Veritas Investment Research Trains Guns On DLF

Veritas Investment Research, which is known for its sharp criticism and has previously ripped apart biggies like Reliance Industries, Reliance Communications and Kingfisher Airlines, has now taken DLF to task through a critical research report.

According to the report (snapshot available with DSIJ), DLF is valued at just Rs 100 per share, which is half its current market price of Rs 200. The report has criticised DLF on the related party transactions, and also alleged that even those numbers have been inflated. The impact of the report is such that the Ministry of Corporate Affairs has ordered an inspection into the accounts books of DLF. We, at DSIJ, have tried to analyses this report.

The real estate sector has been in troubled waters for quite some time now. Rising interest costs, slower economic growth, a rising debt burden and declining realisations made sure that the sector will be under pressure. What added to the woes was the decline in sales volumes and the consistently depleting affordability. With DLF being the largest player in the realty sector, it is no wonder that the scrip has witnessed a blow. The net debt that is as high as Rs 22758 crore with hardly any free cash flow being generated, has put the company in distress.

If we take a look at DLF’s performance since the IPO, it witnessed a good response initially, going up to Rs 1200 as compared to the issue price of Rs 525 in 2007. However, the impact of the slowdown in 2008 was such that the scrip tumbled from the high of Rs 1200 in January 2008 to just Rs 200, showing an erosion of 83 per cent as compared to that of 16 per cent in the Sensex since then. Even if we consider the drop in the price since the IPO, it is around 60 per cent, as compared to that of 24 per cent in the Sensex. So, it is clear that the scrip has underperformed.

According to Veritas, the problems existed since the IPO days itself. The report says, “Claims made by management about its ability to execute were fanciful”. It further states, “Aggressive accounting approved by auditors, perpetuated & aided by investment bankers during the IPO process and the ill-informed media frenzy surrounding the IPO have all contributed to the myth that DLF is a corporate pillar of India”.

The report also alleged that, “Most importantly, we do not believe the disclosed book equity and asset base of the Company. We believe that via its dealings with DLF Assets Ltd (DAL), from FY07 to FY11, DLF inflated sales by at least Rs 11,236 crore and its profit before tax by Rs 7,233 crore”.  In the past, even we had raised queries about DAL, as it used to the single bidder for the purchase of assets and was promoted by DLF promoters.

The Veritas report adds, “DLF has undertaken questionable related party transactions to boost the value of DAL prior to its acquisition by DLF, thereby subverting the interest of minority shareholders via a higher purchase price for DAL”.

Veritas also raised questions about the execution capability, since the IPO management has faltered at every step in executing its plans, such a joint venture in hotels business and mega townships.

In addition to these points, a big blow comes from the following statement. “If your investment decision incorporates management integrity, then bypassing DLF will be an easy choice”. Even if points like aggressive and conflicting accounting policies and the inability to deliver on promises are ignored, what worries investors is the highly levered balance sheet, with a debt/EBITDA of 6x. What makes matters worse is that restructuring is also quite difficult. Hence, diluting stake seems to be the only option available for the company.

Thus, despite the company having a pool of land bank, Veritas has given a sell recommendation on DLF.

Although the report has been made public, DLF management has called the report “mischievous and presumptive” as Veritas Analysts apparently never contacted the DLF management for a clarification.

The scrip has taken beating of around 12 on the bourses (against less than 1% on the Sensex) since the report has been published on Mar 1, 2012. Considering all these factors, we recommend that investors should stay away from the counter.