Saturday, June 23, 2012


Stay Selective: Improving Execution Is Key

 Valuations limit downside; focus on visibility. B/S strength — With the real-estate sector having underperformed the Sensex by 40% in the past two years, we believe that most of the sector challenges are priced in. We see the most significant upside in stocks where 1) large part of NAV is front loaded and transparent 2) balance sheets are healthy 3) micro market demand and pricing are healthy. Our top picks are (1) Phoenix Mills (~80% of NAV on the ground and rental annuities are steady); and (2) Prestige Estates (Bengaluru exposure, good execution/disclosures).

 Pockets of resilience amid broader slowdown — The sector has been out of favour in the past 3-4 years due to execution delays, stressed balance sheets, increasing interest burdens, cost inflation and slowing absorption. While these headwinds will still take time to resolve, the landscape has its bright spots e.g. resilient prices (especially in Mumbai) and steady absorption in Bengaluru/Chennai on higher end-user demand.

 Higher asset turnover is key to longer term — On our analysis, lower RoE for leading Indian developers (DLF/Unitech) compared to peers in Brazil and China (~3% v/s 15%) is mainly due to lower asset turnover ( ~17% v/s ~45%+). But large land banks and approval/execution delays in India constrain any pick-up in the near term.

 DLF downgraded to Neutral (from Buy) — DLF has outperformed BSE Realty over the past year on hopes of debt reduction and a turnaround. But non-core asset sales over the next 5-6 months will likely help only at the margin (~Rs48bn over FY10-12 has not cut debt materially due to continued capex of ~Rs3-4bn/qtr). We downgrade to Neutral − and await a pick-up in execution/sales/margins to become more constructive.

 Adjusting NAVs — Our NAVs now (1) roll forward to Mar'13E (Sep'12E earlier) (2) do away with our earlier probability-weighted blended NAV methodology (assuming 15% price cut) given recent price hikes, partly inflation-led (3) factor in further execution delays (4) marginally adjust cost of capital assumptions (in some cases).

 Transfers of coverage — With the report, we transfer coverage of Ascendas India
Trust, DLF, Oberoi Realty, Phoenix Mills, Prestige Estates, Sunteck Realty and Unitech to Atul Tiwari from Surendra Goyal.