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India: Real Estate
Equity Research
In focus: Operating cash, disclosures; initiate 5 cos; Buy Sobha (CL)
Operating cash and disclosures in focus, initiate on 5 stocks
We initiate on five companies—Oberoi Realty with Buy, Godrej Properties and
Phoenix Mills both with Sell, and Prestige Estates and Jaypee Infratech both
with Neutral. We base our stock selection on the ability of the companies to
generate operating cash, their level of quarterly disclosures, leverage ratios
and valuations. The real estate sector has been very volatile (beta >1.5) since
2007, and we think companies with better disclosures stand a better chance of
gaining investor attention, which could in turn lead to better valuations. We
see increased maturity in the sector over the past one year with improving
cash profiles and the listing of several companies (about US$1 bn market cap).
Valuations beginning to appear reasonable
The 10 Indian real estate stocks under our coverage are currently trading at
1.4X FY12E P/B (at 48% discount to the 3-year average) and below 1-SD on
12-m fwd P/B. Adjusted for equity dilution, some stocks are currently
trading close to trough prices seen in early-CY2009.
Upgrade Sobha to Buy and add to CL; initiate on Oberoi with Buy
We upgrade Sobha to Buy and add it to the Conviction list with a revised 12-
m RNAV-based TP of Rs331 (from Rs360) as we believe expansion into new
cities will drive volumes and revenue growth for the company over FY11EFY13E.
Further, Sobha has generated operating cash in the past six quarters.
We initiate on Oberoi with Buy and a 12-m RNAV-based TP of Rs327. Oberoi
is a Mumbai-based developer that scores well on cash generation, brand
image, and has sector leading RoE. We downgrade Indiabulls Real Estate to
Neutral from Buy on the back of limited visibility on usage of cash. We revise
FY11E-FY13E EPS for existing stocks under our coverage by -36% to +37%
and 12-m RNAV-based TPs by -8% to -46%.
Direction of interest rates and construction costs key headwinds
We prefer geographies that provide some affordability cushion as we
expect headwinds on affordability to persist on account of rising interest
rates and higher construction costs. In our view, Bangalore is well
positioned as pricing levels remain reasonable.
Key risks to our view
(1) Rapid price hikes exerting pressure on volumes, (2) interest rate risk, (3)
volatility in input costs, (4) inability to procure land at reasonable cost.
In focus: Operating cash, disclosures; initiate on 5 companies
In this report, we evaluate companies across metrics such as operating cash generation,
quarterly disclosures, execution history and capability, geographical presence and
valuations. Within our existing coverage of five Indian real estate stocks, based on the
above metrics, we prefer Sobha Developers and HDIL (see Exhibits 13 and 14). We also
initiate coverage on five more stocks—Oberoi Realty (OEBO.BO; Buy), Godrej Properties
(GODR.BO; Sell), Phoenix Mills (PHOE.BO; Sell), Jaypee Infratech (JYPE.BO; Neutral), and
Prestige Estates (PREG.BO; Neutral).
We screen real estate stocks under our coverage based on the following metrics:
Operating cash generation: We believe that earnings for Indian real estate
companies are not comparable because of the different revenue recognition
policies followed by companies. Operating cash, on the other hand, is not affected
by revenue recognition.
Stocks that screen well: Sobha Developers and Oberoi Realty.
Disclosures: We attempt to evaluate companies based on the information in their
quarterly disclosures. We believe that consistent and systematic disclosures help
investors make informed decisions.
Stocks that screen well: Sobha Developers, Oberoi Realty, and Godrej Properties.
Valuations: We analyse companies on P/B versus ROE and P/E to help triangulate
our RNAV based valuations.
Stocks that screen well: Sobha Developers and HDIL.
Execution: We track execution capability and the ability of companies to stick to
their schedules for timely deliveries, ensuring that cash inflows and revenue
recognition are not delayed.
Stocks that screen well: Sobha Developers, Phoenix Mills, and Oberoi Realty.
Our preferred picks: Buy Sobha (on CL), Oberoi Realty, and HDIL
Sobha Developers (SOBH.BO; Buy, on CL; 12-month TP: Rs331; 38% potential upside)
We believe Sobha Developers’ current stock price does not factor in its rising ROE
and consistent cash generating ability. Sobha has generated operating cash in the
past six quarters.
We believe that the increased hiring by the IT industry in the medium term should
have a positive impact on Sobha Developers in FY12E and FY13E, both in terms of
increased residential sales in Bangalore and Pune as well as increased orders for
its contractual business (which caters mainly to Infosys).
We upgrade Sobha to Buy and add it to our Conviction Buy list, from Neutral.
However, we lower our FY11E-FY13E EPS by 7%-17% primarily to account for
higher cost inflation. Consequently, we reduce our 12-month RNAV-based target
price for Sobha to Rs331, from Rs360 previously.
Key risks include weak response to projects in Gurgaon, Chennai and Coimbatore,
slowdown in the IT industry, and delay in collections from customers.
Oberoi Realty (OEBO.BO; Buy; 12-month TP: Rs327; 44% potential upside)
We initiate coverage on Oberoi Realty with a Buy rating as we believe that the
company has a consistent track record of generating operating cash, sector
leading ROEs as well as an unleveraged balance-sheet.
We also believe Oberoi has a good track record of value creation by acquiring
large contiguous land parcels and subsequently developing the parcels through
integrated development comprising residential, office, retail, and hospitality assets
in Mumbai.
Our 12-m target price of Rs327 is set at par with our FY12E RNAV. We believe that
Oberoi’s proven execution track record, debt-free balance sheet and attractive land
parcels do not warrant any discount to RNAV.
Key risks include lower than expected pricing, inability to successfully deploy cash,
delay in project launches.
HDIL (HDIL.BO, Buy; 12-month TP: Rs211; 42% potential upside)
We maintain Buy on HDIL as we believe HDIL’s current stock price does not fully
capture its improving cash flows from Mumbai residential sales.
HDIL also screens well on our valuation framework (Exhibit 13) with FY12E P/B of
0.6X vs sector FY12E P/B of 1.4X. We also believe that HDIL is making progress on
improving its disclosures by including disclosures on new launches, geographical
segments and operating cash before investments.
We lower our FY11E-FY13E EPS by 8%-14% and our 12-month RNAV-based target
price to Rs211, from Rs309, to reflect our more bearish selling price assumptions,
slower progress on the Mumbai International Airport Limited (MIAL) project and
lower TDR sale assumptions. We apply a 30% discount to our FY12E RNAV (10%
earlier) on account of low operating cash flow generation and risk associated with
the slum rehabilitation process as well as geographical concentration risk.
Key risks include delays in key SRA projects; higher than expected correction in
TDR prices and a decline in Mumbai residential demand.
Godrej Properties (GODR.BO; Sell; 12-month TP: Rs527; 12% potential downside)
We believe Godrej Properties is fully priced, reflecting its potential ROE as well as
cash generation (see Exhibit 11). We remain constructive on the business model of
the company as well as its earnings potential, but rate it Sell primarily on
valuations.
