The Five Principles of Success: ‘Romance’, “Vision’, “Motivation’, ‘Curiosity’, ‘Obsession’ – MoatReport.com Monthly Riddle

Dear Friends,

Can You Guess This Asian Wide-Moat Company?

The Five Principles of Success: ‘Romance’, “Vision’, “Motivation’, ‘Curiosity’, ‘Obsession’

MUNGER: I think Warren and I can match anybody’s failures in retail.

BUFFETT: Yeah, we have a really bad record, starting in 1966. We bought what we thought was a second-rate department store in Baltimore at a third-rate price, but we found out very quickly that we bought a fourth-rate department store at a third-rate price. And we failed at it, and we failed… 

MUNGER: Quickly.

BUFFETT: Yeah, quickly. That’s true. We failed other times in retailing. Retailing is a tough, tough business, partly because your competitors are always attempting and very frequently successfully attempting to copy anything you do that’s working. And so the world keeps moving. It’s hard to establish a permanent moat that your competitor can’t cross. And you’ve seen the giants of retail…a lot of giants have been toppled.

MUNGER: Most of the giants of yesteryear are done. 

What is the investment Achilles heel of Warren Buffett and Charlie Munger?

It appears to be in the “tough, tough” retail industry, from the above CNBC interview in 2014, given that it is “hard to establish a permanent moat that your competitors can’t cross”. Also, their biggest error of omission, as Buffett admitted during Berkshire Hathaway 2004 AGM, had been his “thumb-sucking” reluctance in investing more in Wal-Mart in the 1990s because of one-eighth of a point uptick in the stock price. One of the best investment deals that Warren Buffett considered he has made was ironically in a retailer, a furniture store called Nebraska Furniture Mart (NFM). NFM was founded in 1937 by the late Rose Blumkin, fondly known as “Mrs. B”, a Russian immigrant to America, with $500 she had saved for 16 years selling used clothes. NFM was set up in Omaha with no locational or product advantage and goes up against rich, long-entrenched competition – and grew to become one of the top furniture retailers in the country. Buffett had also tried to assemble a furniture empire since with the purchase of Utah-based RC Wiley in May 1995, Star Furniture in Jun 1997, Jordan’s Furniture in Oct 1999, and rental furniture provider CORT Business Services Corporation in Jan 2000. But none came close to matching NFM’s success. In Jun 2004, Berkshire also invested 9% In home furnishing retailer Pier 1 Imports (NYSE: PIR), an investment that did not work out. In Aug 2007, according to Bloomberg news, Buffett even mentioned about the Swedish-controlled flat-packed furniture retail innovator IKEA as a possible investment target, though the trust foundation setup at IKEA made the acquisition impossible.

Make no mistake: NFM and IKEA are the rare exceptions. Furniture retailers face critical economic hurdles and problems in building a wide moat and scaling up the business. Furniture is a category of product that is difficult for a retailer to handle, because (1) inventory turnover rates are low for durable goods, thus few furniture retailers manufacture their own products because of low purchase frequency and distribution efficiency, (2) unlike consumer electronics, it is rare for a furniture manufacturer to have a well-known brand, and it is hard to alter product features notably over a short period, making it difficult to promote replacement demand, (3) furniture sales usually require direct customer contact and explanations in-store, as well as delivery, which adds to the SG&A cost burden. Those rare few innovators who can overcome these formidable business dynamics like IKEA will enjoy increasing returns to scale and the business gets easier as it gets bigger.

In this month of September/October, we investigate another IKEA-like innovator who is the undisputed dominant specialty chain in furniture and home furnishing in its domestic market with rarity value as the only listed Asian company with a unique integrated manufacturing-logistics-retail business model in the industry with an 90% self-developed private label product ratio to sell low- to mid-priced high-quality functional merchandise to the masses. Whereas most furniture retailers simply sell furniture, [Company’s name] has put effort into offering a complete lineup of “home fashion” products which contribute to 60% of its sales. “Home fashion” products are purchased frequently, and by devoting effort to the development of such products, [Company’s name] has achieved the kind of customer-drawing power that other specialty furniture retailers lack. [Company’s name] develops these products itself for over 80% of its offerings.

[Company’s name] has achieved an astounding 29 consecutive years of growth in sales and profit, converting macroeconomic adversities ranging from consumption tax hike to currency volatility into opportunities to grow further. Despite [Company’s name] market leadership, it is still operating in a fragmented domestic market with around 10% market share in the home and garden market and has a long runway ahead to extend its market leadership, particularly in the urban areas. [Company’s name] has expanded its market share in the low-end category, but it has also been releasing mid-priced products that offer additional value in terms of quality and function since 2012, and this has led to the expansion of its customer base. [Company’s name] currently has a network of domestic stores and 37 overseas stores and targets 1,000 stores by 2022, 3,000 stores by 2032. [Company’s name] was established in in 1967 by founder Mr N.

Furniture and home furnishing business has low inventory turnover and loading efficiency is poor. As a result, controlling procurement and distribution costs is critical to achieving low-cost operations and to coordinate store openings and expansion. [Company’s name] manages the whole process of product planning, materials procurement, production, distribution and sales in order to reduce its intermediary costs, which enables it to offer highly functional quality products at low prices. This source of [Company’s name] wide-moat competitive strength is very much under-appreciated until the value investor understands the business economics of the furniture and home furnishing business. [Company’s name] “returns” benefits gained from lower COGS (on raw material changes, design revisions, and improved production yields at overseas plants) to customers through lower pricing. This policy has generated a virtuous circle of sales expansion from increasing economies of scale, and high customer loyalty is captured.

Powered by its unique integrated manufacturing-logistics-retail business model that is perhaps rivalled by only the unlisted giant IKEA, [Company’s name] is able to enjoy a lasting wide-moat competitive advantage that grows stronger with time with the virtuous cycle of customer returns that generate one of the highest ROE at 23.3% and profit margin relative to all its industry peers. Notably, [Company’s name] present operating profit margin at 16.3% is the highest in the industry, which is a steady structural progress over the years from 6% in 2001 to 13% to 2009, and looks set to improve further with a higher sales mix of higher-margin mid-priced quality functional products that expand its customer base. [Company’s name] has a healthy balance sheet with a 13.3% net cash-to-equity ratio to generate an impressive ROE of 23.3% and it currently trades at EV/EBIT 16.3x. [Company’s name] suffered a short-term 23% correction in share price from its recent high in July due to overall market uncertainty and without any major negative firm-specific news. We believe that once its upcoming earnings are announced on Sep 27, 2016 delivering another record-high results, the share price will rebound strongly.

From Wal-Mart to IKEA, companies with a greater sense of Purpose and insurgency in making available to the masses once expensive products and services that used to be affordable by only the rich, the “10X price disruptors”, are powerful super-compounders delivering superior shareholders’ returns for a long period of time. Motivated by this grand purpose to bring true life affluence to customers following his learning trip to US in 1972, Mr. N resolved to cut the middlemen and dedicated his life mission to building a unique integrated manufacturing-logistics-retail business model to offer quality merchandise at low affordable prices. [Company’s name] grew from 2 stores into a nationwide chain with dominant market leadership. We are highly impressed by the unique business model that gets stronger and easier over time and [Company’s name] still has a long runway to grow its store network in the fragmented furniture and home furnishing market in both domestic and overseas markets. [Company’s name] has also developed a powerful human capital strategy which has been a powerful enabler in supporting store expansion to achieve growth in sales and profit for 30 consecutive years. We think this is very rare for an Asian company and [Company’s name] deserves a valuation premium for its staying power and genuine potential to be one of the rare Asian company to reach the $100bn market cap milestone.

Below are some excerpts with the CEO Mr. N on his entrepreneurial journey to scale up his business into a formidable world-class innovator:

Q: “Chairman, [Company’s name] has achieved phenomenal success since it was established in 1967 to command domestic market share leadership in furniture and home fashion & furnishings. Can you share with us how the wonderful story of [Company’s name] started, including your own journey, especially the tipping point and challenges along the way? What is your personal driving force?”

Mr N: “It all began 49 years ago. The year was 1967 when I opened a small furniture store. My tiny 1,000 square foot store served the local community. Then I married and opened another store of about maybe three times that size. We finally managed to earn a decent living with the stores’ sales. However, a year later, another company opened a store of five times that size which made us go almost bankrupt. These were busy days and uncertain times but I continued to look forward and search for ways to grow my new venture.

In 1972, I was then 27, one study tour organized by an industry association to the United States was all it took to change the course of my struggling furniture store. During a week in California, I witnessed how differently Americans shopped and lived. Obviously, that I was deeply shocked. I was truly astonished, moved and struck. In the US there was no stand-alone furniture. Everything was built on the building, like walk-in closets. Compared to our country’s crowded living spaces, California homes were spacious with separate areas for entertaining and dining where guests would be welcomed, and the further back there would be a family-room. American consumers went to convenient retail stores to buy color-coordinated furniture and accessories to enhance their beautiful homes. In contrast, we had only mismatched offerings to choose from. They even had one bathroom on each floor! Most shocking to me was how inexpensive the high-quality merchandise in the US was compared to similar products back home. American furniture was designed to make life easier for consumers, not simply to pad manufacturers’ bottom lines. I recalled that I was so astonished by the difference in furniture and interior decor products in terms of price, selection, and quality.

It was like a dream world, I was so excited I could barely get any sleep. I wanted to bring the affluence of the US to my country. It was at this moment that I decided to bring back to my country what I had learned in the US. At first, I was pursuing my own sales and profit. Then I realized I was wrong. Ever since I visited the US, I changed my life philosophy, setting up an aim to enrich everyday life of people. I made my mind to develop and provide affordable and full-featured products for people. Furniture had occupied an important position in the lifestyle of the people. I would use my company to help people live as prosperously and comfortably as Americans. That wish and determination have never switched since [Company’s name] was founded, and remains there during every moment of its development. Setting and realizing this goal is our greatest pleasure.

Tracing back to the time when we advanced nationwide, we heard customers that they were surprised to see the numerous choices and the low prices in [Company’s name]. We can’t help but imagine the house we like and the room we desire, after what we saw in [Company’s name]. Not to mention it is the first time that we realize our imagination may come true. Every time we hear this, we are reminded once again, that our unremitting efforts have come to a result. We promise to keep an ear out for our customers as always, to step onto the arena of the whole world, to realize our dream deep inside, and to achieve so, we will do our utmost. We continue to chant the strong and simple words ‘to enrich the people’s life’ and to spread a dream to the customers, build a fire of motivation in the employees, stakeholders and business partners.

My personal driving force has been this ‘romance’ and purpose to help people around the world achieve the richness of living in the true sense by providing products with the appropriate quality and functionality for the customers at affordable price. Pursuing higher goals over a long period of time is critical because otherwise improvement will be superficial.

Looking back and our scale of our company is like a dream. [Company’s name] has been able to create value and grow successfully with tenacity and staying power because there was ‘romance’ and a long-term vision. That’s right, I have repeatedly told employees that to work at [Company’s name], it is important to have this five principles of success: ‘Romance’, “Vision’, “Motivation’, ‘Curiosity’, ‘Obsession’. ‘Romance’ is a feeling in one to contribute for the people and for the sake of the world over one’s life. Without such a Purpose, life is nothing. Humans were originally born for the people, for the sake of the world. Life is aspiring to become a person useful to the world. This is an ideal to get right from young, and even when one is 50 years old, 60 years old.”

Who is Mr. N and this Asian wide-moat innovator?

Warm regards,

KB

Chief Investment Officer

Hidden Champions Fund

The Moat Report Asia

www.moatreport.com

A new monthly issue of The Moat Report Asia is now available!

Access the in-depth idea presentation:

http://www.moatreport.com/members/

PS: Below is the link from our Annual Report (Year End March) to our Year End Letter:

http://www.8iholdings.com/media/ref_investmentupdate2016.pdf

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Quick updates on our invested portfolio performance since September 2015 as at 23 Sept 2016:

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Disclaimer: This article is for discussion purposes only and does not constitute an offer, recommendation or solicitation to buy or sell any investments, securities, futures or options.

“Bamboo Innovators bend, not break, even in the most terrifying storm that would snap the mighty resisting oak tree. It survives, therefore it conquers.”
BAMBOO LETTER UPDATE | Sep 26, 2016
Bamboo Innovator Insight (Issue 128)

  • The weekly insight is a teaser into the opportunities – and pitfalls! – in the Asian capital jungles.
  • Get The Moat Report Asia – a monthly in-depth presentation report of around 30-40 pages covering the business model of the company, why it has a wide moat and why the moat may continue to widen, a special section on “Inside the Leader’s Mind” to understand their thinking process in building up the business, the context – why now (certain corporate or industry events or groundbreaking news), valuations (why it can compound 2-3x in the next 5 years), potential risks and how it is part of the systematic process in the Bamboo Innovator Index of 200+ companies out of 15,000+ in the Asia ex-Japan universe.
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Asia’s #1 Solution Specialist in Parking Systems and Prefabricated Building – MoatReport.com Monthly Riddle

Dear Friends,

Can You Guess This Asian Wide-Moat Company?

