Factored In Negatives

Brigade Enterprises (BEL) is a Bangalore-based developer focused on housing for the middle- and upper-middle income segments. Though it has traditionally been a Bangalore-focused developer, in recent times it has expanded into other South Indian cities such as Mysore, Hyderabad and Chennai.
Its ongoing projects can be divided into residential projects of around 6 million square feet (msf) which are complete or are nearing completion, and another 3 msf (at its flagship Gateway and Metropolis projects) of commercial and hospitality projects. BEL also has additional planned development of 29 msf in South India. The company has five subsidiaries. The first is Brigade Hospitality Services Ltd, which manages its clubs, service residences, and convention centres. It is the only profit-making subsidiary: it made a profit of Rs 75 lakh in FY10. Brigade Tetrarch is into sports-related activities while Brigade Estates and Projects, Brigade Properties, and Brigade Infrastructure & Power are all real estate developers.
BEL also has a 50:50 joint venture (JV) with Classic Valmark (a group of land owners). The JV is called BCV Developers and it aims to develop 120 acres of land in Devanahalli, Bangalore.

Positives
Important projects nearing completion. BEL delivered four residential projects and two commercial projects in FY11. According to the company’s management, it will complete 3 msf of projects — Brigade Gateway at Malleshwaram and Brigade Metropolis at Whitefield — in CY11. Soon the company will begin to earn lease rental from these projects. Moreover, North Star Office, which has got the status of World Trade Centre (WTC), has commenced leasing its office premises.
The company’s management has informed that it will launch another 9 msf over the next 12 months. Key projects like Devanahalli and Kanakpura townships will be launched in the second half of the current calendar year.
Inventory to decline. With many of its projects nearing completion, the company’s inventory is expected to decline in FY12. Almost 80 per cent of the space is leased out in its key asset Orion Mall, even though it will be operational only in Q3FY12. About 25 per cent of WTC have been leased out, with rental income expected to begin flowing from Q2FY12. The 230-room Sheraton Hotel at Gateway became operational in Q1FY12 and rental income from it will further add to the company’s future cash flow.
Sale of hospital assets. In Q3FY11, BEL reported the sale of its hospital asset at Brigade Gateway Project at Malleshwaram for Rs 123.10 crore. It has used a part of the sales proceeds to pay off about Rs 60 crore of its outstanding debt. This one-time income generation will also boost the company’s cash holdings, which at the end of FY10 stood at Rs 30.67 crore.

Concerns
Concentration risk. BEL has a total land bank of 32.2 msf of saleable projects (excluding the ongoing projects), of which two-third is in Bangalore. This concentration of land bank at only one place makes the company particularly susceptible to state- or region-specific risks. Moreover, the property market is very region-specific. In the past also, it has been seen that even though the overall property market may be doing well, the market in a specific state or region could be depressed. This overwhelming dependence on Bangalore, especially in a sector as volatile as real estate, increases BEL’s risk profile.
Excessive reliance on IT/ITES. Being a Bangalore-centred company, its prospects are closely intertwined with the outlook of the IT/ITES sector. Most of the demand for both its commercial and residential projects emanates from IT/ITES companies and their employees. This excessive reliance on the IT/ITES sector is a matter of concern.
Concentration on middle-income segment. Most of the residential launches of the company are targeted at the middle-income segment. During boom time, this strategy played out very well as this segment has got both the affluence and the desire to own property. But the problem is that this is the most competitive of all segments and most real estate players compete in this space. BEL is now attempting to address this problem by launching Brigade Value Homes.
Rising inventory. The company’s rising inventory level is a matter of concern. This is quite a common phenomenon among real estate companies. Their reluctance to increase sales by reducing prices is resulting in high inventory levels. The lowest inventory days (this measure shows how long it will take for the company to turn its inventory into sales) of BEL was 152.38 in FY07. Since then inventory had more than quadrupled progressively to 555 by the end of FY10. Simultaneously a low and declining inventory turnover ratio, 0.66 versus its own five-year average of 1.38 (it shows how many times the inventory is sold and replaced in the given period), reflects our earlier concern that the company might be holding on to its inventory. But with the real estate market in Bangalore having recovered from its slump and the expected completion of some its bigger projects, this ratio is expected to come down in future.
High interest expenses. Till FY10 the company had an interest obligation of Rs 71 crore on outstanding consolidated debt of Rs 766 crore (Rs 654 crore standalone). Hence its interest as a percentage of debt stood at 9.27 per cent while interest as a percentage of cash flow from operations stood at 68.72 per cent. Moreover, in FY11 the company’s total debt (consolidated) went further up to Rs 923 crore (Rs 780 crore standalone). The sheer quantum of debt servicing cost dents the company’s attractiveness for investors.
Low return on investment. The way the company’s management has managed capital leaves a lot to be desired. After the company successfully raised Rs 648 crore at the end of 2007 from the public, its return on capital employed has been on a downward spiral. Currently it is languishing at 3.61 per cent (FY10) compared to a peak of 43.38 per cent (FY07).

Financials
Even though the sector as a whole is in crisis, BEL has been able to get some of the basics right. It has got a decent five-year annualised sales growth of 16 per cent and EPS growth of 14.49 per cent. After a drop in performance in FY09 and FY10, its FY11 performance shows promise. Both its sales and profits have gone up, with profits touching a five-year high of `119 crore. After languishing at 10.4 per cent for the last two years, its operating margins have improved to 35.9 per cent, beating its peak performance of FY08.
But fundamentally the company has a weakness that the management must address soon to allay investors’ concerns. BEL currently has an interest payout as a percentage of debt at 9.27 per cent (FY10) while its return on capital employed is 3.61 per cent (FY10). These numbers are unsustainable in the long run. They imply that the company has borrowed capital at rates that are higher than what it is earning from it. From shareholders’ point of view it is basically depleting value.

Valuation
BEL’s issue price at the time of listing (December 2007) was Rs 390, and currently it is trading at Rs 68.25, which translates into an absolute capital erosion of 81 per cent at an annualised rate of (-)37 per cent. Hence the question now is: does BEL’s current pricing take into account the fundamental flaws of the company?
Currently the company is trading at a price-to-earnings ratio (P/E) of 5.81, way below its median P/E of 18.27. The price-earnings to growth (PEG) ratio of the company stands at 0.58. Moreover even comparing its historical (median) price-book value (P/B) of .58, BEL is currently trading at a discount of 52 per cent.
Analysts at Edelweiss Research estimate that the company will grow its bottomline at a CAGR of around 23 per cent between FY11-13. The current low valuation of BEL indicates that its current price indeed factors in the shortcomings of the company. Given its positive prospects, investors looking for an exposure to the real estate sector may invest in this stock while bearing in mind the risks involved.