Indian Stocks Research

Real estate stocks reality check

There are different ways to value a company or a sector, whether it is a sunrise sector or a booming sector. And it definitely applies to real estate stocks. Now there is a fundamental principle in valuing any company it is the future potential earnings. No matter what sector the company operates it is this future earnings potential that drives the stock price.
And most of the times it is just common sense. Infact in my view point real estate sector is the easiest sector to value provided we have sufficient details.

This discussion is not about the future prospects of Indian reality sector (as it is more complex topic due to the diversity of the Indian market) but more about the listed stocks in Indian exchanges.

How to value a real estate company?

As I said earlier it is very easy to value a real estate company but provided all the relevant data is there and believe me not many data is required for that. But the problem is that the management of many real estate companies purposefully doesn’t give those simple details which forces the people to value the company based on the available data

So what about valuing a real estate company based on land bank?

That is the most popular way to value a real estate company. But the popularity is more in real estate company management and real estate consultant. This is because they can put astonishing value to a stock based on the land bank and cash in on the boom.

Now let us see what is the danger in valuing a company based on land bank. Basically for a real estate company land is a raw material. Now it is up to the company how they want to convert these raw materials in to attractive end products. Land is just like a raw material to real estate company as techie people to a software company or copper mines or zinc mines to sterlite. You don’t value a sterlite or a tata steel for the raw materials they own in terms of inventory or mines but rather you value them based on their capacity and efficiency of production.

Same is the case with a software company also. You don’t value an Infosys or wipro based on the number of people they have but their order book , ability to scale and efficiency to deliver on time. Just think if Reliance or ONGC were valued based on the crude oil reserves they own in their wells the share price of Reliance or ONGC should have touched 1,00000 (yes one lack) by now. This is because oil in well is just oil in well and will not have any impact for the company or shareholders unless you process it sell in the market. And there are many uncertain factors some are more to do with the company and some are to do with the environment in which the company operates in. I bet you that if tomorrow Reliance come out and say that they will refine all the oil in their wells in just one month I am sure the company’s stock price will touch the figure I have mentioned above. But in reality it cannot happen due to some external and internal factors.

So why only value real estate companies based on land bank?. Now that’s a question that investors who invest in these companies need to ask themselves. Real estate company valuations are touching absurd levels and many are trading at a ridiculous multiples of their entire land bank. No one thinks that there is an effort required in terms of scale and money to convert those raw materials in to meaningful assets and it requires more thought and creativity from the management to make this in to an attractive end product.

Now that last sentence is really important. The current trend among real estate companies is that to build a residential project or a retail mall or an IT park (or an SEZ) . Common man are you going to convert all your raw materials in to similar products. Then by the time it completes it is going to be a disaster.

Another important factor is the scale. How the company is aiming to scale their operations so that the company can generate more revenues going forward. Belive me even if the company has a huge land bank it will not generate revenues for the shareholder unless the company is able to scale. And not even 5% of the management of the listed real estate space has the expertise and equipments to scale up their operation to justify these valuations going forward.

I will give you some examples. The data will not give false indications.
Lets take the case of some prominent real estate stocks

Mahindra Gesco.

The company has a market cap of 3700Cr. But look at the quarterly numbers.
Details below

	Sep '05	Dec '05	Mar '06	Jun '06	Sep '06
Sales Turnover	22.95	31.14	42.44	34.28	45.41
Net Profit	2.32	2.53	3.86	3.38	2.80
EPS	0.75	0.81	1.24	1.09	0.90

The PE in FY07 will be close to 250. Market Cap/Sales ratio is 23 (Yes 23.)
Even Infosys has a MarketCap/Sales ratio of 10 and the company is growing QoQ.

Look at the Quarterly numbers this clearly shows that the company is not able to scale. But the market cap and PE suggest that the company should at least grow 100% QoQ for at least next 5 years.


Ansal Properties

This has a market cap of 3500Cr . Look at the Qtr numbers
Details below

	Sep '05	Dec '05	Mar '06	Jun '06	Sep '06
Sales Turnover	70.27	66.69	123	160	148
Net Profit	7	8	11	28	22
EPS	4	5	7	8	4

Same case this also has problems in scaling

You can paint a similar picture in other stocks also like Peninsula Land where the
market cap is 2400Cr and the sales is stagnent in 120 levels.


I am not against this kind of valuation if the companies are able to grow on a sustained basis. Now you can argue that we are all paying for future growth. That is all rubbish. How much future are you looking at one year , two year ??. Believe me that is not the case these are high gestation business in the range of 7-10 years. Which investor has the courage to buy at this rate for 10 years. You do not have the valuation cusion at these rates and you are not aware of the uncertain environment that many happen in next 10 years.

Look at Unitech valuation at 40,000Cr (Yes a market cap of fourty thousand cr) the market Cap to Sales ratio is 30 times. And most of its projects will start in 2007 and end in 2010-2015. For example a One Crore(10,383,943 sq feet) square feet residential apartment complex will start in 2006 End and will get completed in June 2013 (This is the projected date). Now who on earth will know that what is the state of that project or the real estate market in 2013. Or even the company is able to complete such a project. Believe me this is not the only project that the company is starting in 2007 (may be some 20-25 projects I could get from the company’s site).

