REAL ESTATE hemmed in by debt: Edelweiss reports

Q2FY12, in line with our expectation, was a weak quarter for the realty sector. A 3.1% YoY revenue growth and a 22.7% YoY dip in profit clearly reflect continued pressures of rising input and interest costs in the sector.
We continue to maintain ‘Underweight’ stance in light of no signs of high interest rates, margin pressures and burgeoning debt levels abating in H2FY12, even though asset sales may lighten the debt burden marginally. We continue to prefer companies with strong balance sheets and exposure to high visibility rental assets. Oberoi Realty and Phoenix
Mills are our top picks.
Volumes steady rising input costs/interest rates hurt profitability
Although the sector posted steady operational performance YoY with revenue rising 3.1%, the 22.7% dip in profit across our universe of 14 companies clearly reflects the continued effect of rising input costs and high interest rates. While sales volume at the pan?India level was steady, Mumbai property market continued to post lacklustre sales.
In terms of positive surprises, Bengaluru?based players such as Prestige Estates and Sobha Developers reported strong sales volumes while the biggest disappointment on the margin front was DLF—295bps YoY dip in PAT margin in spite of over 700bps YoY surge in EBITDA margin.
Debt still at elevated level, asset sales may ease pain marginally
With a combined net debt of 11 companies at INR403bn as of Q2FY12 (ex?Oberoi Realty/Jaypee Infratech), which represents a 19% YoY and 5% QoQ rise in net debt, developers continue to struggle to remain operating cash flow positive post interest payments. Although asset sales may marginally prop cash inflows, do not expect any material debt reduction in H2FY12 across our coverage universe. A key monitorable for DLF in H2FY12 will be the closure of the Aman Resorts deal (INR20bn sale value), as receipts from asset sales of I in H2FY12 may only serve to bring back net debt
to Q1FY12 level (INR215bn).
Outlook: Cautious; stick with low gearing/rental yield names
Focus over the coming six months is likely to be on macro issues with all eyes on a possible peaking out of interest rates and easing of the regulatory overhang. Till then, can expect developers to continue to depend on high?cost funding and play the waiting game when it comes to reducing prices across projects, especially in Mumbai city/suburbs. As a result, we expect cash flow/funding concerns to contribute to the sector’s underperformance in the near term and maintain our ‘Underweight’ stance.