• 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.

The Scale of Life in Business and Value Investing

“Basically, when you get to my age, you’ll really measure your success in life by how many of the people you want to have love you actually do love you. I know people who have a lot of money, and they get testimonial dinners and they get hospital wings named after them. But the truth is that nobody in the world loves them. If you get to my age in life and nobody thinks well of you, I don’t care how big your bank account is, your life is a disaster. That’s the ultimate test of how you have lived your life. The trouble with love is that you can’t buy it … The only way to get love is to be lovable … The more you give love away, the more you get.”

– Warren Buffett’s address to the Georgia Tech students on his greatest success and greatest failure

“Americans love Volkswagen, and now even more,” US transportation secretary Ray LaHood enthused when he opened Volkswagen’s plant in Tennessee in May 2011, hailing the company’s efficient “clean diesel” engines as the route to long-term energy security in the US.

The simple yet profound comment – “The trouble with love is that you can’t buy it” – made by Warren Buffett when students at Georgia Tech asked him about his greatest success and greatest failure, seemed particularly apt in the wake of the emissions fraud at Volkswagen which exploded last week.

At least 11 million “clean diesel” VW vehicles were outfitted with sophisticated “defeat device” software designed to cheat strict emission tests for the past six years by cleverly putting a lid on emissions during testing in lab conditions, but spewed up to 40 times the legal limit of nitrogen oxide emissions, which creates smog and has been linked to increased asthma attacks and other respiratory illnesses, when not tested. The scandal has wiped more than €24bn ($26.8bn) off VW’s market value and VW faced a fine of up to $16bn in the US alone and a possible criminal investigation.

The fraud was first uncovered in 2014 by John German, a hardworking automotive research engineer who earns a modest salary at a small non-profit organisation dedicated to helping to reduce vehicle emissions. John German carried out a simple test with results that were handed over to the Environment Protection Agency (EPA): checking the car’s emissions on real roads rather than in lab test conditions. John German commented: “VW had a chance to fix the problem, and they continued to try and cheat and do what they had done. That’s just amazing. Companies should realise they might get away with stuff for a little while, but it will catch up with them.”

Last week, we are honoured and grateful to be able to have the opportunity to share our thoughts and to have a sincere and productive conversation with the top management team at the regulatory authority in Singapore 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.  Accounting information can be used to inform – or to deceive. 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.

Public disclosure of the List of companies in the highest risk decile by the five fraud categories (tunneling fraud; grand capex fraud; M&A deals potion fraud; all-in-the-family expense and liability shift; consolidation craftiness fraud) on the regulatory websites to inform and educate public (Financial Literacy 2.0) can (a) prevent harm before fraud happens, and (b) spur the potentially fraudulent firms to act to improve their corporate governance, e.g. return back part of the expropriated “missing cash”, to get themselves off the List. This will also bring about greater efficiency in the overall regulatory system given the limited resources in going after so many fraudulent cases which may occur and implode systematically during poor market and economic conditions (e.g. the reverse merger fraud wave in U.S. that was concentrated in 2011).

We were recently asked a question in a light-hearted way on why does Buffett keep growing money if he “measure your success in life by how many of the people you want to have love you actually do love you”.

Essentially, when one commits to an idea larger than oneself to care for and to serve other people, “wealth creation” takes on a Purpose and meaning, as opposed to opportunistic money gathering through complex financial engineering schemes and tunneling fraud that eventually unwind to harm others. For Buffett-Munger, their idea larger than themselves is manifested in the creation of a focused vehicle Berkshire Hathaway, which compounds not only wealth for shareholders but more importantly, compounds values and virtues as an exemplary role model in the way business is conducted and how they live their life in a simple and frugal way. The Berkshire Hathaway Bus carries more passengers and supporters who get positively energized towards the right direction in the journey of Life in the increasingly harsh and pretentious world…

Interestingly, we had written a positive and uplifting story back in March 2011, the year in which accounting frauds imploded systematically, from Sino-Forest to Longtop Financial Technologies, including the reverse merger fraud wave in US, and the emergence of the likes of Muddy Waters/Carson Block and Sahm Adrangi/Kerrisdale.

