03 March 2012

Real Estate/Property - India 50 bps cut = 3-4% price cut; BofA Merrill Lynch,

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Real Estate/Property - India
50 bps cut = 3-4% price cut;
not enough to attract demand
􀂄 50 bps cut = 3-4% price cut only
Our economist expects a 50 bps rate cut in 2QCY12. Developers are holding
prices primarily hinged on this rate cycle turn for demand to return. However, our
analysis shows a 50 bps rate cut equates to mere 3-4% reduction in cost of
acquisition; which we believe will not be enough to attract demand.
Waiting for 100bps cut in FY13 might be too late
We believe, with poor cash flows, developers will disappoint the market on volume
and cash flows in FY13 also if they decide to wait out for demand to return once a
total of 100 bps is cut in FY13.

Time correction versus price correction
There seems a consensus opinion built-up around possibility of real estate prices
under-going time correction rather than price correction. We believe the same is
possible for affordable cities of Bangalore and Noida as prices remain stable in
FY13 and 100 bps rate cut reduces cost by 7-8%. Developers in both cities are
offering 3-4% discount to close deals. However, we believe the city of Mumbai will
have to witness a double digit correction beyond the 7-8% reduction due to rate
cuts. Anecdotal data shows discounts of 6-8% available depending on the project.
History says only price correction can do the trick
We believe the market will be disappointed with operational performance of real
estate firms, if prices stay sticky leading to poor volumes. Past cycles show stock
prices lag price correction but lead volume recovery by a quarter to two.
Volumes with sound realization remains critical
3QFY12 witnessed volume recovery but at lowered realization as developers
continued their focus on affordable housing to weather tough market conditions.
We believe new launches (mid-end to high-end) in core markets (at discounted
prices) will help improve cash flows.
Current rally does not corroborate with physical market
We believe the current rally in real estate stocks could be overdone and
recommend caution as the current rally led by global liquidity does not corroborate
with the physical market trends wherein 1) sales volume continue to wilt, 2) unsold
inventory remains high 3) balance sheets remain stretched 4) asset sale progress
slow 5) capital availability still tight and 6) execution has slowed.
Can buy fundamentals at dips
We like firms with sound balance sheet, annuity income and launch visibility; thus
recommend BUY on Oberoi (C-1-7, Rs287.45) and Underperform: HDIL (C-3-9
Rs120), IBREL (C-3-8, RsV-3-8).


Price objective basis & risk
Housing Development and Infrastructure (XGHSF)
Our preferred valuation methodology is NAV, calculated by discounting the cash
flow from each of the real estate projects.The price objective of Rs85 reflects a
discount of 25% to our net NAV estimate of Rs113. We expect HDIL to trade at a
discount of 25% due to high debt levels, low NAV visibility and high regulatory
risks to its projects. Key assumptions underlying our NAV are WACC of 14.7%,
capitalization rate of 11-12% and inflation of 5% from FY13 on both selling price
and construction costs. On a P/E basis, at our PO of Rs85, the stock would trade
at 6x FY12E earnings. Upside risks are lower than expected correction in prices
and completion of FSI sale as guided. Downside risks are a cancellation of FSI
sale and higher than expected correction in prices.
Indiabulls Real Estate Ltd (IBELF)
Our preferred valuation methodology is NAV, calculated by discounting the cash
flows from each of the real-estate projects. Therefore, our price objective of Rs56
is based on a 20% discount to our NAV of Rs70. We expect IBREL to trade at
20% discount to NAV due to regulatory risks and poor earnings visibility. Key
assumptions underlying our NAV are WACC of 14.7%, capitalization rate of 11-
12% and inflation of 5% from FY14 on both selling prices and construction costs.
On a P/E basis, at our PO of Rs56, the stock would trade at 12x FY13E earnings.
Upside risks to our estimate are better than expected volume offtake in its
Mumbai projects. Downside risks are sharper than expected increase in debt due
to poor cash flows.
Oberoi Realty Ltd (XRXOF)
Our preferred valuation methodology is NAV, calculated by discounting the cash
flows from each of the real estate projects. Our price objective of Rs290 is
therefore based on our NAV of Rs290. Key assumptions underlying our NAV are
WACC of 14%, capitalization rate of 10-11% and inflation of 5% from FY13 on
both selling price and construction costs. On a P/E basis, at our PO of Rs290, the
stock would trade at 12x FY13E earnings. Downside risks are lower than
expected volume and delay in revival of demand for commercial real estate.

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