Slowing earnings and moderate growth potential do not justify the stock's high valuation.

The stock of real-estate developer Phoenix Mills has gained around 50 per cent since last June. Clearing the bill to allow foreign direct investment in retail, launching its three million sq ft residential project in Bangalore and opening its Chennai mall have buoyed the stock. But at its current price of Rs 258, the stock trades at 45 times its FY13 consolidated earnings — much higher than the average levels (35 times) it had traded at in the past. We recommend that investors sell their stock, given that its current valuation is not justified by the company’s moderating earnings and growth potential.

Mall momentum to moderate

High Street Phoenix (HSP) was developed in 1987 on the company’s textile mill land in Mumbai and is currently a 3.3 million sq ft retail mall. Phoenix Market City malls are operational in Pune, Bangalore, Chennai and Mumbai.

The four million sq ft retail space contributes lease income and revenue share from tenants. Leased area, occupancy levels and average rents have improved and tenants have reported higher revenue per sq ft.

The company also operates malls, totalling two million sq ft, in Tier 2 and Tier 3 cities such as Lucknow, Bareily, Agra, Varanasi and Indore through its subsidiaries. An additional three million sq ft is expected to be operational over the next 18 months. But retail space uptake in non-metros has been weak and may not improve in the near future; this could impact Phoenix’ mall occupancy in these markets.

Branded mall developers such as Phoenix Mills are expected to benefit from demand for quality real estate from retailers, based on the projected 25 per cent growth in organised retail industry in India.

But due to the current weak macro economic climate, retailers may face pressure on sales. This could affect Phoenix Mills’ revenues and profits. Over 90 per cent of the company’s metro mall spaces are already leased out (see table) and future revenue growth in this segment is limited to rent escalations and revenue share.

Property and hospitality

Phoenix Mills also sells mixed-use projects linked to the mall locations in Mumbai, Chennai, Pune and Bangalore. There are now seven residential and three commercial projects being developed as joint ventures with venture funds and land owners.

The company’s ownership interest is around 3.5 million sq ft of unsold area across cities, and it plans to spend Rs 1,400 crore for stake buy-out in the next two years.

Real estate consultants feel that the Bangalore residential market, where Phoenix Mills’ largest project (around 4 million sq ft) is based, is expected to pick-up, after being subdued in the last few years.

The property sales market has cash flow risks, and revenue and profit growth are usually moderate at best. Price earnings multiple for real estate developers is only around 15 times.

Also, the company has been facing cash collection issues in two of the three commercial properties in Mumbai, with only a third of the sale value collected so far. This market may remain sluggish in the near term, dampening revenue growth prospects.

The company also owns and operates the Shangri-La hotel in Mumbai and Courtyard by Marriott in Agra. In FY2013, the average room rent was around Rs 9,500, generating an income of Rs 16 crore.

After expenses and interest, the loss incurred was Rs 46 crore. As more rooms become operational, revenue and margins may improve. But occupancy and rents in the hospitality segment are likely to remain tepid in the near term.

Expensive buy

Developers such as Prestige Estates and Oberoi Realty, which own and lease retail assets, in addition to selling residential and commercial assets, trade at a price to earnings multiple of 18 and 13 respectively.

Retail lease contributes around 10 per cent share of revenues for Prestige and around 7 per cent for Oberoi.

Phoenix Mills derives around half of its revenue from retail assets. The company’s price-to-earnings multiple has increased from around 25 times in June 2012 to 45 times currently.

This seems expensive, given that growth in the company’s sales and profit has moderated. Income growth was around 19 per cent in FY13, much lower than the growth in earlier years (84 per cent growth in FY12 and 62 per cent growth in FY11). Profit margins fell from 39.5 per cent in FY11 to 22 per cent in FY12 and further to 17.3 per cent in FY13. The slower revenue growth and fall in margins have led to earnings per share dipping 20 per cent in FY-13. Revenue growth from Shangri-La hotel, up-tick in mall lease rentals, sales growth in residential and commercial properties are all likely to be moderate and there are no triggers for a sharp growth in revenues.

Also, the company’s debt levels are not expected to reduce, due to construction expenses and capital needed for stake buy-outs. Hence, interest cost reduction and profit growth from de-leveraging is not likely in the near future.

Financial performance

Phoenix Mills reported standalone revenue of around Rs 271 crore in FY13, a 36 per cent increase from the previous year, and its profits grew 27 per cent to Rs 134 crore. Operating margins improved to 66 per cent in FY13, up from 62 per cent last year.

But consolidated income grew at a slower 19 per cent to Rs 522 crore. Profits however fell around 20 percent, to Rs 84 crore, due to higher interest expense ( up 50 per cent to Rs 143 crore) and higher tax rate (34 per cent rate, up from 18 per cent in FY12).

Borrowings increased 22 per cent in FY13 and is currently at Rs 1,833 crore. The company has been operating cash flow positive, thanks to its lease income.

(This article was published on June 22, 2013)
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