Pricing a growth stock
Business Standard / New Delhi June 15, 2007

The huge demand from institutional investors for the DLF issue of issues underscores the tremendous international appetite for Indian stocks. The issue’s performance also highlights the fact that, though domestic retail investors may find the pricing aggressive, there are enough institutional takers for local issuances. If local investors are conscious of the risks involved in real estate prices levelling off, in the company’s rapid growth assumptions as also the history when it comes to corporate governance, the institutional investor who is supposed to be more rigorous before showing the money, has no doubts.

 There is the question of understanding new and fast-growing industries in rapidly growing economies, and how to value them correctly. This is where global institutional investors seem to come out on top. Whether it was believing in the mobile penetration or the retail proliferation story, they have been the early adopters, and have made good money in Bharti and Pantaloon. Real estate is probably at the same level as was telecom and retail, three or four years ago. Understanding the sector and putting a fair value to the price is not an easy task. It is also relevant that with a market capitalisation of close to Rs 1 lakh crore, DLF’s listing would boost India’s market capitalisation by 2.5 per cent. Potentially, this could also increase India’s weight in the global equity indices.

 The questions that have bothered domestic analysts are whether DLF has the financial strength to earn the valuations that it has sought and whether its pricing is purely based on a promise by the management to develop its 10,000-acre land bank profitably, and that too within a very short span of time. The intrinsic value of the company or the net asset value of the company for March 2007 is less than 5 per cent of the market capitalisation, while its profit for the last year was less than 2 per cent of the market value. There is a lot of discounting of the future in the current price. 

Valuing a company with sales, earnings or assets which are going to be significantly higher in the future than what they are now requires faith in the management on keeping promises. In the case of DLF, there is lack of clarity on the value of the land holding, the titles and the rights to development of the land, and so on. For a sample, more than 60 per cent of company’s land is still agricultural land which needs government clearance to be used for any other purpose, the cost of which is indeterminable. As for real estate prices heading upward, which is a key selling point for DLF, its own aggressive development schedule could keep prices under check. Interestingly, the March 2007 earnings figures for DLF were approximately 40 per cent short of the figures projected by investment bankers in December 2006, when the issue was being pre-sold to potential investors. This demonstrates the risk of under-performance.

 In the current bull run, several high- profile stocks have hit the market and they were sold at high valuations because they had a good story to tell—for example, Jet Airways, which lost approximately 65 per cent during its worst phase and still trades significantly below offer price. More recently, take the case of Cairn Energy, which trades at a 17 per cent discount to the issue price. DLF too could face similar challenges in its journey to achieving its sky-high projections. The more a stock value deviates from its intrinsic potential, the higher are the chances of it hitting a rock. Since the stock in question will become the eighth-largest in terms of market capitalisation, it will soon become a key constituent of the leading indices. Any failure on the company’s part to meet projections will risk spoiling the stock market sentiment.


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