A particular quote from the article has reminded once again about the importance for value investors to avoid the seemingly profitable companies who take short-cuts to buy love, those who do not care about the Process to Care and Serve others, those who engaged in complex financial engineering schemes and tunneling fraud that eventually unwind to harm others:

“Commerce is not merely about the measurement of the weight of profits collected in multiple clever transactions to build abstract personal wealth. Only in the endeavour to perform first for customers, and serve them with the highest possible integrity and character, can commerce find its foundation for durable business success and create society’s abundance. The secret at Wal-Mart, Amazon and Vanguard to gaining the “Fu, Lu, Shou” (“Good Fortune, Prosperity, Longevity”) wide-moat compounding success is that the less they take, the more the customer and fund investor make. That is why enterprises designed for the public weal are the quintessential Bamboo Innovators – the bigger it is, the easier, not harder, it gets.”

The Scale of Life in Business and Value Investing

By KEE Koon Boon on 5 March 2011

Commerce would not have progress beyond the barter system without the invention of a system of weights and measures. Before there was the traditional Chinese steelyard (“gancheng”, 杆秤), buyers and sellers eye the heap of goods to determine their weight. It is difficult to achieve a fair trade. With the “gancheng”, the object to be weighed hangs at one end of the beam, while the weights at the other end are slided left or right until a perfect balance of the beam is found. Reading of the mark where the weight-string rests is made to determine the weight of the object. There are 16 markings on the arm of a “gancheng”, such that 16 “qian” in weight is equivalent to 1 “liang” and 16 “liang” is equivalent to 1 “jin” (or 604.79 grams). The Chinese unit of measurement was based on the number 16 instead of 10.

But why 16? The wisdom behind this number will help us understand why Bamboo Innovators Sam Walton of Wal-Mart and Amazon Inc grew stronger and more resilient over time like a bamboo, why Vanguard Group is the world’s largest mutual fund manager with $1.6 trillion in assets under management.

16 is the sum of 7, 6 and 3. 7 stands for the “Beidou Seven-Star Constellation”, which symbolizes the need to have the right direction in our heart when we use the measurement tool to make money and not be too greedy. 6 stands for the directions North, South, East, West, Up, and Down, which cautions us to stay centered in our ethical principles when making money. Lastly, 3 stand for Fu (Good Fortune, 福), Lu (Prosperity, 禄), Shou (Longevity, 寿). When we make money by squeezing one “liang” improperly out of others, we lose “Fu” (损福); wrench two “liang” and we lose “Lu” (伤禄); expropriate three “liang” and we lose “Shou” (折寿). Give money back to the customers and society in a sustainable way and we gain “Fu, Lu, Shou”. Thus, the 16-unit scale is not merely a tool to measure and make money, but more importantly, it is a scale to guide and measure our values in life and in business.

The late retail giant Sam Walton, whom the world’s greatest investor Warren Buffett felt was the greatest CEO of all time, saw the anomaly of retailers overcharging the customers. Sam seeks to correct things by being a champion of the customer with Wal-Mart’s “Everyday Low Prices” by passing along cost savings back to the customers to make better things ever more affordable to people of lesser means. This resulted in Wal-Mart gaining “Fu”, “Lu”, “Shou” and its astounding wide-moat compounding success to over S$200 billion in market capitalization from its initial listing size in 1970 of S$40 million.

Jeff Bezos sacrificed the financial comfort and glamor of his investment banking job to establish Amazon in 1994 with the support of his wife and the life savings of $300,000 from his parents. Now, the internet retailer beats its brick-and-mortar giants at their own game by delivering goods cheaper to its customers. Surveys by Morgan Stanley and Wells Fargo found that Amazon sold a broad range of items 6 to 19 percent cheaper than Wal-Mart. By leveraging its scalable infrastructure and virtuosity in analytics in delivering a dependable and enjoyable customer experience, the customer-centric Amazon has grown bigger more quickly than any company in retail history. Wal-Mart took 27 years to hit $30 billion in sales while Amazon did it in 16 years and its market cap multiplied to nearly $80 billion.

