By Param Desai, Mihir Salot (Angel Broking)

Rationale for our Neutral view

- Unique business model: Godrej Properties Limited (GPL) intends to develop its projects through joint development agreements with land owners. Under this asset-light model, GPL will enter into revenue, profit or area-sharing agreements with land owners, instead of an outright purchase of the land. This model avoids direct land dealings for GPL and the locking-up of extensive capital in land. Around 80% of GPL's existing land bank will be executed through joint developments with partners.

- Illustrious Parentage: The Godrej brand name has been associated with quality and strong corporate governance. Both of its existing listed entities, Godrej Consumer Products and Godrej Industries have given CAGR Returns of 48% and 77%, respectively, to investors since 2001. We believe that GPL could leverage its parentage brand (with respect to access to the land at Vikhroli and a strong customer preference towards it), assuring a timely delivery of execution.

- Projects skewed towards long-gestation townships: More than 50% of GPL's existing land bank is exposed towards township projects and in one location (Ahmedabad), which will be executed over the next ten years. Any delay in this execution or a fall in property prices in Ahmedabad will impact our NAV estimates, as 50% of our NAV is derived from this project.

- Too early to discount Vikhroli land: The Maharashtra government has repealed the ULCA (Urban Land Ceiling Act), with the intention of creating more, low cost housing. As per media reports, GPL could get access to a substantial portion of land parcels in the central suburbs of Mumbai. The management intends to create a model similar to the Bandra-Kurla Complex, once it has access to large tracts of land in the central suburbs. However, confusion over the repeal of the ULCA still prevails, as the BMC (Brihanmumbai Municipal Corporation) is yet to finalise a way to ensure whether the land belongs to the builder or the Government. This confusion would be ended once the ULCA provides the BMC with a list of its holdings. We believe that due to a lack of clarity, it is too early to discount access to land for GPL in our one-year forward NAV.

- Fairly Valued: Our fair NAV for GPL (based on its existing land bank) works out to Rs469/share. Around 50% of the NAV is derived from its township project in Ahmedabad. We have factored in a 5% price escalation from FY2011E onwards in the construction and capital value for all its residential projects from the current levels, and a 5% correction in Rentals in FY2011E, but a 5% increase from FY2012E onwards for all its commercial and retail projects. We believe that the IPO is fairly priced and keep a Neutral view on it. However, investors can look at alternate, existing listed players like Anant Raj, which have a debt-free balance sheet, land at prime locations and is trading at a significant discount to our one-year forward NAV.

Company Background

Godrej Properties, a subsidiary of the renowned Godrej Industries, is involved in developing residential, commercial, retail and IT projects across the country. GPL is part of the legacy established by the Godrej Group, which has proved its mettle in several businesses over the past  112 years. The commitment to creating value for its investors is evident from the fact that the two group companies (Godrej Industries and Godrej Consumers Products) listed on the Stock Exchanges have delivered CAGR Returns of 77% and 48%, respectively, to investors since 2001.

Land bank details

So far, the company has developed a total of 23 projects, comprising of 16 residential and seven commercial projects, aggregating to an area of approximately 5.1mn sq ft. GPL's total land reserve currently stands at 391 acres, translating into a saleable area of 50.2mn sq ft. Around 50% of its saleable area is coming from the Ahmedabad township project, which will be executed over the next ten years. The outstanding land payments towards the acquisition of 391 acres currently stand at Rs293cr, which will be paid through the IPO proceeds.

Mix of Land Reserves

GPL is in the middle of a swift transition, in terms of the contribution of its land reserves to the overall product portfolio. A0s it began with a focus on residential sector, around 3.9mn sq ft of its completed project pipeline came from the residential sector. However, the contribution break-up of ongoing projects paints a different picture, as commercial projects comprise of around 11.4mn sq ft of the total 32.1mn sq ft. The forthcoming projects mark a substantial shift in GPL's portfolio, as nearly 11.4mn sq ft of the total 18.1mn sq ft shall be contributed by the commercial segment.

