Prestige Estates Projects: Losing ground - Sell

The stock of real estate player, Prestige Estates Projects, has run up 30 per cent since our ‘hold’ recommendation last July. Then, the valuation was reasonable, in line with its historical averages, despite the company missing its sales targets. The company was also a good bet on the Bengaluru market. However, its sales volumes in both the mid-income and premium categories of the residential market have fallen, raising concerns. Moreover, the slowdown in the IT sector looms large over the Bengaluru property market.

On the other hand, the stock has rallied sharply in the past few months, partially in the hope that the company would benefit from the consolidation expected from the implementation of the Real Estate (Regulation and Development), 2016 Act (RERA). At the current price of ₹245, the stock seems overvalued. It quotes at a price-to-earnings ratio of 38 times, as against the three-year average of 19 times. Even on a one-year forward PE basis, it quotes at 24 times the price-to-earnings, higher than its three-year average. Most of the positives seem to be priced in, with little scope for further appreciation in the near future. Investors can sell the stock.

Prestige Estates is a well-known realty player in Bengaluru. About 86 per cent of its ongoing projects are in the city, while the rest are from Kochi, Hyderabad, Chennai, Mysore and Mangaluru. In 2015-16, it earned 89 per cent of its revenues from the residential property business, while rental income constituted the rest.

In 2016-17, the company has been struggling to meet its new sales and volumes targets. It has achieved only about half its full-year target of ₹3,500-4,000 crore in new sales for 2016-17 in the first nine months, with demonetisation adding to the woes.

However, it has achieved 85 per cent of its full-year revenue recognition target of ₹4,000-4,500 crore, with many of its past projects reaching the 25 per cent threshold for recognition in the books of accounts. The company currently has about 32 million square feet (msf) of ongoing residential projects in the country, of which about ₹3,500 crore is expected to reach revenue recognition target in 2017-18.

But new sales have been falling consistently across mid and premium markets, indicative of the demand weakness, especially in Bengaluru. For the nine months ending December 2016, mid-income residential sales were down 15 per cent y-o-y to ₹1,097 crore. Premium residential sales were down 42 per cent y-o-y to ₹166 crore. During the period, overall realisations were up just 3 per cent to ₹6,211 per square feet.

Sales volumes were down 17 per cent y-o-y in the mid-income residential segment, while that of premium residential was down 56 per cent during the nine months ended December 2016. High inventory of the slow-moving premium houses is also a challenge. As of December 2016, premium and luxury projects accounted for a third of the overall stock for the company in terms of value.

Incremental demand remains poor for the residential market. With slowdown witnessed in the IT sector, the Bengaluru residential market could feel the pinch.

The silver lining is the growing rental income, up by 26 per cent y-o-y to ₹404 crore in the first nine months of 2016-17. While commercial rental income is growing, it is not big enough to make a significant difference to the company’s financials.

Moreover, the company is facing margin pressures. Cost overruns and increasing employee costs have impacted its operating margin during the nine months ended December 2016. Operating margin was down to 21.7 per cent as against 27.1 per cent the previous year.

In 2015-16, net sales were up 38 per cent y-o-y while net profit was up 6 per cent. However, during the nine months ended December 2016, sales were down 20 per cent y-o-y to ₹3,300 crore while net profit was down 67 per cent to ₹180 crore.