Multiple headwinds mar stock valuations of real estate developers

Multiple headwinds mar stock valuations of real estate developers

Paradoxically, although fiscal 2011 (FY11) saw a rebound in real estate prices, stocks in the sector are languishing. Though the realty index of the Bombay Stock Exchange did show signs of improving during the first six months of FY11, it has consistently underperformed the benchmark Sensex till date.

Shares of large real estate developers such as DLF Ltd, Unitech Ltd and Housing Development and Infrastructure Ltd (HDIL) have fallen by 25%, 41% and 31%, respectively, from April 2010 levels.

Negative newsflow haunts the sector. For example, a Mintreport on Tuesday highlighted concerns of bankers on the inability of realtors to repay and service loans due to paucity of funds.

Little wonder, valuations have consistently fallen. Shares of leading realty firms trade at a discount of 40-50% to their net asset values, almost twice the discount at the end of the September quarter. This is despite a reasonable performance estimated for the Mar-ch quarter, which is likely to have seen improved fundamentals with higher year-on-year (y-o-y) revenue and operating profit on more execution.

Sentiment turned negative in the wake of reports questioning the transparency of realty firms and their governance standards. he money trail in at least some scams led to some realty firms. This hit valuations, which were already down due to existing concerns on rising interest rates.

Rising interest rates cut both ways—one, it lowers affordability and housing demand, and two, it increases the interest burden on money borrowed by firms. A report by Ambit Capital Pvt. Ltd, although estimating higher y-o-y revenue for the March quarter, says, “Data indicates marked slowdown in volume offtake owing to high realty prices across key markets (NCR, Mumbai residential markets are reaching new highs, while Pune and Bangalore prices are still at a discount of 20-25% to FY08 highs)."

This implies buyers’ resistance to higher prices. A Motilal Oswal Securities Ltd report points out relatively lower affordability among buyers, despite rising incomes in the last eight quarters. Besides, buyers are cautious and prefer finished projects. So, upfront advances are down to 10% from 25-40% about three years ago.

But realty price recovery in FY11 against the troughs hit in FY09 will ensure a y-o-y revenue growth for most firms such as DLF, HDIL, Puravankara Projects Ltd and Mahindra Lifespace Developers Ltd. Some such as DLF will also register an uptick in commercial lease rentals, an impact of robust economic recovery in the country.

Some firms, which have stepped up new launches in the March quarter, could also see revenues inching up in the first two quarters of FY12. But, stiffer lending norms and low appetite of private equity investors for realty firms due to credibility issues have dried up fund flows to the sector, or made it more expensive. Execution delays along with higher cost of funds will see pressure on profit margins in the medium term, particularly for large pan-India players.

From an equity investment viewpoint, the discounted valuations may be attractive entry points for long-term investors. But at this stage, it may be hard to sift the grain from the chaff. Firms such as HDIL that have high exposure to Mumbai may see headwinds in sales, while DLF may register lower profit growth due to high interest burden.

Analysts seem to prefer firms such as Sobha Developers Ltd and Puravankara Projects, which have exposure to the southern markets where recovery in the ITES (information technology enabled services) space is driving sales momentum. But, unless the sector gains credibility, valuations may not change.

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