Capital Market Review (CM Rating 40/100) - DLF : Skimming the large land bank
The issue has been priced very aggressively even though current trends in the real-estate sector are not encouraging
DLF, the largest real-estate developer in India, develops residential, commercial and retail properties. In the residential realty space, the company builds and sells a wide range of properties including houses, duplexes and apartments of varying sizes, with focus on the higher end of the market. In the commercial segment, it develops and sells/leases commercial office space, with a focus on properties attractive to large multinational tenants. And, in the retail segment, it focuses on developing, managing and mainly leasing shopping malls, which include multiplex cinemas.
Of late, DLF has diversified into the hospitality sector, infrastructure project construction and development of special economic zones (SEZs) through joint ventures with eminent overseas and domestic players. The company has also picked up strategic stake or ramped up stake in companies offering crucial services relating to property development.
The proceeds of the issue will be used to fund acquisition of land and development rights, to meet construction and development cost, and prepayment of loans.
Strengths
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* Reputed and established player in the Indian realty industry, specially in the north, with long successful track record since 1946. Has developed approximately 224 million square feet (sq ft) including 195 million sq ft of plots, 19 million sq ft of residential properties, seven million sq ft of commercial properties, and three million sq ft of retail properties. Final approval has been received for four IT- pecific SEZ in the country: two in Gurgaon and one each in Pune and Chennai.
* End April 2007, had a land bank of 10,255 acres across various regions of India with an aggregate estimated developable area of approximately 574 million sq ft including four million sq ft of completed development. Residential projects comprised saleable area of approximately seven million sq ft and let-table and saleable are of commercial and retail properties of 27 million sq ft and 10 million sq ft, respectively. In addition, has entered into arrangement for acquisition of development rights for about 554 acres.
* About 171 million of the 574-million sq ft developable area is located in or near developed urban areas, and a significant proportion of the balance is in or near areas that will be developed as urban areas under the draft master plans of relevant urban bodies.
* Enjoys strong margin upward of Rs 1800 per sq feet due to strong focus on luxury and premium segment and low average cost of land of around Rs 270-300 per sq ft in the National Capital Region (NCR), comprising 51% of its land bank.
* The specialised joint ventures (JVs) for engineering design, construction and project management with renowned players imply better control on completion of project as work can be outsourced to owned JV companies managed by global players unlike earlier third-party contractors. This will also help command premium rates and attract premium clients.
Weaknesses
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* Yet to get certificate of change of land use for 60% of the land bank from competent authorities.
* Debt-equity ratio was 2.5:1 end March 2007, and 4.35:1 end March 2006. Moreover, subsidiaries had preference share capital of Rs. 949.8 crore. In addition, there are guarantees outstanding of Rs 8.6 crore on a consolidated basis, and Rs 462.9 crore of put option against the preference shares issued by an associate company end March 2007. Outstanding end April 2007 included Rs. 4395.6 crore as payment for acquisition of land reserves and Rs 1054.0 crore for acquisition of 554 acres for which development plans are at a preliminary stage. These payments may have to be funded by the incurrence of additional debt. The hospitality, infrastructure development and SEZ plans will also involve substantial capital outlay.
* Certain commercial properties have been sold to DLF Assets Pvt Ltd (DAL), a promoter group company, for Rs 2401.5 crore in the fiscal ended March 20‘07. Due to this transaction, the total income and profit before tax was boosted by Rs 2207.1 crore and Rs 1564 crore (which along with other one-time sales of assets and investments have been treated as extraordinary by us). Net profit after minority interest was just Rs 43 crore on sales of Rs 434 crore in the fourth quarter ended March 2007. Besides artificially boosting financials, this transaction raises many doubts.
* Commercial and retail-property development and the upmarket segment of the residential property, where the focus is, are sensitive to economic conditions.
* Operations have historically been in and around Delhi and Gurgaon. The ability to manage projects across various regions in the country is yet to be proved.
* Corporate governance record is not encouraging.
Valuation
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DLF reported consolidated sales of Rs 2615.20 crore in the year ended March 2007. This includes one-time income of Rs 880.5 crore. Excluding this sales are up 50% to Rs 1734.7 crore. Net profit before minority interest, inflated by an extraordinary (EO) profit on account of sale of commercial properties and divestment of shares in subsidiaries amounting Rs 1817.10 crore stood at Rs 1943.70 crore. Profit before tax (PBT) before EO shows a rise of 110% to Rs 732.40 crore.
EPS (excluding EO) on post-issue equity capital of Rs 340.88 crore works out Rs 3.3. On a lower price band of Rs 500, P/E stands at 152 times, and on the upper price band of Rs 550 P/E is 167 times.
Parsvnath Developers trades around Rs 320.25 giving P/E of 19 times FY 2007 consolidated earning. Unitech, quoting around Rs 604.40, trades at P/E of 37.5 of its FY 2007 consolidated earning. Notably, Unitech’s land-bank size is comparable to DLF.
While P/E is not the only criterion to compare real-estate stocks, the very high P/E shows that lot of cream has already been skimmed from this cake, specially when there are chances of the sector turning sour.
Investment in DLF is investment in its land bank. Hence, the valuation of DLF will depend on how much and how fast revenue and profit will be generated from this land bank and how fast and at what rate and locations it is adding to its land bank. This in turn depends on growth in real- estate rates, prevailing interest rates, economic growth, expansion in organised retail and flow of foreign liquidity to this sector.
Currently real-estate rates in many Indian centres are very high by global standards. This makes them commercially unattractive and beyond the average home-buyers’ capacity to pay. In spite of the government’s attempts to control bank as well as foreign fund flows to this sector, limited supply of developed real estate has been the main culprit for keeping the rates high.
Even if there is a temporary mismatch in demand-supply, which is possible as most real-estate companies led by DLF are planning massive additional supply over the next few years, there could be fall in real-estate prices, specially when investor demand has been one of the major drivers of real-estate rates in the past couple of years.
In a way real-estate stocks are like commodity stocks which go up when commodity (real-estate) prices go up and fall when they come down, irrespective of the volume growth or the current financial performance. How the interest rates will behave going forward is very crucial. Even if the current rates prevail for an extended period, it will be negative for the real-estate sector, while a fall in interest rates will be a big positive. Overall, this sector is for high risk-high-return, professional long-term investors and not for weak-hearted small investors.
Zerodha (Trading Account)
RHP