Asia’s #1 Solution Specialist in Parking Systems and Prefabricated Building

ParkingIs it possible that a three-car parking lot area can be transformed into a 36-car parking space to effectively utilise urban space and efficiently manage costs and maintenance requirements for both landowners and operators?

In this month of August, we investigate the innovator who makes this possible as Asia’s leading comprehensive manufacturer and solution specialist in automated parking systems and prefabricated building, making urban space more valuable and solving growing persistent urban parking congestion woes. [Company’s name] has rarity value as the only company in its country to do systemized construction by using H-type lightweight steel frame for structures of 10-40m, in frontage and 1,000m2 or less in gross floor space, and it is one of the few listed manufacturers with its own production plants in building materials and fabricated components which the company has established over the years to become a network of factories to supply its products nationwide. Thus, the company enjoys a lower cost structure by business model design and choice given that H-type lightweight steel frames, having less volume than frames used in the past, are readily adopted for systemized construction, resulting in reduction of costs.

[Company’s name] is the unknown hidden champion essential to the lower-capex expansion and successful growth story of the well-known convenience store FamilyMart and so on. [Company’s name] wide-moat competitive strength lies in having its own integrated manufacturing and design capability, technological capabilities, solution-providing ability, and nationwide network of factories, which are highly evaluated by its loyal clients who provide recurring income to the company as they expand. By utilizing knowhow in systemized construction, [Company’s name] has been able to expand its multi-level parking structure business and the company has established a formidable position in this specialized niche segment of the market with a #1 position.

Established in 1961 by founder Mr. M to produce prefabricated garage to keep cars protected from elements of weather, [Company’s name] grew successfully by taking up greater roles such as parking, and operational management, achieving the highest share in the domestic market in terms of installation record by 1999 and has since extended its dominant market leadership. Led by second generation leader who took over as CEO in 1998, [Company’s name] has undertaken organizational reform and has been aggressive in (1) executing M&A strategy, including a transformative acquisition of the business unit of a local MNC in March 2016 at book value, (2) executing alliance strategy, (3) growing higher-margin “stock-based” (as opposed to flow-based) recurring income business, and (4) expanding overseas in China and ASEAN markets (including customer wins in Singapore, Malaysia, Thailand and Vietnam), (5) enhancing its marketing and sales force.

This world-class hidden champion solving real-world problems in parking and urban space management generates profits with a 20.6% ROE and efficient cash conversion cycle of 52 days, yet trades at a reasonable valuation of EV/Sales 0.83x, EV/EBIT 10.8x and EV/EBITDA 9.2x with a decent 3.2% dividend yield.

Below are some excerpts with the CEO Mr. M on his entrepreneurial journey to scale up the family business into a formidable world-class innovator:

Q: “[Company’s name] has achieved phenomenal success since it was established in 1961 by founder Mr. M to command domestic market share leadership in automated parking systems and prefabricated buildings. Can you share with us how the wonderful story of [Company’s name] started, including your own journey from joining the family business, especially the tipping point and challenges along the way?”

Mr. M: “Since our establishment in 1961, we have always aimed at being the one and only company in the prefabricated houses and parking systems business that provides comprehensive support from design, development, manufacturing, construction to after-sales services. We have always provided superb quality products and sincere services. By 1999, we obtained the highest share in the domestic market regarding the accumulated total of installation record and our company holds an overwhelming proportion of sales for parking structures with ramps.

Trusted by customers, we have a history of providing original parking structures and prefabricated building products for various settings. At the time when tower-type parking structures were regarded most commonly as vertical circulating structures, based on our unique technology, we developed parking structures with vehicle lift technology which is now regarded as a standard in tower-type parking structures. We are also the only company in the country that produces turntables featuring forward loading and unloading capabilities for car parks, and its facilities can service electric cars. Think about this for a moment: From a three-car parking lot, [Company’s name] is able to transform the area into a 36-car parking space and efficiently manage costs and maintenance requirements. As a parking system manufacturer, we execute the maintenance and emergency response for parking systems with a nation-wide network system. In addition, we apply the results from such activities to product development and refinement for quality improvement.

I was 36 years old when I first became the president in 1998. It was a tough time. We had recorded a loss for the fifth consecutive year. We had unprofitable businesses and loans due. I did a drastic reform of management, restructuring the unprofitable businesses and subsidiaries, build the identity and competitive advantage of the company, strengthen our core competencies. In order to carry out the reform, I consider the ‘awareness’ of each and every employee as the most important factor of success. Hence, I promote the reform of the culture, management philosophy.

Looking back, it was a study in grit and life in many ways. With the experience, we continue to think of this question, ‘How can we disperse risk in doing business.’ Profitable business without giving peace of mind is still not good enough. We emphasize the importance of the underlying business foundation. And I’m not going to expand the business far away from its core business competencies. We will dig deep into the architectural-peripheral businesses that are consistent with our core competencies and strengths.”

Q: “Can you share more about your business model and strategy to build stable recurring income?”

Mr. M: “Prefabricated building itself has a large and long wave of demand. We also get consistent orders for logistics facilities, convenience and retail store chain expansion, such as from some of our loyal customers FamilyMart and Tully’s Coffee, hospitals and welfare facilities. Parking convenience and safety issues are steadily rising in Asia as emerging economies charge to business and infrastructure development. Providing valuable space and efficiency with its automated parking systems and prefabricated houses, [Company’s name] is creating next-generation space management solutions that add value to residential, commercial and production sites. We also reach out to government people and architects, offering our know-how in solving parking problems. With the high cost of land, our towers and parking solutions can save a lot of floor space and improve the safety of parking lots.

While prefabricated building has a large and long wave of demand, as a strategy to build a stable recurring income, we are expanding the one-stop-solution ‘stock business’, as opposed to the ‘flow business’, and parking structure business overseas. The stock business includes maintenance of parking structures, operation and management of car and/or bicycle parking, management, of business facilities, and management and maintenance of commercial facilities.

We also operate businesses in China, Thailand and Singapore. In China, we focus on operation and management of parking facilities of theme parks and hospitals and over 18,000 parking lots are managed by the maintenance subsidiary, including operating a two-storey parking system for the Fudan University Shanghai Cancer Center. Our joint venture experience in Shanghai allowed us to focus more on operating parking spaces, aside from selling the systems. In Singapore, we develop the parking structure construction business by capturing the projects by Singapore’s Housing & Development Board and to promote the development of the Malaysian and ASEAN market.

Growth can be expected, judging from the potential of our accumulated know-how in parking structures in urban areas which suffer from a perpetual shortage of parking spaces. This business has a higher gross margin at 30-40% than other businesses. Expansion of the ‘stock business’ will make the company’s profit structure more resilient and will better cover fixed costs. We have our in-house maintenance department. Almost every month, the ‘stock business’ obtain income that is earned prudently, as compared to one-time sales transaction, and can cover the selling, general and administrative expenses so that we can better understand our operating leverage from our sales revenue, how much can sales revenue stretch to earn profits. The ‘stock business’ is steadily gaining shape as a hard foundation to overcome changes in temporary demand and work has become more and more fun.”

Q: “What is the corporate culture and values like at [Company’s name]?”

Mr. M: “With the rapid changes in the social environment and customer preferences in the recent years, there is a demand for significant changes in corporate values. There is a need to rebuild our company’s uniqueness and predominance by enhancing core competencies, and to build a system that brings out the best of the abilities of both individual employees and the organization at large.

When I came in, I reorganised our unprofitable businesses. To accelerate our reform, I’ve informed my employees that they are most important to us and I took time to explain our corporate culture, management philosophy so that it can be infiltrated and practiced. It is also important to have a strong relationship of trust between our partners. Each of them represents the consciousness of [Company’s name]. We operate under a detail-oriented sales system that enables instant response to the needs of local customers. Every employee is conscious of the environment and gives the highest priority on proposing solutions that are beneficial both to the society and customers.”

With our new company theme Space is Value, we will continue to introduce innovative products and proposals that will satisfy our customers not only at the time but long into the future as well. [Company’s name] will dedicate every effort to developing our company in order to meet today’s demands for a socially valuable enterprise. We have built a cordial relationship of trust with our customers, shareholders, investors, our business partners, our employees. Regardless whether they are internal and external, we cherish the point of contact with all stakeholders, to enhance communication with all. The behavior of each and every employee is the original of the consciousness that is itself [Company’s name], and we will carefully consider the moment in contact with everyone, keeping in mind a sincere and responsible behavior. We want to continue to grow as a company that is trusted by you as had been since our establishment in 1961.”

Who is Mr. M and this Asian wide-moat innovator and Hidden Champion?

Warm regards,

KB

Chief Investment Officer

Hidden Champions Fund

The Moat Report Asia

www.moatreport.com

宁静致远

A new monthly issue of The Moat Report Asia is now available!

Access the in-depth idea presentation:

http://www.moatreport.com/members/

PS: Below is the link from our Annual Report (Year End March) to our Year End Letter:

http://www.8iholdings.com/media/ref_investmentupdate2016.pdf

Image 002

Quick updates on our invested portfolio performance since September 2015 as at 29 July 2016:

Cost (S$M) Market Value (S$M) Returns (S$M)
S$19.91m S$22.74m S$2.84m
Closed positions (S$0.07m)
Net returns S$2.76m

 

Country Portfolio Weight Gains/(Losses) (S$M) Returns (S$M)
Japan 45.6% S$1.1m 5.6%
Australia 36.9% S$0.98m 4.9%
India 6.9% S$0.62m 3.1%
Greater China & Taiwan 10.7% S$0.12m 0.6%
Closed positions (S$0.07m) (0.4%)
Total S$2.76m 13.9%

 

Sector Portfolio Weight Gains/(Losses) (S$M) Returns (S$M)
Consumer Healthcare & Consumables 31.8% S$0.99m 5.6%
Transport, Travel & Hospitality 36.9% S$0.98m 4.9%
Non-Banking Financial Companies (NBFCs) 6.2% S$0.63m 3.1%
Specialty Retailers 16.9% S$0.35m 0.6%
Business Services & Products 0.3% S$0.00m 0.0%
Tech & Media 8.1% (S$0.10m) (0.5%)
Closed positions (S$0.07m) (0.4%)
Total S$2.76m 13.9%

Outperformance in fragile, turbulent markets: Our invested portfolio generated positive absolute returns of +9% (excluding cash), or a S$2.76m investment gain, since Sept 2015 till 29 July 2016, outperforming Asian market indexes which decline over the same period.

  • High-conviction investment strategy with transparency: Out of our current 21 portfolio stocks, we have 15 winners (+15.4%) and 6 losers (-1.5%). Out of our 15 winners, we are Top 20 Shareholder for 6 companies.
  • Low volatility, high resilience portfolio: Our portfolio turnover ratio is low at around 20% and we do not engage in market-timing by darting in and out of the markets on a short-term trading basis. Our portfolio standard deviation is below 10%, significantly lower than the MSCI Asia market index standard deviation of over 22%.
  • Portfolio stocks continue to achieve resilient structural growth in quality earnings with robust return on equity: Our portfolio stock characteristics have a weighted return on equity (ROE) of 21.9% and weighted revenue have been growing by 9% over the recent three years, generating increasing returns to scale with a 28.2% growth in operating profit due to the scalability of the business model forged by an indestructible intangible knowhow accumulated over the years to create value for their target customer base and compound growth with resilience in a difficult business environment.
“Bamboo Innovators bend, not break, even in the most terrifying storm that would snap the mighty resisting oak tree. It survives, therefore it conquers.”
BAMBOO LETTER UPDATE | Aug 1, 2016
Bamboo Innovator Insight (Issue 127)

  • The weekly insight is a teaser into the opportunities – and pitfalls! – in the Asian capital jungles.
  • Get The Moat Report Asia – a monthly in-depth presentation report of around 30-40 pages covering the business model of the company, why it has a wide moat and why the moat may continue to widen, a special section on “Inside the Leader’s Mind” to understand their thinking process in building up the business, the context – why now (certain corporate or industry events or groundbreaking news), valuations (why it can compound 2-3x in the next 5 years), potential risks and how it is part of the systematic process in the Bamboo Innovator Index of 200+ companies out of 15,000+ in the Asia ex-Japan universe.
  • Our paid Members from North America, Europe, the Oceania and Asia include professional value investors with over $20 billion in asset under management in equities, some of the world’s biggest secretive global hedge fund giants, and savvy private individual investors who are lifelong learners in the art of value investing.

Hidden Champions Fund Year End Letter

Hidden Champions Fund Year End Letter

Dear Friends,

The Hidden Champion Fund in listed Asian equities generated positive absolute returns of +15.4% or a S$2.7m investment gain (in SGD terms as at 1 July 2016) since September 2015, outperforming Asian market indexes which decline over the same period. Some salient points on the Hidden Champions Fund performance since our financial year end March 2016:

1) Outperformance during fragile and turbulent market conditions:

  • The Fund generated positive absolute returns of +15.4% or a S$2.7m investment gain (in SGD terms as at 1 July 2016) since September 2015, outperforming Asian market indexes which decline over the same period.
  • This outperformance is powered by a double-digit gain from our high-conviction top position which comprised around one-third of our portfolio NAV. We are also a Top 15 Shareholder in this world-class wide-moat company with dominant market leadership as the largest provider of nation-wide tourism and transportation services generating record profitability with a visible long runway ahead to compound growth with resilience.

