Realty's collateral damage : The Economic Times

Though there is no big cut in real estate prices yet, the slowdown in sales volume has started taking a toll on the associated sectors.

The significant slowdown in residential real estate market, which could last for a couple of years, is bad news for the entire economy.

“Since real estate and construction play a major role in economic activity and employment generation, the downturn will pull down the overall GDP numbers,“ says Sanjeev Prasad, Senior ED and CoHead, Kotak Institutional Equities.Given that protracted slowdown will have a seriously damaging effect on several sectors, companies and stocks, be cautious before you make your next investment.

After realty, building material companies--cement, steel, paints, etc--will be the worst affected due to a slowdown in demand, say experts. Banking and financial services companies will be the next in line as the real estate slowdown will push up their non-performing assets (NPA). And, finally, FMCG companies, that were riding on rural consumption, will also take a hit as the overall downturn impacts rural income. Let us take a closer look at these sectors and the companies likely to be most affected.

Real estate

Since most real estate developers operate in specific markets, how they are impacted will depend on the market dynamics of their region. “The Northern market is bad, Mumbai is also weak, just few pockets--Bengaluru and Pune--are reasonably strong,“ says Prasad.This means companies like Sobha will be relatively less affected because of their focus on Bengaluru.However, NCR-focused companies such as DLF, will see problems compound if the price correction in the region deepens. High debt is another problem faced by most developers and, therefore, companies with strong balance sheets, such as Oberoi Realty, will have an have an edge over peers.

Steel

For companies from steel sector, the Indian real estate slowdown has come at the worst possible time. This is because this global commodity is already facing problems on account of a huge over-capacity, especially in China. “In addition to the negative global demand-supply situation, the steel sector companies are also loaded with debt,“ says Phani Shekhar, Fund Manager, PMS, Karvy Stock Broking. Even as the government is trying to protect the sector by increasing the import duty, the recent devaluation of the Chinese currency, yuan, is going to worsen the sector's woes. In addition to dumping steel into India, Chinese companies will also snatch other export markets from Indian companies. Com panies like Tata Steel, which have large Euro pean operations, may continue to be under pressure for sometime.

Cement

The real estate slowdown has already started impacting the cement companies. As is visible from the cement production chart, domestic cement production growth has fallen to its lowest level in the past 10 years. Since there is a huge month-on-month production variation, we have used the six month moving average for calculating the year-on-year growth. However, unlike the steel sector, Indian cement companies don't have to fear about the Chinese dumping. “Cement is a localised industry because transportation becomes problematic beyond 250 km,“ says Shekhar.

Paints

Even though the paint sector will be impacted due to the slowdown, it will be relatively less worse off than the sectors mentioned before.There is a strong recurring demand in the decorative paint segment.The industrial paint segment is also expected to grow as demand im proves. Equally importantly, crude derivatives are a major part of the raw material for making paints, and the fall in crude prices will help paint companies reduce their cost of production. However, high valuation--Asian Paints, for instance, is quoting at 60-times its historical earnings per share--more than adequately factors in most of these prospects.

BFSI

Among the banking and financial services companies, not surprisingly, the housing finance segment, with its 100% exposure to real estate, will take the maximum hit.Banks too have a significantly high exposure to realty. As per the Reserve Bank of India data, banks have around 15% exposure to the realty sector. Experts say this could be much higher. “We estimate that the real exposure of the banking sector is higher--close to 25%--because SME loans are largely collaterised by real estate and agri loans,“ says Saurabh Mukherjea, CEO, Institutional Equities, Ambit Capital. Banks with high real estate exposure such as ICICI Bank will be the most impacted if these loans go bad.

Rural theme

Rural consumption is already down because of a very modest increase in food grains' minimum support prices--for two years in a row--and also because of a global fall in cash crop prices. “The rural wage growth problem is being compounded now because of a reverse migration as unemployed construction workers in the cities move back to the villages,“ says Mukherjea. As visible from the rural wage growth chart, wages are growing at their lowest rate in the past 10 years. Faltering monsoon, which is 10% be low average, as of now, is another factor that will reduce the rural income and torpedo the hopes of several companies which were banking on rural consumption.