This article by MOI Global instructor Scott Miller is excerpted from a letter of Greenhaven Road Capital, based in Greenwich, Connecticut.
If an operator can turn a profit during very challenging times, it portends well for performance when the environment improves. Investors like to think about peak and trough earnings for cyclical industries. Earnings during boom times are often afforded a low P/E multiple because they are considered unsustainable. Similarly, during trough or recession times, a higher P/E may be applied because it is highly likely that earnings will rise with an improvement in the economy. A low P/E ratio on depressed trough earnings can be an interesting investment set-up because we may see revenue growth, earnings growth, and multiple expansion (a higher P/E). In short, this combination can lead to an investment that returns multiples of the original investment.
In the past two letters, I have mentioned building a position in a South African company that fits this description. It is certainly not the proverbial “best of times” in South Africa. Unemployment is hovering around 30%, the country has wrestled with government corruption, there are rolling power outages, and there are a host of apartheid-linked legacy inequality issues. The economy is bouncing in and out of recession. Consumer confidence is low and interest rates are comparatively high. None of this is a favorable backdrop for housing, yet Balwin Properties (BWN.JO) has endured, and actually prospered. If I were going to pick a place in the world to operate a home builder, it would not be South Africa. However, if I could only buy one home builder, it might be Balwin Properties.
In the “worst of times” description above, I left out the fact that South Africa has a housing shortage of about 3 million homes, 700,000 of which fall into Balwin’s core product category. Demand is reinforced by urbanization as well as a growing middle class. Balwin Properties caters to this rising middle class by developing multi-family, sectional title housing, primarily in the form of one-, two-, and three-bedroom four-story walk-up apartments with prices ranging from $40,000 to $150,000 USD: the entry to mid-market segment. Their developments are located in high-density, high-growth urban nodes across key metropolitan areas such as Cape Town, Johannesburg, Pretoria, and Durban.
While the Balwin properties vary in terms of size, they all have lifestyle centers, housing amenities like gym/fitness spaces, one or two restaurants, spa/wellness areas, children’s play areas, swimming pools, mini sports fields, and spaces for gathering. The Blyde development in Pretoria even boasts Africa’s first Crystal Lagoons lagoon for swimming, kayaking, and paddle-boarding. Apartments have the exact same finishes (dishwashers, faucets, cabinets, etc.), which allows Balwin to benefit from scale. Still, the quality is surprisingly high. Doors are thick, brand names are used, and they are well laid out. The projects are developed in phases. On average, a development sells 25 apartments per month, and a new phase of development will not be started until it is largely pre-sold.
Property development is not a “great business.” It is cyclical, there are low barriers to entry, and it is capitalintensive. Balwin does receive some benefits from its scale in purchasing, advertising and sales, and a small “brand” premium, but ultimately, I believe that this is a better investment than business. Insiders own in excess of 50% of the shares and the company is led by an owner-operator. Given the economic headwinds in South Africa and tightness in the mortgage market, it is probable that these are not peak earnings. We acquired our shares at a P/E multiple of less than 3x and a 50% discount to tangible book value, which largely constitutes land holdings at cost and developments under construction. There is a realistic path to a multi-bagger.
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