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Property -Tread carefully… and carry a big stick
Adopt a selective approach in the Indian real estate sector: Vertigo-inducing residential
prices, fund raising and corporate governance incidents remind us of the 2007 hey-days. The
key difference is that real estate stocks are 60-70% below all-time highs, while the market
index has retraced its journey. But is this really a case of broad-based sector mis-pricing? We
don’t think so. We believe a selective approach is required to gain exposure to sustainable
strategies and ‘sane’ markets. We recommend buying residential cost/price leaders (HDIL,
Prestige) and developers focussing on IT commercial and retail (Phoenix, and Anant Raj).
Sector being pulled in multiple directions: India is experiencing strong GDP growth,
which is driving the uptake of commercial and retail space and prompting end-users to buy
residential property. However, recent memories of the boom of 2007 (followed by 2008’s
crisis) give rise to some scepticism. Note that residential prices in parts of Mumbai and the
NCR are now higher than the 2007 peak. On the other hand, markets like Bangalore are
seeing improvement in volumes even as prices inch up. In some areas of NCR suburbs,
speculators have driven volumes to more than twice the historical high of 2007. We believe
these liquidity-driven phenomena are unlikely to sustain beyond the next 6-12 months.
Sector also faces multiple headwinds. Sector-specific policy tightening may be stronger
than 2006/07 since speculators refuse to back off easily, having seen a V-shaped
residential price recovery.
The valuation conundrum: Moving closer to cash flows: One common theme, which
has emerged in conversations with investors is that investing in Indian real estate has
become very frustrating. This is due to variation in analyst NAVs and the variety of ways in
which these are calculated. We are therefore adopting a new, more transparent, way of
calculating NAVs. We explicitly value only those projects where we expect execution in the
next 5 years. We value the rest at land cost and leave out parcels where we can’t foresee
development or sale in the next 10 years. This affects existing NAV estimates by 10-15%.
We also concede that NAVs do not adequately reward immediate monetization. We
present cash flow multiples as an alternate method for valuation and to gauge where
stocks should trade relative to NAV.
Be selective: Sobha, HDIL and Phoenix stand out: Our stock picks are based on
comfort on valuations, corporate governance/ disclosures, cash flows and subsector
preferences. Anant Raj and Phoenix (followed by DLF) are set to benefit from improving
physical market cues in IT / ITeS commercial and retail leasing. We would avoid Ansal,
Omaxe and IBREL given our view that record-breaking residential prices (coinciding with
falling volumes) and volumes (driven by speculation) are unsustainable. We prefer players
in relatively ‘sane’ markets such as Bangalore (Sobha and Prestige) and price warriors
focussing on asset turnover (HDIL).
Sector Top Picks
Sobha - Blue blooded Bangalore play (Outperform; TP: Rs430; upside 42%)
Strong core market: Direct play on Bangalore residential (57% of NAV), which is showing
signs of ‘sanity’- volumes improving even as prices inch up.
Improving balance sheet: Debt under control due to secondary offering (past and future)
land sales, pick up in residential sales.
Good quality land bank and disclosures and focus on execution
Sector Top Picks
HDIL - Value masked by near-term concerns (Outperform; TP: Rs316; upside 90%)
The right strategy in Mumbai: Competitive pricing has allowed HDIL to emerge as a
price warrior in every micro market. HDIL has consistently been able to sell inventory
within weeks of launch, as seen in places such as Kurla, Mulund and Palghar.
Fortified balance sheet: Gearing ratio improved due to fund raisings, strength in TDR
market and successful launches
Volatility in stock price in the near term due to concerns regarding airport project; value
should emerge in 3-6 months
Sector Top Picks
Phoenix Mills - Time for some retail therapy (Outperform; TP: Rs216, upside 24%)
Focussed play on strong momentum in retail market: Leasing pick up driven by strong
same store sales growth trends.
Progress to be immediately visible in earnings growth- New projects coming on
stream and renegotiation at existing property is expected t drive earnings growth going
forward. We expect an earnings CAGR of 49% over the next three years.
No concerns on balance sheet - Rent inflow from existing assets to cover more than
100% of the annual interest cost.
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