Battling the odds

Moving from a small town in Uttar Pradesh to England to study aeronautical engineering and then the ascent to become a realty czar owning a bevy of luxury cars and a private jet, not to mention India’s largest real estate development company, having a market capitalisation of ₹1.8 lakh crore at its peak in 2008, reads more like a script out of one of Bollywood’s typical rags to riches movies. Yet that is the true life story of Kushal Pal Singh, the man behind real estate behemoth DLF. 

The real picture is far from rosy 

Leverage continues to be an area of concern despite recent asset sale efforts

It is also a journey filled with a determination to succeed against the odds as can be evinced by two examples. In the 1970s a Haryana chief minister blocked clearances for DLF’s projects in its bastion of Gurgaon. None the less, today it is its largest market. Similarly Singh also campaigned vigorously (and successfully) to change the guidelines of the Urban Land Ceiling and Regulation Act in DLFs favour, an act which changed its fortunes.

It is such resolve and pluckiness that Singh will have to draw upon and demonstrate to extract DLF from the mess that it has got into of late. Recently, DLF’s stock price tanked about 30% in a single day to an all-time low of ₹100 after market regulator Sebi issued a diktat banning the company from accessing the capital markets for a period of three years. (The watchdog’s investigation, on the basis of a complaint filed by Kimsuk Krishna Sinha, found that DLF had not disclosed a police complaint filed in 2007 against its subsidiary Sudipti Estates in the prospectus of its IPO in the same year. Further it was found that the company’s claim of Sudipti not being its subsidiary and being sold off was untrue along with similar claims of several subsidiary companies being sold, with the money trail being traced back to the wives of several of its key managerial personnel.) 

The company has already challenged the order in the Securities Appellate Tribunal (SAT) and, if need be, will challenge it in the Supreme Court but Sebi’s ban has clearly spooked investors. 

 Domino effect

For one, access to funding becomes a challenge. Post the order, DLF cannot participate in any listed issuance such as equity, preferential allotments, debt or REITs in either the primary or secondary market for the next three years. It also can’t float any collateralised mortgage backed securities or non-convertible debentures, something that it has actively been doing over the past six months. 

Hitting the plinth

At its current market price of ₹110, the stock is trading near its all-time low

Second, it also puts into jeopardy DLF’s plans to pare its debt. Driven by asset sales, its debt has come down from ₹21,677 crore in FY10 to around ₹19,064 crore currently, but, given that the company is not making enough cash from operations, investors are worried about DLF’s ability to service its interest cost. “In Q1FY15, DLF’s net debt increased by ₹540 crore to ₹19,000 crore despite non-core inflows of ₹240 crore, highlighting that operations continue to consume cash. Q1FY15 operating cash flow and other income of ₹520 crore remains short of cash interest outgo of ₹760 crore,” says Atul Tiwari, analyst, Citi Research.

Importantly, this comes at a time when the real estate market is beaten down and expected to remain sluggish. Also, given that it has 57 million square feet of projects under construction, the company needs ₹2,500 crore annually to fund the construction of its projects. Given that volume growth has been muted for long owing to a slowdown in sales from the Gurgaon region — its primary customer base — any further slowdown in construction will severely hurt its future revenue streams and cash flows which are already weakened.

In Q1FY15 DLF’s sales and net profit declined by 25% and 29% respectively on a year-on-year basis. It did not manage to generate any free cash flow owing to its land parcel acquisitions and interest payments. “DLF’s commercial properties are doing fine but the residential property volume has been very poor for the past three years as compared to other players such as Godrej and Mahindra.

Feeling the pinch

Rising interest costs are taking a heavy toll on DLF's bottom line

 They have sold just ₹300 crore of property in each of the last two quarters. If the real estate market doesn’t pick up, especially in its key Gurgaon belt, and if the company doesn’t launch new projects then it will be a difficult act for the company to claw back from its present difficulties,” says Adhidev Chattopadhyay, analyst, HDFC Securities. To put things into perspective, while DLF had targeted new sales of 7.5 million square feet (msf) in FY15, it sold only 0.4 msf in the first quarter of FY15. 

