DLF: Sell

Shares of real estate major DLF tumbled last week after SEBI found irregularities in the company’s 2007 IPO filing.

Does the recent steep fall offer an entry point for investors? Not really. There are at least four reasons why investors should keep away from the stock in the near term until the company’s sales and profit pick up.

For one, even after the fall in the last few months, the stock is not cheap. At ₹110, the stock discounts its 2013-14 earnings by 30 times — a demanding valuation, given that the company has not expanded earnings since 2007-08. DLF’s stock price had rallied over 50 per cent between March and June 2014 on expectations that the company would benefit from the launch of Real Estate Investment Trusts (REITs).

The SEBI order shuts out the option of using this new instrument to raise low-cost funds against its mall and office properties.

The company’s earnings growth is not expected to pick up due to the slow pace of recovery in the Gurgaon market and concerns over the company’s fund-raising ability.

The company faces multiple legal and regulatory issues. The Supreme Court will soon decide on the penalty of ₹630 crore imposed on DLF by the Competition Commission of India.

This is not an isolated case of legal action against the company by buyers; there are other pending cases too.

In September 2014, DLF suffered a setback when the Punjab and Haryana High Court de-allocated 350 acres of prime land in Gurgaon.

In August 2014, the UP Pollution Control Board served a notice to stop construction activity at DLF’s Mall of India in Noida.

The property has a potential of ₹200 crore annual rental income.

In June 2014, the delivery of DLF Riverside luxury project in Kochi was put on hold, after the Kerala Government cancelled a clearance.

In addition to the direct financial implications of these issues, the company’s brand name is likely to be eroded due to these multiple legal issues. If home buyers do not view DLF favourably, the company’s sales will take a hit.

DLF is saddled with high debt which stood at ₹19,000 crore as of June 2014 and may remain at current levels, as per the management. The company’s options for paring debt — by raising equity or through REITs — are curtailed.

The company’s cost of borrowing may also increase due to credit concerns.

Interest expenses increased 6 per cent to ₹2,463 crore in 2013-14. Interest outgo, which is around 30 per cent of sales currently, could increase further, dampening profits.

DLF’s earnings, which have been on a downtrend since the peak in 2007-08, are likely to remain stressed over the next one-two years. In the latest June quarter, the company’s pre-sales was at its lowest ever — 0.4 million square feet (msf).

The management guidance for the next six to eight quarters was also cautious. Demand and prices in Gurgaon, DLF’s main market, continue to be weak.

The company sold only 0.44 msf in its New Gurgaon project in 2013-14 against its target of 2.5 msf a year.

DLF’s earnings and operating cash flow have been deteriorating. Its consolidated net profit was down 12 per cent year-on-year to ₹582 crore in 2013-14, despite a 6 per cent increase in sales to ₹8,298 crore.

Operating cash flow for 2013-14 decreased to ₹2,734 crore from ₹3,822 crore last year.

DLF’s interest cover, a measure of its ability to service debt, is at a precarious level of 1.5 times in 2013-14 from 3.5 times in 2009-10.

There are two bright spots for DLF though. One is its sizeable land bank with a development potential of 307 msf.

The other is the robust lease income from its commercial properties in Gurgaon, Chennai and Hyderabad.

Leased area increased to 0.71 msf in the first quarter of 2014-15, from 0.59 msf in the previous quarter.

The company has guided that lease income will increase to ₹2,100 crore in 2014-15, up from ₹1,950 crore in 2013-14.

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