DLF - Laying down a "new operating strategy". Return to positive FCF zone critical towards re rating stock ::JPmorgan

At the recent analyst day, DLF’s management argued that the company will
soon return to surplus free cash flow territory (a first in 5 years) on the back of
planned debt reduction and launch of high value luxury projects in Gurgaon.
Volume targets are much more modest now; overall cash generation is
expected to improve substantially given high realizations. Focus now is to
enhance the value of core holdings in Phase-V via infrastructure developments
& outsource contracting/ project management to domain experts. A significant
chunk of low margin order-book has now run off and the company is looking
to recapture the price appreciation that has happened in NCR over last 3 years
via new launches that are priced almost 2-3x of 2009/10 levels. Despite
pressures on rent portfolio, the co expects 15-20% pa growth on the back of
planned retail projects and committed escalations in office rents. Whilst the
underlying asset value in the co. is high, in our view, a return to a positive free
cash zone will be critical in re-rating the stock. Response to luxury Phase V
launches hence will be important to watch out for over the next 3 months.
 Development business. Focus on ‘value’ not ‘volume’ given past hits.
Expect to stabilize at Rs 50B FCF in 3 years – The company expects to
re-start its development business, as significant past deliveries take place
over a 6 month period. Key driver of this will be its luxury Gurgaon projects
which will be launched after a gap of 5 years. If these go off well (1.5 msf
p.a expected), it could very well drive DLF’s overall free cash flow
generation to Rs30B+ over a 3 year period.
 Rent co. confident of growing 15-20% pa. 3 year target of Rs 27B vs.
current Rs 17B – On the back of new completions (Mall of Noida), new
office leasing (~2 msf p.a) and committed rent escalations in underlying
office portfolio.
 A ‘re look’ at debt – With debt levels coming down, the co expects to delever
its development business completely and over a 3 year period keep all
debt only in its rent co., which is securitized and hence easily serviceable
thus keeping the core development business (pro cyclical) debt free.
 Earnings to be muted near term as all the new launches of the company
comply with the 25% revenue recognition norm. Hence most new launches
will hit P&L after 4-6 quarters. Cash flows should then precede earnings (a
new normal).
 CCPS resolution likely only by Feb-15 – The promoters have indicated
that they will let the CCPS in DCCDL run till Feb-15 and will decide upon
its conversion only closer to the expiry.

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