DLF CMP: INR211 TP: INR260 Buy

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1 BSE SENSEX S&P CNX 17,413 5,283 Bloomberg DLFU IN Equity Shares (m) 1, Week Range (INR) 261/170 1,6,12 Rel. Perf. (%) 1/-8/0 M.Cap. (INR b) M.Cap. (USD b) August QFY13 Results Update Sector: Real Estate DLF CMP: INR211 TP: INR260 Buy Revenue de-grew 10% YoY (-16% QoQ) to INR22b (v/s est INR25.3b). EBITDA de-grew 4% YoY (up 34% QoQ) to INR10.7b (v/s est INR9.9b), while EBITDA margin improved sharply to 48.6%, up 18.1pp QoQ and 3.2pp YoY. We understand that both (a) lower revenue bookings and (b) higher EBITDA margins are partially attributable to adjustments in POCM accounting on account of increase in area in one of its existing residential projects, which has led to disproportionate cost reduction during 1QFY13. Due to absence of new launches, 1QFY13 sales momentum was subdued at 1.34msf (~INR6b) v/s 6.8msf (INR26b) in 4QFY12 and 2.2msf (INR11b) in 1QFY12. Subdued commercial market outlook is getting reflected in leasing volume. Gross leasing volume was up QoQ to 0.96msf v/s 0.64msf in 4QFY12, but net leasing stood at 0.29msf due to cancellations. The repeated cancellations at DLF's commercial projects is concerning. Cash generation from operations is yet to break even operating expenses and interest payment. A broadbased estimate suggests inflow of INR22.6b (INR17.5b customer collections, INR4.7b of annuity income, rest other income) and outflow of ~INR25.6b (Construction expense INR12.5b, capex INR3.5b, interest INR7.1b, tax INR1.3b), resulting in negative surplus of ~INR2.9b (or INR0.8b post contribution of INR3.7b from proceeds from asset sales). Large ticket transactions (NTC, Wind Mills and Aman resort) are yet to reach conclusive stage. During 1QFY13, DLF concluded the divestment of DLF Hotels and Hospitality Ltd with transaction value of INR5.67b and received the final tranche of ~INR3b, which has been the major contributor of its INR3.65b divestments during the quarter. Given that the divestment proceeds have largely been utilized to bridge negative operating surplus, 1QFY13 net debt remain unaltered at INR235b (0.91x net DER). Valuation and view: We expect improvement in operations and financial leverage over FY13 to render delta to the company. 1QFY13 disappointed on operations front with subdued launch, sales and cash generation. However, we remain hopeful of a strong 2HFY13 with stated launch plan in premium segment. The stock trades at a P/E of 26.8x FY13E EPS of INR7.9 and 1.3x FY13E BV and 28% discount to NAV. Maintain Buy. Sandipan Pal (Sandipan.Pal@MotilalOswal.com); Investors are advised to refer through disclosures made at the end of the Research Report.

2 Key result highlights Revenue booking down 10% YoY, while operating margin improves led by accounting adjustments Revenue de-grew 10% YoY (-16% QoQ) to INR22b (v/s est INR25.3b), which includes (1) annuity income of INR4.7b (lease rental INR4b), (2) Hotel and Power (INR2.1b) and (3) POCM revenue of ~INR14b. EBITDA de-grew 4% YoY (up 34% QoQ) to INR10.7b (v/s est INR9.9b), while EBITDA margin improved sharply to 48.6%, up 18.1pp QoQ and 3.2pp YoY. PAT declined 18% YoY (up 38% QoQ) to INR2.9b (v/s est INR2.5b), driven by higher than estimated EBITDA and other income. Financial expense continues to remain a drag on profitability (58% of EBITDA). Consolidated numbers include INR297m of net loss from insurance and hotel businesses. We believe both (a) lower revenue bookings and (b) higher EBITDA margins are partially attributable to adjustments in POCM accounting on account of increase in area in one of its existing residential projects. The management has mentioned that such adjustment has led to disproportionate cost reduction during 1QFY13. We are illustrating our understanding on the matter with the help of below table: Understanding how additional construction area could lead to lower revenue booking and disproportionate cost reduction in a particular quarter (here Q2) Base case Base Case Post 50% area increase Post 50% area increase Sales value Land cost Construction cost Land cost Paid Paid 1Q 2Q Adj 2Q Construction progress 20% 40% 27% Sales absorption 50% 60% 40% Project cost incurred Total % project cost incurred 60% 70% 56% Sales accrual Revenue booking Cost booking Margin 50% 50% Higher due to negative cost bookings Source: Company/MOSL The increase in area and corresponding cost adjustment have also led to QoQ spurt in other current assets (up by ~INR11.9b) and other current liabilities (up by INR8b). EBITDA margin up with accounting adjustment (%) Source: Company/MOSL 7 August

