DETAILED ANALYSES OF

SECTOR-SPECIFIC LEVERS
WHICH DRIVE THE
COMPANY

About the article

The article is to elucidate different factors, macro-economic variables, sector-specific
parameters which drive a company’s operations based on different sector it
operates in. The article tries to uncover the idiosyncratic drivers for different sectors
and correspondingly its companies too. While lesser emphasis has been laid on the
financial parameters such as EBITDA or PAT growth, more significance has been
given to operation metrics which influence and underpin the financials. The article
focuses more on the qualitative aspects than the quantitative ones. Where possible,
a few reference numbers have been added to reduce subjectivity and enhance
understanding. Some of the sectors are pretty large and diverse; the article tries to
focus on the segments with higher market-cap and greater influence on economy.
While the listed factors are in no way exhaustive, an earnest attempt has been made
to cover all the ‘high-impact’ ones. The article covers five sectors – FMCG, Oil & Gas,
Aviation, IT and Realty in this part; there will be more parts to follow post this
covering other sectors.
 1. FMCG
As Indian economy continues to grow between 7% – 7.5%, private consumption (household
spending on the goods and services) which accounts for ~60% of GDP is keeping our growth rate
ticking. The growth of the FMCG sector is in many ways the barometer of the private consumption
and forms the cornerstone of Indian consumption story. Unlike the discretionary expenditure which
is more cyclical, these tend to be more stable. Based on end use, the FMCG industry can be broadly
categorised into:

• Food and beverages,

• Personal care and
• Healthcare

The key driving factors for growth of FMCG sector are rising incomes, growing youth population,
increasing brand consciousness, introduction of GST helping the organised players and under-
penetration of branded products. Brand strength of a product or company is valued very highly in
this industry.

Volumes | Prices
The growth of an FMCG company’s top-line, in value terms, is led by two legs – Price Growth and
Volume Growth. A study conducted by Nielsen, a marketing research company demonstrates a
gradual transition from price-led to volume-led growth in the last five years, as the companies are
focussing more on keeping their prices low (companies are resorting to reduce grammage while
keeping the price point same) to penetrate more and increase the sales volume. Besides, volume
growth is also an indicator of upbeat consumer sentiment and demand.

Source: Business Standard (December 2018)

Hence, volume growth is one parameter investors need to look at closely while a company reports
its quarterly and annual numbers. Investors also need to look at the average product price hikes and
if these are adequately compensating for the increase in input prices, else the margins will take a hit.
A consistent double-digit volume growth and a 4-5% price hike forms an ideal case for investing.
Distribution Network
Distribution network is the cornerstone for sustainable growth in the FMCG industry. Given the
under-penetration of the branded products, gradual rise in per capita income and growing demand
for quality goods and services, FMCG companies are enhancing their distribution network with
special focus on in the Tier- III, IV cities and rural areas. Improvement in the distribution networks
augurs well for the volume-led growth of the company. So, the investor presentations and annual
reports need to be examined to understand the growth in distribution network of the company.
Also, there are some companies which are weaker in certain regions like Britannia which has a low
presence in Hindi speaking belt. In these cases, investors should also look at how the company is
improving its footprint in these under-penetrated areas.

Meanwhile, there is a trend of democratization of the branded/premium products by providing

them in smaller packages at cheaper price range of 5Rs, 10Rs etc. to tap into the low-ticket
consumer segments and gradually up-trade them. This also helps in sustaining the volume growth of
the company.

Company Retail Network (in mn.)

Britannia 4.5
HUL 6.6
Nestle 3.9
ITC 4.5
Godrej Consumer 4.5
Dabur 5.4
Colgate 5.1
Parle 5.7
Source: Company reports, 2017

Another trend which has been lately catching up in the companies is the rise of direct distribution
network i.e. the companies circumvent the intermediate wholesalers and reach the retailers
directly. As the wholesalers were grappling with GST transition issues, companies started reaching
out to retailers directly through expansion of their in-house direct distribution channels. Although
this increases the distribution cost, companies such as Britannia and ITC (both of which have ~30%
direct distribution network) have reported its positive impact on sales and reduction in inventory
levels after adoption.

