DLF, Prestige are a buy even with inventories at 6-year high

With financial costs becoming dearer for real estate developers across the country and absorption rates at close to 2008 crisis levels, one would want to stay away from real estate stocks.Absorption reflects how much people are actually buying. And with little signs of a recovery in sales before elections in May 2014, earnings in realty stocks are likely to stay weak amid tight liquidity conditions and high funding costs.

Most markets, except Bengaluru, saw weakening sales during the quarter. The key area of concern is rising inventory levels, with Mumbai and NCR exhibiting elevated levels of 41 inventory months.

With residential property prices having increased by 10-47 percent over the last two years across most tier-I markets, pre-sales across the country have steadily declined.



Mumbai is the worst hit with absorption at six-year lows driving developers to lower prices 8 percent year to date with construction at a standstill, thanks to a high backlog of pending regulatory approvals. Most developers are strained for liquidity and buyer confidence is low given lack of execution on projects.

"Real estate developers have been caught in a trap of ambitious expansion, decelerating sales, hardening interest rates, and weakening cash flows," Knight Frank, a real estate consultancy firm, said in a report.

According to the report, gross debt in the sector has more than doubled to 55 percent since financial year 2009 with some firms even defaulting on their debt obligations. Private equity funds and foreign investors aren't too fond of betting on real estate right now either. Foreign direct investment has plummeted from 9 percent in FY12 to 3 percent in FY14 so far.

"This seems to be just the beginning of doom for highly leveraged realty firms," Knight Frank said.

Given the overall slowdown in the economy, outlook for interest rates and the other macroeconomic challenges, investors have dumped realty stocks. In the past six months, the BSE Realty index has fallen by 30 percent.Little wonder that HDIL, Kolte Patil Developers, Unitech, Oberoi Realty, DLF and Sobha Developers have slipped between 44 and 70 percent in the first eight months of 2013.

Several property stocks are trading at trough valuations of 60-65 percent discounts to net asset values and, according to UBS Investment research, it's time to be selective and buy stocks with growing rental asset portfolios, fully paid prime land bank reserves and better pre-sales outlook.

"We foresee recent land acquisition reforms making land aggregation difficultand significantly increasing land costs, rising FSI (floor space index)costs/taxes, cost inflation, progressing infra projects (Metro, monorail, freeways, bridges/expressways), significantly keeping land/asset prices firm despite this low demand environment. Developers with fully paid land banks in tier 1 and 2 cities are best-positioned with a significant competitive advantage," said Ashish Jagnani, real estate analyst in a report titled "Property weak but valuations outweigh."

Given these factors, UBS is bullish on DLF as an asset play and Prestige as a cash flow play.

The brokerage believes that at a valuation of Rs104 a share for DLF's rental asset portfolio (24 million square feet), the stock significantly undervalues the development business and its prime land reserves ( 320 million square foot of which 90 percent is fully paid up).

"We see DLF as a compelling asset play; and believe improved deleveraging and cash flow visibility following recent healthy first quarter pre-sales of Rs 2,400 crore to be key catalysts," said Jagnani.

Edelweiss too likes DLF for its strong annuity portfolio and high value land parcels.

"DLFs strategy of focusing on luxury projects and developments backed by execution by best-in-class third party contractors against in-house executions will result in superior cashflows," said Edelweiss in a report.

Key expected launches/sales for the company are Sky Court II and New Gurgaon, Lucknow and Panchkula plots and further sales in


Prestige, on the other hand, has had a strong pre-sales momentum so far.

"Unrecognised sales of Rs 5,600 crore (and) expected 20 percent CAGR in rentals in FY13-16 provide Prestige with much superior earnings/cash flow profile vis-a-vis the sector, and (with a) valuation of 54 percent discount to NAV...we see a favourable risk-reward (ratio)," the report said.

Prestige sales grew 13 percent YoY in volume terms and 14 percent in price terms to 1.83 million sq ft and Rs 1,070 crore, respectively. Total launches for the quarter stood at 5.21 million sq ft of total developable area, while collections for the first half of financial year 2014 stood at Rs 1,227.2 crore, which is a growth of 32 percent year on year.

JP Morgan has maintained 'Overweight' rating on the stock and expects the stock to touch Rs 205 in the next 12-months.

According to the brokerage, the company's operating performance remained strong in Q2 despite a seasonally weak quarter and challenging macro.

"This was due to high launch activity and steady absorption trends in Bangalore. Prestige has continued to deliver a good beat across all operating parameters, i.e. pre-sales, collections and launches. With this, it has already achieved in 1H 60 percent of its full year guidance. Given the impressive pre-sale performance over the last three years and locked-in rental growth, we believe PEPL can deliver substantial free cash flow growth over the next 2 years," the report said.

Even Karvy Stock Broking has maintained 'Buy' on Prestige Estate Projects, with a target price of Rs 207 as against current market price (CMP) of Rs 137 with 51 percent upside in its report.

Commenting on the investment rationale, Karvy said, ''Q2FY14 sales volume continues to remain strong for our coverage universe and the much hyped sentiments of inventory buildup, demand erosion and price correction is yet to play out."

The brokerage believes strong launch pipeline and focus on further balance-sheet stabilisation are near term catalysts for the stock.

Updated Date: Dec 20, 2014 23:28 PM

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