Piramal: Thoughts on current state.

Piramal closed on March 20th at a market price of INR 684 with a market cap of INR 15.4K crores. The shares outstanding as of Dec 31st was 20.45 crores with a dividend yield of 4%. Given the fall from grace the stock price has experienced, it will be worthwhile to examine both the liability side and the asset side and summarise what we know.

Networth:

  1. Company capitalisation and access to capital: A classic example of this was Yes Bank where they struggled to raise capital and the bad loans soured and the RBI stepped in. However, that is not the case with Piramal. With the recent cap raise and the sale of DRG, the net worth is estimated to be close to 34K crores or INR 1382 / share.
  2. DRG: Clarivate has confirmed that is has closed the DRG for $950M with a payment of $900M to Piramal Enterprises which amounts to close to INR 6K crores. You can see the link of Clarivate’s SEC filing here on March 2nd. We can safely assume that this INR 6K crores is available to Piramal for now. This is approximately 39% of the market cap of the company as of March 21st.
  3. The rights issue for INR 5,400 crores that the company executed in Jan was fully subscribed and the company has received the proceeds. It is important to note that the promoters of the company fully participated in the rights issue. This is another 35% of the market cap of the company.
  4. Less than 9 months ago, the company sold its stake in STFC for 2,300 crores.
  5. It is clear that the company has had access to liquidity from the stake sales very close to the market cap of the company today.
  6. In addition, the company has announced the monetisation of the Shriram stake, which is estimated to bring 7-8K crores into the coffers. However, it needs to be seen whether with the economy further deteriorating drastically and the Covid impact whether the Sep timeframe given by the management holds good.
  7. Furthermore, the company has announced that they are considering a stake sale of 20% in the Pharma business and the proceeds here will fund the further growth of Pharma and will ensure that any incremental capital is available for the financial services business.

Liabilities:

  1. The company needs to have the ability to roll over the debt or repay the debt over the next few months to a year while the economy suffers from both a prolonged real estate crisis and the impact of Covid.
  2. The company has moved from reliance on commercial paper and reduced the exposure from 18K crores 18 months ago to negligible amount as of Dec 2019.
  3. It has gone into longer term bank debt and bank funding has increased from 49% to 67% of the total borrowings. (See appendix A for points 2. and 3.)
  4. Recently, the company has accessed 1,900 crores at 9% per annum which provides further comfort that the cost of funding is coming down.
  5. What is even more important in my opinion is that the banks have had access to the books and have examined closely the assets of the book before lending to Piramal. This was confirmed by the management during one of the recent conference calls on March 12th. (Appendix B)
  6. The other thing that NBFC’s have to worry about is the ALM mis-match. Appendix 3 shows that close to 17K crores outflow is expected up to the next 12 months. Given the fact that they have close to 4.5K crores cash, Pharma generating proforma 1.5K crore operating cash flow over 12 months, capital raise and access to cash, high CAR of 32% before considering any payments coming from projects being refinanced or closed or the book run down, there should be a fair amount of comfort that the company will be fine in the next 12 months.

Asset Quality: The wholesale financing book is what seems to have scared the investors the most.

