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Indiabulls Real Estate Ltd
Downside protected; Reiterate Buy
Quality assets at deep discount; valuation compelling
We reiterate our Buy rating on IBREL with PO of Rs142, as we believe that post
45% correction from the Nov’ 10 peak, the share price more than adequately
reflects the near term challenges. We cut our NAV estimate by 32% to Rs167 as
we now only value the company’s key projects where there is visibility on launch
and execution over the next 2 years. We believe the stock looks compelling from
a risk-return perspective as downside risk to our NAV estimates are very low. We
have also cut our earnings by 20-25% to reflect lower sales volume in FY11-13E.
Lower Parel: All is not lost, execution will be key
IBREL derives 60% of its valuation from projects located in Lower Parel, Mumbai.
The stock is currently factoring in over 45% correction in residential prices, which
we believe is very unlikely. While we do believe developers have gone overboard
in the luxury quotient in the micro market leading to short term oversupply. But
IBREL being the first mover, is at least 12-15 months ahead of competition on
execution which will be key factor in determining the future sales in these projects.
Power business: On-ground progress
We value the power business at 1x P/B and believe this subsidiary has achieved
substantial progress on execution of projects in the last 12 months, having placed
most of the orders with reputed contractors like BHEL. It has also achieved
financial closure for the 5,400MW project and has started to draw down the debt
for construction. The restructuring of power investment will further add value to
IBREL shareholders though it is still 3-4 months away.
Investment in new land assets key risk
IBREL has consistently invested in land in the last 3-4 years and we believe an
increase in debt due to further investment in land assets is the key risk to our call.
Reiterate Buy, PO of Rs142
We reiterate our Buy rating on IBREL with a price objective of Rs142 offering
30% potential upside from the current levels. Our PO if based on 15% discount to
our NAV of Rs167. We have cut our PO by 32% as we are now valuing only the
key projects with visibility on launch and execution over the next two years in our
NAV estimates.
We believe the stock offers value even after we build in a sharp cut of 25-30% in
sale price in its key real estate projects. Further, the market is ignoring
considerable execution progress made by its power subsidiary where IBREL
holds a 58.5% stake. In our revised NAV, we are valuing only the Lower Parel
projects (with lower prices), the power subsidiary at 1x P/B, and other real estate
projects in Panvel and Gurgaon that have already been launched for sale by
IBREL leading to 32% drop in NAV.
Key triggers –
The improving execution in its Lower Parel projects over next 6-12 months
will help establish its ability to deliver the project and we believe will also
improve sales volume
Increased leasing at the Lower Parel projects where currently only 50% is
leased
Restructuring of the power subsidiary in next 6 months
Lower Parel: Execution to decide the winner
IBREL’s projects in Lower Parel, Mumbai account for Rs110/share or 60% of its
NAV and thus is most important for stock performance. The micro market has
seen a number of residential launches in the last two years in the super luxury
segment. This has led to concern on absorption of the residential units and
expectation of a sharp drop in prices in the near future. We try and address some
of these concerns below and have built in very conservative estimates for our
NAV calculation of the projects located in the micro market. The residential
developments account for 56% of NAV while office developments 44% of NAV.
We have built in a sale price of Rs18,000-20,000/sq ft for the residential
developments (25-30% drop from the current ASP) and believe prices are unlikely
to fall below these levels.
Oversupply but all under construction
While there is talk about oversupply, it is only in terms of launches and not ready
supply of apartments. As of now, very few projects are expected to be completed
over the next two years and even in those pre-sales are above 70%. Therefore,
prices for ready apartments will continue to remain high at over Rs30,000/sq ft,
which we believe would provide support to under-construction projects.
Ready supply only post FY15
In the last 18 months, we have seen around 6-7 projects being launched offering
over 3,000 apartments for sale, but the construction on most of the projects has
only started in the last six months. This would imply the ready stock will come in
the market only four years from now. Even in these projects, over 40% of
inventory is sold. Since most of the projects are promising over 70 floors (being
developed in India for the first time), we expect execution delays of 12-18 months.
Launches getting staggered due to approval delays
We expect another 3-4 projects to be launched in 12 months but these projects
were expected in 2010 itself and have now been delayed due to lack of
approvals. The visibility beyond these projects is not great and we are unlikely to
see any big launches since the land supply is mostly coming from auction of old
mill land by government entity. Further, the state government is no longer
granting higher FSI under the parking policy (developers in recent projects have
managed to increase FSI from 1.33 to almost 4 under this policy).
