Improving fundamentals of the mid-cap realty firm Sobha Developers Ltd (SDL) have seen its stock hold out despite adverse circumstances such as lower sales volumes, rising interest rates and the investigations that hit most companies in the real estate business. Since April, the stock has significantly outperformed both the BSE mid-cap index and the realty index.
Moreover, the outlook is promising given the firm’s improving balance sheet strength and higher realizations on sales. A report from Antique Stock Broking Ltd says, “Average realizations have increased to Rs4,000/sq. ft in October and November 2010 vs.Rs3,750/sq. ft in 2Q FY11.” This has happened thanks to the rising employment in the information technology space and the stronger focus on the premium segment where SDL has an edge compared with most peers. There is room for improvement, too, as analysts say realty prices are still 18-20% off the peak levels reached in 2007.
SDL’s cautious approach to new launches has ensured reasonably low level of unsold inventory that adds to interest costs. “We have sold 74% of our ongoing projects of around 9.6 mn sq. ft,” says S. Baaskaran, chief financial offer, SDL. The high pace of execution and delivery of ongoing projects has improved billing rates. Besides, its contractual business aids profitability with operating profit margin of around 15%. During the September quarter, SDL maintained stable operating profit margins of 21%—in line with the year-ago period.
But, from an investor perspective, SDL’s steady approach to deleveraging its balance sheet will pay off in terms of higher net profit margins. The management sold Rs120 crore worth of land in the first six months of fiscal 2011, and is expected to sell another Rs100 crore in the near term. Interest cost as a percentage of sales could drop from to 12% in fiscal 2011 from 15% a year ago. Debt-equity ratio would also be trimmed to 0.5-0.6: 1, from 0.7:1 at present—better than peers such as Prestige Estates Projects Ltd and Puravankara Projects Ltd.
The positive impact of lower interest burden was seen in the September quarter performance, where the 90% year-on-year (y-o-y) jump in the company’s net revenue to Rs425.7 crore cascaded down to a 109% y-o-y jump in net profit to Rs53.8 crore.
There are concerns on SDL’s entry into new locations such as the National Capital Region and Chennai, where the market is sluggish with a proliferation of big competitors. Another risk is the political instability in Bangalore where SDL has a major presence.
SDL’s shares trade at Rs322 apiece—at a 20% discount to its estimated 12-month forward net asset value (NAV)— which leaves room for upsides. The buoyancy in the Bangalore market, along with its ability to command a premium pricing over its peers in the region, are added triggers as the market recovers.