Saturday, January 7, 2012

Nesco Ltd

We value investors are a funny breed. I have over the past couple of years experienced that though we might share the same framework and thought process for some explicable reasons the portfolio of value investors rarely seem to match beyond maybe 20 – 30% of stocks. I regularly compare notes with my fellow friends and value investors Rohit Chauhan and Neeraj Marathe ( and a few more ) and funnily I have found that all of us have different stocks that we are comfortable with.
So it was a interesting that during the last week of December it transpired out of conversations/emails that all three of us have been independently looking at a company - Nesco Ltd. So we decided that post the year end break without discussing individual thought processes or our view on the company, we will put out posts on our blogs with our perspective on this investment opportunity. We thought it would be an interesting exercise for us as well as the readers of our blogs to have a post on the same company at the same time. The idea is not to see who is right or who is wrong. All three of us know that even if we reach a consensus, all three of us could be very wrong and even if all of us have different conclusions, all three could be very right! Well thats the best thing about investing, there is no one way of doing things.
You can check out Neeraj Marathe’s post at  http://neerajmarathe.blogspot.com/  and Rohit Chauhan's post at  http://valueinvestorindia.blogspot.com/ 
So here goes my side of the story 
Nesco Ltd was established in 1939 as New Std Engg and operated in the capital goods business. The company had plants in multiple locations in Mumbai which it finally consolidated at a single location in Goregaon on the Western suburbs of Mumbai with a 70 acre plot.
The company started incurring losses in its capital goods business and gradually shifted to the business to Gujarat and converted the Mumbai land bank into a exhibition and convention centre. The size of the land bank coupled with close proximity to the airports and the national highway has enabled it to become one of the premier exhibition centres in the country and has conducted over 500 exhibitions and events at the location. The closest competitor in Mumbai, Nehru Centre is less than 1/15th the size in terms of exhibition space.
The company has also converted its old plant sheds into IT parks and is in the process of constructing a large IT park ( IT park 3). IT park III will have nearly 8,00,000 sq feet of space and the company has leased  out a significant chunk of this project which is under construction and should be ready for fit outs in the next couple of months. 
The management has been conservative and has repaid the debt on the books and has used the internal accrual route to fund expansion for the IT park that it is setting up. The management has clearly stated plans for IT park IV and IT park V where it intends to use the cash flow generated out of the exhibition business and rental income to fund construction of the remaining IT parks.

Financials
FY 2011
a) Income
1)       Convention Business -  65.62 crores ( up 21% over previous year)
2)       IT Park ( rent Income ) – 51.61 crores
3)       Capital Goods business -  16.82 crores ( Down from 24.8 crores in the previous year)
4)       Income from investments and other income -  10 crores
b) Cash/ Investments on Balance sheet -  168 crores
c) Net Profit -  68 crores
d) Cashflow from operations -  78 crores
HY -  2011 -2012
a) Income
1) Convention Business -  25 crores ( HY 2011 -  21 crores )
2)       IT Park ( rent Income ) – 51.61 crores
3)       Capital Goods business -  15.29 crores (HY 2011 -  6.61 crores )
4)       Income from investments and other income -  3.15 crores (  HY 2011 -  3.63 crores )
b) Cash/ Investments on Balance sheet -  215 crores
c) Net Profit -  25 crores

