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Oberoi Realty Ltd
Setting new benchmarks; new
Buy with Rs290 PO
Best placed to benefit from slowdown
We initiate coverage on Oberoi Realty with Buy rating and PO of Rs290, offering
20% upside potential. Oberoi’s top-notch corporate governance and strong NAV
visibility make it a benchmark developer for gaining exposure to the highly
lucrative Mumbai real estate market. We expect Oberoi to be least impacted by
correction in residential prices in Mumbai due to its balanced mix of assets.
Further, tighter liquidity environment will offer Oberoi great opportunity to deploy
its Rs16bn of cash in land assets in Mumbai at reasonable valuations.
Balanced mix of assets should reduce NAV volatility
Oberoi has a balanced mix of assets, which we believe would help it wade
through the slowdown relatively unscathed, since the demand pick up in
office/retail space should offset the slowdown in residential market. It derives only
34% of its NAV from residential market and so it is least sensitive to changes in
residential prices. Every 1% reduction in price impacts its NAV by just 0.5%
against 1-3% impact on other developers.
Cash deployment, key upside trigger
We expect the current weakness in Mumbai residential segment and rising
interest rates to lead to a drop in land prices over the next 6-9 months. Oberoi,
with a cash chest of Rs16bn, is best placed to benefit from the softness in land
prices in Mumbai. We think Oberoi also has an edge over other developers to win
redevelopment projects due to its strong balance sheet and premium positioning.
Slowdown in Mumbai residential market priced in
The expected slowdown in residential segment in Mumbai remains the key
headwind for the stock’s performance over next six months. Also the low free float
of 12% could lead to volatility in stock performance.
Investment thesis
Best play on Mumbai realty; New Buy
We initiate coverage on Oberoi Realty with Buy and PO of Rs290, offering 20%
upside potential. Our PO is based on our FY12 NAV of Rs290, comprising of
Rs241 from real estate and Rs49 from cash in books. We value Oberoi at a
premium to its peers given its benchmark position in Mumbai real estate sector,
strong balance sheet, and higher visibility on NAV. We like the story of Oberoi
Realty with great land bank, strong cash flows and unlevered balance sheet,
coupled with top-notch corporate governance and disclosures.
Oberoi is currently the only Mumbai real estate play offering investors
exposure to all the premium segments of real estate, unlike HDIL (slum
redevelopment play) or IBREL (primarily central Mumbai).
We believe the current tight liquidity environment will provide Oberoi with
great opportunity to invest surplus cash in NAV-accretive lands/projects,
while a balanced mix of assets will cushion NAV impact due to the expected
weakness in residential segment. Our NAV already factors in the impact of
sluggish volumes and prices in residential segment.
Oberoi is the only developer to have shown consistent cash generation, while
other developers have struggled to generate cash from operations, whether it
is due to investments in new projects/lands (in spite of sitting on large land
bank) or restructuring.
Key triggers over the next six months -
Investment of surplus cash in NAV-accretive projects
Launch of Mulund and Worli projects
Sale of under-construction office property - Prisma
Good visibility on NAV
We expect Oberoi to execute its current projects over the next 6-7 years, with
over 90% of the land bank in prime locations in Mumbai. This increases the
visibility and confidence in its NAV, unlike other developers where only 40-50% of
their NAV is expected to be realized over the next 5-6 years. Further, NAV quality
is strong, as around 18% of its NAV is from cash sitting in the balance sheet and
18% from rent-generating leased assets. Its land bank does not carry any risk of
change in regulation or litigation since it holds clear titles for most of the land
parcels. Baring two projects which are in the final stages of approval, most other
projects have all the approvals in place.
Strong cash flow – rarity in Indian realty
Oberoi Realty is expected to generate strong cash flows over the next 2-3 years
as its key projects are launched over FY12. Since the land cost is historical (most
of the lands were purchased in 2003-05, when land prices were low in Mumbai),
and residential prices have seen a great run in Mumbai since 2005, we expect the
company to generate an EBIDTA margin in excess of 60% even after factoring in
flat to10% drop in residential prices in FY12. Further, its premium positioning and
exceptional brand value have enabled it to charge a premium to its competition.