Is FSI under threat? Unlikely for approved projects
Residential projects in the micro market have been granted higher FSI of up to 4
against the normal FSI of 1.33 under the public parking policy. As per our
conversation with developers, all planned projects have already got approval from
the local authorities for the higher FSI. The state government is currently
reviewing the policy and is not granting new approvals, but is not looking to
change the policy retrospectively.
Execution will be key differentiator
We believe the success of announced projects will be largely dependent on the
execution progress since there is a lot of concern on the ability of developers to
execute projects offering over 70 floors. We believe IBREL has a distinct
advantage over its peers on this aspect because its project was the first to be
launched and hence is almost 12 months ahead of competition in terms of
execution. Secondly, none of the company’s projects are offering 90-110 floors,
and have mostly around 50 habitable floors with the first 20 floors being car
parks. This, we believe, will substantially reduce the execution challenge and
costing of the project as compared to its competitors.
Also, as seen in the office development in the micro market, IBREL has managed
to launch the project much ahead of competition.
Pricing cheap relative to South Mumbai
If we compare the prices in Lower Parel to those in South Mumbai, they are still
35-40% cheaper and therefore offer a good alternative to those aspiring to stay in
South Mumbai. Most of these apartments are offering best-in-class amenities like
private swimming pools, private escalators, private garden etc, which India is
experiencing for the first time.
We do not expect prices to fall below Rs18,000-20,000/sq ft since the
construction cost for most of these projects would be upward of Rs6,000/sq ft with
land cost upwards of Rs7,000/sq ft (NTC plans to auction extra FSI of 0.2mn sq ft
with a base price of Rs11,000/sq ft), and developers would be unwilling to cut
prices below these levels. Like in office projects, even in worst of the times,
developers refused to reduce rentals below Rs150/sq ft. Similarly, developers are
unlikely to cut residential prices below Rs20,000/sq ft. Most developers have
deep pockets and are in no hurry to sell their projects cheap.
Residential: Near-term challenges, but factored in
Sky Residences – 3.3mn sq ft – This project, which accounts for 12% of our
NAV for IBREL, was launched in 2009 and comprises three towers. It has pre-sold
over 1.5mn sq ft with average realization of Rs25,000/sq ft. The construction is in
full swing across the three towers with the first tower expected to be completed in
the next four years. We have assumed a sale price of Rs18,000/sq ft with sales
spread across the next five years. We do expect sales to remain soft over the next
12 months due to the current high prices (exceed Rs25,000/sq ft) and on
expectations of a price correction. But the sales volume will improve as execution
becomes visible in the next 12 months and prices stabilize at lower levels.
Indiabulls Bleu – Worli – We have assumed a normal FSI of 1.33 for this project
and expect it to be launched in FY12 with a development period of five years.
IBREL has invested Rs21bn for the land, though we are ascribing only Rs16bn
for the project due to lower FSI and conservative sale price assumptions. The
project is better located as compared to its Sky project, and other projects in the
vicinity are commanding over Rs30,000/sq ft. We have assumed sale price of
Rs20,000/sq ft and construction cost of Rs6,000/sq ft for the project.
Office leasing at steady pace
IBREL has leased 1.4mn sq ft of its 3.8mn sq ft of office development with rentals
averaging around Rs160-170/sq ft. The firm expects to complete 1.2mn sq ft of
development in the next 6-9 months while the remaining 0.5mn sq ft is under
planning. We have valued the currently ready asset – One Indiabulls centre at
Rs165/sq ft /month and the Indiabulls Financial Centre at Rs140/sq ft / month with
a 11% cap rate, which we believe is conservative.
Supply to cap rental recovery
The location will continue to see oversupply for the next two years and the rentals
are expected to remain at Rs150-170/sq ft. Even after many developers converted
their planned office projects into residential development, the under-construction
projects will almost double the office stock in the next three years. Also, vacancy
levels are expected to increase from around 20% currently to over 25% in 2011.
Some of the key projects in advance stages of construction include those by
Indiabulls Real Estate, Peninsula Developers, Marathon, Kohinoor and Lodha.
