Real Estate - Better times ahead; sector update ::Edelweiss

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Q3FY12 was a good quarter for the sector overall with improving volumes and stabilized EBITDA margins (ex-DLF), indicating waning cost pressures. Realisations continued to improve on a like-to-like basis and policy hurdles subsided. Approvals picked up in Mumbai and Chennai, while resolution of the land row in Noida gave fillip to volumes in the micro-market. While stickiness in debt despite asset monetization was a disappointment, we are enthused by improvement in the operational metrics. Hence, we turn ‘overweight’ on the sector. We prefer companies with good quality/prime assets to play the down-cycle in interest rates. Our top picks in the sector are Jaypee Infratech and Phoenix Mills.

Cost pressures wane, volumes up; realizations robust

The sector demonstrated stabilized EBITDA (ex-DLF); with declining inflation, EBITDA margins pose upside risks to our estimates. Volumes have been robust across most micro-markets (ex Mumbai, Ahmedabad) with Bangalore maintaining strength even as NCR volumes surged on the back of resolution of Noida land row. Realizations remained firm across most micro-markets with stray instances of project specific discounts in form of EMI holidays/freebies. Mumbai volumes have remained sluggish, but are expected to pick up in H2CY12 driven by new launches post the new DCR.

Debt remains untamed – Another quarter of increase

Aggregate net debt of 11 companies (ex-JPIN, Oberoi Realty; please refer Table 5) remained stubbornly high, up 2.4% QoQ, closing at INR417bn for the quarter. Expectations of asset sales materialized, but did not reduce the debt, marking a key disappointment from the sector in the quarter. Debt servicing will continue to remain the bête noire of the sector, especially as USD11bn of PE investments are likely to attain maturity over the next 2-3 years.

Outlook: Selective; prefer companies with quality assets

While certain dark spots remain in terms of high debt and expected PE exits, the overall picture appears much brighter with improving volumes, stabilizing margins, pick up in approvals and peaking of interest rates. Consequently, we revise our sector stance from ‘underweight’ to ‘overweight’ with NAV upgrades likely to be performance-driven.  Within stocks, Jaypee Infratech [JPIN, BUY – resurgence in volumes, imminent launch of Yamuna Expressway (YE)] and Phoenix Mills (PHNX, BUY, strong annuities business) are our top picks in the sector. We also like Brigade Enterprises (BRGD, BUY, prime commercial assets and pipeline of residential projects) and Mahindra Lifespaces (MLIFE, BUY, low gearing level).

Real Estate - Better times ahead; sector update