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.
source :- investingvalues.blogspot