Power: Visible progress in projects
Indiabulls Power accounts for Rs62/sh or 34% of our NAV estimate, and we
believe our valuation is conservative given the on-ground progress achieved by
this vertical in project implementation. IBREL has a 58.5% stake in Indiabulls
Power is planning to demerge its investment in the power subsidiary into a
separate entity and subsequently merge it with Indiabulls Power. This will make
IBREL a pure real estate play. The shareholders of IBREL will receive 2.97share
of Indiabulls Power on completion of the restructuring exercise.
We have valued the power subsidiary at 1x P/B while arriving at our NAV for
IBREL. Most of the pure utility players are currently trading at 1.5-2x price to book
multiple. Our valuation at 30-50% discount factors in most of the downside from
likely delays in commissioning of the projects and expected correction in power
tariffs from FY13. Indiabulls Power’s first plant is expected to start operations
from FY13. During the last 2-3 quarters, the power subsidiary has made
considerable progress in implementation of projects, which makes us believe that
our valuation at 1x P/B is conservative. We highlight some of the steps taken by
the management below.
Orders in place – Indiabulls has placed the order for BTG with BHEL for 20 sets
of 270MW, making it the second-largest customer of BHEL providing credibility to
its plans and assuring quality and timely implementation of the order. The first of
the power plants is expected to come on stream as early as FY13. Orders for
other segments of the power plant have also been placed with different reputed
contractors like Shapoorji for BTG civil and structures, L&T for the coal handling
plant, and Areva for the power transformer.
Financial closure and approvals in place- IBREL has achieved financial
closure for all the two phases of the both the projects and has started the draw
down for Phase 1 of the project. It has so far drawn Rs4.25bn for the Amravati
and Rs3bn for the Nashik projects. Other approvals like coal and water linkages
are also in place while the land was acquired way back in 2008-09.
The company has signed a power purchase agreement (PPA) with the
Maharashtra government for Phase 1 of the 1200MW Amravati project at
3.26/unit for 25 years. It plans to sign further deals as the plants near
commissioning.
Other land bank
IBREL’s other land banks include the ones in Panvel and Gurgaon. The company
has already launched residential projects in these two locations. We have valued
these projects at prices which are at a 15-20% discount to current prices and
contribute Rs12/sh or 7% of our NAV.
Gurgaon - IBREL has launched two projects in Gurgaon, a location where it has
two more land parcels. Its land bank is located along the upcoming Gurgaon -
Dwarka expressway where the residential price is around Rs3,000-3,200/sq ft.
We have assumed a realization at Rs2,700/sq ft.
Panvel - The project has seen very good response in the last 18 months with
prices increasing from Rs2,000/sq ft to over Rs3,700/sq ft currently. The approval
for setting up of the second Mumbai airport close to the project led to a sharp runup
in prices. We have assumed average realization of Rs3,000/sq ft. Apart from
the current project, IBREL has a large land parcel in Panvel which we have not
valued.
Key land banks not considered for valuation
Delhi - The project was among the first few that IBREL launched, but has been
delayed due to litigation. It has now got all the approvals from the court and we
expect IBREL to launch the project within the next 12-18 months.
The Panvel project has additional development potential of over 15mn sq ft,
which we believe is extremely valuable given the progress on development of the
second airport in Navi Mumbai.
Earnings to remain unexciting
We have cut our earnings estimate for FY11-13 by 15-20% to factor in lower
sales volume and prices. We expect the EBIDTA margin to also drop from 23% in
FY11 to 19% in FY12/13 as IBREL launches its premium project Indiabulls Bleu,
which will make a very thin margin due to very high land cost paid by IBREL. We
have also built in a drop in sales volume to 3.2mn sq ft in FY12 from 4.5mn sq ft
in FY11
IBREL has started recognizing revenue from real estate development in FY11
only and since one of its flagship projects in Central Mumbai/ Lower Parel is
parked in IPIT, a REIT listed in Singapore, it is not reflected in its earnings. The
company owns a 45% stake in IPIT and will receive dividend once IPIT’s cash
flows improve, which we think is unlikely before FY13. We have not built in any
earnings from IPIT in our model for FY12-13.
Cash flows to remain muted
The cash flow is expected to remain muted given the large projects are parked in
IPIT and we have taken conservative assumption on volume. In real estate
business we expect IBREL to show marginally positive cash flow over next two
years. We estimate free cash flow of Rs0.8bn and Rs2.7bn in FY12 and FY13
respectively.
The consolidated debt will show an increase given the investment in power
projects by Indiabulls Power. This also leads to large negative cash flow for next
couple of years at the consolidated level.