  1. The total finance loan book is INR ~51K crores. Housing finance is 6K crores, commercial real estate is 11K crores, CPG and ECL is 9K crores and the big chunk which is the residential real estate is 25K crores.
  2. So far, the company has reported only 1.8% GNPA and 1000 crores of provisioning so far. Again, given the recent experience with Yes Bank, the investors are being wary of companies that have exposure to stressed sectors but reporting very little GNPA and defaults.
  3. Firstly, it must be noted that, Piramal did not have any exposure to Yes Bank, Altico, IL&FS, DHFL, ADAG etc. which have gone bust. The fact that the company has dodged exposure to these stressed accounts indicate a certain level of quality of the book. Unlike Yes Bank, which had exposure to every stressed asset, Piramal seems to have dodged the bullet so far.
  4. In the housing finance segment, there is speculation that the government might provide some relief to MSME and non-salaried people towards EMI’s to help through the Covid situation. Hopefully, they will provide extended DPD guidelines to NBFC’s as well. Even if not, the GNPA’s might spike up. Unless Covid paralyses the economy over the next 6-12 months and things don’t get back to normal, the risk in the actual underlying defaults will be negligible. It must also be noted that the company has stressed multiple times that it is providing adequate LTV and security provisions in its loan book.
  5. The commercial real estate has not seen much stress in the last 2-3 years. Unless something new comes up as part of Covid and extended significant delays in construction, it would be fair to say that the commercial book will be fine.
  6. The corporate lending groups with its 9K crore book will see stress. We know that the Delhi Baroda truck financing with exposure of INR 75 crores is stressed. The Essel exposure from Piramal is close to INR 200 crores now. We should clearly expect to see more slippages from this and the GNPA shoot up over the next few months.
  7. The real estate wholesale financing segment is 25K crores. Piramal has run down close to 10K crores of the this segment over the last 18 months. The number of developers who were more than 15% of the net worth of the company has come down to 4 to 1. The one is Lodha.
  8. Lodha will have a INR 2500 crore exposure to Piramal by April.  A couple of positive developments. In the recent call, it was clarified that the capital under security for this loan is close to INR 6000 crores (Appendix D) Finished goods inventory is close to INR 2300 crores with another INR 1000 crores completing over the next 3 months. In addition, Lodha just tapped the capital markets to refinance and repay bonds. See link here. In addition, the last 12 months sales for Lodha was close to 7000 crores and continues to the largest real estate developer in India. While the current Covid shutdown and the resulting economic bumps might stagger payments, it is highly unlikely that Piramal will need to take a write down on  Lodha.
  9. In addition, it is worth noting that some of the accounts that Piramal has in stage 3 assets, they are moving to get the title of the lands and recover the loan. Easier said than done but the company has demonstrated that they can execute such moves well in the past.
  10. So far, the company has demonstrated that is can manage the risk and the recoveries from customers that it is lending to, have a low LTV ratio and a better than average risk monitoring system.
  11. It must be noted that no way does this mean that the loan book won’t sour in the near future or the stage 2/3 provisions will need to go up and more money needs to be set aside for provisioning, all we get comfort from is that the fact the management seems to have demonstrated reasonably well that it can manage the risk it is taking on.

Management: Understated in the market is what I call the Say-Do ratio of the management. Lots of companies make promises but it is execution that matters. Contrast the equity raising by both Yes Bank and Piramal around the same timeframe and the results each of them has had.

  1. Raising of capital through rights sale
  2. Completing the promise of bring in 8-10K crore equity into the business
  3. Reducing reliance on commercial paper. The management laid out the roadmap 12 months ago.
  4. Reducing reliance on exposure to single borrower names
  5. Piramal has put balance sheet strength over sheer growth reversing the earlier stance.
  6. The only con that I can direct to the management is the fact that they did not build a Fort Knox balance sheet from the start and had to go through several stake sales, cap raises (albeit at a premium to today’s stock price) to build a solid balance sheet. However, the management has shown that it will learn and correct mistakes quickly.

Unless it comes to light that the management is completely fraudulent, it is reasonable to assume that Piramal will weather the storm.

Valuation:

  1. The December end shares outstanding was: 20.5 crores. With INR 5,400 crores coming in at INR 1,300; approx. 4.2 more shares would be added. The total new shareholding will be at 24.6-24.7 crore shares.
  2. Total net worth at INR 34K crores or 1,382 per share and CMP is at 684 or 0.5 P/B.
  3. Total borrowings are at 50K crores.
  4. Enterprise value is at 64K crores: 50K borrowings + 14K  market cap.
  5. SOTP would be as follows (following Dec 2019):
    1. Shriram stake – INR 6-8K Crores
    2. DRG Cash – INR 6K Crores
    3. Rights issue – INR 5.4K Crores
    4. Commercial RE – INR 11 K Crores
    5. Housing Finance – INR 6K crores
    6. Pharma business – INR 15K Crores (@ 10X EV/EBITDA)
    7. Cash – INR 4.5K Crores.
  6. Sub-total of assets before residential RE and CPG/ECL assets is approx. INR 56K crores.
  7. The market is today valuing the INR 34K crores worth of assets at less than INR 10K Crores. It can also be reasonably shown that the INR 2.5K Crores to Lodha is reasonably safe. So, the market is valuing close to INR 31K crores of others at INR 7.5K crores.
  8. Depending on the risk appetite of the investor, it will open up interesting possibilities.

I am interested in your thoughts and comments. please mail me: contact@beowulfcap.com

Disclosure: Long several NBFC’s and Banks including Piramal.

Disclaimers: See FAQ here. Not a recommendation. Not a registered advisor. Just sharing my thoughts.

Appendix A:

Screenshot 2020-03-22 at 9.53.53 AM

Appendix B:

Screenshot 2020-03-22 at 9.57.00 AM

Appendix C:

Screenshot 2020-03-22 at 10.48.27 AM

Appendix D:

Screenshot 2020-03-22 at 10.22.57 AM

Piramal Watch

On Friday, Piramal announced the sale of DRG, the healthcare focussed IT analytics firm, to Clarivate for $950M. With this, Piramal will receive $900M at the close of the deal and $50M 12 months after the deal closure. You can find the press release here. More interestingly, you can find, Clarivate’s presentation on the deal here

Coupled with the rights issue and CCD worth about $770M, Piramal will have raised around $1.6B in capital starting October 2019 (provided the Rights issue, underwritten by the promoters, go through successfully). In addition, the reliance away from commercial paper into longer term bank loans and the proceeds from the sale of STFC, will play a key role in improving the liquidity position and the balance sheet of Piramal significantly. Coupled with the fact that the D/E of the business was low, total construction finance book a little over $4.3B, it looks like the balance is finally tilting in Piramal’s favour that will allow it to wait out the downturn in real estate while opening up a few offensive moves.

While the opportunity cost might be high, Piramal has long been a counter-cyclical investor and time will tell whether he can extend this to a leveraged financial model.

Disclosure: Long Piramal.

Disclaimers: here

 

Piramal Watch: Another strong quarter from the numbers!

We had written about Piramal Enterprises before here recently. Last night, they announced their results. Strong revenue and profit growth at 21% YoY. As expected, the focus on was their financial services portion of the business. The book was flat quarter or quarter with about 5K crores of repayment and 4.8K crores of disbursements.

Screenshot from 2019-07-31 04-52-13.png

The real estate book is starting to show signs of diversification with a lower wholesale residential RE portion but it is still 47% of the book.

Screenshot from 2019-07-31 04-56-07.png

The ROA and ROE seems to be holding up well for the business. GNPA actually fell in the quarter based on 90 dpd. It does look like payments are coming in through for Piramal as of now.  I suspect there is a lot of advance payments that is going on here that is causing this to look very strong and probably some better risk management as well.

Screenshot from 2019-07-31 04-59-05.png

A detailed book sensitivity shows that there are probably around 10% of the deals that need attention which is not concerning given that Piramal has shown an ability to actually implement corrective action and fix them in the last few quarters.

Screenshot from 2019-07-31 05-03-42

The key news was on the liability and equity side. The company informed that they were planning to bring in 8K-10k crores of equity on what they called significant growth and consolidation opportunities that are opening up on the NBFC.

I will also link here the CNBC transcript that shows a more aggressive yet cautious contrarian waiting for the right opportunities to open up in the NBFC space. It was good to see that they are treading with caution and watching instead of jumping into the first deal they get. With a solid quarter behind them, will this be a case of yet another counter cyclical aggression from Piramal? Only time will tell.

Disclosure: Long Piramal.

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….