2) Low volatility, high resilience portfolio:

  • Our portfolio turnover ratio is low at around 20% and we do not engage in market-timing by darting in and out of the markets on a short-term trading basis.
  • Our portfolio standard deviation is around 10%, significantly lower than the MSCI Asia market index standard deviation of over 22%.

3) High-conviction investment strategy with transparency:

  • We adopt a high-conviction concentrated investing approach with a targeted 20 to 25 stocks. We currently have 18 Hidden Champions in our portfolio who command market leadership in their business field.
  • We aim to be a Top 20 Shareholder disclosed in the Annual Report of the companies we invest in as a demonstration of our conviction and transparency in the investment process. We are a Top 20 Shareholder in 6 of our portfolio stocks.
  • We make the conscious decision to not invest in and avoid stocks in cyclical industries, including commodities & energy, property & construction, and banks.

4) Portfolio stocks continue to achieve resilient structural growth in quality earnings with robust return on equity:

  • As macroeconomic conditions and prospects continue to deteriorate, our portfolio stocks continue to achieve resilient structural growth in quality earnings as a result of their continuous launch of new product innovations and gaining of market share as focused quiet long-term industry consolidators.
  • Our portfolio stock characteristics have a weighted return on equity (ROE) of 21.9% and weighted revenue have been growing by 9% over the recent three years, generating increasing returns to scale with a 28.2% growth in operating profit due to the scalability of the business model forged by an indestructible intangible knowhow accumulated over the years to create value for their target customer base and compound value in difficult business environment.

FHAThe outperformance of the Fund is possible because of our multi-manager team-based investment process implemented since September 2015, led by our analyst team comprising of Kelvin Seetoh, Jackson Yeow, Sim Zhipeng and Joshua Zhang. We are pleased to welcome the addition of a new member to our investment analyst team, Ms Joyce Pang, who joins us on 9 May 2016.

Our approach to value investing in increasingly turbulent and fragile markets is to invest in the Hidden Champions, agile creatures darting between the legs of multinational monsters who are dominant global players in sophisticated, hard-to-imitate niche products and valuable critical niches that are largely invisible to the average consumer, yet are indispensable to our daily lives. The Hidden Champions create maximum benefits for a target customer group, solving their most burning problems better than any competitor. This innovation strategy requires a deep knowledge of customer needs, which is generated through direct customer contact. Successfully solving this customer problem would then create a “success spiral”. A key source of their wide-moat is their sustained commitment and even obsession to customer needs, which is only possible in our view when there is a Purpose and values system guiding the firm.

The Hidden Champions had their roots as the esprit de corps of Germany’s Mighty Mittelstand, the more than 3.5 million small and midsize family enterprises that form the backbone of Germany’s resilient export-driven economy, employing more than 78% of workers and contributing more than half of the country’s GDP. The Mittelstand traces its roots to the Middle Ages, when the country that is now Germany was divided into hundreds of states. Competition between them created a number of industrial regions with their own educational institutions, banks and political administrations. The Mittelstand had to export early on with a global-orientation in their business model, given that some German states were smaller than two football fields.

Well-known Mittelstand enterprises that became well-known giants include BMW, Audi, SAP AG, Adidas, Hugo Boss, Robert Bosch, Siemens, consumer giants Beiersdorf and Henkel, dialysis giant Fresenius, pharmaceuticals giant Bayer, chemicals giant BASF, industrial gas specialist Linde AG, truck and engine maker MAN SE, and so on. There are also lesser-known, quiet, resilient, successful compounders, including commercial kitchen equipment company Rational AG, door technology systems specialist Dorma+Kaba, sanitary systems specialist Geberit, eyewear specialist Fielmann, specialty chemicals specialists Brenntag and Lanxess, high-end cleaning equipment Kärcher, Würth group (the “Fastenal of Europe”), auto gasket maker Elringklinger, flavor and fragrance specialist Symrise, lab solution specialist Sartorius, medical vision technology specialist Carl Zeiss Meditec, packaging and bottling machine maker Krones, wound medical product specialist Paul Hartmann, and so on.

From a value investing perspective, investing at an earlier stage in the long-term growth trajectory path of these Hidden Champions – in Asia – will prove rewarding

To read more, below is the link from our Annual Report to our full Investment Update:

http://www.8iholdings.com/media/ref_investmentupdate2016.pdf

Image 002

Warm regards,

KB

Chief Investment Officer

Hidden Champions Fund

The Moat Report Asia

www.moatreport.com

宁静致远

A new monthly issue of The Moat Report Asia is now available!

Access the in-depth idea presentation:

http://www.moatreport.com/members/

PS: We will be working on the Monthly Report in the upcoming weeks ahead and we will replace the weekly articles with some occasional write-ups.

In the month of May/Jun 2016, we investigate an Asian Hidden Champion whom we believe strongly is “Asia’s next Muji” as the pioneer in creating an innovative retail management platform leveraging upon the commercial value of its specialty stores to attract customer flow and monetize the flow through retail management. This Hidden Champion commands a strong brand equity with a huge loyal customer flow in which over 180m visitors visited their stores annually, out of which 15m+ are foreign tourists. Their specialty stores have become major tourist attractions and cultural icons for visitors with strong brand recognition. Similar to Muji, this wide-moat innovator is able to thrive despite the disruption of ecommerce. Notably, since FY2012 to TTM Mar 2016, its sales, EBIT and EBITDA have grown 34.5%, 143.3% and 77.2% respectively, one of the rare few Asian departmental/specialty retail operators to be able to generate double-digit growth and with a visible long runway.

[Company’s name] operates an asset-light concessionaire sales model and its core competency is its deep know-how in conceptualizing, planning, designing and managing the store and retail spaces and earns fixed based rent and percentage of sales to participate in its tenants’ growth. [Company’s name] generally does not own properties but rents from landlords and sublets retail space/booths to selected chosen smaller vendors who are creative brand owners, enabling them to scale up the selling of their artisan products to the targeted customers. [Company’s name] strong brand value in attracting customer flow translates to strong bargaining power in rental contract terms (typically 15-20 years) and is a key tenant to attract long-term retail partners (eg Starbucks, 7-Eleven, McDonald’s) in the retail space managed by the company. As a result, [Company’s name] has one of the highest asset turnover (sales/total assets) at 90%, far higher compared to the 20-40% for well-managed Asian departmental rivals including Philippines’ SM Investment, Thailand’s Central Pattana due to its asset-light business model. MUJI’s asset turnover is probably the highest in Asia at 153%.

[Company’s name] sales have increased 17% in the past 3-4 years since FY13 and EBIT and operating cashflow growth is faster at 51% and 105% respectively due to a rising network effect and execution success in overseas expansion and growth in membership to over 1m. Total floor space of over 280,000 sqm is up 36% from 2011 and expected to increase another 45% by 2020, setting the strong foundation to at least double profits in the next 5 years.

[Company’s name] has a visible long run way to reinvest its profits back into the core business to extend its market leadership and widen the moat to provide long-term downside protection in terminal value. [Company’s name] has a healthy balance sheet with net cash that has increased 39% from FY13, 53.3% of book equity (11% of market cap) which, coupled with its decent 4.08% dividend yield, could provide some short-term downside protection. This Hidden Champion has a ROE of 24.7% and trades at EV/Sales 1.87x, EV/EBIT 17.8x, EV/EBITDA 11.6x while MUJI trades at EV/Sales 2.43x, EV/EBIT 21.7x, EV/EBITDA 17.7x, a 22-52% premium over [Company’s name]. We think that [Company’s name] deserves to trade at a higher premium once there is greater investor awareness when they continue to deliver quality earnings growth with higher ROE which has increased from 19.5% in FY13 to 24.7% in the latest TTM Mar 2016 and is expected to climb higher from its underappreciated expansion plan.

“Bamboo Innovators bend, not break, even in the most terrifying storm that would snap the mighty resisting oak tree. It survives, therefore it conquers.”
BAMBOO LETTER UPDATE | Jun 14, 2016
Bamboo Innovator Insight (Issue 125)

  • The weekly insight is a teaser into the opportunities – and pitfalls! – in the Asian capital jungles.
  • Get The Moat Report Asia – a monthly in-depth presentation report of around 30-40 pages covering the business model of the company, why it has a wide moat and why the moat may continue to widen, a special section on “Inside the Leader’s Mind” to understand their thinking process in building up the business, the context – why now (certain corporate or industry events or groundbreaking news), valuations (why it can compound 2-3x in the next 5 years), potential risks and how it is part of the systematic process in the Bamboo Innovator Index of 200+ companies out of 15,000+ in the Asia ex-Japan universe.
  • Our paid Members from North America, Europe, the Oceania and Asia include professional value investors with over $20 billion in asset under management in equities, some of the world’s biggest secretive global hedge fund giants, and savvy private individual investors who are lifelong learners in the art of value investing.

Asia’s next MUJI: “A place where you are able to allow the heart to seek solace, to explore your mission in life.” – Bamboo Innovator Monthly Riddle

Asia’s next MUJI: “A place where you are able to allow the heart to seek solace, to explore your mission in life.”

Can You Guess This Asian Wide-Moat Company?

Dear Friends,

Can Hidden Champions co-exist and even thrive to compound value together with mighty giants?

Consider Amazon which had compounded into a $336-billion-market-cap ecommerce juggernaut, with a market value exceeding that of Singapore’s $300-billion GDP. It has been estimated that of every additional $1 Americans spent for items online, Amazon captured 51 cents. Since Amazon Prime was launched in 2007, the annual membership program had grown to 5 million members in 2011, scaling up to over 54 million members in 2015 with average member estimated to spend over $1,100 annually. Notably, Amazon was up 300% since the end of 2011, outperforming the 63% rise for the S&P 500 index and 18% gain for Wal-Mart over the same period.

As Amazon obliterates the conventional physical retailers, there is an Asian Hidden Champion that compounded 600% over the same period to a market cap of $6.7bn. This Hidden Champion is Ryohin Keikaku (7453 JP), owner of MUJI. MUJI stands for Mujirushi Ryohin (無印良品), which translates to “No Brand Quality Goods” and “All Value No Frills”. None of MUJI’s 7,500 “minimalist” products, including household products, apparel and food products have a logo or are wrapped in fancy, distinctive packaging. Plain but not generic, MUJI’s products have a simple aesthetic that appeals to certain customers. In fact, it is the lack of a name brand that many find enticing. With more than 700 stores worldwide (284 directly-managed and 117 licensed stores in Japan), including 301 stores overseas (130 in China), the Japanese specialty retailer has a cult-like following. We had written earlier about the story of MUJI in “Brand It Like Buffett in Asian Wide-Moat Consumer-Brand Innovators” and how MUJI illustrates that wide-moat innovators can co-exist to compound value alongside the powerful giant.

In this month of June/July, we investigate another Asian Hidden Champion whom we believe strongly is “Asia’s next Muji” as the pioneer in creating an innovative retail management platform leveraging upon the commercial value of its specialty stores to attract customer flow and monetize the flow through retail management. This Hidden Champion commands a strong brand equity with a huge loyal customer flow in which over 180m visitors visited their stores annually, out of which 15m+ are foreign tourists. Their specialty stores have become major tourist attractions and cultural icons for visitors with strong brand recognition. Similar to Muji, this wide-moat innovator is able to thrive despite the disruption of ecommerce. Notably, since FY2012 to TTM Mar 2016, its sales, EBIT and EBITDA have grown 34.5%, 143.3% and 77.2% respectively, one of the rare few Asian departmental/ specialty retail operators to be able to generate double-digit growth and with a visible long runway.

[Company’s name] operates an asset-light concessionaire sales model and its core competency is its deep know-how in conceptualizing, planning, designing and managing the store and retail spaces and earns fixed based rent and percentage of sales to participate in its tenants’ growth. [Company’s name] generally does not own properties but rents from landlords and sublets retail space/booths to selected chosen smaller vendors who are creative brand owners, enabling them to scale up the selling of their artisan products to the targeted customers. [Company’s name] strong brand value in attracting customer flow translates to strong bargaining power in rental contract terms (typically 15-20 years) and is a key tenant to attract long-term retail partners (eg Starbucks, 7-Eleven, McDonald’s) in the retail space managed by the company. As a result, [Company’s name] has one of the highest asset turnover (sales/total assets) at 90%, far higher compared to the 20-40% for well-managed Asian departmental rivals including Philippines’ SM Investment, Thailand’s Central Pattana due to its asset-light business model. MUJI’s asset turnover is probably the highest in Asia at 153%.