We estimate Oberoi to generate surplus cash of Rs4.3bn in FY12 and Rs7.4bn in
FY13 (post investment in construction of commercial assets which are expected
to be leased).
Balanced mix of assets
Oberoi has a balanced mix of assets, whether it is residential or commercial mix
or development and leasing mix. The NAV contribution from various segments is
evenly balanced. We believe this strategy will help reduce the impact of the
property cycles. While for the next 12 months we expect demand for residential
space to remain soft due to high prices and rising interest rates, demand for
office/retail space is expected to remain strong, cushioning the impact on NAV.
Oberoi’s sensitivity to change in residential prices is relatively low compared to its
peers. For every 1% reduction in residential prices, the impact on its NAV is just
0.5% against 1-3% for its peers.
Table 1: Impact on NAV due to 10% change in residential prices
Oberoi 5%
DLF 10%
Unitech 17%
HDIL 20%
Sobha 30%
Source: BofA Merrill Lynch Global Research
Earnings story to play out from FY13
The earnings story for Oberoi will play out from FY13 when all its projects reach
the revenue recognition stage (it starts recognizing revenue only when 20% of the
construction cost is spent). We expect Oberoi Realty to show an earnings CAGR
of 38% over FY10-13. In FY13, almost 6-7 projects will approach recognition
stage, against just three currently, as four new projects are in the process of
being launched in the next six months. It typically takes 12-15 months for a
project to reach the revenue-recognition stage from launch. Further, since most of
these projects will take at least four years for completion, we expect the earnings
momentum to sustain beyond FY13 also.
The earnings growth for FY12 is highly dependent on the sale of its office project
Prisma, for which it is currently negotiating with a large business house for sale of
the entire block. Other than Prisma, we expect only Exquisite Ph-II to reach the
revenue-recognition stage by 4QFY12, leading to a modest 9% earnings growth
in FY12.
PO based on NAV of Rs290
Our PO of Rs290 is based on 1x NAV and offers 20% upside potential. We
expect Oberoi to trade at its NAV compared to other developers due to its topnotch
brand and corporate governance, premium quality assets with monetization
over the next 6-7 years and a strong balance sheet with high cash balance.
Valued at premium to its peers
We expect Oberoi Realty to trade at premium to its other Mumbai peers (no
discount to NAV compared to 15% discount for IBREL and HDIL) given –
Strong balance sheet with Rs16bn cash, investment of which in new assets
will lead to increase in NAV
Better disclosure and more clarity on monetization of assets
Low risk of delays in the projects since most approvals are in place
NAV valuation factors in uncertainty
Our NAV is based on the following assumptions -
Development period of seven years
15% drop in residential prices in FY12 and an increase of 5% each year
thereafter
Leased assets valued at 10% capitalization rate, while under-construction
assets valued at 11% capitalization rate
The cash in the balance sheet forms 17% of its NAV and its deployment in
NAV-accretive projects is the key for stock performance.
WACC of 14%
Table 2 and 3 lay out the key components of our NAV calculation and
sensitivities.
What will drive NAV growth –
Investment of Cash
Oberoi currently has Rs16bn of cash with no debt in its balance sheet. It can
further raise over Rs8-10bn of debt against its operating commercial assets like
mall/office and hotel. Therefore, deployment of these funds over the next 6-12
months in acquiring new projects/lands would be the key for Oberoi’s NAV
growth. We believe the current environment of low residential volume and tight
liquidity with rising interest rates will reduce competition for Oberoi in land/project
auctions and negotiations. A drop in residential prices by 3QFY12 should also
lead to a drop in land prices.
The recent relaxation in norms for redevelopment of properties in Coastal
regulation zone and higher FSI for redevelopment of old residential societies has
opened up a large opportunity for Oberoi Realty. Its strong balance sheet and
premium positioning should further help Oberoi win redevelopment projects
against its competitors.
Compression of Cap Rates in Office
Oberoi is developing a large portfolio of office assets, and 33% of its NAV is
derived from this segment. We expect the demand for office space to remain
strong over the next 12-18 months, with rentals increasing from FY12. We believe
the strong performance by office segment over the next one year should lead to
compression in cap rates. We have currently valued the under-construction office
assets at 11% capitalization rate and leased assets at 10%. Every 1% change in
capitalization rate should lead to 5% change in NAV for Oberoi Realty.
