Balance sheet and valuations remain key in an uncertain demand environment for real estate co:: Credit Suisse

 The demand environment remains uncertain: Residential
absorption remains muted along with high inventory levels. On the
commercial side, although absolute inventory has dropped
significantly in the past two-and-a-half years, the inventory levels
as a proportion to absorption remain very high. Full report.
 The balance sheet becomes important in this environment: We
prefer stocks that have low leverage, which will enable them to
manage a poor demand environment better and buy land parcels, if
attractive.
 This, coupled with relative valuations, makes Oberoi our preferred
pick: Among the Indian property names, Oberoi has the strongest
balance sheet (it has net cash), attractive relative valuations (FY14
P/E of 8x, EV/EBITDA of 5x) and reasonable ROE (15% in FY14).
 We assume coverage on Oberoi with OUTPERFORM and on DLF
with NEUTRAL: Our target price for Oberoi of Rs275, implying
43% upside, is based on 15% discount to NAV. Our DLF TP of
Rs190 presents 8% upside and is based on a DCF model.

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The demand environment remains uncertain
The residential inventory levels in most of the key cities remain at
historic high levels, and inventory levels as a proportion of absorption
remain high in absolute levels. Absorption levels have remained
muted and stagnant. On the commercial front, absolute inventory has
dropped significantly in the past two-and-a-half years but inventory
levels as a proportion of absorption still remains very high.

The balance sheet becomes important in this environment
Given the uncertainty in the demand environment, we believe that the
balance sheet becomes more important. Our preference, in this
environment, will be stocks that have low leverage, which will enable
them to tide over this environment better, and to buy interesting land
parcels if they come up in the market.
We like Oberoi’s conservative strategy in this environment. Unlike
many peers in the sector that are highly leveraged, Oberoi actually
has a strong net cash position.
DLF seems focussed on bringing down the debt in its balance sheet,
aided by operational cash flows, equity issuance and further
divestment. However, its guided ‘steady-state’ gross profit of Rs82.5
bn and FCF of Rs30 bn appear aggressive. Also, there is some
uncertainty on the cash inflow of the recent sale of Aman that it has
announced.
This, coupled with relative valuations, makes Oberoi our
preferred pick
Among the Indian property names, Oberoi has the strongest balance
sheet, attractive relative valuations and reasonable ROE.
Consequently, Oberoi is our preferred pick and we assume coverage
with an OUTPERFORM rating and a target price of Rs275, implying
43% upside. The stock trades at consensus 12-month forward P/E of
8x and EV/EBITDA of 4x, at the lower end of the trading range of its
Indian peers. Our property-wise NAV calculations suggest a NAV of
Rs325 and our target price of Rs275 is based on a 15% discount to
the NAV given certain regulatory approvals are still awaited.
We assume coverage of DLF with a target price of Rs190, 8% upside,
based on a DCF model. While the stock has come off 23% in the past
one month, the stock does not look attractive compared to many
regional and local peers. With a 3.0% FY14E ROE, it compares
unfavourably on a ROE-P/B screen. Also, the conversion of the
founders’ CCPS in 2015 poses uncertainty in terms of the extent of
dilution for minority shareholders and will result in further equity
issuance, in addition to the recent one.