Realty stocks: Select carefully

In 2012, the Sensex returned 25.7 per cent whereas the realty index gave 53 per cent returns. While this is also because the realty index had dipped 52 per cent in 2011, experts say the real estate sector is set to improve.

According to them, the sector will give decent returns on the back of expected policy actions, new launches and stronger earnings. India's huge domestic savings and limited alternative investment opportunities also add confidence to the sector, they point out.

So, is it a good time to enter this sector? Sonam Udasi, head of research at IDBI Capital, says valuations of real-estate stocks were cheap about five months earlier.

"However, if an investor still wants to enter the sector now, he should selectively look at the company's leveraging and cash-flow position along with its corporate governance status."

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Someone who is looking at putting money into real estate purely from an investment point of view should consider realty stocks.

Reason: investing in realty stocks doesn't involve issues such as illiquidity, difficulty in getting title properties cleared and other legal issues that one faces while investing in properties.

Hence, investing in stocks is better than a direct exposure to real estate. However, you should have certain things in mind.

Cash-flow position of the company, the amount of debt it carries in its book, the company' land bank, how well it is managed, and its record in terms of project launches are a few things to look at before taking the plunge.

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Cash-flow:

India Ratings has revised its outlook on the real estate sector in 2012-13 to stable from negative last year.

The rating agency says the deterioration in operating profits has stopped and there is better free cash flow thanks to persistent demand.

Developers have been able to maintain good cash-flow positions because despite low volumes, they have maintained high level housing prices.

Any increase in the price of a property will gradually push up the company's stock price as the company shows its ability to generate better cash flows in the coming years.

When a company has good cash flows, this means it is in a position to capture the lucrative opportunities around it, such as acquiring land, upgrading technology, launching better projects, etc.

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Debt:

There is a mix of debt-free, debt-ridden and well-managed companies in the sector. The more the debt in a company's books, the higher the chances of risk. Banks might also be wary of funding projects of such companies.

"For instance, even if Oberoi is a debt-free company, one cannot blindly enter it at these levels. This is because the stock price has already risen by 39 per cent, closing at Rs 290 on December 2012," says Udasi of IDBI Capital.

While Oberoi is debt-free, it has disappointed investors by sitting on huge cash and also showing some signs of delay in its projects in the past 18 months, say experts.

Most real estate companies are working on reducing debt by selling their non-core assets and land, thereby improving their balance sheets. DLF carries heavy debt of Rs 25,065 crore (Rs 250.65 billion)` for FY12, which increased by 4.48 per cent from FY11.

However, Nitin Idnani, senior vice-president at Axis Capital, says DLF could be a good stock to look at as the company is targeting debt reduction to reach Rs 18,000 crore (Rs 180 billion) by March 2013 with sale of the Aman Resorts and its wind power business. Despite the de-leveraging that DLF is undergoing, it still continues to remain a debt-heavy company amongst its competitors.

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Land bank:

DLF, Anant Raj and Prestige have land worth Rs 2,589 crore (Rs 25.89 billion), Rs 1,411 crore (Rs 14.11 billion) and Rs 453 crore (Rs 4.53 billion), respectively.

However, one shouldn't make the mistake of looking at this factor alone while buying a stock.

However, Sandip Sabharwal, CEO (portfolio management services) at Prabhudas Lilladher, cautions investors to look at other factors as well.

"If the company has acquired a land just four or five years back, then chances are it may have not appreciated enough. Hence, this alone cannot be a trigger to buy the stock."

However, if the Land Acquisition Bill to increase land prices is cleared in the Budget session of Parliament, it will impact developers which are undertaking large projects.

This factor will indicate how much land is under the company's purview, as this land will, in turn, be used to build projects or some could even sell it to repay interest and reduce debt accordingly.

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Track record:

Oberoi, DLF, Prestige and Sobha Developers have a slew of launches in the pipeline in cities such as Mumbai, Gurgaon and Bangalore.

According to real estate analysts, one should not get carried away by the projects and launches of the company.

One should do a reality check by seeing if the company's launches in the past were on time and sold seamlessly. This is because delay in the projects will mean pressure on their cash flow positions.

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Corporate governance:

While real estate is not regulated, corporate governance of a real estate company might be a good indicator. Corporate governance goes much beyond the balance sheet and the associated numbers.

This may be an important indicator because it shows how well the company is managed. It includes its timely reporting, coupled with how transparent the company is.

According to experts, Oberoi and Godrej are good with their corporate social responsibilities, which also come under corporate governance activities.

Some experts are positive on JP Infrastructure and Phoenix Mills. JP has finished building the Yamuna Expressway. Also, it is the largest land holder in the National Capital Region (NCR). Whereas, foreign direct investment (FDI) in retail will help increase annuity income for Phoenix Mills.

Banking experts expect a dip in interest rates by a good 100 basis points in the Reserve Bank of India's mid-quarter monetary policy review on March 19. If it happens, it will work for the benefit of leveraged developers such as DLF.

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Regulatory landscape:

The Real Estate (Regulation and Development) Bill is still in a draft stage. If that gets passed, every state will have a real estate regulatory authority and, with that, more transparency in real estate transactions.

Possible amendments in the special economic zone (SEZ) policy will revive export growth, impacted by introduction of minimum alternate tax and divided distribution tax on SEZs in 2010-11.

"This will be a positive (move) for Unitech, DLF and Parsvnath because they have developments in SEZ areas. Private equity investments in real estate projects increased by 30 per cent in 2012 to $1.1 billion," adds Idnani of Axis Capital.

All this put together will work for this sector and its growth, hopefully.