Headwinds –
Weakness in residential segment
We expect the weakness in Mumbai’s residential segment to continue for the next
couple of quarters, with low volumes, as developers try to hold on to high prices.
We expect correction in prices before the onset of the festive season in
September 2011 and subsequent recovery in volumes. But correction would be
limited to 10-20%, depending on the micro market.
For Oberoi, we have already built in 15% lower prices for its upcoming new
launches in FY12 and don’t expect realizations to fall sharply. But the negative
news flow on low volumes and expected correction will likely put pressure on the
stock’s performance. Even post correction, we don’t expect the residential prices
in Mumbai to rebound very sharply. The residential prices are unlikely to see the
run we saw in the past 5-6 years in Mumbai. Our expectation is that in the long
run (next 3-4 years), residential prices in Mumbai will see only modest gains of 5-
10%, lower than the income growth given the improving supply due to large
redevelopment projects.
Low free float
The stock was listed in October 2011 and has just 12% of its equity shares as
free float. This increases the volatility in the medium to short term. The promoter
and the private equity share holding is in the lock in period till October 2011,
though post that we could see increase liquidity as and when the private equity
investor looks to exit.
Key projects
Oberoi Realty primarily has five projects (four in Mumbai and one in Pune), with a
total development area of 20mn sq ft. It has already started development on two
of the projects, while another two are expected to be launched in the next six
months.
Three key projects driving its NAV are:
Oberoi Garden City –Goregaon east
Oasis Worli
Oberoi Exotica – Mulund
Garden City, Goregaon #1
Development area 9mn sq ft; 58% of the land bank
NAV of Rs49.6bn; 63% of total NAV
Oberoi Realty is developing a large township in Goregaon, spread over 75 acres.
It has already developed over 2mn sq ft of residential, office, retail and hospitality
in the location, while it has plans to further develop 7.7mn sq ft over the next 6-7
years. The township is expected to contribute Rs49.6bn or 63% of its NAV and
thus the success of the project would be the key driver of the stock. The currently
leased and operational assets contribute 33% to the NAV of the project.
It plans to develop 5.33mn sq ft of residential space for sale and 2.4mn sq ft of
office space for leasing, in addition to the 1.66mn sq ft of commercial
development which is already operational and generating rental income. Oberoi
has followed a unique model for township development, where it has developed
amenities, infrastructure and commercial developments like retail mall, 5-star
hotel, international school and office space prior to developing the residential
space. This, we believe, has helped Oberoi to command a premium of 10-15% for
its residential developments over its competition.
Risks
Downside Risks
Mumbai residential volume and prices – All assets of Oberoi Realty are
located in Mumbai. Therefore, property demand and prices in Mumbai will drive
the stock’s performance. We expect the volumes to remain soft in Mumbai over
the next six months, with correction in prices of 10-15%.
Investment of surplus cash – Oberoi is currently sitting on Rs16bn of cash
which will further increase to Rs19bn by the end of FY12. Therefore, successful
deployment of cash is very important to sustain future growth.
Execution delays – It plans to execute over 10mn sq ft over the next five years
and utilize the expertise of external companies like L&T to execute the project.
Therefore any delays in obtaining approvals or execution by third parties will
impact cash flows.
Supply of office – Oberoi plans to construct over 4mn sq ft of office over the
next 4-5 years. Currently, the supply of office space is higher than the demand
and therefore the rentals in Mumbai are expected to remain flat for the next 12
months.
Low free float – Oberoi currently has free float of just 12% with 78.5% stake
held by promoters and 9.5% with the private equity investor. The shareholding of
both the promoters and the private equity investor is locked in till October 2011
and therefore unlikely to depress the stock performance, though post October
2011, there is a risk for supply of new equity. Due to low float the stock
performance could be volatile.
Management
The promoter Vikas Oberoi is the Chairman and MD of the company. He has over
two decades of experience in the real estate sector. The promoter group has
completed 33 projects covering over 5mn sq ft. The management team has vast
experience and most have been with the firm for more than seven years.
