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Business News/ Opinion / Online-views/  Realty sector needs introspection
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Realty sector needs introspection

The affordable segment of the market is still promising.

Pradeep Gaur/MintPremium
Pradeep Gaur/Mint

The lacklustre performance of real estate companies is inevitably fuelling negative sentiments about the sector with growth rates slipping consistently over several quarters. Reports featuring the slowdown in residential sales across locations, higher vacancy in retail and oversupply in the office market are accentuating these sentiments. Inventory turnaround is taking a beating, particularly in the money-spinning premium to luxury residential segments in metro cities.

This hypothesis can be tested by studying financial results announced by listed real estate companies. We chose 23 companies spread over western, northern and the southern regions of the country accounting for a mix of mid-size and very large developers, with the exception of the eastern region, which anyway accounts for a small proportion of the industry.

The findings

The findings were anything but surprising. Sales declined by 4% in FY12 compared with a growth of 31% in FY11. Around 70% of the companies reported declining or static sales and 74% declining/static profits. The profit fall is a Profitabilitysharp 28% compared with the growth of 7.7% in the previous year. has taken a severe beating. Profit to sales ratio has been steadily declining for these companies, down from 25% in FY10 to about 15% in FY12.

Among other reasons, a sharp rise in interest cost has contributed significantly to lower profits. Interest to sales which was under 10% during FY10 has climbed by almost 50%. It stands at 15% for FY12. The total debt burden of these companies has been marching up though they seem to have plateaued during the last fiscal. As on March 2012, the debt burden was almost 46,000 crore, virtually the same as in the previous year, signalling roll over or substitution of debts.

Since interest cost on account of land and construction capital is loaded to work in progress and charged to the profit and loss account over the duration of the project, the charge for the respective years does not represent the total interest outgo. The balance gets carried over as inventory, accumulation of which will squeeze profit margins in subsequent years. Unless, of course, realization increases, which seems unlikely in the near term.

Overall inventory has been steadily mounting despite sales showing a divergent trend. At 59,451 crore, it is 11% higher than the previous year. However, the growth rate of inventory has slowed down confirming once again the pressure on working capital and squeeze on margins. As a result, land acquisition and new project launches have slowed down.

Debtors, too, have climbed by 15% over the previous year, on top of 25% growth in the previous year. Since the residential segment is typically supposed to be self-financing, it seems that sales realization is not in tandem with the construction progress. The combined net worth of all the 23 companies stands at about 77,000 crore. In this reference, the debt-equity ratio at less than one may appear to be in the comfort zone. However, at an absolute level the debt exposure is extraordinarily high considering that cash flow from operations has slowed down, making debt servicing a real challenge.

No improvement even now

While the above analysis is based on numbers for year ending March 2012, the market scenario remains weak even today. Although the affordable segment of the market is still promising, the money spinning premium and luxury segment has not moved up an inch on the improvement scale. It is, hence, obvious that the state of affairs is unlikely to improve unless there is significant change in the stimulus that can lift sentiment and boost sales. With new launches having slowed down, till inventory pile is cleared, it is inevitable that profit pressures will mount due to usual inflationary pressure and higher interest cost.

If one were to see the latest quarterly performance of some of these companies, it stands out very clearly that the trend of declining profit continues unabated in the June 2012 quarter. Chances are that the September 2012 quarter is unlikely to be better, unless of course the festive spirit lifts up the mood. It must be remembered that the last festival was a wash out. Since then consumer spending has declined further as even the retail sector is now reporting flat to lower same store sales.

What needs to be done

To sum up, the industry needs to introspect to extricate itself from the current situation. The affordability angle, unless tackled, will continue to be a hurdle. Some developers believe that even lowering prices may not stimulate sales. This, of course, is an assumption. A serious buyer is perhaps able to walk away with discounts, which together with the fact that sales at the lower end of the market remain buoyant, proves that at the right price the buyer is ready and waiting.

This is not the first time that the industry is going through such a precarious situation. At one level, ever since the market has opened to foreign direct investment in 2006, the complexion of the exposure has changed. The overall exposure of the banking system alone is above 1 trillion. On top of that, we have private participants such as private equity funds and non-banking financial institutions. Any further stalemate is likely to be disastrous for all the stakeholders.

Lest there be a precipitous fall, the industry and in particular the consumer can gain immensely if the industry responds with a win-win solution given the current environment. Merely banking on the anticipated festival buoyancy will barely be a solution.

Pranab Datta is vice-chairman and managing director, Knight Frank India.

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Published: 17 Sep 2012, 08:26 PM IST
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