An investment can be considered in the Initial Public Offer (IPO) of Omaxe, a real-estate company with its current revenues comparable to players such as Sobha Developers and Parsvnath Developers.
The company’s previous avatar as a contractor has not only enabled it to graduate into a real-estate developer but has provided it with a reasonable track record of execution.
The above process has also accelerated the bottomline growth and profit margins.
However, the key to success for this company with substantial business in North India, may lie in establishing its brand presence amidst bigger and better-known players such DLF, Unitech and Ansal Properties.
Competition apart, the company’s ability to bring professionalism in terms of disclosure and transparency could be a vital indicator of the company’s performance.
At the offer price of Rs 265-310, the price-earnings multiple is 18-20 times the company’s consolidated earnings for 2006-07 on the expanded equity base. The offer is at a discount to peers of a similar size.
Further, based on the company’s planned projects and current projects under development, the PE (at the offer price) stands at 10-12 times its likely consolidated earnings two years from now.
The company nevertheless carries a higher risk profile than some of its peers, given the relatively concentrated geographic presence and lesser experience in the commercial/retailing space.
Background
Omaxe is a construction and real-estate development company, with predominant business in the residential segment. The company started out as a contractor and executed 120 projects in such capacity, before moving on to becoming a developer in 2001. This background is comparable to Sobha Developers, which was also in the contracting business earlier.
In its new capacity, Omaxe has developed 5.13 million sq ft, comprising group housing projects, integrated townships and commercial projects. The company plans to raise Rs 470-550 crore through this offer. The proceeds are to be utilised towards land acquisition for current and future projects, for part-repayment of loans and to meet some of the construction cost of existing projects. Post-issue, the market cap (based on the offer price band) would be Rs 4,500-5,300 crore.
Comfort from land reserve
Omaxe has declared land reserves of 3,255 acres, representing 150 million sq ft of developable area, mainly in North India, but spread across nine states. This holding can be broadly classified into four divisions.
One, land owned by itself or through subsidiaries, which is 34 per cent of the total developable area. Two, 15 per cent of the area is under joint development agreement. We view this as the next best strategy to owning land directly, since the landowner evinces interest in the completion of the project.
Three, the company has sole development rights for 42 per cent of the developable area. The company has clearly stated that such land is owned by group companies and associates, providing comfort that the strategy is unlikely to generate any risk of disruption to the development process.
Finally, a minimal 9 per cent of area is under agreement to acquire, part of which is lease-hold land given by various state authorities for a period ranging from 90-99 years. This agreement is also likely to benefit the company, as it would get to fully enjoy revenue generated from such lease-hold land.
The above mix lends a positive view on the land-holding and appears to mitigate typical risks related to owning and developing land.
Late starter
Omaxe has seen an improvement in its operating profit margins (OPMs) from 18 per cent in 2005-06 to 24 per cent in 2006-07. This is as a result of substantially scaling down operations in contracting business (with no new projects under this segment, post-March 2006) and concentrating on realty development.
The OPMs are, nevertheless, lower than other realty majors in the National Capital Region. That land cost plays a major role in determining the OPMs of realty players is a given.
Looking back, players such as DLF and Unitech enjoy superior margins as a result of sitting on a land bank accumulated perhaps over a period of 10-20 years.
However, players such as Sobha Developers and Omaxe may have been accumulating land, over the past four-five years, as they have recently slipped into the developer’s role.
The cost of brand-building may also have taken its toll on the margins. Therefore, a comparison with recent entrants reveals that the margins appear reasonable.
Further, Omaxe has so far earned a majority of its revenue from group housing. The current project mix reveals that integrated townships have taken precedence over group housing; commercial projects are also gaining a place in the business mix.
The last two mentioned segments are more lucrative; the historical price realisation of the company in these segments also reveals this.
We expect the company’s operating and net margins to improve over the next two-three years, with this changing business mix. While the term ‘group housing’ is typically associated to mass low-cost housing, Omaxe has an interesting mix of apartments and condominiums. This mix may also provide a healthy average price realisation for these projects.
Fewer the better
The company has stated that it has received an in-principle approval for a multi-product SEZ which is, however, subject to the government relaxing the 5,000 hectare (12,355 acres)-ceiling. While we have not factored in any revenue from this segment, that the company has not gone in for too many plans in this segment is a positive.
With lack of clarity on the Government’s stand in this space, the fewer the plans (that a realty player has in this segment) the better, from an earnings visibility perspective.
Risks
Omaxe operates in a region that has already cultivated larger, established players. While the company will see serious competition in the NCR, the present developable area is skewed in favour of other states, which constitute close to 63 per cent of the total acreage.
This spread, across nine States and 30 cities may still provide enough room for the company to expand in its area of expertise.
The company has declared additional income for earlier years after it was subject to a search and seizure operation by the Income-Tax Department. Any proceedings that are underway may result in the company paying interest and penalties.
While this may dent net profits in the short-term, we are more concerned about the governance issues that these proceedings raise. Lack of transparency in transactions and poor governance have for long been impediments to higher valuations for realty stocks, and these have begun to be addressed only in recent times with better practices.
The company’s debt-equity ratio is likely to remain at about two even after the repayment of loans, post-issue. However, its ability to service its finance charges lends confidence. Its working-capital requirements may also be partly met with occasional cash flow from plotted developments, which from part of integrated township projects.
The offer is open from July 17-20. JM Financial is the book-running lead manager.