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C hanging landscape
India in the early stage of development cycle—significant growth potential
India’s property market is highly fragmented and unorganised—its growth
restricted by a lack of reforms and institutional funding. Structurally, we believe
the large housing shortage, favourable demographics, strong macroeconomic
drivers and robust service sector growth present significant opportunities for
developers. We expect India’s property market to experience long-term secular
growth, despite short-term cyclical difficulties.
Newsflow could remain a near-term overhang but we see limited downside
Rising interest rates, low macro visibility amidst high oil prices, developers
missing pre-sales targets, muted near-term earnings, and ongoing 2G and political
issues may have a negative impact on property stocks in the near term. We are
revising our price targets and estimates for several companies in the sector.
How negative sentiment on the property sector could change
We believe the change would initially be driven by macro factors including easing
liquidity, stable rates and 7%-plus GDP growth. We expect improved company
disclosure, government reforms, increasing institutional ownership, and the
inclusion of India in the Asian benchmark real estate indices to trigger a re-rating.
Valuations close to historical trough levels; attractive risk-reward profiles
The sector is trading at a 53% discount to our base NAV estimate (similar to credit
crisis levels) and at 1.4x P/BV. With fundamentals much better than during the last
crisis, we believe Indian property stocks provide an attractive risk-reward opportunity.
We recommend a top-down macro approach and view property stocks as leveraged
plays on housing demand and asset prices. Our top picks are DLF among large caps,
Phoenix Mills and Prestige Estates Projects among mid-caps; and Indiabulls Real
Estate among high risk-reward stocks.
Summary and investment case
Indian real estate market background
India’s property market has traditionally been highly fragmented and
unorganised (organised developers have less than a 20% share), and hence
under-developed (15% of GDP, 1% of India market cap). The housing segment
dominates (70% of the market), similar to most developing economies, with
commercial real estate still in a nascent stage of growth. Lack of reforms, the
government’s cautious approach to foreign direct investment (FDI), poor
company disclosure, and unhealthy trade practices had restricted institutional
funding for the sector, thus limiting growth. That said, the government has
started to realise the sector’s importance to macro growth, reflected by its efforts
to relax FDI norms in 2005 and encourage institutional funding. Our channel
checks indicate the industry recorded a 30% CAGR over 2005-10. Despite this,
India still seems to be in the early stages of the development cycle compared
with other emerging markets.
Significant growth potential—structural drivers intact
We believe India’s property market provides a significant development opportunity,
and that the key drivers are structural—a housing shortage (approximately 25m
households), demographics (young population, nuclear families), and rapidly
evolving financial systems. We believe India’s high savings rate (20% of income)
has a high probability of being invested in property, as property is increasingly being
viewed as a hedge to inflation, with higher demand and progress on infrastructure
projects driving up asset prices. Robust growth in the services sector (54% of GDP),
and sustained GDP growth of 7%-plus has also enhanced demand for real estate. In
effect, we expect India’s real estate markets to experience long-term secular growth,
despite short-term cyclical difficulties.
Newsflow, tight liquidity—may be a near-term overhang…
We believe the following could be a near-term overhang on sector performance: 1)
consensus expectations of further interest rate hikes of 50-75bp over the next two
quarters to tame inflation; 2) tightening liquidity; 3) developers likely missing
launch/pre-sale targets, impacting Q4 FY11 and Q1 FY12 earnings; and 4) ongoing
2G issues and the fluid political situation. With property share prices down 45% over
the past six months and valuations at historical trough levels, we think the negative
news flow/investor pessimism is priced in and that absolute downside is limited.
....but physical market above crisis levels
Our analysis and channel checks suggest the following: 1) residential pre-sales
in key cities (except a few areas in Mumbai) in October 2010 to March 2011
were healthy at 214m sq ft, 2x higher than during the most recent crisis (October
2008 to March 2009); 2) the commercial property sector has recovered strongly;
3) residential inventory is significantly below the crisis level of 392m sq ft; and
4) liquidity is tight, but above the most recent crisis level, with a low probability
of debt/interest/land payment default. This underscores our view that core
fundamentals are much better than during the most recent crisis period of
October 2008 to March 2009.
Challenges remain
India slipped from fourth place in 2010 to sixth place in 2011 in UBS’s investor
survey conducted for preferred emerging real estate markets. This is primarily
because structural challenges in India are perceived to outweigh near-term return
potential, the key challenges being: 1) poor disclosure; 2) weak corporate
governance; 3) lack of scale in cash flow; 4) low return ratios along with capital
inefficiency; 5) valuation methodology being a challenge; and 6) rising interest
rates affecting affordability, and high funding costs for developers.