Thus, in evaluating the investment merits of specialty/departmental retail operators in an online ecommerce era which is disrupting conventional physical retailers, we first examine whether the business has demonstrated resilient double-digit growth in sales and EBIT from FY2012, and generated strong recurring cashflow from healthy cash conversion cycle and balance sheet. Next, we looked into its asset turnover, cash conversion cycle and debt leverage to assess whether the business has the ability to expand and scale up without onerous use of capital and with a healthy net-cash position.

[Company’s name] sales have increased 17% in the past 3-4 years since FY13 and EBIT and operating cashflow growth is faster at 51% and 105% respectively due to a rising network effect and execution success in overseas expansion and growth in membership to over 1m. Total floor space of over 280,000 sqm is up 36% from 2011 and expected to increase another 45% by 2020, setting the strong foundation to at least double profits in the next 5 years.

[Company’s name] has a visible long run way to reinvest its profits back into the core business to extend its market leadership and widen the moat to provide long-term downside protection in terminal value. [Company’s name] has a healthy balance sheet with net cash that has increased 39% from FY13, 53.3% of book equity (11% of market cap) which, coupled with its decent 4.08% dividend yield, could provide some short-term downside protection. This Hidden Champion has a ROE of 24.7% and trades at EV/Sales 1.87x, EV/EBIT 17.8x, EV/EBITDA 11.6x while MUJI trades at EV/Sales 2.43x, EV/EBIT 21.7x, EV/EBITDA 17.7x, a 22-52% premium over [Company’s name]. We think that [Company’s name] deserves to trade at a higher premium once there is greater investor awareness when they continue to deliver quality earnings growth with higher ROE which has increased from 19.5% in FY13 to 24.7% in the latest TTM Mar 2016 and is expected to climb higher from its underappreciated expansion plan.

Importantly, the burning sense of mission forged by the founder Mr W and now succeeded by the second-generation leader is visible as the moving thrust for the [Company’s name] employees and business partners who entered into an interaction with the customer with a sense of purpose and demonstrating care in serving the customers, forming the intangible culture of excellence. We believe this is rare in Asian firms and deserves a valuation premium.

As Mr W elucidated:

[Company’s name] uses the creative combination of ‘human, space, activity’ to engineer and engender a unique cultural ambience and atmosphere… We understood that our core expertise is our retail management know-how which we have accumulated over the years. We are aware that the world’s retail industry underwent different phases of development. The first stage is to buy things, to shop. The second stage is to have a retail experience. [Company’s name] instead enters into the third stage, not only about shopping and retail experience, but also about co-involving and co-engaging with our customers to participate in our activities, whether they are art exhibition, dynamic dance performance, culinary workshops, lectures or even a space where people can hear your views. People crave the human interactions that can happen at [Company’s name], something that might be absent in office environments. [Company’s name] is an intellectual sanctuary. They also might be seeking an escape from family squabbles at home, or even looking for love.”

The entrepreneurial story of Mr W is also inspiring and uplifting and below are some excerpts:

Q: “What is your motivation, drive and confidence behind your long-time dedication in building [Company’s name] despite the risks and losses?”

Mr W: “Confidence comes from determination and a strong belief in one’s original purpose and intent. I have spent my longest period away from work in the ICU (Intensive Care Unit). I have always held a heart filled with gratitude to face illness. The pain from the sickness forced me to face my inner worth and purpose. Actually, life is lonely. Sickness brought me a new understanding of life. A work colleague sent me a card that says, ‘Mr W, God wants to give you a special medicine, that’s why you fell sick.’

When I am feeling depressed during my sickness, I will ask, ‘Why me?’ Actually, we should not only ask, ‘Why me?’ which would lead to feelings of indignation, unwillingness, and the soul will be in a negative state, but rather we should think deeper, ‘Why not not me?’. Nobody has the right to declare that poverty should not belong to me, pain and sickness should not be borne by me. The sickness is my mentor who gave me an important lesson to see myself. Rather than say [Company’s name] is a business, it is more a life journey – to explore, to learn and to understand life. The second time I saw myself was when [Company’s name] incurred 15 years of losses; I saw my own earnest attitude towards my life, how I persisted despite the odds.

I believe money and power come and go, but to be able to serve others is meaningful and of value in life and of the proper nature. [Company’s name] had walked into the everyday life of people, enabling anyone to be able to extend their hand to reach out to a beautiful lifestyle experience.

The value of an enterprise is more than its bottom line because there are many people who know how to turn a buck, what matters is an enterprise’s positive impact on customers and the industry. We are in the service industry so we have to think about whether we can first benefit others, benefit the public, benefit the industry, and only then can this enterprise survive in the society and it will be in its proper place.

 Till now, I do not think I am the boss; I am just working for the society, it’s just that everyone’s role is different. Everyone understands that we have to die eventually and we cannot carry anything in our death. Hence, what we can create, what we can leave behind for society, is the most important starting point to keep caring.

Any business has risks, what I want to do is to offer society some positive momentum regardless of the risk. Everyone in life have their own ‘homework’ to do, you have to be willing to do it and enjoy doing it.

I wish everyone in the city can find their smiles, warmth and friendship in [Company’s name]… a place where you are able to allow the heart to seek solace, to explore your mission in life. Life requires the bearing of a heart filled with humility and gratitude. Everyone has his mission in the world, I carry out mine with all my heart and energy. A man can’t live without dreams. Quoting Emerson, we need to ‘hitch your wagon to a star.”

Who is Mr W and this Asian wide-moat innovator and Hidden Champion?

Warm regards,

KB

Chief Investment Officer

Hidden Champions Fund

The Moat Report Asia

www.moatreport.com

宁静致远

A new monthly issue of The Moat Report Asia is now available!

Access the in-depth idea presentation:

http://www.moatreport.com/members/

PS: We will be working on the Monthly Report in the upcoming weeks ahead and we will replace the weekly articles with some occasional write-ups, including our upcoming Year End Letter for the Hidden Champions Fund. Since Sep 2015, Asian market indexes were generally down and our Hidden Champions Fund had generated positive absolute returns of around 15% (in SGD terms as at 14 Jun 2016). This outperformance is powered by a double-digit gain from our high-conviction top position which comprised around one-third of our portfolio NAV. We are also a Top 15 Shareholder in this world-class wide-moat company with dominant market leadership as the largest provider of nation-wide tourism and transportation services generating record profitability with a visible long runway ahead to compound growth with resilience. We do not engage in market-timing by darting in and out of the markets on a short-term trading basis and our portfolio turnover ratio is low at under 15%. Our portfolio standard deviation is below 10%, significantly lower than the MSCI Asia market index standard deviation of 22%. We aim to be a Top 20 Shareholder disclosed in the Annual Report of the companies we invest in as a demonstration of our conviction and transparency in the investment process. We adopt a high-conviction concentrated investing approach with a targeted 20-25 stocks and we currently have 18 Hidden Champions in our portfolio.

At the moment, we are managing permanent capital for the Hidden Champions Fund. We are partnering with an established and reputable Indian asset manager in setting up a licensed and regulated fund structure to tap external funds from potential external institutional investors and accredited high network investors. The Fund will be registered with regulators and agencies in various jurisdictions for distribution permission in US, UK, and HK. For US investors, the administrator to the Fund will be handling regulatory reporting requirements such as issuing PFIC statements. The Fund will be tax-free for both capital gains and dividend distribution. The Fund will be in compliance with regulatory standards and the external custodian & banker is Standard Chartered Bank, auditor is KPMG), and the administrator is Trident Trust.

Through this partnership, we will have our own DEMAT account and legal stock ownership in our Fund name when investing in Indian equities, as opposed to other funds purchasing stocks through a nominee which suffer the risks associated with forgery and due to damaged stock certificates. This process required stringent KYC checks due to Indian regulation which required more time as opposed to the regular entity. We believe that this time-demanding process is worthwhile as we are positive on the Indian market as a fertile ground for the emergence and growth of Hidden Champions. India is also a unique vibrant and versatile hub for “frugal innovations”: cost-effective and affordable solutions of various varieties that cater to price-sensitive consumers. Our Hidden Champions Fund has recently invested in an Indian frugal innovator at 4% of our NAV and it has since rose over 30% from our investment cost.

Personally, I will never forget how during one of our business trips to India, a senior Tata executive handed me the Keepers of the Flame: A Century of Trust, a limited-copy DVD film on the life and times of the three great Tata stalwarts – Jamsetji, JRD and Naval – and shared with me over lunch this belief:

“A person or an organization may be down temporarily due to circumstances beyond himself or herself. But he or she may rise up from the values they held fast as keepers of the flame”.

Tata Group, with a total revenue of over $100 billion, is special among all MNCs in the world. Its mission is more than just economic. What makes Tata different is that its societal purpose powered its economic progress. The inspiring story of S Ramadorai who transformed Tata Consultancy Services (TCS) from a US$155 million operation when he inherited the company as CEO in 1996 into a wide-moat compounder with sales of US$16 billion and a market value of US$74 billion employing over a quarter million people in 42 countries has also touched our hearts deeply. The Godrej Group is also part of this core group of Hidden Champions which have the “highest order of competitive advantage” that is beyond fitting them into the usual Porter-style matrix of “low-cost” or “differentiation” strategy, as shared with me by Mr. G Sunderraman, the Head of Innovation and EVP at Godrej & Boyce, the holding company of the reputable Godrej family at their corporate headquarters at Vikhroli in northeast Mumbai. This “highest order” of competitive edge is having the trust and support amongst its community of customers, suppliers and employees and the learning ability to sense and respond with agility to the emerging and evolving needs of the customers.

We are now in the final stages of completing the administration of the fund setup, having set up a 100% owned subsidiary that owns and controls 100% of the Fund. We are working hard to finalize the admin paperwork which requires time and will be finished up. We thank you for your patience while we work towards delivering the Fund for the investor. We expect the Fund to be ready for soft launch by end July 2016 and we will announce in due time the details of the Fund.

“Bamboo Innovators bend, not break, even in the most terrifying storm that would snap the mighty resisting oak tree. It survives, therefore it conquers.”
BAMBOO LETTER UPDATE | Jun 14, 2016
Bamboo Innovator Insight (Issue 125)

  • The weekly insight is a teaser into the opportunities – and pitfalls! – in the Asian capital jungles.
  • Get The Moat Report Asia – a monthly in-depth presentation report of around 30-40 pages covering the business model of the company, why it has a wide moat and why the moat may continue to widen, a special section on “Inside the Leader’s Mind” to understand their thinking process in building up the business, the context – why now (certain corporate or industry events or groundbreaking news), valuations (why it can compound 2-3x in the next 5 years), potential risks and how it is part of the systematic process in the Bamboo Innovator Index of 200+ companies out of 15,000+ in the Asia ex-Japan universe.
  • Our paid Members from North America, Europe, the Oceania and Asia include professional value investors with over $20 billion in asset under management in equities, some of the world’s biggest secretive global hedge fund giants, and savvy private individual investors who are lifelong learners in the art of value investing.

Hidden Champions: Our North Star Investment Strategy to Navigate Turbulent & Fragile Markets – Bamboo Innovator Weekly Insight

“Bamboo Innovators bend, not break, even in the most terrifying storm that would snap the mighty resisting oak tree. It survives, therefore it conquers.”
BAMBOO LETTER UPDATE | May 2, 2016
Bamboo Innovator Insight (Issue 124)

  • The weekly insight is a teaser into the opportunities – and pitfalls! – in the Asian capital jungles.
  • Get The Moat Report Asia – a monthly in-depth presentation report of around 30-40 pages covering the business model of the company, why it has a wide moat and why the moat may continue to widen, a special section on “Inside the Leader’s Mind” to understand their thinking process in building up the business, the context – why now (certain corporate or industry events or groundbreaking news), valuations (why it can compound 2-3x in the next 5 years), potential risks and how it is part of the systematic process in the Bamboo Innovator Index of 200+ companies out of 15,000+ in the Asia ex-Japan universe.
  • Our paid Members from North America, Europe, the Oceania and Asia include professional value investors with over $20 billion in asset under management in equities, some of the world’s biggest secretive global hedge fund giants, and savvy private individual investors who are lifelong learners in the art of value investing.
Dear Friends,

Happy Labor Day!

Below is an early peek into excerpts from our March Year End Letter of our Hidden Champions Fund which we were working on while staying tune to the broadcast of the ever-insightful Berkshire Hathaway AGM 2016.

Hidden Champions: Our North Star Investment Strategy to Navigate Turbulent & Fragile Markets 

“Governing with excellence (德) can be compared to being the North Star: The North Star dwells in its place, and the multitude of stars pay it tribute.” – Confucius, Analects 2:1

“Successful CEOs are like gems you find on a beach. There are many pebbles, many beautifully colored ones, but they are all stones. Now and again, you will come across a real precious gem, a real emerald, pick it up, polish it. He must have a set of qualities that fits with the job, has energy, drive, ability to interact with people, ability to get people to work with him in a team… You look at all the successful companies, what is the key? Their brainpower. The thinker, good management, good innovators.” – Lee Kuan Yew, founding Prime Minister of modern Singapore, in Hard Truths to Keep Singapore Going

Dear Shareholders,

Your funds in listed Asian equities have achieved a % 12-month rolling return (in SGD terms) against a decline of: 11.3% for the MSCI Asia Pacific index, 11.7% for the Australia All Ord index, 12% for the Nikkei 225 index, and 17.6% for Singapore’s FTSE STI index over the same period.

