Building on rough terrain

Building on rough terrain
The Hindu Business Line, February 08, 2009, Page 11

The company is among the better placed developers to weather the current slowdown. Investors keen to participate in the yet-to-mature real estate sector can consider accumulating the DLF stock.

VidyaBala

While much was being said about the slowing real-estate sector in mid-2008, the September quarter results of the bigger developers such as DLF did not hint at dire prospects for the sector. A gradual slowdown appeared to be on the cards, though. However, the last four months have seen the sector flounder as demand dried up, along with liquidity.

The latest quarter financials speak loud and clear ¬the realty sector is in the midst of a deep correction. So much so that, the largest developer in the listed space, DLF, witnessed a 62 per cent decline in sales and 69 per cent decline in net profits in the December quarter compared to year ago -numbers. The stock market too has responded by beating down the stock by 56 per cent (to Rs 138 now), from its 2009 high of Rs 300.

Given the muted prospects for the company and the sector, should investors retain their exposure to the stock of DLF? They should.

ACCUMULATE
In fact, investors keen to participate in the yet-to-mature real-estate sector in India can consider accumulating the DLF stock. We believe that the company is among the better-placed developers to weather the current slow down.

It can achieve this by tactically altering business strategies and meeting the sector demands as and when there are signs of revival.

The company's guarded approach of preserving its balance-sheet at the cost of postponing some revenues al-¬so appears prudent in these perilous times when it does not take much to get entangled in a debt trap.

The recent spate of incentives given to developers and home loan buyers, combined with the declining interest rates, can be expected to boost demand in the realty sector.

What to expect: Investors who bought the stock at higher levels can average their costs by buying at current prices. Hold with at least a three-five-year perspective to fully participate in a revival. At the current market price, the stock trades at 4.8 times its expected consolidated earnings for FY09. Investors - may have to be prepared for a decline in earnings in FY -09 and muted performance until the first half of FY -10.

We expect a gradual revival after this period, primarily driven by the residential segment, followed by the retail space.

The fortunes of the commercial segment would, however, be tied, mainly to the prospects of the IT sector and revival in this segment may take longer, as significant ex- supply starts kicking in.

PILLS TO COUNTER
SLOWDOWN
Residential segment: DLF has been one of the early players to recognise the slowing demand scenario and shift strategies accordingly. The company, moved to mid-income housing over a year ago, when the premium segment demand appeared sluggish.

In fact, the company managed good growth over the first three quarters of 2008 due to its timely entry into this space.

The company has also been steadily reducing property prices at a time when even smaller players have been reluctant to do so. The weighted average price of its apartments sold in the December quarter at Rs 2,736 is over 40 per cent lower than its sale price a year ago.

Even over the last quarter, the average sale price declined by 8 per cent. In some of its new launches in the Rs 25-30 lakh category, its pricing has been aggressive in relation to the local market prices. On the other hand, it has completely postponed all launches of luxury homes.

DLF has also launched plotted developments in cities such as Pune and Hyderabad to hasten the working capital flow.

While these strategies are yet to yield expected results, we believe that it may be wrong to expect an immediate spurt in demand; the relatively attractive property offerings experimented in the mid-income segment, along with the declining interest rates, may help the residential segment, where DLF has about 14.4 million square feet under construction.

Office and retail segment: DLF has been taking a cautious stance on office space as it anticipates marginal cancellations with corporates putting on hold their expansion plans. DLF has, therefore, resorted to suspension of activity in about 35 per cent of its 35 million sq ft of commercial space under construction.

In. more recent times, the company also shifted focus to the sale model rather than lease model (where such projects are typically sold to group company DAL).

This essentially means that sale to DAL would significantly come down in the near future.

Meanwhile, a good part of debtor dues from sales to be made to DAL by March 2009 may get monetised if DAL succeeds in securing private equity funding, which it is currently working on. Failure to do this may once again increase debtors outstanding from the group company.

Interestingly, while the volume of leases booked has dropped drastically, and lease rates are lower than the September quarter, the December office lease rate at Rs 51 per sq ft, is still higher than a year ago rate of Rs 43 (it is another matter that average costs too have gone up).

This suggests that DLF has been selective in choosing on¬1y those areas for leasing where prices are firm. This trend was visible in the company's retail sales as well.

Aside from its shifting business mix, DLF has also postponed some of its capital-intensive hotel projects (other than joint venture projects) and de notified a special economic zone that was instead calibrated into a residential project.

These measures may help it respond to the changing market needs and keep liquidity flow from drying up.

DEBT
As a result, DLF's net debt: equity position has remained at a safe 0.6 per cent. The company has not incurred fresh debt for operations, the whole of the last quarter.

A good part of the debt has also been converted into long-term dues as a result of securitisation of sales/rent receivables. The average cost of debt is currently 11.9 per cent. For the quarter ended December 2008, DLF's operating profit margins slumped to 56 per cent from 69 per cent a year ago. Reduction in revenues in the high-margin lease segment, entry into mid income housing and the sharp slashes in price were the key reasons for the decline.

Margins may see further drag with more budget houses being sold in the coming quarters. Therefore, increase in volumes would be the key to reasonable growth.