The realtor’s interest outgo in FY14 stood at nearly ₹2,500 crore, which was 61% of its operating profit. Apart from this, the company is also incurring capex and land acquisition of ₹500 crore each year. In order to improve its cash flows, the company has resorted to selling some of its non-core assets including its convention center at Dwarka, commercial assets in Pune and Noida, a few land parcels and wind energy and power assets. By selling off Aman Resorts and the insurance business, DLF has managed to raise capital to the tune of ₹5,500 crore and pare gross debt by ₹5,000 crore. 

Concentrated bet

Residential real estate continues to be a major chunk of DLF's land bank and a large part of that is in Gurgaon

In light of the adverse regulatory development, most analysts are expecting that DLF will have to further rely on asset sales. “When you have heavy debt, corporate governance issues and little to no political leverage, there will be selling of assets. Distress sales may happen as many parties are interested in buying their assets at lower prices,” says Gaurav Parikh, managing director, Jeena Scriptech. 

Counter attack

In such a gloomy scenario what can Singh and his team do to turn the company’s fortunes? Aashiesh Agarwaal, who tracks the company at Edelweiss Securities, offers a few clues. “Whatever plans the promoters had to divest and dilute their stake in order to raise equity for debt reduction will not happen now. Aside from private equity, DLF can sell some of its land parcels or rental assets. They could also tap loans from banks and NBFCs,” he says. 

A hidden ace for DLF could be the enhanced cash flow from the rental business as it is through with most of the capital expenditure planned for the rental business. That cash can now be utilised as working capital for its incomplete projects. The management estimates an operating income of around ₹2,500 crore from rentals over the next three years. 

The Sebi ban isn’t the only regulatory uncertainty surrounding the stock. On the basis of a complaint filed by one of the owners association of some of DLF’s properties on the grounds that DLF was imposing unfair conditions on owners of apartments, the Competition Commission of India and the Competition Appellate Tribunal had imposed a ₹650 crore penalty, nearly 7.5% of its total turnover at the time, with a stiff 9% interest charge. DLF had appealed against this order in the apex court which, unfortunately for DLF, ruled in favour of CCI.

Then, on the basis of a complaint filed in the Punjab and Haryana high court that nearly 350 acres of land worth ₹1,700 crore in Gurgaon had been acquired by DLF in a dubious manner, the court cancelled the land allotment. This matter, too, is pending in the Supreme Court. Further the company also has outstanding tax demands owing to disallowance of SEZ profits amounting to ₹3,270 crore that could pose a huge contingent liability threat. 

 Collateral Damage

The slew of litigation has cast a negative shadow on the stock as has its leverage, which is expected to balloon further. The key development, however, will be the verdict of the SAT tribunal. If the Sebi order is reversed or if, as analysts feel, the period of the ban is reduced from three years to one year, Singh can breathe a huge sigh of relief. If the SAT appeal is over-ruled and the case drags in the Supreme Court, DLF could be forced to divest a big portion of its core and non-core land parcels at a discount.

The other threat that hangs over DLF in case of an unfavorable SAT ruling is its potential exclusion from the benchmark Nifty. Already, Institutional Investor Advisory Service, a proxy advisory firm is of the opinion that after the three-year Sebi ban, it is pertinent to ask whether DLF should remain a front-line index stock. “Being part of the CNX Nifty, DLF attracts several equity retail and institutional shareholders. Index funds will also be required to hold the stock in almost the same measure as its weight in the index. But, with the recent Sebi order, markets must question whether it should remain a constituent of a principal index,” it states in a recent note. 

The unease is apparent as despite a net asset value of around ₹230 per share, analysts perceive it to be a risky proposition at its current market price of ₹110. They are fearful about the sustainability of DLF’s debt, its ability to monetise assets, the industry environment and high contingent liability sitting in the form of several litigations. “Given the size and scale of the company, the volumes that they are doing are just not good enough. If you take into account the capex and land acquisition they do, they continue to burn cash every quarter which is not sustainable,” says Agarwaal of Edelweiss. Given the underlying regulatory uncertainties surrounding the stock and the fact that its own management sees recovery only five to six quarters from here on, it is best to steer away for a while.