India Mini Conference - London 2007

31 August 2007

Citigroup Global Markets | Equity Research

DLF (DLF.BO)

Big Player, Opportunity, Ambition

Tier-one developer — DLF is India's largest developer with an emerging pan-India presence. The company has a large diversified landbank of ~ 615m sqft spread across more than 10,255 acres and a development mix that is leveraged toward commercial and retail development.

 What differentiates DLF? —

1) Focus on scale with a portfolio mix of ~615m sq. ft spread across top-tier cities;

 2) strong cash reserves in this liquidity srained environment,

 3 a de-risked business model, with JVs in construction and hotels aiding growth, and

 4) a robust earnings CAGR of 81% for FY07-10E.

 Relatively good proxy to play yield compression — DLF's large pipeline of IT SEZ projects and strategy to sell assets to DLF Assets or others at lower cap rates of 9% vs.10% earlier should boost cash flows. However, this remains contingent on capital. We expect more such structures for its retail/hotel assets.

Development mix geared toward commercial and retail space — DLF has 49m sq ft under construction, which is largely geared toward commercial and retail projects — less sensitive to interest rates. In residential, the focus is super luxury-premium projects, most of which are pre-sold. While residential

remains a core area, growth will likely be more back-ended. We believe this to an extent insulates DLF from the current slowdown in the residential space.

Key risks —

 1) Concentration risk in NCR (40% of portfolio),

 2) high exposure to DLF Assets and its ability to raise capital;

3) price, demand and execution risks.

Company description

DLF is one of India's oldest real estate developers. Established in Delhi in 1946,it has continued to expand and diversify its real estate businesses, and is among the largest developers in India. It has historically built its businesses in Delhi and adjoining areas, known as the National Capital Region (NCR). While, Gurgaon in the NCR continues to be the hub of its business, DLF has meaningfully diversified into other geographic locations over the past few years.These expansions are spread across India, with a particular focus on the

Northern India Belt, Calcutta, Mumbai, Chennai, and a number of other large and rapidly growing cities. DLF's initial real estate development was focused on residential colonies and townships, and remained so until a decade ago. It further diversified into the development of commercial office space in the early

1990s, and with significant success, has substantially scaled up these developments. DLF also entered retail mall developments in the early 2000s, and is pursuing this business aggressively. DLF also has a very strong brand, with a reputation as one of the foremost and most credible developers in the

country. The company recently made a primary offering of 175m shares at Rs525 per share. DLF is a family owned and controlled business with promoters holding 90% stake (post the recent IPO).

Recent developments

Industry trends: The Indian real estate development opportunity is structural, large and will last for long, in our view. However, we believe the sector is in for some cyclical pain in the near-term — sustained high interest rates are damaging affordability; there is significant slowdown in volumes; property prices are cooling off, particularly in the residential segment; and supply risks exist.

In this scenario, we see markets increasingly distinguishing between tier-one developers and the surfeit of small developers.

Results: DLF's standalone 1Q FY08 revenues were Rs11,219m. Standalone EBITDA increased 26% yoy to Rs8,8710m and net profit increased 42% to Rs5,793m. Standalone EBITDA margin increased from 61% in 1Q FY07 to 78% in 1Q FY08. 1Q FY08 consolidated revenues, EBITDA and net profit were Rs30,738m, Rs22,039m and Rs15,155m, respectively.

News flow & developments

DLF purchased 38 acres of prime land in Delhi at a cost of Rs16bn, making it the largest private sector land deal in the country.

Awarded an esteemed project worth Rs60bn to develop and operate an international convention centre at Dwarka in Delhi.

Announced a 95-acre township at Durgapur in West Bengal.

Signed an MOU with American realty firm Hines to develop a landmark  commercial complex covering more than 2.5m sq ft in Gurgaon.

Investment thesis

We rate DLF Buy/Medium Risk (1M), with a target price of Rs725. DLF's focus on scale, integrated development with execution record, and a large land holding spread across top-tier growth cities differentiates it from its peers. Its diversified portfolio of ~615m sq.ft is relatively leveraged toward commercial/IT Parks/Retail mall (35% of total development) assets, which should provide a good hedge particularly in the near-term, when the residential segment is seeing some slowdown. Strong cash flows (Rs94.7bn) and a de-leveraged balance sheet give it a competitive advantage in the current liquidity-strained environment. We expect its new joint ventures in construction and hotels to complement the core business, aid growth and offer valuation upside.

