Wisdom From The Heart

I just finished reading Wisdom From The Heart, a short form biography written about Om Gupta, founder of Ashiana Housing Limited (see book here).  The book traces Mr. Gupta’s start in the housing construction business until his death in 2013.  There are many lessons to be learned from the way he conducted his life and the culture he set forth at Ashiana.

For context, Ashiana Housing is a homebuilder which develops housing projects in up and coming tier II Indian cities. It is widely respected for its customer service, on time deliveries, extreme capital prudence (no net debt), world class rates of return on development (30%-125%), low employee turnover, and business ethics.

Below are some principles Om Gupta followed in leading his life and building his company.  Dale Carnegie would be proud.

  • Always smile
  • Don’t sweat the small stuff (money, being cheated, temporary disputes)
  • Be tidy and organized
  • Collect facts, verify information is accurate, and be decisive
  • Don’t be in awe of extremely wealthy, successful individuals; show tremendous respect for those less fortunate
  • Listen with the intent of understanding the other person; show genuine interest in others
  • Inspire others through magnanimity, trust, and confidence
  • Delegation is the art of clear instruction, tolerating mistakes, and trust
  • Pay your employees, suppliers, and creditors on time, no exceptions
  • Live / operate within your means; never extend yourself with excessive leverage
  • The only way to benefit from other human beings is to give abundantly
  • Always do what’s fair or even what’s more than fair; the returns will come down the line
  • Always focus on what’s going well; block out the small disturbances in your life
  • Don’t be poisoned by greed and growth; build something the right way which will live beyond you

A homebuilding operation is mostly a capital allocation operation.  The best operators purchase land when prices are favorable and sit still when there’s excessive optimism.  In addition, the best homebuilders are able to fund projects in advance through customers’ capital as opposed to shareholder equity.  Ashiana’s model is very similar to NVR in this regard.  The company has also added significant value by providing an incredible customer experience (leading to repeat purchases and referrals), supporting local communities, and empowering employees.  In a highly competitive industry, it has managed to thrive by sticking to the values outlined by its founder, Mr. Om Gupta.

Ashiana is a name which is worth tracking.  I’m doing more work to see whether valuation makes sense.


Smart & Final – Return on Equity

A quick way to assess the quality of a business is to look at the return it as able to generate on tangible equity.  Companies which are able to consistently generate high returns on equity typically benefit from a form of competitive advantage.  Calculating ROE is not as formulaic as net income / average equity because accounting treatment often masks the earnings power and capitalization of the enterprise.  Let’s look at Smart & Final as a case study.

Google Finance shows returns on equity for S&F of 2.5% in 2013 and 7.5% in Q4 ’14.  These numbers indicate a weak business with limited competitive strength.  Let’s dive into the numbers to see if this is the case.  Below, I’ve adjusted the balance sheet to determine the amount of equity capital that would need to be in the business to support current operations.  I first convert all the net debt to equity, then strip out intangibles such as goodwill and trademarks.  This gives us an accurate picture of how much equity capital would be in the business today if no acquisitions or debt financings were consummated.

I then turn to the income statement to determine an accurate figure for normalized, unlevered earnings.  I start with EBITDA and add back all the one-time, non-recurring charges to get to an appropriate adjusted EBITDA figure.  Note, many adjustments presented by management are bogus and as such it’s important to be conservative in your approach.  Finally, I adjust the D&A figure to get an accurate picture of steady state earnings.  S&F is spending nearly $100 million of capex per annum, 75% of which is being directed towards growth.  Maintenance capex is a more modest $25 million, or $100k per store.  The income statement should reflect the earnings power of the enterprise based on the amount of equity capital which has been plowed into the business.  As such, $25 million is a more appropriate figure for the calculation because it reflects the ongoing capital needs required to support existing operations.

The numbers, as adjusted, depict a tier 1 enterprise.  For context, the S&P 500 as a whole earns ~12% on equity.

For FY 2014, S&F will likely generate north of $150 million of unlevered, adjusted pre-tax earnings.  This compares to an adjusted market capitalization (assuming all debt is equity) of $1.7 billion, implying a pre-tax trading multiple of ~11.3x.  Buffett has repeatedly said that 10x pre-tax is a good price to pay for a wonderful business so we’re not too far from his measuring stick.

What makes S&F intriguing is the abundant opportunity it has to deploy capital at high rates of return over the next decade.  The company currently operates 252 stores across 6 states and Mexico.  ~190 of those stores are located in California.  The company believes it can open an additional 150 stores in existing markets plus convert ~40 of its existing stores to the higher return “Extra!” format.  Per management’s figures, this will require an additional ~$450 million of capex over the coming years.  If history is a guide, the capital spend should generate 20-25% cash on cash returns.  Bigger picture, once the business starts developing a stronger brand presence, it has an opportunity to expand eastward.

