NESCO - The Exhibit! - Nirmal Bang

New Standard Engineering Company (Nesco), which is sitting on 70 acres of prime land (60% yet to be monetised) at Goregaon (East), Mumbai, runs a highly profitable and sustainable niche exhibition space rental business. This is well supported by annuity income from its commercial realty division, which will be boosted further by the leasing of its new tower III space. We expect the company's operating cash flow to double to Rs3.3bn over FY12-FY15E (yield of 12% based on FY15E operating cash flow) and 25% earnings CAGR over FY13EFY15E as the exhibition business outlook remains stable apart from gradual leasing of tower III space. We have assigned a Buy rating to the stock with a target price of Rs1,129 (20% discount to our one-year forward NAV), implying a 46% upside from the current market price.

Niche and highly profitable exhibition space rental business: The Indian trade exhibition business, pegged at Rs9bn currently, has potential to grow to Rs50bn by 2020 (20% CAGR) as per UFI (the international association of exhibition organisers). Nesco, being the second-largest space provider in India with an 45,000sqm area, offers exhibitors large covered spaces (as compared to competitors who either have open space or smaller space) in Mumbai-one of the largest trade exhibition markets in India. Further, the trade exhibition business remains highly profitable as it has excellent cash flow characteristics, with stand-space deposits often paid a year in advance and also renewals are typically in the range of 65% to 85%. We believe the trade exhibition business is in a sweet spot in India as trade shows are being held regularly with the markets being opened up to foreign investors, thereby driving up the space occupancy rate, in our view. We have factored in 14% revenue CAGR over FY13E-FY15E in respect of Nesco's exhibition business driven by improvement in the occupancy rate.

Strong cash flow, healthy return ratios: Nesco's exhibition business operates on negative working capital, where 50% of the money is received in advance (prior six months) from exhibition organisers. Further, its commercial realty business requires only maintenance, which comes to 10% of its total rental income. We expect Nesco to generate free cash flow of Rs2.4bn over FY12-FY15E as against Rs0.7bn (FY09-FY12), led by improvement in the occupancy rate (exhibition business) and gradual leasing of its tower III space. Further, we expect its RoE/RoCE to sustain at 25.2%/31.5%, respectively, for FY15E, higher than industry peers.

Tower III to drive leasing income: Leasing of commercial space in Mumbai has been muted over the past six quarters with corporate expansion activity remaining subdued. Despite subdued commercial activity, Nesco has successfully managed to pre-lease 0.1mn sq ft (15% occupancy rate) in tower III (0.65mn sq ft) to KPMG for Rs100/sq ft/month (expected to occupy by 1QFY14). We expect rental income from the commercial space segment to post a 61% CAGR at Rs679mn over FY13E-FY15E, largely led by leasing of tower III space. We have factored in lower occupancy rates of 20%/50% for FY14E/FY15E, respectively, for tower III.

Outlook and valuation

Nesco has monetised only 25 acres of land so far out of its 70 acres. We believe the company is likely to get value on operational assets rather than its entire land parcel. Hence, we have valued the stock on the basis of operational assets, i.e. 0.45mn sq ft of exhibition space and 0.9mn sq ft of commercial assets, as per the NAV method. Faster monetisation of its remaining land bank could act as a positive trigger for the stock. Further, we expect Nesco's cash and liquid investments to top Rs4.3bn in FY15E (Rs304/share, 40% of current market capitalisation), providing valuation support to the stock and also lead to higher dividend pay-out. At the CMP, the stock trades at a 45% discount to our one-year forward NAV of Rs1,411/share. We have assigned a Buy rating to the stock with a target price of Rs1,129, which is at a 20% discount to our NAV. We have assigned 15% cost of equity, 11% capitalisation rate and a tax rate of 30% from FY13E, while arriving at our NAV. The ongoing rate for land parcels in and around the vicinity of Nesco is in the range of ~Rs400- Rs500mn/acre, which translates into Rs35bn for the company's 70-acre property. This works out to 3.5x its current market capitalisation after excluding cash, thereby providing enough margin of safety and limiting the downside from the CMP, in our view.

Source : Equity Bulls

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