What are we reading?

Ruanne, Cunniff & Goldfarb investor day transcripts — Must read (Valuewalk)

The one-word answer on why Bill Gates and Warren Buffett have been successful (SocialMediaWeek)

The unbelievable financial alchemy at Silverlake Axis (Valuewalk)

Ashiana’s Q1 Conf Call Transcripts (Ashiana Housing)

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Ashiana Housing — review after the quarter

What happens when one of your top holdings loses close to 20% in a week. Full one-fifth of the market cap wipes out. Lots of investors likes to blog real-time when a security goes up 20%. Very few tend to write when it goes down.

Observation no. 1: Ashiana housing can be had 20% cheaper now than 10 days ago. Had to get that out of my system. The intrinsic value has come down a bit after a horrendous first quarter earnings. Net-net I paid a higher price than I could have this week. Since I was not expecting such a down quarter and Mr. Market’s reaction to it there was no way I could have anticipated this response.

Observation no. 2: Instead of blindly cost averaging down, like most investors would do. We are re-evaluating the intrinsic value with the additional information we have in hand.

Background:

Ashiana housing is one of the larger holdings we have in our portfolio. It is a business model we understand in the construction business. We do not really very well understand the business models of many other real-estate companies that count of large land banks as part of the valuation. We like the asset light model that Ashiana follows where they treat land as a raw material. Secondly, the company is developing a reputation with existing home owners by delivering good quality homes on-time and with good quality. It has almost become a competitive advantage for the company as 90% of the new sales are coming from referrals as per the latest from the company. Thirdly, the company seems to boast a decent management that is minority shareholder friendly.

Long term view:

In the long-run there are only a few questions that matter: a. Will the long term demand from affordable housing increase in India? The answer is overwhelming yes. b. Can Ashiana housing provide the best possible affordable housing to the growing population in India? Ashiana’s culture, execution record and processes seems to indicate that the company will survive long term and be one of the best providers of affordable housing c. Can the company scale up the execution and do so profitably? The current IRR of the projects that the company executes is north of 30%. The hurdle rate is high in our opinion. Even if it lowered to 25%, we think it is a very viable business model.

While executing currently, the company is building a network effect with huge portion of the housing units being booked upfront. This gives the company the advances required to complete the project and hand it over making the capital requirements very low. The higher the percentage of happy customers, more are the referrals for the next project. Ashiana seems to be on the right treadmill at this point. In a booming economy, real estate is all about location, location and location. In a down economy, it is all about reputation, reputation and reputation. Without reputation, capital requirements and cost of capital goes up very, very fast. Ashiana seems to be doing okay in this regard with 70% bookings on all ongoing projects.

So what happened this quarter?

  • The company has been constructing or executing at the rate of 0.5 million sq. ft per quarter. It has scaled up the operations to be able to execute around 2.5 million sq. ft a year. However, flat bookings are down to 0.16 million sq. ft this quarter and the company has slashed its guidance from 2.2 million sq. ft to 1.5 million sq. ft for the year (which is optimistic as per the company)
  • The year will be challenging from a cash flow perspective as the bookings have come down. However, given the advances already collected from customers, the company does not see much of a challenge to execution.
  • The company is seeing a decline of 25% in enquiries and 5-7% decline in site visits.
  • The company had previously indicated that it would deliver 1,800-2,000 units this fiscal and is maintaining the number. This will result in 1.5-2 Billion INR (after share of associates) for this year and the pipeline for next year deliveries also look robust.

When you take a step back, it looks like the real estate is going through what will be a significant draw down. A bubble in the real estate was expected and there has been some correction in the sector in the last couple of months but it does look like it is more in the early part of the innings rather an end of the draw down. Given that Ashiana housing caters mainly to tier II and III cities where the prices are a lot more reasonable compared to the tier I cities and Ashiana’s focus on non-Tier I cities does bode well for the company. However, one can expect collateral damage to the company as can be evidenced from the lower sales booking in the quarter. Perhaps, the argument of the tier II and III cities may not hold good as there is a draw down in the real estate.

Just like we were not able to predict this week’s draw down, we are equally inept at being predict when the real estate draw down will end. However, we are convinced that through the draw down process, the strong will get separated from the weak. We also firmly believe that Ashiana housing has the right ingredients to survive through this if the company continues to execute on existing projects.  Nothing about the company has changed that attracted us to the company in the first place, its execution, management, business models are intact.

However, given that we are hearing in the market about real-estate and the tight credit situation that many developers are facing, we are well aware of the opportunity cost that we are paying to to hold this scrip. We think it will even out but it will take quite a few years before we get paid for it. At this point, we are content to let Ashiana execute on the INR 338 crores worth of customer advances sitting on the balance sheet from the projects that the company is executing now. It has 6 million Sq. Ft of on-going projects which is close to 70% booked. This ensures that the company can sustain some amount of pain but it will be interesting to see when the trend reverses for the company.