This outperformance is buttressed by a 7% (est) absolute return (in SGD terms) from our investment cost of the revamped portfolio in the second-half since September 2015, powered by a double-digit gain from our high-conviction top position, ASX-listed Sealink Travel, which comprised around one-third of our portfolio NAV. We are also a Top 15 Shareholder in this world-class wide-moat company with dominant market leadership as the largest provider of nation-wide tourism and transportation services generating record profitability with a visible long runway ahead to compound growth with resilience.

We aim to be a Top 20 Shareholder disclosed in the Annual Report of the companies we invest in as a demonstration of our conviction and transparency in the investment process. As will be detailed in the tables and descriptions in the below section, we are a Top 20 Shareholder in 7 world-class wide-moat companies, out of the 19 portfolio stocks (we added 5 stocks after the financial year end in April which were up 9.2% as at 29 April) that we look to accumulate more, up to becoming a substantial shareholder with 5% stake, as they continue to deliver in their business fundamentals.

This outperformance is possible because of our multi-manager team-based investment process implemented by since September 2015, led by our analyst team comprising of Kelvin Seetoh, Jackson Yeow, Sim Zhipeng and Joshua Zhang. This teamwork greatly strengthens our ability to invest with high conviction in wide-moat companies, making an architectural shift from time-telling to clockwork with a build-to-last structure for our shareholders. As Jim Collins, author of the Built to Last and Good to Great, puts it aptly: “Imagine you met a remarkable person who could look at the sun or stars at any time and state the exact time and date. But wouldn’t the person be even more amazing if, instead of telling the time, he or she built a clock that could tell the time forever?”

Hidden Champions: Our North Star Investment Strategy to Navigate Turbulent & Fragile Markets 

“Explorers depend on the North Star when there are no other landmarks in sight. The same relationship exists between you and your right life, the ultimate realization of your potential for happiness. I believe that a knowledge of that perfect life sits inside you just as the North Star sits in its unaltering spot… Your life follows your attention. Wherever you look, you end up going.”

– Martha Beck, author of Finding Your Own North Star

The clock that we are building together as a team to tell the time forever is the Inner Compass and systematic investment process that leads us to our North Star to navigate increasingly turbulent and fragile markets – to the Hidden Champions.

Our approach to value investing is to invest in the Hidden Champions, agile creatures darting between the legs of multinational monsters who are dominant global players in sophisticated, hard-to-imitate niche products and valuable critical niches that are largely invisible to the average consumer. The Hidden Champions create maximum benefits for a target customer group, solving their most burning problems better than any competitor. This innovation strategy requires a deep knowledge of customer needs, which is generated through direct customer contact. Successfully solving this customer problem would then create a “success spiral”. A key source of their wide-moat is their sustained commitment and even obsession to customer needs, which is only possible in our view when there is a Purpose and values system guiding the firm.

The Hidden Champions had their roots as the esprit de corps of Germany’s Mighty Mittelstand, the more than 3.5 million small and midsize family enterprises that form the backbone of Germany’s resilient export-driven economy, employing more than 78% of workers and contributing more than half of the country’s GDP. The Mittelstand traces its roots to the Middle Ages, when the country that is now Germany was divided into hundreds of states. Competition between them created a number of industrial regions with their own educational institutions, banks and political administrations. The Mittelstand had to export early on with a global-orientation in their business model, given that some German states were smaller than two football fields.

Well-known Mittelstand enterprises that became well-known giants include BMW, Audi, SAP AG, Adidas, Hugo Boss, Robert Bosch, Siemens, consumer giants Beiersdorf and Henkel, dialysis giant Fresenius, pharmaceuticals giant Bayer, chemicals giant BASF, industrial gas specialist Linde AG, truck and engine maker MAN SE, and so on. There are also lesser-known, quiet, resilient, successful compounders, including commercial kitchen equipment company Rational AG, eyewear specialist Fielmann, specialty chemicals specialists Brenntag and Lanxess, high-end cleaning equipment Kärcher, Würth group (the “Fastenal of Europe”), auto gasket maker Elringklinger, flavor and fragrance specialist Symrise, lab solution specialist Sartorius, medical vision technology specialist Carl Zeiss Meditec, packaging and bottling machine maker Krones, wound medical products Paul Hartmann, and so on.

From a value investing perspective, investing at an earlier stage in the long-term growth trajectory path of these Hidden Champions – in Asia – will prove rewarding, as highlighted in an investment case insight into Rational AG, which we also share in 8IH’s inaugural value investing educational program in Shanghai.

<ARTICLE SNIPPED>

The Capital Cycle and Sale of Investments

In the book Capital Returns: Investing Through the Capital Cycle edited by Edward Chancellor, the capital cycle analysis can be adapted to make informed decisions on the sale of stock before problems surfaced. In the intriguing case of Vestas Wind Systems, its capex-to-depreciation had risen from just 1 time in 2005 to nearly 5 times in 2008, contributing to excess capacity in the wind turbine sector. Overinvestment is not a solitary activity; it comes about because several players un an industry have been increasing capacity at the same time. When market participants respond to perceived increases in demand by increasing capacity in an industry, they fail to consider the impact of increasing supply on returns. Subsequently, the share price of Vestas crashed over 90% from the peak.

Following the appointment of a new Swedish chairman in early 2013, significant restructuring was implemented at a time when investor fears about weak industry demand had proved too pessimistic and capex was slashed to 0.4 times depreciation in 2013, boosting cashflow and helping to repair the weak balance sheet, sending share price to rise 360%. The case of Vestas illuminated the investment insight that excess returns can be captured by exploiting the managerial decisions in capital allocation in capex: a low (high) capex-to-depreciation is a buy (sell) signal.

Vesta Wind Systems: Capex-to-Depreciation and Relative Share Price Performance

Vesta

Source: Capital Returns: Investing Through the Capital Cycle by Edward Chancellor (2016)

During the second-half of the financial year, our notable divestments are Hartalega Holdings Berhad and Major Cineplex Group at an average price of RM 5.86 and THB 32.11 respectively, recording a 96% and 77.4% gains on both companies respectively. We were uncomfortable with the expensive valuations accorded to their growth expansion plans which face increasing headwinds in lower ASP in nitrile gloves due to intense competition from new entrants and balance sheet constraints in taking on more debt to finance capex to increase the number of screens in sub-urban and rural regions and in regional countries, including their highly-geared shopping mall operators-business partners, some of whom have announced plans to slow down in building more malls.

Hartalega: Capex-to-Depreciation, EBIT-to-Capex and Relative Share Price Performance

Hartalega

From the capital cycle chart on Hartalega, we can observe that capex-to-depreciation had shot up aggressively in FY2015 and for TTM2016, contributing to the industry oversupply situation, while the capex-efficiency (as measured by the EBIT profitability generated per dollar of capex spend) had plunged due to lower ASP and higher operating cost.

The same can be observed in Major Cineplex in which the capex-to-depreciation had spiked up in FY2015 while capex-efficiency had declined precipitously after five golden years of capex-efficiency during FY2010-2014. Subsequently after we sold Major Cineplex, it reported a Bt139m net profit for 4Q15, down 33% YoY and 60% QoQ. Stripping out extra items—a net-of-tax gain from selling shares held in India’s PVR Cinema and trading in Thailand’s SF shares in 4Q14 and 3Q15—core profits dive 26% YoY and 41% QoQ. We also agree with former successful studio Grammy Tai Hub (GTH) chief Visute Poolvoralaks who commented that there is a growing risk that Thai audiences have lost faith in Thai movies simply because film production standards vary so much. Thais pay the same ticket price for every movie, so when ones are not good or worth the money, they lose confidence in Thai films in general and opt instead for Hollywood offerings – and Major is increasingly expanding into film production of Thai movies. Having said that, we find that the wide-moat of Major remains intact and will revisit the stock if the price retreats to Bt20 and below.

Major Cineplex: Capex-to-Depreciation, EBIT-to-Capex and Relative Share Price Performance

Major

We are also uncomfortable with the growing investor fever for movie & entertainment-related companies and some of them are exploiting investors’ attention to hype up their prospects with box-office ticketing fraud.

Shifang Holdings (1831 HK): Roller-Coaster Share Price

Shifang

Take the case of HK-listed Shifang Holdings, which owns the rights to the earnings of the blockbuster Ip Man movie. “Ip Man 3” saw ticket sales of 400 million yuan in its first three days of release. Shortly after that big start, however, local news reports raised allegations of box-office ticketing fraud. It turns out that Shifang snapped up tickets worth 56 million yuan, guaranteeing a hot opening week. Chinese authorities have opened a probe into the case. The fraud dealt a severe blow to the share price of Shifang. Shares in Shifang surged to HK$3.75 on Feb. 26, the highest level since it listed in 2010. Then came the box-office scandal. It took only four trading days for the stock to plunge 80% to HK$0.76 on March 10.

We do not engage in market-timing by darting in and out of the markets on a short-term trading basis. After our restructuring, our portfolio turnover ratio is low at 3.1%. The portfolio turnover came from our sale of 6 stocks (3 in India, 2 in Thailand, 1 in Japan) due to some slight concerns on their business model sustainability, of which 4 are at a small profit and 2 with losses, at an overall 0.75% loss from our cost as a percentage of our NAV.

The daily liquidity of our portfolio stocks, if we were to account for one-third of the daily volume traded based on the past 30-day average price, is 25.7% of our portfolio NAV, i.e. we can liquidate one-quarter of our portfolio NAV in one day if need be without destabilizing the stock prices.

Avoiding a “Valeant Situation” In Overconcentration of a Deteriorating Moat

Analyzing the capital cycle has also proven useful in evaluating and avoiding the risk of investing in Valeant Pharmaceuticals, dubbed the “Enron of Pharma”. Hedge fund manager Bill Ackman compared “platform stock” Valeant to early-stage Berkshire Hathaway in early 2015; William Thorndike, author of The Outsiders, compared Valeant’s CEO Michael Person to Liberty’s cable billionaire John Malone. Valeant’s share price collapsed in Oct 2015, hurting many sophisticated institutional investors with concentrated portfolio bets on the drug firm. Charlie Munger back in March 2015 had criticized Valeant: “Companies like ITT Corp., made money back in the 1960s in an ‘evil way’ by buying businesses with low-quality earnings then playing accounting games to push valuations higher. Valeant, the pharmaceutical company, is ITT come back to life. It wasn’t moral the first time. And the second time, it’s not better. And people are enthusiastic about it. I’m holding my nose.” Valeant relied on “gamesmanship” to run up its value and created a “phony growth record.” Buffett, at the Berkshire Hathaway AGM 2016, said Valeant’s troubles illustrate a principle passed on to him by a friend: “If you’re looking for a manager, find someone who is intelligent, energetic and has integrity. If he doesn’t have the last, make sure he lacks the first two.”

Valeant: Capex-to-Depreciation, EBIT-to-Capex and Relative Share Price Performance

Valeant

We noted various articles back in 2014 that shed insights about the corporate culture and accounting of Valeant, and one of them was featured on Apr 22, 2014 in Wall Street Journal titled “Allergan Pursuer Valeant: A Drug Maker With Little Patience for Science”. Valeant CEO Michael Pearson is known as an aggressive cost cutter. Valeant’s corporate culture is that it does not want to spend money on science and sees no wrong in substantially jacking up prices of drugs after acquiring them. From the above chart on Valeant, we can see that since Michael Pearson took over as CEO in 2008, capex-to-depreciation had soared, a warning sign to avoid the stock.

Why do investors and corporate managers pay so little attention to the inverse relationship between capital spending and future investment returns? The short answer is that they appear to be infatuated with asset growth. An empirical study by finance researchers Sheridan Titman, John Wei and Xie Feixue in the Journal of Financial And Quantitative Analysis found that the average firm destroys value when they invest substantially and a long-short strategy that goes LONG low-capex firms and SHORT high-capex firms earn an annual compounded 16.9% returns. Why? There is execution risk and investors consistently fail to appreciate managerial motivations to put the best possible spin on their new “growth opportunities” when raising capital to fund their “expenditures”. The aim of the capital cycle analysis is to spot these developments in advance of the market. Thus the capital cycle analysis in capex-to-depreciation and EBIT-to-capex is an informative signal about future firm value creation – and destruction.

Combining Capital Cycle With Marketing & Long-Range Information in the Value Creation Process

Long-term investing works because there is less competition for really valuable bits of information. The real advantage comes from asking more valuable questions. The short-term investor asks questions in the hope of gleaning clues to near-term outcomes: relating typically to operating margins, earnings per share and revenue trends over the next quarter. In order to build a viable, economically important track record, the short-term investor may need to perform this trick many thousands of times in a career or/and employ large amounts of financial leverage to exploit marginal opportunities.

