upside) and Orbit Corporation (ORB IN, 127% Upside)  remain our top picks in the coverage universe.