Valuation

Our target price of Rs725 is based on a 25% premium to an estimated core NAV of Rs530, and Rs62 for other asset holdings and new JV businesses (Rs45/share for the existing 4.6m sq.ft leased assets and 7.2m sq.ft plot, and Rs17/share for DLF's share in construction and hotel JVs). We believe an NAV based valuation methodology is most appropriate for developers, as it factors the varied development projects and spread out time frame. Our NAV estimate of Rs530 is based on the following assumptions:

1) current market prices will persist, without any price inflation;

 2) development volume will be 606m sq.ft (as ~9m is already recognized as revenue in FY07);

3) a cap rate of 9% for commercial/IT Park, IT SEZs in Super Metros and Metros, and 10% for other

locations;

4) all projects undertaken by DLF will be completed largely on schedule; though given the scale of the roll-out, we expect risk of delays;

5) an average cost of capital of 14%; and

6) a tax rate of 25%.

Risks

We rate DLF Medium Risk. This is different from the Speculative Risk rating assigned by our  quantitative risk-rating system (which measures the stock's volatility over a 260-day period) to stocks that have less than one year's trading history. The key reasons for assigning a Medium Risk rating include:

1) the company's robust business model;

2) pan-India land bank with initiatives to derisk the business model through new business JVs; and

3) relatively healthy cash flows, at a time when most developers are facing funding constraints.

The main downside risks to our investment thesis and target price include:

 1) Concentration in the NCR region, particularly Gurgaon (33% of development), where risk of excess supply over the next 2-3 years is high;

2) Related party transaction and conflict of interest risks with DLF Assets;

3) Delays in execution of projects and planned developments would impact the company's reputation

and our NAV assumptions; and

4) A rapidly changing property market environment could lead to property price-demand risks, regulatory risks and potential supply risks.

Disclaimer- I  hold DLF and I only use research reports to validate certain facts and do not follow Buy/Sell recommendations by them without doing my homework.

Kulmanjee,

Price target revised to Rs300 

Key points

• With a revised capital expenditure (capex) plan of 14 million metric tonne (MMT) by the end of FY2009, India Cements will emerge as one of the top five cement players in India in terms of capacity. The company will witness a robust volume growth of 23% over FY2007-09. 
• South India is expected to witness a strong cement demand in the next couple of years due to heightened industrial activity and upcoming government projects.
• The company received the Madras High Court's approval for merger of Visaka Cements in Q1FY2008.
• For Q1FY2008, the combined turnover of the company stood at Rs701 crore. The turnover was much in line with our expectations. Backed by higher realisations, the operating profit margin (OPM) improved by 400 basis points year on year (yoy) to 38%, whereas the earnings before interest, tax, depreciation and amortisation (EBITDA) per tonne stood at Rs1,150. Consequently, the profit before tax (PBT) stood higher at Rs215 crore beating our expectation of Rs200 crore for the same.
• In the last couple of months, the cement retail price have touched Rs280 per bag in certain regions and the dealers expect it to touch Rs300 per bag in the coming months. Considering the rise in prices, we are upgrading our estimates by 33.9% for FY2008 and 32.5% for FY2009.
• The company's strategy of augmenting its capacity through the brownfield route at a lower capital cost will enhance the company’s return on capital employed (RoCE) going forward. The Lower capital cost coupled with higher profitability will put the company's financials in an enviable position.
• Healthy financials, a leadership position in the South and a lower promoter stake make the company a potential target for acquisition. Whether the promoters will sell their stake is a question that time will answer but in case that happens we believe the acquirer will have to pay a hefty premium to the company as it will directly make them the market leader in the South.
• We expect the earnings of the company to grow at a compounded annual growth rate (CAGR) of 27% over FY2007-09 on an enhanced equity capital of Rs260 crore. At the current market price of Rs263, the stock is currently trading at 9.5x its FY2009E earnings per share (EPS) and at an enterprise value (EV)/EBITDA of 5.1x. Considering all these aspects, we maintain our positive outlook on the stock with a revised price target of Rs300.

Disclaimer- I  do not hold  position in this stock and I only use research reports to validate certain facts and do not follow Buy/Sell recommendations by them without doing my homework.