Impact of housing scam on real estate stocks

A CBI investigation into bribe taking at the highest echelons of Public Sectors Banks (Central Bank of India, Punjab National Bank , Bank of India) and public sector financial institutions (LIC, LIC Housing Finance) has led to several arrests of senior management personnel. Though media reports suggest that the main beneficiary of the largesee of bribed senior management has been the real estate sector, the CBI has not named any real estate company as an accused.

The allegation relate to corporates availing General Corporate Loans through Financial Intemediaries (FIs). A specifc FI, Money Matters, has allegedly bribed senior officials in these public sector financial institutions and thereby procured loans for corporates. Besides sanctioning the loans, the bribed senior officials are also alleged to have passed on confidential competitive information to corporate through the named FI.

Brokerage house Ambit commented on the on the impact of housing scam in real estate stocks, which is as follows:

Debt levels will go up, the cost of borrowing will rise, execution will be impacted: Inspite of strong sales and robust prices, real estate firms have not been able to reduce debt and interest repayments. Instead, the debt has been refinanced. Out discussion with the coverage universe suggests that none of the above companies will generate positive cashflows in FY11 basis and net debt will go up by FY11 end. The only exception is HDIL which has raised money through a QIP.

We believe debt restructuring / refinancing would go through increased scrutiny and the required asset security will go up. This will result in delays in refinancing and will push up the higher cost of borrowing. The cascading negative effect will be on execution of the development land bank. That in turn will generate more upward pressure on real estate firms` debt:equity levels. To give a sense of the downside impact of this negative dynamic, we analyzed the impact of a 100-200 bps rise in WACC to our model.

We expect a 10-20% correction in property prices

Developers will have to now rely more on internal business cash flows to service debt and improve execution. This will have to be funded by increased sales and new launches at attractive prices. We expect prices in metros to correct by 10-15% with Mumbai seeing a sharper correction at 15-20%. SEBI has already asked Mutual Funds to keep real estate companies under the “Negative List:“ for short to medium term liquidity. The RBI has increased risk weightages for retail housing loans above Rs7.5million. The only window which was left for developers to encash was Bank Financing and we expect this to now go through even more extensive screening and approvals.

Our view on stocks

We would recommend investors to look at low D/E equity companies with a focus on execution and reasonable product pricing. Though even in a bear case scenario of WACC was increasing by 200bps, our coverage universe offers healthy upside. We believe that tnhe recent 2G scam coupled with this Loan scam presents a good opportunity to enter stocks not exposed to these factors. HDIL (HDIL IN, 55% Upside) , Puravankara Project (PVKP IN, 60% Upside) and Orbit Corporation (ORB IN, 127% Upside) remain our top picks in the coverage universe.

Among the “Not Rated “ Universe we would advise investors to consider, Sobha Developers (for its D/E of 0.6x), Oberoi Realty (for being debt free and having surplus cash post IPO for land acquisitions), Prestige Estates (for Commercial exposure to the Bangalore market). We would advice investors to avoid DB Realty and Unitech until some clarity emerges on the 2G telecom investigation.

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