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Parsvnath IPO: Our view - Views on News from Equitymaster
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Parsvnath IPO: Our view
Nov 6, 2006

Parsvnath Developers Limited (PDL), one of the leading players in the real estate industry in India, has launched its initial public offering today. The company has put on offer 33.2 m shares and the offer price is in the range of Rs 250 to Rs 300 per share. At the higher price level, the company will be collecting Rs 9.9 bn from this IPO. The issue will close on November 10, 2006. Here is a brief analysis of the issue. We shall put up a detailed review shortly.

Company background
Parsvnath Developers Limited (PDL) is one of the leading players in the real estate industry in India. The company was incorporated in 1990 and commenced business as a marketing company for real estate projects. It then moved into construction of residential projects, and currently has operations across 41 cities in India. Over the years, the company has gradually reduced its dependence from standalone residential projects (49% of revenues in 1QFY07 against 82% in FY03. Instead, PDL now derives a substantial chunk of its revenues from development of integrated townships (48% of 1QFY07 revenues).

Currently, PDL has acquired land and rights for development of 20 integrated townships, 27 commercial complexes including shopping malls, multiplexes, office space and a complete metro station and 25 residential projects. The company also plans to construct 14 hotels and 4 information technology parks on commercial land acquired by it. In addition to this, it has also obtained approvals from the government of India for development of nine SEZ projects (special economic zones).

PDL has seen some good times in the past and its performance over the last five years vindicates the same. During the period FY02 to FY06, the company has grown its sales and net profits at compounded rates of 121% and 139% respectively. Also noticeably, unlike most other companies in the construction sector, which have not been able to improve margins due to intense competition and the consequent fight for volumes, PDL has managed to earn higher margins. Its EBIDTA margins have been in the range of 18% to 23% during the past four years and this is commendable. The company has, however, suffered on the net profitability front, mainly due to increasing tax liabilities. As of October 15, 2006, PDL directly owned or held development rights for an estimated 108.6 m sq ft of saleable area.

Reasons to apply
Housing - The demand driver: As per HDFC, India has a housing shortage of 19.4 m units, including 12.7 m in rural areas and 6.7 units in urban areas. In recent times, the country has seen a rapid rise in housing demand, which is reflected in housing loan disbursals (30% CAGR in the past five years). We expect disbursals to grow at 20% to 25% CAGR over the next three years. Increased foreign participation in the Indian real estate industry is likely to open up new growth avenues. Domestic consumption driven growth is also likely to provide a fillip for development in the hospitality and retailing spaces. Long-term growth, however, is likely to be widespread and not concentrated in few metros. This shall be a positive for players like PDL who are focusing on non-metro locations and are also diversifying across real estate verticals (hotels, offices, malls and IT parks).

Diversified presence: PDL currently derives nearly 74% of its revenues from the state of Haryana. This contribution has, in fact, increased over the past few years. However, the company is charting a conscious strategy of de-risking its business from a single region/state. And this is seen from the diversification of its projects in 41 cities and 14 states of India. Further, PDL is developing residential complexes that directed at both the high income and the economy segment, which enables it to access customers across a range of income groups. The company is also focusing aggressively on the non-metro cities across India. During FY06 and 1QFY07, the company derived nearly 99% and 88% of its revenues from projects in non-metro cities.

De-risking portfolio: PDL earned 49% and 48% of its revenues from residential and integrated township projects respectively in 1QFY07. However, the company continues to target a more diversified bouquet, which we believe is a positive. Its portfolio also spans the Delhi Metro Rail BOT projects, commercial complexes, hotels, SEZs and informational technology parks. As of October 15, 2006, PDL directly owned or held development rights for an estimated 108.6 m sq ft of saleable area, which included host of projects in the abovementioned segments.

Reasons not to apply
The flip side of ‘land banks’: Land banks, like order backlogs for engineering and construction companies, provides visibility for future growth. However, these also contain execution risks. Land, for instance, is a highly illiquid asset. And in times of economic downturns, when land demand and prices move downhill, companies that have built up large land banks at higher prices might have to take huge hits on their balance sheets. This situation is currently being witnessed in the US housing market, where several real estate companies are near bankruptcy due to depreciated values of the land banks that they had created during ‘good’ times.

In India as well, land prices in some places, Haryana included (PDL earns its highest share of revenues from the state), have escalated beyond reality and we might see some real bubbles going forward. This is a big risk to investments in real estate stocks, including PDL.

Investors also need to understand that there is a lag between the time companies acquire land or development rights (build up land banks) and the time that they can construct and develop such project and sell their inventories. Further, the actual timing of the completion of a project may be different from its forecasted schedules for a number of reasons, including obtaining governmental approvals and building permits. In addition, the real estate investments, both in land and constructed inventories, are relatively illiquid, which may limit companies’ ability to vary their exposure in the real estate business promptly in response to changes in economic or other conditions.

Comparative Valuations & Comments
We have compared PDL with DLF, Unitech and DS Kulkarni. Our analysis shows that the company has an upper hand over its peers or most performance parameters. The company especially scores over its other real estate companies on profitability and return fronts (see table below). As far as valuations are concerned, though these look a bit stretched from an FY06 earnings perspective, there is a justification for the same in the expected strong growth from real estate companies, especially the better performing ones like PDL and DLF.

Comparative evaluation
Particulars PDL DLF Unitech DS Kulkarni
Land bank (m sq ft) 108.6 215.1 NA NA
FY06 Sales (Rs m) 6,438 11,450 8,928 1,330
FY06 PAT (Rs m) 1,070 2,274 877 176
Averages/CAGR (FY02-FY06, %)
Sales CAGR 120.5 34.5 45.3 45.3
PAT CAGR 138.7 61.5 101.4 57.4
Avg. OPM 19.5 23.4 7.9 5.9
Avg. NPM 16.7 12.0 5.3 7.1
Avg. RoE 52.2 14.3 14.2 18.6
P/E* 51.8 NA 363.0 37.4
* For PDL, higher price of Rs 300 is considered. EPS for all companies is for FY06

Investors need to understand that real estate is a long-term investment class and as such, speculation in related stocks might be frought with high levels of risk. While land banks and development rights on them provides some sort of visibility for future growth, there are flip sides attached to it in terms of volatility in land prices and execution of planned development.

Considering PDL’s past track record and its plans for the future, we have a positive view on the company. As such, investors with long-term holding perspective can ‘Apply’ to the issue. We shall soon put up our detailed view on this issue.

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