Realty Check: The Indian Real Estate Story
  
 

Insights

Dun & Bradstreet has attempted to understand the current trends of the Indian real estate industry through a financial analysis of a sample of listed companies. This section provides a brief overview of the current and past performances of these listed real estate companies.

The sample selected for this analysis comprised those listed real estate companies that had a sales turnover of more than Rs 750 mn. A fair representative list of 34 real estate companies whose financial information was available for the last four years was arrived at and selected for the purpose of the analysis.

The 34 real estate companies were further categorised into large, medium, and small-sized companies based on their total income by using the 80:15: 5 principal. In line with this principal, the large, medium, and small-sized comprise 9, 11, and 14 companies, respectively. These nine large-sized companies together accounted for close to 80% of the total income, whereas the 11 medium-sized companies accounted for the remaining 15% share in total income, and 14 small-sized companies accounted for the bottom 5% share in total income.

This classification was primarily done to study the dynamics and operating efficiencies of the small, medium and large players within the real estate industry. Although small companies contributed just 5% to the total income their representation was 41.2% (14 small companies) among the 34 companies being evaluated.

Section - I

The End of Good Times

The numbers for the quarter ended Dec 2008 bear testimony to the fact that the boom in the property market has come to an end. Real estate companies have reported dismal sales numbers for the quarter-ended Dec 2008, as volumes have dried up and net sales of large, medium and small companies have declined by 63.6%, 43.9%, and 20.4%, respectively as compared to the same quarter last year. Almost all realty companies, irrespective of their revenue size, failed to maintain their net profit margins1 during the quarter. The large companies have been adversely affected as these companies reported a loss from operations, although a miniscule one. However, after adjusting for other income of Rs 5,457.4 mn, the large real estate companies have a reported profit of Rs 4,201.4 mn. During the quarter ended Dec 2008 the net profit from operations for medium and small companies fell by 81.4% and 63.3% respectively as compared to the same quarter last year.

As the revenues have fallen, developers are finding it difficult to adjust costs. With significantly lower demand and price pressures, the developers have slashed rates for new projects. Furthermore, it is the excessive leverage that has begun to hurt them as cash flows are blocked in inventories and developers are facing an increase in interest outgo amid falling sales. The other expense developers are struggling to adjust is the salaries or the compensation to employees which were around 5-6% of net sales during FY08, and now account for over 11-12% of net sales after the sharp decline in sales. However the slowdown in the rate of development along with fall in prices of steel and cement has led to a reduction in the construction related costs of the developers. Additionally, the rise in interest costs by 75-80% amid higher working capital requirements has magnified the decline in bottom line.

Developers left with huge accumulated stock are finding it difficult to find buyers for their properties. With buyers shying away from the market and developers having more inventories in their hands, there is immense pressure on pricing. The huge unsold inventory has forced developers to slash prices to deleverage and repay debt in troubled times like today. The drying out of advances and the inability of developers to sell completed properties or properties nearing completion amid a demand slowdown has forced developers to further raise debt in spite of struggling to meet their present debt obligations. Most developers have restructured or refinanced the debt that was due in the near term. In a bid to survive the cash crunch, capital-starved developers have started selling plots and unfinished projects where they intended to undertake capital-intensive projects.

Developers have begun to feel the stress from their key customer segments as well. Sectors such as IT, financial services, retail, hospitality, etc., - big consumers of real estate - have been hit hard by the slump are postponing their capital expenses. This has further added to the woes of the real estate developers. Lease rental are also under pressure with retailers re-negotiating deals with developers and in a few cases taking the unprecedented steps of shutting down shutters in malls that have refused to lower rentals. In a few residential property projects where customers have booked properties through advances, customers are pressuring developers to commit refunds for projects where the work has come to standstill or where initial customers paid a higher amount as compared to revised pricing for new customers. The sector has now turned into a buyer’s market, with developers left with no option but to quote realistic prices.

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During the boom, developers had stretched themselves and borrowed heavily to benefit from the real estate upturn, which is now turning out to be a burden for a few developers who are likely to not even be able to cover the interest costs.

