Man Financial - D.S. Kulkarni Developers

DSKDL is a niche real estate company with more than 90% of its interests in residential properties in and around Pune. However, it is spreading its wings in Mumbai, Bangalore, Hyderabad, Delhi, and USA.

The company has constructed and handed over 15,000 tenements (approximately 12.5 mn sq. ft) in the past.

The company's ongoing projects indicate that it will build on an average 4 mn sq. ft. of property for the next four years, including FY07; 90% of these tenements are in and around Pune.

The company has a unique policy of transferring acquired land at a significant discount to the market price to DSKDL and the management says that it will continue with this policy in the foreseeable future.

The company is known for its innovative customer-centric approach and has also three quality certifications (the only construction company to have these)

The company has 650 acres (28.3 mn sq. ft, based on FSI of 1) of unused land spread across Pune, Mumbai, and Bangalore which is lying vacant and projects on this land are presumed to begin six years from FY07.

NPV of ongoing projects and unused land with 35% discount comes to Rs 688, a 115% premium to CMP of Rs 317. We have debited Rs 17.5bn for consideration paid to privately held companies.

The management indicates that it will go through the SPV route for undertaking larger projects in future wherein it will maintain 75-80% of the equity interest while the rest is offloaded in favour of a VC partner after valuing the specific project

Above NPV does not take into account the upside from projects in Hyderabad (400 acres land), Delhi (500 acres), and the project in the US (3,000 acres land bank) to construct 280 villas in Connecticut.

Risks: Overdependence on Pune's residential real estate market, transfer pricing policies, propensity to fund larger working capital in order to take advantage of rising residential property prices trend. Pune is a developing market for IT and ITES industry with demand-supply favouring the rising price trend. The company's past transfer pricing arrangements have been transparent benefiting shareholders of DSKDL and management indicates those to continue in foreseeable future.

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D. S. Kulkarni Developers: Buy

An established presence in Pune, which is one of the fast growing Tier-II markets; moving up the chain through high-value projects; and a comfortable land bank, augur well for D. S. Kulkarni Developers' earnings growth in the medium term.

The real-estate segment is still at a nascent stage in the domestic listed space, with a high risk-return element. Convoluted structuring of transactions has for long led to valuation discount of stocks in the sector, although the market is now undergoing a change with more norms in place.

The stage is now set for big unlisted players to make an entry. Combined with the arrival of real-estate mutual funds, this may well see the industry take on a more active role in the stock market over the long term. Investors willing to take the risks that come with an early entry in this fast-emerging space may invest in D. S. Kulkarni with a medium-term perspective. At the current market price, the stock trades at about 15 times its likely earnings for FY-07 and is at a discount to players such as Ansal Properties and Infrastructure.

The Tier-II market boom

D. S. Kulkarni has for long enjoyed a strong presence and brand recall in Pune. The Mumbai-Pune express connectivity has not only led to the city growing in the commercial and residential space, but also paved the way for it to emerge as a major IT and IT-enabled services destination among Tier-II cities.

The demand for housing would be a natural extension of increased need for office space. D. S. Kulkarni is well-placed to capitalise on the housing boom. Its recent venture into IT Parks may also act as a reference point for future projects.

Moving up the value chain

D. S. Kulkarni has a business strategy of catering to the mass-housing segment, keeping in mind low-cost housing. While this will continue to remain its primary objective, the company plans to move up the value chain with high-value projects.

Its ongoing DSK Vishwa project has a graded structure, where it would move from low- and middle-income group housing to IT parks and luxury houses and then villas. This strategy of targeting high-income clients, especially the IT-employed, who are backed by rapidly rising salaries, could improve margins steadily.

Land cushion

Apart from over 15 projects on hand, D. S. Kulkarni has about Rs 500-crore worth of land bank accumulated over years. Sitting on land purchased at relatively lower costs is likely to ensure that future projects have firm operating profit margins (OPMs). The increased supply of land through NTC mills may not affect the prices of housing projects for D. S. Kulkarni , as its construction activity still predominantly caters to the middle-income group.

This segment has valuation metrics different from the up-market projects that are likely to come up in the mill land.

Financials

D. S. Kulkarni's bottomline has grown at an annualised rate of 50 per cent over the past five years. The current projects are likely to accelerate this pace over FY07-11. The OPM at 16 per cent for FY-06 is likely to remain healthy as a result of firm realty pricing in Mumbai and Pune.

Its diversification into Bangalore and plans to enter Hyderabad, Kolkata and Tier-II cities such as Nagpur, are likely to mitigate risks of regional disparities in land regulations.

The company's debt-equity ratio appears less uncomfortable after the rights offer made early this year. With more venture capitalist companies and funds showing interest in the real-estate space, raising funds may no longer be a major task for the company.

Risks

The company's revenues may rise 150 per cent over the next couple of years, thanks to the projects on hand. However, execution delays can affect earnings growth. D. S. Kulkarni has applied for developing three special economic zones.

This segment is fraught with uncertainties such as long gestation periods and the risk of entering a new territory. The Land Ceiling Act in Maharashtra has led to real-estate companies routing land transactions through associate companies. This cumbersome practice keeps land dealings out of books and affects the transparency.