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Star1965
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Fund manager with top brokerage in Mumbai. Ivy educated for whatever its worth. Need to remain anonymous given institutional constraints.
  • INDIAN REAL ESTATE STOCKS - THE 2011 CONTRARIAN SECTOR 0 comments
    Jan 3, 2011 12:19 AM | about stocks: EPI, INP, PIN, INDY, SCIN, EEM, BKF, BIK, INDZ, BRIS, INDL, IBN, HDB, VWO
    I have received various private queries on real estate. Boarders will recall that I called the bottom on the sector about a month back. I shall summarise the argument for why real estate stocks are the classic contrarian play for 2011. Before I begin, patience, gentlemen, is the key. In particular, don’t bother about today’s and tomorrow’s price movement. Also don’t make the classic retail blunder of selling after making 10 or 15 % when a 100 % upside looks likely. Also please do not buy the smaller counters in the sector. Buy only the blue chips in the sector. Top picks are India Bulls Real Estate, HDIL, Orbit and Unitech. They are the ones that have the both the value argument, and the volume to attract massive FII buying, which is happening as we speak.
     
    Donald Trump one of the world`s leading and most astute real estate developers is investing in Indian real estate for the first time. Mr. Trump will be in Mumbai to announce a new project. “I think India has amazing long-term potential. The country is going to be one of the greatest places in the world to buy real estate,” says the real estate magnate in an exclusive interview in GQ India’s forthcoming issue. PLEASE SEE ATTACHED STORY. http://www.dnaindia.com/mumbai/report_us-business-tycoon-donald-trump-to-visit-mumbai-announce-real-estate-project_1487433
     
    The disconnect between the real estate market and the scripts is growing by the day. Real estate has more than recovered from the 2009 slump. Looking at recruitment ads, we sees that there is shortage of people from civil engineers, to karigars and bricklayers. A housing and construction boom is on. Yet the scripts are trading at 52 week lows. ( BTW, Unitech promoters have hiked their stake yesterday in their company. Insiders buying shares, and raising stakes, is one of the most bullish signs in a sector.)

    The slump in real estate stocks is ironic, because real estate is the biggest beneficiary of 9 % GDP growth. It is also the biggest beneficiary of the Indian demographic story. After all, you are born, then you finish school and college, then you find a job and get married. Then what do you do ? You buy a house for your expanding family.

    Valuations are astonishing. Many of these stocks are trading at 50 to 60 % discounts to their net asset values (NAV). Now the NAV calculation is simple. If I take all the land and flats under construction and sell them, then pay of all the debts on the company’s books, I get the NAV. Consequently, most company shares should sell AT OR CLOSE TO, THEIR NAVs. Instead they are trading at massive discounts. The market is behaving as though some sort of nuclear bomb has gone off on these company’s properties. ( In fact, if there was a market for corporate control in India, it makes sense acquiring these companies, breaking them up, selling their assets and paying off their debts, to realize value).

    Consider the following companies stock prices and their NAVs. IB Real current price of 130 vs NAV of 280. HDIL current price of 185 vs NAV of 370. Orbit current price of 80 vs NAV of 180.  To trade at their NAVs implies a 100 % upside in these stocks from here. Remember the NAV itself is subject to upside revision particularly for IB Real, HDIL and Orbit.
     
    A panic bottom was reached in late November due to the socalled “scam”. This was nothing but a bunch of mid level managers at banks getting paid by middlemen to facilitate loans. These middlemen are called loan syndication agents (LSAs) and the industry if full of them. The mistake this time was that the LSAs  bribed mid level managers to facilitate paperwork, a common Indian practice. As a result, blue chip real estate companies have lost 50 % of their value in weeks !!  This is a disproportionate result. Notice also that not a single real estate company, let alone a blue chip one, has been named in the scam.

    There is also short term earnings momentum due to the base effect. Many of these companies reported lousy earnings last December, so earnings growth just due to the base effect will be considerable.

    Real estate companies with substantial presence around Mumbai will benefit particularly from the final clearance to the Panvel airport project, - and the transharbour link - done a few weeks back by the Environment Ministry. Land prices are already rising substantially in anticipation.  The price on India Bulls Green, a 20 mln sq ft project in Panvel has doubled almost from 2200 psf to 4000 psf, a gain in potential sales of 4000 cr on a mkt cap of 5000 cr. ! Imagine India Bulls current NAV upside from current levels of Rs 280 with this project. Also imagine future upside as Panvel becomes a suburb like Santa Cruz. After all, the IB Real city project is four times the size of Nariman Point. Astonishing !! Please see the attached story from the Business Standard.   http://www.business-standard.com/taketwo/news/kolkata-metros-rideneglect/418602/

    The stock according to Motilal Oswal should do 16 per share earnings, leading to a multiple of 9 vs a market trading at 21 times.  This is comfortable, actually dirt cheap given the upside. In India Bulls Real Estate's case the undervaluation reaches bizaare proportions. The company has a listed power subsidiary and IB Real's stake in the subsidiary is worth 100 per share.  The current price is 135. So I get the entire real estate business with all the upside outlined earlier at 35 per share !!

    Other beneficiaries are HDIL and Orbit.

    The real estate sector interests me currently because it is a genuine contrarian investment. Genuine contrarian investing is tough, dangerous, and for most people, psychologically impossible. That is why it is so hugely profitable, and practiced by all the great masters of investing. It involves buying from the crowd what the crowd hates, and selling to the crowd what the crowd loves. There are two basic requirements and I shall consider them with regard to the RE industry. First, there has to be overwhelming strong consensus, either positive or negative, about a sector. With regards to real estate, there is overwhelming strong negative consensus. There is not a single brokerage or analyst who is positive about the sector, and all are heavily underweight. The entire sector has become a dog.

    Second, that strong consensus has to be supported by “weak” reasons. This is an important, and profound, point that deserves detailed explanation. In contrarian investing, a weak reason is not a weak reason per se. It is a reason that so widely known, that it is already “baked into the price”. Thus in real estate, “interest rates are rising and this will affect demand for housing” . Also, the “scam may make banks more cautions about lending” to the sector. These are all valid reasons. But because the whole world and their grandmothers are talking about it, it is already in the price, which is why the price is so low. Hence in contrarian investing, this is a weak reason.  A weak reason may also have no basis in current reality. One reason cited is that "these companies have very high debt levels" . This is yesterday's story and downright wrong.  I note that India Bulls Real and HDIL have debt equity ratios of less than 0.3, as compared to conservative cyclicals like TISCO or TELCO that have debt equity ratios in excess of 1.0. !!

     
    Two things can then happen. Firstly, the sector becomes vulnerable to positive news surprises that will suddenly cause the price to flare up. This could be an earnings surprise. Or FDI changes in real estate/retail. ( I note that Indian inflation concerns due to a faulty retail sector supply chain are reaching very high levels. The government as per press reports is considering further liberalising FDI in the retail sector to allow major retail chains to invest. These chains will demand large amounts of property in major metros).   Secondly, valuation considerations start to predominate when prices fall so low. Fund managers looking for alpha and seeking to deploy excess cash, realize their stupidity and start buying in. This generates momentum, and trend followers pile in, and we have a full blown rally.
     
    Themes: India, Real Estate Stocks: EPI, INP, PIN, INDY, SCIN, EEM, BKF, BIK, INDZ, BRIS, INDL, IBN, HDB, VWO
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