Documente Academic
Documente Profesional
Documente Cultură
April 2014
REITs
TRANSPARENCY
Regulation Bill
TRANSPARENCY
Company Act 2013
TRANSPARENCY
IDERS
MERS
CUSTO
OV
AL PR
CAPIT
TORS
GULA
S/RE
AKER
YM
POLIC
Related party
transactions
OPACITY
Non-uniform
Accounting practices
OPACITY
Wilful diversion
of funds
OPACITY
Thematic:
Analyst:
Krishnan ASV
+91 22 3043 3205
vkrishnan@ambitcapital.com
Real Estate
CONTENTS
SECTOR
Executive summary.. 4
Accounting in real estate - A b lack box........ 6
Accounting for land - Further latitude. 7
Revised guidance note (GN) strea mlines revenue recognition 10
yet not watertight
Related party transactions (RPTs) galore... 14
Category mix and leverage suggest wilful d ivers ion of funds.. 18
Methodology... 20
Valuation - a perspective. 25
What can investors look forward to?...................................................................... 27
- Companies Act 2013 - towards greater transparency. 28
yet onerous on real estate
- Impact of 2014 Gen eral Elections - lessons from 2009.. 30
- Real Estate Regulation Bill - pro-consumer; towards greater disclosures.31
- Real Estate Investment Trusts (REITs) - limited eligibility; 32
unlimited candidates
COMPANIES
Oberoi Realty (BUY): Launch pipeline crucia l. 35
Sobha Developers (BUY): Position of relative strength. 57
Page 2
Real Estate
NEGATIVE
THEMATIC
Oberoi Realty
Target Price: 290
Upside : 30%
BUY
Sobha Developers
Target Price: 491
Upside : 30%
Companies
43%
1.71
Unitech
72%
0.37
5%
1.82
25%
1.82
Whilst the revised guidance note (GN) prescribes a uniform threshold for firms
to begin recognising revenues from a project, our discussions with practising
auditors suggest that the revised GN is not yet completely watertight. This
includes instances such as developers entering into a separate sale of land
contract (contributing to aggressive revenue recognition), discretion exercised
around what constitutes critical approvals and ambiguity around JDAs.
DLF
Oberoi Realty
Godrej Properties
Phoenix Mills
26%
0.93
8%
1.46
Sobha Developers
29%
1.46
Mid-sized companies - mcap between
US$200mn and US$500mn
Omaxe
32%
1.32
Indiabulls Real Estate
8%
0.35
HDIL
8%
0.27
On an average, the top-three categories of RPTs account for c.70% of the total
related party transactions. A large proportion of RPTs are only ways of funding
group entities, with most categories reversing themselves during the year and
not earning any interest. We also argue that a bulk of construction finance
(working capital loans raised for under-construction projects) raised by
developers for residential projects is diverted towards either land acquisition or
stalled projects that are starved for capital (suffering from cost overruns).
Anant Raj
4%
0.42
DB Realty
Peninsula Land
Sunteck Realty
0%
1.79
Mahindra Lifespace
3%
1.07
Developers
Puravankara Projects
4%
0.70
Small-sized companies - mcap between
US$100mn and US$200mn
Parsvnath Developers
9%
0.40
52%
0.51
1%
0.66
19%
0.61
1%
1.74
Brigade Enterprises
88%
0.58
28%
0.56
Hubtown
Ashiana Housing
Analyst Details
Krishnan ASV
+91 22 30433205
vkrishnan@ambitcapital.com
Ambit Capital and / or its affiliates do and seek to do business including investment banking with companies covered in its research reports. As a result, investors should be aware that Ambit Capital
may have a conflict of interest that could affect the objectivity of this report. Investors should not consider this report as the only factor in making their investment decision.
Real Estate
Executive summary
The BSE Realty Index has delivered returns in line with the BSE Sensex since the
beginning of 2014; however, the Indian realty sector continues to suffer from a high
credibility deficit across stakeholders, which is largely attributable to a lack of
transparency in reported financials and a lack of like-for-like (LFL) comparable
parameters across companies.
To help investors with LFL comparison, we identify 21 real estate firms, categorise
them into three separate buckets by market capitalisation and use four categories of
accounting metrics (as shown in the exhibit below) to score these firms on their
accounting quality.
Exhibit 1: Categories of accounting checks
Category
Ratios
(1) CFO/EBITDA, (2) change in depreciation rate, and (3) miscellaneous expenses as a
proportion of total expenses
(1) Cash yield, (2) debtors more than six months as a proportion of total debtors, and (3)
contingent liability as a proportion of net worth
(1) CWIP to gross block, (2) cost of construction to construction work-in-progress, and (3)
cumulative CFO plus CFI to median revenues
(1) Audit fees as a proportion of standalone revenues, (2) audit fees as a proportion of total
auditor remuneration, and (3) unaudited assets as proportion of consolidated assets
Among larger firms, Oberoi Realty, Prestige Estates and Phoenix Mills, and among
smaller firms, Omaxe, Peninsula Land and Kolte Patil, are more transparent.
Exhibit 2: The final realty check - across accounting metrics
Company
P&L checks
Balance sheet
Cash pilferage checks Audit quality checks
checks
Overall score
Strong,
Moderate,
Weak
Page 4
Real Estate
We have deliberately refrained from using the full moon ( ) in Exhibit 2 above, given
the general lack of transparency around origination and sale transactions in the
sector.
Having established a pecking order on accounting quality, we present a valuation
approach underpinned by the cash conversion cycle and the adjusted net worth to
highlight undervalued stocks. We eliminate four outliers (on cash conversion cycle)
and map the remaining real estate developers on the consensus FY14 consolidated
P/B multiple (on the X-axis) and the six-year median cash conversion cycle (in number
of days) on the Y-axis. The size of the bubble in Exhibit 3 below indicates the
contingent liabilities (as a proportion of net worth), customer advances that are yet to
go through the P&L, and unbilled revenues.
Exhibit 3: Cash conversion cycle (in number of days) vs P/B multiple - Oberoi and Sobha cheaper than Prestige
1,200
Puravankara
Unitech
1,000
800
Parsvnath
600
Hubtown
Kolte Patil
Mahindra Lifespace
Peninsula Land
DB Realty
400
200
DLF
Brigade Enterprises
Godrej Properties
Omaxe
Prestige Estates
Oberoi Realty
Ashiana Housing
Sobha Developers
Anant Raj
FY15 P/B
-200
-
0.5
1.0
1.5
2.0
2.5
3.0
Source: Companies, Bloomberg, Ambit Capital research; Note: X-axis denotes consensus FY14 P/B, Y-axis denotes the six-year median cash conversion cycle (in
number of days) and the s i z e of the bu bbl e de note s conti nge nt l i abi l i ti e s (as a pr opor ti on of ne t w or th)
Since not all contingent liabilities devolve on the parent entity (some are genuine), we
use a conditional adjustment factor on contingent liabilities to arrive at the adjusted
net worth. The higher the contingent liabilities, higher the adjustment factor that we
use to derive the adjusted net worth.
Exhibit 4: Deriving the adjustment factor for contingent liabilities
CL (% of NW)
Deduction from NW
10% of CL
10% - 30% of NW
20% of CL
Over 30% of NW
30% of CL
Source: Ambit Capital research; CL denotes Contingent Liabilities; NW denotes net worth
The outliers that we have eliminated from Exhibit 3 are Phoenix Mills (significantly
negative cash conversion cycle), Indiabulls Real Estate, HDIL and Sunteck Realty
(significantly high cash conversion cycle). The largest bubble in Exhibit 3 is equivalent
to 75% of net worth (Brigade Enterprises) whilst the smallest bubble is equivalent to
1% of net worth (Peninsula Land and Puravankara Projects). An ideal BUY signal
combines a low cash conversion cycle, a relatively attractive valuation and a smaller
bubble. On the other hand, the ideal SELL signal combines a high cash conversion
cycle, an expensive valuation and a large bubble.
Although the cash conversion cycle (in number of days) is the least common
denominator for most of the firms in this analysis, it is worth highlighting that
companies with a lean P&L are unduly penalised. Given that the variables in the cash
conversion cycle (inventory days, debtor days and creditor days) employ P&L elements
(either revenues or cost of sales) in the denominator, the revenue recognition
approach, especially the project completion method, disproportionately impacts such
firms. We highlight HDIL and Sunteck Realty as outliers on account of the revenue
recognition policy (project completion method) and hence, they are not strictly
comparable on the cash conversion scale.
Page 5
Real Estate
DLF
Godrej
Properties
HDIL
Indiabulls Real
Estate
Kolte Patil
Mahindra
Lifespaces
Oberoi Realty
Omaxe
Threshold
policy
Minimum
collection
30%
None
No policy
Considered
20%
None
No policy
Considered
100%
NA
NA
Considered
25%
None
No policy
Not considered
20%
None
No policy
Considered
25%
None
Yes
Considered
20%
None
NA
Not considered
30%
None
No policy
Considered
Phoenix Mills
Not considered
Peninsula Land
Prestige Estates
Sunteck Realty
Considered
20-30%
None
No policy
No policy
100%
NA
NA
Considered
Unitech
Considered
Page 6
Real Estate
Exhibit 6: Accounting for land across the lifecycle of a real estate project
Balance sheet entries
Stage
Land acquisition
Development / construction
(prior to revenue recognition
being triggered)
Mix-use /
undecided
Inventory Construction
Work-in-Progress
(+ve)
Cash (-ve)
Cash (-ve)
Inventory Construction
Work-in-Progress
(+ve)
Cash (-ve) /
Customer
advances (+ve)
Cash (-ve)
Mix-use /
undecided
Capitalised
Capitalised
Capitalised
Capitalised
Capitalised
Capitalised
Depreciation
Cash (-ve)
Development / construction
(once revenue recognition is
triggered)
Inventory Construction
Work-in-Progress
(-ve)
Cash (+ve) /
Debtors (+ve)
Revenue
Revenue
Revenue
Inventory Construction
Work-in-Progress
(-ve)
Depreciation
Cash (+ve)
Cash (+ve)
Cash (+ve)
Revenue
Page 7
Real Estate
Accounting for land as inventory - too many cost categories loaded up
The carrying value of land, when treated as inventory, is lower of cost or the net
realisable value (NRV). Given that developers expect to earn a positive return on their
operations, the expected NRV is often typically higher than cost. However, there exists
wide disparity in cost categories that are loaded up to the carrying cost of inventory
on the balance sheet. In most instances, companies are fairly ambiguous about the
cost components that are included in the carrying cost of inventory.
Components of cost
Method of valuation
First-in-First-out
Not disclosed
Not disclosed
First-in-First-out
Average cost
Not disclosed
Not disclosed
Not disclosed
Not disclosed
Not disclosed
Not disclosed
Page 8
Real Estate
Impairment in estimated value of land is not carried out transparently
More importantly, when treated as inventory, any impairment in the estimated costs
is not routed through the P&L but adjusted directly against the inventory balance (in
projects where revenue recognition is not triggered) or adjusted in the percentage of
completion (POC) component for the project (where revenue recognition is triggered).
For instance, if the original cost of a project was estimated at `100 and the actual
cumulative cost incurred on the project was at `60, the POC method would imply
revenue recognition of 60% of the estimated revenues. However, during the following
year, if the cost incurred on the project is `30 (taking the cumulative cost incurred on
the project to `90) and the firm believes that a further `60 needs to be incurred to
complete the project (implying total project cost at `150), the POC method would
imply that revenue recognition remains at 60%.
This is especially the case when unreasonable estimates of unusual cost categories
are loaded up to the cost of inventory (cost of land including development rights and
cost of construction) that is carried on the balance sheet. It is worth highlighting that
firms have often significantly under-estimated as well as over-estimated project costs.
For instance, firms often resort to write-offs after having inflated the carrying cost of
inventory with unconventional categories of costs. On the contrary, under-estimation
of project costs results in aggressive revenue recognition (since the 25% threshold for
revenue recognition is achieved earlier on a lower denominator), which is followed by
absorption of significant cost escalation thereafter.
Page 9
Real Estate
The revised GN prescribes the following conditional criteria for real estate companies
to begin recognising revenues from a project under the POC method:
All critical approvals that are necessary for project commencement have been
obtained;
At least 25% of the estimated construction and development cost (excluding the
cost of land) has been incurred;
At least 25% of the estimated project revenues has been secured by binding
contracts; and
At least 10% of the estimated revenues have been realised on each contract as of
the date of reporting.