3 QoQ Interest/EBITDA continues to be at elevated level (%) Cash conversions deteriorated QoQ, but above 9MFY12 level Source: Company/MOSL Sales plummeted due to no fresh launch; leasing run-rate weak, repeated cancellations concerning After a strong 4QFY12, DLF posted a subdued sales performance in 1QFY13. It sold 1.34msf (estimated sales value of ~INR6b) v/s 6.8msf (INR26b) in 4QFY12 and 2.2msf (INR11b) in 1QFY12. Almost 50% of the sales are from Gurgaon projects. We believe higher proportion of sale mix towards high margin Gurgaon projects has been the key to improve blended realizations. We expect most of the DLF's planned launches including Magnolia 2 to be pushed back to 2HFY13 due to impending weak "no home buying" season. We expect meaningful uptick in 2HFY13 (as has been the historical trend). We estimate FY13 sales of ~12msf (INR60b) v/s management guidance of INR65b. Subdued commercial market outlook is getting reflected in leasing volume. Gross leasing volume up QoQ to 0.96msf v/s 0.64msf in 4QFY12, but net leasing stood at 0.29msf due to cancellations. The repeated cancellations at DLF's commercial projects are concerning, and present a huge downside risk to its FY13 leasing guidance of ~2msf. Total area under lease stood at ~22.6msf. Rental income from commercial and retail spaces remains steady QoQ at INR4b, while total annuity income declined to INR4.7b v/s INR4.5b in 4QFY12. We estimate rental income to grow from INR16b in FY12 to INR18b in FY13. The management has guided for increase in focus over improving average rentals and leasing of semi-finished and ready to occupy properties thereby limiting capex in the near term. During 1QFY13, DLF delivered 2.1msf of rental assets (at Gurgaon and Chennai), which would be key contributor to rental growth in FY13. 7 August

4 Lack of new launches (msf) led to QoQ decline in sales (INR b) Blended realizations improves with higher sales mix in Gurgaon Leasing volume hit by several cancellations (msf) Asset u/c suggests growing focus on residential Source: Company/MOSL 7 August

5 Operations yet to churn desired surplus cash; moderate asset sales led to no positive surprise on de-leveraging Cash generation from operations is yet to break even operating expenses and interest payment. A broadbased estimate suggests inflow of INR22.6b (INR17.5b customer collections, INR4.7b of annuity income, rest other income) and outflow of ~INR25.6b (Construction expense INR12.5b, capex INR3.5b, interest INR7.1b, tax INR1.3b), resulting in negative surplus of ~INR2.9b (or INR0.8b post contribution of INR3.7b from proceeds from asset sales). Large ticket transactions (NTC, Wind Mills and Aman resort) are yet to reach conclusive stage. During 1QFY13, DLF concluded the divestment of DLF Hotels and Hospitality Ltd with transaction value of INR5.67b and received the final tranche of ~INR2b, which has been the major contributor of its INR3.65b worth of divestments during the quarter. Given that the divestment proceeds have largely been utilized to bridge operating cash deficit, net debt remains unaltered at INR235b (0.91x net DER). Operating cash flow yet to reach desired level No big ticket asset sales in 1QFY13 (INR b) Net debt unaltered Source: Company/MOSL 7 August

