Credit Suisse Securities is bullish on the real estate sector but feels that investors need to be choosy, given high valuations.
We are witnessing a structural bull run in the real estate sector in India. The reasons for growth and the potential opportunity have already been well documented — a strong and sustained GDP growth led by the services sector; favourable demographics with existing shortage of housing, growing urbanisation, and the emergence of a new middle class with rapidly rising income levels.
All these are fundamentally strong macroeconomic factors implying a long-term opportunity in the sector. However, the sharp rise in property prices and higher mortgage rates have begun to hurt demand. Transactions have slowed, as reflected in the decline in mortgage lending for most banks. We believe that affordability needs to improve, either through a fall in price or a decline in mortgage rates, for genuine buyers to come back into the market.
A 10-15% fall in prices is likely over the next 6-12 months and could trigger an immediate recovery in demand. Growth is likely to be high in the residential segment. The companies likely to excel in the current environment will be those with a large diversified landbank, strong execution ability and a strong balance sheet.
We prefer developers with large, well-diversified, low-cost land reserves substantially paid for and with clear titles. Long-term investors should build exposure to the real estate sector, but only at the right price. Our top pick is Sobha Developers, followed by Parsvnath Developers.
Sobha Developers: Sobha is our top pick in the sector, and offers 23% potential upside. It is trading at a 15.3% discount to NAV even as strong earnings momentum over 2007-10 makes valuations attractive. The company’s reputation as a quality builder in Bengaluru and a preferred contractor for Infosys should serve it well as it expands in the high-growth markets across southern India. We initiate coverage with an outperformer rating.
Parsvnath Developers: Parsvnath is our preferred stock for investors looking to play the tier III growth story. This is in light of the rapid expansion in the scale of execution the company has achieved and the potential for faster churn of its landbank. We initiate coverage with an outperformer rating.
DLF: The company has the largest landbank and is one of the few developers to have demonstrated execution capabilities on large-scale projects. It trades at an 18.6% premium to our estimated 2007-8 net asset value of Rs 644, against average premiums of 23% and 45% for its peers in Hong Kong and China respectively. We initiate with a neutral rating on valuation grounds.
Unitech: With its large landbank and innovative business strategy, Unitech is well placed to benefit from the large volume opportunity in the sector. The stock has risen 48% in the past 30 days and now trades at over a 27.6% premium to our 2007-8 NAV, the highest in our coverage universe. We initiate neutral rating on the stock.