Of the above parameters, in practice, obtaining all critical approvals and incurring
25% of the estimated costs are the critical activities within any project, since the other
two activities (securing 25% of the estimated project revenues through contracts AND
collecting 10% of the estimated revenues) have a total float.
Still leaves room for subjective judgment
Whilst the revised guidance note is far more elaborate and specific in terms of
prescribing a uniform threshold for companies to begin recognising revenue from a
project, our discussions with several practising auditors suggest that the revised GN is
not yet watertight. For instance, an area where real estate companies tend to exercise
subjectivity is around what constitutes critical approvals. Developers often begin
recognising revenues from sale of units on the 10th floor even when they have only
obtained a partial commencement certificate (say, 5 floors) in a multi-storeyed tower.
This is especially true in properties in the National Capital Region (NCR) and units
that are sold to self-funded buyers (buyers who do not opt for a bank loan).
Revised GN a prescription, not mandatory on real estate companies
Whilst most listed real estate companies claim to comply with the revised GN in their
FY13 Annual Report, this practice is not being followed across all projects of a listed
entity, since a GN is only recommendatory in nature and not an accounting standard
by itself. As a result, despite the revised guidance note being in force since 1 April
2012, Sunteck Realty (SRIN) and HDIL, both listed developers, continue to recognise
revenues under the project completion method. Similarly, the revised GN prescribes
minimum 10% collections on each contract as a pre-condition for revenue
recognition; however, companies often aggregate collections from a project and
hence, end up recognising revenues aggressively.
Page 10
Real Estate
Exhibit 8: Illustrative example of change in revenue recognition policies since the issuance of the revised guidance note
Company
Mahindra Lifespace
Developers Ltd.
(a) Project for which revenue is recognised for the first time on or
after 1 April 2012
The Institute of Chartered Accountants of India has issued Guidance
Note on Accounting for Real Estate Transactions (Revised 2012) in
connection with the revenue recognition for a real estate project
which commences on or after 1 April 2012 and also to real estate
projects which have already commenced but where revenue is being
recognised for the first time on or after 1 April 2012.
In this scenario, the company recognises revenue in proportion to
the actual project cost incurred (including land cost) as against the
total estimated project cost (including land cost), subject to achieving
the threshold level of project cost (excluding land cost) as well as
area sold, in line with the Guidance Note and depending on the type
of project.
(b) Project for which revenue recognition has commenced prior to 1
April 2012
In this scenario, the company recognises revenue in proportion to
the actual project cost incurred (excluding land cost) as against the
total estimated project cost (excluding land cost) subject to
completion of construction work to a certain level depending on the
type of the project.
DLF Ltd.
Page 11
Real Estate
Company
Parsvnath Developers
Ltd.
During the year the company adopted the guidelines prescribed by the Guidance
note on Accounting Treatment for real estate transactions (Revised 2012) issued
by the Institute of Chartered Accountants of India, inter alia , with regard to
thresholds for commencement of revenue recognition for projects and the basis for
determining percentage of completion. The adoption of the said guidelines has no
significant effect in the revenues and costs recognised for projects during the year.
Revenue from the sale of properties under construction is recognised on the basis
of the Sale Agreements (provided the significant risk and rewards have been
transferred to the buyer and there is reasonable certainty of realisation of the
monies), proportionate to the percentage of physical completion of
construction/development work, as certified by the companys technical personnel.
Source: Companies, Ambit Capital research; Note: * in addition to revenue recognition policy disclosed in the respective 2011-12 Annual Reports
Page 12
Real Estate
Simultaneously employing two accounting policies on revenue recognition
As can be seen from the above exhibit, consequent to the issuance of the revised GN,
most real estate companies are currently following two policies simultaneously. The
revised GN is applied to all real estate projects that commenced on or after 1 April
2012 and also to projects that have already commenced but where revenue is
recognised for the first time on or after 1 April 2012. On the other hand, the
erstwhile guidance note is still applied to all the prior projects.
Page 13
Real Estate
Joint
ventures
Associates
Other related
parties
11
47
96
DB Realty Ltd.
20
17
37
266
12
17
110
15
36
83
10
DLF Ltd.
239
14
12
Omaxe Ltd.
94
19
23
21
13
14
Mahindra Lifespace
Developers Ltd.
Oberoi Realty Ltd.
21
20
10
10
10
243
14
Unitech Ltd.
Remarks
72
Page 14
Real Estate
RPTs - occasionally genuine but consistently misused
As captured in our real estate accounting thematic, Mirror, Mirror on the Wall dated
26 July 2011, RPTs can take various forms, especially given the number of special
purpose vehicles (SPVs) that are floated by real estate companies for the purchase of
land from the market (further details on page 26 of this note).
There are many genuine reasons for the existence of related party transactions. A few
such reasons are highlighted below:
Prior to a firm listing on the BSE/NSE, transactions are carried out to sell stake in
a joint venture to an external party for a specific project to avoid sharing the
private groups consolidated accounts with the JV partner (this is also a manner of
funding).
Whilst there are many genuine reasons for group structures and transactions between
group companies, there is no denying that group structures have also been used by
controlling shareholders to treat minority shareholders inequitably, often resulting in
a disproportionate transfer of wealth to the controlling shareholders.
Ideally, the operating cycle in a real estate project (from commencement to transfer
of risk) should revolve around a single entity that is responsible for land acquisition,
construction, marketing and sale/lease of properties such that cash flows can also be
mapped in a straightforward manner, as illustrated in Exhibit 10 below.
Exhibit 10: An ideal real estate operational cycle
However, in the real world, the existence of a large number of transactions between
a company and its related parties including subsidiaries, JVs and associate companies
makes the operating cycle complex and less transparent to analyse.
Exhibit 11: Possible complexities due to related party transactions - inflated costs and
balance sheet
Given the evidence that has emerged over the past few years regarding the use (or
misuse) of related party transactions to pull cash out of listed entities, investors should
be careful about companies with:
Page 15
Real Estate
Funding of related parties most frequent among RPTs
For the 21 companies in this exercise, we have mapped the three most frequently
employed categories of RPTs (maximum contribution to the total RPTs). This analysis is
based on the outstanding balance in the particular category as of March 2013.
Exhibit 12: Most prolific categories of related party transactions (RPTs) as of March 2013
RPT 1
RPT 2
RPT 3
Non-convertible debentures
DB Realty Ltd.
Corporate guarantees
DLF Ltd.
Sale of units
Investment / redemption of
debentures
Investments in subsidiaries
Advance against purchase of
shares
Advances received under
agreement to sell
Investment in equity
Advances for projects
HDIL
Hubtown Ltd.
Indiabulls Real Estate Ltd.
Other payables
Corporate guarantees
Debtors
Investment in debentures
Finance given
Inter-corporate deposits
Loans given
Deposit received
Rent income
Omaxe Ltd.
Inter-corporate deposits
Trade payables
Borrowings
Other payables
Investment in debentures
Guarantees
Land advance
Receivables
Deposits given
Preference shares
Current investment
Unitech Ltd.
Investment in debentures
Advances received
Remuneration paid
It is worth highlighting that the top-three categories of RPTs account for ~70% of the
total related party transactions on average. As can be seen from the above exhibit, a
bulk of the categories of RPTs employed by real estate developers are merely ways of
funding the related party entities. As loans and advances attract significant
investor scrutiny, firms have resorted to other modes of providing capital
through investment in equity or quasi-equity instruments and tunnelling.
Our analysis shows that a large proportion of RPTs (especially the likes of intercorporate deposits) does not earn interest and tend to get reversed during the year.
From the limited number of companies that disclose details around end-year
outstanding balances as well as maximum outstanding balances during the year, we
observe that the end-year outstanding balances are less than 20% of the maximum
outstanding balances in a majority of the RPTs, implying year-end window dressing.
Going forward, with the notification of over 280 sections under the Companies Act
2013 (more details on pages 27 and 28 of this note), we expect real estate
developers to find it progressively difficult to engage in RPTs without an adequate
explanation that justifies the rationale for such transactions.
Page 16
Real Estate
It is worth highlighting that Indian banks are not allowed to lend to real estate
companies for the purpose of land acquisition. However, given the regulatory
arbitrage (around exposure limits, extent of scrutiny, and stricter end-user
classification) between banks and NBFCs lending to real estate companies, the NBFC
route is conveniently exploited. In fact, we argue that a significant proportion of what
appears to be non-bank debt to real estate companies is also bank lending to the
sector, albeit in an indirect manner.
Exhibit 13: Regulatory arbitrage between bank lending and non-bank lending
Relatively lower
regulatory scrutiny leads
to arbitrage
Bank
Bank
Bank
Housing finance
company (HFC)
Other NBFC
Based on our analysis (captured in Exhibit 14), we argue that real estate companies
have only two primary sources of funding: banks and High Net-worth Individuals
(HNIs and ultra HNIs).
Exhibit 14: Major channels of real estate funding in India
Pre-2005
2005-2007
2008-2009
2010-2011
2012-2013
Offshore listing
Offshore listing
Offshore listing
Offshore listing
Offshore listing
IPO
IPO
IPO
IPO
IPO
QIP
QIP
QIP
PE funds
PE funds
PE funds
PE funds
ECBs
ECBs
ECBs
ECBs
NBFC lending
NBFC lending
NBFC lending
NBFC lending
NBFC lending
Bank lending
Bank lending
Bank lending
Bank lending
Bank lending
Private lending
Private lending
Private lending
Private lending
Private lending
Source: JLL publications; Note: Cells highlighted in BOL D indicate very high levels of activity in that channel
during the period, cells highlighted in Red indicate average levels of activity in the channel during the period
Page 17
Real Estate
As captured in the exhibit above, bank funding (direct) to the real estate sector has
been sporadic. On the other hand, the NBFC channel and private lending channel
have consistently seen high levels of activity nearly every year. This is reflective of the
existing regulatory arbitrage between banks and NBFCs lending to real estate.
Banks are under far greater regulatory scrutiny from the Reserve Bank of India (RBI)
on exposure to the real estate sector. In fact, bank exposure to commercial real estate
(CRE) is mandatorily classified under sensitive sector exposure as part of banks
statutory reporting. Another area that contributes to the regulatory arbitrage between
banks and NBFCs lending to real estate companies is the prevalent laxity in end-user
classification at NBFCs, where exposure to real estate is often camouflaged as MSME
(Medium, Small and Micro industries) exposure or unsecured personal lending
(whereby HNIs and ultra-HNIs leverage themselves to fund special purpose vehicles).
Given this regulatory arbitrage, banks find it easier to lend to real estate companies
through intermediaries like NBFCs, as captured in Exhibit 13. Also, given the NBFC
dependence on bank funding (80%), a large proportion of NBFC lending in Exhibit 14
is, in fact, disguised bank lending. It is worth highlighting that growth in bank lending
to NBFCs has been consistently north of the headline credit growth being reported by
the banking system and also does not undergo as much regulatory scrutiny as bank
lending to other end-user industries (like infrastructure).
Exhibit 15: Growth in loan book - reflecting regulatory arbitrage
YoY growth trends (%)
2009-10
2010-11
2011-12
2008-09
16.8
21.3
16.6
13.3
14.8
Real estate
-0.3
5.8
15.6
11.9
9.2
Housing
2012-13 2013-14*
7.7
19.3
12.3
14.0
17.6
10.5
10.5
10.7
0.3
10.2
NBFCs
14.8
62.3
23.9
12.6
17.6
HDFC Ltd
16.7
15.0
19.6
20.3
20.7
17.0
26.2
37.6
34.2
23.5
23.4
17.0
Source: RBI, Companies, Ambit Capital research; Note: * 2013-14 indicates YoY growth as of Dec13
However, it is also worth highlighting that the statutory auditors, in every case, certify
the following (or a variant of this version) in the listed companies Annual Reports:
In our opinion and according to the information and explanations given to us, the
term loans have been applied for the purposes for which they were
obtained/secured.
Whilst the first certification amounts to covenant compliance (this is especially critical
for banks to monitor whether the borrower is fulfilling the conditions under which the
loans were granted), the second certification is a clean chit being given by an auditor
to a firm that short-term funding is not being funnelled into creation of long-term
assets (presumably land acquisition).
Our discussions with senior chartered accountants suggest that covenant compliance,
although mandatory, is only offered in passing reference by banks. Checks around
end-use or purpose compliance are nearly non-existent in the system, as auditors
tend to treat these as mere check boxes that need to be ticked.
