|Hitting pay dirt: Sanjay
Chandra (R) with his father Ramesh Chandra
April 7 this year, within minutes of the stock market opening,
Unitech shares hit the 5 per cent circuit breaker on the upper
side. The stock price jumped to Rs 3,064.90 before trade in the
scrip was halted for the rest of the day from its previous close
of Rs 2,918.95. (A price circuit break is a safety mechanism that
limits the price movement either way in a single trading session.)
Nothing unusual there. It was news in the air acting on a relatively
illiquid stock. The volumes traded were a relatively modest 23,246
shares on NSE, largely because of the limited free float in the
stock (promoters, the Chandras, owned 60 per cent of the company
at that time, with private corporate bodies holding another 24
per cent and the public 11 per cent).
In the days that followed, the story was
repeated. Meanwhile on May 12, the company approved a bonus issue
and a stock split. The frenzy, however, continued. On May 16,
the stock fell 5 per cent, yet again within minutes of the market
opening, locking out investors from trade.
Even after the stock split became effective
June 23, Unitech continued to hit the circuit breaker every day,
easing somewhat only in August when the price had risen to Rs
13,100 (adjusted for bonus and stock split). However, during this
spectacular rise, the volume of trade sometimes was as low as
690 shares. The situation today could not be more different. Average
volumes are up to 10-20 lakh shares per day.
Naturally, then, the Delhi-based real estate
company Unitech has managed an astonishing 2,000 per cent-plus
increase in its average market value to Rs 14,786 crore in the
first half of this financial year compared with the same period
If anything announces the arrival of the
real estate sector at the gate, this does. Not just Unitech, which
is the biggest gainer in terms of percentage among this year's
BT 500 companies, but other stocks such as Ansal Property and
Infrastructure and Mahindra Gesco have also been on an upswing.
Paradoxically, despite the increase in Unitech and other real
estate (re) stocks, their combined contribution to the total market
cap of Indian equities is just around 1 per cent-way below the
25-30 per cent in economies such as Singapore and Hong Kong.
|What has helped Unitech is a
20-year-history of remaining listed with a clear, defined
Ugly Duckling to Stock Market Darling
In India, real estate companies have traditionally
either not listed on the bourses or if they have, then found the
discipline required for quarterly reporting of earnings a bit
too much. Remember, the other National Capital Region or NCR-based
real estate giant DLF delisted from the Bombay Stock Exchange
in 1982 and from the Delhi Stock Exchange in 2003. And even the
few that remained listed, such as Unitech (it has been listed
for 20 years now), attracted poor investor interest. In other
words, few scrips, low free floats coupled with the overall opaqueness
of the sector and restrictive policies made real estate stocks
backbenchers in market performance. Indeed, the Unitech stock
was languishing between Rs 100 and Rs 300 for most of 2004.
Easing of policy and regulatory bottlenecks
changed the scenario. Allowing foreign direct investment (FDI)
in real estate projects was the most crucial driver of a re-rating
of the entire sector. In February 2005, the government decided
to allow FDI up to 100 per cent under the automatic route in townships,
housing, built-up infrastructure and construction projects.
Sanjay Chandra, Unitech's 34-year-old Managing
Director, sums up the change: "Till a year ago, real estate
was a totally ignored sector. We never used to get any investor
meeting requests. Now, we have a full-fledged investor relations
department since there are at least 30-40 requests per month,
mostly from foreign institutional investors." Another issue
that provided fillip to the sector was the high-decibel marketing
of the abortive IPO of Unitech's competitor and peer in NCR, DLF.
"Whenever there is a large public issue in a sector, there
is a rub-off on other sector stocks as well," says S. Ramesh,
coo, Kotak Investment Bank, who was involved with the now-postponed
DLF initial public offer.
market value has soared, too, but not as much as Unitech's.
One reason, say analysts, is a lack of sufficient information
Sushil Ansal, Chairman, Ansal Properties & Infrastructure
However, a more fundamental reason driving
up these stocks was the inherent growth story. "Indian real
estate sector is likely to continue to grow over the next four-five
years backed by strong economic growth," says Ramesh Sanka,
Group CFO, DLF. According to the industry thumbrule, real estate
grows two to three times the GDP growth of a country. With India
growing at 8 per cent per annum, a 20-25 per cent growth in real
estate is not unexpected. Low supplies of developed real estate
coupled with rising demand, increasing salaries and aspirations
make real estate sector a good investment opportunity.
The sector advantages apart, a few company-specific
details have made Unitech shine. A 20-year-history of remaining
listed with a clear, defined corporate structure helped. The company
has some 100-odd subsidiaries for land acquisition, but the promoters
do not have companies for land acquisition that they privately
own. Not the case with most of its fellow competitors. "We
are the only real estate company that does 100 per cent of the
business in the company itself. As a family, we do not own any
real estate asset other than the house in which we live,"
The Valuation Enigma
However, the pace of sectoral re-rating has
left many investors breathless-wondering about the realism and
the sustainability of the valuations. For instance, Unitech's
average market capitalisation in the first half of the current
financial rose to over Rs 14,786 crore, up from Rs 645 crore last
year. How realistic are these valuations? It is tough to take
a call given the complex models and valuation metrics of real
estate companies, believe most market participants. "Location
is key to valuations as it decides pricing. The rest, like construction
costs, are international commodities," says DLF's Sanka.
