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Steady operational performance; healthy debt reduction

Highest ever pre-sales with steady volumes and improving realizations

* Sobha reported a sales volume of 1.34msf, flat both on a YoY/QoQ basis. However, on the back of 14%/3% YoY/QoQ increase in realization, the company reported its highest ever sales booking of INR11.6b, breaching its previous high of INR11.4b in 1QFY23.

* The company launched three projects during the quarter with saleable area of 0.9msf, including its first project launch in Trivandrum, Kerala.

* Sales volume in Bengaluru sustained at over 1.0msf and contributed 78% to overall sales, while other notable contribution came from Kerala at 8%. Rest of the cities contributed 2-5% of the total sales.

* Revenue declined 17% YoY to INR6.7b and was in-line with estimates as the company delivered 0.8msf of projects. EBITDA declined 48% YoY to INR0.9b and generated a margin of 14% (down 900bp YoY). PAT was down 70% YoY to INR192m, adversely impacted by higher tax rate.

Strong cash flow performance leads to healthy debt reduction

* Total cash inflow increased 46% YoY to INR13.3b, led by the highest ever collections from the residential segment at INR10.8b, up 49%/22% YoY/QoQ.

* Post interest, OCF tripled YoY to INR2.6b, leading to surplus cash flows of INR2.2b. As a result, net debt declined to INR19b or 0.8x of equity.

* From here on, the company expects debt reduction to be gradual with increased land spends both on existing parcels as well as new project additions.

Highlights from the management commentary

* Demand Outlook: The company continues to see good demand despite rising mortgage rates. If new launches go as per plan, the company can achieve 3-3.5msf in 2HFY23 (v/s 2.7msf in 1HFY23). In the near term, SOBHA can achieve sales volume of 7-8msf and can increase up to 10msf over the medium term.

* New Launches: Depending on approvals, it can launch ~4msf in 2HFY23. Overall, the inventory including upcoming projects continues to be strong at 23msf, providing visibility for the next few years.

* The company intends to launch a township project at Hoskote in a few years. The Hosur project is at a fairly advanced stage and is expected to be launched in FY24.

* Operating Margin especially in the contractual business in H1 was adversely impacted by cost escalation and contract termination during Covid in ongoing projects.

* The segment continues to witness headwinds, and hence, delaying profitability improvement but residential profitability should bounce back to 25% moving forward.

Valuation and view

* Sobha delivered a steady operational performance and expects to grow its sales volumes by 20-30% in FY23 with gradual growth from there on. We maintain our FY23-24E pre-sales. Our PAT estimates for FY23/24 increased 31%/29%, reflecting the impact of re-statement.

* We expect re-rating triggers from the launch of large land parcels such as Hosur, Hoskote, and Chennai. While the first phase of launch in Hosur is still a few quarters away and Hoskote at least two to three years, the current valuation implies 45% discount to book value of its land beyond the near-term pipeline, which is unjustified.

* We assign a 20% (unchanged) discount to derived land value and value it at INR42b (v/s INR23b implied). We reiterate our Buy rating on the stock with a TP of INR855 (v/s INR850 earlier), indicating an upside potential of 31%.

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