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Cresud (CRESY:US)

Mkt Price:  USD 11.30

Mkt Cap:  USD 561.1 mio

Debt/Assets %:  12.7%

P/B:  0.35  (adjusted)

Fair Value:  USD 32.66

Upside Potential:  189%

Continuing from my previous Cresud post:  CRESY has a tough B/S to tackle. First, it’s denominated in Argentinean Peso (4.2620 ARS per USD), a fairly stable…but potentially very unstable currency, second, it wildly understates many assets which are carried at cost, and third, it consolidates listed entities (IRSA (IRSA:AR), and also BrasilAgro (AGRO3:BZ) going forward) in which Cresud has a controlling and/or majority stake. My approach to dealing with this is to construct a B/S and Fair Value on a ‘look-through’ basis. There are a number of components to work through:

Let’s start with i) Farmland: Cresud owns 474,124 hectares (2.47105 acres per hectare), and 132,000 ha under a long term concession. I assume a $2,500 per hectare (approx. $1,000 per acre) Fair Value on the owned farmland, and apply a 50% discount to the concession land. They also lease about 65 K ha from third parties, but I’ll ignore this despite the presumably positive net P&L impact. This valuation is well supported by general Argentinean land prices/trends and Cresud’s own recent history of farm purchases/sales. In fact, I’d stress that I believe this is a very conservative valuation, and I’d contemplate increasing it if Cresud actually reached my initial Fair Value target, which would probably imply a pretty strong momentum/following has developed in the stock at that point anyway. But let’s not get ahead of ourselves – not something we need to worry about at this point…! Of course, this valuation is wildly different, for example, than the current USD 12,900 per acre valuation in Ireland (despite the collapse in Irish asset values) that I highlighted in a previous post – this valuation differential/arbitrage opportunity is the obvious fundamental support for this investment thesis.  Therefore, the Farmland Fair Value amounts to USD 1,350.3 million.

Next we have ii) Market Value of IRSA & BrasilAgro:  Subsequent to the recent year-end, Cresud increased its stake in IRSA from 57.7% to 63.2%, so based on the current Mkt Cap of ARS 2,690.8 mio, the IRSA stake is worth USD 399.0 mio. The 35.75% BrasilAgro stake, based on a current Market Cap of BRL 531.1 mio (@ 1.7625 BRL per USD), is worth USD 107.7 mio.

Finally, we have iii) Debt:  I’m ignoring IRSA & BrasilAgro debt, as they’re held at the subsidiary level (from a Cresud perspective), and is implied anyway in the market valuations of these companies. I’m also ignoring all other Cresud assets and liabilities that I have not detailed here, as the net position is volatile, but note that the net is positive and basically represents Inventories. Taking a look at the most recent Cresud Parent Company B/S, Cresud Debt outstanding was ARS 746.5 mio plus a subsequent issuance of a USD 60 mio Note, giving us a total of USD 235.1 mio. This gives us a Debt/Assets Ratio of 13% (on a look-through basis) which gives us a great Margin of Safety, though this should be taken with a grain of salt as clearly these Assets are not liquid or realizable in the short run. Therefore, when evaluating the Margin of Safety, it’s very important to also check the day-to-day financials of the company and I’m pleased to see that Cresud has positive and improving net income and free cashflow (plus consistently increasing crop production). This consideration is important for all P/B bargain stocks, if you are faced with negative net income/cashflow situations you need to more aggressively discount your Fair Value to reflect this, and of course realize this creates a much higher hurdle to closing any perceived valuation gap.

Now we can step back and consider some of the more qualitative factors. The obvious one is the elephant in the room – pretty much all of Cresud’s assets are in Argentina. Yes, that concerns me, and limits my portfolio allocation. Argentina is booming, but seems to be ultimately heading for disaster again, nothing new there. Debt is not particularly the problem this time around, as the prior default rebased debt to a manageable level, but inflation is clearly understated in official statistics and threatening to get out of control, as is the case with some other key  government and country ratios. However, now that Cristina Fernandez de Kirchner is beginning a new term, we may finally see some improvement in the government’s fiscal and monetary discipline. The other shoe is the exchange rate – clearly the ARS is being supported by the central bank, but this puts them between a rock and a hard place – support of the peso drains reserves and ultimately chokes the economy/exports, while a more significant adjustment lower in the rate (to reflect true ARS purchasing power) would probably add further fuel to the fire of the current economic/inflation boom. Therefore, the macro environment is prospectively poor for our thesis – we risk currency depreciation and the ever present threat of government risk/intervention – but I think this is countered by the level of stock undervaluation and the ‘micro’ picture.

Looking on a micro basis, I am more encouraged. First, the value of Cresud is anchored in real assets, that are attractive locally and globally, and that have historically proven that they can act as a store of value in the face of inflation and/or in USD terms. Second, Cresud is rather amazingly 75 years old this year, and at the peak of its financial strength – yes, companies decline/disappear all the time, sometime overnight, but to exhibit this kind of longevity in a country like Argentina is surely a testament to the underlying strength and flexibility of the company and its management. Speaking of, I am also encouraged by the shareholder register – directors/management clearly eat their own cooking with a 38.5% stake owned by Eduardo Elsztain (Chairman) and Alejandro Elsztain (CEO, they are brothers) and a 2.2% stake held by the other directors/management (plus there is an 8.4% stake held by D.E. Shaw). Incidentally, the Elsztains had a very close and successful relationship with George Soros throughout the 1990s.

Summing up, we have a great agricultural investment thesis, we have a reassuring Margin of Safety with a Debt/Assets ratio of 13% and an (Adjusted) P/B Ratio of 0.35, we have a deeply invested Owner-Operator, and finally we can calculate a Fair Value (based on 49.656 mio ADS outstanding) of $32.66 per share giving us a Upside Potential of 189%. I’d prefer a larger stake, but feel somewhat limited by the macro environment as I described above – based on this, and recent price developments, I recently topped up my portfolio allocation on Cresud from 2.2% to 2.6%.

Btw I see that, after days of dithering, Papademos has finally been installed as the Greek Interim Prime Minister. I would observe that nobody with ‘Interim’ in their title has ever been able to exercise real power…and also question why this historic opportunity was squandered? If we all have to focus so painfully on this Greek crisis, couldn’t we focus on Eva Kaili as PM instead (No. 5, and why the hell is Cristina not on this list?!)?!