DLF: 2Q a tad lower; office demand back with a bang: HSBC

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DLF Ltd (DLFU IN)
OW(V): 2Q a tad lower; office demand back with a bang
􀀗 Q2 earnings (just like Q1), 7% below HSBC est. However,
fresh volume surprised us on the upside and adjusted free
cash flows continued the positive momentum
􀀗 Commercial demand recovery theme now clearly evident.
We expect investors to perceive Q2 positively
􀀗 Retain OW(V) and TP of INR386. Successful new project
launches during H2 FY11 are key share price catalysts




Q2 earnings: Positives outweigh the negatives. DLF reported a 3% y-o-y fall in
earnings to INR4.2bn (7% below HSBC and consensus) primarily owing to lower than
expected EBITDA margin of 43% (HSBC est. 53%). The weak margins were cushioned
by 39% y-o-y growth in total income (11% above HSBC est.) and lower tax rate (15%
against expectation of 28%). However, the weak results were overshadowed by healthy
fresh volume data (2.1m sq ft of residential vs HSBC est. of 1.8m sq ft) and commercial
leasing of 2m sq ft (HSBC est. 0.8m sq ft). Additionally, free cash flows (adjusted for
non-core income) sustained the positive momentum.

Commercial demand recovery theme playing out well. Our central investment theme for DLF
has been the recovery in commercial and luxury residential, where DLF has a strong foothold. This
is now playing out well as per expectations. DLF booked c2m sq ft of fresh lease volumes during
Q2 FY11, which comprised office space of 1.6m sq ft (HSBC est. 0.75m sq ft) and retail space of
0.4m sq ft (HSBC est. 0.1m sq ft). The higher volumes more than made up for the c25% lower
pricing (awaiting more clarity on the location mix), which could change over H2 FY11.

We lower earnings by 9-14% to factor in higher interest capitalization; marginal impact on
cash flows. We have revised our net profit forecasts down by 14% in FY11 to INR19.6bn and 10%
in FY12 and 9% in FY13 to INR28b each to factor in higher interest capitalization. We have made
no changes to operating forecasts and hence cash flows remain almost constant.

Our preferred sector pick. We continue to value DLF at INR386 (calculated using DCF analysis
of its real estate project cash flows), which is at a par to its FY11e NAV along with a terminal value
of INR19. DLF is our preferred pick for exposure to the revival in India’s commercial property
sector as it has the highest share of GAV attributed to the commercial segment (44% vs. peers at 25-
35%). DLF is trading at 1.8x FY12e PB and at par to its NAV. The stock has traded at a peak
FY12e PB of 2.0x and 14% premium to NAV over the past 12 months.