NESCO Initiating Coverage Research Report By Nirmal Bang

Step In Before It Is Too Late

We initiate coverage on NESCO with a Buy rating and a target price of Rs794 based on FY20E SOTP (sum of the parts) valuation, implying an upside of 30% from the CMP. Our optimism on NESCO is supported by: 1) Strategy focused on increasing rentable area supported by the expected increase in lease rentals. 2) Healthy balance sheet with a net cash balance. 3) Strong cash flow with positive FCFF. 4) Earnings expected to grow sharply post restructuring.

Strategy focused on commercial area, exhibition and convention centre: NESCO management’s strategy is focused on: 1) Developing the entire land bank of 70 acres (usable 58 acres) in Goregaon, Mumbai, into a commercial complex and an exhibition centre with total rentable area of approximately 9.5mn sqft over the next 20 years. 2) Entry into hotels and food catering business verticals. 3) Strict financial discipline with capex for the proposed expansion to be funded through internal accruals.

Long-term plan to build and lease 5mn sqft of commercial space: NESCO IT Park has total leasable area of 1.02mn sqft as of FY17-end. Following the ongoing restructuring, leasable area will come down to 0.67mn sqft by FY19E. Post restructuring, leasable area of NESCO IT Park is expected to touch 1.87mn sqft by FY21E and 2.87mn sqft by FY24E. Over a 20-year period, the leasable area is expected to increase to 5mn sqft. NESCO has an attractive client base which includes companies like MSCI, KPMG and HSBC. Approximately, 45% of revenues are generated from leasing of commercial space.

Bombay exhibition centre leasable area to be expanded to 4.5mn sqft in next 20 years: Bombay Exhibition Centre (BEC) contributed 42% to total revenues in FY17. It has total leasable area of 0.64mn sqft which is expected to increase with the addition of 0.45mn sqft of convention centre (Phase1- FY23E).Along with the upcoming expansion plan, it benefits from client stickiness which also acts as a cushion during an economic downturn. Over the next 20 years, the total space is expected to be expanded to 4.5mn sqft.

Healthy balance sheet with net cash position: NESCO has maintained strong financial discipline with the capex for expansion being funded from internal accruals. As of FY17-end, the company had cash plus investment balance of Rs4.9bn on a balance sheet size of Rs10.3bn. We expect the company to maintain financial discipline which adds to our comfort.

Consistently positive free cash flows: Free cash flows have been in the range of Rs22mn-Rs641mn over FY10-FY17 and we expect the positive cash flow trend to continue.

Muted earnings growth at 6% CAGR (FY17-FY20E) because of restructuring: We expect subdued earnings growth over FY17-FY20E because of restructuring undertaken by the company. After the first phase of restructuring, we expect the earnings to register a 35% CAGR over FY21E-FY23E.

We recommend Buy rating with a target price of Rs794: Our target price of Rs794 is based on FY20E SOTP based valuation. Our valuation is driven by the restructuring of NESCO IT Park, increase in rentable space of BEC and the expected rise in rental rates. Our optimism is supported by a healthy balance sheet, consistently positive free cash flow and the management’s growth-oriented focus with expansion of flagship business over the next 20 years.

NESCO stock currently trades at Rs613, which is at a discount of 22% to our target price. We have assigned Buy rating to the stock.

Conservative valuation does not include proposed 5.5mn sqft in leasable area: In our SOTP based valuation, we have considered only 3.96mn sqft of leasable area for NESCO IT Park and Bombay Exhibition Centre. Over a 20-year horizon, the management plans to utilise 4.5mn sqft of leasable area for Bombay Exhibition Centre and 5mn sqft of leasable area for NESCO IT Park.

Risks: Delay in execution of expansion plan and any unexpected rise in the vacancy rate.