Getting the cycle right – Villa World

Chairman, Wilson Asset Management
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A perusal of the BRW Rich 200 list will provide ample motivation for any ambitious young entrepreneur to dive into the property development game. It appears that the property industry has made more people wealthy than any other in Australia.

The pre-GFC property boom that we experienced was perhaps not as extreme as previous property booms, such as the one that crashed at the end of the 1980s, which brought the mighty Westpac to its knees (along with many others). However, the excessive lending and high inflation did result in a speculative bubble in property that ultimately led to many, many property business failures when the banks finally called in their loans. As Warren Buffet likes to say, “We don’t find out who is swimming naked until the tide goes out.” Well, as with all booms, it finally busted and those swimming naked got blown-up.

The exception

One small listed residential property developer that rode this rollercoaster is Villa World Limited (ASX: VLW). Villa World has been listed since 2004, but started life back in 1986, so the company has been around the block, so to speak. It had residential development projects in Queensland and Victoria.

At its peak back in December 2005, the stock price reached $6.30. During the post-GFC period the stock fell all the way to about 30 cents – ouch! What a painful reminder of what often happens to cyclical businesses when the party stops.

We started buying Villa World early this year at around $1.20. At the time, it had net tangible assets (‘NTA’) of $1.76 and had gone some way towards cleaning up its balance sheet, and the mess left behind by the GFC and the indiscretions committed during the boom.

We took the view that the long-term bear market in residential building would start to improve, based on interest rate cuts and a significant under supply of residential property. We also liked the buffer provided by the discount to NTA.

In Villa World’s recent pre-release update, we were encouraged to see that the balance sheet is well on the way to being cleaned-up (although debt remains high) and demand for the company’s affordable home packages continues to firm, particularly in the Queensland market where the company is based.

It’s encouraging to see the NTA edging up too, the last report pegged it at $1.85. While Villa World’s underlying business is profitable, it is still experiencing non-recurring losses due to balance sheet clean-up. Its underlying profit for the 2013 year of $11 million is around a third of its ‘peak of cycle’ earnings back in 2005. It may be a long road back, but potential upside is clearly substantial.

Evidence of clean-up

The stock is under-owned by institutions, and the company has done very little marketing while it has focussed on getting its ‘house in order’.

For us, it’s a classic counter cyclical play and while some bought the stock earlier in its recovery, we wanted to wait until we saw evidence of the recovery and sale of non-core assets before buying. As we have said before, we wait until we can identify re-rating catalysts for a cheap stock before venturing in.

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