INSIGHT: Unitech’s unreal rise

The share price of Unitech Ltd has gained 66.7% since September 1, 2006. The stock has been hitting the upper circuit for the last three days and closed at Rs 320.45 on September 27. The reasons can be partly traced to last week’s management presentation to investors disclosing details of various projects and their implementation schedule. The surprise element came in the form of the geographical split of its land bank, which - contrary to general belief - is well-spread across all regions and not restricted to the National Capital Region. The company also disclosed plans for its four multi-product and sector-specific special economic zones (SEZ). These revelations seem to have excited the market. CLSA has come out with a positive report and has estimated the net present value (NPV) of Unitech at Rs 429 per share - on the basis of 397 million square feet (MSF) of constructed saleable space, 65.7 MSF to be sold as plots (excluding SEZs) and a weighted average selling price of Rs 3,350 per sq ft.

But the market is obviously not differentiating between plans and their execution. Given growing protests over SEZs, the need for environmental clearance and permission for conversion of agriculture land to non-agriculture use, real estate investment experts do not rule out delays. CLSA estimates that every six months of average delay will change the NPV by Rs 35 per share.

Secondly, any significant increase in interest rates can also dampen demand for homes, which is a large contributor to Unitech’s revenues. Lastly, if real estate prices cool off from their current high levels, it will lead to lower profits for the real estate division, which accounted for 54.6% of total segmental profits in 2005-06. As per CLSA estimates, a 1% change in selling prices will lead to a 2% change in NPV per share. Rising real estate prices (during the last two years) have helped consolidated profit margins for the real estate division jump from 7.7% in 2003-04 to 22% in 2005-06. The construction division’s margins rose from 8.5% to 13% during this period.

Unitech’s plans, which involve completing most of its projects (excluding SEZs) by 2013, translate to construction of an average 66 MSF annually for the next seven years. Contrast this with the fact that the company has developed just over 10 MSF and about 1,000 acres in plots during the last 20 years. Also, compare this with 28 MSF of constructed area (residential, commercial and retail) delivered in Mumbai (including Thane and New Mumbai) and 20 MSF in Pune during 2005-06. Are the markets listening?

Basel II implications

Rules made in the Swiss town of Basel determine the ground rules for the way banks around the world account for the loans they give out. Essentially, these rules (called Basel I) tell banks how much capital they need to cover the risk that their loans might go bad. The problem with these rules is that they do not distinguish between better customers and risky ones within the same category. Thus lending to the Tatas may carry the same risk-weight as a small company that may go belly up anytime. This makes capital use relatively inefficient. Ideally, a bank lending money to a highly rated company should have to provide for less capital than for one which has a lower rating. Basel II, the new norms that banks will have to follow by the end of this financial year, will enable banks to make precisely this kind of differentiation. If done well, it should help them lend money cheaper to creditworthy companies compared to the rest.

In India, there might be some problem implementing a standardised approach to credit risk, since this means relying on external agencies for ratings. Currently, only 10% of the corporate exposure of banks is rated by external rating agencies. Hence, at least for starters, banks may end up applying Basel I weights (which would effectively means 100% weightage) for the remaining exposures. Basel II will benefit banks that have excellent internal information systems that allow them to differentiate one risk from another quickly. Banks like HDFC Bank and ICICI Bank are well-positioned to benefit from it compared to more bureaucratic state-run banks.