>India Property Initiating Coverage: Cheap. Really? (Jefferies)

Key Takeaway

Property sector investment at inflection point is all about getting the timing right and fraught with risks. We are not trying to make a call on the cycle turning from here but presenting a case for remaining selective while investing in the sector given the far-reaching structural changes. We initiate coverage on eight companies with Oberoi Realty as our top Buy and DLF as our top

Underperform.

A free meal, no more

2011 has provided enough empirical evidence of a structural shift over the past five years. The shift to construction linked payment and buyers becoming selective has made development more capital intensive. Cheap land acquisition, a major value creator earlier, is no longer as lucrative with land owners demanding share in conversion gains. Increasing construction costs and manpower shortages are hindering growth prospects. Regulatory interference is rising and both equity and debt has become scarce and expensive. As a consequence the business is no longer as profitable as it used to be.

There will be new industry leaders that will emerge in this new era and the critical success factors will now shift to a) clean and converted land banks, b) strong balance sheets, c)

execution strengths, d) transparency, and e) lower litigation risks.

Challenging times ahead

After two years of strong volume growth across most cities, we are at the cusp of a cyclical volume slowdown. Recent trends indicate that residential volumes are beginning to slow down with a 14% YoY drop in All-India June-11 volumes on rising mortgage rates and alltime high property prices. With developers’ reluctance to cut prices, we believe that volume recovery will get pushed into 2H FY13. We expect a significant slowdown in Mumbai and Gurgaon volumes while Bangalore, Chennai and Pune expected to perform relatively better in FY12.

No gain in being bold

Realty sector has underperformed without any de-rating with consensus continuing to remain bullish on growth prospects and FII ownership at all-time highs. MSCI real estate index is up only 6% since Mar'09 and has underperformed both the autos and staples which are up 234% and 62% respectively. Despite that real estate sector has not seen any valuation de-rating vis-à-vis these sectors. Additionally, timing was critical for stock returns in the real estate sector. If one was a few months too early or late in catching the bottom for real estate stocks, most of the 2009 out-performance would have been lost.

Initiate coverage on the sector

Being selective remains the key to investing in the sector and we like management with positive cashflows, stronger balance sheets and low risks. We initiate on Oberoi, Sobha and Prestige with Buy ratings, Godrej properties and Unitech with Hold ratings and DLF, IBREL and HDIL with Underperform ratings.

To read the full report: India Property