Key takeaways from DLF Annual Report 2015-16

Can be downloaded from http://www.dlf.in/images/downloads/DLF_Annual-Report-2015-16-Final.pdf

• Employee cost reduced from Rs 349crores to 316crores despite a 20% revenue growth. 
• 31.3MnSqft is rented out for Rs 26000MINR(annualized) at a 95% occupancy rate. This equates to Rs 850/Sqft/year or Rs 71/Sqft/month(!!). This with a reinvestment capex of just 5% of rental revenue. 
• Investments in infrastructure paying out
• 16lane road 8.5kms length from Delhi to Golf Course road nearing completion
• Cybercity metro investments and highway spend
• Consolidated Borrowing costs reduced y-o-y from 11.86%(11.48% standalone) to 11%(10.55% for standalone)
• CSR Spend of 10.4crores is fully spent
• Around 2000 permanenent employees of which 18% women
• MD&A section contains details on litigation notably SEBI, COMPAT and P&H court orders. This is material but cannot be fully appreciated from the annual report.
• Possible transfer pricing complexity here-since holding company does NOT account for majority of assets or profits. Below table indicates this. There does not seem negligible risk of tunneling since these key entities are nearly all 100% owned. But this profit split is strange.
  

How to analyze Indian real estate stocks-some pointers

On my other blog focused on special situations, I'd given my views on why real estate stocks trade at historically low(intra sector and relative to broader market)[http://specialsituationsindia.blogspot.com/2011/12/why-do-indian-real-estate-companies.html]. But at the same time, one has debt free stocks like Oberoi Realty trading at P/BV of 2.9x, and DLF trading around 1.5x FY11 book value. So why this difference? After reading annual reports/concalls and investor relations of the S&P CNX Realty Index(whose 10 stocks accounted for 80% of the listed real estate stocks) stocks like DLF, Unitech, HDIL, Oberoi Realty, Phoenix Mills, Sobha Developers, Godrej Properties, Parsvnath Developer Ltd, Anant Raj and DB Realty, I gleaned some insights which I proceed to share in this blog post.

1. Location Location Location:-Like the 4Ps of the marketing, the 1L of realty is location, which drives the possible uses(commercial, residential) and also development restrictions(for example height restrictions in areas near airports). 
2. Extreme interest rate sensitivity:-Builders being highly levered, and most first time house buyers incurring debt to purchase house, both demand and costs are influenced by home loan interest rates and bank interest rates, which move in tandem. While commercial real estate demand is less sensitive to interest rates than residential, the effect is still there. Hence, sector is sensitive and suffered due to RBI's consecutive interest rate hikes.Also, bank lending margin requirements play a crucial role. In late 2010, RBI had lowered the Loan To Value (LTV) to 80% from 90%.  This led to a 100% increase in margin requirement from an individual homeowner
3. Understanding percentage completion accounting:-Investors may wonder whether project completion based on actual work completed on the ground or is it more based on advances, payments made to contractors? A lot of approval costs(development fee etc) and architectures cost  goes into the overall development cost, and so initially, the  work completion is  higher but later on it is ideally based purely on the milestone base or slab base. If the cost estimates change, then profit estimate gets affected. For example, DB Realty recognized a negative revenue of Rs 92.4 crores in FY11, in its project Orchid Ozone, on account of upward revision of originally envisaged Project cost, which increased from Rs. 6,250 Million to Rs. 8,170 Million.
4. Use of partnership firms to execute SPVs:-This is done to avoid the repeated double taxation of dividend via dividend distribution tax, and also to execute projects jointly/co-developing. Hence, the Companies Act does not apply to attaching the separate balance sheets of these companies, which may be an issue if not consolidated(stake below 50% etc). If too many partnerships are <50%, then it is matter of concern from governance perspective & investor risk.
5. Interest expense-capitalized AND expensed:-Before doing ratio analysis, remember that interest during project period is often capitalized, and hence the interest expense line item does not reflect the total interest expense. While notes to accounts in annual reports disclose that, it is not done in interim quarterly reports. So remember that during modelling TTM numbers. 
6. Land Bank equivalent of revenue visibility:-As Anant Raj mentions in its annual report, in realty business, land bank is equivalent of visibility. Visibility of revenues,visibility of profits and most importantly, visibility of cash flows. Caveat for shareholders though - the land bank has to be prime, bought at the right price, and should be ready for developments. If the prices rise too high, they do not make ROI sense, and if location poor/under litigation, development is delayed blocking capital and accruing interest. 
7. Land Records:-In India, property records do not provide a guarantee of title.  Property records in India have not been fully computerised and are generally maintained and updated manually through physical records of all land-related documents. The title to agricultural land is often fragmented and the land  may, in many cases, have multiple owners and claimants who may not have perfect title to it

Hence, plenty of groundwork is advisable before investing in real estate stocks. 

