On less risky terrain

On less risky terrain
The Hindu Business Line, July 19, 2009, Page 11

'Fortune favours the brave' - this Latin proverb may well sum up the changing fortunes of Unitech as well as the high risk-return proposition that may be awaiting the prospective investors of Unitech.

Unitech's unremitting efforts to tide over a precarious state of high leverage, high receivables, plunging sales and low cash during the realty slowdown of the last one year seem to be paying off. Among the larger players, we believe that Unitech has been most proactive in combating the slowdown. There are signals that these efforts would translate into a healthier balance sheet that is low on debt and a more sustainable earnings stream for the company, though margins may moderate.

Investors with a three-year investment perspective can consider buying the stock of Unitech on declines linked to broad markets.

Investment strategy

At the current market price of Rs 76 the stock trades at 10 times its earnings for 2008-09. Note that even the FY-09 earnings were aided by reasonably good performance during the first half of that fiscal. This may not be sustained in the current financial year. The valuation only gets marginally expensive at 13 times its expected FY-10 earnings, factoring in an expanded equity base and revenue from new launches accruing over the next couple of years. An investment in the stock, at this stage, could still hold uncertainties. Even as Unitech has done well to tackle company-specific issues, the macro concern over the pace of recovery in realty still remains a matter of conjecture. A longer investment time-frame may, therefore, be needed.

The trials

While smaller realty companies took the first hit from the realty slowdown, it wasn't long before players such as Unitech were also impacted. Unitech has traditionally been high on leverage. However, comfortable revenue growth rates ensured that debt was serviced. Lower sales volume as well as rapid drying up of funding avenues - visible from September 2008 - spelt trouble. By December 2008, the company's receivables galloped to Rs 1,345 crore from Rs 750 crore in March 2008. Debt increased by over Rs 2,000 crore to Rs 10,900 crore during the December quarter, with higher number of near-term repayment schedules. Sales volume, meanwhile, plummeted over 85 per cent in the above quarter. Added to this, rumours of the company defaulting on payments, made fund raising extremely difficult.

The efforts

Unitech, unlike its peer DLF, was in a more difficult spot then, as it was more highly leveraged than the latter. As bank credit and customer advances - the key sources of working capital - started drying up, the first positive for Unitech's came in the form of a stake sale in its telecom venture - Unitech Wireless. While the inflows from the sale came at a later date, Unitech's consolidated balance sheet received some relief as a part of the debt for the telecom business was shifted from its books.

The next relief came in the form of debt restructuring package allowed to banks by corporates. These events, despite providing some respite to the pressurised balance sheet, did not free up cash for the launches (mostly middle income housing) that the company was resorting to. It was then that Unitech went on an asset monetising spree, selling its hotel and office spaces, freeing up at least Rs 650 crore of cash. The monetising initiative is still on, with the company negotiating to offload more hotel properties.

Unitech was also one of the fist companies to capitalise on the turnaround in the equity markets through two quick successive rounds of qualified institutional placements, through which it is reported to have garnered about Rs 4,400 crore. Besides, the company's first's QIP at Rs 38.5 per share left much on the table for investors; this smart strategy led to a successful second QIP offer. Unitech's debt at Rs 7,800 crore (as of May 2009) and gearing of 1.5 are likely to come down further to these measures. The company has also issued warrants to a promoter group company.

The above de-leveraging/fund raising measures are not only likely to reduce the debt burden significantly, but also ensure execution of projects taken up. In the process, Unitech has also unlocked value from non-core businesses such as telecom (the company is also said be negotiating to sell its tower manufacturing business) thereby lightening its balance sheet as well as conserving resources for the core realty business.

Business strategy

Meanwhile, to revive sales volume, Unitech had resorted to shifting focus to middle-income housing. It stalled many commercial projects where the demand scenario was abysmal and instead concentrated on the residential space. Prices too were slashed by as much as 25 per cent.

While the effect of this was tepid in the March quarter, the company has sold about 3.2 million sq.ft of the close to 14 million sq ft of area launched since April 2009. To put this in perspective, the company sold 3 million sq. ft of properties for the full year ending March 2009. If the company is able to sell properties at the pace at which it has in recent months, the volumes may provide some cushion for the lower realisations from selling mid-income housing/discount properties.

The challenge for Unitech, is in keeping the volumes ticking for at least the next six-nine months not only to grow its revenue but also to revive its working capital cycle. For this, the nascent recovery visible in real-estate may have to be sustained. The near term concern is that the equity expansion of over 40 per cent (excluding warrants) may dilute the earnings over the next one year.

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Surprisingly, Unitech has managed a better show than most other larger players for the full year ending FY-09. While revenues declined by 30 per cent to Rs 2,890 crore net profits contracted 26 per cent to Rs 1,198 crore. Operating profit margins expanded marginally to 55 per cent.

Going forward, with an average land cost of about Rs 200 per sq ft, OPMs may gradually contract to 40 per cent unless the company is once again able to command better pricing power. Any improvement in commercial project off take may also support profit margins.