The stock is currently trading at 4.1X FY12E P/B vs a sector average of 1.4X. On
FY12E P/E, Godrej Properties trades at 25.9X vs a sector average of 11.1X. We
believe that the current growth and returns profile do not justify such a high
premium over the sector.
Our 12-m TP of Rs 527 is set at par with our FY12E RNAV.
Key risks include higher than expected pricing, new deals and land acquisition
from the Godrej group.
Phoenix Mills (PHOE.BO; Sell; 12-month TP: Rs214; 15% potential upside)
We believe the current valuation for Phoenix Mills does not factor in potential
delays in the completion of “market cities” under development (31% of FY12E
RNAV).
Phoenix Mills has outperformed the BSE Realty Index by 34% since January 2010
(see Exhibit 72). The stock is currently trading at 1.6X FY12E P/B vs a sector
average of 1.4X. On FY12E P/E, Phoenix Mills trades at 28.5X vs a sector average of
11.1X. We believe that the current growth and returns profile does not justify such
a high premium over the rest of the sector. We initiate on Phoenix Mills with a Sell.
Our 12-m TP of Rs 214 is set at a 20% discount to our FY12E RNAV of Rs267 due to
the risk of delays in completion of key projects in CY2011E.
Key risks include creation of favourable exit structures for co-investors,
capitalization rate less than 10%, faster than expected operational stability in retail
malls.
Jaypee Infratech (JYPE.BO; Neutral; 12-month TP: Rs78; 31% potential upside)
We have a favourable outlook on the visibility of revenues for Jaypee Infratech
over the next 3 years given the 31mn sqft of cumulative sales. We also believe that
the timely completion of the Yamuna Expressway would enhance the value of its
first two land parcels.
The stock is currently trading at 1.3X FY12E P/B vs sector average of 1.4X. On
FY12E P/E, Jaypee Infratech trades at 5.8X vs sector average of 11.1X. While the
stock appears attractive on valuations, we believe lower than expected toll
revenues from the Yamuna Expressway could result in near-term headwinds.
We initiate on Jaypee Infratech with a Neutral rating. Our 12-m TP of Rs78 is set at
a 20% discount to FY12E RNAV of Rs97 to account for significant scale up in
execution required for timely completion of projects and concentration risk.
Key risks: upside—higher than expected pricing in the parcels further away from
Delhi, faster than expected completion of Expressway; downside—slower than
expected execution.
Prestige Estates (PREG.BO; Neutral; 12-month TP: Rs169; 32% potential upside)
Prestige is a Bangalore-based developer with a good development track record in
the residential, commercial, retail and hospitality segments in South India.
The stock is currently trading at 1.7X FY12E P/B vs sector average of 1.4X. On
FY12E P/E, Prestige trades at 12.8X vs sector average of 11.1X. We forecast an
FY12E ROE of 14% and believe that current valuations reflect a balanced riskreward
profile.
We initiate on Prestige with Neutral and a 12-m FY12E RNAV-based target price of
Rs169. We set our target price at a 10% discount to FY12E RNAV of Rs188.
Key risks: upside—faster than expected recovery in Bangalore prices; downside—
delay in launches in Bangalore and Chennai and an adverse demand scenario in
South India.
Indiabulls Real Estate (INRL.BO; Neutral; 12-month TP: Rs135; 17% potential upside)
We downgrade Indiabulls Real Estate to Neutral from Buy, as we believe that while
the company is delivering EPS growth, there is limited visibility on the use of its
cash flow. Indiabulls is down 42.5% since we added it to our Buy List on Nov 8,
2010, vs the Sensex down 12.4% (12m -35.9% vs Sensex +13.9%). We attribute this
underperformance to: (1) sharp fall in the real estate index by 44%, and (2) low
volumes in Lower Parel projects.
We have also lowered our FY12E RNAV to Rs225 from Rs310 on account of lower
cash balances (investments into new land parcels), lower power business
valuations and weak sales in the Lower Parel project. We lower our 12-month
RNAV-based TP to Rs135 from Rs 248 as we widen our discount to FY12E RNAV to
40% from 20% due to low operating cash generation, less near-term land
monetization and limited visibility on balance sheet changes.
We have increased our FY11E-FY12E EPS estimates by 37% and 22%, respectively,
and cut our FY13E EPS by 10% on better visibility in the accounting policy as
revenue is booked faster than cash accretion, resulting in higher receivables
(receivables up to Rs3.9 bn in 3QFY11 vs Rs0.19 bn in 4QFY10 vs 9MFY11 revenues
of Rs8.7 bn).
Key risks: upside—faster than expected sales in Gurgaon, Panvel; downside—
cancellation of sales at Lower Parel, Worli.
Unitech (UNTE.BO; Neutral; 12-month TP: Rs49; 40% potential upside)
We retain our Neutral rating on Unitech. We lower our FY12E RNAV to Rs69 from
Rs87 on account lower valuation of telecom business, assuming higher
construction costs and slower execution. We lower our 12-month RNAV-based TP
to Rs49 from Rs87 as we now apply a 30% discount to FY12E RNAV due to limited
disclosures, risks associated with high promoter leverage (see Exhibit 30) and slow
execution.
We lower our FY11E-FY13E EPS for Unitech by 9%-31% as we assume lower sales
volumes, higher construction costs and slower execution.
Key risks: upside—increased pace of execution on ongoing projects; downside—
delays in completion of projects.
DLF (DLF.BO; Neutral; 12-month TP: Rs294; 23% potential upside)
We retain our Neutral rating for DLF. We lower our FY11E-FY13E EPS estimates for
DLF by 26%-36% due to a delay in key projects such as NTC Mills in Mumbai,
higher construction cost and interest assumptions.
We reduce our 12-m RNAV-based target price to Rs294 from Rs 378 due to delay in
projects as well as applying a 10% discount to FY12E RNAV (see Exhibit 14).
Key risks: upside—faster than expected approvals for Mumbai project, faster than
expected debt reduction; downside—slower than anticipated asset sales,
continued slowdown in the commercial property market.
Valuations volatile, but now undemanding
Led by concerns on financing and cashflow management, the Indian real estate sector has
seen a significant correction of 40%+ since October 2010. This has led to the sector trading
at undemanding multiples with respect to its own trading history as well as the broader
market. On a one-year forward P/B basis, the sector is now trading below more than 1-SD,
which is quite significant since the bands are quite wide with the sector having a beta of 1.5.
The sector is now trading at 60% discount to the broader NIFTY on 1-year forward P/B
compared with average 38% discount since January 2009 (average 3% discount since
August 2007).
Furthermore, adjusting for fresh equity raised recently would imply that HDIL and INRL are
currently trading at prices similar to early-2009 lows. Adjusted price for Unitech would be
Rs22, which is lower than its first QIP price of Rs38.5 in April 2009 (see Exhibit 9).