Page 18
Real Estate
Methodology
We identify 21 real estate firms and categorise them into three separate buckets by
market capitalisation. We use the following 12 accounting ratios, categorised into
four buckets, to score the real estate firms based on their accounting quality.
Exhibit 16: Key categories of accounting checks
Category
Ratios
(1) Cash yield, (2) debtors more than six months as a proportion
of total debtors, and (3) contingent liability as a proportion of
net worth
Whilst we have detailed the accounting ratios under each of these categories over the
next few pages, we summarise our observations in Exhibit 17 below.
Exhibit 17: The final realty check - across accounting metrics
Company
P&L checks
Balance sheet
Cash pilferage checks Audit quality checks
checks
Overall score
Strong,
Moderate,
Weak
Page 19
Real Estate
CFO / EBITDA
Change in
depreciation rate
Miscellaneous expenses
(% of total expenses)
Overall score
Strong,
Moderate,
Weak
Page 20
Real Estate
Cash yield
Debtors over 6m
Contingent liabilities
Overall score
Strong,
Moderate,
Weak
Page 21
Real Estate
Overall score
Strong,
Moderate,
Weak
Page 22
Real Estate
Audit fees
Auditors
remuneration
Overall score
Strong,
Moderate,
Weak
Page 23
Real Estate
Valuation - a perspective
Adjusted NW (%
of reported NW)
Company
Anant Raj
92%
Ashiana Housing
Brigade Enterprises
Given that cash generation is the single most critical driver of valuation in real estate
firms, we derive the cash conversion cycle for each of the past six years (FY08-13).
We then use a six-year median as our first critical driver in this valuation approach.
The higher the cash conversion cycle, the longer a developer needs working capital
finance. Similarly, lower the cash conversion cycle, lesser the need for working capital
finance and lesser the idle capital employed.
Critical valuation driver 2: Adjusted net worth
Given that the P/B multiple-based approach is often used as an alternative to DCFbased valuation (the ideal approach), we argue that it is critical to adjust a firms
net worth for contingent liabilities, customer advances and unbilled revenues
to derive a fair P/B multiple.
Since not all contingent liabilities devolve on the parent entity (some are genuine), we
use a conditional adjustment factor on contingent liabilities to arrive at the adjusted
net worth. The higher the contingent liabilities, higher the adjustment factor that we
use to derive the adjusted net worth.
Exhibit 22: Deriving the adjustment factor for contingent liabilities
Adjustment factor (deduction
from NW)
CL (% of NW)
DB Realty
86%
100%
DLF
80%
Godrej Properties
118%
HDIL
115%
Hubtown
108%
121%
127%
102%
116%
Omaxe
Parsvnath
Developers
Peninsula Land
155%
Phoenix Mills
Prestige Estate
Projects
Puravankara Projects
105%
10% of CL
Sobha Developers
10% - 30% of NW
20% of CL
Sunteck Realty
Over 30% of NW
30% of CL
Unitech
Source: Ambit Capital research; CL denotes Contingent Liabilities; NW denotes net worth
131%
88%
99%
133%
102%
97%
426%
87%
Methodology
In Exhibit 22, we eliminate four outliers (on the cash conversion cycle) and map the
remaining real estate companies on consensus FY15 consolidated P/B multiple (on
the X-axis) and the six-year median cash conversion cycle (in number of days) on the
Y-axis. The size of the bubble denotes contingent liabilities (as a proportion of net
worth).
Exhibit 23: Cash conversion cycle (in number of days) vs P/B multiple - Oberoi and Sobha cheaper than Prestige
1,200
Puravankara
Unitech
1,000
800
Parsvnath
600
Hubtown
Kolte Patil
Mahindra Lifespace
Peninsula Land
400
DB Realty
200
DLF
Brigade Enterprises
Godrej Properties
Omaxe
Oberoi Realty
Prestige Estates
Ashiana Housing
Sobha Developers
Anant Raj
FY15 P/B
-200
-
0.5
1.0
1.5
2.0
2.5
3.0
Source: Companies, Bloomberg, Ambit Capital research; Note: X-axis denotes consensus FY14 P/B, Y-axis denotes the six-year median cash conversion cycle (in
number of days) and the s i z e of the bu bbl e de note s conti nge nt l i abi l i ti e s (as a pr opor ti on of ne t w or th)
Page 24
Real Estate
Exhibit 24: Large-sized real estate companies
2,000
Unitech
1,000
DLF
Oberoi Realty
Godrej Properties
Prestige Estates
Sobha Developers
-1,000
-2,000
-3,000
Phoenix Mills
-4,000
FY15 P/B
-5,000
(0.50)
0.50
1.00
1.50
2.00
2.50
Source: Companies, Bloomberg, Ambit Capital research; Note: X-axis denotes consensus FY14 P/B, Y-axis
denotes the six-year median cash conversion cycle (in number of days) and the size of the bubble de note s the
conti nge nt l i abi l i ti e s (as a pr opor ti on of ne t w or th)
8,000
7,000
Sunteck Realty
6,000
5,000
4,000
HDIL
3,000
2,000
Indiabulls
1,000
Puravankara
Mahindra Life
Anant Raj
Omaxe
FY15 P/B
-1,000
(0.50)
0.50
1.00
1.50
2.00
2.50
Source: Companies, Bloomberg, Ambit Capital research; Note: X-axis denotes consensus FY14 P/B, Y-axis
denotes the six-year median cash conversion cycle (in number of days) and the s i ze of the bubble de note s the
conti nge nt l i abi l i ti e s (as a pr opor ti on of ne t w or th)
1,200
Kolte Patil
1,000
800
Parsvnath
Hubtown
600
Peninsula
400
DB Realty
200
Ashiana Housing
Brigade Enterprises
FY15 P/B
-200
(0.50)
0.50
1.00
1.50
2.00
2.50
3.00
Source: Companies, Bloomberg, Ambit Capital research; Note: X-axis denotes consensus FY14 P/B, Y-axis
denotes the six-year median cash conversion cycle (in number of days) and the s i ze of the bubble de note s the
conti nge nt l i abi l i ti e s (as a pr opor ti on of ne t w or th)
Page 25
Real Estate
Each of these four policy initiatives is likely to drive greater operational transparency
in real estate companies. Given the extent of financial duress that a majority of the
real estate companies find themselves under and a dangling carrot in the shape of
potential fresh funding from REITs, our discussions with senior partners and senior
executives across the Big-4 auditors suggest that developers are gradually
undertaking a massive clean-up operation. Whilst this push towards transparency is
partly driven by the impending beauty parade for fresh capital (to become REITfriendly), experts also attribute this effort to their desire to comply with the revised
guidance note and the Companies Act 2013.
As a result, some of the large developers are beginning to appoint one of the Big-4 in
an advisory capacity to help align customer sales/payment contracts with the revised
revenue recognition norms. These consulting assignments are aimed at structuring a
developers payment/sales contracts with its clients so that the cash collections are
closely aligned with the revised revenue recognition norms.
We analyse the impact of each of these policy measures on the real estate sector in
chronological order (in the order in which these are likely to occur) from page 27 to
page 33).
Exhibit 27: Key catalysts for the real estate sector over the next 18 months
Catalysts
Key highlights
Likely impact
Streamlining of approvals
Incremental job creation
Mandatory listing of REITs within 18 months of registration Likely to restrict entry to serious and large players,
At least 90% of the REIT assets to be invested in completed broad-base the shareholding and enhance price
and rent-generating assets
discovery
At least 90% of the net income to be distributed to unit
holders
Page 26
Real Estate
Real estate firms own, directly or indirectly, 100% or a majority share in the
equity capital in such SPVs and/or have majority representation on the Board of
Directors of such SPVs.
Share capital of SPVs, a small quantum in itself, is held by a third party, which
also controls the governing body of the SPVs. In such cases, the real estate
companies are involved with the SPVs in various other transactions, such as
lending, giving exclusive rights to develop land, providing guarantee against
funds borrowed by SPVs and guaranteeing a minimum return to capital providers,
which may restrict the decision-making powers of the SPV.
The more stringent definitions of control and subsidiary under the Companies Act
2013 will impact the related party disclosure requirement.
Preparation of consolidated financial statements (CFS)
The preparation of CFS has become mandatory for all companies, which operate
through subsidiaries, joint ventures or associates. Our discussions with senior
executives at the Big-4 auditors suggest that companies that do not operate through
subsidiaries but through joint ventures (JVs) and associates may also have to prepare
CFS. This compares with the current practice of unlisted companies not having to
prepare CFS. Given the structure of a typical real estate firm in India (as explained
above), this requirement will impose a higher compliance cost on real estate
companies.
Dividend restrictions on companies relying on public deposits
The Companies Act 2013 prescribes that a company cannot declare any dividend if it
fails to comply with the provisions related to the acceptance and repayment of
deposits. Thus, if a real estate company accepts a deposit and is unable to fulfil the
provisions related to the acceptance or repayment of such deposits, the Companies
Act 2013 prohibits shareholder payback in the form of dividend. Of the 21 companies
in our analysis, we find that Godrej Properties relies heavily on public deposits.
Related party transactions - under greater scrutiny
Although at some deviation from the prevailing AS18, the Companies Act 2013, for
the first time, carries a definition of related party and related party transactions.
Instead of the erstwhile practice of securing approval from the Central Government
Page 27
Real Estate
for entering into related-party transactions (RPTs), companies will now need to pass a
special resolution at the general shareholder meeting, wherein interested members
will not be entitled to vote on such resolutions. Whilst this provision is likely to ensure
closer scrutiny of related-party transactions by shareholders (hence, less possibility of
stealth), minority shareholders may continue to be silent spectators if shareholder
activism remains weak.
Even assuming arms-length related-party transactions, such transactions will need to
be referred to in the Boards report to shareholders alongside an explanation for
entering into such transactions. This disclosure requirement is also likely to cover
non-cash transactions involving directors, if they are entered with a related party.
Against the backdrop of real estate developers increasingly entering into JDAs with
land owners, such SPVs also may come within the ambit of related party
transactions.
Limit imposed on layered subsidiaries (Section 2 Explanation (d) of clause 87)
The definition of subsidiary as included in the Companies Act 2013 prohibits certain
class or classes of holding company (to be prescribed) from having multiple layers of
subsidiaries beyond such numbers as may be prescribed. With such a restrictive
section, it appears that a holding company will no longer be able to hold subsidiaries
beyond a specified number. In the absence of any specific rules (conditions or subclauses), this is likely to have a meaningful implication on real estate developers on
account of the multi-layered subsidiaries that are typical of the sector.
Mandatory rotation of auditors/audit firms (Section 139)
The Act mandates rotation of audit firms for all companies (with the exception of
small companies and single-person companies). All real estate companies (provided
they do not qualify as either small companies or single-person companies) will now
have to appoint an audit firm for a term of 5 or 10 years, with a mandatory annual
ratification by shareholders. Real estate companies are specifically impacted because
of the usual long-term relationship that they enjoy with audit firms, which will now
face mandatory rotation.
It is worth highlighting that other than Sobha Developers, none of the other
mainstream real estate companies are audited by the Big-4. Whilst this is especially
reflective of the well-entrenched nexus between the audit firms and the real estate
companies, this is also a damning indictment of the lack of transparency in the sector.
Mandatory debenture redemption reserve (Section 71 clause 4)
The Companies Act 2013 mandates that debenture-issuing companies need to create
a debenture redemption reserve (DRR) account out of its available surplus, which can
only be used towards redeeming such debentures. The DRR should comply with the
following conditions:
This is especially critical for the real estate sector since most developers have milked
non-convertible debentures (NCDs) as an instrument given the difficulties in securing
construction finance from banks in recent times. Whilst the minimum DRR corpus will
reduce the distributable surplus available to shareholders (for dividend payout), the
minimum 15% investment/deposit clause will reduce investible surplus and hence,
drag the investment returns for real estate companies. Most real estate developers
have a sizeable exposure (in excess of 5% of their net worth) to NCDs, a bulk of
which is unsecured and short term in nature. However, developers also carry a DRR
on their balance sheet, covering about 20% of the value of the debentures, on an
average.
Page 28
Real Estate
With opinion polls pointing to an NDA coalition winning the most number of seats in
the forthcoming General Elections, the fundamental catalysts are likely to be
impacted in the following manner:
Between the two catalysts outlined above, the election outcome is likely to have an
immediate impact on the supply side (streamlining of approvals), resulting in a
further build-up in inventory levels and a medium- to long-term impact on the
demand side (faster income generation, better affordability and higher absorption
rates). We argue that an improvement in the demand-side variables is more critical to
the fundamental performance of the sector, as demonstrated in Exhibit 29.