Concrete Business Strategy

The relatively established players in the Real Estate business possess an edge over GPL in terms of a larger acreage of land reserves (with the same being bought at relatively lower average acquisition costs over a period of time). In order to match the size of such players, GPL would have to commit a huge amount of capital to build up substantial land reserves, which would also involve a long pay-back period after development. However, to counter the same, GPL has devised a unique strategy, whereby it intends to develop its projects through joint development agreements with land owners. Under this asset-light model, GPL will enter into revenue, profit or area-sharing agreements with land owners, instead of an outright purchase of the land. This model avoids direct land dealings for GPL and the locking-up of extensive capital in land. Around 80% of GPL's existing land bank will be executed through joint developments with partners.

IPO Details

GPL is coming out with an IPO (fresh issue of 0.94cr shares) in the price band of Rs490-530 a share. The company proposes to use the issue proceeds for acquisition of land development rights for upcoming projects, construction of upcoming projects, repayment of loans and to meet working capital requirements.

Rationale for our Recommendation

Improving demand scenario

The Real Estate Sector in India is now on a gradually improving curve, with new projects being launched and the liquidity position of developers improving, on the back of QIPs and proposed public issue offers. This has been strongly supported by the Government's policies, which allowed housing loans to individuals carrying a risk weightage of 50% to be increased from Rs2mn to Rs3mn, and allowed for the rescheduling of bank debt without it being classified as a NPL. Over the last six months, listed companies have raised US $3.5bn through QIPs and the issuance of warrants. Further, US $3bn would be raised from proposed IPOs hitting the markets in early 2010. According to Cushman & Wakefield, the forecast for pan-India commercial office space stands at 196m sq ft, while retail space demand stands at 43mn sq ft for 2009-13. The demand for the Hospitality and Residential Segments is estimated at over 690,000 room nights and 7.5m units, respectively, over the mentioned period. We expect the demand for Commercial and Retail Segments to pick up in 2HFY2011E, owing to a renewed interest from companies, allowing these segments to catch up with Residential.

Too early to discount Vikhroli land

Currently, Godrej & Boyce has leased 36.5 acres of land for a period of 99 years, commencing from April 2010, to Godrej Industries, which, in turn, has given development rights to GPL. Under the current agreement, GPL intends to develop residential, commercial and retail, where it will  share 40% of the overall profit with Godrej Industries. As per media reports, it seems that GPL could have additional access to 2,000-3,000 acres of land in the central suburbs of Mumbai, with a repeal of the ULCA. We have not factored in such land bank addition in our NAV calculations, due to a lack of clarity from the Maharashtra Government (with respect to ULCA).

Projects skewed towards long-gestation townships

Fifty percent of GPL's land bank is derived from its Ahmedabad township project, which is of high gestation as it will be executed over the next ten years. Any delay in this execution or a fall in property prices in Ahmedabad will impact our NAV estimates, as 50% of our NAV derives from this project. Generally, township projects are of long-gestation, and require residential, educational,  medical, community, commercial or institutional buildings, and the creation of the required facilities of roads, water supply, water treatment, sanitation and sewerage systems.Historically, in an economic downturn the execution of township projects is the worst-affected.

Other Investment Concerns

Fall in property prices

Property prices fell 20-50% across India in FY2009. However, in the last six months, prices have increased 5-20% from their bottom, especially in Mumbai and Delhi. For valuation purposes, we have assumed a 5% increase in the Residential prices, and a 5% decline in the Commercial and Hotel rentals in FY2011E (from the current level), with a 5% increase thereon. Thus, a greater-than-expected correction in the prices will impact our NAV estimates.

Delay in recovery of non-reidential segments

Forty-five percent of GPL's saleable area is non-residential (i.e. commercial and retail). The company intends to adopt a lease model for these assets. The property market slowdown in FY2009 resulted in a decline in asset prices and rentals by 20-40% across India, along with lower occupancy levels. However, owing to softening Interest rates and the improving Employment outlook, a surge in demand was witnessed in the Residential Sector, unlike that in the Non-Residential Sector. Historically, it has been seen that demand in the Non-Residential Sector lags improvement in the economy. Besides, around 70% of the demand for commercial space comes from the IT/ITES Sector. Our interaction with industry participants indicates that leasing inquiries have improved, with the overall IT/ITES Sector looking at expanding its employee base. We have assumed recovery in the Non-Residential Segment in 2HFY2011E, but any delays will impact our pricing assumptions.