We see four distinct phases in a short four-year trading period for the sector (see Exhibit
10):
Phase I (January 2007-January 2008). This phase saw valuations driven by land bank
acquisitions rather than execution. Various companies built land banks through a mix of
equity as well as debt. This phase saw rapid balance sheet expansion for most companies.
Phase II (January 2008-March 2009). Real estate index fell 85% as focus shifted to
execution and demand slowed down due to lower affordability and low buyer confidence.
Furthermore, the global credit crisis led do financing issues for the sector as companies
were relying a lot on commercial paper.
Phase III (May 2009-November 2010). This phase saw more range bound trading for the
sector driven by fundamental issues. Post sharp rebound after May 2009 general elections,
real estate stocks started pricing in both volume as well as pricing recovery, which led to
their underperformance.
Phase IV (November 2010-current). Led by concerns over financing issues, the real estate
sector has corrected by 40+% in the past four months. Unlike in CY2008, the current stock
price correction is not matched by corresponding sharp earning downgrades. The recent
stock price fall has brought into focus various issues such as quarterly disclosures and
discipline on cashflow generation as well as usage.
Valuations now increasingly comparable with regional peers
Post the sharp correction, the valuations of Indian real estate stocks have started to appear
reasonable, even with respect to regional companies. Indian real estate stocks have a
relatively short track record compared with other sectors and consequently there is limited
historical P/B, P/E or P/NAV data available for these companies. In our view, this is one of
the key reasons that makes the sector volatile and newsflow-driven.
Exhibits 6 and 7 show comparison between Indian companies and regional peers based on
FY13E estimates. Godrej Properties looks expensive, while Sobha Developers, HDIL and
INRL appear undervalued.
Operating cash generation, disclosures key determinants
Key factors we look for in formulating our view include:
Cashflow pattern. We prefer companies that have a good track record of operating
cashflow generation. As a corollary to this, we prefer companies that have the capability of
returning cash to stakeholders (debt as well as equity). Oberoi Realty, Sobha Developers
and Phoenix Mills screen well on this parameter.
Quarterly disclosures. Given the backdrop of uncertainty and high volatility in the sector,
we believe companies with better disclosure and hence improved transparency stand a
better chance of gaining investor attention, which could in turn lead to better valuations.
Pricing comfort. We like geographies where the price rise has been limited and hence
there is some cushion of affordability to accommodate higher interest rates. We prefer
Bangalore residential market the most. Companies with largest NAV accruing from
Bangalore include Sobha Developers and Prestige Projects.
Execution. We prefer companies which have: (1) large area under execution as a
proportion of their land bank, and (2) good delivery track record with lesser delays.
Exhibit 13 summarizes our framework for stock selection. We have a Buy rating on Sobha
Developers (on CL), Oberoi Realty and HDIL. Our 12-month target prices are based on
FY2012E RNAV. Exhibit 14 below, explains the rationale behind the discounts we have used,
to arrive at our target prices.
We believe that the sector is slowly moving towards maturity
1) We see some improvement in disclosures. We believe availability of limited
information has been one of the key reasons for volatile stock performance. We believe
that disclosure patterns of various companies are showing an improving trend especially in
the case of operating data (Exhibit 15). Higher competition to attract investor attention is
one of the key reasons driving this change especially since seven new companies have
listed in the past five quarters. We find the disclosure levels of some of the recently listed
companies such as Oberoi Realty, Godrej Properties and Prestige Estates quite good and
we believe this trend could likely pick up. Moreover, new listings have provided depth to
the sector in terms of more data points.
Further, we believe additional details such as cashflow generation and usage, and land
bank details would be helpful. In our view, disclosure policies and norms should be
consistent across companies for e.g. what to recognize as part of sold apartments. We see
companies with better disclosures witnessing lower beta and going forward this could
translate into improved valuations, in our view.
2) More companies generating operating cashflow. Another important signal that the
sector is slowly moving towards maturity is that more companies have started to generate
operating cashflow. Sobha, Oberoi Realty and Phoenix Mills generated operating cashflow
in FY2010 and we expect a similar trend to continue based on current project execution
patterns (see Exhibit 18). In addition, we expect Jaypee Infratech to start generating
significant operating cashflows post completion of Delhi-Agra Yamuna Expressway project.
We see sector aggregate RoEs trending up from 8% in FY2010 to 11% in FY13E as
execution for various companies improves. More importantly, we see more linkages
between PAT and cashflow which is quite different from FY07-FY08 (see Exhibit 18).
We believe a judicious land banking strategy is among the most important parameters that
determine operating cashflow and presents the largest downside risk to our assumptions.
In our view, companies should consider investing in new land banks only when a
proportion of area under execution reaches a particular threshold. Large land purchases,
when current assets are not being monetized fully, could lead to lower RoEs on account of
lower asset turnover, in our view. Exhibit 20 summarizes area under execution for various
companies and the current landbanking strategy. Companies such as DLF, Unitech and
HDIL have started investing in more land despite having large undeveloped portfolio of
projects.
Headwinds persist in the form of higher interest rates, costs
India currently faces the issue of high inflation and current monetary policy action is being
driven to control inflationary expectations. HDFC has recently increased home loan rates
for individuals by 125-150 bp. Home loan rates may go up further, in our view, as our
economist forecasts a cumulative hike in interest rates of 100 bp in CY2011.
Bangalore offers the best affordability cushion. Given interest rate headwinds, we prefer
Bangalore market the most. Selling prices in Bangalore and Noida have remained stable
and this has led to some affordability cushion. We believe rise in interest rates by 100 bp
will be balanced by rise in salaries. Hence the affordability equation will hinge on
movement in selling prices. In our view, a 15%-20% discount to current prices in Mumbai
may lead to demand revival, while Bangalore will likely see stable demand at current prices.
Also, if customers defer purchases due to higher interest rates, we think real estate
companies may consider providing an interest rate cushion of 1%-2% for 3-4 years. This
could imply an indirect discount of 4%-5%, which could help push sales, in our view.
Oberoi Realty and Phoenix Mills have unleveraged balance sheets. We believe that all
companies in our coverage universe have reasonable leverage ratios with FY12E
Debt/EBITDA < 3 (see Exhibit 25). DLF has Debt/EBITDA of 3.7X but has large recurring
income, which enables it to raise longer tenure loans. INRL has higher Debt/EBITDA on
account of its power business. Within our coverage universe, Oberoi Realty has the most
unleveraged balance sheet. We believe Oberoi Realty—with its ability to add land
reserves—is best positioned to benefit in the event of land price decline triggered by
continued high interest rates and fall in end-product prices.
High inflation may put pressure on construction costs. Higher commodity prices may
put pressure on construction costs. Exhibit 26 and Exhibit 27 shows price trends in two key
materials used for construction—cement and steel. Furthermore, high inflation can lead to
cost pressures on labor. Longer term, we have assumed 5% inflation in construction costs
as well as selling prices. We think it is reasonable looking at the change in prices of
steel/cement over the past 10-year period. In addition, we now incorporate an additional
5% cost inflation in FY2012E.
