Build(er) to Wealth

If I had tons of money (I know I can dream big), the one business I would have definitely done was of Real estate. For me it is one of the few business where a large amount of capital can be deployed at very attractive return rates

Also, it is a fairly simple business to understand. It is similar to a manufacturing without the complexities associated in manufacturing.  So one needs to acquire a land as his raw material at a reasonable price, then build/ manufacture the flat and sell it at a marked up price (on which he has substantial control).

And then I woke from my dream and realised to my utter dismay I can't become a builder. But, on other hand I realised I can do own such businesses by buying their stocks.

This led my search into the real estate sector, and again to my dismay  return ratios of  most companies in this sector were horrible.

Quoting from the movie Snatch > Never underestimate the predictability of Stupidity", i realised that despite the pricing power real estate companies enjoy they committed the same mistakes which their manufacturing counterparts with no pricing power had did.

In manufacturing what happens if a company buys lot of raw materials  and demand slows down.  Well you get one real messy situation as your fixed costs and interest costs kill you. This is what also happened with most real estate players. They bought land banks using debt on the assumption that demand would keep growing forever at a furious pace, and when the tide turned, the debt burdened almost wiped them out.

In all this mess i though did find a company which seemingly behaved like the company in my dream. Its name is Ashiana Housing


Background: 
Ashiana Housing (http://www.ashianahousing.com/index.php) is a real estate developer with focus on group housing cost/old age housing. Their main focus till now has been developing projects in Tier-2 towns like Bhiwadi, Jaipur, Jamshedpur etc.


The big differential between Ashiana Housing and other builders is that Ashiana treats land as a raw material rather than an investment and thus focuses on execution rather than chasing land banks.

By following this business model Ashiana has entered into a positive feedback loop explained below. Such loops are rare to find and  are very difficult for competition to replicate. ( Read more about this in this Book )

1)  Due to its  focus on execution, Ashiana has an impeccable track record of completing its project before scheduled delivery dates.
2) This has led to banks offering full disbursements of home loans ( around 60-70% of flats are purchased using home loans) rather than funding construction linked loans. This leads to lower interest costs for the customer, since in a construction linked funding loan only interest is repaid till the complete disbursement
3) This then leads to more customers preferring Ashiana over other builders, even though Ashiana usually has a premium attached to it
4) This leads to float for Ashiana in form of advances from customers, who in turn have been funded by banks. This interest free float can then be utilised by Ashiana for land acquisition or quicker project execution or for forming JV's with other land owners


The above is verified by the fact that Ashiana is almost a zero debt company and has cash of around Rs. 85 Crs as on 31st December 2012. Since has not blown away its cash in land bank game and acquiring assets its average 5 year RoE is around 35%.

Present scenario:

Ashiana had been suffering from 2 problems, one related to its valuation and another completely unrelated to its valuation.

The unrelated Problem:: Company changed its method of accounting from percentage completion method  (POC)to contract completion method. In the first method as the construction happens and sales get booked, revenues are recognised and so there is a smoothness in reported revenues. Under the POC method, revenue gets accounted after a certain minimum cost threshold is reached which varies from 5% to 25% of budgeted costs. However this method does not reflect the liabilities and assets of the company accurately. Ideally,  till the flat is delivered to customer the entire amount received from customer is liability but in POC method this is never accounted for.
In contrast in contract completion method revenue is recognised only when the ownership of flat has been transferred to customer a la manufacturing setup. This often leads to lumpiness in revenues and low visibility of revenues in immediate future.

Ashiana changed its method of accounting from POC to contract completion, leading to loss in visibility of revenues for few quarters. Now Mr. Market hates uncertainties, and since there is uncertainty in revenues he has not been kind to the company.


The Related Problem:: In a ruling in 2011, government of Rajasthan had stopped giving any fresh permissions of conversion of Agricultural land into non-agricultural land. This led to what we can say as raw material shortage for Ashiana. However in last 4-5 months, most of these issues have been resolved at government levels and Ashiana is now getting regular approvals (raw material) for its construction activities.

Now, since the problem related to valuation has been resolved lets actually look at

Valuations:

The first step I took was to look at the cash flows which company will accrue over say a period of next 3-5 years. The calculations for this is given in the table below. The data for future saleable area is taken from company presentations and can vary a bit

Present Saleable area	Location	Saleable Area(in lac sq. ft)	Area booked	Gap
Ashiana Aangan	Bhiwadi	20.56	20.52	0.04
Utsav	Jaipur	3.7	2.47	1.23
Ashiana Brahmananda	Jamshedpur	4.8	4.67	0.13
Ashiana Amarbagh	Jodhpur	5.95	5.82	0.13
Utsav	Lavassa	6.87	2.61	4.26
Rangoli	Jaipur	26.06	16.88	9.18
Marize Plaza	Jamshedpur	0.83	0.3	0.53
Treehouse	Bhiwadi	1.2	0.46	0.74
Ashiana Aangan	Neemrana	4.2	2.93	1.27
Future Saleable Area
Ashiana Town Thada	Bhiwadi	39	0	39
Utsav	Kolkatta	7.5	0	7.5
Milakpur Land	Bhiwadi	31.49	0	31.49
Ashiana Navrang	Halol	6.43	0	6.43
Gulmohar Garden	Jaipur	11.5	0	11.5
Anantara	Jamshedpur	4.69	0	4.69
	Jodhpur	5	0	5
	Neemrana	3.6	0	3.6
Total Saleable Area				126.72

