Improved valuations, falling debt make Sobha Ltd a good long-term bet
Updated on 28 Sept 2016
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With just a 1% year-on-year increase in net profit, Sobha has disappointed the market with its numbers for the first quarter of 2016-17. Sale of its land at Hinjewadi, Pune, at a low price is one of the reasons for this performance-the disputed land's sale, however, has resolved litigation issues.

A 2% margin contraction because of the transition to the new Indian accounting standards (Ind-AS) beginning 2016-17 is another reason for this. The impact will be more pronounced in the real estate developer's joint ventures and joint development agreements. However, analysts are getting bullish on the counter because it has become free cash flow (FCF) positive during the quarter and is expected maintain this in the coming quarters. Sobha has also reduced its debt using the proceeds from the Hinjewadi land sale. Its net debt-equity ratio is now placed only at 0.8-times.

The company is expected to go slow on new land acquisition and on development of commercial projects and, with this, its net debt is expected to come down further. With the real estate market still stagnant, the company plans to reduce new launches and to focus more on monetising the current inventory. This should help its operational metrics in 2016-17.
Sobha can be termed as a best-in-class real estate company in terms of execution. And, since it is mostly in the residential market, it should benefit from the cyclical recovery in demand- as and when it happens. Dream Acres, a mid-income project in Bengaluru, continues to deliver good sales even in a weak market scenario, and Sobha plans on launching additional phases there.

To reduce its concentration risk in Bengaluru, the company has diversified operations to other cities such as Gurgaoan, Chennai and Kochi.
Having underperformed the market by 17% in the last three months-stock fell 9% compared to an 8% rise in the Sensex- valuations have improved now.

It means most of the near term pain has already been factored-in the price and, therefore, it is a good long-term bet. However, investors should note that its margin will remain under pressure in second quarter also because of increased sales and advertising costs linked to new launches.

The volatility in profits due to Ind-AS adjustments will also continue throughout 2016-17. However, these adjustments will not have any impact on cash flows or on its balance sheet.