A strong foundation

IPO REVIEW

Though Bangalore-based Sobha Developers' IPO is priced dearly, it should bring decent long term returns.

From new-age buildings for corporates like Infosys and plush houses in Bangalore, Sobha Developers is one of the major South-based players in the construction and real estate business.

With a well diversified portfolio, integrated operations, substantial land reserves and foray into newer locations, this property player seems to have got the equation right. With real estate being the flavour of the season, Sobha Developers thinks it is the right time to raise funds from the capital markets.

Though some analysts feel the issue is aggressively priced, they are confident of Sobha's business model, aggressive management and earnings visibility. They advise investors to subscribe to the issue which promises to offer good returns in medium to long term.

Balanced portfolio
One of the leading Indian real estate players, Sobha Developers' portfolio boasts of residential, contractual and commercial projects, developed over 11.5 million sq ft during the past decade.

With 63 per cent revenues coming from residential properties, Sobha takes up contractual work to cushion its business from real estate cycles.

Realising the latent demand for posh corporate houses, Sobha Developers has made smart moves to take up contractual work.

The company has constructed 75 projects on a contract basis in eight Indian states covering 8.42 million sq ft. Sobha will develop 23 contractual projects for leading corporates like Infosys, Taj Residency, Hewlett Packard in states of Karnataka, Andhra Pradesh, Orissa, Tamil Nadu, Punjab and Maharashtra.

Sobha makes residential apartments, villas, row houses and luxury apartments with amenities like clubhouses, swimming pools and shopping complexes. It has developed 21 residential projects in Bangalore covering 2.98 million sq ft.

At present, Sobha is working on 15 residential complexes spread over 4.97 million sq ft and has planned another 13 projects covering 5.2 million sq ft.

Real value
Driven by the rapid expansion by corporates, the retail boom and rising aspirations of the burgeoning middle class, the Indian real estate business is expected to grow at a CAGR of 33 per cent through FY05-10. While 80 per cent of the demand will come from residential space, speedy pace of consumerism and business expansions will drive demand for contract builders.

The margins of leading real estate players stand high at 16 to 20 per cent in India against 6 to 8 per cent in other developed markets.

Moreover, with increased premiums for quality real estate, organised players making firm footprints in the highly fragmented property market are welcoming happy times.

Banking on land
Recognising the future potential of the real estate business and that developers have an edge over contractors when it comes to realisations, Sobha has been building its own real estate portfolio by creating a land bank.

The ability to spot emerging trends and potential land locations has helped Sobha to bag development rights in suburbs of tier-I cities and in tier II cities, ahead of competition.

The company plans to make top-end residential and commercial projects over owned land of around 118 million sq ft spread across seven cities, which is valued at around Rs 735 crore to 776 crore.

The development would take around seven to eight years. Sobha has also entered into land arrangements to procure about 117 million sq ft.

Integrated player
In an industry where outsourcing is the norm, Sobha Developers has in-house resources to deliver projects from conceptualisation to completion. The company constructs its own projects and undertakes interior and finishing works as well as manufacture of raw materials.

This integrated player has in-house architects, a concrete block making plant, an interiors and woodworks factory, a metal and glazing plant, all of which assure timely and quality raw materials supply.

Thus, Sobha can control cost overruns and enjoy good margins with no dependence on suppliers.

Having tasted success of its backward integration strategy, Sobha now wants to diversify its portfolio by entering into specialised service segments.

The company wants to build hotels, malls, integrated townships, shopping complexes, multiplexes and undertake plot developments. Forward integration would enable Sobha to provide products across the real estate value chain.

Bangalore blues
Sobha has constructed convention centres, software development blocks, multiplexes, hostels, and education and research centres for Infosys. About 83 per cent of its contractual projects were executed for Infosys across six states and further Sobha will be working on 13 future projects valued at Rs 299 crore.

Most of Sobha's revenues come from Infosys and though the tech major has big expansion plans, excess dependence may raise concerns. However Sobha's association with Infosys is also the key catalyst that will help this real estate maker to increase its contractual clientele.

With most of its projects based in Bangalore, Sobha Developers is exposed to risks of regional slowdown and having realised this, the company is acquiring lands in other regions to reduce risks. Sobha is expanding business in cities like Mysore, Hyderabad, Pune, Mumbai, Chennai, Goa and Jaipur.

A long term pick
Sobha Developers is coming out with a net public offering of 80 lakh shares, priced within band of Rs 550-640 each. It plans to raise between Rs 440 crore and Rs 512 crore, to fund land acquisitions (Rs 234.3 crore), loan repayments (Rs 132.2 crore) as well as ongoing ad planned projects (Rs 142.5 crore).

Sobha Developers' revenues have registered CAGR of 75 per cent through FY04-06 and stand at Rs 597 crore in FY06. During the same period, operating profit and net profit have grown at a CAGR of 175 per cent and 57 per cent respectively.
 

FANCY STRUCTURE
(Rs crore)	H1 FY07	FY06	FY05	FY04
Net sales	517.63	596.62	453.06	195.09
Y-o-Y growth (%)	105.65	31.68	132.23	79.40
Operating profit	84.76	109.66	53.59	14.46
Y-o-Y growth (%)	165.35	104.62	270.62	1492.51
OPM (%)	16.38	18.38	11.83	7.41
Net profit	53.97	89.23	33.85	8.88
Y-o-Y growth (%)	132.10	163.61	281.14	624.39
NPM (%)	10.43	14.96	7.47	4.55

With an annualised EPS of Rs 14.8, the FY07 valuations of Sobha Developers stand at 43 times at the upper end of the band and 37 times at the lower end.

Sobha's shares are priced at 45.9 times the FY06 earnings at the cap price and 39.5 times at the floor price. The FY06 valuations of peers stand at: BL Kashyap (31x), Ansal Properties (83x) and DS Kulkarni (19x).

Says Alok Agarwal, senior analyst, Motilal Oswal Securities, "Sobha Developers looks steeply priced and dearer relative to Parsvnath. But we can expect listing gains from the scrip, thanks to the euphoria over the real estate sector. However, considering the backward integrated business model and good margins, we are likely to see good gains from Sobha Developers stock over the medium to long term."

"We recommend subscribing to the issue and expect listing as well as long term gains from Sobha Developers. Given its management, good track record, quality projects and land reserves, we think Sobha Developers is a promising story. However, we see real value unfolding FY09 onwards, when its land reserves start generating cash flows," says Jaspreet Singh Arora, analyst, Anand Rathi Securities.

Issue opens: November 23
Issue closes: November 29