The Hindu Business Line : Sobha Developers: Invest at cut-off

As the income from current projects is likely to get bunched up only from FY-08, investors may need to consider a long time horizon of two to three years while investing in this stock.

MR P. N. C. MENON (right), Chairman, Sobha Developers Ltd, with Mr Ravi Menon, Vice-Chairman. — Paul Noronha

Investors with a high-risk appetite can consider investing at cut-off in the initial public offer of Sobha Developers (Sobha), a real-estate player. Strong growth in the residential and commercial space, steady contractual projects from IT giant Infosys, and a healthy land bank are the key positives for the company. Unlike the recent IPO by Parsvnath in the realty space, Sobha can at best be termed a South-based player, with Bangalore being its key revenue contributor. Thus the company carries the risk of geographical concentration. High dependence on a single client in the contract segment adds to the risk profile.

Sobha's present and prospective revenue segments, however, appear to offer relatively better visibility to earnings growth than its peers whose revenue streams are ridden with uncertainties from new ventures such as special economic zones. In the price band of Rs 550-640, the price earnings multiple is 19-22 times the company's likely FY-08 earnings on a diluted basis. As income from current projects is likely to bunch up only from FY-08, investors should be willing to hold with a time-horizon of two-three years.

Profile

Sobha is a real-estate developer with income from residential and contractual projects. The company has 2,747 acres reserves (close to 70 per cent of it in Bangalore) and additionally land arrangements, which are contractual, or on a joint development basis. Sobha plans to use the proceeds of the offer to finance land acquisitions, for construction and development of existing and proposed residential projects and repay some loans.

Changing business mix

Sobha Developers is a core player in the residential space and has completed over 25 projects in Bangalore. The current and future projects indicate that the company proposes to capitalise on this core strength. The company has 10 million square feet of ongoing and forthcoming projects in the residential segment, which is likely to add about Rs. 2000 crore to the top line in the next couple of years.

Revenue from this space has gone up from 40 per cent of total turnover in FY-04 to 63 per cent in FY-06. This has come about through a reduction in the proportion of contractual projects.

We consider this a healthy trend; for one, operating profit margins (OPM) are superior in real-estate development than contract to build.

Two, Infosys being the chief client contributing to the contractual segment, Sobha's risk profile is magnified by dependence on a single client for revenue. We view this change in mix as a move towards reducing risk and improving margins. The OPM, for instance, has jumped to close to 20 per cent in FY-06 from less than 10 per cent in FY-04.

The contract segment may see further diminution if the company is successful in its plans of building malls, multiplexes and integrated townships. An agreement with Reliance Energy for a consortium mooted by the Andhra Pradesh Industrial Infrastructure Corporation for development of a business district and trade towers appears to be a move towards diversifying its revenue stream.

Backward integration model

In the listed space, Sobha's backward integration model may be termed as unique, as it has in-house resources to deliver a project from conceptualisation to completion. This includes having its own concrete block making plant, woodwork and metal glazing factory. While it is true that a number of delays in projects in this industry can be attributed to sub-contracting, the latter may well turn out to be an economical proposition in some activities.

While Sobha is better equipped to finish projects on time, it may have to contend with price threats from competitors who can economise through sub-contracting. This issue may have appeared less significant so far, as most of its residential apartments belonged to the luxury category where quality and class often take precedence over price. The company has, however, ventured into its `dream series' of more affordable apartments, where pricing may prove the key variable.

Sobha's top line has grown at a compounded rate of 75 per cent over the past three years, with earnings surging by 320 per cent in the same period. While we are sanguine about the prospects of the company, we expect the future growth to be far more sedate.

In the contractual project space, Infosys still contributes 83 per cent to the segmental revenue. While the company's ability to retain this client is commendable, the skewed revenue nevertheless heightens risk. Land acquisition-related problems in Karnataka (where the company chiefly operates) is another risk factor to reckon with.

Offer details: The initial public offer is open from November 23-29. The company seeks to raise Rs 490-570 crore through this offer. Kotak Mahindra Capital and Enam Financial Consultants are the book-running lead managers. IL&FS Investsmart is the co-book running lead manager.

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