I briefly discussed CRESY after the Argentine government appropriated YPF. At that time I focused on the market value of the non Argentine assets thinking that in the event of an appropriation of the Argentine assets, share holders would come out just fine based on the value of their non Argentine holdings.
The stock has dropped about 20% since I last looked at, so I am taking another look. To remind you, CRESY is a conglomerate domiciled in Argentina that owns a variety of assets – most of them Argentine real estate. Much of this is through a controlling position in IRSA Inversiones y Representaciones (ADR ticker IRS) which owns shopping malls and hotels, again mostly in Argentina. More interesting to me are CRESY’s agricultural land holdings, which include more than 685,000 hectacres of land split between:
The company fashions itself as a developer of sorts, and buys land with the intention to improve it and re-sell it. For example, using land for corn or soy is more profitable than using land for grazing, so they try to buy land that has been traditionally used for grazing and improve it so that it can be used for agriculture. Given the company’s balance sheet and personnel, they believe they can increase the yield from the land through modern farming techniques and equipment that previous land owners may not have had access too. Basically they are just taking traditional land and applying modern, industrial farming techniques to the land.
This is an asset heavy business, but unlike railroads or cruise lines, the assets (the land) don’t have to be depreciated and replaced. Rather, land typically appreciates over time. However, accounting conventions do not adequately address the upward revaluation of land holdings, meaning that their book value is likely understated by a fair measure. The Brooklyn Investor did a brief writeup on CRESY a few months back and demonstrated that CRESY has effectively grown book value in the past. According to the company’s 3/31/12 6K the book value of the company is 2,192,778,000 pesos, or $488,783,000 USD (according to google’s exchange rate). With current non-diluted ADR shares outstanding of 55,891,537, that is a BV / share of about $8.75 per share vs current ADR prices of around $7.50 / share… a ~14% discount to a likely understated book.
So – what does the book value consist of, how defensible is its value, and should this company trade below book?
According to the recent 20F roughly 64% of the total assets fall under “real estate” and 36% fall under “agriculture/feedlot.” Unfortunately the components of those assets (ie PP&E vs intangibles etc etc – obviously PP&E is what we really care about here) are not split out, but PP&E is about 55% of the total asset base and 21% is “investments” which is not defined, but I believe to be capitalized improvements to PP&E. There is also cash and inventories, but the point is that the vast majority of the balance sheet is hard assets, not intangibles or good will. In fact, the company carries negative goodwill which represents the discount purchase prices they have paid on assets in the past – evidence of skillful capital allocation.
First, the “real estate” business which consists of shopping centers, offices and non shopping rental properties, hotels, and development property held for sale. My big fear here would be that a lot of this property was acquired in the mid 2000s at inflated prices and is now at risk of being written down in the event of a renewed global slow down. However most of the shopping centers were acquired in the 1990s, with a touch more than 25% of the total appraised value of shopping centers having been acquired in 2009-2010. This is somewhat comforting as the company was not on a shopping spree in an overheating market, reducing the likely hood of a write down.
Additionally, the company believes that Argentina is still going through an evolution away from neighborhood shops and towards fully developed malls… sort of like the US in the 50s or 60s. I doubt that any area that has not yet fully embraced a mall culture will reach the amount of malls that the US presently has due to the advent of internet shopping, but the point is that Argentina is not “over-malled” like the US is, and there is still an opportunity to refine and centralize shopping destinations in Argentina – despite internet sales.
Additionally, the properties they buy for development and sale are in under or undeveloped areas of densely populated areas, or on the outskirts of Buenos Aires with convenient access to the city. Again the company is not top ticking the market as these properties often lack even basic infrastructure which the company then puts in before selling the properties. This is basically a play on a continued population / urbanization trend in Argentina.
The hotel and office building businesses are slightly more concerning as they are more attached to premium parts of the market, but again, the company was not on an acquisition binge through the early 2000s. These investments are basically a play on Buenos Aires continuing to develop as an international city for both business and tourism – longer term I think both are likely, however, there is a chance all of the above could be written down in a global slow down.
The agricultural business is less concerning. As stated above, the company buys agricultural lands and increases their yield. In the longer term, I am very positive on South American farm land. The global population is bound to grow, and food demand from a growing global middle class will make total food demand grow exponentially. In order to meet this demand the world needs arable land. In order to grow crops in a price competitive way this land needs to be close to water. South America is really the only place that will be able to meet this need on a kind of large scale.
In the shorter term, if there is a global slow down farm land is unlikely to lose much value. People still need to eat, and farm land should benefit from a flight to safety affect as both an inflation hedge and the source of non discretionary food. That is not to say that CRESY’s stock won’t sell off – it likely will, especially given the high debt load and fears of a freezing credit environment – but I think the value of the actual land is pretty safe.
In summary, I think that the book value of the property and land is reasonably safe from being written down, so I feel comfortable looking at this as a ROE / book value story. Over the last 10 years ROE has averaged 6.4%, and over the last 3 years it has averaged 8.6%.
The ROE numbers are not all that impressive, but there are a few things to think about here. First, assuming our cost of capital is 10%, returns of 6 or 8% can be just fine if you’re buying the assets at a discount, which we would be. Second, the story here isn’t really about the year to year income – its more about the appreciation of land over time. The year to year income will reflect some property sales, but it is more representative of sales of beef, milk, crops, and income from tenants. Third, how has the composition of ROEs changed over the years?
A quick look at 10 years of Dupont break down show that leverage has been the contributor to ROE in recent years which is of course less than ideal.
But is it a problem? More on that later.