Testing times for real estate stocks

By: Karshni on 08:53

In spite of concerns on the sector’s financial health, realty stocks have spiralled up in the past one year. The BSE realty index returned around 35%, much more than the benchmark index, recouping after being battered down for nearly three years prior to that. That said, any further rise in stock prices of realty firms hinges on an increase in demand and higher sales, although that is unlikely to be the trend in the December quarter.

The uptick in stocks seen so far has been the culmination of several factors. One, investors’ belief that realty firms have hit the bottom; two, improved financials as realty firms tried to lower debt by raising funds through equity or divesting non-core assets as with DLF Ltd. And the third factor is the hope that a fall in inflation and interest rates will buoy the sector’s profitability in the forthcoming quarters. Through the slump, firms like DLF, India Bulls Real Estates Ltd and Unitech Ltd have tried to hasten execution and cut construction costs to ease pressure on profit margins. Although the December quarter results will be a mixed bag, the operating margin for the sector should expand by around 150 basis points (bps) from the year-ago period. One bps is one-hundredth of a percentage point.

Indeed, cost rationalization when coupled with higher demand and sales, will improve the return on equity of real estate firms. Historically, sales have improved with a reduction in interest rates, which is expected in the current year. A Crisil Research report states that absorption of new residential units across six key cities is likely to increase at a compounded annual growth rate of 7% in the next two years, with Mumbai registering the highest CAGR of 14% in the next two years due to huge pent-up demand. Meanwhile, the Bangalore realty market is likely to see a stable rise in sales with firms such as Sobha Developers Ltd and Prestige Estates Ltd benefiting.

Analysts believe that a gradual recovery in sales and capital values in real estate is expected by the second half of calendar year 2013. Moreover, commercial leasing activity is likely to take a little longer to improve, given the recessionary economic conditions. December quarter revenue growth is likely to remain more or less flat, with profitability improving because of cost-reduction measures and better product and market mix by developers.

Most positive factors such as a reduction in interest rates and improved profit margins are built into present stock price valuations. Any further increase in share prices will come only from actual sales growth translating into robust revenue accretion.

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