Companies such as DLF and Sobha have indicated the need for gradual selling to protect
margins in an inflationary environment. This strategy has the risk of expanding the working
capital cycle. Companies which are most protected from construction cost inflation are
Oberoi Realty (highest gross margin) and DLF, Prestige (highest proportion of recurring
income). In addition, Bangalore offers an affordability cushion and hence companies
having strong brand equity (Sobha, Prestige Projects) have the ability to pass on higher
construction costs to consumers.
Volume-based strategy key to generating higher RoEs, in our view
We prefer a volume-based strategy to a pricing-based strategy. Most real estate companies
follow a pricing-based strategy which focuses on profit maximization than return
maximization. We think companies should adopt a flexible pricing strategy as it could help
meet volume targets. Key strategies of various companies are as below:
DLF: DLF plans to maintain a strategy to protect margins and take price increases in line
with increase in costs. DLF has disappointed on FY11E residential sales on account of lower
launches, which it indicated was due to delay in getting necessary government approvals.
Unitech: Unitech has moved from a volume-led strategy to pricing-led strategy. In mid-
2009, Unitech entered into the affordable housing segment and it saw large residential
volumes. But now the company has shifted focus to profit maximization and quarterly
volumes have seen a continuous drop.
HDIL: We like HDIL’s strategy as it has been launching residential projects at 15%-20%
discount to other projects in the same geographical area.
Sobha: In our view, Sobha manages to keep a fine balance between protecting gross
margins and achieving targeted volumes. For Bangalore, we believe this is a prudent
strategy as price rise in the city has been rational and thus there is an affordability cushion.
Oberoi Realty: ORL adopts a strategy of sales linked to progress of the project. In the past,
ORL has been flexible in rationalizing prices as seen in the case of Oberoi Splendour in
May 2009. ORL cut pricing by around 20%, which played a key role in restarting sales
momentum in Mumbai and consequently we build in 10%-15% lower prices into our model.
Signaling actions, disclosures important, in our view
In our view, the sector could see lesser volatility if disclosure levels improved and became
more consistent. In addition, we believe signaling actions could help improve valuations.
Four signaling options available to companies include dividend payment, equity buyback,
promoter purchase, and debt repayment. We think signaling actions should not take
precedence over business actions, but rather complement them.
Exhibit 30 summarizes options available to companies under our coverage. We believe the
most-suited options currently available for Indian companies are debt repayment and
dividend payment. Equity buyback may not be a prudent strategy in FY12E, given a difficult
liquidity environment, in our view. Regarding promoter purchase, we view direct market
purchase preferable than issue of warrants
From an equity perspective, we think consistent dividend payment can be a good signaling
action and currently there is limited guidance from the managements about the same. We
believe healthy dividend payout indicates: (1) management’s intention to share profits with
minority shareholders, (2) better cashflow management, and (3) company’s adherence to
debt covenants and its ability to maintain healthy debt service ratios.
Sobha Developers, Godrej Properties and Phoenix Mills have the best dividend payment track
record. Jaypee Infratech has declared an interim dividend of Rs0.75 in Jan 2011. Further, we
believe consistent and regular dividend payments indicate better cash management. Exhibit
31 shows that Chinese companies have average dividend payout ratios of 20%-30%.
Better, more consistent disclosures key
Quarterly revenue break-up vertical-wise and city-wise: Exhibit 34 gives details of
various relevant segments. We see Sobha, HDIL and Godrej Properties providing a good
account of this data. We believe this will not only help in understand seasonality (if any),
but also provides more data points for comparison across companies.
Inventory/loans and advances details: Exhibit 35 highlights that a large portion of the
balance sheet of most companies comprises inventories and loans & advances. We think a
break-up in terms of land being used in current projects, construction WIP, other land and
interest capitalized information would be very useful. In addition, any key changes leading
to a change in these items would help, in our view.
Common and consistent accounting policies. There is no standard set of accounting
policies being followed by real estate companies. We observe three kinds of accounting
policies for revenue booking, which, in order of aggressiveness, are: (1) percentage
completion on total cost (land + construction), (2) percentage completion on construction
cost, and (3) project cost basis.
Monthly operating data. Most companies have started giving cumulative sales value as
well as volume data. Most Chinese companies report operating data on a monthly basis
and also give geographical data. Exhibit 37 summarizes operating information available on
a quarterly basis and potentially useful data.
Land purchase guidance. Chinese companies disclose value of new land purchases on a
consistent basis. We believe similar data and guidance on future land purchases could be
potentially useful in valuing Indian real estate companies.
Key risks
Rapid price hikes may put downward pressure on volumes
We model healthy volume offtake in the residential segment assuming moderate price
hikes. However, if developers were to increase prices rapidly (as seen in CY2007), volumes
may come under severe pressure. This could result in higher phasing of the land bank, thus
reducing near-term cashflow visibility. Impact on NAV valuation would likely be negative,
although partially mitigated by higher pricing. However, we think such a scenario is
unlikely in the medium term as developers would focus more on ensuring healthy demand
than higher pricing comfort.
Property prices are cyclical
We believe a significant decline in property prices due to: (1) higher interest rates, (2) a
significant increase in supply, and (3) a demand slowdown, may impact revenue
assumptions and earnings. However, we note that post the sharp correction in property
prices in early-2009, companies are in consolidation mode across most locations and the
risk of another sharp fall is limited.
Interest rate risk
A sharp increase in interest rates may impact revenues and earnings of the residential
segment. A moderate interest rate regime over the past decade and the availability of
financing from housing finance companies and banks have been the key demand drivers
for the residential segment. However, the Reserve Bank of India in its latest monetary
policy has expressed discomfort at the rise in residential prices and has initiated some
tightening measures for individual real estate loans more than Rs7.5 mn. In our view,
lowering this limit could raise the borrowing costs for a larger proportion of consumers,
thus affecting affordability. Mortgage rates may also rise on the back of general tightening
to curb inflation.
Sharp increase in commercial demand
We expect commercial pricing and new launches to remain weak over the next 3-4
quarters due to high current inventory of 40 months. However, faster growth in the IT
sector and higher non-IT demand due to robust economic growth could present a key
upside risk to our assumptions. Improvement in sentiment may also result in lower cap
rates than our estimate of 9% for commercial real estate and 10% for retail real estate.
Rapid appreciation of input costs
A sharp increase in prices of construction material used by the real estate sector may have
a negative impact on profitability. We note that a major component of the construction cost
is accounted for by cement and steel, prices of which could rise as the economic
environment improves.
Inability to procure land at reasonable costs
Competition in real estate markets is primarily based on the availability and cost of land.
We see competition from both domestic and foreign companies in bidding for new
property development projects. Oberoi Realty and INRL need to continuously replenish
land bank and high land costs would adversely impact growth and margins.
