Sobha Developers - Steep discount?

vivek_mashrani · September 3, 2020, 7:57am

Future perspective is based on lot of data points and strong trends that are emerging.

Shift to permanent work from home >> see this survey here
Acceleration of virtual education formats >> please check these proxy data points: (a) Byju’s growth - read here (b) Forbes research here
Internet connectivity and penetration trends here…some more here
Acceleration of AI and Automation >> some data points here

Again, these trends generally are slow and steady; it’s like boiling frog syndrome. Real impact will be seen when J-curve effect kicks in. See how suddenly small businesses are struggling due to covid which did not have online presence (though online channel migration is happening since long).

I believe beneficiary in long term would be top tier builders in Tier 2 and 3 cities. Also, we have to see this along with affordability, visibility around job stability and infrastructure improvement by government.

And lastly, in India, aspiration was never a problem, everyone wants to live in top class house, have their kids in top school, work in top class company…it’s all about affordability and supply.

harsh.beria93 · September 3, 2020, 8:21am

You have missed out the very long term macrotrend of urbanization, individual families rather than joint families, and the median Indian age of 27. Houses are bought by an individual in their late 30s, so about 500 million individuals (~200 mn families) will buy houses over the next 15 years. Also how does automation and AI impact demand for residential real estate? How does virtual education impact demand for residential real estate? How does better internet connectivity impact demand for residential real estate? We shouldn’t be missing the wheat for the chaff based on a given macro disruption event, and a given narrative.

India is a grossly underpenetrated market in terms of home ownership (just like every other thing because we are still quite poor). It will be more useful if we try to study the impact of macro shocks on real-estate based on actual data points rather than a narrative.

Real-estate is a pure demand supply game, and interest rates have a large impact on creating demand. Currently, home loans are offered at attractive terms (starting at 7% to salaried individuals link). State governments has started offering incentives by reducing stamp duty (link). Demand has kept growing over the last 5 years, whereas supply has shrunk (see RBI report and corresponding post). The residential real-estate prices have gone up (not down) for most major micromarkets barring Delhi NCR (look at the NHB residex chart for FY20 report). There are lots of other factors at play the importance of which shouldn’t be omitted. Anyway, we shouldn’t be discussing general real-estate in this thread because its supposed to be discussion around Sobha, which is a play on Bangalore micromarket.

vivek_mashrani · September 3, 2020, 8:47am

Harsh,

The discussion is on premium high ticket real estate. Your point on macro trend on urbanization is correct and hence I mentioned that question is on affordability of such premium real estate in metros. Food for thought to connect these two - see population growth in Mumbai for last 10 years, increase in slums vs. growth in premium real estate players.

Ultimately, one needs job stability, cash flow visibility to buy real estate. Hence, increase in automation and AI which are inversely proportional to job creation, hence demand for premium real estate gets hampered.

Again better internet connectivity in tier 2 and 3 cities will accelerate migration of permanent WFH from metros to these cities, hence impacting demand of premium real estate in metros.

Also, on interest rates, probably it looks like we are bottom of cycle and maybe another 50 basis point max on downside looks high probability. And reversal of this will only further impair the demand.

The real-estate prices keeps going up not due to demand but due to factors like circle rates, increase in raw material prices and more re-pricing on paper due to RERA. If you do some ground level scuttle-butt and talk to builders you will get this picture.

Hope this was useful for you to connect the dots.

Sidhant · September 3, 2020, 1:37pm

@vivek_mashrani
I don’t think WFH means never going to office. The presence in office atleast for some days a month will be required for most of the jobs. This means that maybe the people can live in places further away from office areas, as daily travel will not be required. The change may be that people may prefer longer commute time from cheaper houses in locations further away from office areas. Will WFH mean that people will start working from any city/town, I don’t think so.

So this may drive demand for residential real estate near to office locations lower, and increase demand in areas further away. Same is the effect of new metro lines/road infra, which allows the people to live further away from their work places. In that case the commute time reduces/ more distance can be covered in same time, whereas due to WFH fewer commutes may be required.

disc: not invested.

basumallick · September 4, 2020, 6:17am

One simple point - India does not have a demand problem. Ever. In anything. Our overflowing population means that we are always in need of more and more stuff - be it houses or food or cars or underwear!! So, people creating an investment thesis on aggregate demand on anything is missing the point.

I have made this mistake in the past. India is a hugely power deficient country. So, power discoms and power producers ought to do well always. Practically, never really happens. Same story in nearly all real asset or infra related businesses.

So, assuming that demand will always be there, let’s look at some of the critical supply factors for real estate:

Cost of land and building materials
FSR in large cities and towns
Credit cost for home builders

Currently, credit is practically drained out of the system from small and mid-sized builders. The biggest source of credit to them where players like Indiabulls, DHFL and other such NBFCs who have now severely cut back and practically stopped lending. So, the next step is a massive consolidation in the industry, which seems to be already underway.

There is huge inventory pileup across all major cities which the builders are sitting on and unable to sell. Those would need to get sold first, probably even at a discount to prevailing market rates.