Shareholding
The promoter holds a 78.5% stake in the company, while 9.46% is held by a real
estate fund advised by Morgan Stanley. They invested Rs6.75bn in January 2007
for their stake in Oberoi Realty.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Oberoi Realty Ltd
Setting new benchmarks; new
Buy with Rs290 PO
Best placed to benefit from slowdown
We initiate coverage on Oberoi Realty with Buy rating and PO of Rs290, offering
20% upside potential. Oberoi’s top-notch corporate governance and strong NAV
visibility make it a benchmark developer for gaining exposure to the highly
lucrative Mumbai real estate market. We expect Oberoi to be least impacted by
correction in residential prices in Mumbai due to its balanced mix of assets.
Further, tighter liquidity environment will offer Oberoi great opportunity to deploy
its Rs16bn of cash in land assets in Mumbai at reasonable valuations.
Balanced mix of assets should reduce NAV volatility
Oberoi has a balanced mix of assets, which we believe would help it wade
through the slowdown relatively unscathed, since the demand pick up in
office/retail space should offset the slowdown in residential market. It derives only
34% of its NAV from residential market and so it is least sensitive to changes in
residential prices. Every 1% reduction in price impacts its NAV by just 0.5%
against 1-3% impact on other developers.
Cash deployment, key upside trigger
We expect the current weakness in Mumbai residential segment and rising
interest rates to lead to a drop in land prices over the next 6-9 months. Oberoi,
with a cash chest of Rs16bn, is best placed to benefit from the softness in land
prices in Mumbai. We think Oberoi also has an edge over other developers to win
redevelopment projects due to its strong balance sheet and premium positioning.
Slowdown in Mumbai residential market priced in
The expected slowdown in residential segment in Mumbai remains the key
headwind for the stock’s performance over next six months. Also the low free float
of 12% could lead to volatility in stock performance.
Investment thesis
Best play on Mumbai realty; New Buy
We initiate coverage on Oberoi Realty with Buy and PO of Rs290, offering 20%
upside potential. Our PO is based on our FY12 NAV of Rs290, comprising of
Rs241 from real estate and Rs49 from cash in books. We value Oberoi at a
premium to its peers given its benchmark position in Mumbai real estate sector,
strong balance sheet, and higher visibility on NAV. We like the story of Oberoi
Realty with great land bank, strong cash flows and unlevered balance sheet,
coupled with top-notch corporate governance and disclosures.
Oberoi is currently the only Mumbai real estate play offering investors
exposure to all the premium segments of real estate, unlike HDIL (slum
redevelopment play) or IBREL (primarily central Mumbai).
We believe the current tight liquidity environment will provide Oberoi with
great opportunity to invest surplus cash in NAV-accretive lands/projects,
while a balanced mix of assets will cushion NAV impact due to the expected
weakness in residential segment. Our NAV already factors in the impact of
sluggish volumes and prices in residential segment.
Oberoi is the only developer to have shown consistent cash generation, while
other developers have struggled to generate cash from operations, whether it
is due to investments in new projects/lands (in spite of sitting on large land
bank) or restructuring.
Key triggers over the next six months -
Investment of surplus cash in NAV-accretive projects
Launch of Mulund and Worli projects
Sale of under-construction office property - Prisma
Good visibility on NAV
We expect Oberoi to execute its current projects over the next 6-7 years, with
over 90% of the land bank in prime locations in Mumbai. This increases the
visibility and confidence in its NAV, unlike other developers where only 40-50% of
their NAV is expected to be realized over the next 5-6 years. Further, NAV quality
is strong, as around 18% of its NAV is from cash sitting in the balance sheet and
18% from rent-generating leased assets. Its land bank does not carry any risk of
change in regulation or litigation since it holds clear titles for most of the land
parcels. Baring two projects which are in the final stages of approval, most other
projects have all the approvals in place.
Strong cash flow – rarity in Indian realty
Oberoi Realty is expected to generate strong cash flows over the next 2-3 years
as its key projects are launched over FY12. Since the land cost is historical (most
of the lands were purchased in 2003-05, when land prices were low in Mumbai),
and residential prices have seen a great run in Mumbai since 2005, we expect the
company to generate an EBIDTA margin in excess of 60% even after factoring in
flat to10% drop in residential prices in FY12. Further, its premium positioning and
exceptional brand value have enabled it to charge a premium to its competition.
