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Property
Action
The recovery in the residential segment is over and now it is essential to ensure
growth in volumes and execution, to lower dependence on external funding.
Improvement in the office segment should help developers monetise some of their
leased assets. The current pessimism for the sector is unwarranted, in our view,
and we continue to prefer HDIL Ltd, Unitech Ltd and Puravankara.
Catalysts
A sharp upward move in volumes, led by strong economic growth, would make us
more bullish. Rapid and large increases in interest rates would make us bearish.
Anchor themes
CY11-12 will be a crucial period for developers, as they need to sell and execute
higher volumes, not only to deleverage themselves, but also to justify the large land
banks they hold. If volumes are not substantially higher from here by CY12, then
developers may not be able to get full value for their large land holdings.
Pessimism unwarranted
Regional divergence to increase in the residential segment
The recovery phase in the residential segment in India is now over, in our view.
After the homogeneous pick-up in volumes seen across the country over the past
18 months, we think that in CY11F macro factors such as policy shocks,
increasing interest rates and lower funding availability for developers could
temper the overall demand scenario and affordability will play a larger role in
deciding volume growth in each region. We maintain our view that the South
Indian cities of Bangalore and Chennai are likely to show greater increases in
volumes than Mumbai and the National Capital Region (NCR) owing to far better
affordability metrics. We expect prices in Mumbai and NCR to hold steady in
1HCY11F, while there could be a 10-15% correction (or discounts being offered)
in 2HCY11. For the rest of India, we expect prices to remain flat or display slow
upward movement.
Commercial segment to show an uptick in leasing and rents
Leasing demand should reach pre-recession 2008 levels by 1QCY11F, in our
view. Over the past eight quarters, supply has, on average, been around 11mn
sqft which is much lower than the pre-crisis levels. We expect supply to increase
over the next two quarters and we see supply moderating only in CY12F,
resulting in rents starting to increase, at the earliest, from 2HCY11F. We expect
the larger, organised developers to see the benefits of improving leasing demand
and stable rents before unorganised smaller players as there is a flight to quality
assisted by competitive rents. CY11F may also see the long-awaited REIT listing
of DLF Assets Ltd.
Execution to gain increased focus
Apart from ensuring that sales pick up through appropriate pricing, we believe,
developers will have to make certain that execution does not falter. This will be
especially crucial, given that cashflows are now linked to construction. In CY11F,
a large chunk of developers’ debt comes up for repayment and, we believe, it is
necessary for developers to speed up execution from the current levels to ensure
robust cash flows. Developers who are unable to show evidence of execution are
likely to face funding issues – both debt and equity.
Too much pessimism in stock prices
Following the recent 2G telecom issues and the property loan scandal in India,
property stocks have corrected further by 15-30% over the past one month vs a 2% fall
in the BSE Sensex. Investors are concerned that banks are likely to restrict funding to
the sector following these concerns and may even recall loans. However, we think, this
is highly unlikely; banks may tighten their processes and lengthen the timeline to
sanction loans, but are unlikely to either restrict lending or recall their loans. Stepping
back from the negative news flow surrounding the sector, one would realise that the
issues are company-specific and not endemic to the sector. Property stocks are now
trading at a 30-45% discount to their net asset values (NAV) which we think is building
in too much pessimism. We would prefer to be invested in volume-oriented plays such
as Unitech Ltd, Puravankara Projects Ltd and in companies which are able to generate
land in Mumbai in an inexpensive manner like HDIL Ltd. We would expect the discount
to NAV for these stocks to narrow in CY11F, as the companies deliver on sales
volumes and execution.
Valuation methodologies and risks
Unitech: We value the company in two parts: 1) net asset value of the current land
bank at INR78 per share and 2) Unitech Infra valued at INR22 per share. Our cost of
capital assumption is 13.75%.
Downside risks include: 1) a reduction in liquidity and capital availability for developers,
2) stalled economic growth recovery, 3) an inability to successfully sell projects or
construct them and 4) rising interest rates.
HDIL: We value HDIL using our net asset value estimate of its current saleable area at
INR366 per share, without any discount/premium to NAV, and with cost of equity at
15%.
Downside risks include 1) a delay in shifting of slum dwellers in Phase 1 of the airport
slum rehab project; 2) an increase in FSI in Mumbai, which would affect demand and
pricing of TDR; and 3) an increase in interest rates, which would affect demand for
property and sentiment for property stocks
Puravankara Projects Ltd: We value the stock using our net asset value estimate of
its current land bank at INR168 per share, without any discount to NAV, and with cost
of capital at 13.5%. We think the biggest risk is the potential failure to sell and execute
projects on time, resulting in cash flow problems.
Downside risks: 1) a reduction in liquidity and capital availability for developers,
2) stalled economic growth. 3) Rising interest rates along with policy action to restrict
lending to property developers which could lead to refinancing risks for Puravankara.
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