This Stock Will Rise from the Ashes of India's Real Estate Market

Jan 27, 2018

Kunal Thanvi, Research analyst

I wrote to you last week about the orphaned real estate sector and how it has recently been adopted, i.e. by the Real Estate Regulatory Act or RERA.

While RERA has set the stage for organised and ethical players, we have to remember that the real estate sector is cyclical in nature.

And - hopefully you will agree - it is very tricky to predict a cyclical turn or pick a cyclical company.

It is tricky, but possible. How do you do it?

One of the best ways to pick a strong company in the cyclical sector is when it's going through a multiyear downturn.

However, if a downturn continues for, say, five years, is it wise to keep holding such a stock and feel the pain for such a long period?

How can you find out whether the cycle is about to turn?

I found the answer in a wonderful book I just read - Capital Returns by Edward Chancellor

It's a book I highly recommend. In it, Chancellor says...

The answer lies in finding the supply side of the industry.

Capital Returns is a compilation of letters written by Marathon Investment Management to their clients. Over the years the book has become influential in the understanding of and betting on capital cycles across industries.

Here's an example...

There's a company A in an industry X.

Over the years, A has generated supernormal profits because A is the only player in the industry. It controls the supply.

However, looking at these supernormal profits three more players B, C, and D enter the market (assuming the market has no barriers of entry). The market gets fragmented and the supply now exceeds the demand.

This results in lower profits for all the players; which starts a slowdown in the industry with supply exceeding the demand.

We call this a cyclical downturn

Now, poor demand and poor returns lead to production cuts, cost cutting, and weak players exiting the industry - in short, there is some check on the supply side.

When the supply is checked, demand once again exceeds supply - the cycle turns.

The players that survive the down cycle rise high when the cyclical upturn happens.

This is the situation of the real estate sector in India. Since 2014, the real estate sector has been in a downturn.

After a dream run between 2008 to 2014 the sector saw huge supply across the country. This resulted in supply exceeding demand, leading to the downturn.

Real estate players suffered from returns and profits falling to multi-year lows.

Demonetisation and GST further depressed the sector. These events had a severe impact on demand and the demand-supply gap widened.

With this cyclical downturn the question remains - is this the right time to buy real estate stocks?

The answer again lies in the supply side of the industry.

Well, with the Real Estate Regulatory Authority Act (RERA) 2016, the sector is all set to consolidate with a tighter control over new projects, and money moving from one project to another, among other things.

The real estate sector has never before had a regulator; it was ridden with unethical and unscrupulous players.

However, with demonetisation, and now RERA, these players are facing the heat and the industry is entering a consolidation phase.

Thus, consolidation is expected to bring a check on the supply side.

This presents an opportunity in the sector, and as they say you need to pick the best company in a cyclical sector. The Smart Money Secrets team is about to recommend one of best players in the sector. The report is about to be released today. Stay Tuned.

PS: Speaking of unregulated sectors, you must have noticed the giant crash in bitcoin prices. Where regulations is a good thing for real estate, it might not be so good for cryptos. To get the full crypto story, click here.

SME IPOs Follow the Path of Big Ticket IPOs in 2017

We've constantly mentioned how the IPO euphoria has peaked in recent times. It now looks like the smaller companies have also joined the party. The recent SME IPO data for 2017 certainly seems to suggest so.

SME IPO Boom in 2017

The amount raised by SME IPOs in 2017 stood at 17.85 billion, more than three times the amount raised in 2016. The number of SME IPOs launched also doubled from 66 to 132.

With big ticket IPOs in the limelight in 2017, SMEs have also joined in to get a share of the pie. If past history is anything to go by, the IPO wave has generally been followed by a market correction. That too major ones. We've seen stocks debut just before the 2000-01 dotcom bubble. Then the IPO euphoria in 2008 was followed by the sub-prime crisis.

While it doesn't make sense to completely ignore this space, a certain sense of caution is definitely merited.

The Government is Back to Save the Banks

The government had announced the bank recapitalization plan on 24th October 2017. Within the parameters of this plan, Rs 2.11 trillion was to be infused into the financial system to revive struggling Public sector banks.

The first set was taken on Wednesday, 24 January. To start with, an amount of Rs 881 billion would be infused into 20 public sector banks. These banks handle more than 80% of the stressed asset accounts.

The government wants these banks to support MSME growth post this infusion. Also, the performance of these banks will be closely monitored. On the priority list is the resolution of large ticket default cases. These need to be referred to the NCLT tribunal. Also, PSU banks would need to monetize their non-core activities.

While these measures are more than welcome, the Fiscal deficit problem looms large for the government. Since the capital is infused by raising bonds, direct impact on fiscal deficit won't be impacted. But India's debt-to-GDP ratio is expected to rise further.

The government is already walking on a tightrope when it comes to balancing the growth and fiscal deficit. A successful resolution to the long standing bad loans problem will be a welcome relief.

What the Markets Looked Like This Week

Global stock markets rose on the final trading day, recouping losses from earlier in the week, as the dollar steadied against other currencies.

Major indexes in the US hit to session highs, finishing the day squarely in record territory and booking a fourth straight weekly advance. A reading of fourth-quarter gross domestic product came in slightly softer than expected but was viewed by wall street as healthy enough not to derail the perception that the economy is on firm footing.

President Donald Trump delivered a keynote speech at the World Economic Forum in Davos, Switzerland highlighting the strength of the domestic economy and offered a less protectionist stance on international trade.

The European markets ended Friday's session with modest gains. The markets climbed in early trade, but settled into a sideways pattern for the bulk of the session. France's CAC 40 was up 0.87% while London's FTSE 100 was up 0.65% and Germany's DAX was up 0.31%.

Stock markets in Asia were mixed with benchmark indices in Hong Kong and China surging by 1.6% and 0.3% respectively, while the index in Japan ended the week lower by 0.2%.

Back home, benchmark indices in India logged marginal gains of 0.3%, as a spurt in pharma stocks propelled the BSE Sensex to close the year above 34,000 levels.

Happy Investing,

Kunal Thanvi (Research Analyst)

PS: By the way, if you are interested in learning more about rea estate investment in India, and how to take advantage of these new moves in the sector, sign up for this free webinar where Ashwin Ramesh, an expert in Indian real estate, talks about how to find the best opportunities right now.

The webinar airs January 30 at 1 pm. Register here to receive a reminder.

Investment Mantra of the Day

"People who succeed in the stock market also accept periodic losses, setbacks, and unexpected occurrences. Calamitous drops do not scare them out of the game." - Peter Lynch

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2 Responses to "This Stock Will Rise from the Ashes of India's Real Estate Market"


Feb 7, 2018



r ramachandra reddy

Feb 1, 2018

good to read

Like (3)
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