Rural Segment
Rural segment has been one of the key growth engines for the FMCG segment in India. According to
Nielsen report, rural segment has grown at a pace 3-5% higher than the urban counterpart because
of low base, government initiatives to boost the rural per capita income (farm and non-farm) and a
near-normal rainfall in recent years. Now, rural segment contributes to ~40% of the overall sales and
is gradually increasing its share in the overall FMCG sales pie. So, clearly this is one segment that all
the FMCG companies are focusing on to ensure robust growth.

However, the caveat remains the excessive dependence of this segment on agriculture; hence extent
of rainfall, crop production and their prices dictate the rural demand considerably. Investors need to
keep a close watch on rainfall forecast/commentary by met agencies to get a heads-up of the
impending rural demand.
 Source: Mint (April 2019)

New Launches
To meet the growing demands of the consumers who seek novelty, best available
technology/materials, best healthcare products and the like, FMCG companies have to come up with
new product launches to stay in top of the game. New launches can also help to diversify a
company’s product portfolio or tap into a new consumer segment. Given this context it is important
for investors to keep track of the company’s launch pipeline in the next 12 months and how the
products launched in past 1-2 years are faring (in terms of their contribution to revenue). Investors
need to assess company’s R&D facilities and expenditure (as % of revenue) via-a-vis its peers. Higher
R&D spends point towards the management’s foresight to conceive and develop products for the
future, stay relevant through innovation and ensure long term value creation for the company. Also,
management commentary needs to be watched to understand the margins of these new products.

Another trend which has been doing rounds is the premiumisation. Given the rise in consumer
health consciousness and propensity to pay, companies are launching premium products with better
features offered at a higher price point. This is a welcome trend as these products invariably offer
better margins to the company.

Other Key Monitorables

• Capacity utilisation and addition
• Marketing spends
 2. Energy | Oil & Gas
India is the third largest consumer of energy. Oil consumption has grown at 4.78% CAGR in the last
10 years to reach 4.69 million barrels per day(mbpd) in the year 2017 (Source: ibef). Given India’s
low production of oil and therefore high imports, oil plays a huge role setting economy’s inflation,
current account deficit (CAD) and fiscal deficit (FD).

The Oil & Gas industry supply chain can be broadly classified into 3 segments:

• Upstream (Exploration and Production)

• Midstream (Transportation) and
• Downstream (Processing and Refining)

Since, India imports most of its crude oil and there are only a couple of companies (ONGC and OIL)
operating in pure-play upstream segment, the article focusses mainly on the downstream segment
i.e. Refineries/Oil Marketing companies (OMCs), which are some of the industry and market heavy-
weights and are therefore widely tracked by analysts.

Gross refining margins (GRMs):

It is the spread between the buying price of crude oil (input) and the average selling price of finished
goods (output) after refining i.e. the amount company earns by turning each barrel of crude oil into
finished refining products.

GRMs are a function of a refinery’s complexity. Complexity is the ability of the refinery to convert
low quality cheaper crude into higher valued refinery products and fuel. GRM will be higher if the
refinery produces more of higher valued products such as LPG, Petrol, Naptha etc. GRM also
depends on oil consumed to produce finished goods and refinery losses. Complexity is measured
using the parameter Nelson complexity index (NCI). Usually, refinery with an NCI > 10.0 is regarded
as a complex refinery. Not surprisingly, most of the PSU refineries which were set up decades back
with erstwhile technologies have lower GRMs, while the private companies such as Reliance with
state-of-the-art complex refineries have higher GRMs. Higher GRMs are reflective of higher margins
and therefore accentuate company’s superior operational performance. Analysts usually benchmark
these GRMs to Singapore GRM which is basically the average of GRMs of major Asian refiners; GRMs
consistently beating the Singapore benchmark are desirable.

