On promised land

An underperformer so far, Sobha Developers appears ripe to join the real estate party on the bourses. There is no doubt about real estate stocks being the flavour of the season. The BSE Realty index has secularly beaten the Sensex by an increasing margin over the past few months. Although the visible reason for the sector's outperformance appears to be the recent ULCRA repeal in Maharashtra, the rally has not spared the stocks of real estate developers from other parts of the country as well. With growth in realty prices slowing down in some pockets of tier-II and tier-III cities, demand from genuine buyers has raised its head once more, keeping the hopes for the sector buoyant as ever. Regional markets such as the southern cities of Bangalore, Mysore, Chennai and Cochin, or the likes of Ludhiana, Manesar and Faridabad are witnessing high demand owing to rising industry penetration. The time therefore seems to be appropriate to take a look at players which are likely to dominate such markets due to their concentration in these cities. Sobha Developers is one such player with presence in Bangalore, Chennai, Cochin, Hosur, Mysore and a few more, with a well-diversified business mix between real estate development and contract construction. A well-situated land bank, promising project portfolio along with a contracting business of repute makes Sobha's an attractive business. Although its real estate business is predominantly based in Bangalore, the company is now expanding into other southern cities, besides Pune in Maharashtra. A large part of its revenues comes from residential real estate construction, and now the company aims to increase the proportion of commercial real estate in its project pipeline. Turning keysMore than a third of Sobha's revenues come from its contracting business, which undertakes turnkey construction work for others. It is a preferred contractor for Infosys, and carries out majority of the development work for the latter. Since the operating margins from contracting are a tad lower at about 17-18 per cent compared with the real estate development business, the company aims to focus more on real estate development. This is likely to result in a smaller share of revenues coming from the contracting business, going forward. Consequently, the execution of the company's real estate development will be strengthened. At present, the company has about 8 million sq ft of ongoing development work on a contracting basis. Real focusDemand for real estate in Bangalore has remained strong owing to the information technology industry, while that in cities like Chennai, Cochin, Coimbatore, Hosur, Mysore and Thrissur is on an uptrend as new industries are flooding to set up their facilities. Sobha has its land-bank spread in these cities, albeit with almost half of it concentrated in Bangalore. At present, about 12 million sq ft of saleable area is under own-development, with nearly 50 per cent of the development already pre-sold. In the second quarter of FY08, Sobha added about 500 acre (1 acre is about 43,500 sq ft) to its land reserves, taking the total to approximately 4,000 acre. "We plan to launch about a million sq ft for sale every month now on over the coming 24-30 months," claims J C Sharma, managing director, Sobha Developers. Price runHigh home-loan interest rates and a rampant rise in real estate prices are being blamed for a slowdown in demand growth for real estate in tier-II and tier-III cities, and a resulting correction in prices to the extent of 10-30 per cent. However, this does not seem to have dampened the enthusiasm of builders, largely due to demand from genuine buyers. "In spite of a slowdown in demand, we are looking forward to a 20 per cent y-o-y increase in realisations on an average, going forward," says Sharma. Owing to the high concentration in Bangalore, so far Sobha has enjoyed an average realisation of Rs 3,000 per sq ft. The low acquisition cost of land at historical prices cushions the company against rising raw material and construction costs, which have been increasing at approximately 20 per cent y-o-y. ValuationSobha's stock has remained a consistent underperformer compared with the broader markets, as well as other real estate peers. In August this year, Morgan Stanley had valued the company's net asset value (NAV) at Rs 1,100 a share and set a price target of Rs 1,172. In September, Credit Suisse had assigned a NAV of Rs 1,080 a share to Sobha. Now at Rs 923, the stock still trades at about 15 per cent discount to its then target NAV. Notably, Sobha has since then added about 500 acre to its land reserves. MARGIN PLAYRs crore FY07 FY08E FY09ERevenues 1186.4 1600.0 2500.0Operating profit 257.1 400.0 625.0OPM (%) 21.7 25.0 25.0Net profit 161.5 224.0 350.0NPM (%) 13.6 14.0 14.0 As the business mix changes with a bias toward real estate development, the profitability too, is likely to increase significantly. Keeping in view Sobha's execution capabilities, it is likely that the company will keep up to its promise of launching 1 million sq ft every month. Again, it is looking to acquire land in regions other than the south, which include Mumbai, Pune and Northern Capital Region (NCR). To sum it up all, there appears ample headroom for the stock and the time is right for Sobha to tread upward.

On promised land

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