India Equity Research Reports, IPO and Stock News
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India: Real Estate
Equity Research
In focus: Operating cash, disclosures; initiate 5 cos; Buy Sobha (CL)
Operating cash and disclosures in focus, initiate on 5 stocks
We initiate on five companies—Oberoi Realty with Buy, Godrej Properties and
Phoenix Mills both with Sell, and Prestige Estates and Jaypee Infratech both
with Neutral. We base our stock selection on the ability of the companies to
generate operating cash, their level of quarterly disclosures, leverage ratios
and valuations. The real estate sector has been very volatile (beta >1.5) since
2007, and we think companies with better disclosures stand a better chance of
gaining investor attention, which could in turn lead to better valuations. We
see increased maturity in the sector over the past one year with improving
cash profiles and the listing of several companies (about US$1 bn market cap).
Valuations beginning to appear reasonable
The 10 Indian real estate stocks under our coverage are currently trading at
1.4X FY12E P/B (at 48% discount to the 3-year average) and below 1-SD on
12-m fwd P/B. Adjusted for equity dilution, some stocks are currently
trading close to trough prices seen in early-CY2009.
Upgrade Sobha to Buy and add to CL; initiate on Oberoi with Buy
We upgrade Sobha to Buy and add it to the Conviction list with a revised 12-
m RNAV-based TP of Rs331 (from Rs360) as we believe expansion into new
cities will drive volumes and revenue growth for the company over FY11EFY13E.
Further, Sobha has generated operating cash in the past six quarters.
We initiate on Oberoi with Buy and a 12-m RNAV-based TP of Rs327. Oberoi
is a Mumbai-based developer that scores well on cash generation, brand
image, and has sector leading RoE. We downgrade Indiabulls Real Estate to
Neutral from Buy on the back of limited visibility on usage of cash. We revise
FY11E-FY13E EPS for existing stocks under our coverage by -36% to +37%
and 12-m RNAV-based TPs by -8% to -46%.
Direction of interest rates and construction costs key headwinds
We prefer geographies that provide some affordability cushion as we
expect headwinds on affordability to persist on account of rising interest
rates and higher construction costs. In our view, Bangalore is well
positioned as pricing levels remain reasonable.
Key risks to our view
(1) Rapid price hikes exerting pressure on volumes, (2) interest rate risk, (3)
volatility in input costs, (4) inability to procure land at reasonable cost.
In focus: Operating cash, disclosures; initiate on 5 companies
In this report, we evaluate companies across metrics such as operating cash generation,
quarterly disclosures, execution history and capability, geographical presence and
valuations. Within our existing coverage of five Indian real estate stocks, based on the
above metrics, we prefer Sobha Developers and HDIL (see Exhibits 13 and 14). We also
initiate coverage on five more stocks—Oberoi Realty (OEBO.BO; Buy), Godrej Properties
(GODR.BO; Sell), Phoenix Mills (PHOE.BO; Sell), Jaypee Infratech (JYPE.BO; Neutral), and
Prestige Estates (PREG.BO; Neutral).
We screen real estate stocks under our coverage based on the following metrics:
Operating cash generation: We believe that earnings for Indian real estate
companies are not comparable because of the different revenue recognition
policies followed by companies. Operating cash, on the other hand, is not affected
by revenue recognition.
Stocks that screen well: Sobha Developers and Oberoi Realty.
Disclosures: We attempt to evaluate companies based on the information in their
quarterly disclosures. We believe that consistent and systematic disclosures help
investors make informed decisions.
Stocks that screen well: Sobha Developers, Oberoi Realty, and Godrej Properties.
Valuations: We analyse companies on P/B versus ROE and P/E to help triangulate
our RNAV based valuations.
Stocks that screen well: Sobha Developers and HDIL.
Execution: We track execution capability and the ability of companies to stick to
their schedules for timely deliveries, ensuring that cash inflows and revenue
recognition are not delayed.
Stocks that screen well: Sobha Developers, Phoenix Mills, and Oberoi Realty.
Our preferred picks: Buy Sobha (on CL), Oberoi Realty, and HDIL
Sobha Developers (SOBH.BO; Buy, on CL; 12-month TP: Rs331; 38% potential upside)
We believe Sobha Developers’ current stock price does not factor in its rising ROE
and consistent cash generating ability. Sobha has generated operating cash in the
past six quarters.
We believe that the increased hiring by the IT industry in the medium term should
have a positive impact on Sobha Developers in FY12E and FY13E, both in terms of
increased residential sales in Bangalore and Pune as well as increased orders for
its contractual business (which caters mainly to Infosys).
We upgrade Sobha to Buy and add it to our Conviction Buy list, from Neutral.
However, we lower our FY11E-FY13E EPS by 7%-17% primarily to account for
higher cost inflation. Consequently, we reduce our 12-month RNAV-based target
price for Sobha to Rs331, from Rs360 previously.
Key risks include weak response to projects in Gurgaon, Chennai and Coimbatore,
slowdown in the IT industry, and delay in collections from customers.
Oberoi Realty (OEBO.BO; Buy; 12-month TP: Rs327; 44% potential upside)
We initiate coverage on Oberoi Realty with a Buy rating as we believe that the
company has a consistent track record of generating operating cash, sector
leading ROEs as well as an unleveraged balance-sheet.
We also believe Oberoi has a good track record of value creation by acquiring
large contiguous land parcels and subsequently developing the parcels through
integrated development comprising residential, office, retail, and hospitality assets
in Mumbai.
Our 12-m target price of Rs327 is set at par with our FY12E RNAV. We believe that
Oberoi’s proven execution track record, debt-free balance sheet and attractive land
parcels do not warrant any discount to RNAV.
Key risks include lower than expected pricing, inability to successfully deploy cash,
delay in project launches.
HDIL (HDIL.BO, Buy; 12-month TP: Rs211; 42% potential upside)
We maintain Buy on HDIL as we believe HDIL’s current stock price does not fully
capture its improving cash flows from Mumbai residential sales.
HDIL also screens well on our valuation framework (Exhibit 13) with FY12E P/B of
0.6X vs sector FY12E P/B of 1.4X. We also believe that HDIL is making progress on
improving its disclosures by including disclosures on new launches, geographical
segments and operating cash before investments.
We lower our FY11E-FY13E EPS by 8%-14% and our 12-month RNAV-based target
price to Rs211, from Rs309, to reflect our more bearish selling price assumptions,
slower progress on the Mumbai International Airport Limited (MIAL) project and
lower TDR sale assumptions. We apply a 30% discount to our FY12E RNAV (10%
earlier) on account of low operating cash flow generation and risk associated with
the slum rehabilitation process as well as geographical concentration risk.
Key risks include delays in key SRA projects; higher than expected correction in
TDR prices and a decline in Mumbai residential demand.
Godrej Properties (GODR.BO; Sell; 12-month TP: Rs527; 12% potential downside)
We believe Godrej Properties is fully priced, reflecting its potential ROE as well as
cash generation (see Exhibit 11). We remain constructive on the business model of
the company as well as its earnings potential, but rate it Sell primarily on
valuations.
