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:
- 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.
- 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)
- 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.
Saurabh
PS- Invested in Ashiana Housing, and hence views may be biased
