Real Estate Sector update: Strong performance despite seasonality - Motilal Oswal Financial Services
Strong performance despite seasonality
Management commentaries indicate limited concerns on rising interest rates
In this report, we highlight the key insights from the recently concluded 2QFY23 earnings season, the management commentaries of major developers, and the near-term demand outlook.
* Despite seasonality, the top 12 listed companies witnessed an 8% QoQ and a 29% YoY growth in pre-sales. It is worth noting that in volume terms, these companies cumulatively reported just 3% YoY growth. While the sales mix has played its part (especially for OBER), it is evident that the industry has taken sufficient price hikes to offset the cost inflation.
* Except for SOBHA and MLIFE, where launches were relatively moderate (from 1QFY23 levels), all companies witnessed healthy launches in 2Q, with the top 12 listed companies cumulatively launching 14msf of projects.
* On the back of a strong launch pipeline of over 50msf in 2H (27msf in 1H) and a limited impact on demand, despite a 170bp increase in mortgage rates, we retain our presales estimates for our Coverage Universe and expect to deliver a healthy 26% YoY growth in bookings in FY23.
Companies halfway through their FY23 guidance, but cautious on revising it
* In 1HFY23, the top 12 listed companies clocked pre-sales of INR315b, up 85% YoY, but down only 6% from 2HFY23 levels, despite a 170bp rise in mortgage rates. With this, most companies are halfway through their FY23 pre-sales guidance.
* Companies in our Coverage Universe launched 27msf of projects in 1H, which is expected to rise to 55msf in 2HFY23. Historically, 2H has been stronger than 1H as it contributes 55-60% of full-year pre-sales.
* While companies are internally confident of delivering more than what they have guided for on account of the strong launch pipeline and a seasonally favorable second half, managements remain cautious on revising their guidance, citing the risk of a further increase in interest rates.
Mortgage rate hike poses a key near-term risk, but companies are not concerned until there is another 75-100bp hike
* Mortgage rates have risen by 170bp in the last six months, leading to a 15% rise in EMIs or a 10-year increase in the tenure of an INR10m home loan.
* Our analysis of the past two rate hike cycles (refer Exhibit 1) indicates that demand was impacted only after the initial 150-175bp hike.
* We had also argued that the past two rate hike cycles were accompanied by steep price hikes (refer Exhibit 2 and 3), which isn’t the case this time, and hence the impact on affordability is limited to the increase in EMIs.
* While companies remained cautious about raising their FY23 pre-sales estimates, managements indicated that demand may remain strong till rates rise by another 75-100bp or until mortgage rates cross double-digits.
* Our sensitivity analysis (refer Exhibit 5) indicates that for an every 25bp rise in mortgage rates from here on, EMIs will increase by 2%.
Impact on EMIs: Companies considerate while raising prices
* Property prices across cities have increased by 5-8% on an average, which, along with the impact of interest rate hikes, have reduced affordability by ~20%.
* With the price hikes, companies have managed to fully pass on the increase in costs. While companies remain positive on the pricing trajectory ahead, they are also considerate of the impact on EMIs due to interest rate hikes on affordability.
* LODHA intends to ensure that the cumulative impact of mortgage rate hikes and pricing growth remains below wage growth, so as to maintain affordability.
* SOBHA indicated that the price hikes may be more calibrated and of a lower magnitude from here on. We believe that price hikes, especially in the Affordable/Mid-Income segment, may not be over 3%/4% from here on.
Despite near term risks, companies stay focused on business development
* Brushing aside near-term risks, companies continue to focus on larger themes in the sector, with a massive consolidation opportunity ahead. Companies have laid an incremental focus on business development (BD), with a clear visibility on the pipeline. To meet its near-term capital requirements, companies like PEPL and PURVA has also tied up for AIFs to acquire new projects.
* LODHA added four new projects in 2QFY23, with a GDV of INR31b. It has achieved over 60% of its FY23 BD guidance, and remains on track to sign new projects, with a GDV of INR150b in FY23.
* GPL too has made significant progress on the BD front as it added seven new projects with a GDV of ~INR90b so far in FY23. It aims to add new projects with a cumulative GDV of INR150b by FY23-end. The management’s focus of late has been on increasing its economic interest in new projects. Consequently, the bulk of its recent project additions is outright purchases.
* PEPL has tied-up multiple funding sources (via the HDFC platform and AIF) and is aggressively pursuing new project acquisitions to sustain the enhanced run-rate in bookings.
* After paring down its debt over the last five-to-six quarters, SOBHA plans to increase its spending on BD, both on existing land parcels as well as new project additions. It plans to spend INR3b on new project additions annually.
Valuation and view
* While a rising interest rate scenario is likely to have a sentimental impact on the sector in the near term, in a scenario with: 1) high construction costs and cost of capital, and 2) constrained industry growth, larger developers will further consolidate their market share.
* We continue to prefer players with an ability to generate robust cash flow over next three-to-four years and invest in developing their pipeline, which will provide further growth visibility and lead to a re-rating.
* We have a Buy rating on LODHA, OBER, PEPL, BRGD, SOBHA, and MLIFE, and are Neutral on DLFU and GPL. LODHA, PEPL, and BRGD are our preferred picks.
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