DLF - funding pressures/margin focus; downgrade to Hold:: Edelweiss

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DLF (DLFU IN, INR 296, downgrade to Hold)

n  Rising interest rates and tighter lending norms to hit realty

In an environment of rising interest rates (owing to inflationary pressures and deposit rate hikes by financial institutions), developers’ funding costs are likely to rise in CY11. Our channel checks indicate that debt funding to real estate companies has come under scrutiny as a fallout of the recent bribes-for-loan ‘scam’. The ‘scam’ has also raised possibilities of delays in loan sanction to developers in the near-to-medium term.

 

n  DLF’s high gross debt causes concern; costs likely to go up

As of Q2FY11, DLF had net debt of INR 199 bn (net D/E of 0.73x) at an average cost of 10.5%. With mandatory debt repayment of ~INR 16.7 bn in H2FY11 amid an environment of rising interest/construction costs, we believe that DLF should ideally focus on maximising volumes instead of margins over the medium term.

n  Volumes to come under pressure due to margin expansion strategy

DLF has guided for new sales bookings of ~12 msf in FY11, of which, it has already achieved ~4 msf in H1FY11; it is likely to generate the balance, largely from plot sales of ~5-6 msf at Gurgaon/Chandigarh/Indore. Although plot sales help to front-end cash flows, we believe the company’s pricing of Gurgaon plots at INR 60,000+/sq yard could bring volumes under pressure (since there several other large landowners in the vicinity offering products at discount). Further, the Reserve Bank of India (RBI) and National Housing Bank’s (NHB) directives to limit loan-to-value (LTV) ratio on housing loans to 80% may dampen volumes, especially in the premium end, which is DLF’s focus area.

n  Outlook & valuations: Downgrade to ‘HOLD’ with NAV of INR 326/share

Robust demand for residential housing and recovery in commercial real estate are positives for DLF on the macro-economic front. However, rising operating/ funding costs, along with downward pressure on volumes due to DLF’s focus on margin maximisation, are key concerns. Accordingly, we cut our NAV for DLF to INR 326/share on FY12 basis (INR 417 earlier), assuming 150bps rise in cost of debt, higher operating expenses and lower sales volumes, going forward. Hence, we downgrade our recommendation to ‘HOLD’ from ‘BUY’. On relative return basis we rate it ‘Sector Performer’.