Shareholders of DLF can exit the stock. A debt-laden balance sheet, slackening pace of property sales and compulsion to sell its own assets — some lucrative ones — to keep the business afloat, do not provide comfort to the company’s prospects for the next one-two years.

The real-estate sector’s prospects too have been dented by economic slowdown and high interest rates. While a few listed players have bucked the trend, most of them have fallen into a slowdown phase.

Any significant improvement in DLF’s earnings growth is unlikely in the next 12-15 months. The management too has acknowledged that it does not see much relief over this period.

As an investor, you may miss out on more lucrative opportunities in the market by holding on to the DLF stock. At the current market price of Rs 210, the stock trades at 31 times its trailing consolidated earnings. The valuation is too demanding, given that the company has not expanded earnings since FY-08.

The slide

Since its peak year in FY-08, DLF saw a steady slide in its sales and earnings. From Rs 14,432 crore in FY-08, consolidated sales fell to Rs 9,630 crore in FY-12.

Net profits fell a massive 85 per cent over this period to Rs 1,178 crore in FY-12. DLF struggled to sell properties over this period and also had to deal with both working-capital crunch and a mounting debt.

It adopted a two-pronged strategy to meet this. One, it sold more plots — that is, land not converted into property. This meant faster inflow of cash compared with the relatively longer period over which it would get cash from selling properties. But selling plots instead of properties is not lucrative. It hit profit margins.

Two, it started selling some of its assets, which it termed as ‘non-core’ (to its primary business of real estate development). These included assets such as resorts, hotels, wind power business and land. Its recent sale of its lucrative Mumbai mill land, though, was akin to selling a core asset. Also, these strategies do not appear to have yielded the desired results so far. For one, its operating cash flow position has been rather weak.

For the latest ended June quarter, the company’s operating cash flow of Rs 664 crore did not cover interest cost of Rs 740 crore.

While this picture may improve in the second half when sales normally pick up, such a tightrope walk does not provide confidence, given that interest burden may not decline any time soon.

Deficit in operating cash also means that part of the proceeds from its non-core asset sale is being used to bridge operating cash deficit rather than to repay debt.

The result: Cash from asset sale may not always go to reduce debt. This is visible in its June quarter, when gross debt, at Rs 25,060 crore, remained almost unchanged from the previous quarter, despite Rs 370 crore of inflows from asset sales.

Besides, the company has been incurring capital expenditure, both to consolidate land holdings for its development and rental businesses. That too requires cash. As a result, its de-leveraging plan has been rather slow.

The outcome of a penalty demand from the Competition Commission of India, besides income-tax claims under litigation, are other possible risks that can suck cash.

Slow pace of sales

The pace at which DLF has been selling properties has also not been encouraging. It sold 1.34 million sq. ft in the June quarter as against 2.2 million sq. ft. a year ago. That it did not launch new projects during the quarter may be one reason.

Still, the number is less, considering that it sold just 3.3 per cent of the 40.6 million sq. ft of properties (other than those built for lease) under construction. This number could pick up once it sells more plots. But selling plots is unlikely to provide support to profit margins. The company’s operating margins rose in the June 2012 quarter to more than 50 per cent as a result of increase in floor space index in a project (which means higher space to build with land cost remaining fixed).

But margins are likely to move back to the 35-40 per cent range seen in recent years. This may be reversed only when the company sells more properties instead of plots. The company’s operating profits covered interest costs by less than two times. The company would have to hasten to sell its Aman Resorts property and wind power business, which may fetch another Rs 2,500-3,000 crore.

In all, if the company is able to meet its divestment target of Rs 5,000 crore this year and use this entirely to reduce debt, interest outflow may reduce by a fifth. This may be the key to lift earnings.

(This article was published on August 18, 2012)
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