Oberoi Realty - better invest in its stock than buy a flat

Real Estate companies in India are going through a rough phase. There has been significant slowdown in demand and prices - the worst hit have been the ones which over-stretched themselves during the boom to buy land at lavish premiums, funded with debt. I think real estate business has huge potential in India, considering the demographics, low urbanization and rapidly increasing demand for residential and commercial space. The current slump would subside and sooner or later the growth in real estate sector is bound to happen, think it makes sense to invest in this space. After going through a number of listed real estate players, the one that captivated me the most is OBEROI REALTY. 



This company is a Mumbai-centric developer with mainly 3 segments - residential, commercial and hospitality. It has a reputation for building quality projects and enjoys a good brand value in the market, for which its projects are often sold at premium compared to peers. Its promoters (not be confused with those of Oberoi Hotels) have a reputation of good corporate governance and clear vision. I have listed down some reasons which, according to me, make this stock a good buy.


a) Revenue mix - The company gets revenue of around 800 crores annually, of which rentals from its commercial properties account for roughly 160 crores, nearly 20%. This is interesting from an investor's point of view, considering the fact that the rental business enjoys EBITDA margins of whooping 99% !!! Practically every penny it gets from rental adds to its profit and can be assumed to be royalty payment which the company would keep on getting from properties it has invested in. The rentals (around 125/sq ft/month) have a fair chance of heading north, given the strong presence Oberoi Mall has in Goregaon/Malad area.

b) Good Margins  - Oberoi Realty works with EBITDA margins of around 60% and PAT margins of 45% !! There are very few companies with market cap of 6,500 crores plus operating on such healthy margins. The hospitality business (which runs Westin) has the lowest margins of 30% (not bad at all for Hotels), otherwise the residential and rental business are highly profit-making. This gives an insight into the mindset of the management, which is more focused on quality than quantity and has restricted itself to few projects with good sell-ability rather than stretching itself and working on many projects with lower profitability.

c) Cash Reserves - Oberoi Realty is sitting on cash reserves of appx 1000 crores!! This is very important in current context when companies in similar business and same geography and in neck-deep trouble owing to high debt levels and have engaged in desperate asset sale to service their debt. It presents a great opportunity for the company which is now in a position to get a great bargain to purchase land, when there aren't many buyers and the prices are low. To just give an example, there were talks with HDIL to buy TDR (transfer of development rights) @2100/sq ft instead of 3000/sq ft, at which HDIL was already selling TDRs. This was due to the fact that HDIL was keen to bring down the debt levels and was ready to sell TDRs at below market value.

d) Good Valuations - At current market price of 185 and EPS of 15 on a trailing basis, P/E works out to be just 12, which I think makes it highly undervalued. For a company which has grown well in 5 years, maintained good margins, built quality projects and saved cash even in troubled times, the valuations are cheap. The cash reserves alone work out to be 30 per share, leave alone the investment properties of Oberoi Mall (6 lacs sq ft), Commerz I (4 lacs sq ft), Westin Hotel (4 lacs sq ft) and many more properties under construction (as well as land bank!). The share trades at 1.5x the book value of 125 and EV/EBITDA of 9x. I don't have the precise information, but I am sure the sum of parts valuation of the portfolio of Oberoi Realty's properties would yield the same conclusion, that is, the stock is fairly undervalued.

e) Upcoming Projects - Besides having a strong brand presence in the suburbs of Goregaon, Oberoi Realty is doing a big residential project of 1.5 million sq ft in the premium Worli area of Mumbai (has already constructed 20 plus floors till date). With projects lined up in Mulund and Pune as well, the company seems to be in no mood to leave any opportunity present in the current market conditions. It has great expectations from the Worli project, which would start contributing to its bottom line from next quarter. In a recent interview, the management said that they have already sold enough and just have to build more to realize profits.


A few negatives have contributed in keeping the share price depressed, some of them being:-

a) Poor performance in Q1FY14 - the company was able to sell just 48,000 sq ft residential area, equivalent to 23 flats, which was a huge disappointment compared to previous year's figure of 115,000 sq ft area. This reflects the kind of slump Mumbai's real estate players are going through.

b) The Mulund project has been delayed due to regulatory hurdles and environmental clearances and may pose a threat for the company in future.

c) The slowdown may be more prolonged than expected and the poor performance of last quarter, if repeats in coming quarters can adversely effect the valuations and fundamentals of the company.

Though the negatives pose risk for the company, it is relatively well shielded from major downside, unlike its peers. It doesn't have to worry about inflows, with rental income contributing well, it has good projects in hand and doesn't have to worry about bookings, has the capability to complete these projects with own capital, in case required bookings don't happen and can get bargain on land deals. Although it may be premature to say that the real estate sector is headed for a turn around immediately, I think the valuations, fundamentals and the sensibility and vision of management make Oberoi Realty a good bet. Investors with some appetite for risk and looking for a proxy for real estate play definitely stand a chance to earn good returns on their Investment. 

