Thursday, 17 July 2014

Ashiana Housing Limited: Opportunity For "Real" Gains Through Differentiated Business Model


Since my last post in mid march, the market has briskly moved upwards and sentiments have changed dramatically. Many market players and analysts have proclaimed that the "decisive victory" for the BJP led NDA in general elections is going to be the game changer. It is felt that the new government will usher in the "directional" changes for Indian economy leading to structural bull market for many years to come. This "optimism" has clearly reflected in the way market has behaved since May 16. In last 4 months, Indices have increased by 20% and broader market has outperformed indices by significant margins. Personally, I do agree that there are some palpable green shoots on number of front and pro-business and stable government can bring the "growth" back to Indian economy. However,at the same time I also believe that it is still too early to treat the current economy and business environment as "clear sky"!


For a bottom-up value investor, the market gyrations are less relevant though rising market does pose a challenge of "bargains" suddenly disappearing from the horizon! I am sure like me, many of you would have given a pass to some high quality businesses because of the steep valuations or would have stretched "paying up for quality" theory to the extreme for justifying the "buy" decision at high valuations. However, in this market it is increasingly important to focus on "value" and not get carried away by various "rationales" offered by number of market participant for paying up! In this market and with current valuations, it is important to recognize the fact that one may not encounter the opportunities to make 5-10 baggers in 3 years like it used to exist 3-4 years ago in businesses like Mayur/Cera/Atul Auto and many others. The prudent approach should be to invest in companies with strong, scalable and differentiated business models run by efficient and ethical management by paying up "fair value". In numerous companies that I have analysed in the past 3 months, I have identified 4-5 such companies which fits the bill in my opinion. In this post, I am going to talk about Ashiana Housing Limited which belong to real estate sector and in my opinion has sustainable, scalable and differentiated business model. The company is also available at decent valuations, making it all the more interesting. 



Ashiana Housing Limited:

I must admit that I too fell prey to stereotyping real estate companies and ignored AHL in spite of AHL popping up in the my stock screener number of times in last 3 years. However, once I completed my analysis recently, I realized how far the realities can be from stereotypes! I have no hesitation in saying that AHL's annual reports are the best amongst the ARs that I have come across so far. They provide clear  and accurate picture about the dynamics of the business and substantiates the same through enough information to validate what they tell about business. Management clearly articulates the risk and limitations while defining the way forward with clear road map. Even if you decide not to move ahead with further analysis of the company in this article, my sincere request to you is to read the ARs once to understand, what it takes to provide holistic and accurate perspective to shareholders about the business!  Now let's talk about the business.


Basics about the business:

  • AHL is a 35 year old real-estate developer with sustained focus on two segments: Middle income group housing and housing for senior citizens.
  • It’s geographical focus areas are       
    • Satellite towns/areas connected with Metros
    •  Geographies developed around large industrial clusters
    • Tier-II/Tier-III towns
  • Addressable customer segments are
    • Persons in middle income group having aspirations to own a house having all the amenities equivalent to high end group housings
    • Senior citizens who want to live a quality life amongst like minded people at affordable cost
  • AHL started its operations from Patna and subsequently became the first organized player in Jamshedpur market. AHL, currently, has presence in following geographies.
o Bhiwadi (Rajasthan) - fast growing industrial area with close
  proximity to NCR/Delhi
o   Neemrana (Rajasthan) - emerging Industrial hub in Rajasthan
o   Jaipur (Rajasthan) - fast growing city and capital of Rajasthan
o   Jodhpur (Rajasthan) - a key tourist attraction and major city of the
   state
o   Jamshedpur (Jharkhand) - one of the oldest industrial town in India
o  Lavasa (Maharashtra) - located at 1 hour distance from Pune. The
  city is first amongst the planned modern city with all basic
  amenities 
o Halol ( Gujarat) - A town located near Vadodara with large and
  expanding industrial cluster

  • AHL has developed a reputation for consistently delivering high quality homes on/before schedule at affordable rates with top class common amenities. It has earned the trust of customers in most of the market it has completed projects. It is perceived as highly ethical company by customers in respective market.
  • Due to above advantages, AHL commands premium over its peers in most of its markets. According to management in established markets, it commands 5-7% premium as compared to other players

Salient features of the business model:


What distinguishes AHL from its peers is the business model. The business model has been uniquely carved out to ensure a judicious balance of risk aversion and growth. To give a flavour of what I mean consider this(from AR):

