In lecture 27 of BFBV V12 , Prof. Bakshi had mentioned a point of “Role of Cash: Nesco vs Nirlon”. Now, I don’t know what he had discussed with his class, but since I had studied these 2 companies, I am venturing a guess on what the Prof. may have discussed in class on this point. This is not a recommendation to buy or sell either. This is purely an exercise for academic purposes.
Nesco and Nirlon are two Mumbai based companies that have their prime business areas in Goregaon. In fact they are almost next-door neighbors separated only by a road. There are quite a few similarities and if you are an investor in either you should study the other, for they present similarities and contrasts. In this blog, I have focused only on one aspect- the role of cash.
Nesco and Nirlon began their lives in the 50s/ 60s. Nesco began as a manufacturer of Forge Hammers and Nirlon as a textile company. In the early 1990s, Nesco decided to develop the 70 acre land by constructing an exhibition center. Nirlon on the other hand filed for bankruptcy sometime in the 80s and for nearly 2 decades was under the BIFR.
Sometime in the 2000s, they both found themselves sitting on prime industrial land that could be developed to cater to the rapidly rising services industry. Nobody knew how profitable this could become for both these companies in the decade to come. However, the journey from manufacturing to a prime real estate developer providing services has been markedly different for both these companies.
Please see the comparison here before you see my concluding remarks below.
My opinionated views on the role of cash is:
1. The combination of 0 debt and a 400 Cr treasury gives Nesco the staying power during tough economic conditions.
2. Cash gives structural advantages to Nesco.
Refer to the Common Size P&L sheet and in it you will see:
> Cash in hand generates interest income which shows up as Other Income of 6% in 2016.
> By not using Debt, Nesco saves on interest costs, which adds to shareholder earnings. Nirlon on the other hand paid 25% of every Rupee in sales in servicing debt.
> Combining the above 2 points, Nesco’s shareholders earn an approximate 31% advantage over Nirlon every year. In other words, say Nesco and Nirlon have revenue from operations of 100 Rs and have similar expenses. So their operating income (EBITDA) would be the same too and if you focused only on EBITDA, you would think they are both equally good. But because Nirlon gives away 25 Rs as interest for every 100 Rs of sales, its shareholders would be worse off than Nesco’s. So year after year, Nesco’s shareholders would find their earnings going up much more than Nirlon’s.
3. Cash is the equivalent of the loaded gun. This is what Buffett had to say in the 1987 Annual Letter to Shareholders:
Alas, what is "tight" and "cheap" money is far from clear at any particular time. We have no ability to forecast interest rates and - maintaining our usual open-minded spirit - believe that no one else can. Therefore, we simply borrow when conditions seem non-oppressive and hope that we will later find intelligent expansion or acquisition opportunities, which - as we have said - are most likely to pop up when conditions in the debt market are clearly oppressive. Our basic principle is that if you want to shoot rare, fast-moving elephants, you should always carry a loaded gun.
So Cash allows Berkshire to purchase companies or invest at a time when others are fearful. I hope the management of Nesco takes this leaf out of Berkshire’s letters and deploys it in a manner that’s beneficial to the long term investor.
My analysis may be very rudimentary or even completely off the mark. Please fee free to let me know if I have overlooked any key aspects.