We saw extensive coverage of Kingfisher Airlines mounting debt for last two weeks and it still continues. I don’t understand whether news are being covered because of its promoters or there is genuine concern about the company and industry. Sometimes it feels similar to ‘run on the bank’ like syndrome and few sadist just waiting to celebrate death of the company. The real problem/concerns for the company/industry seems to be lost in midst of the expert opinion by analyst/leaders.
Lot of bullshit has been written on predatory pricing by the players which is killing the industry. But sorry people I beg to differ here. We need to answer simple question here? Who are the competitors? Are the industry players competing among themselves? Or are they replaceable? Let me go back to history. Indian aviation sector became attractive, once the burgeoning middle class started using the service, which was made available through low cost carrier like Deccan. Other important trigger was the growth of the corporates especially in service industry like IT. Let us consider each of this segment and understand their possible action in case there wasn’t predatory pricing by the players as termed by the analyst. Corporates in that case would prefer to use the services of teleconferences/video conferences which are made available at much lower cost. Further most of MNC are already used to such services when interacting with their overseas clients. Also during the recent economic crisis lot of corporates did transition to such services. So increasing price would certainly have negative impact on the volumes in this segment. It may be countered with argument not all cities/towns might have such facility but then do these cities/towns have decent airport and volume to make that routes viable for any airlines? Second important segment was middle class of India which has always been price sensitive.People in this segment still check the fares of second/third AC railway tickets and perform the cost benefit analysis. So here industry players aren’t competing among themselves but with other industry which is highly subsidised and can afford to run in losses since it intends to make up by other services. In such a market dynamics I don’t see any other option for the aviation sector but to keep price low especially in high inflation scenario.
Before applying any futher thoughts on pricing let us analyze the cost structure of airlines.To add to all pricing woes, the most important cost for the sector is aviation fuel whose prices have been volatile and it needs to be imported. The prices are function of the global demand, not the domestic demand and are decided by few countries that have huge resevoirs of oil. No company in industry can decrease this cost by backward integration nor does the law permits them to manage their own imports.So the cost is subject to not only the volatility in commodity market but also foreign exchange market.Further the companies have high fixed operating cost and in case of low volume they lead to high losses. Not to forget the seasonality factor & regulator who seems to keep close watch on the prices. Further weather & operational inefficiency of the security/airport staff also impact the volumes for the industry.Shortage of qualified pilots & skilled cabin crew leads to additional cost for the industry.It is very important to appreciate all these factors because careful assumptions are to be made to determine cost per traveler/seat on the route. Without knowing the cost no pricing strategy can be devised. The complexity in this case is that assumption are not only required on demand/supply side but on aviation fuel, seasonal effect etc. Any variation in these assumption can have huge impact on pricing strategy.
So on the one hand industry is competing with subsidized railways and the new technology which curtails their pricing power and on the other hand the cost structure is dependent on the global economic factors which are beyond the control of the industry. Pricing in such scenario can be very tricky. Aviation industry is known to have used demand pricing strategy across the globe wherein the prices increases as demand increases. However in India regulator has put some caveats in place to avoid cartels. Further globally the industry doesn’t face same challenges as in Indian scenario. Is this time to rethink pricing strategy? What can be learnt from shipping industry/telecom industry? I have no answers to the pricing woes but I bet its one of the most challenging business problems. We have just scratched the issue here with minimal knowledge of the industry. But certainly it has got my grey cells working. In fact next post I would like to focus on the financial woes of industry & KFA especially.Maybe it might throw up some answers then!!
Land Bank Story
Its been long break for me from blogging but with new year am back in action. Its normal tendency to ensure that you fulfil your New Year resolution atleast in first month of the year and thats what this blog signifies. 2010 has certainly been the year I would like to forget except for change of job and role at fag end of the year which has been positive event in my life. I think its enough update about me and I don’t think it’s interesting enough to discuss and the waste space on my blogs.
The title can mislead the people who have not been following the markets. So let get it clear for such people that I am not sharing any story about bank nor land but its buzz word of 2010. Its story which has got my grey cells thinking for quite some time. Story that once again exhibits conflict between my theoretical understanding and empirical evidence. So I thought to write about it and get the views of others to clear my doubts.
