Realty company Prestige Estates Projects missed its residential sales target for the financial year 2015-16 by a wide margin. Its operating margin and debt-equity ratio deteriorated. Challenges such as a tepid residential market and regulatory approvals could continue impacting growth. However, lease rental income has been growing steadily, acting as a good hedge. Also, the company is expanding into new geographies and businesses. The stock is reasonably valued in line with its historical average. Investors can adopt a wait-and-watch approach, and hold the stock for now.

Big miss Prestige Estates is a well-known realty player in Bengaluru. However, the weak run in the residential market saw the company miss its sales target for new residential flats by a wide margin in 2015-16. As against the sales guidance of ₹5,750-6,000 crore for 2015-16, it managed only half that figure (₹3,150 crore).

During the year, launch volumes were 8.4 msf — lower by 30 per cent against the year’s target. Delay in regulatory approvals along with the inability to launch its projects in Chennai and Hyderabad weighed on the company.

The management has now put up a sales target of ₹4,000-4,500 crore of new residential sales for 2016-17, indicating a more conservative approach. It expects to achieve this on the back of 10-12 msf of new launches. However, the order by the National Green Tribunal in May 2016 could impact its constructions near lakes and wetlands in Bengaluru.

Deteriorating financials The company’s sales grew 38 per cent to ₹4,569 crore in 2015-16 but net profit was up just 8 per cent to ₹394 crore. During the year, margins took a beating — because of cost overruns in some of its projects. In 2015-16, operating margin fell to 24 per cent from 31 per cent in the previous year.

Its debt-equity ratio increased from 0.76 times as of March 2015 to 1.14 times as of March 2016. This was primarily due to the buyout of the private equity stake in Exora business park. Increased capex on leasing properties as well as fresh land acquisitions are expected to put further pressure on the company’s balance sheet, before revenue kicks in.

However, lease rentals have acted as a good hedge for the company. It grew 37 per cent in 2015-16 to ₹447 crore and currently contributes about 10-12 percent of its overall revenues– with the leasable area as well as rental rates – growing steadily over the years. The company plans to ramp up development of leasing properties. While a relatively stable business, it has to keep an eye on occupancy rates and lease rates.

The management expects overall rentals to increase to ₹616 crore in 2016-17.

Prestige Estates is diversifying into new geographies — Pune and Ahmedabad. While expansion beyond its core south (mainly Bengaluru) market could pay off, it entails risk of execution. The company also recently ventured into the competitive business of warehousing .

The stock is down 16 per cent in the last year and at the current market price of ₹188 seems reasonably priced. It is quoting at 20 times its trailing twelve month earnings, almost in line with the three year average of 19 times

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