So, valuations can vary significantly for different companies
depending on the areas of operation. Sanka, however, adds that
institutions are fast learning the intricacies of valuing the
real estate business.
Normally for real estate companies, step-ups
in valuation are available at each stage of development-land aggregation,
regulatory approvals and then the construction of the property.
The valuations are mostly linked to the sale prices of the completed
projects and how they can be valued in the current context. Final
sale prices are often dependent on multiple macro-economic factors
such as interest costs.
With nearly 70 per cent of the margins coming
at the consolidation stage, different companies adopt different
methods for acquisition-directly from farmers, from aggregators,
government land auctions or a public-private model. Unitech, for
instance, stays away from government auctions since it considers
Kotak Mahindra Bank's Ramesh says that investors
are more comfortable using net asset value (NAV) as a valuation
benchmark rather than price-to-earnings (PE) ratio. And NAVs are
more sensitive to the final sale prices of the real estate developments.
A recent report by foreign brokerage CLSA pegs Unitech's valuation
at $7.5 billion (or Rs 34,500 crore) based on the value of its
land bank, without including the sez projects. This works out
to a per share value of Rs 429. Typically, companies in similar
economies trade at a 20-25 per cent discount to the net present
value or NPV (see How Analysts Value Unitech).
Similarly, another sum-of-parts valuation
by UBS Investment Research pegs the figure at Rs 444 based on
the discounted cash flow method. This works out to a PE multiple
of 19.3 based on the projected 2007-08 earnings. Unitech's Chandra
himself believes that the Indian market is not yet ready to value
real estate companies properly. No surprise, then, that Unitech
is not too keen on raising fresh capital from the domestic market.
(If guidelines are relaxed at some point, it may go in for a listing
on London's aim, which is a stock market for small global companies.)
issues raised by its minority owners, DLF's IPO would have
created one of India's most valuable real estate companies
Vice Chairman, DLF Group
Betting on Growth
Easier policies, increased institutionalisation
and robust demand have led to increased scales of the projects.
That suits Unitech, which has diversified at multiple levels.
Unitech's main foray into SEZs is via a three-way joint venture
with Salim Group and Universal Success to develop 38,000 acres
in West Bengal. Another significant project of 20,000 acres is
in Haryana on the outskirts of Delhi. The company, however, is
resolute in its focus on residential housing. Rising demand, easier
upfront financing, quick absorption and fewer speculative positions
make it sound base for the company. "For every 100 sq. ft
of office space you create, you need around 500-600 sq. ft of
living space," says Chandra, explaining why housing will
remain the company's mainstay. With SEZs, residential housing
will constitute around 60 per cent of the total usage, down from
the current 70 per cent-plus. However, in line with its focus
on large and integrated projects, the company has now entered
into the hospitality business, where it will build and own the
hotel but outsource the branding and management. In terms of geography,
the company is keen on suburbs of metros where most job creation
is happening. Forays in tier-II towns are restricted to places
where the company can do all kinds of projects and get to be the
leader as well (see The Unitech Land Bank). Unitech believes in
the "build and sell" model, where it develops and then
sells property to again replenish its land bank. As a result,
nearly a third of its land bank is only two or three years old,
with the remainder being a year old.
According to UBS Securities, the total cost
of land is around Rs 5,000 crore, of which Rs 4,000 crore has
yet to be paid. Chandra shrugs off concerns about the higher cost
of the acquisition in recent times, saying that as parts of a
large tract of land are developed, the balance continues to grow
in value. "In Gurgaon, we may have acquired land at Rs 1
lakh an acre, but today we may sell a parking spot for Rs 2.5
lakh," he explains. On the Bengal expressway project, Unitech
is working on a "land instead of toll" basis to drive
down its acquisition costs.
Apart from housing, where the build and sell
model works fine, Unitech is securitising the rental incomes from
lease-based properties. "As the reit- (real estate investment
trust-)like structures evolve in India, it would be possible to
list them on the stock exchanges," Chandra adds. This model
obviates the need for big capital requirements by Unitech. Though
the sector is flush with equity funds (over $4 billion, or Rs
18,400 crore, at last count from private equity funds), Unitech
would prefer debt for sometime to come. "Interest costs have
gone up, but debt is still cheaper," says Chandra, adding
that the company is still under-leveraged (it has about Rs 1,700
crore of debt on its books). Strategic investors are a simple
no-no. "We've been there, done that. There is little value
add other than capital, which is an international commodity."
As construction costs go up for the industry
in general, "execution will be a key risk going forward",
says DLF's Sanka. Chandra agrees, adding that, "With all
the construction that is happening, we need to build our internal
infrastructure and we would need external support, good quality
staff and contractors." And the price to pay may be heavy.
According to the CLSA report, every six months of average delay
will affect the net present value by Rs 35. One strategy Unitech
has adopted to beat timeline and quality worries is to outsource
project construction to firms such as Shapoorji Pallonji, Simplex,
Nagarjuna Constructions and Unibuild. It only intends to focus
on project marketing and development functions.
Tapering real estate prices is yet another
risk. Here again UBS estimates a reduction of 5 per cent can dent
valuations also by 5 per cent. Chandra, however, believes that
the largely housing portfolio hedges this risk well. Yet, it is
early days in the Indian real estate sector. Clarity on many of
these would emerge once "some 10-12 more deals are done,
and a few more quarters of guidance and earnings would help settle
valuation issues", Kotak's Ramesh says. For the time being
though, the Chandras aren't losing sleep over it.