Debt-free status for residential operations positive for DLF

Investors should await timeline for fund infusion and extent of equity dilution

Three years after the plan to sell the 40 per cent stake held by promoters in rental assets housed under DLF’s subsidiary, DLF Cyber City Developers (DCCDL), was initiated, DLF and its promoters announced that they have struck a deal. Reco Diamond, an affiliate of GIC Real Estate of Singapore will be buying 33 per cent stake of promoters in DCCDL, while the rest will be bought by DCCDL over the next one year — total value Rs 11,900 crore.
 
An analyst at a domestic brokerage says the deal is positive for DLF, though a large part of it was already factored in the stock price. The stock has gained 67 per cent since the start of the year, on expectation of a deal closure and pick-up in real estate demand. The deal valuations, however, are marginally lower than the Street expectations of Rs 12,000-14,000 crore (equity value) for the assets. Hence, analysts say the time it will take to execute this deal (expected to be closed in the current financial year) and the investment by promoters into DLF without breaching the 75 per cent norms on promoter holding (now at 74.95 per cent) is what the Street will be closely monitoring.
 
As part of the deal, the promoters will get Rs 11,900 crore for the 40 per cent stake in DCCDL, which translates to an enterprise value of Rs 35,617 crore. The proceeds to the promoters is expected to be ploughed back to DLF, which will help the company reduce its Rs 25,898 crore net debt as of June 30, 2017. The company could look at qualified institutional placement (QIP) and then a rights issues to bring in additional equity, while keeping promoter holding below the stipulated level.
 

Assuming that if Rs 10,000 crore is invested back into the company by the promoters, the equity dilution would be about 23 per cent at current prices. Including preferential allotment to promoters/non-promoters, total investment into DLF will be Rs 13,000 crore. This should help make the residential segment of DLF nearly debt-free. Of the nearly Rs 26,000 crore net debt, net debt attributable to DLF (excluding DCCDL), according to the company, is Rs 20,500 crore. Unlike the residential segment, DCCDL has strong cash-flows and generated about Rs 1,100 crore at the pre-tax level on revenue of Rs 3,662 crore in FY17. In the June quarter, while revenue for the residential and rental segments were similar at Rs 1,000 crore each, operating profit of the DCCDL at Rs 660 crore was about thrice that of the residential segment. Further debt reduction and equity expansion would depend on the QIP and rights offer.

 
While the reduction in debt will help stem DLF’s annual interest outgo to the tune of Rs 3,000 crore, it will be a while before the equity dilution will turn earnings accretive, given the sluggish demand environment.
 
Meanwhile, given the Real Estate Regulation Act, the company has also stopped its pre-sales across projects from May, which will translate to muted sales in the September quarter as well. Analysts at JPMorgan expect free cash flow for the business to remain weak for FY18, given the changed residential strategy of completing projects before selling but should pick up from FY19 onwards, as ongoing projects start to deliver. They expect rental business to deliver double-digit growth for the current year. In fact, the DLF management has also indicated the operational cash flow deficit of Rs 750 crore a quarter will remain over the next two to three quarters due to change in company’s focus to selling projects only after completion.
 
Overall, while the sale of promoter stake in DCCDL is positive, investors should await clarity on sales trend, especially in the company’s core market of the National Capital Region, and the timeline for debt reduction and quantum of equity dilution before considering any investment into the company.