Gaurav A Parikh

With over 5,500 listed companies (though just 1,300 are traded daily) on the BSE and over 1,600 on the NSE, there’s always a problem of plenty — to ensure that you don’t end up being the next big sucker!

Hence, I can’t resist talking about my previous two picks that have done well. Shemaroo Entertainment, suggested as the stock for 2015 at Rs.159, has gained 140% to Rs.387, while Astec Lifesciences, recommended for 2016 at Rs.238, is up 160% at Rs.619, after touching a high of Rs.695. I hope, I can score a hat-trick with my pick for 2017. It would be really sweet as I’ve really stuck my neck out on this one!

This time we are talking about the Mumbai-based Ruby Mills, which will, incidentally, be celebrating 100 years in CY17. Could it give a 100% return from its current Rs.313 levels is what we are going to talk about.

Run of the mill
Cotton textile mills in the city, which had all turned sick in the 1980s, got a breather through the Development Control Rules (DCR) 1991 that allowed them to develop their real estate. But the 1991 DCR was quite a non-starter for most mills, as the factory structure could not be demolished. Except Phoenix Mills, which build a huge mall and entertainment zone within their existing structure at Lower Parel, others could not do much as there was no ready buyer or developer if the factory could not be demolished. The mills took the matter up to the Supreme Court, resulting in new DCR in 2001. 

It was around this time that I took a fancy to listed mill stocks — Ruby, Swan & Dawn — and showcased their hidden potential at asset valuation training workshops. The mills as per the rules were allowed to monetise their real estate, even by demolishing the existing structure, as long as 30% of the proceeds were earmarked for social purposes. 

The Shah family of Ruby Mills too decided to monetise the Dadar property. The textile division, comprising the entire spinning and weaving operations, was shifted out of the city. In 2006, Reliance Retail was to buy the property for Rs.400 crore but the deal fell through. ‘The Ruby’ tower, located close to the busy Dadar station, has been jointly developed by the company and Mindset Estate, a 100% subsidiary of Rohan Lifescapes, promoted by Harresh Mehta. The total leasable and saleable area of the tower is 1.25 million sq ft on a total FSI of 2.66 times. The tower houses well-known names such as Axis Bank, Ernst & Young, BDO and Sharekhan. Axis Bank, in fact, picked up another 2 lakh square feet earlier in 2016 for Rs.320 crore. It also has a major banking relationship with Ruby Mills, more on that later. The company also has another undeveloped property adjoining the tower.

Ruby Mills, which had 138 permanent employees as of March 2016, has no subsidiary. Thus, real estate is the trigger for the pick and not the textile business. The real estate potential, however, remains locked up owing to alleged FSI Violations while building ‘The Ruby.’ Any unlocking will thus be a huge immediate trigger. The risk, of course, stares at you in the face as to why this hurdle has not been crossed for the past five years from 2011 when the tower was ready for occupation and given that the new DCR 2012 is already in force.

This is what the directors had to state in the FY16 annual report: “Land Development at Dadar: The construction of office building structure is complete as per the approved plan under the earlier DCR. The state government has notified modified DCR in 2012 wherein plans approved under the old DCR have an option to comply with the new DCR. The company is exploring this option. In the current year lease/sales are expected to pick up due to current improved market conditions for office spaces.” So, my rationale for the stock is the unlocking of the real estate potential.

Core business
In FY16, the textiles business accounted for 85% of revenues at Rs.180 crore, almost all from fabric sales, while textile exports stood at Rs.5 crore. Real estate contributes 15% or Rs.32 crore to the topline. But what is pertinent to note is that the realty business contributes Rs.27 crore to the bottomline (Rs.41 in FY16), while the textiles business contributes Rs.24 crore. For the first half of the current fiscal, PAT stood at Rs.15 crore against Rs.18 crore in the corresponding first half of FY16.

As on September 2016, long term borrowings stood at Rs.651 crore, a chunk of which is deployed in real estate development. Most of the long term borrowings are on account of lease rental discounting, leave & licence and loan against property. The two major lenders are: Axis Bank, which has extended Rs.84 crore loan against the property, and Allahabad Bank, which has granted a term loan of Rs.138 crore, including an overdraft limit of Rs.100 crore. Under the lease rental discounting scheme, the outstanding was Rs.129 crore. There is also over Rs.100 crore in current liabilities as advance received against sale of premises. Thus, most of the loans have been applied for the real estate business.