I then tried to estimate a normal case and worst case scenario for the company

	Normal Case	worst case
Average Realisation per sq.ft	2500	1750
Expected Sales over 5 years ( Total Saleable Area* Avg. Realisation)	3168	2217.6
PAT over 5years# ( In Crs)	792	443.52

# Best Case Margins are 25% which is historical and worst case assumption is that it reduces to 20%

Considering the unique nature of business if we suppose that company doesn’t acquire any fresh land bank, it will have minimal running expenses and almost all of PAT will be available as free cash to the company. Let me further worsen the case and assume that all this cash flow is accrued to company only in 5th year ( Ashiana completes projects usually in 3 years). The scenarios then look like this

 

All fig. In Crores	Normal Case	Worst Case
PAT over 3 years= Free Cash Flow	792	443.52
Discount rate of 10% for period of 4 years	491.77	275.39
Add Cash as on 31/12/2012	85	85
Market Cap	576.77	360.39
Present Market Cap	460

Conclusion:

1. At a Mcap of Rs. 360 Crs company ( Make my dream true and let it reach this level) will be nearly valued at distress valuations with no visibility in sales growth and with almost no possibility of increasing its sales price, both of which seem unlikely.
2. Even in case of normal scenario, we have assumed that company is not going to use cash to buy more land. In all probability it will buy more land and thus employ capital at rates in excess of 30% ( historical RoE)
3. I have been a buyer in this stock on every dips, and in case it falls to levels of Mcap of Rs. 360 Crs I will do significant addition into it.
 

Thanks and Happy Investing

Saurabh

PS- Invested in Ashiana Housing, and hence views may be biased

The Growth Conundrum

As a long term investor, one should be concerned with two things while buying a stock,

• Quality of the Business
• Price at which one buys the stock

Courtesy of internet, screens, forums, list of bloggers on this blog the the chances of you coming across good businesses and stock ideas is pretty high (serendipity). So without much effort the first point is taken care of.

It is on the second point that divergence appear amongst investors, and it appears more so in case when we are talking of stocks on high growth path.

For last few days I have been struggling to solve this problem of "what price to pay for growth" until i bumped onto one of the blogs of Aswath Damodaran ( If anyone wants to learn valuation, please go through his lectures. They are free and brilliant). The link to these blogs are here and here

Based on the blog I ran the test on 5 companies, who meet probably all criteria of a quality business. These were: Amara Raja, Astral Poly, Atul Auto, GRP and Kaveri Seeds.

Before, jumping to conclusions of the test let me first share the methodology here.

Step: 1 : Find out the enterprise value of the stock ( Mcap+Debt- Cash)
Step: 2:  If we assume that company doesn't do any growth going forward then it can pay the entire income out to stockholders as dividends and as interest to lenders.In this case, operating income from the most recent period will be cash flow each year in perpetuity. The value of these cash flows can be computed by discounting back at a cost of capital to yield a value for assets in place.By doing this we know what is the value of assets which company holds now.
Step 3: This involves calculating the value of assets which are required for growth. To calculate this we would need the following inputs

• Expected growth rate: I have assumed 25% for all the 5 companies
• Expected Return on Capital: I have taken average last 5 years as an indicator for this.
• Length of Growth: I have assumed 5 years,since all of them operate and have strengths to deliver growth for long periods.
• Reinvestment Rate: For a company to grow it needs to reinvest money it earns into business which can be calculated as Reinvestment Rate= Expected growth rate/RoC

Once we have this data in place we simply to a DCF for 5 years, with operating income of each year being reduced by the reinvestment amount required.

Step 4: The difference between EV(Step 1) and Value of Assets( Step 2) gives us the price which we are paying for growth.
Step 5: Comparing price found in step 4 with value of assets for growth( Step 3) will give us an indication whether this stock is overpriced/cheap/fairly valued.

The results of my analysis courtesy Prof. Damodaran are given below. Also attached is the link for excel sheet with all calculations. It is a modified version of what Prof. has shared on his blog. 
 

Inputs	Amara Raja	Astral	Atul Auto	GRP	Kaveri
Growth Rate	25.00%	25.00%	25.00%	25.00%	25.00%
RoC ( Avg. 5 years)	31.00%	21.80%	30.00%*	29.40%	20.00%
Growth Period	5	5	5	5	5
Cost of Capital	15.00%	15.00%	15.00%	15.00%	15.00%
Stock Price	239	310	114	1603	1073.00
Outputs ( In Crs)
Enterprise Value	3918	727	121	269	1361
Value of Assets in Place	1442	322	107	159	427
Value of Assets for Growth	1107	149	80	116	159
Price Paid for Growth	2476	405	13	111	934
Price Paid/Value	2.24	2.71	0.17	0.96	5.89

* For Atul Auto RoC is average of last 3 years.