I don’t know that is a viable size for inexperienced Indian real estate companies. So that being the case why you should value a company based on land holdings rather than the projected cash flow. Ultimately that is what matters for most of the investors.

What if the real estate bubble burst?

Scary!!! This is one factor that no one is considering when they invest in real estate stocks right now. Yes the bubble will burst at some point of time. It has happened in more mature markets like America and Japan so that will definitely happen here also.

Now what makes matter worse in Indian scenario is the absence of an exit in the form of real estate trusts. And looking at the supply in the next 2-10 years I strongly feel that it will be difficult to get absorbed in to the market. (Infact if you look at just one company Unitech’s plan for next 10 years in terms of total salable residential plots ..i doubt even that itself will get absorbed)

The biggest problem is that 80% of all upcoming real estate projects are targeted at the residential market and with the prices of per square feet skyrocketing I feel that only from upper middle class will be able to afford such prices. If you want a reasonable flat in any of the metros or in small towns the average price is around 1500-2000Rs / Square feet.
Now if any one wants to buy a mid size flat of 1500sq feet the total cost will be some where around 35-40 lacks. And from where it comes from banks and the poor guy with an average monthly salary of 50,000 ( am talking of a reasonably salaried person) will be blocked for the next 15-20 years (As banks will take most of his monthly salary as EMI).

Now any problem with his employment even 5-10 years down the line can create a ripple effect in the property supply ( Don’t forget the tech meltdown in 2001)

Conclusion

So why to invest in a sector which has astonishing valuation and full of uncertainty going forward. More over real estate company management is not at all transparent in India.
The classic case is Unitech. The management never conveyed to their share holders about the land they hold or their future projects till their market cap reached 40,000. The scrip sky rocketed from 1 Rs to 500Rs (Adjusted for split and bonus) in just one year. And the management kept on buying the shares at low levels from the market. When it reached that kind of valuations they put a beautiful corporate presentation in their company site about the amount of land they hold and the projects expected start and end date. Only recently the media and the analysts got the full picture o their land bank and are trying to value based on that. So why you as a retail investor get in to these kind of a bubble with your hard earned money. Don’t forget the tech boom in 2000 when the companies were valued just based on the sector they were in. Visual soft which was at 10,000 is at 100 odd levels and many companies went burst. So make sure that you got trapped in to such a situation.

I am not too bearish as I painted above.

I don’t want to paint a completely bearish picture as I know that there are many investors that are bullish on the real estate sector. What I said above are some of the concerns I do have about the sector. So if you ask me will the real estate stock can go up from here , sure it can but the risk will be high too. There can also be a possibility that the correction may not even come if India grows at the same rate and the percentage of high income group people keep on increasing.

A company which I am bullish on but don’t have any stake

That’s an interesting caption. The company in focus is “Prime Textile” primarily a textile company from Tirupur. Even though I am bullish on the company based on the current valuation I do not have any stake in the company.
Lets look at the valuation details.
The Market cap for the company at the current price of 133 is just 60Cr. And more importantly its textile division is also doing good. The company is currently undergoing an expansion of its textile division. The topline from textile division is around 120Cr.

Now the company has a real estate division (Its not a subsidiary) . The company owns centrally located and commercially strategic landed properties at Tirupur. Out of the total holding of 28 acres, an extent of 17 acres is appurtenant to the Spinning Unit and the balance 11 acres is reserved for residential purposes.

The company has taken up construction of Luxury Residential Apartments and a Commercial Complex on a portion of land admeasuring about 6 acres.
Phase-1 construction of 3 blocks comprising 212 Residential apartments (overall saleable area: 268,903 square feet) is in full swing and likely to be ready for occupation by end-December 2006. Phase-2 construction of 5 blocks comprising 200 Residential apartments (overall saleable area: 312,142 square feet) will shortly be commenced.

The Commercial Complex will have overall saleable area: 273,506 square feet and aims at attracting biggest and best of the brands in retail trading.

If you attach a price tag of 2000Rs / square feet for the residential property the total value will come to around 120Cr And if you consider a rental rate of 25rs per square ft for commercial complex the rent per year will be some thing like 8Cr ( I don’t think they are planning to sell the commercial property, So that will be a recurring income).

The whole project started some 1 year back and at that time itself the company has stated that the first phase of residential apart will get completed in 2006-End and is right on track.

So a small company with small scale of real estate operations and more over the future price if not in the valuation.

Many respective people off late have taken some position in the stock . One among them is Manek Bhansali of Enam who has a 2.5% stake. He is known for his value buys in the Indian stock market. So may be at a Market cap of just 60 Cr this one is worth a look.

Disclaimer

As of now I do not have a stake in the company.

posted by Sajith @ 7:34 AM