Exhibit 29: Sales and inventory build-up since 2009 General Elections in top-3 cities
Source: Liases Foras, Bloomberg, Ambit Capital research; Note: Sales denotes quarterly run rate (in million
square feet) in Indias top-three cities (Delhi/NCR, Mumbai/MMR and Bengaluru) with the March 2009
observation indexed to 100; Inventory (number of quarters) is scaled to RHS
Page 29
Real Estate
For the purpose of this analysis, we have cumulated the sales and inventory data for
Indias top-three real estate markets viz. Delhi (NCR), Mumbai (MMR) and Bengaluru.
The sales run rate (the red column in Exhibit 29) has been on a consistently upward
curve since the March 2009 quarter. To put this in perspective, the quarterly run rate
of sales in these three markets has grown from 20msf during the March 2009 quarter
to 49msf during the December 2013 quarter. Put differently, the average quarterly
run rate of sales since the March 2009 quarter (between the June 2009 quarter and
the December 2013 quarter) is at about 44msf.
Our analysis indicates two things: whilst on the one hand it demonstrates the March
2009 quarter as an outlier (at the lower end), it also proves that the sales momentum
has been steady through the past 19 quarters. Hence, we argue that the real estate
sector is in a crisis despite steady quarterly sales because of the equally steady rise in
inventory and consequently, lower absorption levels, as reflected in the inventory
pile-up (black line in Exhibit 29).
Against this backdrop, we argue that the results of the 2014 General Elections are
likely to impact the supply-side inventory ahead of the demand-side sales
momentum.
Page 30
Real Estate
Developers need to open a separate bank account (escrow account) for each
project and will have to ring fence 70% of the customer advances to be used only
towards the completion of that particular project
As with many other policy measures that involve Parliament intervention (for approval
and passing through both Houses), we expect this Bill to be enacted only once a
stable government is in place at the Centre.
Merits of the escrow mechanism
Whilst our discussions with experts suggest heavy lobbying by developers on this Bill,
if enacted in its current form, the Real Estate Regulation and Development Bill 2013 is
likely to mitigate the risk of diversion of funds (as highlighted on pages 16 and 17,
funds borrowed against one project are often deployed in another project). Such ringfencing would make cash less fungible and result in greater transparency in project
cash flows, a welcome development, especially from the perspective of capital
providers. Whilst the escrow mechanism benefits capital providers in terms of greater
transparency and reduced risk of diversion of funds, it is possible that the lower risk
profile is reflected in lower cost of capital for developers.
Page 31
Real Estate
Year of
introduction of
REITs
Aggregate market
Number of REITs
capitalization (US$
(#)
mn)
% of global REIT
market
Australia
1985
52
86,169
8.0
100%
Canada
1994
50
48,526
4.5
No restriction
100%*
85% of tax-exempt
profits
France
2003
37
68,193
6.3
Thin capitalisation
rules
Germany
2007
1,657
0.2
45%
Hong Kong
2003
11
23,925
2.2
45%
90% of audited
annual net income
after tax
Japan
2000
41
64,414
6.0
No restriction
>90% of distributable
profits
Singapore
1999
32
45,538
4.2
35%-60%
90% of taxable
income
United Kingdom
2007
23
49,007
4.6
90% of tax-property
rental profits
United States
1960
163
621,924
57.7
No restriction
90% of taxable
ordinary income
Source: EPRA, Ambit Capital research; Note: * Canada imposes full tax on any undistributed surplus - hence, in practice, 100% of the profits get distributed; # the
profit distribution obligation is usually imposed on the REITs ordinary income (excluding capital gains)
A look at Exhibit 30 suggests that a REIT market needs at least a decade of operations
to mature both in terms of market depth (the number of REITs) as well as capturing
investor appetite (market capitalisation as a percentage of the global REIT market).
With the exception of the United Kingdom, which has seen rapid acceptance of REITs,
most other countries gain only about 20-30bps of the global market capitalisation
share every year during the evolution stage of REITs.
Globally, REITs typically invest in real estate formats such as business parks, industrial
parks, hotels, retail space, office space, serviced apartments (between 80% and 95%
of the investible capital is employed in these formats) whilst the residential asset class
accounts for less than one-fifth of the REIT assets.
Page 32
Real Estate
Sponsor lock-in of 25% for the first three years and 15% thereafter
At least 90% of the REIT assets should be invested in completed (post issuance of
occupancy certificate) and rent-generating assets (projects that are at least 75%
rented or leased out) in India
Leverage (gearing ratio) capped at 50%; credit rating from SEBI-registered credit
rating agency and approval of unit holders mandatory in case leverage is in
excess of 25%
Page 33
Real Estate
Page 34
Oberoi Realty
BUY
COMPANY INSIGHT
OBER IN EQUITY
Real Estate
Oberoi Realty emerged as the highest bidder for a 25-acre land parcel
in the western suburbs of Mumbai, which has put to rest any concerns
around the re-deployment of its surplus capital. We factor in net debt of
0.3x (to fund this land acquisition), and we expect the launch of at least
three projects during FY15 to revive Oberois operating cash flows from
` 1.7bn in FY14E to ` 9bn by FY15E. Using a project-based DCF approach,
we value Oberoi at ` 290, implying 7.3x FY15E FCFE.
Recommendation
Accounting:
Predictability:
Earnings Momentum:
Mcap (bn):
6M ADV (mn):
CMP:
TP (12 mths):
Upside (%):
`74/US$1.2
`46/US$0.8
`224
`290
30
Flags
GREEN
AMBER
GREEN
Catalyst
Partial launch of Worli project by 1QFY15
Completion of Borivali land acquisition
Part-launch in Mulund project by 1HFY15
Performance (%)
140
120
100
80
60
We expect Oberoi to have paid the EMD of `1.15bn on the Borivali land from its
existing cash balance (of `4.5bn as of December 2013). Given that banks are
not allowed to lend towards land acquisition, we expect the balance land cost
(`10bn) to be funded through discounting of cash flows from its annuity assets
(including two upcoming annuity projects). We expect Oberoi to be cash-positive
by end-FY15 on the back of the Worli and Mulund launches.
Apr-13
May-13
Jun-13
Jul-13
Aug-13
Sep-13
Oct-13
Nov-13
Dec-13
Jan-14
Feb-14
Mar-14
40
Sensex
OBER IN
FY12
FY13
FY14E
FY15E
FY16E
8,247
10,476
8,599
11,742
14,370
4,836
6,121
4,218
6,832
8,347
4,630
5,048
3,205
4,810
6,540
14.1
15.4
9.8
14.7
19.9
RoE (%)
13.6
13.7
7.9
11.0
13.5
P/E (x)
16.0
14.6
23.0
15.4
11.3
P/B (x)
2.1
1.9
1.8
1.6
1.4
Analyst Details
Krishnan ASV
+91 22 3043 3205
vkrishnan@ambitcapital.com
Oberoi Realty
Company Background
FY13
FY14E
FY15E
FY16E
7,813
5,469
7,110
9,243
956
1,146
2,336
2,453
1,398
1,504
1,798
2,096
250
330
391
485
58
150
107
92
10,476
8,599
11,742
14,370
Operating costs
(3,715)
(3,698)
(4,110)
(5,029)
(640)
(684)
(800)
(994)
(4,355)
(4,381)
(4,910)
(6,023)
EBITDA
6,121
4,218
6,832
8,347
PBT
6,830
4,644
6,972
9,478
PAT
5,048
3,205
4,810
6,540
15.4
9.8
14.7
19.9
Total SG&A
Total operating expenditure
EPS (`)
Balance Sheet
Year to March (` mn)
Shareholders funds
Loan funds
Net Fixed assets
Investments
Cash flow
FY13
FY14E
FY15E
FY16E
38,968
41,685
45,763
51,308
8,000
8,000
10,714
10,423
10,626
12,297
4,000
Cash
10,725
9,886
6,418
280
Working capital
17,528
25,375
36,719
38,730
118.7
127.0
139.4
156.3
Format
Area (sft)
FY14E
FY15E
FY16E
Total pre-tax CF
2,546
13,049
14,181
Tax
(840)
(4,306)
(4,680)
CFO
1,706
8,743
9,501
FCFE
2,443
10,220
10,961
Changes in WC
7,847
11,344
2,011
Likely launch
FY15
Worli
Residential
1,783,928
1QFY15
Worli
Hospitality
336,375
1QFY15
Mulund Phase I
Residential
1,600,690
2QFY15
Residential
274,550
4QFY15
Commerz II - Phase I
Commercial
725,769
4QFY15
35.0%
30.0%
25.0%
20.0%
15.0%
10.0%
5.0%
0.0%
32.1%
22.3% 21.4%
26.1% 26.8%
23.1%
5.9%
FY16
Splendor Phase IV
Residential
118,986
Borivali
Residential
1,846,876
Page 36
Oberoi Realty
The limited availability of inventory has contributed significantly not only towards
weak unit sales (Part A - Exhibit 1) but also towards sluggish cash collections (Part C Exhibit 1).
Exhibit 1: Quarterly project-wise snapshot - limited inventory contributing to weakness in unit sales during 3QFY14
Project-wise quarterly run rate
4QFY12
1QFY13
2QFY13
3QFY13
4QFY13
1QFY14
2QFY14 3QFY14
Oberoi Exquisite
27,950
28,600
27,820
39,630
41,600
21,960
16,250
10,790
Oberoi Esquire
74,715
58,065
70,410
52,680
46,095
25,180
22,985
17,560
Oberoi Seven
5,650
5,650
5,650
41,860
23,660
20,020
18,200
10,920
1,820
Oberoi Splendor
20,727
7,896
11,844
7,896
19,740
114,744
170,902
123,871
130,094
124,056
118,355
48,960
153,979
28,350
441.9
495.2
488.3
781.2
739.6
477.6
384.7
225.7
1,036.2
926.6
1,099.5
783.5
780.4
411.0
433.1
348.9
80.0
90.0
0.0
90.0
0.0
0.0
0.0
0.0
650.6
374.2
345.2
310.7
202.0
36.1
0.0
0.0
Oberoi Splendor
455.9
190.2
287.0
198.5
504.6
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
3,178.9
0.0
2,665
2,076
2,220
2,164
2,227
925
3,997
575
Oberoi Exquisite
708.2
660.7
585.9
560.1
1,401.9
848.2
829.8
222.7
Oberoi Esquire
333.6
384.5
325.7
365.8
242.7
81.2
121.5
75.4
80.0
90.0
0.0
90.0
0.0
0.0
0.0
0.0
414.0
742.5
462.4
363.3
200.2
130.9
91.5
7.0
Oberoi Splendor
259.9
382.0
189.4
294.5
413.2
110.8
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
770.7
0.0
1,796
2,260
1,563
1,674
2,258
1,171
1,814
305
Oasis Residential#
Total area sold (sft)
PART B: Value of area sold (` mn)
Oberoi Exquisite
Oberoi Esquire
Oberoi Seven
Oasis Residential#
Total area sold (sft)
PART C: Cash collections (` mn)
Oberoi Seven
Oasis Residential#
Total cash collections (` mn)
Source: Company, Ambit Capital research; Note: # figures are cumulative until 9MFY14, as per management disclosures and include collections related to
transfers from another joint venture (with ICICI Ventures) that were originally sold during 2006-07.
Page 37
Oberoi Realty
Too many cash guzzlers; not enough cash generators
Our analysis of project-wise cash flows suggests that cash flows from the completed
projects (Seven, Splendor and Splendor Grande) have been exhausted, leaving little
headroom for incremental collections in the absence of fresh sales in these projects.
All of these three projects are nearly fully sold out, resulting in negligible incremental
inflows.