GRM comparison of Indian OMCs

Singapore GRM: Dec’17 – 7.2$/barrel, Dec’18 – 4.4$/barrel
Source: Business Standard (February 2019)
Any discussion on GRM would be incomplete without discussing Inventory losses/gains. The
changes in crude oil price from the time crude oil is purchased and shipped to the time it is refined
into finished goods and delivered for marketing is significant. Since the price of the finished goods is
directly linked to the on-going crude oil price, the company can make loss/gain if the crude oil price
has reduced/increased during the refining phase. This loss/gain is termed as Inventory loss/gain. This
does have an impact on the GRM based on magnitude of loss/gain. A point to be noted here is these
losses/gains do change every quarter based on the price trends of crude (which again has a cyclical
nature since it’s a commodity) affecting company’s corresponding earnings for that quarter only and
hence does not have a substantial impact for the company from a long-term perspective as the cycle
plays out.

Refer to Annexure 1 for refinery capacities and NCIs of downstream entities

Marketing margins:

In India, most of the PSU refining companies – HPCL, BPCL and IOCL, refine and also market the oil
i.e. they refine the crude oil and sell the products through their outlets (through dealers), hence are
called oil marketing companies (OMC). Together these three OMC company outlets constitute more
than 90% of the entire market. Here’s where marketing margin comes to the fore. Marketing margin
is the difference between the price at which product is sold to dealer and the price at which it is
purchased from the refinery. Since, these OMCs are govt. owned PSUs and finished goods such as
petrol and diesel affect the public directly, marketing margins are monitored by Govt and there have
been instances of government intervention to reduce these (when crude oil peaks) thereby
adversely affecting the margins. Gross marketing margins are also affected by macro conditions as
explained in the subsequent section.

Retail selling price

VAT
Dealer commission
46.82
Excise duty
Price charged to dealers
6.92
1.43 Price paid by OMCs to refineries
10.66

27.81
Marketing margins

25.51

Note: Numbers used just for illustration

Refinery throughput:

The company’s capacity for refining crude oil over a period of time is another metric to look at.
Usually, Indian refineries operate at a near 100% capacity utilisation, given the high demand. Higher
throughput is indicative of higher processing capability and hence higher output volumes. In this
context, keeping track of the capacity addition (in terms of both - capacity in MMTPA and
improvement in complexity brought about by the new capacities) – planned and under development
is vital, since this provides visibility to the future revenue and earnings growth.
Brent crude | Exchange rates:

Since most of the downstream companies import crude from abroad, investor need to stay abreast
of the prevailing Brent crude oil (benchmark) prices, demand-supply outlook (with special focus on
OPEC commentary) for the crude and potential macro/political shocks. Naturally, a rising crude oil
trend is favourable for upstream companies, unlike their downstream counterparts.

Another equally important factor to watch out for is the exchange rate, since a falling rupee will only
aggravate the input costs to purchase a barrel of crude oil in rupee terms (usually these companies
are completely hedged). Due to worsening crude oil and exchange rate, the input cost increases,
however the selling prices of the final products do not increase by the same magnitude, thereby
compressing their marketing margins. Further, extent of revenue earned through exports needs to
be watched for in the annual reports, as this provides a natural hedge for the worsening exchange
rates.

Other key factors:

Companies such as RIL, BPCL are into upstream segment too; vertical integration thus provides them
a hedge against the fluctuation in oil prices – scale of vertical integration in terms of crude oil output
and their capex need to be closely watched.
 3. Aviation:
Although aviation in market cap terms (with only three listed players) appears miniscule, yet the
sector’s consistent mid-to-high teen growth and the sheer potential – with reports quoting how
Indian aviation market is touted to become world’s third largest market by 2024 (Source: Ibef)
makes it too important to miss. Besides, the share of travel and tourism to GDP stands at ~10% and
hence assumes importance. This sector remains closely tracked by analysts. Low domestic
seats/capita, high economic growth, decreasing differential between air and AC rail fares,
government initiatives such as UDAN to improve penetration into Tier III and IV cities are some of
the macro factors supporting aviation growth in India. Interestingly the metrics and parameters used
to gauge an airline performance are quite different.

