Stock Review: GODREJ PROPERTIES

Shares in Godrej Properties Ltd (GPL) have returned 11 per cent since the start of the year, compared to a 39 per cent drop in the Bombay Stock Exchange Realty index. The index is down due to macro headwinds like falling demand, high interest rates, 2G scam fallout and fears that recent land acquisition and regulatory action by the Competition Commission of India could impact the entire sector. GPL is among the few realty stocks that have outperformed, thanks to its business model and better revenue visibility.

Against the traditional model of buying land, analysts say, GPL's joint development approach seems to be a better model, given that land is the largest cost component. Suman Memani of Pinc Securities says the joint development model helps bring down the cost of land and this translates into less debt and in a high interest rate environment, lower interest outgo. In addition to this model, what has helped the stock deliver better returns is the perception that the company scores high on the corporate governance parameter, he says. While the company has a robust business model and recently took on value accretive projects such as the Jet Airways deal, most of the upsides are factored in the current price of `722.

VALUE ACCRETIVE DEALS

The company signed two major deals last month. The first was to develop a million square feet of commercial space at Bandra Kurla Complex (BKC) in Mumbai, while the second was to develop two million square feet of residential space at Gurgaon.

The management has indicated the BKC deal could bring in revenues of `3,500-4,000 crore, based on realisations that are expected to be upwards of `30,000 per sq ft. The Gurgaon project is expected to yield `700-800 crore and add 18 per share to the net asset value. The BKC project, on the other hand, is expected to generate earnings of `45 per share, believe J P Morgan analysts Gunjan Prithyani and Saurabh Kumar. While the BKC deal is value accretive, the `360-crore debt obligation and `135-crore upfront payment will mean an increase in debt of nearly `500 crore. This will take the total debt to `1,440 crore and net debt-equity ratio to 1.4 times, one of the highest among listed entities, feel Prithyani and Kumar. Further, with GPL footing the development cost (estimated at `810 crore over the next four years by IDFC Securities), cash flows are likely to be strained. However, the GPL management has indicated it will bring in a private equity (PE) player to mitigate the cash flow pressures due to the project.

MARGINS HIT

While the company recorded robust revenue growth, margins fell to 18 per cent in the June quarter, compared to 45 per cent in the year-ago period. It attributed the lower Ebitda margins to higher sales at its commercial project in Kolkata (Godrej Waterside). It garnered `32 crore from the project, with an average price of 5,100 per sq ft. Given the construction cost of `3,000 per sq ft and 58 per cent area shared with land owners, GPL just managed to break even, pushing the margins down. In addition to this, there were no PE deals in the quarter, which typically are at higher margins. This further dented profitability. However, Pirojsha Godrej, executive director at GPL, believes margins are likely to move to the historical average of 30-40 per cent. Net profit, at `10 crore, was much below estimates due to a sharp fall in other income and higher tax rates.

2011-12: STRONG SALES, PROFIT PRESSURE

While the macro environment continues to be tough for the sector, the GPL management expects strong growth in 201112 on the back of new launches and joint development deals. The company, which sold 0.56 million sq ft in the June quarter, is likely to end the year at 4-5 million sq ft, feel analysts at Pinc Research.

While the company has a scalable business model (four new joint development deals over the last two quarters), Nitin Agarwal of IDFC Securities believes with significant portion of area/revenues shared with land owners and most projects in the mid-income segment, value creation from the new JDAs is likely to be relatively muted.

However, Sandipan Pal of Motilal Oswal Securities says traction in existing deals with group companies is a key longterm positive for GPL. "The remaining deals at Bangalore (100 acres) and Mohali (75 acres), along with huge potential in Vikhroli (500-600 acres), offer further value unlocking potential," he says. Against this backdrop, investors with a twothree year horizon may consider the stock on dips.