Russian Real Estate - Etalon Group Our Favorite in an Environment of Uncertainty

We reinitiate our coverage of the Russian real estate sector and expand it to include PIK Group. While the long-term fundamentals are strong, the sector has entered a period of uncertainty, with rising interest rates and less government support. In this environment, we favor companies with a clear strategy, less reliance on mortgages, an attractive valuation, and predictable and high dividends. Hence, our preferred exposure to the sector is Etalon Group.> Market outlook. The housing market has entered a period of uncertainty. Prices have risen 40% since 2019, but we think they may pull back 7-8% in core markets in 2H21 before returning to growth in line with inflation. Were it not for the constrained supply (below the end-2019 level) and high construction cost inflation, a deeper correction could be expected. We expect housing prices to correct and cost inflation to put pressure on developers' now-elevated margins, though we do not see margins dropping below the average level observed before the housing price rally.> LSR Group: HOLD, R891 target price. LSR looks attractive at a 3.8 2021E EV/EBITDA and 0.3 P/NAV, 18% and 44% discounts to the five-year averages. However, the sharp downgrade to the 2021 sales guidance (a 4% y-o-y drop in monetary terms is now guided) and the new plan to get into the hotel business put future dividends at risk, while the company's decision to skip the interim dividend for 1H21 may have already dented the investment case. We have the stock at HOLD.> Etalon Group: BUY, $2.45 target price. Etalon has the most stable outlook in the current environment from a risk/reward prospective. While it does not have the strongest growth profile, it has a clear strategy for replenishing its project portfolio and is less reliant on mortgages than LSR and PIK. It has also kept its leverage under control and remains committed to fixed dividends - we project a 9% dividend yield for Etalon for 2021 versus 3% for PIK and 4% for LSR. With 37% upside to our target price, we rate Etalon a BUY.> PIK Group: HOLD, R1,530 target price. It is PIK that has the strongest growth profile of the homebuilders under our coverage, which explains the high 2021 multiples for the stock (a 7.2 EV/EBITDA, 1.5 P/NAV and 10 P/E). It has a large land bank, continues to expand beyond the MMA and is developing innovative businesses, such as prop-tech (online trading of apartments in the secondary market), which could be a revolutionary story, though it is yet unproved in a volatile market. Considering all of these factors, we set a target price for PIK Group of R1,530 per share. While the outlook for the business is strong, there is limited upside for the stock after its 142% rise YTD; on valuation grounds, we rate it a HOLD.