Exhibit 2: Project-wise outstanding collections - cash collections running significantly ahead of project progress
Collections outstanding by project (` mn)
4QFY12
1QFY13
2QFY13
3QFY13
4QFY13
1QFY14
2QFY14
3QFY14
Oberoi Exquisite
Cumulative sales (` mn)
7,901.5
8,562.2
9,148.1
2,303.9
2,138.4
2,040.8
2,261.9
1,599.6
1,229.0
783.9
786.9
Collection (% of sales)
77.4%
80.0%
81.8%
81.1%
87.4%
90.7%
94.2%
94.3%
47.1%
51.0%
57.0%
64.0%
71.0%
78.0%
83.0%
88.0%
Oberoi Esquire
Cumulative sales (` mn)
8,537.0
3,036.1
3,420.6
3,746.3
4,112.1
4,354.8
4,436.0
4,557.5
4,632.9
5,500.9
6,043.0
6,816.8
7,234.5
7,772.2
8,102.0
8,413.6
8,687.1
35.6%
36.1%
35.5%
36.2%
35.9%
35.4%
35.1%
34.8%
BTL
BTL
BTL
BTL
BTL
BTL
BTL
BTL
320.0
410.0
410.0
500.0
500.0
500.0
500.0
500.0
320.0
410.0
410.0
500.0
500.0
500.0
500.0
500.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
Collection (% of sales)
100.0%
100.0%
100.0%
100.0%
100.0%
100.0%
100.0%
100.0%
100.0%
100.0%
100.0%
100.0%
100.0%
100.0%
100.0%
100.0%
2,876.6
3,250.8
3,596.0
3,906.7
4,108.7
4,144.8
4,144.8
4,144.8
2,147.0
2,889.5
3,351.9
3,715.2
3,915.4
4,046.3
4,137.8
4,144.8
Collection (% of sales)
Percentage of completion (%)
Oberoi Seven
729.6
361.3
244.1
191.5
193.3
98.5
7.0
0.0
Collection (% of sales)
74.6%
88.9%
93.2%
95.1%
95.3%
97.6%
99.8%
100.0%
62.3%
69.0%
82.0%
92.0%
95.0%
98.0%
100.0%
100.0%
Oberoi Splendor
Cumulative sales (` mn)
2,807.3
2,615.5
2,713.1
2,617.1
2,708.5
2,597.7
2,597.7
2,597.7
98.5%
99.8%
99.2%
99.8%
99.3%
100.0%
100.0%
100.0%
100.0%
100.0%
100.0%
100.0%
100.0%
100.0%
100.0%
100.0%
0.0
0.0
0.0
0.0
0.0
0.0
3,178.9
3,178.9
0.0
0.0
0.0
0.0
0.0
0.0
770.7
770.7
0.0
0.0
0.0
0.0
0.0
0.0
2,408.2
2,408.2
Collection (% of sales)
NA
NA
NA
NA
NA
NA
24.2%
24.2%
NA
NA
NA
NA
NA
NA
BTL
BTL
Collection (% of sales)
Percentage of completion (%)
Oasis Residential#
Source: Company, Ambit Capital research; Note: # figures are cumulative until 9MFY14, as per management disclosures and include collections pertaining to
transfers from a joint venture (with ICICI Ventures) that were originally sold during 2006-07; BTL indicates below threshold level
On the other hand, cash collected from under-construction projects (Exquisite, Esquire
and Oasis) are running significantly ahead of the progress (percentage of completion)
in each of these projects. We expect Exquisite and Esquire to remain net consumers of
cash at least until 1QFY15 whilst Oasis is likely to be cash-surplus upon launch.
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Oberoi Realty
Strong launch pipeline across formats lends visibility to FY15 cash flows
We expect Oberoi to launch at least three incremental projects (across formats) over
the course of FY15. We ascribe a relatively higher probability to the launch of the
Worli project and the first phase of the Mulund project by 1HFY15.
Exhibit 3: Launch pipeline - ideal feedstock for the cash flow engine
Year / Property
Format
Area (sft)
Likely launch
Residential
1,783,928
1QFY15
FY15
Worli
Worli
Hospitality
336,375
1QFY15
Mulund Phase I
Residential
1,600,690
2QFY15
Residential
274,550
4QFY15
Commercial
800,000
4QFY15
Residential
118,986
Borivali Phase I
Residential
1,846,876
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Oberoi Realty
Area (sft)
Land area
1,089,000
272,250
81,675
Base FSI
Remarks
Converted from 25 acres
25% of the land area
10% of net land area (adjusted for amenities)
735,075
272,250
816,750
1,824,075
638,426
2,462,501
Saleable area
3,693,752
4,432,502
Page 40
Oberoi Realty
Project likely to be launched in two phases
We expect the Borivali project to be launched in two equal phases (c.1.85msf each),
with the first phase likely to be launched during FY16 followed by a second phase
launch during FY19. We expect the project to be sold out over 7 years.
Exhibit 5: Assumptions driving the Borivali project - Phase I launch during FY16 and Phase II launch during FY19
Borivali project economics
FY14E
FY15E
FY16E
FY17E
FY18E
FY19E
FY20E
FY21E
FY22E
0.0%
0.0%
10.0%
15.0%
15.0%
20.0%
15.0%
15.0%
10.0%
13,000
14,040
15,163
15,921
16,717
17,553
18,431
8.0%
8.0%
5.0%
5.0%
5.0%
5.0%
5.0%
10.0%
15.0%
15.0%
20.0%
20.0%
15.0%
10.0%
25.0%
25.0%
20.0%
15.0%
10.0%
20.0%
35.0%
55.0%
75.0%
90.0%
100.0%
3,500
3,675
3,859
4,052
4,254
4,467
4,690
5.0%
5.0%
5.0%
5.0%
5.0%
5.0%
Revenues
Sales (% of est. saleable area)
Average realisation (`/sft)
15,848
0.0%
0.0%
10.0%
90.0%
Costs
Land cost (% incurred)
Fungible FSI + TDR costs (% incurred)
5.0%
4,097
FY14
FY15E
FY16E
FY17E
FY18E
FY19E
FY20E
FY21E
FY22E
240
1,647
4,408
8,440
12,569
16,668
14,568
240
1,647
4,408
8,440
12,569
16,668
14,568
(1,826)
(2,316)
(3,252)
(4,141)
(4,184)
(2,970)
(2,079)
(137)
(275)
(687)
(687)
(549)
(412)
(1,551)
(1,629)
(2,566)
(3,592)
(3,771)
(2,970)
(2,079)
(10,262)
(1,586)
(669)
1,155
4,299
8,386
13,698
12,489
Inflows (A)
Cash collections
Outflows (B)
Land cost incurred
(1,125)
(10,262)
(1,125)
(10,125)
Fungible, TDR
Construction cost incurred
Net cash flow (A-B)
(1,125)
FY15E
FY16E
FY17E
FY18E
FY19E
FY20E
1,875
1,940
2,024
2,089
2,159
2,167
335
623
1,433
1,760
2,020
2,176
2,209
2,563
3,457
3,850
4,179
4,343
Our channel checks suggest that lenders currently offer lease rental discounting at
about 13-13.5%. We believe that Oberoi, on account of its well-capitalised balance
sheet, is likely to raise debt at the lower end of this price band.
As demonstrated in Exhibit 7, assuming Oberoi can only discount lease rentals from
its existing annuity assets (Commerz I, Westin, Oberoi Mall and Oberoi International
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Oberoi Realty
School), Oberoi will need to securitise its receivables for the next six years. On the
other hand, if Oberoi is able to discount lease rentals even from the upcoming
annuity assets (subject to similarly stable tenancy), receivables from FY15-18 are
adequate to finance this debt.
If cash remains fungible (as against a proposal in the Real Estate Regulation Bill that
calls for ring-fencing of 70% of cash flows from a project), we expect Oberoi to repay
the project debt of `8bn by end-FY16, subject to project launches at Worli and
Mulund by 1HFY15.
CARE assigns top rating for ` 8.5bn facility
As per Oberois recent filings, CARE, a rating agency, has assigned the highest rating
for a combination of short-term and long-term facilities for `8.5bn to be availed by
Oberoi. The long-term rating has been assigned to Incline Realty Private Limited, a
wholly-owned subsidiary of Oberoi Realty, recently floated exclusively for developing
the Borivali land parcel.
Exhibit 8: Top ratings secured for facilities worth `8.5bn
Instrument
Commercial paper
Non-convertible debentures
Rating
A1+
1,000
7,500
Average per square foot realisation of `15,500 through the project life-cycle
Average per square foot construction cost of `4,100 through the project life-cycle
Media reports estimate the saleable area on the Borivali land parcel ranging between
3.6msf and 4msf (the upper end of this range is ~8% higher than our saleable area
assumptions on this project). Faster-than-anticipated execution of the project (say, a
Phase II launch in FY18), higher realisations through the project life-cycle (from better
sales velocity) and lower-than-anticipated cost of debt (on account of superior credit
profile benefiting from better debt servicing) pose an upside risk to our project cash
flow assumptions. Such upside risks would impact our project valuation (excluding
land cost) by ~40% and the overall SOTP valuation by ~10% (`29) net of land cost.
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Oberoi Realty
Project details
Oberoi has an ongoing project slate of 7.1msf under-construction and a planned
project portfolio of 10.4msf, predominantly consisting of residential properties. Whilst
the ongoing project portfolio (see Exhibit 8) is relatively more concentrated, the
portfolio of planned projects (see Exhibit 9) is comparatively better diversified.
Exhibit 9: Under-construction projects (7.1msf)
Hospitality,
4.7%
Social infra,
16.1%
Office
space,
23.4%
Retail, 2.7%
Hospitality,
12.4%
Residential,
65.2%
Office
space, 3.6%
Residential,
71.9%
Residential projects
Excluding the Borivali land that was acquired towards the end of March 2014, Oberoi
has an ongoing residential project portfolio of about 5.1msf.
Exhibit 11: Key residential projects - approval / launch / completion / sale status
Properties under development
Saleable area
Launch
(sft)
Percentage of
Clearances /
completion
approval status
(POC)
OC for floors 31 to
88%
50 pending
Partial CC until the
BTL
30 th floor
BTL
Oberoi Exquisite
1,535,670
October 2009
Oberoi Esquire
1,504,815
February 2011
Oasis Residential
1,783,928
3,201,380
BTL
Borivali project
3,693,752
Land acquired
NA
274,550
Sangamcity, Pune
773,951
Time to
completion
(months)
Unsold inventory
(%)
6 months
33%
36 months
35%
48 months
NA
48 months
NA
NA
NA
Source: Company, Ambit Capital research; Note: BTL - below threshold level; OC - occupancy certificate; CC - commencement certificate
Although the projects enumerated in Exhibit 10 have relatively greater visibility, other
properties (such as Oberois Khar project and Phase IV of Splendor) have relatively
lower project-level visibility.
Given our assumptions around area sales run rate and cash collections (detailed
separately in the valuation section of this note), we expect the current pipeline of the
ongoing residential projects to be completely sold out by FY23E. We expect cash
collections from residential projects to peak during FY17E-19E.
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Oberoi Realty
Annuity projects
Oberoi currently has four operational annuity assets, which account for 35% of the
companys total operating revenues (during 9MFY14). Although the contribution of
annuity assets appears exaggerated on account of the extremely weak residential
project launches and sales during 9MFY14, the annuity assets have consistently
contributed north of 15% to the companys operating revenues since FY10. Whilst this
is partly on account of the relative maturity of the properties (all of these have been
in existence for over five years), the strong fundamentals of these properties are also
a function of the companys strategy to develop residential townships centred on
commercial properties.
Exhibit 12: Movement in key metrics in Oberois annuity projects - higher occupancy at the cost of easing rentals
Properties
4QFY12
1QFY13
2QFY13
3QFY13
4QFY13
1QFY14
2QFY14
3QFY14
79.0%
79.5%
80.7%
80.6%
83.4%
83.4%
85.8%
85.8%
128
129
129
130
131
132
128
128
93.7%
95.8%
97.6%
98.2%
96.7%
97.7%
99.2%
99.8%
94.3%
93.5%
94.3%
94.6%
95.1%
99.4%
99.1%
98.0%
125
128
124
129
125
126
137
137
96.0%
96.5%
95.5%
95.9%
94.2%
97.1%
96.0%
94.4%
Occupancy (%)
72.3%
66.8%
65.1%
67.8%
74.6%
72.5%
76.2%
73.1%
RevPAR (`)
5,886
4,637
4,761
5,606
6,085
5,599
5,659
6,185
37.7%
24.6%
21.7%
33.8%
34.1%
30.8%
28.4%
28.5%
Currently, Mumbais total office space stock is 101msf, of which 78msf is occupied,
resulting in a vacancy level of 23%. Vacancy levels have been increasing consistently
since 2009 when they were at 12%, due to the massive influx of nearly 38msf of new
supply since 2009.
Against this backdrop, Oberoi, despite its strategy of developing townships around a
central commercial property, is likely to be only marginally less vulnerable to the
effects of a general economic slowdown. Oberoi, has one operational office-use
property (Commerz I, 0.36msf) and is slated to launch another (Phase I Commerz II,
0.7msf) later this year.