Historical trough valuations the catalyst
The sector is trading at 1) a 53% discount to our base NAV estimate (close to
the 60% discount during the credit crisis) and a 24% discount to our bear-case
NAV estimate; and 2) 1.4x P/BV. We view historical trough level valuations as
the key catalyst for a share price re-rating. Even after adjusting for a higher
WACC (14-17%) in our NAV estimates, we think India property stocks, trading
at 40% discounts or more, are in the ‘value zone’ and provide significant upside
potential—historical trends reflect this. Further, with fundamentals better than
during the most recent crisis, we think Indian property stocks offer an attractive
risk-reward opportunity on a 12-month horizon.
Best strategy—top-down macro approach
Owing to India’s strong macro drivers, significant development opportunity and
the near-term challenges, we think it is best to view the country’s real estate
sector as a top-down macro theme for a leveraged play on housing demand and
rising asset prices. We believe the risk-reward opportunity is attractive, with: 1)
property share prices down 20-60% over the past six months; 2) assets/land,
property prices holding up across cities; 3) developers’ land reserves fully paid
for; and 4) stocks trading close to historical trough valuations. That said, we
expect the sector to be volatile in the near term, and view historical trough
valuations as a catalyst for outperformance. Our qualitative analysis suggests
focusing on developers with strong business models, prime land reserves, better
disclosures, and low leverage risk in the current environment. We prefer DLF
among large-cap stocks, Phoenix Mills and Prestige Estates Projects (Prestige
Estates) among quality mid-caps, and Indiabulls Real Estate (IBREL) in the high
risk-reward category.
Top picks—based on risk appetite
Low risk appetite—We recommend quality stocks that are very liquid and
prefer DLF among large caps and Phoenix Mills and Prestige Estates among
quality mid-caps. We believe these companies’ superior model-asset mix and
relatively attractive valuations will drive outperformance.
High risk appetite—We view these stocks as high risk-reward plays, which
have corrected 45-80% over the past three months. We prefer IBREL, as we
think its valuation provides a good margin of safety. We believe these stocks are
best positioned to outperform the sector on any pull-back in risk appetite.
Statement of Risk
We believe key risks for real estate companies include a prolonged higher
interest rate environment (one+year), higher mortgage rates impacting consumer
affordability, slower annual GDP growth of <7% impacting demand for
residential and commercial properties, changes in foreign direct investment
regulations impacting capital availability for the sector, changes in regulatory
policies impacting commercial viability of development, and inflation impacting
consumer affordability.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
C hanging landscape
India in the early stage of development cycle—significant growth potential
India’s property market is highly fragmented and unorganised—its growth
restricted by a lack of reforms and institutional funding. Structurally, we believe
the large housing shortage, favourable demographics, strong macroeconomic
drivers and robust service sector growth present significant opportunities for
developers. We expect India’s property market to experience long-term secular
growth, despite short-term cyclical difficulties.
Newsflow could remain a near-term overhang but we see limited downside
Rising interest rates, low macro visibility amidst high oil prices, developers
missing pre-sales targets, muted near-term earnings, and ongoing 2G and political
issues may have a negative impact on property stocks in the near term. We are
revising our price targets and estimates for several companies in the sector.
How negative sentiment on the property sector could change
We believe the change would initially be driven by macro factors including easing
liquidity, stable rates and 7%-plus GDP growth. We expect improved company
disclosure, government reforms, increasing institutional ownership, and the
inclusion of India in the Asian benchmark real estate indices to trigger a re-rating.
Valuations close to historical trough levels; attractive risk-reward profiles
The sector is trading at a 53% discount to our base NAV estimate (similar to credit
crisis levels) and at 1.4x P/BV. With fundamentals much better than during the last
crisis, we believe Indian property stocks provide an attractive risk-reward opportunity.
We recommend a top-down macro approach and view property stocks as leveraged
plays on housing demand and asset prices. Our top picks are DLF among large caps,
Phoenix Mills and Prestige Estates Projects among mid-caps; and Indiabulls Real
Estate among high risk-reward stocks.
Summary and investment case
Indian real estate market background
India’s property market has traditionally been highly fragmented and
unorganised (organised developers have less than a 20% share), and hence
under-developed (15% of GDP, 1% of India market cap). The housing segment
dominates (70% of the market), similar to most developing economies, with
commercial real estate still in a nascent stage of growth. Lack of reforms, the
government’s cautious approach to foreign direct investment (FDI), poor
company disclosure, and unhealthy trade practices had restricted institutional
funding for the sector, thus limiting growth. That said, the government has
started to realise the sector’s importance to macro growth, reflected by its efforts
to relax FDI norms in 2005 and encourage institutional funding. Our channel
checks indicate the industry recorded a 30% CAGR over 2005-10. Despite this,
India still seems to be in the early stages of the development cycle compared
with other emerging markets.