Interestingly, an aggregate of Rs.622 crore also reflects under the head “Assets” showing two huge amounts of Rs.397 crore and Rs.225 crore due from the Rohan Lifescapes under the development agreement. Under a development agreement, the company granted the development rights to Mindset Estate to develop 36,000 square metres out of its freehold land at Dadar. Any cost of construction and further costs (including interest on borrowings for the said construction) that may be incurred by the company for the development is to be reimbursed by the developer, Mindset Estate. Accordingly, the cost incurred by the company in FY16 for the construction is shown as due (Rs.397 crore) from the developer. The Rs.225 crore is shown under short-term loans and advances recoverable in cash or in kind or for value to be received from the developer. This one reason why the finance cost is just Rs.13.04 crore and nearly all of this is because of the TUF loans that the company has availed for the textile business. Finance costs for the real estate loans are, instead, included in the amounts due from the developer.

The company has already received approval from the state government to develop additional constructed area of approximately 5,000 square metres over and above the area covered under the development agreement. The related cost of such area to be owned by the company is mutually agreed upon with the developer on an appropriate basis. As on March 31, 2016, the company has entered into a leave and licence agreement with a party in respect of the said constructed area and carried forward Rs.26.50 crore in capital work-in-progress. The said cost may be adjusted or increased when the developer completes the construction of the total area, including the construction of the common areas.

Real value
The company’s equity, post a 1:1 bonus in October 2015, stands at Rs.8.36 crore, comprising 1.67 crore shares of face value Rs.5 each. The Shah family owns nearly 75% of the equity, while close to 6,300 shareholders hold the balance stake. What makes the floating stock even lower is that a large part of what is classified as non-promoter holding is concentrated in a few hands. For instance, 2.92% (444,432 shares) is held by Adrik Traders. Daily trading volumes are often in just hundreds. Many other high networth non-promoter shareholders hold huge chunks and are not in selling mode. This creates a further dearth of floating stock. Investors must consider this relative illiquidity in trading when they plan any selloff as this could impact price.

I just see two ‘L’s quite clearly “liquidity and litigation risks” both on account of continuing delay hurdles in Ruby Mills’ real estate segment. Despite an EPS of over Rs.25,Ruby Mills struggled in FY16 to repay loans on time and defaults ranged between one to three months. On the one hand it has created loan liabilities on account of real estate development which need to be paid when due and, on the other, it has created an asset of such construction costs to be recoverable from Mindset Estate, the developer. There appears to be a mismatch in cash flows on this account that led to delays in loan repayments. There is another ‘L’ related to listing, rather delisting. Corporate governance standards in India and love for minority shareholders continue to be tested regularly. I just hope that once the hurdles towards the real estate development are removed, the promoters do not pursue the path of delisting before unlocking true real estate potential.

The recent demonetisation is already a business dampener in the short term and there is widespread expectation of real estate prices dropping sharply. The positives though are the new Real Estate Regulation Act aimed at facilitating institutional and high networth investments through REITs and easing liquidity and exit challenges facing the sector.

Despite the delay in facilitating a full occupancy at ‘The Ruby’, the reason I am sticking my neck out for Ruby Mills is because I’m a sucker for the potential for non-linear profitability as it gets to develop the surplus land and increase occupancy at the tower. Real estate income at just Rs.32 crore (15% of revenues) should then well to over Rs.100 crore.

In 2008, the share price (adjusted) recorded a high of Rs.1,076 but fell to Rs.126, post the crisis. In 2010, it recovered back to Rs.681, before dropping to a low of Rs.131 in 2013. In CY16, it touched Rs.518 and is now quoting at Rs.313. At current levels, the stock is trading at a
P/BV of 1.4x (BV as of September 30, 2016 is Rs.228). Now, if one takes into account the potential jump in profitability ‘if’ the real estate potential is truly fully unlocked, then this Ruby could well be worth the find.

Disclaimer: In his valuation training workshops, the writer uses Ruby Mills and other companies as illustrations to determine value versus price