Gafisa Revisited And Restructured

One of the biggest conundrums investors can face is when a market abandons the fundamentals for a broad-based sell-off in its names. Not so very long ago, I can remember Ford (F) at a buck, Bank of America (BAC) at $2, and Pulte Homes (PHM) at $3. The desire to flee during the financial crisis had created once-in-a-lifetime fire sale prices in those blue chip names.

Thus when questioning the recent fall of Gafisa (GFA), an investor might ask himself, “What does political upheaval, a rise in inflation, street-riots involving millions, and a sudden crash in emerging markets (to the tune of 20%), do to the price of assets in those markets?”

If you’re thinking discount, that would be very accurate. The recent meteoric rise in the 10 year Treasury yield created a selling panic in the emerging markets.

It’s the bond market’s anticipation of a once-in-a-lifetime upswing in the Interest Rate Cycle. Dubbed the “Great Rotation”, the bond market f ears the recent upswing could be the harbinger of a permanent rise in borrowing costs, and a preference for equities over bonds. Higher borrowing costs (cost of money, credit) in high-inflation, emerging markets like Brazil and India, cools those markets dramatically.

It is interesting to note that last year’s July 23-25, 2012 low in the 10 year treasury bond matched its previous lows of 1945. At 1.4%, it was only the second time since 1790 that there had been a print that low. A year later, the 10 year yield has nearly doubled (96%), and the last phase of this rise created a selling panic in the emerging markets.

So what about Gafisa? First of all, it sold down in lock-step with the Brazilian market during the Spring debacle, so there was nothing particularly individual about its dramatic move down. GFA dropped 41% from $4.10 to its lows at $2.40. The EWZ (Brazilian Fund) dropped 26% from $55 to $41.

Secondly, the company initiated a major switch in its bu siness model during the midst of this investor chaos. After a multi-year rise in its suburban real estate division under a very successful division manager, Gafisa decided to sell 70% of that division (Alphaville) to Blackstone, a private equity firm, on June 7, 2013. At the time of the sale, Brazilian real estate was approaching some of the highest-prices in the world.

The success of this division had been marred by a coincident acquisition of a low-income housing unit (Tenda, 2008) that had racked up significant losses and was hobbled with unsold inventory. There had also been a geographic diversification of its high-end residential product (Gafisa) into none-core markets across Brazil, and this had proven to be modestly unsuccessful.

So the company decided to re-trench. It would restructure and re-invest in its high-potential low-income brand (Tenda), while maintaining its high-rise residential offering (Gafisa). Geographically, it would focus on its home mark ets of Rio and Sao Paulo in preparation for the World Cup and 2016 Olympics.

The Alphaville sale netted enough cash to reduce its debt-to-capital ratio to 57%; and this garnered an immediate upgrade of its corporate debt by Fitch from A- to A. Gafisa is one of only two companies within the sector rated by Fitch Ratings with an ‘A’ or higher rating of its corporate debt.

In their comments, Fitch said the upgrade was partially ” the result of Gafisa’s consistent improvement in operating performance, its significant growth in revenues and its strong position as a leading homebuilder in Brazil”.

Additionally, Fitch cited that it expects Gafisa should “significantly increase its revenues and generation of cash flow as it continues to expand geographically and diversify the products offered and the socioeconomic segments served.” (PR Newswire, May 5, 2013).

Coincident with the sale to Blackstone, two institutional investors bought 12.33% of the “new” Gafisa Group. Goldman Sachs (GS) International purchased (5.3%) on May, 17, 2013; and Polo International purchased (7.03%) on June 13, 2013. These institutions were obviously apprised of the events surrounding the company before the Blackstone purchase. Today’s price of $2.75 is approximately 35% below Goldmans’ original cost for its shares.

In my previous article, I described the aluminum-mold method that Tenda will utilize in 100% of its new construction; and I also outlined the new business model for this division.

I think investors would be well-served to follow the Gafisa story alongside Blackstone, Goldman Sachs, and Polo Group. Indeed, on July 5, 2013 BTG Pactual Group analysts raised their recommendation on the shares to “buy” from “neutral”, saying recent losses in the stock were overdone.

As a postscript, only 5% of Brazilian real estate is purchased with a mortgage, making it one of the lowest Mortgage to GDP nations in the w orld. There is also relatively high inflation (7%), low unemployment, and upward mobility that are continuously pressuring housing. Thus the acquisition of a residence (at a moderate, fixed price) carries great benefit for a home-owner.

The government is very eager to do something about its low-income housing problem. To facilitate affordable housing, they must work with a large, reputable builder with a long track record and who can ramp the scale of construction.

This is where Gafisa’s Tenda unit enters the picture. If they can successfully answer this need, a win-win situation evolves for the company, the government, and new home-buyers. Because most low-income construction funding will be government-based, Tenda’s revenues are tied less to the Brazilian real estate cycle and more to the government’s spending on social projects, which it has said will be its priority for the next 4 years.

As far as the wind-down of the former Gafisa business model throug h the remainder of 2013 into 2014, I still peg the company’s book value at $5.40.

At $2.75 (July 23, 2013), the company has a $594ML (US) market cap and is trading just above its cash level of $523ML (US). This valuation doesn’t include the additional $890ML in Tenda and Gafisa inventory on its books, plus a pile of receivables. The stock is trading at 0.45x book. Its debt is investment-rated A. It appears fundamentally and technically cheap, and I have doubled my position at these prices (@$2.50 ADR).

The act of “buying low” can be psychologically difficult when an opportunity like Gafisa actually presents itself. But as Helene Meisler, the technical analyst at realmoney.com once opined, “By the time it looks good, you’re too late.

source : http://seekingalpha.com/article/1568332-gafisa-revisited-and-restructured?source=yahoo