The recent hikes in interest rates and the continuing scenario of unaffordable housing may prove to be an intimidating combination for the real-estate sector and realty developers. While rising cost of home loans can affect demand, higher funding requirements and steadily rising borrowing costs present risks for developers.
While the prospects for the sector over the long-term remain bright, the current macro environment for realty stocks is definitely less favourable than seen at the time of many of the IPOs in the sector.
Tackling real issues
Given the above, companies with a comfortable funding position, ability to generate quick cash flows and a reasonably assured near-term revenue stream, may make for better investment options within the sector. In this context, we recommend that investors in Parsvnath Developers exit the stock. The company's aggressive portfolio of long-term revenue yielding assets, significant funding requirements for the above projects combined with high exposure to the National Capital Region (NCR), which is now showing signs of slowdown, add to the risks in the investment.
Investors can instead take exposure to Housing Development and Infrastructure (HDIL). The company, focussed on the Mumbai region, has experience in high-potential slum rehabilitation schemes and relatively easy access to funds through sale of Transferable Development Rights (TDRs), with several projects due for completion in the near future. (See our IPO analysis in Business Line edition dated June 24, 2007 ). At a P-E multiple of about 6 times its trailing 12 month earnings, the HDIL stock is at a slim premium to Parsvnath.
Regional risks
From being an NCR-focussed player, Parsvnath has made an attempt to diversify into other regions in the South and West. However, the Delhi NCR and northern regions together still account for 69 per cent of the saleable area. Its exposure to Tier-II and Tier-III cities also remains high.
While in a different kind of market, this combination would have fetched the company premium pricing and faster growth, the current scenario has made the task more difficult for Parsvnath. Over 50 per cent of Parsvnath's saleable area arises from the residential space.
With higher home loan rates, developers may have to resort to lower pricing and other offers to woo customers. Such a move could well result in lower profitability for players in the medium term.
For instance, the company, in early 2008 announced an 'EMI reimbursement' scheme (for a 2.2 million sq ft project ) for customers to provide flexibility in payment plans. Similar instances of discounts or EMI holidays by developers especially in NCR appears to suggest that demand could be waning. Further, Parsvnath's presence in Tier-III cities is also a risk, as the demand-supply disequilibrium is greater in these cities compared to a prime market such as Mumbai.
While the commercial scene had remained strong until 2007, a Cushman & Wakefield report is suggestive of increasing supply in Delhi and NCR . Vacancy rates in Noida, for instance, have increased from less than 4 per cent in the fourth quarter of 2007 to 15 per cent in the second quarter of 2008. The lease as well as capital values may, therefore, face the risk of a decline. The risk of Parsvnath's inventory entering the market during a high supply phase appears high.
Few near-term drivers
Parsvnath's high exposure (36 per cent) to Special Economic Zones (SEZs) also does not also provide comfort, given the long-term nature of revenue flows from such projects. The only steady contribution to revenues could come from BOT projects bagged from the Delhi Metro Rail Corporation. The proportion of saleable area from this project, however, remains insignificant.
Increasing funding needs
Parsvnath has about 211 million sq. ft of developable area with 79 million sq ft under construction. The funding requirement will, therefore, continue to be high. Cash flows, especially from residential projects, could be slower if liberal payment schemes are continued.
With a high gearing ratio of close to two, Parsvnath may find it tough to borrow at reasonable interest rates. Its average borrowing costs over the last two quarters have remained at 13 per cent; this could, however, increase with the recent spate of rate hikes. While there have been inflows from private funding channels, investors have been selective in their projects. Parsvnath's Mumbai 'BEST' depot project has received investments from the Saffron group funds.
Investments in riskier core realty projects have been less forthcoming in recent months except for large players such as Unitech or DLF.
Financials
Parsvnath's consolidated sales and profits for the quarter ended June 2008 have witnessed a decline. While cost of development has seen a marginal increase, steep increase in staff costs have pulled down operating profit margins by 300 basis points. Interest costs have increased five-fold on a Y-o-Y basis. The quantum of debtors has more than doubled even as sales slowed. This again, poses a risk to the much-needed cash flow required to ease working-capital requirements.