AHL's net worth has grown 22 times from 2002 to 2012, without diluting equity or leveraging the balance sheet. I am yet to hear any listed Indian real estate company achieve this feat! Here are the basic tenets of its business model
  •  Unlike other real-estate developers, AHL does not work on land bank concept but rather treats land as just raw material. It keeps 5-7 years of yearly construction rate as land inventory. This makes the whole business model relatively asset light compared to its peers. This improves the free cash flow and limits the leverage required. Unlike all other real estate players, AHL is a debt free company (net of cash).
  • It focuses on geographies where there is above average growth in socio-economic parameters and cost of land parcel in a new project does not exceed 30% of the project cost.Geographical expansion is well calibrated as AHL is very selective in entering new geography. Here is what AHL has to say for the same 
"As a company we want to have limited investment in land assets only enough to help service our current/planned level of sales. This strategy has helped us grow at a fast clip, without using too much capital. We feel that our capital efficiency is one of the best in the industry largely because of this strategy.

We want to acquire land in areas of economic activity,and always consider a project after assessing the feasibility of purchasing power of the target customers. We have an in-house team that surveys potential areas, and makes assessment on the capacity of that micro market to absorb home units.It’s only if we find the demographics and economic activity of an area favorable, that we will look for a land parcel in that area. 

We broadly look for an IRR of over 30% in any project we choose to invest."
  • It very actively works on partnership/joint venture model with land owner. It adopts various mechanisms such revenue share, space share and equity share for partnerships. Partnership/joint venture model helps AHL de-risks the project from land acquisition and approval related issues to a large extent at the same time minimizes its investment in land parcels thus keeping the business model asset light.
  • AHL has its own construction team and does not hand over the construction to third party contractors. This strategy has two distinct advantage
    •  It helps AHL maintain a firm grip on the quality of construction and timing
    • Any efficiency gains made during construction is for the benefit of AHL
  • AHL provides facility management services post hand over phase throughout the project life. This ensures that the common amenities and facilities are properly maintained and the quality of life remains superiors for the residents. This results into higher customer satisfaction levels, better realization for properties in re-sale market and increased referrals!
  • AHL sells the project through its own sales team and does not involve brokers in the selling process. The benefit of this approach is that AHL largely attracts people who are home dwellers. Direct contact with customers also helps AHL keep their ears to the ground and cuts down the response time to changing needs and preferences of the customers.
  • According to AHL management, the hurdle rate for making an investment in any project is 30% IRR from the project (without accounting for the land price increase and leverage). This unwavering focus on ROI combined with capital efficient business model ensures excellent return on equity for the company.
Key Matrix:

Here is the link for 10 year's financials for the company.


Few noticeable things from the above data are 
  1. AHL is a debt free company and has significant amount of surplus cash
  2. AHL has generated industry leading ROE in excess of 25% consistently due to its unique asset light business model.
  3. AHL has grown briskly for last many years and has funded the growth though internal cash flow generation
  4. Barring for the last two years (and I will talk more about it in next few paragraphs!) AHL's top line and bottomline has grown CAGR 36% and 52% respectively from 2005-06 to 2011-12.
However unlike other companies, the numbers indeed are deceptive, especially for last 2 years. Here is why. AHL changed it's accounting methodology from 2012-13. The revenue recognition was changed from a widely followed "percentage of completion" method in real estate industry to "contract completion".  Here is the basic difference illustrated through numbers! 

Under POC method, company recognizes the proportionate revenue based on percentage of completion for the construction of house. So, let's say A customer buys Rs. 25 lakh house. When AHL completes 10% of the construction, it books 2.5 lakh revenue to its account. 

In the contract completion method, AHL will recognize the revenue of 25 lakh when it hands over the possession of the flat to the customer. Till that point of time, money paid by the customer will be treated as "liability" under Advance from Customer head.

On the face of it, POC method looks perfectly logical till one considers the possibility of project getting stuck midway! Consider that the flat booked by customer was in Lavasa. Company had to stop work while the 80% house is complete. Under, POC method, AHL would have booked 20 lakhs as revenue (25 Lakhs * 80%). However, if the situation is not resolved in favour of AHL, AHL would be liable to give back 20 lakhs to customer! This means, under POC company has overstated its revenue while understated its liability (to pay the customer back 20 lakhs). Under contract completion, AHL would not have booked the revenue as the possession would not have been given while the money received from customer will be lying on balance sheet as liabilities! Thus contract completion method represents far more accurate picture of revenue and liabilities and truly reflects the risk involved in the business. I feel, it is a far more conservative practice and more accurately reflected risk adjusted ground realities. This is what AHL management has to say about changing the accounting policy.... It's music to an investor's ears! 