Interesting features of THE REAL ESTATE (REGULATION & DEVELOPMENT) BILL, 2011

I read the draft version of this bill(http://mhupa.gov.in/W_new/RealEstate_BILL-2011_OM09112011.pdf) and was quite impressed at some of the provisions. Though laws do not bring about change without good implementation, the Government is atleast thinking on good lines. Essentially, the Act aims to ensure fairplay by promoters, have a single web portal for accessing details of approved projects and to have a single pan India tribunal for disputes. Some interesting clauses below and their implications are detailed below.

1. INTEREST  RATE SYMMETRIC:- Section2(u) “interest” means...Explanation.- For the purposes of this clause, the rate of interest chargeable from the allottee by the promoter shall not be more than the rate of interest which the promoter would be liable to pay the allottee in case of default. If only this provision was applied to tax laws also(where Government pays 6% pa on delayed refunds while taking 18% interest for late payments, tax payers would be much more happy. On a lighter vein though, this clause will ensure fairplay in contracts.
2. PROJECT SPECIFIC REGISTRATION:- Section 3. No promoter shall develop any immovable property.. without registering the real estate project and obtaining a certificate of registration from the Real Estate Regulatory Authority established under this Act:  Explanation.- For the purpose of this Act, where immovable property is to be developed in phases then every such phase shall  be considered a standalone real estate project, and the promoter would have to seek registration under the Act for each phase separatel. This would imply that projects need to be registered once on the site, and that even further phases need a distinct registration, which is good.
3. ESCROW ACCOUNT Section4(3) The promoter shall enclose the following documents along with the application referred to in sub-section (1), namely:-(b) (v) that seventy percent of the amounts realized for the real estate project from the allottees, from time to time, would be deposited in a separate account to be maintained in a scheduled  bank, within fifteen days of its realization for meeting the costs of the real estate project and would be used only for that purpose. Completion risk is one thing that has hogged the limelight. Having an escrow account would entail another audit, but would ensure that the project gets completed on time! Now, residential projects cross funding commercial projects may not happen anymore
4. TRANSPARENT MARKET DATA:- Section8. (1) The promoter shall..enter all details of the proposed project ..(2)  The information and documents referred to in sub-section (1)..include,- (g) fortnightly up-to-date list of bookings on the basis of the agreement to sell entered with them. This would ensure that buyers have an accurate assessment of which projects are selling, and this information would allow them to make purchase decisions and in negotiations.
5. 'PRE-FILING CONDITIONS:- Section 9- No promoter shall issue or publish an advertisement or prospectus, or invite any member of the public to buy or book in such projects to be developed or take advances or deposits without obtaining a copy of certificate of registration with the Authority. (2) No promoter shall issue advertisement or prospectus without first filing a copy of such advertisement or prospectus in the office of the Authority/ This borrows several provisions from SEBI Guidelines for equity funding, which is quite interesting in itself! Atleast it would ensure some uniformity in advertisements and 'prospectus'.

However, there is no rose without thorns. The possible cons of the bill are

1. Excessive reliance on the internet:-Since not all realty buyers may be conversant with English/be digitally savvy, the proposed web portal needs to be in multiple languages, and accessible via other modes like mobile etc. 
2. Too small threshold limit for Act:-Since projects above 4000sqfeet carpet area are covered, this would realistically cover any decent size building. While this may be the intention of the act, one wonders whether small builders can bear this compliance cost or not. So either build a NSDL/MCA-21 CFC like compliance infrastructure in place, or else increase the applicability limit for the Act

Like most Indian laws, this is high on intentions but it is to be seen whether it is implemented or not. If implemented, it could go a long way in cleansing the Augean stables of realty.