Asset prices still under a dark cloud
Excessively leveraged private developers may spoil party
Recent RBI data shows overall borrowings in the sector climbed to
INR1,025b. An analysis of leverage within the developer space indicates
that approximately 33% of the loans are with the publicly-listed
companies. While recent QIPs have lowered the public developers’ net
debt-equity to 0.62x from 0.69x earlier, the private developers still remain
vulnerable to a slowdown. Due to the fragmented nature of the property
market in India, private unlisted developers are a major block, with
market share of 70%+. Therefore, as the need to drive sales is still high,
we expect smaller private developers to continue to aggressively price
their products. Further, a high unsold inventory-to-sales ratio of
residential properties in key metros implies that property prices are likely
to recover slowly. In addition, the office and retail sectors, which account
for more than 50% of the publicly listed developer NAVs, are still reeling
due to over-supply and declining rents.
Too many clouds to find the silver lining?
Current developer valuations (of DLF, Unitech, and HDIL) anticipate an
immediate recovery in property prices, with 5% y-y growth for the next
10-15 years, blended EBITDA margins of 29-48%, 10% WACC and a
9% cap rate. This is a highly idealistic contrast to the current reality of:
asset prices and rentals still in decline, high oversupply risk in office and
retail sectors (indicating a delayed recovery), and a high base primelending
rate (BPLR) of 12.25% (or high cost of capital). NAVs also
continue to remain prone to the change in product mix, as seen in DLF’s
case, where landbank has shrunk to 425m sqft, with minimal cash inflow.
At P/BV of 2x+, valuations of DLF, Unitech and HDIL may shrink if
proposed asset sales do not yield more than 100% profit on cost.
We skipped the mid-cycle, retraction appears inevitable
The property sector is now expensive relative to other sectors in India by
most metrics (P/E, etc). Due to the increasing number of asset sales at
lower valuations, we prefer to value developers on P/BV. We
recommend investors enter large-cap property stocks at mid-cycle
property valuations (between 1x-2x adjusted P/BV).
Contents
Private developers’ debt pressure a dampener ............................................................. 3
Analysis of the total debt outstanding in the property sector reveals that of the INR1t of real estate debt
outstanding, approximately 67% lies with the private developers who rely heavily on project sales to
meet their debt obligations. While recent Qualified Institutional Placement (QIPs) have strengthened
the balance sheet of publicly listed developers and helped re-rate few from bankruptcy valuations to
going-concern valuations, we believe the strain in the sector is not over. We expect asset prices to
remain under pressure due to the need to drive volumes and minimize the high unsold inventory.
Office/retail recovery unlikely before FY12 .................................................................... 7
Office and retail segments have been a key earnings driver for the larger property developers over the
last two years. Moreover, non-residential contribution to NAV of larger Indian property developers
varies between 65-82%. Oversupply in these office and retail segments suggests a recovery in rentals
is unlikely before FY11E. Further, we believe a significant change in product mix to the lower-margin
residential segment will keep recurring earnings and DCF-based NAV depressed.
Too many clouds to find the silver lining?...................................................................... 9
Developer stocks have often led the property cycle by 6-12 months in both emerging and developed
economies. Given the difficulty in predicting the bottom of a property cycle, we decided to use property
stocks as our lead indicator and ran a sensitivity analysis to look at what is priced in based on DCFbased
NAVs. Key takeaways are that current valuations are factoring an improbable recovery in the
property market in terms of both volumes and property prices.
QIPs throw a lifeline; earning sustainability key........................................................... 14
We believe property developer valuations are extremely expensive to the overall market in every
metric. Sector P/FY11 EPS hovers around 25x compared to 16x for the market. Even if we looked at
EV/EBITDA for developers on a contracted sales basis in FY10E, developers will have to sell more
than what they managed in the peak of the cycle to sustain current valuations. We recommend
investors to buy property stocks aggressively only at mid-cycle multiples (adjusted P/BV of less than
1.5x). Based on lower downside risks, our current preference for property stocks is IBREL, UT, DLF
and HDIL.
Appendices ................................................................................................................. 19
1. Through-cycle P/BV range of 0.5-2.0x 19
2. Average annual property price increase is 5% in prior property cycle 21
3. Key office space trends across major metros 22
Company updates........................................................................................................ 23
DLF Ltd – REDUCE; CP: INR352.45; TP: INR175.00 24
Housing Dev & Infra – REDUCE; CP: INR247.25; TP: INR98.00 28
Indiabulls Real Estate – HOLD; (from BUY); CP: INR211.55; TP: INR204.00 (from INR175.00) 32
Unitech – REDUCE; CP: INR86.95; TP: INR50.00 (from INR23.00) 37