Supply of real estate in suburbs will likely go up as demand from semi-permanent WFH category starts looking for larger homes at a lower cost point.

In summary, the situation is going to be interesting and I personally feel that the real estate sector, though, may see some near term pain can actually be a very good performer over the next 10 years.

harsh.beria93 · September 4, 2020, 7:45am

About supply side, there is already massive consolidation that has already taken place. One of the very nice research pieces on this was published by Gera (@bheeshma, link, valuePickr post) who showed that consolidation has already taken place in micromarkets like Pune. I am citing this from their 2019 annual report (wordings are not exact though).

In 2017 it took 40 projects to cumulatively sell 10’000 homes in Pune which by 2019 came down to 17 projects to sell 10’000 homes. This implies that average sale of homes in a given project increased from 250 in 2017 to 588 in 2019.

I think the situation is very similar for other micromarkets, every reasonably large listed developer has sold more apartments in FY2020 compared to the previous 3 years.

About availability to credit, this is again super skewed to reputed developers and has nothing to do with size of developer. Godrej (who is the largest guy) has a borrowing cost of 7.75% (this is super low for any developer). Other smaller players like Sobha currently borrow at ~9.6%. Kolte now has a project platform where they get money from private equity who fund projects on an IRR basis. Even smaller players like Ashiana have credit lines with international organizations like IFC whose returns are directly related to project specific IRRs. Domestic mutual funds like ICICI are also super active in this space and fund specific projects. So availability of money is not a problem for reputed developers who have delivered in the past.

About oversupply of inventory, this is a market narrative and has nothing to do with reality. There are two micromarkets that are oversupplied (MMR, Delhi NCR). However, demand supply matches perfectly for markets such as Pune, Hyderabad and Bangalore. Frank Knight reports clearly state the inventory situation. Even within a city, there are multiple micromarkets which can be oversupplied. So its super region specific.

About pricing, real-estate prices are now much more affordable than what the case was a few years ago. I am attaching the price to income ratio graph below for major markets. Low interest rates and government SOPs make pricing further attractive. My family also has a real-estate broking business and we were able to broker the sale of a super luxury flat (priced at ~1.5cr.) in Ranchi during the lockdown. If people come with a reasonable price tag, there are buyers available.

About WFH and ruralization, this is again a market narrative and has nothing to do with reality. If this were true, it was not possible for Godrej to sell flats worth 1485 cr. in Q1FY21 (the lockdown quarter). And where did this sale come from? Bangalore (478 cr.), Pune (358 cr.), NCR (413 cr.) and MMR (236 cr.). And where did the demand come from? Premium housing as affordable housing is oversupplied now because of the large number of project launches in the past couple of years and very few launches in premium space. And how is buying? NRIs and people with a stable job. Savings have actually gone up for people who have a stable job and can continue working from home, because they cannot go out and spend money.

basumallick · September 4, 2020, 8:15am

Your points are well taken but missing perhaps an important perspective because you are looking at it from the organised real estate developer perspective.

As per Anarock Property Consultants, 91% of India’s retail market still remains unorganised underscores the huge latent potential that remains to be explored by organised players. Consolidation has not even begun!!

The majority of builders are small ones who are completely cash strapped. And I am saying this after speaking to about 10 of them and also 2 large property consultants, one based out of Mumbai and one from NCR.

The affordability graph is very suspect to me. In Calcutta, where I live, if I assume the average salary is 10 lakhs (which I am sure is not, probably lesser), then to get a flat for 29 lakhs I will have to go way way out of the city.

Also, you are confusing between a long term trend of shift, or probable shift, to a short term demand boost from pent-up demand in metroes. I think @vivek_mashrani has already mentioned the slow change of long term trends with regards to this. Not sure how far the WFH theme will play out, or if people will mean revert immedaitely once a vaccine is found.

(ref of Anarock report from ET Realty - https://realty.economictimes.indiatimes.com/news/retail/organised-indian-retail-to-capture-19-market-share-by-2020/67656131)

harsh.beria93 · September 4, 2020, 8:37am

Few points:

This unorganised to organised thing is a market narrative. What actually happens is the more efficient players gain market from inefficient ones. By saying unorganized to organised, we imply that unorganised are inefficient which is just not true. For example, another narrative generally floated is retail investors are stupid and institutional ones are good. If that was the case, we wouldn’t be having this discussion on this forum. In economics, this is postulated as productivity growth. I have explained the impact of productivity growth on business cycles in more details in the cyclical investing post.

The affordability graph, and for that matter any other metric should be looked at from a relative prism. I track multiple indicators such as affordability graph, RESIDEX prices, etc. The broad trend is prices are way more affordable now than in 2013.