The link for the excel sheet is here. One can modify all the input parameters into the sheet to see at what price/growth rate/RoC does a stock become overvalued or cheap.




Has this solved my conundrum? Yes, but i have fallen into another conundrum of a few biases :(. More on that later

Till then Happy "growth" Investing.

Regards,
Saurabh
PS- Invested in Atul Auto, GRP & Kaveri Seeds, although all are very small positions as of now.

JB Chemicals: Cash is King

In a rising market such as what we are witnessing today, it becomes increasingly difficult to find good stocks which are cheaply available. 

For me one of the resorts in such a run up is to find statistical graham style cash/debt- capacity bargains (Explained brilliantly by Kiran here: Debt Capacity Bargain) and one of the stocks which has popped up is JB Chemicals (JBC). 

Business of JBC:  JBC was founded by Mr. J.B.Mody and is one of the oldest branded generic drug manufacturers in India. Some of its well known brands are metrogyl, rantac, nicardia etc. JBC also does contract manufacturing with specialty in lozenges and supplies them to various geographies.

Like a typical branded generic play JBC is a good but not great business. The same can be concluded if we look at its RoE & RoC figures, which are in range of 16 to 18% consistently.

The company becomes interesting when we consider that they have recently sold off their OTC business of Russian & Other CIS countries. Sales from this division were around Rs.200 Crs and PAT of around and company received Rs.1200 Crs for the same out of which Rs. 320 Crs was paid as dividend.

At present cash position of the company is as follows:

Cash & Investments= 560 Crs

Less Debt               = 80 Crs 

Balance                 = 480 Crs

Present market cap of the company is around Rs.637 Crs, which means we are getting the whole business for around Rs. 157 Crs or around Rs. 18.

Excluding the CIS business JBC had sales of around Rs.635 Crs in FY 12 and if we assume a nominal growth of 10% & lower end PAT margin of 10%, we get EPS of around 7.5 which means we are effectively buying the company at P/E of 2x, which is much lower than P/E assigned to other comparative companies.

So, it is clearly established that on a valuation front the company looks deep into cheap territory. 

However, there are certain pitfalls one needs to check to ensure that such ideas don't become value trap. Let’s have a look at them

A) Is the management efficient in capital allocation or will they blow away the cash they have got :

Few indicators for this are

• RoE & RoC
• Sales to Free cash flow
• Past usage of cash
• Dividend Payout ratio

1) RoE & RoC- Both look decent but not great which can be expected from a branded generic drugs manufacturer.

	FY12	FY11	FY10	FY09	FY08
RoE	67	16.5	16.5	14.79	11.15
RoC	8.33	17.62	16.59	18.03	10.11

2) Sales to Free Cash Flow- This looks healthy. Any company able to convert around more than 10% of its sales to cash is doing good business. I have not taken this for FY 12 as they comprise of income due to asset sale.

In crs	FY12	FY11	FY10	FY09	FY08
Operating cash	879	133	109	98	38
CAPEX	80	33	12	15	28
FCF	799	100	97	83	10
Sales	797	854	716	670	558
FCF/Sales	-	11.71%	13.55%	12.39%	1.79%

3) Past Usage of Cash: If the company has been generating cash as indicated above it is important to look has the company blown away cash in the past. This can be checked by looking at Dividend Payout ratios, whether they have done unrelated diversification or any special payouts to promoters etc. The same can be checked by again looking at cash flow statements to see if there are lots of investments and if yes where are they going. Similarly is money being constantly used for large CAPEX’s etc can be seen from the cash flow statement.

If we look at AR’s of last 5 years, Dividend Payout Ratio is has been consistently in range of around 13-15% for which is an ok indicator.

The company also doesn’t seem to be very aggressive in CAPEX, or forming subsidiaries or investing in JV’s.

This gives comfort that they will probably not blow away cash in random unrelated things.

B) Integrity of management/Aggressive Accounting- Company is in business for 50 years and there are no as such litigation's/problems evident. Also, spoke too few people in industry who have say management is honest though not the most efficient.

To check for aggressive accounting we looked at cash from operations and PAT for last 5 years. Most of the times there is not much divergence here, which indicates fair accounting by company.

In Crs	FY12	FY11	FY10	FY09	FY08
PAT	677	139	118	25	45
Net Cash flow from operations	879	133	109	98	38

C) Indication of management on future business plans- As per AR of FY12, company has indicated that they want to focus only on pharma segment with more focus on domestic business. They are not is a hurry to use the cash till they get the right opportunities. They are specifically looking to increase product penetration and also get approvals for few other geographies.

Conclusion: JBC looks like a decent bet to me for medium to short term, wherin I expect the valuation gap to close. Although, one needs to keep a track on how does the company plan to utilize the cash? Another point to be noted is that when one looks at cash/debt capacity bargains it is better to have multiple bets.

Regards,

Saurabh

PS- Have initiated a starter position. Also as stated earlier I am invested in other cash/debt bargains like Mazda ltd and Piramal Enterprises ltd