Broadly, across the world there are two business models which are followed:

• Low cost carrier (LCC): Operates with single-class seat configuration, uses least possible
number of aircraft models, point-to-point connectivity model, provides minimal services - charges
for everything from on-board meals to priority check-in. Eg. Indigo, SpiceJet, Air Asia, Go Air
• Full service carrier (FSC): Operates with multiple classes configuration, uses a combination
of narrow and wide body aircrafts, hub-and-spoke model, provides free services like in-flight
entertainment, on-board meals and beverages and priority check-in, higher baggage allowance. Eg.
Air India, Jet, Vistara

Although in India, due to the tight cost structures and smaller price differential between the two,
differences between the two business models are not so rigid as definition suggests and is gradually
diminishing with the introduction of flexible pricing (based on services provided).

Capacity addition | Load factor:

To tap into the rising passenger demand, Indian players have been adding aircrafts at a pace like
never before and have a huge order book of >800 aircrafts. The capacity addition is measured using
the parameter ASK (Available seat kilometre) – one seat flown (empty/full) for a kilometre. Investor
should keep a close watch on the ASK YoY growth numbers. ASK can increase by addition of new
aircraft in fleet or increase in aircraft utilisation - hours an aircraft flies in a day. Bearing in mind the
pax (passenger) growth rate that India is witnessing in recent years, a near 20% or even higher ASK
growth would be desirable as the airlines utilise the rising demand to garner higher market share.

Aggressive capacity expansion or even improper utilisation of existing fleet could lead to deployment
of aircrafts in routes where there’s not enough demand to fill the aircraft capacity. Here’s where PLF
(Passenger load factor) – percentage of aircraft seats filled with passengers assumes significance.
Higher PLF is indicative of fleet being deployed in routes with sufficient demand against the aircraft
capacity. A rising ASK with consistently reducing PLF is not a good sign. PLF > 90% is usually a good
number. Investors should look for the management commentary on the airline’s plan for new
capacity addition; a gradual induction of new aircrafts into its fleet is often preferred.
 Airline Fleet size Orders Market Share PLF
Air India 150 13.1% 80.8%
Air Asia 20 5.9% 87.5%
GoAir 48 113 9.9% 91.4%
IndiGo 221 398 46.9% 86.0%
Jet* 115 5.8% 87.0%
SpiceJet 76 257 13.6% 93.0%
Vistara 21 62 4.2% 86.8%
Source: Wikipedia, DGCA; Note: Market share and PLF are March’19 figures; *Jet fleet size not updated

Utilisation | Age of fleet

Aircraft utilisation is measured by the average time the aircraft flies per day. Higher utilisation
indicates quicker turnaround, more time in air and therefore greater revenue generation per
aircraft. Aircraft utilisation of 12-13 hrs/day is decent for an airline.

Another factor affecting maintenance costs is the average age of airline’s aircraft fleet. Higher the
age, greater will be the frequency of maintenance checks and it will incur higher cost on repairs, thus
increasing the overall cost of maintaining the aircraft. A fleet with an average age close to 5 years
will be ideal.

Impact of crude | Exchange rate:

Aviation fuel or aviation turbine fuel (ATF) constitutes 30 - 40% of total cost and is the most
important factor affecting the airline operations. Hence, investors need to keep a close eye on crude
oil trends and outlook. Usually, crude oil prices above 75$/barrel is conceived to be a red flag and
further increase in crude prices will only push the airline into losses.

Along with crude prices, investors also need to monitor exchange rates closely. Since, crude oil
prices and airlines lease rentals are denominated in foreign currency, any depreciation of rupee will
adversely affect airline cost of operations denting its margins. Given this dependency of earnings on
crude oil and exchange rate, analysts usually perform sensitivity analysis of airline EBITDA for several
scenarios considering different crude oil and exchange rates.

Cost | Revenue

Airline operational costs are measured using the metric CASK (Cost/ASK = total operating expenses /
total ASK) – average cost of flying an aircraft seat (empty/full) for one kilometre. The three major
heads constituting the CASK are: Fuel costs, Leasing costs and others.