Dividend policy
The dividend payout ratio has been poor because the management has chosen to reinvest the cashflow in construction of the new IT building. The management intends to maintain the same as it is averse to taking debt and will use internal accrual to fund further construction over the next four to five years. One can’t argue against this thought process of the management considering the high operating margin and ROCE.
Valuation
The company is currently available at a market cap of Rs 800 crores with no debt on books. Against which we have
Cash / Investment on Books -  215 crores
Net Profit – 68 crores ( Last year) 
IT Park III should start contributing from next year and on a conservative estimate of Rs 80 per sq feet should generate an additional Rs 50 crores of revenue in FY12-13. 
So net cash of the company is available at 5-6 times and which would appear low for a company with high ROE and with steady cashflow and huge entry barrier to the business.
Risks
1)       Though cashflows over the next 4- 5 years are slated to be lined up for construction of IT park IV and V, subsequent to which there is lack of clarity on what the management intends to do with the cashflow going forward. The bladder problem of management either earmarking the cash for its capital good business or blowing it up into unrelated diversifications exists.
2)       The historical low dividend payout ratio though can be argued as logically correct at this stage of the business could however turn out to be a constant thought process for the management.
3)       The biggest risk that I perceive is that the entire business model is constructed around a piece of land in a single location in Mumbai. Mumbai is currently the most expensive city in this country with respect to real estate prices. There is a situation of oversupply of commercial property in Mumbai. The company stands exposed to not just a generic correction in real estate prices ( hence associated rent income )  but more importantly derating of the Mumbai real estate market. There is a increasing trend of companies shifting their IT / ITES operations out of Mumbai to other locations like Bangalore/ Pune/ Gurgaon etc. Case in point is that Intelenet which occupies one of the building did shift a significantly large process of over 2000 ppl to Aurangabad. TCS Eserve which occupies one of the other buildings is expanding its operations in Ahmedabad and other Tier II cities. Considering the 4- 5 year window when shareholders could possibly look at actual cashflow, this is a large risk that the business carries.
 My viewpoint
Prima facie the company appears to be cheap with relatively steady cashflows. I intend to look at company from a different angle.
Is Nesco a cash bargain / holding company and hence should be valued accordingly?
Lets examine the management competency variables
1)       The biggest achievement of NESCO is the piece of land at Goregaon which it fortuitously acquired a long time back.
2)       The current business model and cashflows are dependent on this piece of land.
3)       Can we say the management has competency in the real estate business and can take up more projects beyond this piece of land like any other real estate developer. 
4)       Is the same true about the Convention business? Do we think the management has competency to set up x more convention centres across the country and run it?
5)   The only operating business that management is running which is the capital good business has a chequered past track record.
So lets flip the coin and look at NESCO as a holding company / cash bargain opportunity.  We have a plot of land which on a conservative basis can be valued at RS 2000 crores + 200 crores ( Cash on balance sheet) = Rs 2200 crores.
This piece of land through rent and the convention centre generated about  68 crores of net profit last year . (I m keeping the calculations simple at this point of time without valuing the capital goods business separately) 
Effective yield of 3.4%. This yield should go up to about 5 % with the IT building III coming to play.
The market today values
Holding companies -  25% of intrinsic value
Cash bargains  -  40-50% of cash on balance sheet
 ( One can argue on the merits and demerits of these discounts but if one feels otherwise clearly there are better managements who could  be looked at for cash bargains)
 Considering the relatively lower yield being earned as compared to other cash bargains and management risk we can value the company at about 40% holding value.
 Value of the company -  40%* Rs 2200 crores -  880 crores
Current market cap  - Rs 800 crores.
Conclusion
Considering the lack of visibility of cashflow payout to the shareholders over the next 4- 5 years, I would like to look at this opportunity a couple of years down the line as clarity emerges on the management’s thought process and visibility on dividend payout and deployment of future cashflows.

23 comments:

Neeraj Marathe said...

Doode,
Your final conclusion makes a lot of sense to me..
cheers!
Neeraj

Anonymous said...

Out of the three analysis , I like urs best. Thanks.
Gian

Ninad Kunder said...

Thanks Neeraj.

Ninad Kunder said...

Thanks Gian.

However the objective as I said was really to come up with different perspectives to the same set of data

Cheers

Ninad

Dhwanil said...

Hi Ninad,

An excellent analysis indeed. I think, independent evaluation of the same stock by you, rohit, and niraj is an excellent idea.

NESCO has passed most of the quantitative filters/criterea that I have evolved for investment, however what is holding me back is the business part of it. I am not very comfortable with the quality of business. As you very rightly mentioned, the biggest achievement for NESCO is piece of land that is fortutiosly acquired long time back. I am not able to visualise, where NESCO will be (in terms of business) 10 years down the road.

Regarding, convention center business, I have had a firsthand feel. I have attended 3 exhibitions at BEC. When I compare BEC to some other exhibition centers in hyderabad, Gurgaon, Delhi, I feel that the infrastructure/management of the convention center is very primitive. Thus, I would not put my money on NESCO managing many more convention centers for sure!

In my opinion,NESCO can be considered as an asset play where it should be evaluated against the value of asset with appropriate discounting applied to asset plays.

It would be interesting to receive your comments on some of the ideas that I have namely JB chemicals, Mayur Uniquoters, Oriental Carbon, and Sintex. you can view my analysis at http://valueinvestinginpractice.blogspot.com/

Ninad Kunder said...

Hi Dhwanil

Thanks for u r views. Will visit u r blog and come back with my thoughts on the companies that u have mentioned.

Cheers

Ninad

vijay50 said...

I do not see much value based on all the facts narrated by Ninad in his most comprehensive analysis.The piece of land no doubt is extremely valuable but how is this being put to use is highly debatable.Convention Center is a great idea but it may not be of much value unless it is world class. If this is primitive- this will be a losing business in the future.IT industry is also moving to Tier-II cities as rightly pointed out by Dhwanil- so I do not see much potential even on this count.Good Luck to NESCO..

Ninad Kunder said...

Hi Vijay

I woudn't completely write off the company. At a price and time every thing can become attractive.

I think the key is to have visibility in terms of what the management intends to do with the cashflows and how much of it will come down to the shareholders.

