No buyers at inflated prices, stay wary of real estate: Bhandari
In the latest episode of Ramesh Damani's Wizards of Dalal Street on CNBC-TV18, Manish Bhandari of Vallum Capital listed his views on the performance of real estate sector and whether investment in the sector is a good option.
Giving investment advice, Bhandari cautions against putting money in real estate companies.
He says inventories are piling up after foreign direct investment (FDI) was approved in real estate in 2005, which indicates that there are no buyers at exaggerated prices.
Below is the verbatim transcript of Manish Bhandari’s interview to Ramesh Damani on CNBC-TV18.
Q: I know a hypothesis very dear to you, it is that ‘Disruptions Create Opportunity’; explain that to me.
A: Disruption creates opportunity and one of the – as an observant I looked at the rise of Airbnb which is a challenger to the hotel industry. I have used Airbnb and during my observation and while stay at Airbnb, I figured out that there is an opportunity to make money through the bed linen companies because we can’t own Airbnb directly. There was a bed linen industry in India which was grow up to a size and we have got a few good market players in the bed linen industry and that is how we played a bed linen industry in this.
Q: How did the room nights go for Airbnb to give you that kind of confidence?
A: You will be surprised to know that from 10-15 million odd room nights exactly some five years back, they would be doing some close to 130 million room nights across the world. What is very different about Airbnb versus the hotel industry is that you use printed bedsheets, not the institutional side of the bedsheets and where India has got some kind of edge versus the others. We invested in one company which was among the market leaders in the bed linen industry.
Q: So while staying at Airbnb thought this is the way to play it and then you came back and did your research on this?
A: Yes, exactly. After an observation, you need to go through and look at the competitive advantage of the industry versus the market players, their strength and weaknesses and where there is value for you as an investor and finally you figure it out.
Q: Which year did you make that call?
A: It was in 2013.
Q: How is the bed linen industry panned out after that in India or globally?
A: In India you have an advantage of cheap cotton which is the sourcing advantage that India has and today India has close to 47 percent market share in the US bed linen industry and they have gained market share over a period of time and so the companies have become very valuable.
Q: In 2013 you had another hypothesis which you called ‘Indian Real Estate, The Crumbling Castles’. How did you come across with that hypothesis?
A: I would say it was a bubble of magnitude which we have not seen over a period of time.
Q: This is just after 2008, the global real estate market crashed; now you are seeing in 2013 the Indian market was pin-pricked?
A: If you look at the data, the Indian market, the real estate market, the land prices or the housing prices, would have at least quadrupled between 2008 to 2013-2014. The way I reached to this hypothesis is that my business takes me to a lot of small cities and whenever I used to visit the small cities and I used to get an idea about the bubble in the housing prices or the land prices, it set me thinking that there is something wrong. When I came back and desegregated the whole chain, there were few key reasons why this whole bubble came to such a magnitude of this order.
Q: And they were?
A: One was that there was a Lax monetary policy by the Reserve Bank of India (RBI), the loose fiscal policy by the government as well as the Lax monetary policy which released lot of liquidity in the system and that liquidity flew into real estate. Second thing was also that in 2005 we allowed foreign direct investment (FDI) in real estate and FDI was suppose to create affordable housing.
Rather than creating affordable housing, it created inventory hoarding up and the rise in the price of the inventory which created another set of problem for the real estate. The third thing is that over a period of time, in the span of 2008 till 2012 or so, we had a negative real interest rate for the savers. So finally that inadvertently alludes you to get invested in the physical assets versus the financial assets.
Q: How does a second level thinker like you come across with winning hypothesis from that hypothesis?
A: When you go back on your drawing table and you see what all you could avoid, one of the things was that you could avoid the direct real estate companies and you have not taken an exposure in the real estate companies where underlying value of the business could diminish or the derivatives of the real estate industry which could be very expensive, high-end housing finance companies also where there would be a asset prices growth but not the volume growth.
The second thing was also my hypothesis on the real estate gave me a good idea not to look at investing in the banking sector. There is an exposure of the banking sector in the real estate, they are close USD 150-180 billion out of the USD 900 billion book which set me thinking that apart from the mortgage business, also real estate has found its collateral in the banking sector. So, there would be a problem in the banking sector because of this. So, I avoided being invested in the banking sector.
Q: You talked about real estate as a falling asset class but you also like to catch falling knives. It is a fairly dangerous way to live in markets.
