Indiabulls Research has recommended buy rating on Unitech with target price of Rs 600. The stock is trading at a forward P/E of 25.3x FY08E and 13.6x FY09E.

Indiabulls report on Unitech:

Wealth Creator

Unitech Limited (Unitech), the second largest real estate company in India, is in the purchase and development of real estate. It is the leading player in the NCR and Kolkata markets with a total land bank of 10,900 acres and development rights of 540 millionn sq. ft. Unitech believes in ‘Develop and Sell’ model focusing primarily on the residential segment with appx. 70% share of total revenues. Currently, the company is focusing on suburbs of Tier I cities and is sitting on a huge land bank in Tier II cities to tap future growth. With a continued focus on residential segment and increasing presence in commercial, retail, and hospitality segments of real estate the company is in a strong position to tap the rising real estate demand.

The company posted an exceptional rise in net sales for FY07 of 255% driven by huge residential demand and rising property prices. We expect the growth to slow down from the high level of FY07 as rising interest rates will affect demand in the short term; however we anticipate rise in demand by the end of FY08 or beginning FY09.

Net profit is expected to grow at a CAGR of 54.6% over FY07-09E; however margins are expected to reduce from 39.7% in FY07 to 30.3% in FY09E due to restriction on cheaper overseas borrowings.

The stock is trading at a forward P/E of 25.3x FY08E and 13.6x FY09E. We initiate coverage with a Buy with target price of Rs 600 for FY08. Our target price is based on FY08 P/E of 29x and NAV estimate. Our valuation does not include the potential upside from SEZ business, due to lack of clarity on the plans and uncertainty on regulatory issues.

Investment Rationale

Strong residential demand - future growth driver

The residential sector is projected to have a demand of 80 to 90 million dwelling units over the next 10 to 15 years, primarily driven by the rising middle and lower income groups, decreasing household size, urbanization and increasing mortgage penetration. The company has appx. 25 million sq. ft. of residential projects under construction and 120 acres of land area designated for upcoming residential projects. Considering the fact that nearly 70 percent of the current revenues of the company is from the residential sector and with the continued focus on residential sector, we believe that the company will strongly benefit from the huge residential demand.

Spurt in Commercial real estate demand, driven by IT & ITES industry

GDP of India has historically grown at an average rate of 8% for the past 3 years driven by booming service sector which contributes more than 50% to the GDP. The growth in service sector is primarily driven by IT/ITES sector which is driving the demand for office space in Tier I and Tier II cities. Unitech’s expertise in commercial land development and strong relationship with global leaders who are occupants of its developed property will help it occupy a major share in the commercial retail space market. Currently, 21 million sq. ft. of IT space is under construction by the company.

Increasing presence in the Hotel Industry

The hotel industry is expected to witness strong growth which is reflected by the demand – supply mismatch and rising occupancy costs; demand is expected to outstrip supply by 100% over the next 2 years. The company is targeting hotel development as an integral part of real estate projects. Currently, the company has land available for developing 27 hotels/ services apartments. It has also signed an agreement with Marriott for 832 rooms in the next three years and is in talks with additional properties with Marriott and other hotel chains. The company’s focus will be on the development and construction of hotels and the management will be transferred to international operators. We think this is a prudent business strategy as it will help in maintaining focus on the core business activities and thus maximize returns.

Key Risks

Further tightening of Interest rates
Increase in scope of Service tax coverage
Restricting overseas borrowings
Change in FDI regulations
Rise in cement and steel prices
Delay in completion of planned projects
Overall decline in Indian economy

Outlook

Real estate is expected to grow at a rate of 30% p.a. driven by strong GDP growth, rising middle class, rapid urbanisation, easy availability of credit and improving transparency. With the recent rise in interest rates and tightening of liquidity the growth is expected to slow down in the near term; however, in the long term the sector will continue to grow. The company with its capital efficient business model, strong land bank acquisition strategy with continued focus on residential segment and substantial land reserves in Tier I and Tier II cities is well positioned to tap the growing opportunity in real estate market. We expect that the company’s strong brand equity and consistent track record will enable it to command a premium over its peers. Based on the relative valuation (FY08 P/E 29x) and NAV estimate we value Unitech at of Rs 600 per share and initiate coverage with Buy.