The stock is currently trading at 4.1X FY12E P/B vs a sector average of 1.4X. On
FY12E P/E, Godrej Properties trades at 25.9X vs a sector average of 11.1X. We
believe that the current growth and returns profile do not justify such a high
premium over the sector.
Our 12-m TP of Rs 527 is set at par with our FY12E RNAV.
Key risks include higher than expected pricing, new deals and land acquisition
from the Godrej group.
Phoenix Mills (PHOE.BO; Sell; 12-month TP: Rs214; 15% potential upside)
We believe the current valuation for Phoenix Mills does not factor in potential
delays in the completion of “market cities” under development (31% of FY12E
RNAV).
Phoenix Mills has outperformed the BSE Realty Index by 34% since January 2010
(see Exhibit 72). The stock is currently trading at 1.6X FY12E P/B vs a sector
average of 1.4X. On FY12E P/E, Phoenix Mills trades at 28.5X vs a sector average of
11.1X. We believe that the current growth and returns profile does not justify such
a high premium over the rest of the sector. We initiate on Phoenix Mills with a Sell.
Our 12-m TP of Rs 214 is set at a 20% discount to our FY12E RNAV of Rs267 due to
the risk of delays in completion of key projects in CY2011E.
Key risks include creation of favourable exit structures for co-investors,
capitalization rate less than 10%, faster than expected operational stability in retail
malls.
Jaypee Infratech (JYPE.BO; Neutral; 12-month TP: Rs78; 31% potential upside)
We have a favourable outlook on the visibility of revenues for Jaypee Infratech
over the next 3 years given the 31mn sqft of cumulative sales. We also believe that
the timely completion of the Yamuna Expressway would enhance the value of its
first two land parcels.
The stock is currently trading at 1.3X FY12E P/B vs sector average of 1.4X. On
FY12E P/E, Jaypee Infratech trades at 5.8X vs sector average of 11.1X. While the
stock appears attractive on valuations, we believe lower than expected toll
revenues from the Yamuna Expressway could result in near-term headwinds.
We initiate on Jaypee Infratech with a Neutral rating. Our 12-m TP of Rs78 is set at
a 20% discount to FY12E RNAV of Rs97 to account for significant scale up in
execution required for timely completion of projects and concentration risk.
Key risks: upside—higher than expected pricing in the parcels further away from
Delhi, faster than expected completion of Expressway; downside—slower than
expected execution.
Prestige Estates (PREG.BO; Neutral; 12-month TP: Rs169; 32% potential upside)
Prestige is a Bangalore-based developer with a good development track record in
the residential, commercial, retail and hospitality segments in South India.
The stock is currently trading at 1.7X FY12E P/B vs sector average of 1.4X. On
FY12E P/E, Prestige trades at 12.8X vs sector average of 11.1X. We forecast an
FY12E ROE of 14% and believe that current valuations reflect a balanced riskreward
profile.
We initiate on Prestige with Neutral and a 12-m FY12E RNAV-based target price of
Rs169. We set our target price at a 10% discount to FY12E RNAV of Rs188.
Key risks: upside—faster than expected recovery in Bangalore prices; downside—
delay in launches in Bangalore and Chennai and an adverse demand scenario in
South India.
Indiabulls Real Estate (INRL.BO; Neutral; 12-month TP: Rs135; 17% potential upside)
We downgrade Indiabulls Real Estate to Neutral from Buy, as we believe that while
the company is delivering EPS growth, there is limited visibility on the use of its
cash flow. Indiabulls is down 42.5% since we added it to our Buy List on Nov 8,
2010, vs the Sensex down 12.4% (12m -35.9% vs Sensex +13.9%). We attribute this
underperformance to: (1) sharp fall in the real estate index by 44%, and (2) low
volumes in Lower Parel projects.
We have also lowered our FY12E RNAV to Rs225 from Rs310 on account of lower
cash balances (investments into new land parcels), lower power business
valuations and weak sales in the Lower Parel project. We lower our 12-month
RNAV-based TP to Rs135 from Rs 248 as we widen our discount to FY12E RNAV to
40% from 20% due to low operating cash generation, less near-term land
monetization and limited visibility on balance sheet changes.
We have increased our FY11E-FY12E EPS estimates by 37% and 22%, respectively,
and cut our FY13E EPS by 10% on better visibility in the accounting policy as
revenue is booked faster than cash accretion, resulting in higher receivables
(receivables up to Rs3.9 bn in 3QFY11 vs Rs0.19 bn in 4QFY10 vs 9MFY11 revenues
of Rs8.7 bn).
Key risks: upside—faster than expected sales in Gurgaon, Panvel; downside—
cancellation of sales at Lower Parel, Worli.
Unitech (UNTE.BO; Neutral; 12-month TP: Rs49; 40% potential upside)
We retain our Neutral rating on Unitech. We lower our FY12E RNAV to Rs69 from
Rs87 on account lower valuation of telecom business, assuming higher
construction costs and slower execution. We lower our 12-month RNAV-based TP
to Rs49 from Rs87 as we now apply a 30% discount to FY12E RNAV due to limited
disclosures, risks associated with high promoter leverage (see Exhibit 30) and slow
execution.
We lower our FY11E-FY13E EPS for Unitech by 9%-31% as we assume lower sales
volumes, higher construction costs and slower execution.
Key risks: upside—increased pace of execution on ongoing projects; downside—
delays in completion of projects.
DLF (DLF.BO; Neutral; 12-month TP: Rs294; 23% potential upside)
We retain our Neutral rating for DLF. We lower our FY11E-FY13E EPS estimates for
DLF by 26%-36% due to a delay in key projects such as NTC Mills in Mumbai,
higher construction cost and interest assumptions.
We reduce our 12-m RNAV-based target price to Rs294 from Rs 378 due to delay in
projects as well as applying a 10% discount to FY12E RNAV (see Exhibit 14).
Key risks: upside—faster than expected approvals for Mumbai project, faster than
expected debt reduction; downside—slower than anticipated asset sales,
continued slowdown in the commercial property market.
Valuations volatile, but now undemanding
Led by concerns on financing and cashflow management, the Indian real estate sector has
seen a significant correction of 40%+ since October 2010. This has led to the sector trading
at undemanding multiples with respect to its own trading history as well as the broader
market. On a one-year forward P/B basis, the sector is now trading below more than 1-SD,
which is quite significant since the bands are quite wide with the sector having a beta of 1.5.
The sector is now trading at 60% discount to the broader NIFTY on 1-year forward P/B
compared with average 38% discount since January 2009 (average 3% discount since
August 2007).
Furthermore, adjusting for fresh equity raised recently would imply that HDIL and INRL are
currently trading at prices similar to early-2009 lows. Adjusted price for Unitech would be
Rs22, which is lower than its first QIP price of Rs38.5 in April 2009 (see Exhibit 9).