Exhibit 13: Office-use projects - key metrics
Commercial properties
Estimated
area (sft)
Launch
Occupancy
(%)
Lease rent
(` /sft/mth)
EBITDA
margin (%)
Commerz I
364,888
85.8%
128
99.86%
Commerz II - Phase 1
725,769
4QFY15
NA
NA
NA
Commerz II - Phase 2
1,661,650
FY16
NA
NA
NA
Page 44
Oberoi Realty
Valuation
We use a project-based DCF approach to arrive at a valuation of `290/share (revised
upwards from `277/share), implying a 33% upside. A little over 70% of this valuation
is contributed by residential properties whereas office and retail properties contribute
a further 20% to the sum-of-the-parts valuation.
Exhibit 14: FY15 mix of cash inflows (%)
Hospitality,
7%
Social infra,
3%
Hospitality,
6%
Social infra,
2%
Retail, 7%
Retail, 16%
Office, 13%
Residential,
65%
Office, 9%
Residential,
71%
39
21
16
208
200
150
100
50
-5
0
-50
Residential
Office
Retail
Hospitality
Social infra
Other
income less
SG&A
Net cash
Beyond FY15, we expect Oberoi to maintain 15-25% of its balance sheet size in the
form of cash with any surplus deployed towards investments that earn the company
annual returns of 7.5% on an average. We build in a gradually declining contribution
from customer advances, as ongoing projects progress towards completion. We
expect Oberois funding of vendors and sub-contractors (through loans and advances
on the current assets) to progressively increase as the project moves towards
completion.
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Oberoi Realty
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Oberoi Realty
Residential properties
Annual run rate of area sales: For under-construction projects that are yet to
be launched, we build in a period of 8-10 years for a project to move from the
launch stage to the stock-out stage. For projects that are likely to be sold out
over 8 years, we assume c.50% of the total saleable area to be sold by Year 3
(from launch) and the remaining 50% to be sold over the next 5 years. For
projects that are likely to be sold out over 10 years, we factor in c.50% of the
total saleable area to be sold by Year 4 (from the time of launch) and the balance
50% to be sold over the next 6 years. For all projects, the completely sold out
stage is triggered at least 1-3 years from the time of project completion.
Exhibit 17: Cumulative sales from the time of launch (% of saleable area)
100%
80%
60%
40%
20%
0%
Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10
Project sold in 10 years
Our assumptions around the sales run rate are consistent with a typical project
lifecycle in which sales are high during the initial phase (after the project launch) and
gather fresh momentum as the project nears completion (pull factor on account of
customers looking for ready-to-move-in properties). However, the run rate of sales
tapers off in the interim.
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Oberoi Realty
Exhibit 18: YoY movement in building construction costs in major real estate markets
Mumbai
Delhi
Apr-14
Jan-14
Jul-13
Oct-13
Apr-13
Jan-13
Oct-12
Jul-12
Apr-12
Jan-12
Oct-11
Jul-11
Apr-11
Jan-11
Oct-10
Jul-10
Apr-10
Jan-10
Oct-09
Jul-09
Apr-09
Jan-09
Oct-08
18%
16%
14%
12%
10%
8%
6%
4%
2%
0%
Bangalore
FY14E
FY15E
FY16E
Launch
Stock-out
92%
94%
95%
Oct 2009
FY17E
Oberoi Esquire
34%
77%
94%
Feb 2011
FY17E
Oasis Residential
24%
36%
47%
FY15E
FY22E
Mulund project
0%
20%
35%
FY15E
FY23E
Borivali project
0%
0%
40%
FY16E
FY23E
Oberoi Exquisite
Page 48
Oberoi Realty
Rental rates for annuity projects: Currently, Mumbais total office space stock
is 101msf, of which 78msf is occupied, resulting in a vacancy level of 23%.
Vacancy levels have been increasing consistently since 2009 when they were at
12%, due to the massive influx of nearly 38msf of new supply since 2009.
102
100
2.5
98
2.0
96
1.5
94
92
1.0
90
0.5
88
0.0
86
3QCY12
4QCY12
1QCY13
2QCY13
3QCY13
Source: Knight Frank Office Traction November 2013, Ambit Capital research
Lease rentals in Mumbai have either been steady or declining over the past few
quarters (dotted line in Exhibit 20) although absorption levels have remained healthy
(the red column in Exhibit 20). Although the blended lease rentals in Mumbai are at
sub-`100 levels, Oberois incremental office inventory is being added in Goregaon,
which corresponds to SBD West.
Exhibit 21: Business district-wise lease rent in Mumbai (`/sft/month)
Business district
1QCY12
3QCY12
4QCY12
1QCY13
3QCY13
Average
250
240
245
240
218
239
ABD
245
275
260
265
265
262
Central Mumbai
128
175
135
139
165
148
SBD West
89
110
90
92
102
97
SBD Central
90
90
92
90
85
89
PBD
44
50
44
42
48
46
Source: Knight Frank Office Traction November 2013, Ambit Capital research; Note: CBD & Off CBD corresponds to Nariman Point, Cuffe Parade, Ballard Estate,
Fort, Mahalaxmi, Worli micro-markets; ABD corresponds to BKC, Bandra (E), Kalanagar and Kalina micro-markets; Central Mumbai consists of Parel, Lower Parel,
Dadar and Prabhadevi micro-markets; SBD West consists of Andheri, Jogeshwari, Goregaon and Malad micro-markets; SBD Central corresponds to Chembur,
Kurla, Ghatkopar, Vikhroli, Kanjurmarg, Powai and Bhandup micro-markets; PBD consists of Thane, Airoli, Vashi and Belapur micro-markets
A typical lease rental agreement on Oberois commercial projects lasts for 5-7 years
embedded with a rent reset clause every three years. However, given the ongoing
sluggishness in the broader economic environment and supply outstripping demand
for commercial properties (reflected in rising vacancies), we assume a 1% YoY decline
in lease rental rates for all of Oberois office projects. Any recovery in the office space
segment, with a potential turnaround in absorption levels, poses an upside risk to our
estimates on lease rent.
We assume a 3% YoY rise in the average rentals for Oberoi Mall (retail property) and
a 5% YoY rise in RevPAR (revenue per available room), the key operating metric for
the companys hospitality projects (Westin and Oasis).
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Oberoi Realty
in Mumbai are at an all-time high of over 20%, our analysis suggests that SBD
West, the micro-market corresponding with Oberois upcoming office space
projects, consistently absorbs about one-third of the inventory every quarter (see
Exhibit 22).
Exhibit 22: Business district-wise absorption in Mumbai (%)
Business district
1QCY12
3QCY12
4QCY12
1QCY13
2QCY13
3QCY13
1%
2%
4%
0%
3%
1%
ABD
6%
14%
3%
3%
6%
16%
17%
43%
29%
4%
34%
7%
SBD West
30%
13%
47%
47%
31%
32%
SBD Central
28%
18%
2%
15%
4%
14%
PBD
18%
10%
15%
31%
22%
30%
Central Mumbai
Source: Knight Frank Office Traction November 2013, Ambit Capital research; Note: CBD & Off CBD corresponds to Nariman Point, Cuffe Parade, Ballard Estate,
Fort, Mahalaxmi, Worli micro-markets; ABD corresponds to BKC, Bandra (E), Kalanagar and Kalina micro-markets; Central Mumbai consists of Parel, Lower Parel,
Dadar and Prabhadevi micro-markets; SBD West consists of Andheri, Jogeshwari, Goregaon and Malad micro-markets; SBD Central corresponds to Chembur,
Kurla, Ghatkopar, Vikhroli, Kanjurmarg, Powai and Bhandup micro-markets; PBD consists of Thane, Airoli, Vashi and Belapur micro-markets
We assume occupancy rates for retail projects (Oberoi Mall) to continue at 99%. For
hospitality projects, we assume an average occupancy rate of 75% for the Westin
project (FY15E-19E) and 25-50% for the Worli project, due to the higher supply of
five-star hotels in Worli as compared to a scarcity premium for such hotels in
Goregaon.
Exhibit 23: Assumptions around occupancy levels (%) in Oberois non-residential projects
Occupancy levels (%)
FY14E
FY26E
Office space
Commerz I
85%
85%
85%
88%
88%
88%
90%
90%
90%
93%
93%
93%
95%
Commerz II - Phase 1
25%
50%
75%
80%
85%
85%
85%
85%
85%
85%
85%
85%
Commerz II - Phase II
0%
0%
25%
35%
45%
50%
55%
60%
65%
70%
75%
80%
99%
99%
99%
99%
99%
99%
99%
99%
99%
99%
99%
99%
99%
75%
75%
75%
75%
75%
75%
80%
80%
80%
80%
80%
80%
80%
25%
35%
45%
55%
65%
70%
75%
75%
75%
75%
75%
75%
FY26E
Retail property
Oberoi Mall
Hospitality projects
Westin
Oasis Hospitality
Source: Ambit Capital research
Exhibit 24: EBITDA margin (%) assumptions for Oberois non-residential projects
EBITDA margin (%)
FY14E
Office space
Commerz I
99%
Commerz II - Phase 1
99%
99%
99%
99%
99%
99%
99%
99%
99%
99%
99%
99%
90%
90%
90%
90%
90%
90%
90%
90%
90%
90%
90%
90%
90%
90%
90%
90%
90%
90%
90%
90%
90%
90%
Commerz II - Phase II
Retail property
Oberoi Mall
95%
95%
95%
95%
95%
95%
95%
95%
95%
95%
95%
95%
95%
29%
30%
30%
30%
30%
30%
25%
25%
25%
25%
25%
25%
25%
10%
15%
20%
25%
25%
25%
25%
25%
25%
25%
25%
25%
Hospitality project
Westin
Oasis Hospitality
Source: Ambit Capital research
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Oberoi Realty
For the hospitality projects, we assume a maintenance cost of 10% (of operating
revenues) on the Westin project and 15% (of operating revenues) on the Worli project
(in line with the branded residency theme), undertaken in the form of construction
expenditure. Taken alongside our EBITDA margin assumptions, this would imply that
10% of the operating revenues from the Westin project and 15% of the operating
revenues from the Worli project are being re-invested in the respective projects every
year.
Exhibit 25: Ancillary revenue (% of total revenue) assumptions for Oberois hospitality projects
Ancillary revenues (%)
FY14E
FY15E
FY16E
FY17E
FY18E
FY19E
FY20E
FY21E
FY22E
FY23E
FY24E
FY25E
FY26E
50%
50%
50%
50%
50%
50%
50%
50%
50%
50%
50%
50%
50%
40%
40%
40%
40%
40%
40%
45%
45%
45%
45%
45%
50%
Hospitality project
Westin
Oasis Hospitality
Source: Ambit Capital research
Page 51
Oberoi Realty
Score
Comment
Accounting
GREEN
Despite a sluggish 9MFY14 (in terms of fresh sales and cash flows), Oberoi boasts of a superior cash
conversion ratio relative to its peers as well as a very strong balance sheet (zero leverage).
Predictability
AMBER
Although Oberois two key projects (Worli and Mulund) have been subject to exogenous factors (litigation
and regulatory bottlenecks), resulting in inordinate delays in the launch of both properties. The company
has been unable to guide investors realistically and it has made inadequate documented disclosures
around the status of approvals and clearances.
Earnings momentum
GREEN
Oberoi recently emerged as the highest bidder for the Borivali land (put on the block by Tata Steel); the
stock has witnessed sharp upgrades to its earnings contingent on the land acquisition transaction going
through.
Page 52
Oberoi Realty
Revision in estimates
Exhibit 27: Revision in FY14E/FY15E/FY16E estimates
FY14E
Changes in estimates
Operating income
FY15E
FY16E
Old
New
% change
Old
New
% change
Old
New
% change
10,221
8,599
-15.9%
11,800
11,742
-0.5%
15,074
14,370
-4.7%
EBITDA (` mn)
5,699
4,218
-26.0%
6,846
6,832
-0.2%
8,844
8,347
-5.6%
4,231
3,184
-24.7%
5,526
4,733
-14.3%
7,404
6,371
-14.0%
12.9
9.7
-24.8%
16.8
14.4
-14.2%
22.6
19.4
-14.1%
129.2
126.9
-1.7%
142.5
139.2
-2.3%
161.5
155.6
-3.6%
EPS (`)
BVPS (`)
Source: Ambit Capital research
Given Oberois high operating leverage and zero leverage, the downward revision in
our revenue estimates translates directly to a relatively sharper downgrade to our
FY14E earnings estimates.