We estimate Oberoi to generate surplus cash of Rs4.3bn in FY12 and Rs7.4bn in
FY13 (post investment in construction of commercial assets which are expected
to be leased).
Balanced mix of assets
Oberoi has a balanced mix of assets, whether it is residential or commercial mix
or development and leasing mix. The NAV contribution from various segments is
evenly balanced. We believe this strategy will help reduce the impact of the
property cycles. While for the next 12 months we expect demand for residential
space to remain soft due to high prices and rising interest rates, demand for
office/retail space is expected to remain strong, cushioning the impact on NAV.
Oberoi’s sensitivity to change in residential prices is relatively low compared to its
peers. For every 1% reduction in residential prices, the impact on its NAV is just
0.5% against 1-3% for its peers.
Table 1: Impact on NAV due to 10% change in residential prices
Oberoi 5%
DLF 10%
Unitech 17%
HDIL 20%
Sobha 30%
Source: BofA Merrill Lynch Global Research
Earnings story to play out from FY13
The earnings story for Oberoi will play out from FY13 when all its projects reach
the revenue recognition stage (it starts recognizing revenue only when 20% of the
construction cost is spent). We expect Oberoi Realty to show an earnings CAGR
of 38% over FY10-13. In FY13, almost 6-7 projects will approach recognition
stage, against just three currently, as four new projects are in the process of
being launched in the next six months. It typically takes 12-15 months for a
project to reach the revenue-recognition stage from launch. Further, since most of
these projects will take at least four years for completion, we expect the earnings
momentum to sustain beyond FY13 also.
The earnings growth for FY12 is highly dependent on the sale of its office project
Prisma, for which it is currently negotiating with a large business house for sale of
the entire block. Other than Prisma, we expect only Exquisite Ph-II to reach the
revenue-recognition stage by 4QFY12, leading to a modest 9% earnings growth
in FY12.
PO based on NAV of Rs290
Our PO of Rs290 is based on 1x NAV and offers 20% upside potential. We
expect Oberoi to trade at its NAV compared to other developers due to its topnotch
brand and corporate governance, premium quality assets with monetization
over the next 6-7 years and a strong balance sheet with high cash balance.
Valued at premium to its peers
We expect Oberoi Realty to trade at premium to its other Mumbai peers (no
discount to NAV compared to 15% discount for IBREL and HDIL) given –
Strong balance sheet with Rs16bn cash, investment of which in new assets
will lead to increase in NAV
Better disclosure and more clarity on monetization of assets
Low risk of delays in the projects since most approvals are in place
NAV valuation factors in uncertainty
Our NAV is based on the following assumptions -
Development period of seven years
15% drop in residential prices in FY12 and an increase of 5% each year
thereafter
Leased assets valued at 10% capitalization rate, while under-construction
assets valued at 11% capitalization rate
The cash in the balance sheet forms 17% of its NAV and its deployment in
NAV-accretive projects is the key for stock performance.
WACC of 14%
Table 2 and 3 lay out the key components of our NAV calculation and
sensitivities.
What will drive NAV growth –
Investment of Cash
Oberoi currently has Rs16bn of cash with no debt in its balance sheet. It can
further raise over Rs8-10bn of debt against its operating commercial assets like
mall/office and hotel. Therefore, deployment of these funds over the next 6-12
months in acquiring new projects/lands would be the key for Oberoi’s NAV
growth. We believe the current environment of low residential volume and tight
liquidity with rising interest rates will reduce competition for Oberoi in land/project
auctions and negotiations. A drop in residential prices by 3QFY12 should also
lead to a drop in land prices.
The recent relaxation in norms for redevelopment of properties in Coastal
regulation zone and higher FSI for redevelopment of old residential societies has
opened up a large opportunity for Oberoi Realty. Its strong balance sheet and
premium positioning should further help Oberoi win redevelopment projects
against its competitors.
Compression of Cap Rates in Office
Oberoi is developing a large portfolio of office assets, and 33% of its NAV is
derived from this segment. We expect the demand for office space to remain
strong over the next 12-18 months, with rentals increasing from FY12. We believe
the strong performance by office segment over the next one year should lead to
compression in cap rates. We have currently valued the under-construction office
assets at 11% capitalization rate and leased assets at 10%. Every 1% change in
capitalization rate should lead to 5% change in NAV for Oberoi Realty.