The inventory levels of large, medium and small developers at 1.35, 1.13 and 1.38 times of net sales are turning to be a burden for developers, as they are paying interest (on their debts) to hold the huge pile-up of unsold inventory. The inventory includes finished stock of completed real estate projects, work in progress (undergoing projects), materials, stores, spares, etc. The odds for cleaning up the inventory fast are slim, unless sales pick up.

Interest Payments: A Burden on the Industry

In troubled times like today where liquidity is tight, credit is hard to come by and sales are limited, developers are staring at a scenario where interest expenses are constantly increasing on account of limited and costly refinancing options. The excessive leverage is worrying factor for them as interest payouts have risen by 75-80% for the large, medium, and small companies. Moreover, with cash flows blocked in inventories, developers have been forced to raise additional debt to meet liquidity requirements.

Liquidity will be the Key

Liquidity is a big concern currently, and cash has become the key to survival during these turbulent times. However, the debt raised by developers has not been at favourable interest rates because of the inherent risks and the fact that the real estate sector is classified as sensitive sector lending. It gets worse for debt-laden real estate companies with large near-term debt maturities, heavy borrowings under revolving credit facilities, substantial unfunded development commitments, significant lease expiries, and comparably weaker coverage measures. These companies are required to serve the high cost debt despite falling sales and operating income. The large-sized companies have an interest coverage ratio of 0.88 times, which implies that the EBIT of these companies can cover only 88% of their interest expense.

Interest Expenses Rise Significantly in Last Four Years

In the previous four fiscals, the interest expense of large and medium-sized companies as a percent of debt increased substantially. In FY08, the interest rate (interest expense as a percent of debt) for medium companies jumped to 12.5% from just 7.4% during FY07. Surprisingly, the interest rates (interest expense as a percent of debt) for small companies have remained constant with a downward bias. However, tough liquidity conditions may see the interest expense as a percent of debt rise further during FY09. As the quarterly interest payments during the quarter-ended Dec 2008 have risen by 75-80%, the debt as well as the rate of interest is estimated to have risen manifold during FY09.

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Uncertainty Looms over Projects Under Execution

As on Mar 2008, Capital work-in-progress defined as projects under execution almost doubled for large-sized companies to Rs 53,233.5 mn as compared to Mar 2007; and was almost equal to one-third of the net sales of FY08. The capital work-in-progress for medium-sized companies grew to Rs 2,007 mn, up by 79% as compared to the previous year and was 94.2% of the FY08 net sales.

The realty sector experienced a mad rush as developers entered into land deals at inflated prices towards the end of the real estate boom in FY07 and FY08. However, since the demand scenario has changed drastically over the last twelve months many developers have planned to either postpone or shelve their projects. In few cases the developers have already shelved their projects and surrendered plots auctioned earlier. Some developers have also sold plots where they intended to undertake capital-intensive projects like hotels.

Section - II

Golden Past: The year gone by

During FY05 to FY08, the real estate market experienced a flurry of activity as the property market was attractive, and property prices skyrocketed despite firmness in interest rates towards the start of FY08. The net sales of the 34 real estate companies grew at a 3-year CAGR of 84% to Rs 233.9 bn during FY08. The growth in net sales was fastest in the large companies at a 3-year CAGR of 89% as compared with their medium and small peers, which grew at a 3-year CAGR of 73.6% and 68.9%, respectively.

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Healthy Profits in FY08

During FY05 to FY08, the net profit from operations of these 34 companies grew at a 3-year CAGR of 215% to Rs 68.04 bn. Profit from operations is calculated from net sales after deducting the expenditure and thus excludes the effect of other income. The net profit margins have increased for all companies, irrespective of their revenue size. As on Mar 08, the net profit margin for large, medium and small companies stood at 29.2%, 30.7% and 23.4% respectively as compared to 5.2%, 8% and 6.8% during FY05.