Heading for a paradigm shift?

Today's Economic Times carries the story of a possible stake sale by Tilaknagar Industries (maker of Mansion House, the second best selling Brandy in the world) to retire its debt. Almost everyday, for the past quarter or so, we have seen so many marquee names, opting for asset or stake sale to reduce their debt burden. Yesterday it was IRB Infra, which plans to offload some of its key projects, DLF desperate to sell its Dubai Hotel chain, Suzlon is on the verge of going bankrupt. When there are so many assets on the block, the prices would go down and companies would have to bring in more assets to pay-off debt, leading to a downward spiral and heavy asset depreciation going forward. Conversation with a friend who works in the Asset side of a leading bank reveals the situation on ground is much worse than it appears in news. There is practically very little liquidity with MFIs and loan disbursement is going to dry up due to lack of funds. What adds to the woe is tight monetary policy pursued by RBI to keep the rupee from depreciating further.

In contrast with 2008, one fact which disturbs the most is during that time, markets crashed because of the global factors and lack of 'Investor funds', which were diverted from equity. This time, there seems to be a degradation in business fundamentals itself. Success of the 'India Story' is being questioned - good companies have made suicidal bets by over-leveraging and mismanaging their funds. For example, Financial Technologies, running MCX and NSEL was found running a quasi-ponzi scheme, the rot seems to be prevalent everywhere.

The question, however is, are we heading for a paradigm shift? Is there going to be a change in mindset of Indian Corporate, from high leverage to optimization of balance sheets? Sooner or later, the realization must dawn that borrowing money more than their balance sheet could afford is going to bring doom and lead to a catastrophic end. The policy paralysis, starting with UPA 2 from 2009 onwards is starting to bear fruits now, don't know how deep the rot is going to be. Business, be it manufacturing, tourism, banking carry a mark of pessimism and frustration, because there seems to be no hope, with Government concentrating on more populist policies to appease their vote banks. Seems it is a folly to expect more from the Government, however what businessmen can do is improve efficiency and reduce cost wherever possible. Demand would remain subdued and things don't seem to improve till next year, it is important to stay afloat in this tide. Conservation of capital has to be the key objective, we can afford a slow growth for a couple of years but we can't afford more companies going down. It would lead to a crisis of confidence. What makes matters worse is unlike 2-3 years back, when everyone was buying the emerging markets story, this time with US economy reviving, the FIIs won't waste much time in shunning the Indian markets and park their funds in more lucrative markets and asset classes.

May be things are not as bad as I perceive, still I think Austerity is needed and corporates have already started relooking at their policies. We haven't come across recent buyout deals where the buyer has lavishly overpayed, which was the case earlier. On the contrary, Markets have started punishing companies looking in that direction, as was the case with Indian Hotels' bid for Orient Express or Apollo Tyres' bid for Cooper Tire, both of which being withdrawn. There may be a painful unwinding of Assets going forward, but that would be a good thing, at least the balance sheets would get cleaned up and then the Indian Corporates, with specific advantages of low cost and intellectual capital would be able to prove their mettle in the the global space once again!

NMDC-a great buy at current levels!

After a hiatus of 2 years, I have started looking at the markets once again. Somehow, I get the feeling that there are plenty of opportunities waiting to be explored, when the mood on the street is pessimistic and everyone is selling. Of course, the turbulence prevalent in the market cannot be ignored, there are some serious implications of the falling rupee and rising current account deficit, due to which the high beta and cyclical sectors like realty, infra, metals along with banks have been severely punished. The most severe impact is shared by companies that carry high leverage on their books and undertook huge debts to fund ambitious projects.

However, amid the panic prevalent on the street, one cannot ignore the fact that in times like these, solid companies with very healthy business and strong balance sheets are also punished just because of exodus of investors from the equity markets. This throws up a good opportunity for value investors. One may doubt if that is the case why have investors not already capitalized upon the opportunity. We need to understand that investor psychology is the most important force driving the markets. The 'Mr. Market' analogy of Benjamin Graham aptly explains this psychology when he compares the market to an imaginary person 'Mr Market' who tends to be very emotional. When he is optimistic, he tends to buy everything that is offered, at a premium and when he is sick he is ready to offload whatever he has with him at a discount. With careful fundamental analysis, we can choose which stocks offered by Mr Market are priced below their intrinsic value.

After scanning a large number of companies, I selected few stocks which are worth considering from point of investing, best among them is National Mineral Development Corporation Ltd. (NMDC). It is a public sector company and the largest producer of Iron ore in the country (appx 27 million tons annually!). Without going through the pain of writing a detailed research report, I have listed down some reasons which I think make this stock a stealing buy.