Significant growth potential—structural drivers intact
We believe India’s property market provides a significant development opportunity,
and that the key drivers are structural—a housing shortage (approximately 25m
households), demographics (young population, nuclear families), and rapidly
evolving financial systems. We believe India’s high savings rate (20% of income)
has a high probability of being invested in property, as property is increasingly being
viewed as a hedge to inflation, with higher demand and progress on infrastructure
projects driving up asset prices. Robust growth in the services sector (54% of GDP),
and sustained GDP growth of 7%-plus has also enhanced demand for real estate. In
effect, we expect India’s real estate markets to experience long-term secular growth,
despite short-term cyclical difficulties.
Newsflow, tight liquidity—may be a near-term overhang…
We believe the following could be a near-term overhang on sector performance: 1)
consensus expectations of further interest rate hikes of 50-75bp over the next two
quarters to tame inflation; 2) tightening liquidity; 3) developers likely missing
launch/pre-sale targets, impacting Q4 FY11 and Q1 FY12 earnings; and 4) ongoing
2G issues and the fluid political situation. With property share prices down 45% over
the past six months and valuations at historical trough levels, we think the negative
news flow/investor pessimism is priced in and that absolute downside is limited.
....but physical market above crisis levels
Our analysis and channel checks suggest the following: 1) residential pre-sales
in key cities (except a few areas in Mumbai) in October 2010 to March 2011
were healthy at 214m sq ft, 2x higher than during the most recent crisis (October
2008 to March 2009); 2) the commercial property sector has recovered strongly;
3) residential inventory is significantly below the crisis level of 392m sq ft; and
4) liquidity is tight, but above the most recent crisis level, with a low probability
of debt/interest/land payment default. This underscores our view that core
fundamentals are much better than during the most recent crisis period of
October 2008 to March 2009.
Challenges remain
India slipped from fourth place in 2010 to sixth place in 2011 in UBS’s investor
survey conducted for preferred emerging real estate markets. This is primarily
because structural challenges in India are perceived to outweigh near-term return
potential, the key challenges being: 1) poor disclosure; 2) weak corporate
governance; 3) lack of scale in cash flow; 4) low return ratios along with capital
inefficiency; 5) valuation methodology being a challenge; and 6) rising interest
rates affecting affordability, and high funding costs for developers.
Historical trough valuations the catalyst
The sector is trading at 1) a 53% discount to our base NAV estimate (close to
the 60% discount during the credit crisis) and a 24% discount to our bear-case
NAV estimate; and 2) 1.4x P/BV. We view historical trough level valuations as
the key catalyst for a share price re-rating. Even after adjusting for a higher
WACC (14-17%) in our NAV estimates, we think India property stocks, trading
at 40% discounts or more, are in the ‘value zone’ and provide significant upside
potential—historical trends reflect this. Further, with fundamentals better than
during the most recent crisis, we think Indian property stocks offer an attractive
risk-reward opportunity on a 12-month horizon.
Best strategy—top-down macro approach
Owing to India’s strong macro drivers, significant development opportunity and
the near-term challenges, we think it is best to view the country’s real estate
sector as a top-down macro theme for a leveraged play on housing demand and
rising asset prices. We believe the risk-reward opportunity is attractive, with: 1)
property share prices down 20-60% over the past six months; 2) assets/land,
property prices holding up across cities; 3) developers’ land reserves fully paid
for; and 4) stocks trading close to historical trough valuations. That said, we
expect the sector to be volatile in the near term, and view historical trough
valuations as a catalyst for outperformance. Our qualitative analysis suggests
focusing on developers with strong business models, prime land reserves, better
disclosures, and low leverage risk in the current environment. We prefer DLF
among large-cap stocks, Phoenix Mills and Prestige Estates Projects (Prestige
Estates) among quality mid-caps, and Indiabulls Real Estate (IBREL) in the high
risk-reward category.
Top picks—based on risk appetite
Low risk appetite—We recommend quality stocks that are very liquid and
prefer DLF among large caps and Phoenix Mills and Prestige Estates among
quality mid-caps. We believe these companies’ superior model-asset mix and
relatively attractive valuations will drive outperformance.
High risk appetite—We view these stocks as high risk-reward plays, which
have corrected 45-80% over the past three months. We prefer IBREL, as we
think its valuation provides a good margin of safety. We believe these stocks are
best positioned to outperform the sector on any pull-back in risk appetite.
Statement of Risk
We believe key risks for real estate companies include a prolonged higher
interest rate environment (one+year), higher mortgage rates impacting consumer
affordability, slower annual GDP growth of <7% impacting demand for
residential and commercial properties, changes in foreign direct investment
regulations impacting capital availability for the sector, changes in regulatory
policies impacting commercial viability of development, and inflation impacting
consumer affordability.
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