Down and out- Is ARSS Infra Speculative or Contrarian bet? (CMP Rs46)

A company with market cap of only Rs680mn, having lost more than 60% in last 3 months, perceived to be driven by operators  and in a sector which nobody wants to own, ARSS Infra has all the elements for being a perfect short candidate for many and certainly  in “Not Interested” list for fund managers. I know it could be tremendous risk for my blog to start writing on a company which is down and out with no possible investors.  I might be classified by some of you as a speculator or by some other as inexperienced, untalented and high risk seeker analyst who is interested in making quick money like Rakhi Sawant or India TV.

But then investments is not always about buying the best companies but it is also about buying not so bad companies at a value which is dead cheap. Ofcourse some will argue, bad companies have zero value and will be delisted but then how to classify them is a difficult task. Therefore, let me take you into this company some 2 years back.

Company had raised Rs1030mn through IPO in Feb 2010 with a price band of Rs410-450 per share. At time of listing, nine month financial details for FY10 were all upbeat –Revenue of Rs6100mn ,EPS of Rs 40, book value of Rs 158, RoE at 29% and order book of over Rs25000mn (4x FY09 sales), resulted in huge investor appetite and the issue got oversubscribed by whopping 48 times. With listing gains of Rs300 and then trading firmly to make a high of Rs1250 over next 4 months, ARSS looked poised to be next big infra bet for many with market cap of Rs18000mn.  But that is history now, as financials have deteriorated and so has stock price.

Reported FY12 nos showed contraction in topline, ballooning interest cost, colossal jump in receivables and loss at PAT level. As if it was not enough, inability to meet margin calls by promoters has led to massive selling by financial institutions. As on March 2012, promoters owned 54.5% of equity (80.7 lakh shares) about two-thirds of which was in the pledged form. In June alone, IFCI sold nearly 43 lakh shares, which account for a 29% of ARSS Infra’s equity capital and the stock slipped 26% to Rs 40, which is over 90% lower than the price at which the company had made public issue in early 2010. What surprises me is if IFCI sold 43lac shares even at avg price of Rs 60, it would not have recovered  more than Rs250mn, that is too less for a client who has more than Rs2800mn of long term debt & another 7000mn of ST borrowings. I wonder how institutions operate when they sell shares. But that’s not the agenda in this post, maybe another blog someday on such cases.

Unlike a regular analyst, I don’t want to start believing outright that things will improve immediately & then with an estimated EPS of blah blah and multiple of x, stock should easily trade at Rs100. For companies which are outright in distress with zero visibility in business should in my opinion be valued at liquidation value- (a value that can be recovered by selling physical assets and paying off its debts). Markets are unlikely to give them any premium or multiple as they are enclosed by uncertainty.

Benjamin Graham, a legendary value investor in early 1930’s suggested an easy formula for liquidation. Value of Company > (Total Cash & Equivalents + 0.75 *Receivables+ 0.5*Inventory – Liabilities)  I tried running this criteria over Indian companies but couldn’t find reasonable sized company trading at deep discount to liquidation value. The next simple and logical step is Book value (Value of Assets- Value of Liabilities). Stock trading at discount to book value indicates that market is expecting company to erode value through increased losses which will wear down previous years retained earnings i.e in accounting terms- RoE will be less than required rate of return. For my friends from non-finance background, I know it is difficult to comprehend and is similar to how I see Alpha, Gamma and sin teta, but you can chose to ignore if you want to.

The next obvious question in my mind is what discount to book value is great entry point for value investors? I picked up few construction companies, where sustainability of businesses were in doubt either due to regulatory, political, balance sheet or governance issues to check out what lowest price to book multiple they traded during last 1 year. Since estimation is poor indicator for distressed companies, I relied on reported book value at that point of time. 

Exhibit 1: Large construction companies under stress

Exhibit 2: Pure road construction players at their lowest valuation

Exhibit 3: Similar size peers at their lowest Price to book valuation

The exhibit says it all.. Stress is never permanent as you see how swiftly prices have moved for larger companies whose survival was in question just few months back. I find it difficult to believe, that company with Rs12000mn revenue and B/S size of Rs20000mn to trade at lowest multiple  which was not seen for any company in last 1 year.

Even valuing ARSS at lowest multiple of 0.2x, will take stock price higher by 20% and going by avg of its immediate peers it should double the stock price.  Therefore, I would like to take a small exposure of 3-4% in a portfolio. I believe stocks like ARSS Infra have potential to turn multi-bagger but are surely for high risk seeker investors. If sentiments improve, then we could see going concern value in addition to liquidation value & that could re-rate the stock from current levels. No doubt, we could also see sharp downside cut in the stock as events unfold but I guess it’s worth a risk.

Key Risk

My underlying assumption behind this thesis is ofcourse, reported numbers are genuine and not manipulated as we see in increasing infrastructure and real estate companies and that remains key risk to investment. Next 2 quarters results will determine the destiny of this company and shall be subject to high risk events.