The long term trend is urbanization, younger demographics, increased GDP/capita. This happens over decades whereas themes such as WFH, unorganized to organized, GST consolidation, are market fads to keep participants excited. Real estate is not a 1 or 2 quarter cycle, it takes ~3 years just to deliver a project. Typical downcycles and upcycles last much longer than other businesses. The current downcycle ended in 2017, in 2018, 19 and 20 every reputed company has sold more flats YOY. So this is not a 1 quarter phenomenon that I am jumping on. I have covered this in much more details (from also a money supply perspective) in the cyclical investing post.

harsh.beria93 · October 6, 2020, 4:45pm

Sobha’s commentary (link): Q2 witnessed slight growth (~1% in gross terms) over last year Q2, with average realizations at a 5-quarter high. They are witnessing demand growth in all segments (premium, affordable, etc.) across all markets they operate in. Management suggests that they might be gaining significant market share. Demand is very robust in Bangalore and Kerala (specially Kochi), including in premium housing (2cr+).

sachit · October 7, 2020, 10:50am

Hey guys,
Nice discussion on Sobha thus far. I have a small accounting question
In the FY19 Annual report, the company reports that they executed and delivered 5.41m sqft of area in the Real Estate division. This broadly translates into a revenue of 3500cr JUST for the real estate division. This is quite far from the reported numbers under the real estate division (2300cr) even if I factor in things like Sobha might have less share in revenue in certain projects

Can someone please explain why this revenue was not reported in FY19 financials despite IND AS being implemented?

As per my understanding, under the new accounting method, the company is supposed to report its entire revenue as and when deliveries are made. (This is exactly why the company reversed about 3300cr of revenue for the previous financial years, namely FY18 and before while making books for FY19). I can’t seem to understand what happened.

Any guidance would be really appreciated. @harsh.beria93, @vivek_mashrani, @basumallick, any thoughts?

harsh.beria93 · November 9, 2020, 4:49pm

Management interaction (video1, video2):

Believe that residential recovery is sustainable, sales recovery is equivalent across tier-1,2,3 cities and across home categories
Sales should exceed in FY21H2 than FY20H2, third quarter has started on a better note
14 mn of new launches will happen in H2FY21
Have presence in 7 states and 10 cities (mostly in South India, Ahmedabad, Gurgaon and Maharashtra)
Generated 222 cr. of cash in H1FY21 compared to negative cashflow in H1FY20
Commercial space: Demand should revive in office spaces serving companies where India is gaining global business (eg: IT outsourcing businesses); Demand contraction might happen in mid to smaller sized companies where employees can easily work from home; Retail space recovery like multiplex operations will take some time

Disclosure: Not invested

vivek_mashrani · January 14, 2021, 7:12am

I did some scuttlebutt recently and it looks like rentals have fallen by ~20% and even residential property prices seem to have corrected. Unorganized builders have piled up huge unsold inventory.

This coupled with low interest rate could be probable reason of some demand uptick. Any idea on how realization and margins are panning out?

Dev_S · January 14, 2021, 10:53am

Sobha Q3 update has ever highest realization.

Invested after Q2 results

vivek_mashrani · January 14, 2021, 3:10pm

Thanks. If this trend continues in Q4, it will be interesting to watch.

Important observation here, key market of Bangalore has dipped while Tier 2/3 is firing up… probably Covid impact. Let’s see how this pans out.

Dev_S · April 5, 2021, 12:22pm

Looks like trajectory continues in Q4, volume, value and realization- all are up.

Sales volume, total sales value and total price realisation were up by 48%, 54%, and 5%
respectively as compared to Q4-20.
Net debt reduction with cash flow called out.
Good to note that all geographies have done well, including Key market of Bangalore

Overall optimistic tone…

Dev_S · October 6, 2021, 6:13pm

Q2 updates - as expected lots of Best Ever…

Highlights

Debt reduction
Borrowings cost reduction
Key market- Bangalore performance going strong
Good ramp up in Gurugram and Pune, 3X on QoQ and at 20% of sales in Q2 vs 10% in Q1( jump on HoH basis as well). Healthy geo Diversification.

Not so good

Realization not moving up inspite of higher share of Gurugram and Pune( need to understand project location mix n pricing?) - Q421 was 8000/sqft+, this Qtr it is 7600/sqft+
Kerela subdued- Corona cases issue attributed
Bit of lying on face - Q4 21 had Sobha share sales higher (8742 mil) than Q2 22 - still calling Q2 as best ever quarter( 8542 mil) - hope this is typo or unintentional miss

Numbers look good both on QoQ AND YoY as well as HoH, but again one Qtr and one player is not a best way to look at RE players. Broadly sector trend seems intact.

Invested

Dev_S · April 14, 2022, 5:11pm

https://indiankanoon.org/doc/199965853/

Sobha has been underperformer in last few months, probably company specific elements playing out. Above article highlights an ongoing ED investigation against recently promoted MD Mr Jagdish, Long timer Mr Sharma has moved out from company.

While Sobha is a strong brand in Bangalore, RE is a tricky and Grey shade business, more so when sector is cyclical, recent example of Godrej property getting thrashed for some reasons as well.

While sector may continue to do well and so will Sobha, risks outweigh on being caught on wrong side if betting on wrong horse.

Dis - Exited on recent developments and prolonged weakness on technical ( breaching 200 MA - though it is still holding on near current levels), continue to play RE cycle via ancillaries.