While the prospects for the sector over the long-term remain bright, the current macro environment for realty stocks is definitely less favourable than seen at the time of many of the IPOs in the sector.
Tackling real issues
Given the above, companies with a comfortable funding position, ability to generate quick cash flows and a reasonably assured near-term revenue stream, may make for better investment options within the sector. In this context, we recommend that investors in Parsvnath Developers exit the stock. The company's aggressive portfolio of long-term revenue yielding assets, significant funding requirements for the above projects combined with high exposure to the National Capital Region (NCR), which is now showing signs of slowdown, add to the risks in the investment.
Investors can instead take exposure to Housing Development and Infrastructure (HDIL). The company, focussed on the Mumbai region, has experience in high-potential slum rehabilitation schemes and relatively easy access to funds through sale of Transferable Development Rights (TDRs), with several projects due for completion in the near future. (See our IPO analysis in Business Line edition dated June 24, 2007 ). At a P-E multiple of about 6 times its trailing 12 month earnings, the HDIL stock is at a slim premium to Parsvnath.
Regional risks
From being an NCR-focussed player, Parsvnath has made an attempt to diversify into other regions in the South and West. However, the Delhi NCR and northern regions together still account for 69 per cent of the saleable area. Its exposure to Tier-II and Tier-III cities also remains high.
While in a different kind of market, this combination would have fetched the company premium pricing and faster growth, the current scenario has made the task more difficult for Parsvnath. Over 50 per cent of Parsvnath's saleable area arises from the residential space.
With higher home loan rates, developers may have to resort to lower pricing and other offers to woo customers. Such a move could well result in lower profitability for players in the medium term.
For instance, the company, in early 2008 announced an 'EMI reimbursement' scheme (for a 2.2 million sq ft project ) for customers to provide flexibility in payment plans. Similar instances of discounts or EMI holidays by developers especially in NCR appears to suggest that demand could be waning. Further, Parsvnath's presence in Tier-III cities is also a risk, as the demand-supply disequilibrium is greater in these cities compared to a prime market such as Mumbai.
While the commercial scene had remained strong until 2007, a Cushman & Wakefield report is suggestive of increasing supply in Delhi and NCR . Vacancy rates in Noida, for instance, have increased from less than 4 per cent in the fourth quarter of 2007 to 15 per cent in the second quarter of 2008. The lease as well as capital values may, therefore, face the risk of a decline. The risk of Parsvnath's inventory entering the market during a high supply phase appears high.
Few near-term drivers
Parsvnath's high exposure (36 per cent) to Special Economic Zones (SEZs) also does not also provide comfort, given the long-term nature of revenue flows from such projects. The only steady contribution to revenues could come from BOT projects bagged from the Delhi Metro Rail Corporation. The proportion of saleable area from this project, however, remains insignificant.
Increasing funding needs
Parsvnath has about 211 million sq. ft of developable area with 79 million sq ft under construction. The funding requirement will, therefore, continue to be high. Cash flows, especially from residential projects, could be slower if liberal payment schemes are continued.
With a high gearing ratio of close to two, Parsvnath may find it tough to borrow at reasonable interest rates. Its average borrowing costs over the last two quarters have remained at 13 per cent; this could, however, increase with the recent spate of rate hikes. While there have been inflows from private funding channels, investors have been selective in their projects. Parsvnath's Mumbai 'BEST' depot project has received investments from the Saffron group funds.
Investments in riskier core realty projects have been less forthcoming in recent months except for large players such as Unitech or DLF.
Financials
Parsvnath's consolidated sales and profits for the quarter ended June 2008 have witnessed a decline. While cost of development has seen a marginal increase, steep increase in staff costs have pulled down operating profit margins by 300 basis points. Interest costs have increased five-fold on a Y-o-Y basis. The quantum of debtors has more than doubled even as sales slowed. This again, poses a risk to the much-needed cash flow required to ease working-capital requirements.
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