Airline revenues are measured using the parameter RASK (Revenue / ASK = total revenues / Total
ASK) – total operating revenue per seat (empty / full) flown for one kilometre.

The difference between the revenue and costs i.e. RASK – CASK is the net airline profit realisation
per ASK. The greater the difference between the two, greater will be the airline earnings. The
average of difference value i.e. RASK – CASK of greater than 0.5 Rs. forms an ideal case; however,
the actual value fluctuates a lot depending a lot on crude prices.
Airline Revenue = Pax revenue + Ancillary revenue

Ancillary revenue is the revenue from non-ticket sources such as baggage fees and on-board food
and beverage services. It forms an important revenue source for the LCCs. Ancillary revenue
contribution to overall revenue of more than 10% is desirable, with a similar or better pace of
growth than that of total revenues.

At this juncture, let’s decrypt more some jargons, which investors may find in the earnings
presentations.

RPK (revenue passenger kilometre) – One RPK is created by a paying passenger flying a kilometre.
Meanwhile, ASK is created by a seat flown for a kilometre. Therefore, RPK/ASK also constitutes load
factor.

Revenue per passenger is measured by passenger yield. Yield is given by Pax revenue/RPK. Higher
the yield, more the passenger pays for flying a kilometre thereby improving airline earnings
(assuming cost remains the same). Higher average fare per passenger (another parameter quoted by
few airlines) is also indicative of higher yields. Naturally, FSCs will have higher yields and RASKs
when compared to LCCs as they provide greater number of services.

Airline RASK CASK RASK – CASK

Jet 4.12 4.63 -0.51
SpiceJet 4.05 3.96 0.09
IndiGo 3.4 3.3 0.1
Source: Company presentations; Figures pertain to the period Q4FY18

Current state of Indian Aviation:

With the fall of Jet, Kingfisher and several other smaller airlines, several questions have been raised
if Indian aviation is a good place to be, despite being such a high growth market. The problem has
been the predatory pricing followed by the airliners as a result of the price-sensitivity of Indian
passengers. While lower ticket fares are pretty much alright in a low crude environment, but as the
crude prices shoot up, the cost increases much more than what the airliner increases the fare by as
he fears of losing his load and consequently his market share. This ultimately affects the airline
margins and first victims to fall in this downward spiral would be the FSCs. Their business model of
operation intrinsically demands them to charge a premium for the extra services they offer, but
Indian market being what it is the price differential between LCC and FSC is barely substantive to
cover for the added costs. This along with the fact that the cost of operating and maintaining a
multi-model aircraft fleet and lower loads of business/first class only make things worse for FSCs.
Hence, they operate on very thin margins and are usually the first ones to end up in red when crude
prices hit the roof. The chart above reflects the same with Jet being the only airline with negative
RASK – CASK. In the face of high uncertainties while operating in this sector, a strong balance sheet is
always sought after so that the airline can endure any stresses in the near future, and benefit from
consolidation if any airline goes down.
4. IT:
IT is widely considered as the bellwether for Indian services sector and contributes ~7.7% to
country’s GDP. With index heavy weights such as TCS, Infosys and others which have a presence
across the spectrum of market-capitalisation, the sector assumes great importance for the markets.
The article focusses mostly on the IT service companies who derive majority of revenues through
business process management, consulting and software products & engineering services segments –
a significant amount of each is earned via outsourcing. About ~75% of the entire industry’s revenues
are generated from overseas through exports.

Deal Activity:

Total contract value (TCV) and annual contract value (ACV) of the deal wins are the key
monitorables in the quarterly reports declared by the company. TCV represents the total value of
the deal for the account (client) whereas annual contract value is the recurring average annual value
of the deal. TCV and ACV are very crucial parameters since they give visibility into the future revenue
growth. In this context, the guidance given by the companies during their earnings release assumes
importance as they reveal their growth and margin expectations for the next fiscal. It is through this
margin forecast that we can understand the margin profile of the new deals (if they are margin
accretive or not) and overall macroeconomic conditions affecting the industry.