"However, the long-term benefits of contract completion accounting by far outweigh the short-term transition issues involved. As outlined earlier this conservative method of accounting will more accurately reflect the assets and liabilities of the company. This will make it easy to understand the operating cash flows of the company,which is one of the most important parameter to appreciate the financial health of the company. It will also better reflect the margins of the company, as they will be directly linked to the delivered homes and square footage and not subject to future estimations of project cost. The other benefit of contract completion accounting to the company is that it will help maintain the financial discipline for the business as a whole. The ‘Advance from Customers’ in the liabilities side and ‘Inventories’ in the assets side will let us help in ensuring that the cash inflows from one project are utilized towards the cash outflows of the same project. It will be apparent if advances from a project are utilized to procure land of another project. Lack of discipline around this has been the bane of the industry and has resulted in project delays and mismatched cash flows for many developers. We at Ashiana clearly want to avoid this mistake."



"The shift to contract completion method of accounting from POC method will bring with it short-term pain in terms of reported revenues and profits for the next two years. It will make our profit and loss statement more volatile and not comparable on a quarterly basis. But, the contract completion method of accounting better reflects assets and liabilities of the company. It will easily reflect the company’s financial discipline or the lack of it in utilization of advances from customers. It will create incentives to deliver faster to ensure revenues get reported. Cash flows of the company will be easier to comprehend and margins will not be subject to estimations of future cost. Contract completion method of accounting has its shortcomings but overall it will better capture the financial health of the company."


This clearly indicates that management is strong enough not to fall prey to institutional imperative and do what is right and accurate while creating an incentive system for the management to increase it's efficiency. More importantly, management is willing to take short term pains to ensure long term gains for the stakeholders. So, to cut long story short, the last two year top line/bottom line numbers are aberrations and are not comparable. So how do we judge the performance of the company? Again, management provides the directions

"For the investors to track the performance of our company we are reporting the following figures every quarter in earnings report:


  • Total area sold in sq. ft.
  • Total equivalent area constructed (EAC) in sq. ft.
  • Average realization per sq. ft.
  • Pre tax operating cash flow for the period
By tracking these metrics, the investor can track the performance of the company. Whatever is sold has to be delivered with a time lag of 18-24 months.Over the time we aim to disclose more metrics, which we hope will help our investors to track our operational and financial performance in detail" 

Two things are noteworthy here 
  • Management uses the same metrics internally to monitor its performance
  • The focus clearly is on cash flows
So, here is how it fares on the above metrics.

Year
2009-10
2010-11
2011-12
2012-13
2013-14
EAC
10.22
10.74
14.62
12.27
17.87
Area sold
7.07
13.5
17.83
18.62
22.13
Realization (sq/ft)
2071
2055
2190
2699
2926
Pre-tax cash flow
47.05
53.45
109.67
83.81
125.90
Cash margin per square feet
460.37
497.67
750.13
683.05
704.53

Some noteworthy points that come out of these numbers
  • Equivalent area constructed has grown at 12% CAGR in last 5 years
  • Area sold has increased at brisk pace with 25% CAGR and realization per square foot has increased by 41%. 
  • pre-tax operating cash flows, which reflects the business economics and activity more accurately for the company, has grown at healthy 21% CAGR, unlike the drastic deterioration reflected in the P&L due to change in revenue recognition method.
  • Cash margin per sq. ft (reflecting margin profile) has grown by 50%.`

Thus, it appears to be delivering robust performance on all important parameters. 


Management quality:

AHL has an able, transparent and forward looking management that understands the importance of 

  • Efficient capital allocation (limiting the size of land parcels to keep the business asset light; focus on following JV/partnership model; 30% hurdle rate for new investment decision)
  • Long term value creation over short term fluctuations in earning (Accounting policy change)
  • Benefits of not succumbing to institutional imperative (accounting policy change)
  • Transparent dealing with shareholders (Quality of information provided in AR, disclosures in AR, clearly articulating risks upfront)

Overall, I would rank them along with the best in the business.


Valuation:

On normal metrics of P/E and P/B the company may looked over priced. However, the question to be asked is whether under the typical circumstances of the company, are these metrics relevant enough to base our decisions on? Let's put the current price in the context.

AHL has market cap of 1138 crores while it's pre-operating cash flow is 126 crores. Hence, it is available at 9 times pre-tax cash flows. Let's assume the effective tax rate of 30% (though  AHL has MAT credit entitlement for some of the older projects and hence the current effective tax rate is in the range of 20%). So, AHL is available at 12.5 times post tax operating cash flow. 

So, as an investor, one is getting an entry into a business 
  • having high growth  and huge opportunity size
  • Generating very good return on capital employed and having the possibility to deploy large amount of capital at this high rate of return
  • A differentiated and risk-averse business model 
  • that is unleveraged (a rare for the sector)
  • Run by  rational and transparent management 

at very reasonable valuations at around 12.5 times post-tax cash flows. 