Page 53
Oberoi Realty
SWOT analysis
Exhibit 28: Oberoi Realty - SWOT analysis
Strengths
Weaknesses
Threats
Further delay in launches that drain surplus cash from the balance sheet
Page 54
Oberoi Realty
Balance Sheet
Year to March (` mn)
FY12
FY13
FY14E
FY15E
FY16E
34,688
38,968
41,685
45,763
51,308
8,000
8,000
9,850
10,714
10,423
10,626
12,297
4,000
Cash
12,934
10,725
9,886
6,418
280
Working capital
11,904
17,528
25,375
36,719
38,730
105.7
118.7
127.0
139.4
156.3
FY12
FY13
FY14E
FY15E
FY16E
5,768
7,813
5,469
7,110
9,243
Shareholders funds
Loan funds
Net Fixed assets
Investments
Income statement
Year to March (` mn)
Revenue from residential projects
Hospitality services
Rentals and related income
Property and project management income
Other operating income
897
956
1,146
2,336
2,453
1,289
1,398
1,504
1,798
2,096
229
250
330
391
485
63
58
150
107
92
8,247
10,476
8,599
11,742
14,370
(2,958)
(3,715)
(3,698)
(4,110)
(5,029)
(452)
(640)
(684)
(800)
(994)
(3,411)
(4,355)
(4,381)
(4,910)
(6,023)
EBITDA
4,836
6,121
4,218
6,832
8,347
PBT
6,060
6,830
4,644
6,972
9,478
PAT
4,630
5,048
3,205
4,810
6,540
14.1
15.4
9.8
14.7
19.9
EPS (`)
Source: Company, Ambit Capital research
FY14E
FY15E
FY16E
Total pre-tax CF
2,546
13,049
14,181
Tax
(840)
(4,306)
(4,680)
CFO
1,706
8,743
9,501
FCFE
2,443
10,220
10,961
Changes in WC
7,847
11,344
2,011
Source: Company, Ambit Capital research, Note: All financials pertain to IFRS consolidated accounts
Ratio Analysis
Year to March (` mn)
FY12
FY13
FY14E
FY15E
FY16E
P/E (x)
16.0
14.6
23.0
15.4
11.3
2.1
1.9
1.8
1.6
1.4
P/FCF
43.4
8.5
7.8
P/FCFE
30.3
7.2
6.8
P/BV (x)
ROE %
Net Debt/equity
13.6
13.7
7.9
11.0
13.5
-0.37
-0.28
-0.14
0.03
-0.01
58.6
58.4
49.1
58.2
58.1
Net margin %
47.5
44.0
34.3
36.4
41.3
1.0
1.0
0.7
1.0
1.3
Dividend yield %
Source: Company, Ambit Capital research
Page 55
Oberoi Realty
Page 56
Sobha Developers
BUY
COMPANY INSIGHT
SOBHA IN EQUITY
Real Estate
Recommendation
Mcap (bn):
6M ADV (mn):
CMP:
TP (12 mths):
Upside (%):
`37/US$0.6
`83/US$1.4
`376
`490
30
Flags
Accounting:
Predictability:
Earnings Momentum:
AMBER
AMBER
GREEN
Catalyst
OMR (Chennai) project launch in 1HFY15
Gurgaon project launch during 1HFY15
Launch of APMC project in Bangalore
Performance (%)
140
120
100
80
60
40
Apr-13
May-13
Jun-13
Jul-13
Aug-13
Sep-13
Oct-13
Nov-13
Dec-13
Jan-14
Feb-14
Mar-14
Sobha generated a steady stream of cash inflows from its real estate segment
(quarterly run rate of `4.5bn) and its contracted projects (quarterly run rate of
`1.7bn) during 9MFY14. During 9MFY14, Sobha averaged `0.7bn-0.8bn of
quarterly net cash from operations (CFO), net of interest payouts. With net debt
to equity at 0.6x, Sobha is exposed to a manageable refinancing risk with over
`8.5bn (0.3x net worth) due for repayment during FY15.
Sensex
SOBHA IN
FY12
FY13
FY14E
FY15E
FY16E
14,079
18,645
20,931
24,500
29,765
4,666
5,483
5,905
7,300
8,995
2,060
2,172
2,245
2,845
3,675
21.0
22.1
22.9
29.0
37.5
RoE (%)
10.7
10.5
10.5
12.7
14.7
P/E (x)
17.8
16.8
16.3
12.9
9.9
P/B (x)
1.8
1.7
1.6
1.5
1.3
Analyst Details
Krishnan ASV
+91 22 3043 3205
vkrishnan@ambitcapital.com
Sobha Developers
Company Background
Year to March
Revenues from property
development
Revenues from sale of land &
TDR
Revenue from sale of
manufactured products
Revenues from contractual
projects
Other operating income
Total income
FY13
FY14E
FY15E
FY16E
13,092
15,762
17,984
21,754
1,020
1,477
1,725
2,187
2,766
3,013
3,390
4,261
5,160
43
54
67
84
18,645
20,931
24,500
29,765
Operating costs
Total SG&A (incl. employee
costs)
EBITDA
(9,103)
(10,252)
(12,356)
(14,957)
(4,060)
(4,101)
(4,942)
(5,983)
5,483
5,905
7,300
8,995
PBT
3,239
3,257
4,312
5,376
PAT
2,172
2,245
2,845
3,675
22.1
22.9
29.0
37.5
EPS (`)
Balance Sheet
Cash flow
FY13
FY14E
FY15E
Shareholders fund
21,234
22,819
24,948
Debt
13,787
14,787
15,787
Minority interest
102
102
102
102
3,169
2,634
2,127
1,644
670
4,086
7,631
12,920
31,283
30,986
31,078
30,115
216.5
231.4
252.8
279.7
7,710
10,582
Tax
(1,141)
(1,496)
(1,906)
CFO
5,417
6,214
8,677
FCFE
3,203
3,773
5,875
297
(92)
963
Changes in WC
8,000
540
14.5%
7,000
520
6,000
500
5,000
480 13.5%
4,000
460
3,000
440
2,000
420
14.0%
14.1%
4Q14
3Q14
2Q14
1Q14
4Q13
3Q13
2Q13
1Q13
4Q12
3Q12
2Q12
13.0%
12.7% 12.5%
3Q14
2Q14
1Q14
4Q13
12.0%
0
1Q12
13.5%
13.6%
12.9%
1Q12
1,000
13.7%
3Q13
6,558
2Q13
FY16E
1Q13
Working capital
FY15E
4Q12
FY14E
3Q12
Investments
2Q12
Year to March
Page 58
Sobha Developers
7,000
1,000,000
6,000
800,000
5,000
4,000
600,000
3,000
400,000
2,000
200,000
1,000
4Q14
3Q14
2Q14
1Q14
4Q13
3Q13
2Q13
1Q13
4Q12
3Q12
2Q12
1Q12
4Q14
3Q14
2Q14
1Q14
4Q13
3Q13
2Q13
1Q13
4Q12
3Q12
2Q12
0
1Q12
We attribute the sales momentum to Sobhas strategy of focusing on lower ticket sizes
in the `7.5mn-15mn price bracket that continues to see stable demand. Given the
strong reception to its recent project launches, we believe that Sobha will be able to
deliver volume sales north of 4msf in FY15/FY16E on the back of a relatively strong
pipeline of launches in south India.
Reducing concentration risk; benefiting from diversified presence
At the end of March 2014, Sobha has a real estate presence in 9 cities (up from 4 as
of March 2011). Sobhas primary market remains Bangalore (accounting for c.68% of
volumes and 73% of value sales on an average), which ranks extremely high on the
employment creation and affordability metrics. By FY16, we expect the contribution of
Bangalore to Sobhas volume sales to decline to c.60%.
Exhibit 3: Contribution of newly added locations to overall volumes (% of total sft)
Location
Launch debut
Mysore
1QFY12
Average contribution
to area sold (%)
1.9%
NCR
2QFY12
9.6%
Chennai
4QFY12
8.2%
Kozhikode
2QFY14
4.9%
Cochin
4QFY14
1.8%
Page 59
Sobha Developers
Our discussion with the management team suggests that the company is looking to
nearly double its new sales volume from ~3.6msf (as of FY14) to ~7msf over the next
five years (FY19), with the contribution of Bangalore likely to drift lower to 50%. Even
within Bangalore, Sobha is focused on gradually moving towards smaller-sized units
(from 3BHK formats of 1,800sft-2,000sft to 2BHK formats of 1,350sft) to reduce the
unitary ticket size and enhance its offerings in the affordable segment.
Exhibit 4: Location-wise breakdown of volume sales (sft) - growing contribution from NRI-rich locations
Bangalore
1Q13
2Q13
3Q13
4Q13
1Q14
2Q14
3Q14
4Q14
520,080
590,438
591,216
682,629
603,055
674,622
503,708
630,947
Thrissur
44,096
118,306
88,407
93,034
149,194
103,270
49,064
58,458
Coimbatore
26,005
10,631
19,574
7,160
15,871
17,124
40,171
Pune
30,639
38,621
23,124
45,324
22,912
12,716
24,433
23,395
NCR
135,721
137,600
103,098
132,732
36,255
30,892
23,522
38,114
Chennai
72,083
42,323
67,350
106,377
99,963
86,869
53,523
62,195
Mysore
6,975
8,209
9,881
4,015
9,300
22,128
26,538
19,547
Cochin
NP
NP
NP
NP
NP
NP
NP
16,252
Kozhikode
Total
NP
NP
NP
NP
NP
56,661
42,293
32,193
835,599
946,128
902,650
1,071,271
920,679
1,003,029
740,205
921,272
Source: Company, Ambit Capital research; Note: NP indicates no projects on offer in the city during that quarter
74.0%
72.0%
70.0%
68.0%
66.0%
64.0%
5
62.0%
60.0%
4
1Q12 2Q12 3Q12 4Q12 1Q13 2Q13 3Q13 4Q13 1Q14 2Q14 3Q14 4Q14
Number of cities (RHS)
Our discussions with the management team and independent consultants suggest
that Sobha is actively scouting for land parcels in the southern city of Hyderabad
(either outright acquisition or through the joint development agreement route) to add
to its slate of 9 locations.
Page 60
Sobha Developers
13.5
0.64
540
13.0
0.62
520
440
13.0%
12.7% 12.7%
12.5%
3Q14
2Q14
1Q14
4Q13
3Q13
12.0%
2Q13
420
3Q14
2Q14
1Q14
4Q13
3Q13
2Q13
1Q13
4Q12
0.52
3Q12
10.0
2Q12
0.54
1Q12
10.5
13.5%
12.9%
1Q13
0.56
11.0
460
4Q12
0.58
11.5
480
14.0%
14.1%
13.9%
13.9%
13.7%
13.6%
13.5%
13.6%
13.5%
3Q12
0.6
12.0
500
1Q12
12.5
14.5%
2Q12
Our discussion with rating agencies suggests that the upgrades were primarily driven
by steady cash flows on the back of healthy sales velocity in its ongoing projects and
periodic repayments of its existing debt, with the 3QFY14 volume print an exception
to the trend. Sobhas improving credit profile has been driven by a healthy mix of
recurring cash flows from its contractual projects (~26% of total cash inflows from
operations as of 9MFY14).
Exhibit 8: Segmental cash collections - stable, recurring cash flows from contracts
7,000
6,000
1,037
5,000
4,000
1,788
2,111
5,293
4,923
4,552
4,445
4Q13
1Q14
2Q14
3Q14
1,495
764
798
3,000
2,000
1,230
3,249
3,687
3,883
1Q13
2Q13
3Q13
1,000
0
Real estate
Contracts
Monetization of land
Page 61
Sobha Developers
Over ` 8.5bn (over 50% of outstanding debt) up for repayment during FY15
Our discussion with rating agencies suggests that debt of `8.5bn (of the overall net
debt of `13bn) is up for repayment during FY15. Although Sobha has matching
undrawn sanctioned limits for its ongoing and planned projects, the disbursement of
incremental debt is contingent upon the timely launch and progress of these projects.
Also, one of Sobhas proposed launches over the next four quarters is the
development of a commercial project awarded by APMC (Agricultural Produce Market
Committee), which is likely to result in increased funding requirements.
