RATINGS AND RECOMMENDATIONS

Leading brokerage HDFC Securities has come out with a positive outlook on real estate developer Sobha Ltd, stating that headwinds are largely priced in and risk-reward is now favorable for further rerating. The brokerage believes the stock's underperformance versus real estate sector makes valuations compelling for investors to make a fresh entry. In an in-depth research note, HDFC Securities pointed out that Sobha has faced regulatory headwinds from enforcement agencies like ED and IT department over the past few years, leading to underperformance versus peers like Brigade Enterprises and Prestige Estates. For example, Sobha's presales (booking) growth in its key Bengaluru market has lagged other major developers in the city. Over FY18-23, Sobha's Bengaluru presales have grown at 16% CAGR, much lower than the 29-34% CAGR growth seen at Brigade and Prestige over the same 5-year period. This has resulted in Sobha's market share in Bengaluru declining relative to competitors. However, HDFC Securities believes these headwinds are now largely behind Sobha and the company is refocusing efforts on accelerating growth. The brokerage says Sobha has a strong new launch pipeline of 15 million sq ft across cities like Bengaluru, NCR, Chennai etc. It is also targeting additional new project additions of 15-20 million sq ft, on which work has been ongoing for a few years. The company has significantly strengthened its balance sheet after the COVID pandemic, reducing consolidated gross debt by Rs 15 billion from peak levels. Net debt now stands at a comfortable Rs 16 billion as of June 2022. HDFC Securities expects the ongoing real estate upcycle to generate strong cash flows and operating leverage benefits for Sobha. Given its focus on residential projects, Sobha does not have major commercial or hospitality capex requirements. This will result in sustained free cash flow generation, enabling the company to turn debt free by FY25 as per HDFC estimates. The company has also been increasing its presence beyond its core Bengaluru market over the years. In FY23, non-Bengaluru sales accounted for 36% of overall presales value, up from just 18% in FY18. Sobha has been expanding presence in markets like NCR, Chennai, Kochi, Coimbatore etc. This geographical diversification will aid growth prospects going forward. HDFC Securities has marginally increased its net asset value estimate for Sobha by 10-15%, factoring in higher valuation assumptions for its land bank in line with current market prices. The brokerage maintains a BUY rating on the stock with a revised target price of Rs 1,024 per share, indicating 70% upside from current levels. Attractive Valuations HDFC Securities believes valuations are undemanding at current levels. Sobha is trading at one of the highest discounts to its NAV amongst listed developers at -22%, compared to the historical average of -17%. This provides comfort, according to the brokerage. Sobha's stock has relatively underperformed over the past 1 year, declining 14% between January 2022 and September 2023. This compares to a 6% rise in the Nifty Realty index over the same period. HDFC Securities believes valuations now adequately factor in the past headwinds and investigations. With fundamentals turning positive, the risk-reward is favorable for investors to make a fresh entry. HDFC Securities notes that Sobha trades at the most attractive valuation amongst its peers, with core EV/sales of just 1.1x and P/E ratio of 55x for FY23. This compares favorably to other leading developers like DLF, Brigade, Prestige etc which trade at 4-8x EV/sales. The discount is despite Sobha generating superior return ratios historically. As business momentum picks up, valuation multiples could potentially undergo a significant rerating. Promising Growth The report highlights that Sobha has a total land bank of around 190 million sq ft as of FY22 across cities like Bengaluru, Gurugram, Thrissur, Pune etc. The company has solid experience executing large residential townships, with total delivered area of over 100 million sq ft till date. HDFC Securities estimates Sobha will launch around 6-7 million sq ft of new projects in FY24, followed by 7-8 million sq ft in FY25. Past launches were limited to 3.4 million sq ft in FY22 and 4 million sq ft in FY23 as the company was tied up with regulatory probes. With these issues nearing resolution, Sobha has reiterated its focus on growth in the recent annual report commentary. The research note states that Sobha parent's operations in Dubai have also been scaling up well, with presales of Rs 242 billion achieved in CY22. This is by far the highest presales by any Indian real estate player. The Dubai business had presales of Rs 140 billion in just first 5 months of CY23. This provides technical and capital support for the India business to pursue aggressive expansion. Premium Image According to HDFC Securities, Sobha has created a competitive advantage in terms of its brand positioning as a premium developer. The company focuses on high quality construction and design aesthetic that clients are willing to pay a premium for. Timely delivery of projects over the past 28 years has also earned it significant customer loyalty and credibility. Sobha maintains tight control over quality by having in-house division for activities like architectural design, engineering, construction, interiors, glazing and metal works etc. This helps contain costs and improves project execution efficiency. As a result, Sobha has delivered sector leading margins, return ratios and cash flows during previous real estate upcycles. The company's statutory auditor was changed in FY23 to M/s Walker Chandiok & Co from the erstwhile KPMG affiliate BSR & Co. HDFC Securities sees this positively as it enhances governance and transparency standards. On financial position, the brokerage forecasts Sobha's net debt declining to Rs 15.5 billion in FY24 and the company turning net cash positive by FY25. This is based on cumulative free cash flow generation of nearly Rs 20 billion over FY24-25. Consequently, key credit metrics like debt/EBITDA, interest coverage and debt equity ratios are expected to improve steadily.

Tag: RATINGS AND RECOMMENDATIONS

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