The longer one owns the shares, however, the more important the firm’s underlying economics will be to performance results. Long-term investors therefore seek answers with shelf life. What is relevant today may be relevant in ten years’ time if the investor is to continue owning the shares. Information with a long shelf life is far more valuable than advance knowledge of next quarter’s earnings. We seek insights consistent with our holding period.

Take marketing which can be vital to long-term value creation yet if often ignored. An understanding of the economics of line extensions and an advertising strategy would have proved useful to investors in consumer products companies. Colgate Palmolive introduced its first line extension – a blue minty gel – in the early 1980s, and supported this product with a hefty advertising spend. This was Colgate’s first new toothpaste in a new generation, and line extensions, which had been used successfully in other household goods, were novel to the toothpaste market. By advertising heavily, the firm hoped to change the buying habits of a generation of shoppers who would subconsciously think of Colgate as they approached the toothpaste section of a supermarket, and when they got there, would find a product which was new, superior and, because of advertising spend, trusted.

This is an almost worthless piece of information for the short-term investors as they will be thinking along the lines of: what does the rise in advertising spend in the new line extension product mean for profit margins next quarter? Few investors would have understood, and even fewer would have cared, about the transformation that was taking place. In the two decades since its first line extension, Colgate’s share price has risen 25-fold, handsomely beating the market.  This shows how important it is for long-term investors to understand a firm’s marketing strategy. Yet, given the annual 100% turnover in Colgate shares, very few of the firm’s shareholders have benefitted fully from its success.

Why did so few Colgate investors stay the course? There is strong social and client pressure to boost near-term performance. Even if one has developed the analytical skills to spot the winner, the psychological disposition necessary to own shares for prolonged periods is not easily come by.

Portfolio Stock (Global #3 Consumer Healthcare Device Brand): Ad Expense as % OPEX and EBIT as % Ad Expense

Marketing

We have combined the capital cycle analysis with long-range information such as the marketing expenditure to provide a more informative signal. As an illustration, we observed for one of our portfolio stocks, who is in the consumer healthcare & household lifestyle business, that despite a rise in its advertising spending (as a percentage of total operating expense), EBIT per dollar of advertising has been rising, particularly since FY2014. Furthermore, despite a rising trend of capex investments to expand in response to growing demand for its innovative high-quality products since FY2013, EBIT-to-capex has exceeded capex-to-depreciation for this world-class Hidden Champion who commands a dominant 50-60% domestic market share leadership in its consumer healthcare device and is also the global #3 player and #2 in China (22% market share) where its first China plant in over 80 years is operational in March 2016 after building up strong demand from successful sales in leading online marketplaces JDmall and Alibaba’s Tmall.

ROE of this world-class hidden champion is 14.2% and it trades at EV/EBIT 11.7x, EV/EBITDA 8.8x, EV/Sales 1x, a steep discount to its local consumer goods peers who trade at an average of EV/Sales 2.1x, EV/EBIT 20.2x, EV/EBITDA 14.5x. We think that this steep valuation discount is unjustified given the technical excellence and innovative profile of the company and it deserves to trade at a higher premium once there is greater investor awareness when they continue to deliver quality earnings growth with higher ROE, which has soared from 6.7% in FY13 (YE March) to 14.2% in the latest TTM Dec 2015, and is expected to climb higher from its underappreciated price premiumisation strategy.

This portfolio company, a family business established since 1934 and led by the second-generation business leader, embodies the best of patient sacrifice and stable capital for longer-term profound investments in business and people, with relentless and eternal pursuit of excellence in perfecting its offering, institutionalizing its craftsmanship and codifying the knowledge to pass from one generation to another. We believe it has hit a tipping point in its business model transformation into a complete integrated global producer of innovative rubber and plastic products with long product lifecycle with both engines in household & lifestyle division and industrial division (automotive interior) revving up to compound growth with a visible long runway.

Avoiding our Dark Wood of Errors: Risk of Accounting Irregularities & Tunneling Fraud

Once you have found your North Star, keeping it in view is a fine way to stay on course – as long as the sky remains clear. But what about the cloudy nights and the dark wood of errors? In situations when you feel utterly befogged by the risk of accounting irregularities, we need some help figuring out where our North Star lies. It is helpful to have inner compasses wired into our brain and body to guide us in the search for our true path.

As shared earlier that we are honored and grateful to be able to have the opportunity to share our thoughts on 23 September 2015 with the top management team of the Monetary Authority of Singapore (MAS) about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community, we believe strongly that this potential fintech platform that combines accounting data, especially footnotes, with a wide array of contextual information – including unusual related-party transactions; money-go-round off balance-sheet activities; governance, group structure and ownership analysis; textual and linguistic analysis; analysis of event-based “catalysts” (information-based manipulation) and sensitive market announcements (action-based manipulation in prices and volume) – will provide fresh insights and actionable, dynamic, inter-connected analytical information, as opposed to merely descriptive static data or a loose bag of disparate red flags, on Singapore and Asian companies, for the regulator and the public.

We were quite close to investing an initial investigate stake in an ASX-listed

<ARTICLE SNIPPED>

Caring is an exacting, serious and demanding business, especially when it comes to investing in another person’s financial assets, which are a tangible product of his or her life’s work, a repository of aspirations for the future.

We cannot guarantee success in investment outperformance over the short-term, but we can certainly guarantee one thing: You will be proud to be able to participate positively in the resilient growth of these wide-moat Hidden Champions who are solving real-world problems and have helped to create what the world around you looks like today and tomorrow. You will also be a proud and happy parent for your children when they work in these Hidden Champions. As George Washington puts it aptly, “We cannot guarantee success, but we can at least deserve it”.

Consider some of our portfolio stocks:

Bring your family and loved ones to river cruises in Australia and the Kangaroo Island to experience wildlife and scenery, knowing that you are supporting your holding in Sealink Travel, the quasi-monopoly ferry company and tour operator which has plied the crossing from mainland South Australia to Kangaroo Island since 1989. If your in-laws are visiting, suggest to them to take the natural Capilano Manuka Honey to enjoy both its delicious taste and health benefits, and then thank them for buying from one of your businesses.

For a retail experience perhaps even better than IKEA’s, we would highly recommend you to explore the “Retail Wonderland” home improvement centre as described in the above section and be awestruck by the enchanting assortment of items and the superlative customer service.

When was the last time that you express your appreciation to the people who love you, the people who care for you or the people whom have helped you? In today’s fast paced society, it is easy to neglect the people surrounding you. Instead of texting, harness the power of the pen and experience the positive difference of the act of handwriting. The beauty of a hand written note or letter not only allows you to have a deep connection with the recipient, but it can also be retained and cherished, leaving precious memories that can be re-visited. So grab a top quality pen manufactured by one of our Hidden Champions portfolio stocks and pen your gratitude to acknowledge those who have made a difference in your life today.

We hope this will capture the Hidden Champions Fund investment philosophy of entrepreneurs investing in entrepreneurs. We are of the conviction that the future is created one wide-moat innovator and Hidden Champion at a time and each will flourish from their own wisdom. If you also share in our values and investment process, and support our conscious efforts to promote entrepreneurialism in Asia, we invite you to join us in this uplifting journey to participate in the compounding returns in overlooked and underappreciated wide-moat innovators – and to make a positive difference to society.

Welcome to the exclusive Club of the Hidden Champions.

KEE Koon Boon

Chief Investment Officer

Hidden Champions Fund

PS1: The Monthly report will resume during the last week of May as we will be away on our military reservist training from 4 May. Thank you for your understanding.

PS2: We like to share our presentation slides in Value Investing Shanghai on March 18-20, 2016 where we highlighted high-conviction investment in Hidden Champions to navigate the volatile markets and that such an investment approach has enabled us to outperform with positive absolute returns vs -15% for the MSCI Asia Index, and our highest portfolio-weighted stock at 36% of our portfolio NAV is up more than 16% in SGD:

http://www.moatreport.com/slides-for-value-investing-shanghai-2016/

Value Investing Shanghai Photo

PS3: We like to share our Investor Day Presentation held on 1 December 2015 for our shareholders. The presentation material is available for download on the ASX website:

http://www.asx.com.au/asxpdf/20151102/pdf/432nk9r3hhw4nf.pdf (pg 10-14)

http://www.asx.com.au/asxpdf/20151201/pdf/433hdp24p2twyj.pdf

and our Value Investing Summit 2016 presentation “Quietly Innovating Value with Hidden Champions”:

http://www.moatreport.com/value-investing-summit-2016-quietly-innovating-value-with-hidden-champions/

PS4: We had also recently presented in the Asian Investing Summit 2016 as one of the instructors:

http://www.valueconferences.com/reg/asia16/

Warm regards,

KB

The Moat Report Asia

www.moatreport.com

A new monthly issue of The Moat Report Asia is now available!

Access the in-depth idea presentation:

http://www.moatreport.com/members/

In the month of March/April 2016, we investigate an Asian wide-moat innovator who commands a dominant 50-60% domestic market share leadership in a consumer healthcare device and is also the global #3 player and #2 in China (22% market share) where its first China plant in over 80 years is operational in March 2016 after building up strong demand from successful sales in leading online marketplaces JDmall and Alibaba’s Tmall.

Since the launch of its game-changing innovative new consumer healthcare device premium product in April 2015, its TTM Dec 2015 (YE March) sales is up 7.2% and EBIT soared 67.6%. Under the motto of using science to enrich everyday lives, [Company’s name] is a quiet innovator in leveraging upon its accumulated deep material science and chemistry know-how to continuously launch innovative new products, from consumer healthcare device to a pad that helps heal wounds by absorbing moisture, a technology that it adapted from its popular food wrapping film household product, to protective film-coated lining for motorcycle seats where it commands a 90% market share in US.

ROE of this world-class hidden champion is 14.2% and it trades at EV/EBIT 11.7x, EV/EBITDA 8.8x, EV/Sales 1x, a steep discount to its local consumer goods peers who trade at an average of EV/Sales 2.1x, EV/EBIT 20.2x, EV/EBITDA 14.5x, a 64-110% premium over [Company’s name]. Its consumer healthcare device peers trade at an average of EV/Sales 4.36x, EV/EBIT 19.7x, EV/EBITDA 17.2x, a 69-96% premium over [Company’s name]. We think that this steep valuation discount is unjustified given the technical excellence and innovative profile of [Company’s name] and it deserves to trade at a higher premium once there is greater investor awareness when they continue to deliver quality earnings growth with higher ROE which has soared from 6.7% in FY13 (YE March) to 14.2% in the latest TTM Dec 2015 and is expected to climb higher from its underappreciated price premiumisation strategy.

Sales has increased 24% in the past 3-4 years since FY13 and EBIT and OCF (operating cashflow) growth is faster at 168% due to the price premiumisation strategy. With the upcoming China plant operational in March 2016 and the tipping point in its US factory in automotive interior material, we believe [Company’s name] can build on the momentum to generate $120m operating profits and OCF in the next 4-5 years, similar to the profit scale of its domestic consumer goods peers with market cap of $2.2-3.4bn, thus spurring an upward valuation re-rating towards a potential tripling in market cap to cross $2.4bn based on EV/EBIT 20x from its present $850m market cap.

[Company’s name] embodies the best of patient sacrifice and stable capital for longer-term profound investments in business and people, with relentless and eternal pursuit of excellence in perfecting its offering, institutionalizing its craftsmanship and codifying the knowledge to pass from one generation to another. We believe [Company’s name] has hit a tipping point in its business model transformation into a complete integrated global producer of innovative rubber and plastic products with long product lifecycle with both engines in household & lifestyle division and industrial division (automotive interior) revving up to compound growth in a long runway.

Originals: Investment Insights from Hidden Champions in Intelligent Oven to Food Robot at the Food & Hotel Asia (FHA) 2016 – Bamboo Innovator Weekly Insight

“Bamboo Innovators bend, not break, even in the most terrifying storm that would snap the mighty resisting oak tree. It survives, therefore it conquers.”
BAMBOO LETTER UPDATE | April 18, 2016
Bamboo Innovator Insight (Issue 123)

  • The weekly insight is a teaser into the opportunities – and pitfalls! – in the Asian capital jungles.
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Dear Friends,

Originals: Investment Insights from Hidden Champions in Intelligent Oven to Food Robot at the Food & Hotel Asia (FHA) 2016

Why are Hidden Champions “hidden”? If they are “hidden”, will they become successful companies? Aren’t the successful ones always prominently visible?

An oblique reply: Have you been to a restaurant kitchen? Did you notice what is the brand of the kitchen equipment the professional chefs are using? Would you think a company that makes the equipment produce a good investment?

Often, eyes roll and heads shake – until we share with them the inspiring story of Rational AG, which has compounded over 1,200% since 2000 to a market cap of US$5.9bn, and how its reclusive billionaire founder Siegfried Meister became an Original, a trailblazer in choosing to go against the grain, battle conformity and buck outdated traditions to launch its innovative product. More than 87% of Rational AG’s sales are exports. You can find a Rational AG intelligent cooking system on a Norwegian submarine, a Saudi prince’s yacht, as well as in hospitals and restaurants around the globe. This intelligent cooking equipment system commands a global 54% market leadership in the world’s professional kitchens that include Buckingham Palace and the White House and is behind the success of such famous culinary names as Gordon Ramsay and Paul Bocuse.