1) Monopolistic business - NMDC has exclusive rights for Iron Ore mines with more than 1,360 million tons reserves - Bailadila and Donimalai being the largest and most important ones. Bailadila is known for its high Iron content ore, more than 65%, with best physical and metallurgical properties required for making steel. The company is hopeful of getting some more mining leases, making it one of the few companies which have access to such huge natural resources. The market price of Iron ore (avg of lumps and fines) is INR 3,500 per ton at present. The price has been subdued for more than a year now due to poor demand from steel makers. However, as we see an uptick in the economic cycle, the demand in automobiles and Infra would lead to a demand of Steel and in turn demand for Iron ore. It is interesting to know that NMDC is among the world's lowest cost produces (appx USD 20 per ton including royalty payments!). Don't you think it makes absolute sense to invest in a company which is running a simple business, having monopolistic control of the industry, no dearth of customers, and good operating margins ,appx 65% in NMDC's case?

2) Strong Balance Sheet - In times like these when companies one after the other are opting for Corporate Debt Restructuring or defaulting on their debt obligations, here we have a company which has cash reserves of 21,000 crores! At the current market price of INR 97 per share, the total market cap stands at appx 38,000 crores. In a  way, we can say that out of the price we are paying to buy NMDC, 55% is HARD CASH, almost INR 54 per share. To put it simply, being a debt free company, if the company gets liquidated tomorrow and we don't get back any money from the debtors or from selling the company's assets, we still would be left with 54 rupees cash! The company doesn't need to spend much on expansion and we can assume that the cash rich company would continue to be so in foreseeable future.

3) Good Operating Performance - The company has doubled its turnover from 5,000 crores in FY08 to 10,000 crores in FY13. The operating margins have been consistent during the period about 75% in FY08 to 78% in FY12 and lower at 68% in FY13 (due to lower production and poor demand scenario compared to previous year). I think the operating margins showcase the solid business potential of the company. Of every 100 rupees worth of material it sells, it pockets 75 rupees as cash operating profit. Even after paying 35% income tax, we still get a Profit after tax margins of appx 50%, a very healthy figure not many companies of such scale are capable of posting year after year. This adds significantly to the cash reserves of the company and I see no major downside to the company going forward.

4) Cheap Valuations - The Earnings per share works out to be INR 16 for NMDC. At INR 97 per share market price, it is trading at a price earnings ratio of 6.06. Put simply even if the company continues with the same performance without growing an iota in earnings, it would accumulate enough cash to double its value in 6 years! It is considerably cheaper than the Industry ratio of 12-13 historically. The book value (value of assets - liabilities) stands at INR62 per share. We can safely assume this price to be the bottom where the stock can fall to, given the high cushion its cash reserves offer.The price to book value multiple is appx 1.5, again very cheap. The compounded annual growth in PAT has been appx 15% from FY08 to FY13, the PEG ratio (ratio of PE to historical 5 yrs growth)  stands at a mere 0.4. By market standards, for a stable company like NMDC, a PEG ratio below 1 represents that the company is undervalued. To supplement the above research, it is important to look at another important parameter often used to value metals and mining stocks - EV/EBITDA. The Enterprise value (total of mkt cap and net debt) of NMDC is 38,000-20,000=18,000 crores for NMDC, and EV/EBITDA miltiple of 2.0x. NMDC came up with a FPO in March, 2010, post which the shares have traded at P/E of 10x and EV/EBITDA of 6x, reiterating the fact that compared to the historic valuations, the current valuations are extremely cheap.

5) Good Dividend Yield - The company has a history of giving regular dividend payout. It has been paying more than 20% of the PAT as cash dividends to shareholders for the past many years, increasing substantially to 25% in FY12 and 40% in FY13. The dividend per share was INR 6.50 in FY13 and is expected to be 7.50 or more  going forward. The dividend yield turns out to be ~8% for NMDC, one of the highest among companies of its size. Bank FDs are currently paying 9% as interest, it makes complete sense to buy NMDC shares and earn 8% dividend yield and a fair chance of price appreciation instead of earning 6.3% post-tax return on bank FDs.

Possible Negatives
Being a Government enterprise and administered by the Steel Ministry, we know the potential disadvantages the PSUs are sometimes subjected to - whether it comes to bearing the subsidy burden (like Oil refiners) or bearing the price of extending undue benefits to private sector companies. 
Another possible negative may be the plans of venturing into steel making. The company has already started manufacturing sponge iron 2 years back and is setting up a 3MT per annum steel plant. It may seem that the move would benefit the company by integrating it forward. However, it might deviate from its 'core competency' of mining and divert its excess cash into highly capital intensive and cyclical steel production.

Besides the negatives surrounding the metal and mining industry, I am convinced that the cheap valuations, strong balance sheet and good dividend yield are compelling reasons to take a plunge and buy this stock. It has a considerable 'margin of safety' to safeguard the interests of investors in case the downtrend continues for a prolonged period and has the potential to deliver very good price appreciation when the economic cycle improves.