I’ve developed a preliminary hypothesis that S&F is a good business trading at a reasonable price.  It appears to offer customers a great value proposition – low cost, high quality food products in a convenient format.  The company has only had one year of negative comp store sales growth in the past 25 years, including positive growth in 2009.  I still have a fair amount of work to do on the competitive strategy piece and need to go through the checklist, but this has passed through my initial filters and is worthy of further investigation.

Feedback is certainly welcome.


Recently, I’ve been reading Overbooked by Elizabeth Becker. I was surprised to learn that the worldwide tourism industry is $7 trillion, or >10% of global GDP. It is larger than the oil and gas industry. Curiosity is an innate human trait and mankind will forever want to see the places which he/she has not seen. Tourism has been exploding around the world over the past decade and is poised to grow as the world’s middle class expands, tourism opens up in more countries, and services improve. More significantly, millennials are extremely interested in and willing to spend substantial money on travel, particularly at a young age. The world has become increasingly global and the internet has made travel much more transparent and easy to facilitate. In India, travel is especially popular among young adults a few years out of college. College graduates are typically well paid and either live at home or with roommates, providing for large sums of disposable income. As is the case with most young adults, they spend money on restaurants, mobile phones, movies, and… travel.

The number of Indians traveling outside India today numbers around 15 million. This compares to nearly 100 million Chinese tourists. There is enormous potential in both outbound and domestic tourism in the country.

I was attracted to the sector after reading Prof. Bakshi’s thesis on Thomas Cook India last year. In mid 2012, Fairbridge Capital, a subsidiary of Prem Watsa’s Fairfax Financial, acquired a 75% stake in the tour operator. Watsa laid out his thesis and intentions clearly in his annual letter – Thomas Cook has incredible growth potential and would serve as Fairfax’s investment vehicle in India. For nearly a year, investors had the opportunity to buy into Thomas Cook India for a price comparable to what Fairbridge paid. I didn’t pay enough attention to the opportunity and missed an extremely attractive entry point (the share price has tripled in the last 12 months).

I’ve done a lot of work on Thomas Cook and can’t quite justify paying the price where it is currently trading. In addition, there are a few factors which give me pause. First, the company acquired Sterling Resorts, a timeshare business, which I have mixed feelings about. It’s a very capital intensive and competitive business and the brand has deteriorated in recent years due to poor facility maintenance and customer service. Second, the company’s wholesale forex business is likely to decline in the long term. As such, it’s a company I’m keeping an eye on, but not investing in at current levels.

My work on Thomas Cook naturally led me to Cox & Kings (CKX), the leading domestic and outbound tour operator in India. Cox & Kings and it’s various travel brands are the most widely recognized in India and are associated with high quality and best-in-class customer service. CKX is benefiting from two important macro factors at work in the Indian travel sector. First, organized travel players such as CKX and Thomas Cook are taking share from unorganized players (unorganized players are the small mom and pop travel shops which have very limited services, e.g. only transportation). It turns out that many people would rather book an organized tour than book all the individual components themselves, particularly when traveling outside the country. Booking a tour saves time, provides peace of mind, reduces on the ground hassle, and assures travelers that accommodations will meet certain standards.

Second, the large organized players are taking share from smaller organized players. Although the services are somewhat commodity in nature, scale matters in this industry. Large players such as Cox & Kings have much larger advertising budgets, increasing brand awareness and reach. Second, volume players are able to strike more favorable deals with tourism suppliers, creating favorable pricing. CKX is able to charge lower prices than competing operators, but actually maintains a price premium due to its strong reputation. Cox & Kings generates ~22% gross margin in its tourism operation vs. ~10% for Thomas Cook.

Today, you can buy into Cox & Kings for less than 10x operating income. The stock has tripled in the past year, but is still undervalued. The largest overhang on the stock is extremely high debt levels. Debt / cash flow is currently greater than 5x. The company is taking measures to reduce the debt burden, including selling off non-core assets and bringing outside equity investment. In addition, the company has a number of assets it could sell to cover its obligations. Moreover, earnings currently cover interest charges by greater than 2x.

I’ve been adding some Cox & Kings to the portfolio between Rs. 300 and Rs. 320 per share. I’ll share more detailed thoughts once I’ve finished my work and gone through the checklist. If everything checks out, this will likely become a concentrated position.