Valuation has always been tricky subject to handle and assumptions for the same vary from analyst to analyst. So there is not point on arguing assumptions at any point in time when it comes to valuation. But very few times I have seen disagreement on the methods of valuation or on fundamental concepts. One of such concepts is that valuation is typically done on going concern basis with few exceptions. Exceptions are cases where companies is believed to liquidate or similar cases. But is this being reflected in the market is my question? One can easily check the stocks in market and you will find really high valuations for certain companies which are even loss making. The price commanded by them in the market is high as 100 times its EPS. So I undertook its analysis and found one common buzz word associated with them was “Land Bank” and I realized the difference is because I was doing simple DCF on going concern assumption whereas market price was factoring in the price of its assets. So is this right method since the market suggests so? Is it temporary factor and market will correct in future? But price pattern doesn’t suggest so.
To understand the issue let’s take case of Bombay Dyeing which is most simple one. The company has debt-equity ratio of 9.23, EPS growth of -109.46% but currently commands PE of 115, way above the industry average. The reason is huge land bank available with the company in prime areas of Mumbai. The company PE has been in this range for quite some time due to the speculation of company’s plan to develop real estate. So market valuation has factored in current market price of the land or future cash flows it would generate with the real estate. I would have been comfortable if it was second reason since it follows with going concern assumption. But then would you factor such high valuation for the company who is entering real estate for the first time in life and whose expertise is in textile. Also the risk associated with such project is way high to command this PE. Further if company commands this PE based on the market value of its land then in the downturn why was the stock not punished for low market value of its so called land bank since the news of them developing real estate goes way back to 2008. Why market valued it as textile player then? Should we analyze these companies with two business units and do DCF for both of them? Or should we do DCF for its textile business and add market value of land? If this is market practice why don’t we follow it for all similar stocks? Further this concept inherently is accepting the concepts of mark to market for all the asset class which has been issue of contention for quite some time. The land is illiquid asset and to which level can its market value be factored in our assumptions. Would the investors in this stock continue to be the investor if one time unlocking of value for its land bank is done? Who would be buyers at that point in time? Further company being textile company can still use its proceeds to decrease it debt and use remaining for the future capex in which case investors looking for one time gain would not receive any additional payout. So in this case also it is going to be company capability in textile business that one needs to analyze from long term perspective. All this doesn’t justify to me this high PE for the company given that they have not done well in textiles recently. This is just one of the examples; similar cases exist for Bayer Cropscience, Century textiles, golden tobacco etc. These are questions I am pondering for quite some time. I understand analyst once believes that asset value is realizable and then he factors the same in price so this rule cannot be generic. But then once value is realized the question still exists is where the proceeds would be utilized? Would it be utilized in development of real estate or textile business? Also till the value is realized its only notional value and this concept is used when we value investment companies who might have equities which are of high market value of its book. Otherwise small investment companies like Pioneer investment must command much higher price since it has securities worth more than its market cap at current price and further they are much more liquid. Same is true with other such investment companies.
So what was my intention of the blog? It was not to highlight case of Bombay Dyeing but rather at concept level I wanted to discuss such scenarios. Especially my view is land value at current market price cannot be factored in fully in calculation since it’s not realizable. Further the company’s plan of using the proceeds is very important factor along with the company strategic goals. If its land bank which is attractive, I would rather invest in comparable real estate company than such companies or at least compare it with peers in real estate before coming to this decision. Currently I believe analyst have been more speculative and have gone overboard when factoring the value of ‘landbank’ and have not been consistent with the concept or mark to market in all such cases. I might be proven wrong and cases like Bombay Dyeing might prove them correct but valuation like this makes me rethink my basics. Maybe Bombay Dyeing might not have been right example to discuss this given its long history and brand name but cases like it are in plenty and I would certainly like to understand the investors story in such cases that can prove my view incorrect.
