Unitech: Building bubbles

Source: DNA Money

Real estate developers Unitech and Ansal Properties have reported impressive growths in revenues and profit for the year ended March 2006. Consolidated revenues of Unitech rose by 43% to Rs 893 crore, while Ansal Properties saw a 59% increase to Rs 367 crore. Unitech’s profit before tax and exceptionals jumped by 146% to Rs 139 crore, while Ansal’s pre-tax profit more than trebled to Rs 66 crore.

Given the valuations some of the real estate stocks enjoy currently, it was almost imperative that earnings grow at a fast pace. Unitech currently has a market cap of Rs 22,420 crore, which discounts its net profit of Rs 88 crore by over 255 times. Its market cap/EBITDA multiple is over 166 times. But, in order to justify such valuations based on the discounted cash flow method, the company’s earnings would have to grow at an average rate of 65% for the next 10 years. This is assuming, the company will maintain a dividend payout of about 20%, in line with the payout last fiscal.

It would be foolhardy to justify current valuations with the theory that earnings are expected to grow at such a fast pace for as many years ahead. It’s not surprising, therefore, that valuations of companies like Unitech are defended using other parameters such as the value of the properties owned by the company and those being developed to be sold at a later date. According to news reports, Cushman & Wakefield’s preliminary estimates put Unitech’s land and property holdings at between Rs 60,000 crore and Rs 1,00,000 crore.

Even if the valuation turns out to be at the lower end of the band, and assuming the market values Unitech at a 30% discount to its net asset value, there’s still a long way for the stock to go. But it needs to be noted that these valuations are based on current prices, which needn’t necessarily be in line with what the company actually realises when it sells its properties. In case the real estate boom in India turns out to be a bubble, the actual price realisations would be much lower.

Apart from this risk, it needs to be noted that Unitech has a relatively low floating stock, which brings forth the possibility that even the current rise in its share price could well be the making of a bubble.

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