A weak pipeline of older projects, slow pre-sales in FY13/FY14, and new accounting rules will likely keep earnings subdued for four to five quarters. Plus, DLF Ltd carries single-market (NCR) risk and P/E (price-earnings) valuations appear full?24x and 17x (times) on F15e and F16e (estimates). We have lowered our rating to UW (underweight).
We see earnings challenges ahead? We cite lower pre-sales over the last seven quarters, a weak pipeline of old projects, and new accounting rules…plus single market risk? DLF remains dependent on the NCR region (which remains sluggish) for its earnings over the next two-three years.
We have updated our financial model: We now reflect the slow pace of pre-sales (Rs 38 bn in 9MFY14 versus Rs 60 bn FY14 guidance), slower pace of execution, current prices/cost, and sale of non-core assets. We have cut our earnings estimates by 9% for FY14, 18.3% for FY15, and 33.4% for FY16 and lowered our Mar-15 NAV (net asset value) to Rs 250 per share (vs. Mar-14 NAV of R277). We have lowered our NAV discount to 50% (45%) to arrive at our price target of Rs 125.
DLF expects to break even at the operating level two-three quarters from now: It has pushed forward its FY14 new sales guidance of Rs 60 bn new sales by two-four quarters.
We have assumed Rs 60-70 bn in new sales p.a. for DLF to achieve our profit estimates in FY2015-16: Importantly, these sales translate into accounting profit and cash flows over a period of four to five years for group housing projects (in line with the pace of construction). Our estimates assume early recognition of certain high-value and high-margin Phase V projects (e.g., Camelia), since these are expected to continue to follow old accounting rules. Unwinding of R75 bn in unbilled receivables on the balance sheet could slow the recognition of Phase V projects (although with no cash flow impact).
Focus will return to P/L: With the recent asset sales (Rs 174 bn net debt as of Feb-14), balance sheet improvement ends. The company does not expect any further debt reduction. The pre-sold and unrecognised pipeline of projects appears weak and new earnings drivers are not imminent?Noida Mall (Q3FY15), new launches (June-14 onwards) and sales for current projects are sluggish (high pricing and large ticket size). Plus, we see an overhang from a possible new equity issuance? likely Rs 32 bn?for Rs 16 bn CCPS (compulsorily convertible preference shares) issued to the promoters (Mar-15 conversion) for rentco (40% stake). Reported Q3FY14 core net profit was Rs 1.25 bn (we estimated Rs 1.95 bn).
We have updated our earnings model to reflect delays in new launches, slower pre-sales and new accounting rules.
Risks to our UW thesis: A positive election outcome could drive better investor/customer sentiment and local macro conditions. Earlier and greater new launches and pre-sales could accelerate earnings recovery.
