The Hindu Business Line : Realty stocks beaten down despite strong earnings

BL Research Bureau Which domestic sector index has lost over 50 per cent in the past 6 months eroding its valuations from a P/E of 58.4 times in September 2007 to 16.9 times now? No marks for guessing it right — it is the BSE Realty Index. This index, launched a year ago after a number of prominent real estate companies were listed, has only been seeing new lows every day. P/Es of companies in the index vary from 4 times (Omaxe) to 25 times (Mahindra Lifespaces).

The realty sector has been reeling under multiple concerns: declining property prices, rise in borrowing costs for realty companies and home buyers and increase in construction costs. This has led to some stocks in the BSE Realty Index declining as much as 75 per cent. Are all the concerns genuine or are some of them overdone?

Have earnings caught up?

Despite gloomy times in the stock markets, companies in the BSE Realty Index managed to clock strong growth in profits in FY-08. Hence the contraction in P/E can be partly explained by the surge in earnings. For instance, Akruti City’s P/E has contracted from 57 times in September 2007 to 15 times now. While the stock declined by only 5 per cent over the last 6 months, a near four-fold increase in per share earnings in FY-08 resulted in PE contracting. However, blue chips such as DLF have been beaten down to single-digit P/Es despite strong growth in earnings.

Others such as Indiabulls Real Estate and Phoenix Mills although they took sharp hits, have managed to maintain P/Es of about 15 times as these stocks started showing earnings in their books.

Clearly there has been divergence in the treatment meted out to these stocks by participants. The broad trend in the BSE Realty Index appears to suggest that companies with larger proportion of Mumbai-based assets (Akruti City, Indiabulls Real Estate, Mahindra Lifespaces and Phoenix Mills) have managed to command better valuations than their larger peers with more diversified assets.

Another trend that emerges from the sharp de-rating is that companies are no longer merely valued for the land bank that they accumulate. Stocks of companies such as DLF, Omaxe and Parsvnath Developers were largely inflated for sometime as market analysts placed greater weightage on the value of land held by these companies when arriving at the net asset value (NAV).

The land bank accumulation is seldom talked about now, with realty players themselves showing lesser interest in buying up land. Few takers and low premia for lands auctioned in Mumbai this year is suggestive of this trend.

Bundle of Concerns

Rising cost of construction, slowdown in home buying and decline in property prices are other issues that have resulted in the market de-rating the sector. The first two concerns appear genuine: Lower disbursements of home loans and lower collection of stamp duty in some State Departments may indicate that home buyers remain reluctant to purchase. On the cost front, the price of steel and cement does put pressure on company’s margins. The key concern here could be that companies may write down costs after the completion of projects leading to erosion in margins at a later stage.

Indian realty companies follow the percentage completion method for booking sales. Costs are therefore booked based on estimates until the project is over. A revision in these cost estimates due to steep hike in raw material costs could therefore affect profits. This situation has already come to light in Omaxe’s fourth quarter results.

On the property price front, the concerns could be a little overdone. Latest quarterly numbers show that companies such as DLF, Puravankara Projects and Unitech have managed to sell properties in the same location at higher prices. Many of them have used a combination of strong pricing in high-end markets and aggressive pricing in new markets, to clock healthy volumes and profit margins.

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