Disclosure: Own Ashiana

Disclaimer: I am not a registered research analyst as prescribed by SEBI guidelines and any discussion about a particular investment idea shall not be construed as investment recommendation. This is simply articulation of my personal views. Readers shall do their own due diligence and/or seek advise from profession investment advisor before making an investment decision.

Real Estate in India

In today’s markets, value has been tough to find compared to 21 months ago during Sep. 2013 when the pickings were a lot more richer. However, the astute investor does not have to own the markets, he only needs to find one or two investments that have sufficient margin of safety at any given point of time to create value over the long run. 

Traditionally, we have always been a bottoms up investor. While we will continue to make investments bottoms up, we are okay to see if we can identify points of dislocation in the markets by looking top down as well. Today, there are three points of divergence that we can identify with the markets in general. The performance of real estate stocks, the price of oil going down and price of gold over the last decade.

Before we go further, I must confess my view has been and still is that real estate, oil and gold are all commodities. They do not produce any cash flows on their own (small returns for leasing of gold and real estate) except on their sale. Their market value can be perceived to be the opportunity cost of the buyer. From that point of view, one can make an argument whether it is a real asset or not. However, it has been my observation that one can construct business models around commodities that have the ability to create values like housing lending companies, jewellery businesses, real estate construction and REITs.

Today, we will focus on the real estate business. There are three ways an astute investor can participate in the real estate business. Own real estate (land or flats), lend to the real estate sector or own real estate lending companies and owning real estate construction companies. We will talk briefly into all the the three but our primary purpose is to look at option 3 and explore it further in subsequent posts over the next few weeks.

a. Option One — Owning Real Estate — Traditionally preferred by a lot of investors. One feels secure with a roof on the top of one’s head and society does seem to value individuals owning real estate higher than those who don’t (it is an Indian thing). In key cities, rental yields annually are around 2-3% of the purchase cost of the real estate (assuming we have a construction ready real estate) Even if one were living in our own real estate, it does bring costs down by 2-3% of rental costs per year. Also, after tax breaks, it is possible to borrow at 6% and invest in real estate. It is easy to lever and banks are more willing to lend against the brick and motor assets. However, for the small average investor, it does quickly balloons into a big portion of their assets and entrench them that will prevent the investor from exploring alternate more lucrative investments. Secondly, the unlevered returns from the real estate sector is not alluring as it is after leverage. Several studies indicate that most of the real estate returns come through leverage. It must be noted, that if one does intend to lever up, real estate is probably one of the safer ways to lever one’s equity. Thirdly, liquidity and transaction costs of buying and selling means that it is not always possible to move equity to a more lucrative long term investment without costs and time. Fourthly, there is an ongoing maintenance costs that is needed to maintain real estate. Lastly, getting the right certificates, permits, clean documents are always a hassle in the corruption ridden system.

b. Option two — lend to real estate or own housing lending companies — directly lending to real estate transactions can be perilous without the right systems and processes. Owning housing lending companies might be a better option. Quality of the books and management are always a worry here. There are companies like Gruh finance (terribly expensive) have done this successfully creating a viable business model around real estate. Some banks and NBFC’s are also heavily reliant on housing finance. There are two catches here, the good ones are already very expensive and they too depend on leverage to deliver the returns. Leverage is great on the way up and terrible on the way down. However, an average investor can have non-recourse leverage on his balance sheet by owing common equities of housing lending companies at the right prices. We will leave the exploration of this option to a later date.

c. Option three — own real estate construction companies — just thinking about this sector brings about a bucket full or risks. Corruption to get permits, murky land deals, bad leverage on the balance sheets, shady managements, intense competition, deals that rip the eye balls of customers etc. the bucket keeps filling up. The real estate index has returned (32)%, (16)% and (64)% in the last 1, 2 and 5 year horizon. It is this big negative numbers that caught our attention. When a sector is this beaten down, the chances are it has also influenced some of the good companies to some extent as well. We do want to wade through this sewer to see if there are any good bets that might work out in the long run.  Below are the charts that show the performance of the bigger real estate companies and the index over these horizons.

1 Yr RE

3 Yr RE

5 Yr RE

Over the next few weeks, we will be working on publishing a series of posts looking at the risks of investing here and also into the individual companies. If one closely looks at the five year performance of the real estate companies, hardly any value has been created. Investors have been carrying return free risk for 5 years adjusted for inflation. Not a single company has been able to create value as compared to fixed deposits as well over the same time frame. Prestige estates has been one of the better ones (we have not included Ashiana housing that we own as we think it is an outlier) with 27% return over 5 years. We will be looking into some of these companies over the next few posts. What we are looking for is for no debt to very conservative debt, no dilution, robust business models and good managements. If we do not get these characteristics, we will pass on the sector. However, we do intend to pass on companies like DLF, DB Realty and HDIL where a very cursory question rises more questions than answers.

More to follow….