>INDIA PROPERTY (MACQUARIE RESEARCH)

First, rabbit holes; now, wings of wax

After the rally, what next?
In February 2009, real estate stocks appeared to be tumbling down a rabbit hole, with no signs of a bottom. As we expected (see report How deep does this rabbit hole go, dated 18 March 2009), stocks rallied due to improving liquidity. Although we still believe that this is a good time to accumulate Indian property stocks for the long term, their 200–300% average rise during the past three months has likely led the market to expect a sharp pullback. Should this occur, we would view it as an entry point. Meanwhile, we think it is advisable to take profits from stocks with wings (and feathers) of wax that are flying too close to the sun.

Rally has been backed by fundamentals
Availability of capital in 1Q CY09 was completely frozen, even while the situation in most of Asia was slowly improving. At that time, it looked like there would be some relief for developers as lenders took on more risk. This has now occurred. There have been instances of banks willing to refinance obligations and some asset sales. Importantly, nearly US$2bn of equity was raised by the developers in the past couple of months. This has definitely eased the liquidity pressure on developers. Developers have also cut prices by 20–30%. This has led to a recovery in residential sales volumes in many parts of India. Although the physical markets remain under stress (especially on the commercial and retail fronts), inventory clearance has indeed started.

The NAV upgrade cycle is still in its infancy
These trends led to some NAV upgrades in the past quarter, including by us (even though we were clearly above the Street back in March). We believe this momentum has just started. Analysing past cycles in India is very tough because most developers have been listed for less than three years. However, past cycles in more-developed markets (such as Hong Kong) show that NAVs can move up by 2–3x from the trough to peak cycle. In India, some drivers of upgrades are obvious. WACC of 16–17% and cap rates of 13–14% at bottom-cycle rents and
volumes were clearly pessimistic. NAV downgrades in 2008 were driven by the capital crunch and demand destruction. There have been some NAV revisions stemming from the improved capital scenario. The upgrade cycle on higher volumes and rising prices (after the recent GDP upgrades) has not yet started.

Approach should change from ‘selling into strength’ to ‘buying on dips’. A near-term pullback would not be a major concern, in our view. Stock markets have often had a 20–40% correction 3–6 months after coming off a bottom.

Stock picking: Keep an eye on the fundamentals
Investors should focus on stocks with relatively better-quality balance sheets and a clear and robust monetisation strategy. Based on our scenario analysis and qualitative framework, we believe Indiabulls and Unitech are best placed, with DLF next. We would also advise caution, however. The recent rally has clearly reduced the valuation proposition of Indian property stocks. We have maintained our Overweight position on India in the regional portfolio, but with a reduced weight (from 2% to 1%). We recommend that investors take profits in Provogue,
Akruti, Ansal and Mahindra.

To see full report: INDIA PROPERTY