Revenue productivity | Employee expenses:

IT companies are evidently asset-light unlike their manufacturing counterparts who have huge capex
into physical assets. These companies gain their competitive advantage from human capital;
consequently, employee cost forms the biggest head under the company expenses. They are
typically in the range of 70-75% of the total expenditure. Therefore, productivity of employee holds
the key to improve company’s operational performance. This can be measured by measuring the
metrics – Revenue/employee and employee cost/revenue. This industry is also subject to high
attrition rates which leads of erosion of skills and knowledge capital. Attrition rates of close to 10%
is desirable.

Tech
Parameters TCS Infosys Mindtree Hexaware
Mahindra
Revenue (in INR mn) 1231040 705220 307729 54628 46477
Employees 394998 204107 78304 17723 16205
Employee cost 663960 388930 166240 35641 24799
Rev/Employee 3.12 3.46 3.93 3.08 2.87
Employee cost/Rev 54% 55% 54% 65% 53%
Source: Company reports

Digital revenues:

The world is moving towards digitalisation with digital transformation initiatives through adoption of
technologies like AI, Cloud computing, blockchain etc. As the fastest growing market and huge
market opportunity, digital revenue as percentage of overall revenues and YoY growth rates of
digital revenues are parameters to keep a close eye on. Currently for the larger IT companies, they
constitute >30% of their revenues and their share is continuously moving northwards. Investors
should watch out for companies with a digital growth rate of 35-40% YoY; companies with higher
digital growth are well poised to capture a higher market share in future. In this context, investor
presentations, management commentary and annual reports can be referred to know more about
how the company is re-skilling their employees with new technologies to build these technologies
in-house.

A trend which has been catching up is the gradual shift towards fixed-price contracts and
consequent decrease in pricing power for the IT firm. This in turn worsens the operational efficiency
of the firm. Hence, a move towards digital services and automation which offer non-linear medium
for growth of firm by increasing revenue realisation per employee is sought after by the firms.

Another trend observed in the industry is the growth through the inorganic route via acquisitions.
Indian IT companies are making strategic acquisitions of smaller firms globally to bring their skills
(mostly digital) in-house, thereby improving their capabilities and serve their clients better.

Revenue distribution:

The revenue breakup in terms of verticals – BFSI (largest vertical), Retail, Manufacturing etc and
growth of each vertical needs to be tracked to give more granular picture of how each revenue
stream is evolving. For most of the companies, >90% of revenues originate from outside India.
Hence, exchange rate plays a major role here and assessing the P&L heads in constant currency (CC)
terms will paint a sharper picture of growth. Due to large exposure to overseas markets, tracking the
global macros can give a heads-up for the IT sector growth outlook. It is also desirable to have wider
geographical distribution of clients to diversify risks arising from economic slowdown.

Improvement is desirable in extent of account mining i.e. extracting greater revenue opportunities
from existing accounts by monitoring metrics - incremental revenue growth across top 10 accounts
and revenue/account. Deeper penetration of existing accounts demonstrates nurturing of client
relationships. Assessment of increment in number of clients under each ticket size (viz. $100M+,
$10M+ etc.) helps in understanding revenue trends under each bracket; the higher the growth is
under larger ticket sizes, the better it is.

A superior delivery mix – in terms of higher % of revenue generated from offshore is always sought
after. By having greater resources in India vis-à-vis abroad, the cost of human capital comes down,
improving the operational margins.

Geographical Tech
TCS Infosys Mindtree Hexaware
distribution Mahindra
America 54% 60% 47% 69% 78%
Europe 28% 24% 30% 21% 13%
India 6% 3% 6% 3% 3%
Rest of world 12% 13% 18% 6% 7%
Source: Company reports
 5. Realty | Real estate:
Real estate is a very important sector owing to its interlinkages with economy and financial markets.
It has a very special role to play in India since ~80% of Indian savings are invested into real estate
(Source: Report of the Household Finance Committee, 2017). With the recent government
regulations, Government push for “housing for all” and new market instruments such as REIT, InvIT,
real estate has again come on everyone’s radar after a dull spell. Since residential and commercial
segments together form the largest chunk of the real estate asset market in India, article will mainly
focus on the key factors affecting these segments.

