Margin, volume worries blight DLF and Unitech

Both firms took a hit due to raw material costs in the March quarter, while rising interest rates and asset prices could translate into sluggish volume growth for the year.

Two of the country’s largest realty firms, DLF and Unitech, had a poor March 2011 quarter. The prospects, due to a jump in raw material costs, high interest rates and prices, in 2011-12 do not seem bright. Analysts believe the macroeconomic conditions, as well as the recent performance of these companies, suggest core revenue growth for 2011-12 is likely to be in single digits. They say volumes for both would be flattish in 2011-12 due to consumer affordability issues.

While DLF is likely to record sales of 10.5 million sq ft (versus 10 mn in 2010-11), Unitech’s numbers are estimated at nine to 10 million sq ft (versus 9.16 mn). Further, operating profit margins, which tanked 800-2,500 basis points (bps) for the March quarter, would continue to be under pressure in 2011-12, both due to low volumes and higher costs. Given the cost spike, the DLF management has given a cautious outlook for 2011-12 and believes the situation should improve by the end of the year.
 

WEAK MARGINS
	Q4, FY11		FY11
	DLF	Unitech	DLF	Unitech
Sales booked (mn sqft)	3.8	2.2	10.0	9.2
% change	5.5	-

-20.0 -45.0 Net Sales (Rs cr)2683.01054.09561.03167.0 % change35.0-6.929.07.1 Operating profit (Rs cr)666.0169.03753.0924.0 % change-33.0-28.57.0-16.0 OPM (%)25.016.039.329.0 Change in bps-2500.0-810.0-800.0-800.0 Net profit (Rs cr)345.0113.01640.0568.0 % change-19.0-36.9-5.0-16.0 P/E (x)--23.815.1 % change is year-on-year                              Source: Companies, analyst reports

Given the outlook for DLF and Unitech, analysts believe their stocks would continue to underperform over the next six to 12 months.

COSTS HIT MARGINS
The spike in raw material costs (bricks, sand, cement and steel) in the second half of 2010-11 dented operating profit margins. The DLF management indicated costs of cement, steel and labour had risen 10-30 per cent in the past two quarters, forcing the company to take a one-time cost hit of Rs 475 crore. While operating profit margins for DLF tanked by half to 25 per cent due to this, analysts estimate the high raw material cost shaved 810 bps off Unitech’s margins for the March quarter. Unitech has not reported the March quarter numbers separately.

Going ahead, DLF has indicated a large part of the price inflation was factored in its current projects but wage inflation could account for a one to two percentage point increase in costs. DLF is likely to focus on plotted sales, where the cost to sales ratio is much less than high-rise constructions. The company expects this strategy to help it regain margins of 45 per cent from the March quarter’s sub-30 per cent.

DEBT NEEDS
A key monitorable for the two companies will be debt. While debt in the case of Unitech looks more manageable, with a debt to equity ratio of 0.46, it increased for DLF during 2010-11 by Rs 1,800 crore due to investments in land and in its rental business. Unlike Unitech, reducing its net debt of Rs 21,424 crore has become a priority for DLF. In a investor conference call, Saurabh Chawla, executive director, finance, said it intends to do this by strengthening operational cash flows, enhancing the pace of non-core divestments and moderating investments in land aggregation and capital expenditure. The company has more than doubled its divestment target from Rs 4,500 crore to Rs 10,000 crore over the next two to three years. This is likely to bring its debt to equity levels from the current 0.8 to more manageable levels.

Meanwhile, given the macro environment, muted volume growth and higher costs, analysts expect the working capital (day-to-day) funding needs of the companies to rise. This, in a rising interest rate cycle, will increase interest expenses and impact their net profit margins. Though, some comfort can be drawn from inflow of cash from their rental businesses.

DIVERGENT STRATEGIES
Though both DLF and Unitech are pan-India players, with a presence across various realty verticals, they will be focusing on different segments to improve their financials.

While Unitech’s managing director, Ajay Chandra, has indicated the company’s focus will be in the mid-income and affordable housing segments, DLF’s Chawla says his company will look at high-margin projects such as luxury homes and plotted developments. DLF says it will continue with a strategy of volume moderation in high construction cost and low margin (large) projects. The company believes high inflation will lead to a fall in margins in mid-range residential complexes.

While Unitech will be focusing on rapid launch and affordable housing projects, it is aiming to achieve sales booking of Rs 5,000 crore for 2011-12, as compared to Rs 4,323 crore in 2010-11. Analysts estimate this to translate into sales booking of 10 million sq ft in 2011-12, but say revenue growth will depend on implementation (of projects under construction) and average prices.