Nesco, BMC, and the Most Important Rule of Investing

Driving on Mumbai's Western Express Highway is a nightmare.

Just ask any Mumbaikar who travels daily on this road. The traffic jams are irritating and frustrating.

It's the same story on many other important roads in Mumbai. One of the main reasons for the traffic jams is the Mumbai Metro work currently on at several places.

Why am I telling you this, dear reader?

A very interesting development happened a few days ago.

The Mumbai municipality, commonly known as BMC, asked the Bombay Exhibition Centre (BEC) operated by Nesco Ltd. to stop all events/exhibitions at the venue.

The BMC issued a letter stating the permission for exhibition could not be granted considering the public interest at large.

The stock fell about 5% the following Monday.

The company issued a clarification to the stock exchanges and the stock seems to have stabilised...at least for now.

No matter what happens now, this episode has shed light on a very important point about risks and return going hand in hand.

First, let's have a look at the positives.

Nesco has an exhibition and convention centre - Bombay Exhibition Centre (BEC) - located at Goregaon, on the Western Express Highway in Mumbai.

BEC is the largest exhibition centre in Mumbai. It has hosted more than 1,000 trade fairs, exhibitions, and events till date.

Nesco has a great locational advantage. It's situated on a national highway. It's very close to the airport. The company also enjoys the strategic advantage of having the biggest land parcel in Mumbai. It is very difficult for any company to compete with Nesco.

The company derives around 36% of its revenue from this exhibition business with an operating margin of 80%. This clearly proves the business has a strong competitive advantage.

But all these positives clearly came with risks attached.

The BMC order wasn't the first time the company faced something like this. Earlier, the company had incurred the wrath of the traffic department.

This is what the traffic department said in December 2017:

• Directions have been given to Nesco Ltd. to not accept bookings for more than 50% of the capacity of BEC for events to be conducted on weekdays. Full bookings can be accepted for events to be held on weekends.

As per an article in Times of India, BMC had basically told Nesco not to host any events till completion of Metro construction along the highway.

But the Metro work is expected to be completed in 2019. This would have meant that for more than a year, Nesco would not have been able to host any events!

Now imagine what would have happened to the stock. Imagine if you were a shareholder.

It's shocking, isn't it?

The loss in revenue, the damage to the company's reputation, the impact on future bookings...

Such risks are very difficult to predict.

What can we learn from this?

In investing, there will always be some uncertainty. You can't escape it. On this journey, you need to prepare for such unforeseen risks.

Previously, Sarvajeet wrote about PVR and Inox and how the prices of expensive food items in multiplexes have come under the scanner.

How do you account for such risks? They're not predictable.

The answer lies in always investing with a margin of safety. A margin of safety acts as insurance against even the most unforeseen risks.

As editor of Smart Money Secrets, I often reject stocks based on this principle: margin of safety. This despite the strong business model and competitive advantage enjoyed by some businesses.

As the father of value investing, Ben Graham, once said...

'Margin of safety is always dependent on the price paid. It will be large at one price, small at some higher price, non-existent at some still higher price.'

I will never expose my subscribers to unnecessary risks. I always keep the margin of safety in mind before recommending a stock. That includes my latest recommendation as well.

Coming back to Nesco, what do you think?

Can a blanket ban on exhibitions and trade events be a solution to Mumbai's traffic woes? If not, what could be?

Chart of the Day

Due to a sudden notification regarding a blanket ban on exhibitions/trade events, the stock of Nesco fell about 5% on Monday, 27 August before recovering.

For the fiscal year 2018, the exhibition business contributed around 36% of the revenue and 44% of operating profits.

Exhibition Business - A Cash Cow for Nesco

Its operating margins are close to 80%. This is possible only due to its strategic location and a lack of competition in Mumbai due to the unavailability of such a big land parcel.

No wonder, Nesco enjoys pricing power and could maintain such high margins over the years.

A ban on exhibitions would completely change the picture.

This is why, from an investor's perspective, the margin of safety is so important.

Take the example of this month's Smart Money Secrets recommendation...

Despite its robust business model, long customer relationships, economies of scale, and a transition to a consumer facing business, I still gave a partial buy (50% exposure) on the stock.

Why?

The margin of safety was not sufficient for a full 100% buy.

For that to happen, the stock would have to correct by about 20% or so from current levels. I'll send an update to Smart Money Secrets subscribers when the time is right.

If you're not a subscriber to Smart Money Secrets, you can sign up here.

Regards,


Kunal Thanvi (Research Analyst)
Editor, Smart Money Secrets

PS: Kunal Thanvi, editor of Smart Money Secrets, is the Sherlock Holmes of investing. He is on a mission to reveal the top picks of India's best investors to you. For clean, high quality stock recommendations that won't put your wealth at risk, subscribe to Kunal's Smart Money Secrets.