Similarly, John Bogle saw the anomaly of mutual funds charging exorbitant fees to investors for professing to beat the market, when in fact most of them lagged the market benchmark. Bogle set up Vanguard in 1974 to pioneer low-cost index mutual funds for retail investors. By passing back savings to the investors from advisory fee reductions and economics of scale, its low-expense model enables Vanguard to deliver competitive returns without chasing complex risk that they did not understand or respect. Bogle estimated that the costs of securities intermediation in the funds management industry in 2007 are $528 billion. These include sales loads, management fees, operating and marketing expenses, transaction and advisory fees, hidden turnover costs, and soft dollars, and they recur year after year at around 2.5 percent of average assets. Vanguard’s Lion Infrastructure allowed it to have around a 1 percentage point savings, which, when applied to $1.6 trillion of assets, produces savings of $16 billion annually.

Commerce is not merely about the measurement of the weight of profits collected in multiple clever transactions to build abstract personal wealth. Only in the endeavour to perform first for customers, and serve them with the highest possible integrity and character, can commerce find its foundation for durable business success and create society’s abundance. The secret at Wal-Mart, Amazon and Vanguard to gaining the “Fu, Lu, Shou” (“Good Fortune, Prosperity, Longevity”) wide-moat compounding success is that the less they take, the more the customer and fund investor make. That is why enterprises designed for the public weal are the quintessential Bamboo Innovators – the bigger it is, the easier, not harder, it gets.

Bogle shared a meaningful story from Reverend Fred Craddock who was known for his conversational preaching. Craddock, when visiting in the home of his niece, strikes up a conversation with an old greyhound dog.

“I said to the dog, are you still racing?”

“No,” he replied.

“Well, what’s the matter? Did you get too old to race?”

“No, I still had some race in me.”

“Well, what then? Did you not win?”

“I won over a million dollars for my owner.”

“Well, what was it? Bad treatment?”

“Oh, no,” the dog said, “they treated us royally when we were racing.”

“Did you get crippled?”

“No.”

“Then why?” Craddock pressed, “Why?”

The dog answered, “I quit.”

“You quit?”

“Yes,” he said, “I quit.”

“Why did you quit?”

At last, the reason: “I just quit. Because after all that running and running and running, I found out that the rabbit I was chasing wasn’t even real.”

Bogle believed that the rabbit that he has been chasing in his career, which is “essentially giving investors a fair shake in their quest to accumulate assets for a secure future”, is real. It is not the illusory rabbit of success – defined by the measured wealth, fame, and power – but rather the real rabbit of meaning – defined by the immeasurable integrity and virtue.

Yet, there seems to be something missing in the long hard chase for the rabbit of meaning in the asset management industry. Stage 1 is epitomized by fairness in Vanguard’s low-cost business model. Stage 2 requires a sense of caring to inspire the extra level of intensity and dedication in performing for investors. Such performance-based caring is an exacting and demanding business that requires the ablest and most dedicated navigators who truly care.

Yes, the pursuit of a mission that honors society as a whole is painful and requires sacrifice, tough-mindedness and discipline. Then, rather than chasing after that rabbit, finding that it is fake, and quitting in dismay, like the greyhound, it is worthwhile to chase the real rabbit of life and business despite the pain and sacrifice, and then keep running, and running, and running, as hard as we possibly can.

PS: We also like to share with you an article “Scouring Accounting Footnotes to Prevent Tunneling” which we penned for our local newspaper Business Times Singapore that was published on 19 Aug 2015: PDF article link on SMU website. We are honoured to be able to have the opportunity to present to the top management of the regulatory authorities in Singapore about implementing the fact-based forward-looking fraud detection framework in a world’s first for Singapore.

