Realty valuations in line with long-term average, near pre-RERA rollout level: Jefferies

Post the larger correction seen for residential developers we continue to favour Godrej Properties and Macrotech Developers against DLF and Oberoi realty. Godrej Properties, Macrotech Developers and Prestige Estates Projects are already trading at 16-38 percent discount to their price-to-book averages, Jefferies said.

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Real estate sector valuations are in line with th long-term average and close to the pre-RERA rollout levels, according to the latest Jefferies report.

A potentially delayed pause in the rate hike cycle and risk-off sentiments, particularly for leveraged companies, has led to significant property stock underperformance, said the brokerage firm. It believes that the 40 percent valuation contraction since late 2021 is near past cycle levels.

“Valuations are now at pre-RERA reform levels, ignoring the much improved sector discipline and also the strong housing cycle. Developers with valuations at or below average include Macrotech Developers, Godrej Properties, Prestige Estates Projects and DLF,” the research firm said.

Despite the broader markets under pressure and trading in the red following weak global cues, the BSE realty index managed to stay in the green.

At 10:51am, the index was up 0.32 percent led by Indiabulls Real Estate, Phoenix Mills and Oberoi Realty.

Realty sell-off on rate hike fears

The BSE Realty index is down 12 percent year-to-date (YTD). A 5 percentage point underperformance has come after a hawkish RBI policy on February 8, and the subsequent higher-than-expected inflation print, which have led to anticipation of further rate hikes, though not more than 25-50bps, as pace of hikes have declined, Jefferies said.

Observations from past rate cycles

Jefferies believes that even though investors have seen limited evidence of mortgage rates impacting physical property sales, the property stock valuations demonstrate a reasonably high correlation with the mortgage rates. Higher mortgage rates of around 225 bps over the last 12 months have led to the residential heavy developers, including Macrotech Developers, Godrej Properties and Sobha, decline 18-32 percent, while the average valuations (price to-book basis) of the developers with long history having declined by around 33 percent to 2.2x.

Derating near prior risk-off episodes

“General periods of risk aversion and low liquidity have seen property stocks correct significantly. The 2018 NBFC crisis and partly the 2013-14 emerging market risk-off and sharp rupee depreciation period was also derating even for the realty sector. Overall, peak-to trough de-rating in the current episode has already reached levels similar to the ones in prior,” the brokerage firm said.

Valuations reaching pre-RERA levels

According to the global research firm, the current sector valuations, on an absolute price-to-book comparison basis is in line with the long-term average and close to the pre-RERA rollout levels. The RERA reforms since 2017 have triggered significant industry consolidation and ensured much improved sector discipline.

Moreover, with the housing cycle still in an early period of typically long (6-8-year) cycle. It believes valuations may be close to bottoming.

Strong residential cycles boost cash flow, profit and loss visibility

Jefferies is of the view that the property stock underperformance to be at odds with the strong property cycle. For the none-month period, the pre-sales for the top 10 listed developers is over 37 percent year-on-year in value terms. Industry inventory levels are around 10-year lows. Moreover, the industry leverage levels have continued to decline on strong cash flow generation.

“Most developers are sticking to the low capital-intensive partnership model for new project additions which boosts cash flow visibility. Moreover, while we note that earnings growth has lagged for stocks, the same is due to accounting policy issue, which in turn provides good profit and loss visibility too in the years ahead,” the research firm said.

“Post the larger correction seen for residential developers, we continue to favour Godrej Properties and Macrotech Developers against DLF and Oberoi realty. Godrej Properties, Macrotech Developers and Prestige Estates Projects are trading at 16-38 percent discount to their price-to-book averages,” it said.

“DLF and Godrej Properties are also trading below the average long-term NAV discounts while Oberoi Realty valuations are above average on both PB and NAV basis. A potential topping out of rates in the next few months will be the key event,” Jefferies added.

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