Rational AG Stock Price Performance, 2000-2016, at the Shanghai Value Investing Program 2016

Rational1

Hidden Champions such as Rational AG aren’t well-known to the public and their existence are often taken for granted, although their target customers (e.g. professional chefs) will swear to only use their innovative products or/and excellent services and nothing else. They are the brand behind the brands and they are essential to the well-being and success of our everyday life.

FHASo we were naturally excited when we have the opportunity to meet up close and personal with not one or two, but a whole lot of these global Hidden Champions beyond Rational AG at the Food & Hotel Asia 2016 on 12-15 April at Singapore Expo. Of course, our investment team was also focused on visiting the exhibitor booth of an Asian Hidden Champion who is one of our portfolio stocks and speak to the GM of its overseas business office (photo on the right) – and their customers visiting their booth. This Asian Hidden Champion in our portfolio has 70% domestic market leadership and a dominant 90% overseas market share in automatic machine for a particular food segment. The founder is an Original, a thought leader and pioneer in inventing the world’s first food robot in 1981 because he wanted to bring this particular food – once considered a luxury food – to the masses. The perseverance of the founder is inspiring – he took five years to invent and launch the machine. Till today, this low-profile Hidden Champion is 54.5% majority-owned by the founding family.

This overlooked Hidden Champion generates a ROE of 14.6% and trades at a compelling valuation at EV/Sales 0.41x, EV/EBIT 2.71x and EV/EBITDA 2.33 and has a healthy balance sheet with 54% cash (zero debt) as percentage of market cap. More importantly, we believe it is on the cusp of a tipping point in its business model with 20% of its overall sales coming from overseas with the growing global popularity of the food. Its aftersales consumables and parts business has broke-even in FY13 and is now stable as a profit contributor.

Upon further interaction, we found out that its robotic machines are at least 30-50% more expensive than its rivals, yet customers who were hunting for price bargain in its competitors’ machines have switched back to this Hidden Champion. The reason? Due to the food-science nature of this food segment, there is a certain know-how in producing them in large quantities speedily on a consistent reliable basis, something which their rivals cannot match after some use. Almost 90% of the machine parts are designed in-house and their customers are able to perform maintenance themselves through phone call support or the company’s technical personnel will perform a store visit to solve their customers’ problems.

When we go for the killer question in why can’t Chinese or Indian machine makers buy their robots, tear everything apart and reverse engineer a cheaper version? The GM shared that it is quite impossible as their machine contains several moving machinery parts which is difficult to source and a software designed in-house to make it work. Copycats can imitate a machine that looks alike in the outer hardware casing but it cannot be consistently reliable and fast in producing quality tasty food.

Like their customers, we were amazed that the food produced by the robotic machines taste just as good, if not better, than the handmade food by the professional chef. They were softer in the texture and bite and had a human temperature, unlike the hard version that we thought it might be from a robot. We discovered the secret lies in how the robot is able to inject tiny air pockets at the right point in time to enhance the quality and taste of the food. Through this Hidden Champion, we learnt that it’s not simply about automation; it’s the pursuit of quality exceeding that of handmade food. Most of the initial machines’ ideas originated from the founder himself. Increasingly, the features of a machines are being initiated and suggested by the customers themselves. Every month, in their HQ, the sales team would meet the Research & Development team to discuss and consider implementation of features.

When Rational AG launched its Combi-Steamer in 1976, only very few immediately recognised the revolutionary effects that this innovation would have: from its base in Germany, this multifunctional cooking technology has now firmly established itself throughout the world, via Europe, America, Asia and Australia. A veritable revolution for working processes in large and industrial kitchens all over the world: the combination of dry heat in the form of hot air and damp heat (steam), and the possibility of combining them in any way for the cooking process represented the ideal solution for thermal food preparation, enabling most cooking processes to be performed using one device. For instance, the device recognizes how big and how cold the chicken pieces are, and adjusts the cooking process accordingly. And all this on a very small floor area – a great step forward in using space economically.

Rational AG not only created the market, but has always dominated it. Initially they offered, like 120 other competitors, better air ovens at. But with the invention and introduction of the combi steamer, which allowed cooking with hot air and steam without pressure, the breakthrough came. That was the foundation for the development of a new market. Noteworthy is that Rational AG billionaire founder and electrical engineering entrepreneur Siegfried Meister consciously killed off the firm’s existing product line, which generates 40% of the company’s revenue, for this new intelligent oven. This was a result of his awareness that there was no future in quality conventional convection ovens. The future would be in new technology. By shutting down the entire production of the convection oven line, this high-risk move ensured that every employee concentrated and focused on making the new technology a success.

Rational2

Siegfried Meister, a qualified electrical engineer who has spent many years in the management divisions of several large and medium-sized companies, feels that the immense success of his product concept would have been unthinkable if they had not always paid a great deal of attention to the needs of the customer and the marketplace: specialisation, yes, but not on a product, but a problem area – in other words, customer benefit. Both Rational AG and this Asian wide-moat innovator have an unrelenting urge to innovate and put customer benefit first. Rational AG equip its Combi-Steamer technology over the years with a series of new developments, many of them patented, continually optimising them and improving quality.

The success of Rational AG is based on tinkering and a lot of discipline. A few milestones: Vario-Steaming (1986), automatic self-cleaning (1989), programmable devices (1990), ClimaPlus Series with moisture measurement and control (1993). The launch of the ClimaPlus Combi Series marked a quantum leap in cooking technology (1997), followed by the IQT technology for the CPC range (1999) allowing continuous and automatic management of the entire cooking process, CleanJet and CalcDiagnosis (anti-scaling) System (2000), CombiCheck and UltraVent (2001). True to the corporate goal of always offering maximum benefits to the customer, in 2004, Rational launched another spectacular innovation: the “Self Cooking Centre“, which is designed to reduce the chef’s workload and is self-cleaning, thus providing him with more time for culinary creativity and his guests.

Everything about Rational AG is focused on the customer: the professional chef. Sales and marketing trainee spend three weeks working directly for customers in hospital, hotel and restaurant kitchens. Rational AG employs 300 chefs working in different processes who demonstrate the company’s products and act as “lawyers for the customers”, presenting the customer’s point of view to everyone inside the company

Market saturation is relatively low despite Rational AG market leadership. The customer potential is estimated at more than 3 million commercial kitchens worldwide – from simple innkeeper about fast-food chains and hotels to hospitals and prisons. We were surprised when we realize that the Rational AG intelligent self-cooking center cost around the same price as the robotic machine of this Asian Hidden Champion who also has a similar addressable market potential of at least a million restaurant and hotel kitchens, supermarkets, etc. We are an existing Top 20 shareholders in this Asian Hidden Champion and we look to continue to build up our portfolio position in its stock.

We are inspired by Rational AG’s incredibly high work standards that are hanging on the factory walls in posters that read: Gut Genug? Der Kunde Entscheidet (Good Enough? The Customer Will Decide). We are proud to learn that this Asian wide-moat innovator has similar high work standards since its founding days in 1981.

Most people will not be able to sense and appreciate the obsession and commitment of the Originals like Rational AG and this Asian Hidden Champion in the pursuit of excellence and craftsmanship to serve with love. After all, as Adam Grant, author of “Originals: How Non-Conformists Move the World”, observe shrewdly, “In the quest for happiness, many of us choose to enjoy the world as it is.” The Originals Rational AG and this Asian Hidden Champion move food with their innovation – and in the process, they move the world:

“Originals embrace the uphill battle, striving to make the world what it could be. By struggling to improve life and liberty, they may temporarily give up some pleasure, putting their own happiness on the back burner. In the long-run, though, they have the chance to create a better world. And that – to borrow a turn of phrase from psychologist Brian Little – brings a different kind of satisfaction. Becoming Original is not the easiest path in the pursuit of happiness, but it leaves us perfectly poised for the happiness of pursuit.”

PS1: We like to share our presentation slides in Value Investing Shanghai on March 18-20, 2016 where we highlighted high-conviction investment in Hidden Champions to navigate the volatile markets and that such an investment approach has enabled us to outperform with positive absolute returns vs -15% for the MSCI Asia Index, and our highest portfolio-weighted stock at 36% of our portfolio NAV is up more than 16% in SGD:

http://www.moatreport.com/slides-for-value-investing-shanghai-2016/

Value Investing ShanghaiValue Investing Shanghai Photo

PS2: We like to share our Investor Day Presentation held on 1 December 2015 for our shareholders. The presentation material is available for download on the ASX website:

http://www.asx.com.au/asxpdf/20151102/pdf/432nk9r3hhw4nf.pdf (pg 10-14)

http://www.asx.com.au/asxpdf/20151201/pdf/433hdp24p2twyj.pdf

and our Value Investing Summit 2016 presentation “Quietly Innovating Value with Hidden Champions”:

http://www.moatreport.com/value-investing-summit-2016-quietly-innovating-value-with-hidden-champions/

PS3: We had also recently presented in the Asian Investing Summit 2016 as one of the instructors:

http://www.valueconferences.com/reg/asia16/

Warm regards,

KB

The Moat Report Asia

www.moatreport.com

A new monthly issue of The Moat Report Asia is now available!

Access the in-depth idea presentation:

http://www.moatreport.com/members/

In the month of March/April 2016, we investigate an Asian wide-moat innovator who commands a dominant 50-60% domestic market share leadership in a consumer healthcare device and is also the global #3 player and #2 in China (22% market share) where its first China plant in over 80 years is operational in March 2016 after building up strong demand from successful sales in leading online marketplaces JDmall and Alibaba’s Tmall.

Since the launch of its game-changing innovative new consumer healthcare device premium product in April 2015, its TTM Dec 2015 (YE March) sales is up 7.2% and EBIT soared 67.6%. Under the motto of using science to enrich everyday lives, [Company’s name] is a quiet innovator in leveraging upon its accumulated deep material science and chemistry know-how to continuously launch innovative new products, from consumer healthcare device to a pad that helps heal wounds by absorbing moisture, a technology that it adapted from its popular food wrapping film household product, to protective film-coated lining for motorcycle seats where it commands a 90% market share in US.

ROE of this world-class hidden champion is 14.2% and it trades at EV/EBIT 11.7x, EV/EBITDA 8.8x, EV/Sales 1x, a steep discount to its local consumer goods peers who trade at an average of EV/Sales 2.1x, EV/EBIT 20.2x, EV/EBITDA 14.5x, a 64-110% premium over [Company’s name]. Its consumer healthcare device peers trade at an average of EV/Sales 4.36x, EV/EBIT 19.7x, EV/EBITDA 17.2x, a 69-96% premium over [Company’s name]. We think that this steep valuation discount is unjustified given the technical excellence and innovative profile of [Company’s name] and it deserves to trade at a higher premium once there is greater investor awareness when they continue to deliver quality earnings growth with higher ROE which has soared from 6.7% in FY13 (YE March) to 14.2% in the latest TTM Dec 2015 and is expected to climb higher from its underappreciated price premiumisation strategy.

Sales has increased 24% in the past 3-4 years since FY13 and EBIT and OCF (operating cashflow) growth is faster at 168% due to the price premiumisation strategy. With the upcoming China plant operational in March 2016 and the tipping point in its US factory in automotive interior material, we believe [Company’s name] can build on the momentum to generate $120m operating profits and OCF in the next 4-5 years, similar to the profit scale of its domestic consumer goods peers with market cap of $2.2-3.4bn, thus spurring an upward valuation re-rating towards a potential tripling in market cap to cross $2.4bn based on EV/EBIT 20x from its present $850m market cap.

[Company’s name] embodies the best of patient sacrifice and stable capital for longer-term profound investments in business and people, with relentless and eternal pursuit of excellence in perfecting its offering, institutionalizing its craftsmanship and codifying the knowledge to pass from one generation to another. We believe [Company’s name] has hit a tipping point in its business model transformation into a complete integrated global producer of innovative rubber and plastic products with long product lifecycle with both engines in household & lifestyle division and industrial division (automotive interior) revving up to compound growth in a long runway.

Hoshin Value Investing: Aligning Inner Compass with GPS (Guiding Principle Star) – Bamboo Innovator Weekly Insight

“Bamboo Innovators bend, not break, even in the most terrifying storm that would snap the mighty resisting oak tree. It survives, therefore it conquers.”
BAMBOO LETTER UPDATE | April 11, 2016
Bamboo Innovator Insight (Issue 122)

  • The weekly insight is a teaser into the opportunities – and pitfalls! – in the Asian capital jungles.
  • Get The Moat Report Asia – a monthly in-depth presentation report of around 30-40 pages covering the business model of the company, why it has a wide moat and why the moat may continue to widen, a special section on “Inside the Leader’s Mind” to understand their thinking process in building up the business, the context – why now (certain corporate or industry events or groundbreaking news), valuations (why it can compound 2-3x in the next 5 years), potential risks and how it is part of the systematic process in the Bamboo Innovator Index of 200+ companies out of 15,000+ in the Asia ex-Japan universe.
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Dear Friends,

Hoshin Value Investing: Aligning Inner Compass with GPS (Guiding Principle Star)

“Ideals are like stars; you will not succeed in touching them with your hands. But like the seafaring man on the desert of waves, you choose them as your guides, and following them you will reach your destiny.”

