Value of DLF’s annuity/rental portfolio equals ~95% of its market cap (based on implied cap rate of Embassy REIT at current valuation). Even at 8% cap rate (our base case), the rental portfolio value is >70% of the market cap — which implies gross undervaluation of its residential business at CMP. Full transmission of the ~110 bps interest rate cut over the last seven months in the economy will further drive the value of annuity assets (cap rate compression).
Rentals to grow at 19% CAGR to reach Rs 47 bn by FY22.
Under-construction projects to add Rs 4.6 bn to rentals over next 12-15 months. 2.5 msf of Cyber Park to commence in FY20 (96% is already pre-leased at Rs 119 psf p.m.) and 1.7 msf of Chennai IT SEZ (~60% is pre-leased at Rs 74 psf p.m). Contractual escalation of 15% every 3 years (5% p.a). Mark to market of rentals (current market rentals are 20-35% higher than in-place rents). Low supply of Grade A office space in Gurgaon (net leasing up 26% in CY18) lends strong visibility to rental resets at DCCDL.
Debt concerns behind; generating positive FCF. DLF raised Rs 31.7 bn via QIP and received Rs 22.5 bn from promoters (towards warrant conversion) which helped in meaningfully reducing its development business/ DevCo debt to Rs 34 bn (from Rs 124 bn in Q3FY18). It is already generating positive FCF and likely to continue (with improved sales, lower outlay towards construction and debt-servicing), which will help pare the debt further. Management targets to make DevCo debt free in the mid-term. Volume revival key; biggest beneficiary of revival in NCR market. With ready inventory worth ~Rs 110 bn, we expect sales to ramp up over FY20-21 (Rs 27 bn and Rs 31 bn in FY20E and FY21E vs. Rs 24 bn in FY19). While NCR market remains tepid, any revival over the next 1-2 years can benefit DLF disproportionately (vs. its peers).
At Embassy REIT’s valuation (implied cap rate of 6.4% on FY20 NOI), value of DLF’s rental portfolio is ~95% of its current market cap. At ~50 bps higher cap rate (than Embassy REIT) it is still as high as ~85% of current market cap. We thus believe there is more than adequate cushion to the valuation at the current levels, and thus its residential business is grossly undervalued.