The further growth of developers’ share prices is not justified, unless profitability

improves

In 2008 the ‘WIG-Developers’ Index (comprising Polish and foreign developers’ shares)
declined from around 4,790 to around 1,288 points. The stock market hit bottom on 18
February 2009, when ‘WIG-Developers’ Index fell to around 1,150 points. Today the
‘WIG-Developers’ index has rebounded to approximately 2,800 points.

The share prices of Polish developers listed on Warsaw Stock Exchange have been
rising continuously since the beginning of March 2009, the opposite of what was
witnessed last year. Can we assume further growth of share prices for this sector? The
best way to objectively assess if a further increase is justified is the financial analysis.
Our analysis is based on financial statements, and the most recently published ones are
as of 31 June 2009. We have excluded from our examination foreign developers.

The net asset valuation method provides a lower limit of the value of a company, as it
values a company taking into account the value of its assets. Even if a company
discontinues its operations, the assets can be sold and thus generate cash. The Price/
Net Asset Value ratio (P/NAV) is obtained by dividing current market price of a share by
net asset value attributable to this share. It shows the relationship between market
capitalisation and the accounting value of the company analysed.

As of 31 August 2009 the average P/NAV ratio for 11 Polish developers stood at 106
percent. This means that average market price of developers’ shares is higher by 6
percent compared with the net asset value attributable to those shares. If we go back to
October 2008, the average P/NAV ratio for these entities was only 58 percent. At that
time the shares of the segment considered were valued on the stock exchange at less
than the net asset value attributable to them. If we look at the historical quarterly level of
P/NAV ratio from the end of 2008 to the end of August 2009, we will see continuous
growth in the P/NAV ratio. However, at the end of August 2009, the P/NAV ratio was
below its level at June 2008.

Today, shares of developers listed on Warsaw Stock Exchange are not as attractive to
investors as a year ago. Of course each company should be analysed individually. The
table below presents P/NAV ratio for all of 11 Polish developers. As the P/NAV ratio of
one of the entities examined is 724 percent (incomparably high due to the illiquidity of
its shares), we have excluded this company from our analysis as an “outlier”.

Since the end of 2008, the average P/NAV ratio nearly doubled (increasing 95 percent).
Actually, half of 11 companies analysed have a ratio above the level of 113 percent.
There are however entities with a P/NAV ratio below the level of 100%, and the lowest
analysed ratio amounts to 63 percent. Taking into account the actual average level of
the P/NAV ratio, further growth of developers’ shares would not be justified. This does
not apply to companies with a P/NAV ratio below 100 percent.

As a potential investor I would demand a price lower than the market value of these
shares, unless I assume the future growth of profits of these 11 entities. To investigate
future profitability of this segment, we can analyse the historical level of earnings per
share (so called EPS ratio).
This is a very useful ratio for income based valuation. Comparing the EPS for 11
developers generated in the first 6 months of 2008, and in the corresponding period this
year, we can see, that profits attributable to ordinary shares of these entities have
declined by 33 percent. This means that the total EPS for a portfolio of 11 shares (one
share of each of all 11 entities) declined by 33 percent within one year. In the period
from January to June 2009, half of the 11 companies generated an EPS higher than
0.11 PLN, while in the first 6 months of 2008 this figure was at the level of 0.31 PLN.
The actual average EPS is 0.72 PLN while for the last year it was at the level of 1.09
PLN, a decline of 33 percent. It is worth highlighting that while the EPS ratio was
decreasing, market prices of developers’ shares were increasing. The actual increase in
share prices is a consequence of investors’ assumption, that profits will grow in future
periods. If this is not the case, the increase in market prices above NAV won’t be
justified.
Source: PwC analysis based on data from financial statements and www.money.pl

Luiza Niesłochowska