Developers on a Money Raising Spree

Real estate companies went on a money raising spree over the past few years in order to augment their capital base to fund aggressive expansion plans in various capital-intensive projects. During FY05 to FY08, the capital employed (which primarily comprises equity and debt) increased at a 3-year CAGR of 159%, 101%, and 73% for large, medium, and small companies, respectively. However, it is equity that grew faster at a 3-year CAGR of 186%, 162%, and 80% for large, medium, and small companies, respectively, whereas borrowings grew by 143%, 49%, and 65%, respectively.

In CY07, nine real estate developers accounted for almost one-third of the total capital raised through the primary markets. These nine real estate developers raised Rs 142.47 bn, the highest amount of capital raised by a particular sector during 2007, through public offerings (IPOs).

Large Developers Report Steep Increase in Short Term Debt

The large real estate developers, whose long term debt constitutes 84% of the total debt, saw their long-term debt increase y-o-y by 75% whereas the short term debt catapulted by 214%. The interest outgo however doubled for these large developers during FY08 as compared to FY07. The interest costs as a percent of net sales for large real estate developers have increased from just 3.6% in FY05 to over 10% during FY08.

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Debt-Equity Ratio Falls Despite Huge Debt Build Up

Although both equity and debt levels have grown significantly year on year, a CAGR for the last four years in equity as well as debt shows that the growth in equity has outpaced the growth in debt for these companies, irrespective of their revenue size. This has resulted in the debt-equity ratio dropping considerably despite huge debt pile-up as companies were aggressive in raising equity compared to debt.

During FY08, the debt-equity ratio of large and medium-sized companies declined to 1.11 and 0.38 times for large and medium-sized companies, respectively. In spite of the decline, the debt-equity ratio for large companies is on a higher side. However, the debt-equity ratio for small companies increased to 0.66 times in FY08 as compared to a debt-equity ratio of 0.51 times during FY07.

Development and Construction Costs Key Objectives of Public Issues

To further analyse the objectives of raising equity capital we have collated a sample of 12 companies that were listed during 2006 and 2007 so as to evaluate their purpose of raising capital from their Red Herring Prospectus (RHPs).

The developers that had raised capital through IPOs during 2006 and 2007 intended to use most of the capital for acquisition of land, land development rights, for the purpose of development and construction costs of existing as well as forthcoming projects, investment in subsidiaries, and repayment of debt. The development and construction costs of ongoing as well as planned projects followed by acquisition of land and land development rights were observed as key the objectives of issue for these 12 companies that raised capital through IPOs during the year 2006 and 2007.

Development and construction costs were the key objectives of these issues, with over 57% of the total funds raised intended to be used as development and construction costs for ongoing as well as planned projects; whereas over 36% of the funds raised were intended to be used for acquisition of land and land development rights. Repayment of debt accounted for close to 7% in the total funds raised by these 12 companies. This is because repayment of debt, featured as an objective of issue for just five out of the 12 companies analysed herewith. However, it widely differs on individual basis with a range of over 8% to 50% of the total funds raised intended to be used for repayment of debt.

Small Companies Buck the Trend; Report an Increase in RONW

Return on net worth measures return on shareholders equity. Large and medium companies have experienced a fall in their return on net worth2 since FY07. However, for small companies the return on net worth increased to 25.9% during FY08 as compared to 20.2% in FY07. Although large and medium companies reported record profits during FY08, the growth in equity capital outpaced the growth in net profit at twice the rate. However, for small companies the y-o-y growth in net profit was 118%, as compared to the y-o-y growth in equity of 50.3%, helping it buck the trend.

Small Companies Outperform its Peers in Return on Capital Employed (ROCE)

The return on capital employed (ROCE) is used as a measure for the returns that a company is realising from its capital employed. ROCE is defined as the ratio of profit before interest and taxes (PBIT) to capital employed. Capital employed is calculated as the sum of net worth and borrowings.

The ROCE for smaller firms has been higher as compared to its peers at 21.5% during FY08 which implies that the small firms are using their capital efficiently. Medium sized companies have seen their ROCE drop sharply from 24.5% in FY06 to 19.6% in FY07. During FY08, the ROCE for large and medium sized companies was at 20.2% and 19.8% respectively.

 

1The calculation for net profit from operations and net profit margin does not include other income

2For the calculation of RONW and ROCE, the profitability figures include other income.

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