Sobha Developers - Steep discount?

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Hi @WarrenJhunjhunwalaLy

Interesting handle.

In my opinion -when valuing developers from a quantitative point of view one must keep a few things in mind.

  1. Are the operating margins more than the cost of land in relation to revenue ? e.g if operating margins are 20% and land forms 40% of the average realization per sqft then its not a happy situation for developers

  2. What is the sellout ratio? From the total units launched what is the % sold? This indicates demand for the project , a sellout ratio that is less than 65 to 70% is bad news & indicates pricing pressure. These sellout ratios must be achieved within the 1.5 yrs of launching else you can expect all kinds of construction delays.

  3. What is the average realization per sqft? is it increasing or decreasing? A good brand has a realization that increases by at least 10% every year.

  4. What is the slab cycle and what is the sales cycle in days. Ideally you should be selling faster than you construct - if these things are not present its a problem.

  5. What is the cost of capital? In my experience the average cost of capital in real estate is 15% to 18% for an average developer. Good developers have a cost below 12 to 14% and great ones are below 11-12. Quite clearly cost of capital has to be more than the return at a project specific level. That is why many developers are transitioning to the JV model to reduce cost of capital employed. Unsold inventory (including land lying idle) increases the cost of capital and is detrimental to valuation. Units being built without being sold increase inventory and do more harm than good.

  6. Accounting standards followed.

  7. The encumbrance of the land shown on balance sheets. Developers book land on their balance sheets but no one knows whether its unencumbered or not. The cost of liasoning is an important parameter here which indicates what developers are spending to get land marketable.

These are a few factors that make it very difficult to evaluate developers only from the financial numbers and financial numbers are almost always unreliable when it comes to real estate.

I appreciate your efforts in starting this post but there are vital things missing

  1. Risk factors involved in your thesis

  2. Disclosures of your holdings

  3. Quality of promoters - vital in real estate. Sobha is the name of Mr Menons spouse incidentally.

best
bheeshma

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