Headwinds –
Weakness in residential segment
We expect the weakness in Mumbai’s residential segment to continue for the next
couple of quarters, with low volumes, as developers try to hold on to high prices.
We expect correction in prices before the onset of the festive season in
September 2011 and subsequent recovery in volumes. But correction would be
limited to 10-20%, depending on the micro market.
For Oberoi, we have already built in 15% lower prices for its upcoming new
launches in FY12 and don’t expect realizations to fall sharply. But the negative
news flow on low volumes and expected correction will likely put pressure on the
stock’s performance. Even post correction, we don’t expect the residential prices
in Mumbai to rebound very sharply. The residential prices are unlikely to see the
run we saw in the past 5-6 years in Mumbai. Our expectation is that in the long
run (next 3-4 years), residential prices in Mumbai will see only modest gains of 5-
10%, lower than the income growth given the improving supply due to large
redevelopment projects.
Low free float
The stock was listed in October 2011 and has just 12% of its equity shares as
free float. This increases the volatility in the medium to short term. The promoter
and the private equity share holding is in the lock in period till October 2011,
though post that we could see increase liquidity as and when the private equity
investor looks to exit.
Key projects
Oberoi Realty primarily has five projects (four in Mumbai and one in Pune), with a
total development area of 20mn sq ft. It has already started development on two
of the projects, while another two are expected to be launched in the next six
months.
Three key projects driving its NAV are:
Oberoi Garden City –Goregaon east
Oasis Worli
Oberoi Exotica – Mulund
Garden City, Goregaon #1
Development area 9mn sq ft; 58% of the land bank
NAV of Rs49.6bn; 63% of total NAV
Oberoi Realty is developing a large township in Goregaon, spread over 75 acres.
It has already developed over 2mn sq ft of residential, office, retail and hospitality
in the location, while it has plans to further develop 7.7mn sq ft over the next 6-7
years. The township is expected to contribute Rs49.6bn or 63% of its NAV and
thus the success of the project would be the key driver of the stock. The currently
leased and operational assets contribute 33% to the NAV of the project.
It plans to develop 5.33mn sq ft of residential space for sale and 2.4mn sq ft of
office space for leasing, in addition to the 1.66mn sq ft of commercial
development which is already operational and generating rental income. Oberoi
has followed a unique model for township development, where it has developed
amenities, infrastructure and commercial developments like retail mall, 5-star
hotel, international school and office space prior to developing the residential
space. This, we believe, has helped Oberoi to command a premium of 10-15% for
its residential developments over its competition.
Risks
Downside Risks
Mumbai residential volume and prices – All assets of Oberoi Realty are
located in Mumbai. Therefore, property demand and prices in Mumbai will drive
the stock’s performance. We expect the volumes to remain soft in Mumbai over
the next six months, with correction in prices of 10-15%.
Investment of surplus cash – Oberoi is currently sitting on Rs16bn of cash
which will further increase to Rs19bn by the end of FY12. Therefore, successful
deployment of cash is very important to sustain future growth.
Execution delays – It plans to execute over 10mn sq ft over the next five years
and utilize the expertise of external companies like L&T to execute the project.
Therefore any delays in obtaining approvals or execution by third parties will
impact cash flows.
Supply of office – Oberoi plans to construct over 4mn sq ft of office over the
next 4-5 years. Currently, the supply of office space is higher than the demand
and therefore the rentals in Mumbai are expected to remain flat for the next 12
months.
Low free float – Oberoi currently has free float of just 12% with 78.5% stake
held by promoters and 9.5% with the private equity investor. The shareholding of
both the promoters and the private equity investor is locked in till October 2011
and therefore unlikely to depress the stock performance, though post October
2011, there is a risk for supply of new equity. Due to low float the stock
performance could be volatile.
Management
The promoter Vikas Oberoi is the Chairman and MD of the company. He has over
two decades of experience in the real estate sector. The promoter group has
completed 33 projects covering over 5mn sq ft. The management team has vast
experience and most have been with the firm for more than seven years.
Shareholding
The promoter holds a 78.5% stake in the company, while 9.46% is held by a real
estate fund advised by Morgan Stanley. They invested Rs6.75bn in January 2007
for their stake in Oberoi Realty.
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