– Carl Schutz (1829-1906), German revolutionary and American statesman

We recently came across a thought-provoking and profound Japanese word that captures the essence of value investing in Asia: Hoshin. This unique word connected to us when we were re-evaluating the investment merits of an Asian wide-moat innovator with global market leadership in specialty cutting tools for industrial applications in the aerospace and automotive industry for our Hidden Champions Fund.

Hoshin is a Japanese word and concept translating roughly as Shiny Compass Needle aligned with your Guiding Principle Star (GPS) of Highest Potential. It’s a practice and Way designed to break through apparent chaos to reveal a higher order and direction. Over the past decade past in interacting with Asian entrepreneurs, we find two different groups of entrepreneurs classified by their motivations and inner compass: one that is labeled “Cash is King”—defining success in relation to financial goals, building a business that provides a revenue source in order to capture pleasures elsewhere—and another that is labeled “Make me Whole”—defining success in relation to their commitment to an idea and Purpose larger than themselves to care for and serve others with love. “Make me Whole” entrepreneurs were extremely passionate about their work even if work entails sacrifice and hardship, believing that work impacts, inspires, and changes the lives of those they work with, especially employees. An entrepreneur’s value systems and beliefs can have a strong influence on his/her business decisions, culture, mission, and other important outcomes for his/her organization. We observe in entrepreneurs that having the right Inner Compass of core values is necessary and critical to create value, yet not sufficient to bring about a wide-moat compounder. The Inner Compass must be aligned with the Guiding Principle Star (GPS).

The Guiding Principle Star (GPS) in our approach to value investing is to invest in the Hidden Champions, agile creatures darting between the legs of multinational monsters who are dominant global players in sophisticated, hard-to-imitate niche products and valuable critical niches that are largely invisible to the average consumer. The Hidden Champions create maximum benefits for a target customer group, solving their most burning problems better than any competitor. this innovation strategy requires a deep knowledge of customer needs, which is generated through direct customer contact. Successfully solving this customer problem would then create a “success spiral”. A key source of their wide-moat is their sustained commitment and even obsession to customer needs, which is only possible in our view when there is a values system guiding the firm.

The key difference between the Hidden Champions or Bamboo Innovators and the atypical Asian firms that determine the scalability of the business models lie in the fact that most Asian firms have an emperor-based culture. One lone emperor cannot possibly serve hundreds and thousands of customers to find out their needs at an intimate level and he or she often does not see the need to grow the people around them and frontliners to solve customer needs. It is far easier for the Asian entrepreneur to be the middleman through deal-making to take orders from a few important anchor clients who have the critical access to the end-customers, take capital risk investing in tangible assets and work hard to produce the required products with quality and efficiency — than to attempt to build business models that have direct ownership of the hundreds and thousands of end-customers. As a result, these Asian entrepreneurs are unwilling to share the rewards with their “undeserving” staff who took neither risk nor sacrifice. They treat employees as expenses and not intangible assets, make most or all of the decisions and hoard most resources and information, running the firm as a “one-man show” or as a “team” of high-profile dealmakers/mercenaries who can bring in the sales orders; the job of “everyone else” is to execute efficiently and “productively”. While short-term profits are achieved, the corporate culture is eroded. Eventually, they may face the challenge of business continuity arising from succession woes. There is no terminal value in the business as time becomes an enemy of the business; without terminal value, the DCF analysis would point towards a well-deserved low PE multiple in the valuation of the business.

Founded in 1938 and now led by the second-generation family business leader, this listed world-class hidden champion in specialty cutting tools generates an ROE of 22.3% with the Gross Profit/Total Assets quality measure at 33.5%, the highest in the industry even when compared with the global #1 leader Sandvik’s 31.2%. It has also been a serial repurchaser that bought back over US$83m in stocks since 2003 and trades at an attractive EV/EBIT 9.4x, EV/EBITDA 6.4x.

Underlying the financial numbers is its wide-moat in mastery in material science and innovation. Aircraft contain many times more parts than automobiles. Because these parts need to be both lightweight and very strong, processing is extremely difficult. Aerospace manufacturers need tools with special coatings to provide increased durability when used to process materials that are difficult to cut, such as carbon fiber reinforced plastics (CFRPs) and titanium alloys, including wings and fuselages, in order to achieve significant improvements in fuel efficiency. Manufacturers process these materials using tools made possible by the company’s diamond coating technology, which is based on their patented ultra-fine diamond crystallization technology.

Furthermore, it is a dominant supplier of over 70% of the tools used by Japanese automotive manufacturers for engine machining processes. Engines require closer machining tolerances and more advanced technology than any other automotive part, and over 1,000 high-performance tools are used. The company attributes this success to their commitment to finding answers to the processing problems and needs of their customers, often by visiting customers’ facilities. They apply this experience to the development of new customers, by building close relationships so that they hear from them whenever they have troubles and by helping them to find solutions to problems that arise at automotive production sites around the world.

Stock Price Performance, 1984-2016, of Asian wide-moat innovator (Red) vs Index (Blue)

Tool

On Apr 7, 2016, this listed Asian hidden champion announced the acquisition of 100% ownership in an American tool maker which was founded in 1972 by a master tool maker and missionary “with the desire to spread the gospel of the Lord Jesus Christ” and “built on the ideals of precision, craftsmanship, and integrity”.

Tool2

When we saw the biblical description of this American firm which supplies precise geometry tools for manufacturers in industries such as aerospace, automotive and marine, from top-tier Boeing and Lockheed to the smallest experimental and prototype builders, and its corporate slogan “cut with integrity”, we were reminded of the word Hoshin and another company that Warren Buffett had acquired – Iscar Metalworking.

Warren Buffett, the world’s greatest investor and the apostle of risk aversion, broke his decades-long record of not buying any foreign company with the purchase of an 80 percent stake in Iscar Metalworking, the world’s second largest maker of cutting tools behind Sandvik, which is founded in 1952 in a wooden garage, for US$4 billion in May 2006 – seemingly vulnerable assets in war-torn Israel. Buffett’s view is that if Iscar’s facilities are bombed, it can go build another plant. The plant does not represent the value of the company. It is the “intangible” – the talent of the management, the international base of loyal customers, and the brand – that constitute Iscar’s value. As Iscar’s founder Stef Wertheimer puts it firmly, “We do not miss a single shipment. For our customers around the world, there was no war.” By responding to threats this way, Wertheimer and his team have transformed the very dangers that may make Israel seem risky into evidence of Israel’s inviolable assets. Israelis, by making their economy and their business reputation both a matter of national pride and a measure of national steadfastness, have created for foreign investors a confidence in Israel’s ability to honor, or even surpass, its commitments.

The same thread that connects Iscar, the Asian wide-moat innovator in specialty tools, and the American tool maker is Hoshin, with the qualities of the human spirit: patience, tolerance, a sense of responsibility, fulfilling a Purpose (a calling) and a connection with others through love and service that originates from deep within, living an integrated life, experiencing an inner life and being in community with others. It is part of a central core or essence where people have a profound sense of who they are, where they come from, and where they are going. Aligning one’s inner compass with one’s GPS provide an enormous source of energy, passion, and direction that gives meaning to life and can provide an empowered feeling of success in work and in life.

In other words, the Hidden Champions, Bamboo Innovators and Hoshin entrepreneurs have a soul. In the same way that each of us has an animating energy often called a soul and a physical body through which this soul acts, a business has body and soul. A business has tangible assets in factories, physical facilities, and a collective of people who are generating ideas and coordinating their ways of creating together. This ‘‘soul’’ of business carries the imprint of all the people who are collaborating in the enterprise: the workers, the stockholders, the owners, and the management. The quality of awareness of those who imprint the business will affect everything the business does.

Hidden Champions approach the business with the highest personal quality of awareness and ask the question, ‘‘How can I encourage everyone connected with this enterprise to work from the highest possible level of awareness?’’ This simple shift in focus in turn transforms every aspect of the business. Quality is not merely a material consideration of a product without mistakes; it is an ‘‘extra-material’’ idea that asks for the most imaginative, well-designed, enjoyable, and sustainable product possible. Ethics is not a book of principles to which one retreats in the event of a lawsuit or recall; it is integral to the standard practices of every aspect of the business, how we deal with all the living beings on which business has an impact.

To paraphrase the wisdom of the German revolutionary and American statesman Carl Schutz in the opening quote, like the seafaring man on the desert of waves in choosing to improve the inner quality and Inner Compass of the enterprise in following the GPS (Guiding Principle Star), the Hidden Champions, Bamboo Innovators and Hoshin entrepreneurs expand the capacity of the business for innovation, imagination, collaboration, partnership, and wealth creation – and reach their destiny.

PS1: We like to share our presentation slides in Value Investing Shanghai on March 18-20, 2016 where we highlighted high-conviction investment in Hidden Champions to navigate the volatile markets and that such an investment approach has enabled us to outperform with positive absolute returns vs -15% for the MSCI Asia Index, and our highest portfolio-weighted stock at 36% of our portfolio NAV is up more than 16% in SGD:

http://www.moatreport.com/slides-for-value-investing-shanghai-2016/

Value Investing ShanghaiValue Investing Shanghai Photo

PS2: We like to share our Investor Day Presentation held on 1 December 2015 for our shareholders. The presentation material is available for download on the ASX website:

http://www.asx.com.au/asxpdf/20151102/pdf/432nk9r3hhw4nf.pdf (pg 10-14)

http://www.asx.com.au/asxpdf/20151201/pdf/433hdp24p2twyj.pdf

and our Value Investing Summit 2016 presentation “Quietly Innovating Value with Hidden Champions”:

http://www.moatreport.com/value-investing-summit-2016-quietly-innovating-value-with-hidden-champions/

Warm regards,

KB

The Moat Report Asia

www.moatreport.com

A new monthly issue of The Moat Report Asia is now available!

Access the in-depth idea presentation:

http://www.moatreport.com/members/

In the month of March/April 2016, we investigate an Asian wide-moat innovator who commands a dominant 50-60% domestic market share leadership in a consumer healthcare device and is also the global #3 player and #2 in China (22% market share) where its first China plant in over 80 years is operational in March 2016 after building up strong demand from successful sales in leading online marketplaces JDmall and Alibaba’s Tmall.

Since the launch of its game-changing innovative new consumer healthcare device premium product in April 2015, its TTM Dec 2015 (YE March) sales is up 7.2% and EBIT soared 67.6%. Under the motto of using science to enrich everyday lives, [Company’s name] is a quiet innovator in leveraging upon its accumulated deep material science and chemistry know-how to continuously launch innovative new products, from consumer healthcare device to a pad that helps heal wounds by absorbing moisture, a technology that it adapted from its popular food wrapping film household product, to protective film-coated lining for motorcycle seats where it commands a 90% market share in US.

ROE of this world-class hidden champion is 14.2% and it trades at EV/EBIT 11.7x, EV/EBITDA 8.8x, EV/Sales 1x, a steep discount to its local consumer goods peers who trade at an average of EV/Sales 2.1x, EV/EBIT 20.2x, EV/EBITDA 14.5x, a 64-110% premium over [Company’s name]. Its consumer healthcare device peers trade at an average of EV/Sales 4.36x, EV/EBIT 19.7x, EV/EBITDA 17.2x, a 69-96% premium over [Company’s name]. We think that this steep valuation discount is unjustified given the technical excellence and innovative profile of [Company’s name] and it deserves to trade at a higher premium once there is greater investor awareness when they continue to deliver quality earnings growth with higher ROE which has soared from 6.7% in FY13 (YE March) to 14.2% in the latest TTM Dec 2015 and is expected to climb higher from its underappreciated price premiumisation strategy.

Sales has increased 24% in the past 3-4 years since FY13 and EBIT and OCF (operating cashflow) growth is faster at 168% due to the price premiumisation strategy. With the upcoming China plant operational in March 2016 and the tipping point in its US factory in automotive interior material, we believe [Company’s name] can build on the momentum to generate $120m operating profits and OCF in the next 4-5 years, similar to the profit scale of its domestic consumer goods peers with market cap of $2.2-3.4bn, thus spurring an upward valuation re-rating towards a potential tripling in market cap to cross $2.4bn based on EV/EBIT 20x from its present $850m market cap.

[Company’s name] embodies the best of patient sacrifice and stable capital for longer-term profound investments in business and people, with relentless and eternal pursuit of excellence in perfecting its offering, institutionalizing its craftsmanship and codifying the knowledge to pass from one generation to another. We believe [Company’s name] has hit a tipping point in its business model transformation into a complete integrated global producer of innovative rubber and plastic products with long product lifecycle with both engines in household & lifestyle division and industrial division (automotive interior) revving up to compound growth in a long runway.

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