Real Estate Sector Still In Downtrend

The real sector is in middle of the global economic turmoil and most of the Indian companies in the sector are suffering due to high debt-to-equity ratio and poor cash flows. Though interest rates have softened in last few months, it’s yet to show any positive rub off on the housing demand. Stock investments at this time in real estate companies would get caught in this downtrend.

Affordability continues to be a cause of concern. Even in the fourth quarter earnings we do not expect any cheer for the listed real estate developers. In case property prices drop further and come within the affordability levels; it might help companies to show some improvement in their topline.

On a year-on-year (YoY) basis Dec ’08 quarter was the first time in which the sector reported a huge negative sales growth. A 57% decline in sales cuts a very sorry figure when compared to the 277% YoY growth in the same quarter of last year. This figure was a marginal 2.5% in the previous quarter. Mahindra Lifesciences and Peninsula Land are the only two companies that have reported a positive YoY sales growth. Rest all the other companies, including DLF, Unitech, HDIL and Orbit among others reported 40-80% drop in their quarterly revenues on YoY basis.

Also Read: Stocks Affected Due To Real Estate Downtrend

Industry’s operating margins declined by 500 basis points to 56% in Dec ’08 quarter compared to the corresponding figure year ago. This is attributed to the rising share of affordable housing as developers have shifted their focus from high margin commercial and luxury projects to the former. Net profit margins (NPM) have dropped from 46% to 33% during the period. Rise in interest costs has been the main reason for this decline.

Debt is the only available option for funding projects as raising money from equity markets is not a viable option in these times. This has severely impacted the interest cover for the entire sector. From a good 14.8 times EBIDTA/Interest in the Dec ’07 quarter, it fell to a low of 3.7 times in the Dec ’08 quarter. Companies like Sobha, Unitech and Omaxe among others may find it difficult to service their interest if sales numbers do not improve.

It’s a double whammy for property developers. On one hand existing units are not getting sold and on the other hand interest costs are increasing due to funds already invested in these half complete projects. Rental incomes have also come down. As a result developers are left with little cash in hand to finish residential or commercial projects under construction. Real estate industry has always been a working capital heavy industry, and things have gone from bad to worse in the recent times.

As per the new guidelines in the stimulus package, real estate companies have been able to restructure their debt liability. This helped the companies in reducing the current quarter interest outgo to a considerable extent. In case of Unitech, Rs 10,000 crore on debt was outstanding as per the Dec ’08 quarter results. The amount due for repayment by March ’09 is Rs 2,500 crore. However, the company has been able to restructure Rs 1,000 crore out of this, which means that this amount will be due for repayment after 12-18 months depending on the restructuring terms.

Thus, companies have some breather from quarterly debt repayment. This would free some cash for utilisation toward the completion of projects. This regulatory change has also helped companies to maintain their credit rating at some reasonable levels, as this has an impact on their capability to raise debt. Though the restructuring gives a breather in the short term, it will only prolong the liquidity problem for a number of developers.

Future outlook
As known to all, the potential lies in affordable housing segment. A lot of developers like DLF, Unitech, Parsvnath, Omaxe to name a few, which did not have a presence in this segment have changed their strategy to focus on this segment. Here the margins are low but sales volumes in this segment drive the cash inflows. However, even though interest rate on housing loans is coming down, investor sentiment is still weak. Builders who are willing to sacrifice on high margins and are capable of providing the right product at an affordable price will be able to sail through the tough times.