Major Risks:
  • One of the most significant risk for AHL is the inability to scale up the business model efficiently. Though AHL has scaled up the asset light and integrated delivery model reasonably well, it still is minuscule in size compared to its peers. The aspirational goal of AHL to grow at 25-30% CAGR would mean that company has to scale up its capabilities and business system/processes significantly to meet up with aspirational goal. To give the context, total area constructed has grown only 12% CAGR versus the sales growth of 25% in last 5 years. In order to sell more, company has to build more and faster without compromising on quality! This is the real challenge considering that AHL's internal team overlooking construction has to increase its size and productivity both! 
      What is heartening is that AHL management does acknowledge the same
      and is pro-actively working towards achieving this goal (Refer to 
      Annual Report for FY 13-14 where the whole focus is on execution and 
      capacity building )
  • The affordable housing segment is at the centre of all activities in last few years due to huge opportunity size. All major developers have entered in this space. Moreover, if one has enough capital, the entry barriers are low. Thus, eventually, if large players enter in the affordable housing segment in geography where AHL operates, it's margin may come under pressure.

Overall, I feel this is a very good opportunity to participate in the growth story of Indian middle class through a de-risked  and capital efficient business model executed by a highly rational and transparent management at very reasonable valuation. 


Disclosure: This article shall not be construed as an advise to buy/sell securities. I am invested in AHL with 5% capital allocation at average buying price of 115 

10 comments:

  1. Thanks Dhwanil for candid analysis of AHL. I have been following this for a while now as Rohit C and Prof Bakshi have also analyzed the business (several posts) and are Long on this.

    So it was a good refresher for me. It is indeed rare to have a company like AHL in RE space.

    Vikas

    ReplyDelete
  2. Hi Vikas,

    Thanks for your comments. This comment coming from someone like you who understands Real Estate well, does substantiate that AHL has differentiated business model.

    Best Regards
    Dhwanil Desai

    ReplyDelete
  3. Dhwanil, this is very informative post about Ashiana Housing. I also read about it on fundooprofessor blog few months ago . Could you also post your analysis on other 4-5 companies which you identified in regular intervals. Thanks.

    ReplyDelete
  4. Hi,

    Great article. What parameters you use for screening a stock.

    Thanks


    ReplyDelete
    Replies
    1. Hi Rahul,

      Sorry for delayed response.

      Typically I look for ROE/ROCE of more than 20% , debt/equity < 0.5, 5 yr average OCF/Net Profit > 80%, 5 year average sales growth > 15% 5 year average NP growth > 15%, price to earning of less than 15. However, this is just indicative. Now a days, I do get number of ideas from fellow value investors and I do evaluate them on case to case basis.

      Delete
    2. Thanks,

      What is ocf/net profit. Also in today's bullish market getting low pe stocks can be a task.

      I am eyeing Adi finechem and Kitex garments. Have you studied them?

      Recently I did a screen on somewhat similar parameters and Cummins india showed up. Are you following the same.

      I am also new and reading a lot to learn the basics.

      Hope to share ideas with you.
      Thanks.

      Delete
    3. Hi Rahul,

      OCF to net profit is Operating cash flow/Net Profit.

      I have studied Kitex and have done cursory analysis of Adi too. However due to recent SEBI guidelines for research analyst (which according to my reading is overarching enough to cover blogs too!) and extent of applicability of the same it would not be prudent to comment on investment attractiveness till clarity emerges on this issue. Hence, I request you to excuse me for not expressing views at the moment.

      Best Regards
      Dhwanil Desai

      Delete
  5. This is the perfect blog for anyone who wants to know about this topic. The article is nice and its pleasant to read.

    Stock Market Tips

    ReplyDelete
  6. Hi dhwanil,

    I was reading abt fluidomat and also saw your comments about it on a different forum. What are your current views. You think there is scope for growth and there is demand for the same.

    Thanks

    ReplyDelete
    Replies
    1. Hi Rahul,

      As I mentioned earlier, due to recent guidelines by SEBI for research analyst and lack of clarity about extent of its applicability to public forums/blogs, I would not like to comment on the investment attractiveness on the business.

      However, as per my understanding, the business seems to be on strong footing and has been able to avoid de-growth in extremely challenging environment for the company. As the power sector picks up and as indicated by management, if company is able to build a decent export market, business can scale up nicely from here on as well. At the same time, market seem to have recognized this fact and decent re-rating has taken place.

      Best Regards
      Dhwanil Desai

      Delete