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 September, we investigate a listed Asian family business that has persevered for over fifty years since 1962 in this high-electricity-rates emerging country to sell something that seems risky – air-conditioners and refrigerators to consumers and commercial clients. Led by the capable, down-to-earth third generation leader Mr. C who believe in making available to his countrymen products and services that used to be affordable by only the rich as his family and personal SWFF, [Company’s name] is now the #1 market leader in air-conditioner (36.7% market share) and refrigeration (25.6% market share) which are under-penetrated appliances in the country, with household penetration rates at 6% and 35% respectively, amongst the lowest in Asia where its neighbours have at least twice the penetration rate, representing significant untapped market potential.

Amongst the white good appliances that are disrupted by ecommerce, the sale of aircon and refrigerator remain resilient because they require installation and aftermarket service support. [Company’s name] provides unmatched end-to-end solutions from production to distribution to aftersales services network that spreads across the logistically-challenged country. [Company’s name] has over 90% appliance store coverage nationwide and its unrivalled aftersales service business is supported by over 170 accredited installer companies; over 130 accredited service centers; over 2,000 technicians; rapid sales facilitation and service turnaround from over 1,000 merchandisers deployed at the point of sale; and 8 dedicated parts stores; and a centralized in-house call center, distribution, parts availability/support as well as regional field personnel. Its robust logistics network ensure speedy delivery and fast service response.

In terms of business nature, margins and profitability, [Company’s name] is comparable to India’s Voltas (NSI: VOLTAS), India’s #1 aircon company who is an affiliate of the Tata Group with a 20% market share. [Company’s name] has a much higher and more stable market share than Voltas and generates higher ROE at 23.1% as compared to Voltas’ 18.1%. Yet, [Company’s name] trades at a 140% valuation discount in terms of EV/EBIT and EV/EBITDA at 9x as compared with 21x for Voltas. We think [Company’s name] deserves to command a higher valuation premium for its market leadership in an under-penetrated domestic market, its strong portfolio of synergistic businesses, and its visible long run way to reinvest its profits back into the core business to extend its market leadership and widen the moat. The company has a healthy balance sheet with net cash comprising 26% of book equity due to its integrated business model that has enabled the generation of steady, resilient and growing margins, profits and cashflow and the efficient employment of capital with a 23.1% ROE.

• 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.

Stirring the Soup: Lessons for Value Investors in the Nourishing Growth of Brittania Industries

Who stirs the pot is the most important ingredient in the value creation process of a wide-moat compounder.

This is the illuminating insight in the inspiring book Soup: A Recipe to Nourish Your Team and Culture by Jon Gordon. In the business fable, Nancy, the new CEO of Soup Inc, faced declining sales and low employee morale; the company had lost both flavor and heat and nobody likes lukewarm soup. When Nancy chanced upon the little-known Grandma’s Soup House, she learnt the “stirring” lesson to create a winning culture and team. No matter how carefully different chefs follow the same recipe, the final product always varies a little bit because we can’t separate who stirs the pot from what’s in the pot. As “Grandma” says to Nancy, the one who stirs the pot is the one who impacts the flavor of the soup:

“The love and energy we invest into our life and work determines the quality of it. The love we share in raising our children or developing employees or helping a customer impacts the final product. The love, or lack of love, we give ourselves and share with others will determine whether life is sweet or sour. It determines the fabric and texture of our relationships and how others perceive and receive us. When we love our kids, they feel it. When we stir the pot at work with love, our customers and colleagues notice. Just as soup is a reflection of the soup maker, our lives, careers, and businesses are the reflection of the love and energy that we put forth. Your people are not just a creation of your culture but are creating it every day. They must be encouraged, inspired, and empowered to stir the pot as well, and they must be coached so they are good at it.. If they did it together and poured their heart and soul into making great soup, they would accomplish great things.”

