EVA Brief: JRPT (Jaya Real Property) Q2 2020

This one is another inner dialogue between a decision maker (PM) and an analyst (A) that is playing out in my brain as I consider whether JRPT could be included in my investment.

PM: JRPT. Another real estate developer. We have just analyzed PWON, and it is worrying. But let’s get with the facts first.

A: Well..JRPT has been consistently profitable economically. However, it has been deteriorating at a fast rate since 2018 (3-years avg EVA momentum is -5,7%), and with it, its share price. In 2017, JRPT share price was 900/share. Now, it is 430/share. Net income fails to see that connection, and worse, it could persuade you into thinking that it is severely undervalued.

I should tell you that its recent Q2 (LTM) ROIC is around 13%. Since I used cost of capital of 13%, EVA is still slightly positive. But we are better-off thinking JRPT business as break-even now.

PM: I see. So, its business has been declining since 2018. In a way, it is worse than PWON which just saw sudden contraction this year.

Could you point out what is the major reason for that decline?

A: I’ll try. The reason EVA has been declining has more to do with its profitability than its growth. But it is somewhat connected.

By profitability, I mean EVA margin (or you could also see it somewhat in ROIC). EVA margin fell off hard from 18,5% to just 1,5% now.

This is caused by declining gross margin and a rapid rise in investment that has been value destructive (as shown by more negative EVA).

I strongly believe that the root cause of this decline started when JRPT could no longer sell as much lands in 2018.

The rise in building units and condominium sales tells us that JRPT has decided to switch its focus on that segment to maintain its total revenue.

This switch of focus has led to a continued capital expansion.

This obviously becomes a problem when its revenue could not grow. JRPT revenue practically has been stagnant since 2016. The rise in its building units and condominium could only offset the decline in its land sales.

It has become too heavy with assets to become economically profitable.

To add, building units & condominium segment has a lower gross margin than selling lands.

What is clear now is the decision to expand in building units and condo is destroying EVA. Even without COVID-19, JRPT ability to maintain its economic profit is questionable.

PM: And now comes the pandemic. What has changed?

A: Condominium and rental sales have been hit hard. Condo sales is down 44% from last year. Income from rental is down by 33% from last year. Last year, rental segment contributes 15% to JRPT total revenue.

Obviously, since tenants have problems paying their rents, rental gross margin is down as well. We are seeing rental gross margin down 5%. Condo gross margin is yet to be affected.

PM: So, in short, there is a good chance for JRPT to become economically unprofitable this year.

A: Yes, and it will become harder for JRPT to be a wealth-neutral, especially if the management continues to expand in condo and building unit. It may be the case that this switch in focus is because the management sees that available land that could be sold is getting more limited.

PM: It’s funny how that turns out. We might think that building condo first is more profitable than selling empty lots.

A: It is what it is. That’s why you have to run the numbers.

PM: How bad do you think it will get?

A: It’s important to remember that rental and condo segments are the most impacted this year. Last year, condo contributes 16% to total sales, while rental contributes 15%. Combined, that’s almost 30%.

A rough estimate. Let’s assume that the combination of both segments got slashed by half. All else constant, total revenue would contract by 15%.

Gross margin is likely to be even lower than current Q2 LTM data. A further 1% reduction in gross margin is still a quite mild prediction, I think.

The end result is we could see a huge contraction by the end of this year. EVA momentum would be -10%. That exceeds contraction in 2018.

PM: How would that affect its stock price?

A: Based on above estimation, EVA would be IDR -102 Billion. If that were to be capitalized (divided by its cost of capital), we are seeing NPV of IDR -788 Billion or -57/share.

Current market cap at 430/share is IDR 5.912 Billion. If the market has not yet priced in that NPV, we could see its share price falls to 373/share.

PM: But JRPT has already reached 350/share recently. What is the market saying?

A: The market indeed, for the first time, is viewing JRPT as a wealth destroyer. The market assessment of NPV is IDR-157 Billion/share. Clearly not optimistic and worse than my estimation above.

Unless there is a good reason to expect further EVA deterioration next year, I’d say it’s undervalued right now.

PM: You know what. Looking from your price breakdown, I could see that JRPT value should be around 500/share if it has become a value-neutral, zero EVA company as it is now.

I agree with you that it is nearly impossible for JRPT to go back to its condition prior to 2018 when EVA margin was somewhere around 18%.

Heck, I don’t even believe that EVA margin could go back to 2019 level. Well, at least until new data proves me wrong. And that most likely requires JRPT to rejuvenate its land-selling business, if that is possible.

By looking at its current condition and examining the cause of its decline, I believe a value-neutral is the best outlook I could give to JRPT. In the short run, things could go south as you have analyzed which makes current share price seems fair. The biggest problem is, 500/share gives very little potential rewards even if I’m right.