DLF Limited (DLFU IN) Reported strong office leasing in FY14; reaffirms our positive outlook on office market ::JPMorgan

DLF Limited (DLFU IN) Reported strong office leasing in FY14; reaffirms our positive outlook on office market		Overweight Price: Rs152.35 23 Apr 2014 Price Target: Rs210.00 PT End Date: 30 Mar 2015

DLF reported FY14 leasing of 3msf (source: BSE leasing update), significantly ahead of the company’s full year guidance and last year’s level. This follows a strong leasing achieved by Unitech as well last month for its UCP office portfolio. Strong leasing traction reported by key commercial developers over the recent past reaffirms our positive outlook on the office market. Further, on-the-ground checks suggest that office rents have also started to increase in key markets. We think a five-year down cycle for office segment is now behind us. An improved demand supply balance and expected pick-up in economic activity in 2H could set the stage for a strong revival ahead.

· DLF’s FY14 office leasing surprises positively. DLF, in its leasing update today, reported 3msf of leasing for FY14 (vs. 1.1msf in 9M). This is significantly higher than its full year guidance of 1-1.5msf and FY13 leasing of 1.1msf. Of the total 3msf leased in FY14, 1.7msf of leasing was achieved in Gurgaon. This follows a strong office leasing registered by Unitech’s UCP portfolio, especially for its Gurgaon project. Incremental rentals in new leases have been largely stable to marginally higher, as per the company.

· Annuity portfolio has strong growth levers ahead. In addition to improvement in office leasing, DLF’s annuity portfolio has two big growth levers over the next 3-4 years: a) renewal of large office portfolio (50% of rentals) in its Cyber City Gurgaon from F16/17. Locked-in rentals are 40-50% below current spot rents. These renewals will also coincide with the roll out of its key infrastructure initiatives (mono rail, road work WIP) which could further push up the spot rents in the market; b)completion of ongoing retail portfolio – Opening of Mall of Noida, coupled with the completion of other high-end malls (Chankyapuri and Gurgaon), can add Rs3-4B to annuity income over the next 2-3 years. Noida mall is a 1.8msf mall which is already pre-leased and is expected to open in Oct-14 (Rs100psf avg rent).

· Office market recovery now firmly in sight with leasing activity witnessing improvement across key markets and rents starting to inch up at the margin, especially in prime markets. More importantly, we think demand supply balance is now falling in place in the office market, after being oversupplied for the last 4-5 years. Given the weak demand trends and tight liquidity, most developers scaled back on their commercial capex plans over the last few years, which should keep the new supply levels in check over the next 2-3 years. Correspondingly, vacancy levels should start coming down over the next 2-3 years.

 

Investment Thesis

We think DLF’s cash flows are poised for a turnaround. Markets have been focused on underperformance of core residential business whilst ignoring progress made on debt reduction and steady growth in the annuity portfolio (50% of value). Luxury launch in Delhi (Rs 100b pre sales value), peaking of annuity capex, increased rentals post Mall completion in 2H15 and return to positive FCF are key re-rating triggers, in our view.

Valuation

Maintain Overweight with a Mar-15 Price Target of Rs 210. Our PT is derived from a stabilized cash flow model valuing the development business at 10x and Rent co at 13x cash flow.

Risks to Rating and Price Target

Key downside risks – (a) Delay in launch of luxury Gurgaon projects; b) Increase in debt levels; (c) Sharp increase in policy rates; and (d) Material de-rating of overall macro fundamentals in India.

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