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.
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
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
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.
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.
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
/ 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 Bangalore . 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. Aurangabad
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.
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.