Valuation

Our fair NAV for GPL (based on its existing land bank) works out to Rs469/share. At the lower and higher price band, the IPO will trade at a 4-12% premium to our one-year forward NAV. Around 50% of the NAV is derived from its township project in Ahmedabad. We have factored in a 5% price escalation from FY2011E onwards in the construction and capital value for all its residential projects from the current levels, and a 5% correction in Rentals in FY2011E, but a 5% increase from FY2012E onwards for all its commercial and retail projects. We believe that the IPO is fairly priced and keep a Neutral view on it. However, investors can look at alternate, existing listed players like Anant Raj, which have a debt-free balance sheet, land at prime locations and is trading at a significant discount to our one-year forward NAV.

We have used the following framework to arrive at our One-Year forward NAV

- We have assigned a 14% WACC and a 10% capitalisation rate.

- We have factored in a 5% price escalation from the current levels from FY2011E onwards in the construction and capital value for all its residential projects. Hence, we have valued the company's Residential Segment at Rs432cr, translating into Rs62/share.

- We have factored in a 5% correction in Rentals in FY2011E, and a 5% increase from FY2012E onwards. Hence, we have valued the company's Commercial Segment at Rs1,690cr, translating into Rs242/share.

- We have assumed that its Ahmedabad township project will be executed over the next ten years. Hence, we have valued the project at Rs2,235cr, translating into Rs320/share.

Industry Scenario

Residential Segment: Surge in New Launches

According to Cushman & Wakefield, the pan-India demand for the residential segment is estimated to be approx 7.5mn units by CY2013. This is expected to be contributed by almost all the segments, including Economically Weaker Sections, affordable, mid and luxury segments. However, going forward, around 85% of the total demand is likely to arise from the affordable and mid-luxury segments. It is estimated that the top seven cities (Bengaluru, Chennai, Hyderabad, Kolkata, Mumbai, Pune and NCR) would account for ~4.5mn units of the cumulative demand by CY2013, of which 43% is expected to be contributed by Tier-I cities, Bengaluru, Mumbai (estimated demand of 1.6mn units) and NCR.

We have seen a demand pickup in the first half of FY2010 on account of new launches at discounted prices and improved liquidity, thereby attracting investors. We expect prices to remain stable atthe current level, with a further rise in 2HFY2011E as the demand starts to pick up. The demand in the Indian residential segment has consistently outpaced the supply, owing to India's favorable demographics and a higher growth in disposable income.

Commercial Segment: Rentals to stabilise

The office supply in India has reduced, owing to a delay in execution, on account of subdued demand and a liquidity crunch for developers. The overall vacancy rates are in the range of 11-13%, due to a reduced occupier demand and the lack of pre-commitments resulting in increased availability. We believe that rental values are likely to stabilise across all micro-markets, owing to a renewed interest from companies. According to Cushman & Wakefield, the pan-India demand for office space is estimated to be approximately 195mn sq ft by 2013, with 80% of the growth being contributed by the top seven cities. Among these, Tier-II cities (like Hyderabad, Kolkata and Pune) are expected to grow at a CAGR of 28% over 2009-2013. Bengaluru is estimated to retain its top slot in the commercial market, with a cumulative demand of 38mn sq ft, mainly from the IT/ITES segment. Mumbai and NCR are expected to follow, with a cumulative demand of approx 25mn sq ft each over 2009-2013.

Retail Segment: Still hurting

The slowdown in demand and reduced absorption has forced developers into rescheduling the completion time of their projects, with some even reconsidering their development plans. The fall in retail rentals is the highest among all real estate segments, due to a high vacancy in the existing developments over the last one year. Rentals form 6-10% of the Revenue for retailers like Pantaloon and Shoppers Stop, and 10-15% for foreign brands. The demand slowdown has coincided with a significant supply of malls. We believe that retailers are likely to continue renegotiating rentals at the prevailing values, to attain a more sustainable level. According to Cushman & Wakefield, the pan-India demand for the retail segment is estimated to be around 43mn sq ft by 2013, with the top seven cities contributing nearly 34.6mn sq ft. Tier-I cities are expected to comprise nearly 45% of the cumulative demand, with cities like Bengaluru, Mumbai and NCR collectively contributing 20mn sq ft of the demand. As per Investment Commission of India estimates, the share of organised retail is likely to grow to approximately 15.5% by 2016, from the current 5%.