We see four distinct phases in a short four-year trading period for the sector (see Exhibit
10):
Phase I (January 2007-January 2008). This phase saw valuations driven by land bank
acquisitions rather than execution. Various companies built land banks through a mix of
equity as well as debt. This phase saw rapid balance sheet expansion for most companies.
Phase II (January 2008-March 2009). Real estate index fell 85% as focus shifted to
execution and demand slowed down due to lower affordability and low buyer confidence.
Furthermore, the global credit crisis led do financing issues for the sector as companies
were relying a lot on commercial paper.
Phase III (May 2009-November 2010). This phase saw more range bound trading for the
sector driven by fundamental issues. Post sharp rebound after May 2009 general elections,
real estate stocks started pricing in both volume as well as pricing recovery, which led to
their underperformance.
Phase IV (November 2010-current). Led by concerns over financing issues, the real estate
sector has corrected by 40+% in the past four months. Unlike in CY2008, the current stock
price correction is not matched by corresponding sharp earning downgrades. The recent
stock price fall has brought into focus various issues such as quarterly disclosures and
discipline on cashflow generation as well as usage.
Valuations now increasingly comparable with regional peers
Post the sharp correction, the valuations of Indian real estate stocks have started to appear
reasonable, even with respect to regional companies. Indian real estate stocks have a
relatively short track record compared with other sectors and consequently there is limited
historical P/B, P/E or P/NAV data available for these companies. In our view, this is one of
the key reasons that makes the sector volatile and newsflow-driven.
Exhibits 6 and 7 show comparison between Indian companies and regional peers based on
FY13E estimates. Godrej Properties looks expensive, while Sobha Developers, HDIL and
INRL appear undervalued.
Operating cash generation, disclosures key determinants
Key factors we look for in formulating our view include:
Cashflow pattern. We prefer companies that have a good track record of operating
cashflow generation. As a corollary to this, we prefer companies that have the capability of
returning cash to stakeholders (debt as well as equity). Oberoi Realty, Sobha Developers
and Phoenix Mills screen well on this parameter.
Quarterly disclosures. Given the backdrop of uncertainty and high volatility in the sector,
we believe companies with better disclosure and hence improved transparency stand a
better chance of gaining investor attention, which could in turn lead to better valuations.
Pricing comfort. We like geographies where the price rise has been limited and hence
there is some cushion of affordability to accommodate higher interest rates. We prefer
Bangalore residential market the most. Companies with largest NAV accruing from
Bangalore include Sobha Developers and Prestige Projects.
Execution. We prefer companies which have: (1) large area under execution as a
proportion of their land bank, and (2) good delivery track record with lesser delays.
Exhibit 13 summarizes our framework for stock selection. We have a Buy rating on Sobha
Developers (on CL), Oberoi Realty and HDIL. Our 12-month target prices are based on
FY2012E RNAV. Exhibit 14 below, explains the rationale behind the discounts we have used,
to arrive at our target prices.
We believe that the sector is slowly moving towards maturity
1) We see some improvement in disclosures. We believe availability of limited
information has been one of the key reasons for volatile stock performance. We believe
that disclosure patterns of various companies are showing an improving trend especially in
the case of operating data (Exhibit 15). Higher competition to attract investor attention is
one of the key reasons driving this change especially since seven new companies have
listed in the past five quarters. We find the disclosure levels of some of the recently listed
companies such as Oberoi Realty, Godrej Properties and Prestige Estates quite good and
we believe this trend could likely pick up. Moreover, new listings have provided depth to
the sector in terms of more data points.
Further, we believe additional details such as cashflow generation and usage, and land
bank details would be helpful. In our view, disclosure policies and norms should be
consistent across companies for e.g. what to recognize as part of sold apartments. We see
companies with better disclosures witnessing lower beta and going forward this could
translate into improved valuations, in our view.
2) More companies generating operating cashflow. Another important signal that the
sector is slowly moving towards maturity is that more companies have started to generate
operating cashflow. Sobha, Oberoi Realty and Phoenix Mills generated operating cashflow
in FY2010 and we expect a similar trend to continue based on current project execution
patterns (see Exhibit 18). In addition, we expect Jaypee Infratech to start generating
significant operating cashflows post completion of Delhi-Agra Yamuna Expressway project.
We see sector aggregate RoEs trending up from 8% in FY2010 to 11% in FY13E as
execution for various companies improves. More importantly, we see more linkages
between PAT and cashflow which is quite different from FY07-FY08 (see Exhibit 18).
We believe a judicious land banking strategy is among the most important parameters that
determine operating cashflow and presents the largest downside risk to our assumptions.
In our view, companies should consider investing in new land banks only when a
proportion of area under execution reaches a particular threshold. Large land purchases,
when current assets are not being monetized fully, could lead to lower RoEs on account of
lower asset turnover, in our view. Exhibit 20 summarizes area under execution for various
companies and the current landbanking strategy. Companies such as DLF, Unitech and
HDIL have started investing in more land despite having large undeveloped portfolio of
projects.
Headwinds persist in the form of higher interest rates, costs
India currently faces the issue of high inflation and current monetary policy action is being
driven to control inflationary expectations. HDFC has recently increased home loan rates
for individuals by 125-150 bp. Home loan rates may go up further, in our view, as our
economist forecasts a cumulative hike in interest rates of 100 bp in CY2011.
Bangalore offers the best affordability cushion. Given interest rate headwinds, we prefer
Bangalore market the most. Selling prices in Bangalore and Noida have remained stable
and this has led to some affordability cushion. We believe rise in interest rates by 100 bp
will be balanced by rise in salaries. Hence the affordability equation will hinge on
movement in selling prices. In our view, a 15%-20% discount to current prices in Mumbai
may lead to demand revival, while Bangalore will likely see stable demand at current prices.
Also, if customers defer purchases due to higher interest rates, we think real estate
companies may consider providing an interest rate cushion of 1%-2% for 3-4 years. This
could imply an indirect discount of 4%-5%, which could help push sales, in our view.
Oberoi Realty and Phoenix Mills have unleveraged balance sheets. We believe that all
companies in our coverage universe have reasonable leverage ratios with FY12E
Debt/EBITDA < 3 (see Exhibit 25). DLF has Debt/EBITDA of 3.7X but has large recurring
income, which enables it to raise longer tenure loans. INRL has higher Debt/EBITDA on
account of its power business. Within our coverage universe, Oberoi Realty has the most
unleveraged balance sheet. We believe Oberoi Realty—with its ability to add land
reserves—is best positioned to benefit in the event of land price decline triggered by
continued high interest rates and fall in end-product prices.
High inflation may put pressure on construction costs. Higher commodity prices may
put pressure on construction costs. Exhibit 26 and Exhibit 27 shows price trends in two key
materials used for construction—cement and steel. Furthermore, high inflation can lead to
cost pressures on labor. Longer term, we have assumed 5% inflation in construction costs
as well as selling prices. We think it is reasonable looking at the change in prices of
steel/cement over the past 10-year period. In addition, we now incorporate an additional
5% cost inflation in FY2012E.