Residential
3,323,893
Bangalore
682,143
Gurgaon (NCR)
102,420
Chennai
1,984,850
Coimbatore
206,000
Thrissur
348,480
Commercial
2,063,252
Bangalore
2,063,252
TOTAL
5,387,145
We expect Sobha to launch its commercial project during 2HFY15 to manage its cash
flows better (operating cash inflows are likely to be relatively slower from the
commercial project vis--vis the residential properties). During the early part of FY15,
we believe Sobha will be more aggressive on its residential launches, especially in
Gurgaon (offers higher realisations) and Chennai (offers relatively higher volume).
Going forward, the quantum of undrawn sanctioned limits that Sobha needs to draw
upon as well as the cost of incremental debt will be influenced by:
Page 62
Sobha Developers
Project details
Sobha has an ongoing real estate project slate of 18.9msf under construction (55% in
Bangalore) and a contract portfolio of 9.5msf (60% contracted by Infosys). Whilst the
portfolio of ongoing real estate projects (see Exhibit 10) is relatively more
concentrated in Bangalore, the portfolio of contracts (see Exhibit 11) is comparatively
better-diversified.
Exhibit 10: Location mix of ongoing projects (18.9msf)
Others
6%
Kozhikode
3%
Others
13%
Jaipur
6%
Chennai
5%
Bangalore
32%
Pune
7%
Thrissur
8%
Bangalore
56%
Mangalore
10%
Gurgaon
22%
Hyderabad
17%
Trivandrum
15%
% of land bank
% contribution to DCF
Bangalore
38.2%
41.0%
IT/ITeS
Chennai
17.0%
19.0%
IT/ITeS
Coimbatore
2.7%
2.1%
IT/ITeS
Gurgaon
0.0%
3.0%
BPO/KPO/IT/ITeS
Hosur
15.4%
11.0%
IT/ITeS
Kochi
21.3%
14.0%
NRI
Kozhikode
0.2%
0.2%
NRI
Mysore
0.3%
0.3%
IT/ITeS
Pune
2.3%
7.0%
IT/ITeS
Thrissur
2.5%
2.4%
NRI
Page 63
Sobha Developers
Valuation
We use a sum-of-the-parts (SOTP) approach and arrive at a valuation of `490/share
(marginal upward revision from our earlier valuation of `486/share), implying a 30%
upside. We value the real estate business at `441/share (using a DCF approach) and
the contracts business at `49/share.
Exhibit 13: Sum-of-the-parts valuation (`/share)
Real estate projects valuation (` mn)
Real estate projects (`/shr)
Contracts business valuation (` mn)
Contracts business (`/shr)
Total valuation (` mn)
SOTP Valuation (`/shr)
Source: Ambit Capital research
59,317
1,250
14,654
43,413
98.2
442
Annual run rate of sales: For under-construction projects that are yet to be
launched, we build in about 50% of the total sales to be achieved by Year 1 after
launch and 80% of cumulative sales by Year 3. For all projects, we assume the
stock out stage is triggered about 12-18 months after project completion. For all
the upcoming projects, we build in a delay of 12-18 months in project
completion. Although Sobha claims to complete its residential projects over a
period of 2.5 years to 3.5 years, our assumptions around delays are conservative,
given the usual issues around labour shortage.
Our assumptions around sales run rate are consistent with a typical project life-cycle
in which sales are high during the initial phase (after the project launch) and gather
fresh momentum as the project nears completion (pull factor on account of customers
looking for ready-to-move-in properties). However, the run rate of sales tapers off
during the interim.
Page 64
Sobha Developers
Rise in input costs of construction: For all projects under construction, we have
assumed 8% YoY increase in cost of construction (per sft) during the first four
years of a project and 5% thereafter until project completion. Our assumptions
around YoY cost inflation are based on trends around indexed building
construction costs published by the Construction Industry Development Council
(CIDC). Our estimates around rise in input costs are conservative given the fact
that the cost of building construction increased ~4% in Mumbai and ~5% each in
Delhi and Bangalore over the past five years (between January 2009 and March
2014). Concomitant with our assumptions around growth in blended realisation
rates, we believe that Sobhas pricing power is only restored on select projects
post FY18E.
Exhibit 15: YoY movement in building construction costs in major real estate markets
Mumbai
Delhi
Apr-14
Jan-14
Jul-13
Oct-13
Apr-13
Jan-13
Oct-12
Jul-12
Apr-12
Jan-12
Oct-11
Jul-11
Apr-11
Jan-11
Oct-10
Jul-10
Apr-10
Jan-10
Oct-09
Jul-09
Apr-09
Jan-09
Oct-08
18%
16%
14%
12%
10%
8%
6%
4%
2%
0%
Bangalore
FY15E
FY16E
Remarks
Residential
3.59
3.91
4.37
Contractual sales
3.41
3.98
4.53
Residential
6,534
6,926
7,342
We build in 6% YoY blended rise in realisation rates during FY15E and FY16E
Contracts
1,500
1,620
1,750
23,457
27,081
32,085
5,115
6,448
7,926
1,900
2,050
2,200
12.75%
14%
14%
Volumes (msf)
We expect residential sales to record a 9% YoY growth during FY15E and a
12% YoY growth during FY16E
Given the contractual nature of projects (with relatively higher visibility), we
build in a 17% YoY growth in contract volumes during FY15E and 14% YoY
growth during FY16E
We assume rise in input costs at around 8% for FY15E and 7% for FY16E
We assume a 125bps increase in cost of debt during FY15E and FY16E
Page 65
Sobha Developers
Score
Comment
Accounting
AMBER
Despite an improving cash conversion over the past three years (FY11-13), Sobha
ranks behind its other A-grade peers such as Oberoi Realty; relatively low cash yield;
elevated contingent liabilities as a proportion of net worth; extremely low audit fees
(as proportion of auditor remuneration).
Predictability
AMBER
Instances of missed guidance despite exercising relatively better control over the
supply chain.
Earnings momentum
GREEN
The company launched four new projects (Bangalore, Kozhikode and Cochin) during
4QFY14, and thus, the stock has seen upgrades to its FY15E earnings.
Page 66
Sobha Developers
Revision in estimates
Exhibit 18: Revision in FY14E/FY15E/FY16E estimates
FY14E
Changes in estimates
Operating income
Old
New
FY15E
FY16E
% change
Old
New
% change
Old
New
% change
20,559
20,931
1.8%
24,779
24,500
-1.1%
29,998
29,765
-0.8%
EBITDA (` mn)
6,205
5,905
-4.8%
7,481
7,300
-2.4%
9,058
8,995
-0.7%
2,318
2,245
-3.1%
3,038
2,845
-6.4%
3,870
3,675
-5.0%
23.6
22.9
-3.0%
31.0
29.0
-6.4%
39.5
37.5
-5.2%
232.7
231.4
-0.6%
254.4
252.8
-0.6%
283.4
279.7
-1.3%
EPS (`)
BVPS (`)
Source: Ambit Capital research
Page 67
Sobha Developers
SWOT Analysis
Exhibit 19: Sobha Developers - SWOT analysis
Strengths
Weaknesses
High concentration risk in the contracts business with 60% of orders from
Infosys
Threats
Page 68
Sobha Developers
Balance Sheet
Year to March
FY12
FY13
FY14E
FY15E
FY16E
Shareholders fund
19,956
21,234
22,819
24,948
27,793
Debt
12,440
13,787
14,787
15,787
16,787
Minority interest
355
102
102
102
102
2,810
3,169
2,634
2,127
1,644
Investments
588
670
4,086
7,631
12,920
29,352
31,283
30,986
31,078
30,115
203.5
216.5
231.4
252.8
279.7
FY12
FY13
FY14E
FY15E
FY16E
8,948
13,092
15,762
17,984
21,754
1,365
1,020
1,393
1,477
1,725
2,187
2,766
2,348
3,013
3,390
4,261
5,160
25
43
54
67
84
14,079
18,645
20,931
24,500
29,765
Operating costs
(4,447)
(9,103)
(10,252)
(12,356)
(14,957)
(4,967)
(4,060)
(4,101)
(4,942)
(5,983)
EBITDA
4,666
5,483
5,905
7,300
8,995
PBT
3,177
3,239
3,257
4,312
5,376
PAT
2,060
2,172
2,245
2,845
3,675
21.0
22.1
22.9
29.0
37.5
Income statement
Year to March
EPS (`)
Source: Company, Ambit Capital research
FY14E
FY15E
FY16E
Total pre-tax CF
6,558
7,710
10,582
Tax
(1,141)
(1,496)
(1,906)
CFO
5,417
6,214
8,677
FCFE
3,203
3,773
5,875
297
(92)
963
Changes in WC
Source: Company, Ambit Capital research, Note: All financials pertain to IFRS consolidated accounts
Ratio Analysis
Year to March
FY12
FY13
FY14E
FY15E
FY16E
P/E (x)
17.8
16.8
16.3
12.9
9.9
1.8
1.7
1.6
1.5
1.3
5.5
4.8
3.5
P/BV (x)
P/FCF
P/FCFE
9.4
8.0
5.1
10.5
12.7
14.7
0.65
0.65
0.63
0.60
29.4
30.2
30.2
30.2
14.6
11.6
11.2
12.1
12.7
1.6
2.3
2.4
3.0
3.4
ROE %
10.7
10.5
Debt/equity
0.62
EBITDA margin %
33.1
Net margin %
Dividend yield %
Source: Company, Ambit Capital research
Page 69
Sobha Developers
(022) 30433174
saurabhmukherjea@ambitcapital.com
Research
Analysts
Industry Sectors
Desk-Phone
Aadesh Mehta
(022) 30433239
aadeshmehta@ambitcapital.com
Achint Bhagat
Cement / Infrastructure
(022) 30433178
achintbhagat@ambitcapital.com
Aditya Khemka
Healthcare
(022) 30433272
adityakhemka@ambitcapital.com
Akshay Wadhwa
(022) 30433005
akshaywadhwa@ambitcapital.com
(022) 30433211
ankurrudra@ambitcapital.com
Automobile
(022) 30433285
ashvinshetty@ambitcapital.com
Bhargav Buddhadev
(022) 30433252
bhargavbuddhadev@ambitcapital.com
(022) 30433202
dayanandmittal@ambitcapital.com
Deepesh Agarwal
(022) 30433275
deepeshagarwal@ambitcapital.com
(022) 30433255
gauravmehta@ambitcapital.com
Karan Khanna
Strategy
(022) 30433251
karankhanna@ambitcapital.com
Krishnan ASV
Real Estate
(022) 30433205
vkrishnan@ambitcapital.com
Nitin Bhasin
(022) 30433241
nitinbhasin@ambitcapital.com
Nitin Jain
Technology
(022) 30433291
nitinjain@ambitcapital.com
(022) 30433206
pankajagarwal@ambitcapital.com
Pratik Singhania
(022) 30433264
pratiksinghania@ambitcapital.com
Parita Ashar
(022) 30433223
paritaashar@ambitcapital.com
(022) 30433201
rakshitranjan@ambitcapital.com
Ravi Singh
(022) 30433181
ravisingh@ambitcapital.com
Economy / Strategy
(022) 30433175
ritikamankar@ambitcapital.com
Ritu Modi
Automobile
(022) 30433292
ritumodi@ambitcapital.com
E&C / Infrastructure
(022) 30433203
tanujmukhija@ambitcapital.com
Sales
Name
Regions
Desk-Phone
Deepak Sawhney
India / Asia
(022) 30433295
deepaksawhney@ambitcapital.com
Dharmen Shah
India / Asia
(022) 30433289
dharmenshah@ambitcapital.com
Dipti Mehta
India / USA
(022) 30433053
diptimehta@ambitcapital.com
USA / Europe
(022) 30433259
nityamshah@ambitcapital.com
UK / USA
(022) 30433169
pareespurohit@ambitcapital.com
Praveena Pattabiraman
India / Asia
(022) 30433268
praveenapattabiraman@ambitcapital.com
Sarojini Ramachandran
UK
sarojini@panmure.com
Production
Sajid Merchant
Production
(022) 30433247
sajidmerchant@ambitcapital.com
Sharoz G Hussain
Production
(022) 30433183
sharozghussain@ambitcapital.com
Joel Pereira
Editor
(022) 30433284
joelpereira@ambitcapital.com
Nikhil Pillai
Database
(022) 30433265
nikhilpillai@ambitcapital.com
Page 70
Sobha Developers
Expected return
(over 12-month period from date of initial rating)
Buy
>5%
Sell
<5%
Disclaimer
This report or any portion hereof may not be reprinted, sold or redistributed without the written consent of Ambit Capital. AMBIT Capital Research is disseminated and available primarily electronically, and,
in some cases, in printed form.