Cheers

Ninad

lemasolai said...

An IT Park @ Bombay Exhibition Center makes a lot of sense for the following reasons :

1) Its bang on the Western Expressway.
2) The local stations of Goregaon and Malad are at a stone's throw from there.
3) The surrounding residential areas have reasonably comfortable rentals and living conditions.
4) Jogeshwari-Chembur Link Road is also functional now, which gives it access to eastern parts of Bombay.
5) Most of the IT companies in Bombay are at Mindspace,Malad...reaching which is a pain. The others are either at Ghorbunder Road or SEEPZ,Andheri.
6) Only the land bank of Godrej @ Vikhroli can compete with this size of a land bank.
7) However I beleive NESCO will trump the because of the above factors and also such close proximity to Airport and Hotels.

PS : I am just a student of Marathe Sir, what I have mentioned above r my views only .

Srinath Raja said...

Hi,
The other good thing I noted is that its a debt free company. But as you have suggested , lets wait and watch.
I like your blog.
I am trying to create one on my own as well and its URL is http://smartinvestments-srinath.blogspot.com. Please visit it and drop in your comments.
Thanks
Srinath

Ninad Kunder said...

Hi lemasolai

I am at no point arguing at the merits of the business as well as the thought process of the management.

Having said a good business/ company need not necessarily be a good investment. There is definitely value in the company and predictable cash flows. The key is to ascertain whether value doesnt transform into a value trap bcos of corporate actions.

Cheers

Ninad

Ninad Kunder said...

Hi Srinath

Thanks Srinath. Will drop in on u r blog.

Cheers

Ninad

sameer said...

Hi Ninad,
I was going through this interesting article
http://economictimes.indiatimes.com/features/investors-guide/investors-should-look-for-potential-delisting-candidates-such-as-oracle-fin-gillette-india-blue-dart-express/articleshow/11488451.cms


As new investor, I have no idea about how should we play/handle these situation.

Can u share detailed steps that takes place while delisting and what retail investor has to do???

Regards
Sameer

Ninad Kunder said...

Hi Sameer

I had written a guest post on Rohit's blog on delisting explaining the thought process that I look at. The link is enclosed below.

http://valueinvestorindia.blogspot.com/2010/02/special-opportunity-framework.html

Trust this can answer some of your queries.

Cheers

Ninad

sameer said...

thanks ninad

sameer said...

Hi Ninad,

just a small question (e.g.atlas copco)

After bidding done, discovered price by promoter is 2500.

1)If my tender price is 2300 then would promoter buy it at 2300 OR 2500
2)If my tender price is 2700, will I have chance to sell them at 2500??

sameer said...

Hi Ninad,
Are u playing UTV delisting?
http://calculatedwagers.blogspot.com/2012/01/utv-software-communications-move-to-go.html

Ninad Kunder said...

Hi Sameer

1) The promoter will buy it at 2500

2) You can sell the shares back to the promoter at Rs 2500 post the stock getting delisted from the exchanges for a period of one year.

Yes I m involved on the UTV delisting like my friend Ankur.

Cheers

Ninad

sameer said...

Hi Ninad,
so, assuming no one thinks selfish like me:), why should I ever participate in bidding process as I can sell promoters after everything(all delisting processes/steps) have finished?????

I mean there no advantage of "participating" over "no participating"

but there is disadvantage of "participating" over "no participating"(not immediate exit in case delisting fails as explained by Prof.SB in his post)


OR am I missing smething
Regards
Sameer

Ninad Kunder said...

Hi Sameer

No u r not missing something. But if everybody thinks alike then anyway the delisting itself will fail. So in effect a lose-lose situation and hence providing u no option in the situation itself.

Cheers

Ninad

sameer said...

Hi Ninad,
Look at current RBB data for UTV.
20th Jan 2012, 12:10:10pm

CMP : 1053
bids at 1100:4575458 cumulative bids ipto 1100: 8163201

Clearly discovered price as per definition in SEBI regulations is 1100 and still UTV quoting at 1050.

Is this huge 5% difference only because of risk that "UTV will discard discovered price of 1100"????

Knowing that everybody has access to this data, what is rationale behind this 5% difference???

Priya Chavan said...

Hi Ninad,

A leading financial house is conducting a bloggers meet to discuss Infra bonds in India and impact on it because of budget on the 28th of Jan, 2012.

Kindly share your email id and contact no. with me so that we can take this forward.

Warm regards,
Priya Chavan
priya.chavan@adfactorspr.com

Ninad Kunder said...

Hi Sameer

The difference is to assign some probability to the risk that Disney could reject the discovered price.

Also it will take about 2 - 3 more months before the company is delisted and you can tender the shares to the company. So the gap also covers for the cost of capital for the 3 month period.

Cheers

Ninad