City of operation | Market:

A market study of the cities in which the realtors have assets is very crucial. An understanding of the
idiosyncratic markets of each city of operation is needed for both – residential and commercial
segments. This is because the local market forces operate very differently in every city. The following
market parameters need to be considered for every city:

Commercial: Lease rentals, vacancy levels, absorption (leased property in million sq. feet - msf),
inventory (unleased property), expected supply in next 2-3 years.

Residential: Capital value (quoted in Rs/sf), inventory, launches and sales (both in msf), sales
distribution in different ticket sizes (<25L, 25-50L, 50L-1Cr, >1Cr), Quarters to sell (time needed for
sales of unsold inventory in entirety)

Most of these parameters can be referred from Real estate analyst reports (Collier, JLL, Knight &
Frank, Crisil)

Source: Knight Frank report for residential segment

Residential segment:
Sales and Launches:

Area sold and the area of new launches in msf are the important parameters for investors to keep
tabs on (available in earnings presentations). While area sold indicates the current performance in
terms of number of units sold and average size of each unit, new launches provide visibility into
future revenue. Investors should keep a close eye on the sales performance/bookings of the
launched projects (under various stages of completion) and recently completed ones. With respect
to the cities where new projects have been launched, investors need to take cognisance of how
market factors/parameters (discussed above) are playing out.
For the residential segment, it is also vital to understand which specific segment from low-income
group (<50L), middle-income group (50L-1Cr) and high-income group/luxury segment (>1Cr) are the
projects targeting and how the response for that ticket-size is in that market. Note: There is no clear
definition of these segments, there ticket sizes are just for reference.

Joint development agreement (JDA) is another trend catching up among the developers. JDA is a
contract between the land owner and developer wherein the land-owner transfers his land to
developer in return for certain percentage of units from the project. The developer’s share of
units/area is important in this context.

Inventory - area of unsold property is another key monitorable. The residential market in India
continues to be in stress in India with the value of unsold units reaching ~1L crore rupees for the
listed players in our country (Source: Liases Foras). While a trend of decreasing inventory is
desirable, in case of inventory build-up, investors need to probe into the reasons for the same to
understand if its a temporary phenomenon. Analysts keep a close eye on the management
commentary for the unsold inventory, especially the older ones, as the asset value depreciates with
passage of time. Few companies also give guidance about the expected annual bookings (sales) for
the next 1-2 years

Execution:

Robust execution of the planned and launched projects is the key to short working capital cycle and
quick revenue generation. Hence, the execution timeline of the projects needs to be monitored with
regard to the management guidance in investor/annual reports. Since construction sector is subject
to a lot of regulations and formalities right from land acquisition stage to obtaining several approvals
at different stages of construction, projects may get delayed and hence superior execution
capabilities assume significance. Management commentary on status of pending projects needs
close scrutiny by investors. A weak balance sheet with high D/E levels is a strict no since company’s
liquidity concerns can stall the projects under construction.

Realisation per sq. feet:

Concomitant to the increase in the area sold and revenues, increase in sales realisation, in rupee per
sq. feet terms (Total revenues earned from sales of flats/Total area sold) is desired. This signifies
greater revenue realisation per sq. feet and therefore an increase in capital value of a unit. A 5% YoY
increase in realisation is decent. For better understanding of the realisation and sales trends
forward, the real estate analyst reports can be referred for different markets and micro-markets
(sub-city level demarcations) where the projects are launched or under construction.

Commercial segment:
Commercial assets have a different business revenue model as opposed to their residential
counterparts. After development, commercial developers lease their office assets based on their
contracts (usually long term) and receive annual rentals just like an annuity. Hence, they’ll recover
their capital expenditure gradually instead of an outright sale as in the case of residential assets.

