Godrej Properties IPO Analysis

Investors can currently refrain from the initial public offer of Godrej Properties. At the offer price, the stock would trade at 33-36 times its expected sustainable per share earnings for FY-10 on an expanded equity base.

Mumbai-based realty player, Godrej Properties, follows a joint-development strategy which is not reliant on holding a large land bank. It could turn out to be among the model strategies for the real-estate industry, with a lean structure that does not lock into land cost . The structure has, however, not entirely protected the company from the vagaries of the real-estate cycles; this company too has been hit by the slowdown and has been confronted with a decline in sales, profitability and higher debt over the last year.

With limited projects slotted for completion over the next one-two years, the offer price band of Rs 490-530 does appears a tad expensive for retail investors. The company may warrant a re-look on any sharp stock price declines or on improved scale of operations. Though such valuations are accorded to large players such as DLF and Unitech, Godrej Properties may not be strictly comparable, due to a much smaller revenue base and less diversified operations. Stocks of mid-sized realty companies (a segment in which Godrej Properties can be classified) trade at a good discount to the larger ones.

Background

Godrej Properties is a subsidiary of Godrej Industries. The company has so far completed 23 projects, selling about 3.2 million square feet of residential and commercial property, mostly in Mumbai and its adjoining cities. It currently holds an estimated saleable area of 50 million sq. ft, of which only about 4 per cent is from its own land reserve.

The company plans to raise about Rs 500 crore through this public offer, a good part of which would be used to acquire development rights for its forthcoming projects (which account for 36 per cent of the 50 million sq. ft of saleable area) as well as for repayment of loans.

Joint development

About 77 per cent of the area to be sold by Godrej Properties comes under the joint development model. This model involves entering into development agreements with the owners of land who are typically entitled to a share in the developed property or revenues/profits arising from the same or a combination of the two. This model has the advantage of avoiding direct land dealings for the realty developer and locking up extensive capital in land, leaving funds to meet working capital . On the flip side, purchasing development rights is not cheap especially in cities such as Mumbai. Besides, low-cost land bank accumulated years ago, has enabled bigger players such as DLF to earn superior profit margins. Holding land parcels has also allowed a number of developers to sell plots to tide over the fund crunch and meet their construction costs on other ongoing projects. Further, even as revenues would have to be shared in the joint development model, the entire construction cost would have to be borne by the developer.

Clearly, with long-term projects in hand, Godrej Properties has suffered over the past year, with a debt equity ratio of 2.3 times as of September 2009 (set to reduce post issue), and high working-capital borrowings as well. While the reported interest costs, which are net of interest receipts are negligible, at a gross level they accounted for a stiff 60 per cent of the sales and operating income for the six months ended September 2009. These factors suggest that the development rights model too may not be free from upfront capital costs and can hurt financials if fund flows are affected.

For the year ended March 2009, income from operation fell by about 10 per cent to Rs 205 crore. Total income for FY-09 as well as for the period ending September 2009 was propped up by ‘other income' from sale of the company's equity share in some of the projects to real estate funds.

For the April-September period, for instance, ‘other income' accounted for 50 per cent of the total revenues of Rs 115 crore. At an operating level, therefore, profit margins declined sharply. While this income is not sustainable, that real-estate funds have chosen to invest in the company's projects may be a positive reflection on the quality of projects.

Over FY-08 and FY-09, the company managed operating profit margins of 52 per cent and 34 per cent respectively. The OPMs of FY-08 may be hard to replicate, given the decline in commercial projects and increase in affordable residential projects that are ongoing or planned.

A sizeable number of Godrej Properties' projects are slated for completion post 2012. While revenue on these projects would be booked on percentage completion basis, sale of projects would be yet another issue. The current proportion of projects sold is in the range of 20-45 per cent (except in case of the Mahalaxmi and Bangalore residential projects), and this includes those already launched and slated for completion by 2010.

The company does own development rights to large tracts of land in Vikhroli and a few other cities with group/promoter companies which may help scale up its revenue base significantly once these projects materialise. However, such revenue stream would be available only over the next three-five year period. These developments may be triggers to reconsider investing in the stock.