Companies such as DLF and Sobha have indicated the need for gradual selling to protect
margins in an inflationary environment. This strategy has the risk of expanding the working
capital cycle. Companies which are most protected from construction cost inflation are
Oberoi Realty (highest gross margin) and DLF, Prestige (highest proportion of recurring
income). In addition, Bangalore offers an affordability cushion and hence companies
having strong brand equity (Sobha, Prestige Projects) have the ability to pass on higher
construction costs to consumers.
Volume-based strategy key to generating higher RoEs, in our view
We prefer a volume-based strategy to a pricing-based strategy. Most real estate companies
follow a pricing-based strategy which focuses on profit maximization than return
maximization. We think companies should adopt a flexible pricing strategy as it could help
meet volume targets. Key strategies of various companies are as below:
DLF: DLF plans to maintain a strategy to protect margins and take price increases in line
with increase in costs. DLF has disappointed on FY11E residential sales on account of lower
launches, which it indicated was due to delay in getting necessary government approvals.
Unitech: Unitech has moved from a volume-led strategy to pricing-led strategy. In mid-
2009, Unitech entered into the affordable housing segment and it saw large residential
volumes. But now the company has shifted focus to profit maximization and quarterly
volumes have seen a continuous drop.
HDIL: We like HDIL’s strategy as it has been launching residential projects at 15%-20%
discount to other projects in the same geographical area.
Sobha: In our view, Sobha manages to keep a fine balance between protecting gross
margins and achieving targeted volumes. For Bangalore, we believe this is a prudent
strategy as price rise in the city has been rational and thus there is an affordability cushion.
Oberoi Realty: ORL adopts a strategy of sales linked to progress of the project. In the past,
ORL has been flexible in rationalizing prices as seen in the case of Oberoi Splendour in
May 2009. ORL cut pricing by around 20%, which played a key role in restarting sales
momentum in Mumbai and consequently we build in 10%-15% lower prices into our model.
Signaling actions, disclosures important, in our view
In our view, the sector could see lesser volatility if disclosure levels improved and became
more consistent. In addition, we believe signaling actions could help improve valuations.
Four signaling options available to companies include dividend payment, equity buyback,
promoter purchase, and debt repayment. We think signaling actions should not take
precedence over business actions, but rather complement them.
Exhibit 30 summarizes options available to companies under our coverage. We believe the
most-suited options currently available for Indian companies are debt repayment and
dividend payment. Equity buyback may not be a prudent strategy in FY12E, given a difficult
liquidity environment, in our view. Regarding promoter purchase, we view direct market
purchase preferable than issue of warrants
From an equity perspective, we think consistent dividend payment can be a good signaling
action and currently there is limited guidance from the managements about the same. We
believe healthy dividend payout indicates: (1) management’s intention to share profits with
minority shareholders, (2) better cashflow management, and (3) company’s adherence to
debt covenants and its ability to maintain healthy debt service ratios.
Sobha Developers, Godrej Properties and Phoenix Mills have the best dividend payment track
record. Jaypee Infratech has declared an interim dividend of Rs0.75 in Jan 2011. Further, we
believe consistent and regular dividend payments indicate better cash management. Exhibit
31 shows that Chinese companies have average dividend payout ratios of 20%-30%.
Better, more consistent disclosures key
Quarterly revenue break-up vertical-wise and city-wise: Exhibit 34 gives details of
various relevant segments. We see Sobha, HDIL and Godrej Properties providing a good
account of this data. We believe this will not only help in understand seasonality (if any),
but also provides more data points for comparison across companies.
Inventory/loans and advances details: Exhibit 35 highlights that a large portion of the
balance sheet of most companies comprises inventories and loans & advances. We think a
break-up in terms of land being used in current projects, construction WIP, other land and
interest capitalized information would be very useful. In addition, any key changes leading
to a change in these items would help, in our view.
Common and consistent accounting policies. There is no standard set of accounting
policies being followed by real estate companies. We observe three kinds of accounting
policies for revenue booking, which, in order of aggressiveness, are: (1) percentage
completion on total cost (land + construction), (2) percentage completion on construction
cost, and (3) project cost basis.
Monthly operating data. Most companies have started giving cumulative sales value as
well as volume data. Most Chinese companies report operating data on a monthly basis
and also give geographical data. Exhibit 37 summarizes operating information available on
a quarterly basis and potentially useful data.
Land purchase guidance. Chinese companies disclose value of new land purchases on a
consistent basis. We believe similar data and guidance on future land purchases could be
potentially useful in valuing Indian real estate companies.
Key risks
Rapid price hikes may put downward pressure on volumes
We model healthy volume offtake in the residential segment assuming moderate price
hikes. However, if developers were to increase prices rapidly (as seen in CY2007), volumes
may come under severe pressure. This could result in higher phasing of the land bank, thus
reducing near-term cashflow visibility. Impact on NAV valuation would likely be negative,
although partially mitigated by higher pricing. However, we think such a scenario is
unlikely in the medium term as developers would focus more on ensuring healthy demand
than higher pricing comfort.
Property prices are cyclical
We believe a significant decline in property prices due to: (1) higher interest rates, (2) a
significant increase in supply, and (3) a demand slowdown, may impact revenue
assumptions and earnings. However, we note that post the sharp correction in property
prices in early-2009, companies are in consolidation mode across most locations and the
risk of another sharp fall is limited.
Interest rate risk
A sharp increase in interest rates may impact revenues and earnings of the residential
segment. A moderate interest rate regime over the past decade and the availability of
financing from housing finance companies and banks have been the key demand drivers
for the residential segment. However, the Reserve Bank of India in its latest monetary
policy has expressed discomfort at the rise in residential prices and has initiated some
tightening measures for individual real estate loans more than Rs7.5 mn. In our view,
lowering this limit could raise the borrowing costs for a larger proportion of consumers,
thus affecting affordability. Mortgage rates may also rise on the back of general tightening
to curb inflation.
Sharp increase in commercial demand
We expect commercial pricing and new launches to remain weak over the next 3-4
quarters due to high current inventory of 40 months. However, faster growth in the IT
sector and higher non-IT demand due to robust economic growth could present a key
upside risk to our assumptions. Improvement in sentiment may also result in lower cap
rates than our estimate of 9% for commercial real estate and 10% for retail real estate.
Rapid appreciation of input costs
A sharp increase in prices of construction material used by the real estate sector may have
a negative impact on profitability. We note that a major component of the construction cost
is accounted for by cement and steel, prices of which could rise as the economic
environment improves.
Inability to procure land at reasonable costs
Competition in real estate markets is primarily based on the availability and cost of land.
We see competition from both domestic and foreign companies in bidding for new
property development projects. Oberoi Realty and INRL need to continuously replenish
land bank and high land costs would adversely impact growth and margins.
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