Occupancy levels

Occupancy levels of the commercial assets, a proxy for capacity utilisation indicates the strong
demand for the office space among customers, translating into higher annual rentals from the
property. In fact, few of the marquee companies such as Prestige have a near 100% occupancy rate
reflecting their strong brand value. In metro cities, a strong demand has been observed for Grade ‘A’
office spaces – the premium ones with good infrastructure, access etc. Hence, it is desirable to have
more Grade A assets as part of company’s commercial portfolio, which is the case for bigger
companies.

Supply | Demand | Rentals

Supply pipeline (new projects launched/under development measured in msf), their location and
expected completion deadline are very important monitorables for a developer. Typically, a project
after completion, takes about 3-4 years to achieve full occupancy. Demand/absorption trends and
outlook in the markets also needs to be checked for. Naturally, a tight supply vis-à-vis demand in the
markets where there are upcoming projects translates to lower vacancy levels and higher rentals
consequently. Vacancy levels of 5 – 7% or less and rental appreciation of 5% YoY in the markets
forms an ideal case.

Industry macros

Demand for commercial space is closely linked with business cycles. Since IT/ITes and BFSI constitute
more than 50% of the demand for commercial segment, growth of these sectors needs to be closely
monitored. A proxy for this could be sector’s hiring numbers. A pickup in employment numbers is a
sign of optimism for future business prospects and could eventually result in occupancy of bigger
offices.

Land
Most of the realty developers have land parcels with them for future expansion. Assuming no
projects have been launched on this land, they have to be valued separately. The valuation of the
land has to be done using the prevailing market prices which could be obtained from analyst reports.

Valuation
For valuation of property stocks, DCF/NAV method is preferred in the industry. The different
segments – Residential, commercial and land need to be valued separately based on their individual
future cash flows, capex, debt levels etc. and are added up to arrive at fair value of the company.
Using earnings multiple may not make sense here due to the intrinsic volatility in the earnings from
property. However, if DCF methodology of valuation is not possible for some reason next best bet
would be using a price to book multiple, since book value/net asset value (based on which valuation
is done) of the company can be reasonably stable unlike earnings which can be volatile and lumpy.
For relative valuation with peer group companies, PB ratio is used.

6. Banks | Finance:
Already covered in a previous report
 ANNEXURES
Annexure 1

Company Refinery Installed Capacity Nelson Complexity

(1.02.2018) Index
(MMTPA)
IOCL Barauni (1964) 6 7.8
Koyali (1965) 13.7 10
Haldia (1975) 7.5 10.4
Mathura (1982) 8 8.4
Panipat (1998) 15 10.5
Guwahati (1962) 1 6.7
Digboi (1901) 0.65 11
Bongaigaon(1979) 2.35 8.2
Paradip (2016) 15 12.2
IOCL TOTAL 69.2
CPCL (Chennai Manali (1969) 10.5 5.7
Petroleum) CBR(1993) 1 7.9
CPCL-TOTAL 11.5
BPCL Mumbai (1955) 12 5.4
Kochi (1966) 15.5 5.88
BORL (Bharat Bina (2011) 6 5.97
Oman Refinery
Limited)
NRL (BPCL JV) Numaligarh (1999) 3 -
BPCL-TOTAL 36.5
ONGC Tatipaka (2001) 0.1 -
MRPL Mangalore (1996) 15 6.5
ONGC TOTAL 15.1
HPCL Mumbai (1954) 7.5 8.1
Visakh (1957) 8.3 7.7
HMEL (HPCL JV) Bathinda (2012) 11.3 6.63
HPCL- TOTAL 27.1
RIL* Jamnagar (dta)(1999) 33 11.3
Jamnagar (sez)(2008) 35.2 14
EOL Vadinar (2006) 20 11.8
All India 247.6
Contributed by:
Venkat Samala,
PGP 2017-19,
IIM Bangalore
Email: venkatkkr2@gmail.com
Follow me on:
https://www.linkedin.com/in/venkat-samala-56066843/