The title can mislead the people who have not been following the markets. So let get it clear for such people that I am not sharing any story about bank nor land but its buzz word of 2010. Its story which has got my grey cells thinking for quite some time. Story that once again exhibits conflict between my theoretical understanding and empirical evidence. So I thought to write about it and get the views of others to clear my doubts.
Valuation has always been tricky subject to handle and assumptions for the same vary from analyst to analyst. So there is not point on arguing assumptions at any point in time when it comes to valuation. But very few times I have seen disagreement on the methods of valuation or on fundamental concepts. One of such concepts is that valuation is typically done on going concern basis with few exceptions. Exceptions are cases where companies is believed to liquidate or similar cases. But is this being reflected in the market is my question? One can easily check the stocks in market and you will find really high valuations for certain companies which are even loss making. The price commanded by them in the market is high as 100 times its EPS. So I undertook its analysis and found one common buzz word associated with them was “Land Bank” and I realized the difference is because I was doing simple DCF on going concern assumption whereas market price was factoring in the price of its assets. So is this right method since the market suggests so? Is it temporary factor and market will correct in future? But price pattern doesn’t suggest so.
To understand the issue let’s take case of Bombay Dyeing which is most simple one. The company has debt-equity ratio of 9.23, EPS growth of -109.46% but currently commands PE of 115, way above the industry average. The reason is huge land bank available with the company in prime areas of Mumbai. The company PE has been in this range for quite some time due to the speculation of company’s plan to develop real estate. So market valuation has factored in current market price of the land or future cash flows it would generate with the real estate. I would have been comfortable if it was second reason since it follows with going concern assumption. But then would you factor such high valuation for the company who is entering real estate for the first time in life and whose expertise is in textile. Also the risk associated with such project is way high to command this PE. Further if company commands this PE based on the market value of its land then in the downturn why was the stock not punished for low market value of its so called land bank since the news of them developing real estate goes way back to 2008. Why market valued it as textile player then? Should we analyze these companies with two business units and do DCF for both of them? Or should we do DCF for its textile business and add market value of land? If this is market practice why don’t we follow it for all similar stocks? Further this concept inherently is accepting the concepts of mark to market for all the asset class which has been issue of contention for quite some time. The land is illiquid asset and to which level can its market value be factored in our assumptions. Would the investors in this stock continue to be the investor if one time unlocking of value for its land bank is done? Who would be buyers at that point in time? Further company being textile company can still use its proceeds to decrease it debt and use remaining for the future capex in which case investors looking for one time gain would not receive any additional payout. So in this case also it is going to be company capability in textile business that one needs to analyze from long term perspective. All this doesn’t justify to me this high PE for the company given that they have not done well in textiles recently. This is just one of the examples; similar cases exist for Bayer Cropscience, Century textiles, golden tobacco etc. These are questions I am pondering for quite some time. I understand analyst once believes that asset value is realizable and then he factors the same in price so this rule cannot be generic. But then once value is realized the question still exists is where the proceeds would be utilized? Would it be utilized in development of real estate or textile business? Also till the value is realized its only notional value and this concept is used when we value investment companies who might have equities which are of high market value of its book. Otherwise small investment companies like Pioneer investment must command much higher price since it has securities worth more than its market cap at current price and further they are much more liquid. Same is true with other such investment companies.
So what was my intention of the blog? It was not to highlight case of Bombay Dyeing but rather at concept level I wanted to discuss such scenarios. Especially my view is land value at current market price cannot be factored in fully in calculation since it’s not realizable. Further the company’s plan of using the proceeds is very important factor along with the company strategic goals. If its land bank which is attractive, I would rather invest in comparable real estate company than such companies or at least compare it with peers in real estate before coming to this decision. Currently I believe analyst have been more speculative and have gone overboard when factoring the value of ‘landbank’ and have not been consistent with the concept or mark to market in all such cases. I might be proven wrong and cases like Bombay Dyeing might prove them correct but valuation like this makes me rethink my basics. Maybe Bombay Dyeing might not have been right example to discuss this given its long history and brand name but cases like it are in plenty and I would certainly like to understand the investors story in such cases that can prove my view incorrect.