A: I would say when the knives fallen, the dust is settled, we have enough time to do the cherry picking of the businesses what we would like to invest in.
Q: How do you cherry pick and is there a method to your madness of cherry picking?
A: There is a time value correction which a business or a stock price would undergo through.
Q: Explain that to me in Lehman terms.
A: That would mean that -- the hypothesis is that people overpay for the growth. The market as an aggregate overpay for the growth, market as an aggregate doesn’t like to be invested in loss making businesses. Market needs confirmation, they need conformity of the earnings so when the businesses go through their cycle, there is enough time for you to do the business due diligence, run a screen, get those stocks in place, do the further business due diligences, segregate the companies what you like and be invested in those companies.
Q: So, the first parameter of that is you check that market cap is not grown proportionate to book value?
A: We run various screens and one of the screens would be where the market cap growth, the business value growth is much lower than the book value growth and you can use any time series based on your comfort and finally you will figure out something which will be a list, which would be of some comfort to you and then you could go further. This gives you a very good strength on margin of safety. So, you have very low downside when you do this kind of investing.
Q: You also do a lot of scuttlebutt investing in the sense you go visit AGMs, company conferences, how does that help you?
A: Getting to annual general meetings of the companies, asking the right questions to the management and in those 15-30 minutes you could get much more meatier information about those business strategies of the companies.
Q: There is actually symmetry of information so now you are loading it in your favour by going to those sources.
A: Exactly, so me and my team would do some 70-80 AGMs in a year across India.
Q: So it is a tough way to make a living?
A: Yes, it is a way to make a living but money making is not easy.
Q: Markets are made of demand and supply curves and the curve that you paid a lot of attention to is the supply side of the business, not necessarily the demand side of the business, why do you do that?
A: Less attention was paid on the supply structures of the businesses, how the new entrants are coming, for example, we were lucky enough to make few good investments based on this. 2012 we looked at the microfinance industry after the knives had fallen, the dust has settled. If you look at the industry structure at that point of time, out of 10 players 70 percent would have been into the corporate debt restructuring (CDR).
A very few of them survived. During that survival phase the industry shrunk, the demand shrunk and everything shrunk. No one would have looked at that industry where the demand is shrinking and you have some kind of regulatory structure overhang.
Q: You have more market share now?
A: Exactly and that is what our shareholders would love - to see a profitable business which could survive those downturns.
Q: Is the airline industry going through the same consolidation?
A: A part of it is yes but I would have a different view. There is a consolidation which has happened but the ability to start a new business there is a very small regulatory change what you require and that is you can take a licence and you can start. If the industry becomes profitable lot more people with lot better capital can come and be a part of airlines industry.
So, I don't think that, that would merit in my scheme of things.
Q: Which industry according to you is ripe for consolidation right now?
A: I can talk to you about a industry where we have made an investment. It is the domestic branded fabric industry. Market is too obsessed with the readymade garments. Market has overlooked the fabric industry which is the tier II, tier III, tier IV of India.
Maybe a decade back there used to be a close to 10 brands and today exactly a decade of a long term trend would give you an idea and 2016 hardly two of them sit in the pole position.
Q: You can almost predict them from the ones you know - Raymond and Siyaram perhaps?
A: Exactly, I am referring to them. That pole position gives you a very good advantage, whenever the industry revival happens then you have an opportunity to gain the market share, to capture the pricing shares and host of things together.
Q: Another hypothesis that we are very fond of is the one that dog that did not bark from Sherlock Holmes. How is that helpful in investing?
A: A dog is supposed to bark. I can give you an example, just look at the banking sector. You need to be a bank which should have not grown somewhere in 2009-10-11 or so and you are safe home today. So, every bank was growing double digits and one fine day we would have a bank which is growing very significantly. The whole industry was growing and that was a time to be cautious.
Q: And they all got marooned with NPA problems.
A: Exactly. I can give you another example. I have been on the buy side for some time and in 2008 before the crash happened you need to be a fund manager who was underperforming because you need to sell your winners, protect your assets, be in underperforming stocks and then just wait for that crisis to happen and to play it over. That was a time maybe lot of investors would have questioned you that you are not growing in the way the industry or the markets are growing, the returns are very different, divergent? Answer is yes. That divergent needs to be looked at very much more carefully and that is where the proof of pudding lies.
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