6 Proceeds from asset sales went to bridge negative operating surplus Customer collections improve YoY, but down QoQ due to absence of launches Cash flow analysis 1QFY12 4QFY12 1QFY13 From sales Constructions (Dev Co) Staff Costs Gross CF at Dev CO Rental Operating cost Gross CF at Rent CO Other income (interest/div) Tax Paid Operating CF Leasing capex Land acqusitions Interest payment Dividend payment Pref Share redemption Others Net surplus Divestment Net cash flow Valuation and views DLF trades at ~28% discount to its NAV and seemingly at a reasonable discount to its MTM land value (DLF's land is being carried at a historical acquisition cost of ~INR500/sf, which has appreciated at least 1.5-3x over the years along with the value created by the company). However, given subdued operational performance over FY11-12 and challenging macro, visibility on near-term earnings (rather than asset valuation) would be the key stock driver. We expect improvement in operations and financial leverage over FY13 to render delta to the company. 1QFY13 disappointed on operations front with subdued launch, sales and cash generation. However, we remain hopeful of a strong 2HFY13 with stated launch plan in premium segment. Progress on divestment led deleveraging has been slow and unconvincing so far. But assets under radar (NTC, Wind Mill and Aman), being high value ones, offer huge potential - success in any two could lead to INR30-40b of debt reduction. The management has maintained its confidence of INR50b of debt reduction by FY13 with closure of the stated deals in near future. Regulatory headwinds such as CCI penalty and ITA tax claim continue to remain key concerns. However, we do not expect any near-term negative conclusion/ cash outflow out of these legal procedures. The stock trades at a P/E of 26.8x FY13E EPS of INR7.9 and 1.3x FY13E BV and 28% discount to NAV. Maintain Buy. 7 August

7 DLF: an investment profile Company description DLF, one of the largest and most respected real estate companies in India, has developed many well known urban colonies in Gurgaon, Delhi including South Extension, Greater Kailash, Kailash Colony and Hauz Khas. Since inception, DLF has developed ~230msf, including 22 urban colonies and an integrated 3,000-acre township in Gurgaon, called DLF City. Key investment arguments DLF is uniquely positioned to leverage long-term opportunities in India. It has a significant presence in key cities and market leadership across segments. DLF has been quick to change gears in favor of a high volume mid-income housing strategy and plotted development. Quick monetization through plotted development could boost its cashflow. Sincere effort to asset divestment would be key trigger to de-leveraging. Key investment risks DLF's gross debt stood at to INR250b, while net debt at INR236b, implying net DER of 0.91x. Cost of debt increased to 12.75% as against 10.5% 18 months back. Management has guided for INR60b-70b asset sales over next two years. Successful divestment plan will be key factor. Comparative valuations DLF Unitech Oberoi P/E (x) FY13E FY14E P/BV (x) FY13E FY14E EV/Sales (x) FY13E FY14E EV/EBITDA (x) FY13E FY14E Recent developments DLF posted a subdued sales performance in 1QFY13. It sold 1.34msf (estimated sales value of ~INR6b) v/s 6.8msf (INR26b) in 4QFY12 and 2.2msf (INR11b) in 1QFY12. During 1QFY13, DLF delivered 2.1msf of rental assets (at Gurgaon and Chennai), which would be key contributor to rental growth in FY13. Valuation and view We expect improvement in operations and financial leverage over FY13 to render delta to the company. 1QFY13 disappointed on operations front with subdued launch, sales and cash generation. However, we remain hopeful of a strong 2HFY13 with stated launch plan in premium segment. The stock trades at a P/E of 26.8x FY13E EPS of INR7.9 and 1.3x FY13E BV and 28% discount to NAV. Buy. Sector view RE sector has been a major underperformer over the last 12 months with multiple operational and nonoperational headwinds such as volume slowdown (due to declining affordability), monetary tightening, pilling liquidity pressure etc. However, with imminent rate cut cycle and increasing instances of regulatory pressure subsiding, we believe the outlook will improve going forward. EPS: MOSL forecast v/s consensus (INR) MOSL Consensus Variation Forecast Forecast (%) FY FY Target price and recommendation Current Target Upside Reco. Price (INR) Price (INR) (%) Buy Stock performance (1 year). Shareholding pattern (%) Jun-12 Mar-12 Jun-11 Promoter Domestic Inst Foreign Others August

8 Financials and Valuation 7 August

9 N O T E S 7 August

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