Real estate and infrastructure companies

In simple terms

Real estate developers and infrastructure companies have something in common: they put large amounts of money, much of it borrowed, into projects that take years to complete and pay back. Their reported profit in any one year often says little about how the business is doing. Analysts look instead at the progress of projects, the cash they generate and the debt behind them.

Real estate developers

Why reported profit misleads

Many developers recognise revenue from a housing project only when it is completed and the homes are handed over to buyers. A developer may sell homes in a project over three or four years while it is being built, collecting money from buyers along the way, yet record all the revenue in the year of handover. So:

• Reported revenue reflects completions, not current sales.
• Profit can swing sharply depending on how many projects are finished in a given year.
• A strong selling year may show falling revenue, and a weak one rising revenue.

Better measures

Watch:

• Pre-sales (bookings): the value of homes or offices sold during the period.
• Collections: cash actually received from buyers. Bookings that do not turn into collections may be cancelled.
• Unsold inventory: completed or ongoing units not yet sold, and how many months of sales they represent.
• Land bank: land owned or controlled for future projects, its location, cost and how long it will take to develop.
• Net debt and cash flow, as developers often fund land and construction with borrowing.

Risks

Delays in approvals or construction, cost overruns, falling property prices, buyers cancelling, and debt that becomes hard to refinance. Developers with strong balance sheets can buy land cheaply in downturns; heavily indebted ones may be forced to sell.

Infrastructure companies

Concessions

Many infrastructure companies operate a concession: the right, granted by a government body, to build and run an asset such as a toll road, port, airport, power plant or pipeline for a fixed period, collecting tolls, tariffs or fees. At the end of the period, the asset usually returns to the government.

The value of a concession is the present value of the cash it will generate over its remaining life, as the present value lesson explains. Key questions:

• How long is left on the concession?
• What drives revenue? Traffic or usage (which can disappoint) or a fixed annuity or regulated return (which is steadier)?
• How are tariffs set and adjusted over time?
• What are the operating and maintenance costs?

Debt and execution

Infrastructure projects are usually funded with large, long-term loans, repaid from the asset's cash flows. Debt service coverage, the cash available to pay interest and repayments, is a key measure, as the interest coverage lesson explains. During construction, delays and cost overruns can strain finances before any revenue arrives.

Companies that build projects for others, engineering and construction firms, face different risks: winning contracts at sensible margins, collecting payments from clients, and managing working capital, which can be very large.

Valuation

• Net asset value (NAV): for developers, the value of land and ongoing projects, minus debt; for infrastructure holding companies, the value of each concession, minus debt.
• Discounted cash flow by project: forecasting each project's or concession's cash flows and discounting them.
• P/E is often unsuitable, because profit is lumpy or does not reflect cash.

Why it matters

Judging these companies by reported profit or P/E leads to poor decisions: buying after a year of many handovers, or selling after a quiet one. Their real risks, debt, delays and the economics of each project, need their own measures. Understanding them helps you see value that headline numbers hide, and risks they obscure.

Limitations

Operating measures such as pre-sales are reported by the companies and not always audited in the same way as the accounts. NAV and project DCFs depend on assumptions about prices, traffic and timing. Rules on revenue recognition, approvals and concessions are set by accounting standards and governments and can change.

Common mistakes

• Using P/E for developers with lumpy revenue recognition.
• Ignoring collections, and trusting bookings alone.
• Ignoring concession expiry when valuing infrastructure assets.
• Underestimating debt and execution risk.

Try it yourself

1. Choose a listed property developer and find its pre-sales, collections and net debt for three years from its investor presentations.
2. Compare these with its reported revenue and profit over the same years.
3. Choose a listed infrastructure company and note the remaining life and revenue model of its main concessions.
4. Write a sentence on which measures you would use to value each company.