Goldman Sachs:: Sobha Developers: Breaking out of its shell

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Sobha Developers (SOBH.BO; Buy, on CL): Breaking out of its shell
Investment view
We upgrade Sobha Developers to Buy from Neutral and add it to our
regional Conviction List with a revised 12-month RNAV-based TP of Rs331.
Our favourable view is driven by better launch visibility, improving ROEs,
our favourable view of the Bangalore market, and better disclosures
(Exhibit 13). In addition, we believe Sobha will benefit from the recent
recovery in the IT industry through additional demand created for
apartments as well as increased contracts for its contractual business.

 Residential (74% of gross NAV): We believe that the residential
segment would continue driving revenues for Sobha. We expect
Sobha to launch 8mn sqft in the next 12-18 months, primarily in
Bangalore, but also in Pune, Chennai, and Coimbatore. We forecast
revenues from residential sales to increase to Rs13 bn in FY13E,
from Rs7.7 bn in FY10, driven by rising volumes.
 Contractual business: Sobha’s contractual business was affected
negatively by the slowdown in the IT industry in FY2009-10. We
forecast contractual and manufacturing revenues to increase from
Rs2.7 bn in FY10 to about Rs6.8 bn in FY13E as we think the demand
for office space by the IT industry is likely to increase as evident by
the pick up in hiring by Infosys Technologies (see Exhibit 45).
 Operating leverage provides EBITDA margin cushion. On the
back of higher construction costs, we estimate gross margins to
decline by 200 bp between FY2010-13E, which is offset by operating
leverage. Sobha has high fixed costs due to its backward integration
model wherein all construction activities are performed by various
internal divisions.
 Management planning a more aggressive launch strategy.
Sobha has launched 4.03 mn sqft in 9MFY11 and has provided a
launch guidance of 8 mn sq. ft over the next five quarters. Sobha
has a large land-bank and robust execution capability, which should
enable it to undertake greater number of projects, in our view.
 Debt reduction underway: Healthy operating cashflows have
resulted in debt reduction of Rs2 bn (15% of total) in 1HFY2011. This
includes Rs1.1 bn from sale of land in Pune. We believe land sales
where development is back ended are value accretive.
Valuation
 Sobha Developers is currently trading at a 35% discount to our
FY2012E RNAV of Rs368. On an FY2012E P/B, Sobha trades at 1.1X
versus our coverage average of 1.4X and an FY2012E P/E of 9.4X
versus our coverage average of 11.1X.
 Our 12-month RNAV-based TP of Rs331 is derived by applying a
10% discount to FY12E RNAV of Rs368. We have reduced the
discount to 10% (from 20% earlier) on account of better disclosures
and more visibility on new launches. We lower our FY11E-FY13E
EPS by 7%-17% primarily due to higher cost inflation.
Key risks
 (1) weak sales in Chennai and Coimbatore, (2) delay in Gurgaon
project launch, and (3) order slowdown from Infosys.


Residential business: We believe that residential revenues would increase from Rs7.7 bn
in FY2010 to Rs13 bn in FY2013E driven by increased launches in Bangalore, Gurgaon,
Chennai and Pune. We expect sales to increase from 2.2 mn sqft in FY2010 to 3.9 mn sqft in
FY2013E.
Commercial and retail: We forecast revenue share of commercial + retail to increase from
less than 1% in FY2010 to over 9% in FY2013E as it launches projects in Bangalore, Mysore
and Thrissur. We believe that increased revenues from commercial and retail would
enhance margins and profitability.
Contractual business: We forecast revenues from contractual business to increase from
Rs1.7 bn in FY2010 to Rs4.9 bn in FY2013E. We believe that as the demand for office space
by IT/ITES companies increases in the near term, Sobha’s contractual sales would also
increase. Revenues from contracts fell in FY2009 and FY2010 as a consequence of reduced
hiring by IT/ITES companies. A large portion of contractual revenues of Sobha accrue from
companies such as Infosys, Biocon, ITC, GMR, etc. As the Exhibit 61 below illustrates,
increased hiring by Infosys over the past few quarters should translate into increased
contractual business for Sobha, in our view.