Reading the Soup reminded me of the nourishing growth of Brittania Industries (NSI: BRITTANIA, MV $5.46bn), India’s leading biscuit and confectionery maker who had compounded over 400% since the “soup-stirrer” Varun Berry joined in Jan 2013 as COO and took over the CEO/MD leadership baton from veteran Vinita Bali (2006-13) in Apr 2014. Prior to joining Britannia, Berry was the CEO of Pepsico Foods for South Asia.

Britannia is one of India’s oldest FMCG companies which was set up in Kolkata in 1892 with an initial investment of Rs295. The company started its own distribution network in 1975, taking over from Parry’s. Britannia listed in 1978. After being owned by Nabisco for most of the 1980s, Britannia was acquired by Rajan Pillai towards the end of 1989. In 1921, Britannia imported machinery and becomes the first company East of the Suez to use gas ovens. In 1993, the Nusli Wadia group and Danone became joint owners of the company. After a highly acrimonious ownership tussle in the interim, Danone sold its 25.5% holding for $200m to the Nusli Wadia group in 2009 who now controlled over 51% of Britannia. Britannia also subsequently bought out Fonterra, its joint venture partner in its dairy business. Britannia’s market reach spans 3.5m outlets across India, of which 1m outlets are served directly by the company. Britannia’s major five brands are “Good Day” (premium-priced), “Nutrichoice” (premium-priced), “Marie Gold” (mid-priced), “50:50” (mid-priced), “Tiger” (low-priced) and amongst its portfolio of biscuits (74% of sales, #1 with 35% market share in volume and 28% in value terms vs 30% for Parle), bread (9%, #1 with 50% market share), cake (5%), rusk and a range of dairy products (5%) that include cheese (#2 with 20% market share behind unlisted state cooperative Amul), curd, and specially formulated functional beverage with a dairy base.

Before Britannia was a “hot soup”, it has been struggling under the shadows of unlisted leader Parle, Mondelez/ Kraft, Nestle India who have equally strong, if not better, distribution reach in India and have more iconic brands. Giant ITC had also entered the biscuit market in 2006, proving to be a formidable and serious rival in targeting premium products and eating up the market share of leader Parle, garnering a 15% market share. Britannia’s products have largely been “me-too” versions of global brands.

Britannia Industries (NSI: BRITANNIA) vs Nifty Index – Stock Price Performance, 1994-2015 (top) and Jan 2013-2015 (bottom)

According to industry sources, Sunil Alagh was instrumental in strengthening “Brand Brittania”. An expert in marketing, Alagh was focused on investing in brand building and innovation, with his tenure witnessing the launch of Good Day, Tiger, 50:50, Little Hearts and the Treat portfolio. Most of these brands are the key pillars of Brittania’s biscuit portfolio today. Vinita Bali, according to industry sources, was more focused on building operational efficiencies within the company. Bali shifted the emphasis to cost control from building on its investments in branding and gaining in market share. In FY06, Britannia had an approximately 6% point lead over Parle in market share (in value terms). But, Parle had beaten the company in the volumes game with its mass-market glucose biscuit Parle-G. By 2010, the tables had turned with Parle establishing a 6-7% point lead over Britannia in market share in value terms. Under Bali’s tenure, Britannia lost its place as the value market leader in biscuits to Parle. Also, its EBITDA margins contracted from 11.4% in FY04 to 4.3% in FY10, before recovering to 6.8% in FY13 when Varun Berry joined. Britannia achieved 14.3% EBITDA margin in Q1FY16.

Despite its flaws, Brittania is known for its big marketing interventions and programmes. At one point, almost half the Indian cricket team’s players used bats that sported the Britannia logo. Britannia is one of the few brands that continue to have an Indian ethos and flavour.

With Varun Berry stirring the soup at Brittania, the company refocused its energy and Love back into making innovative products and operational improvements were targeted in realizing this Purpose. Brittania has rationalized nearly 100 SKUs (60 in biscuits, 40 in dairy) to drive a sharper focus on a profitable and scalable portfolio. The idea behind this move is to take a longer-term approach across cost lines with a view to making the entire operations more focused and driving manufacturing costs lower. Under Bali, Britannia had a long tail of products although five major brands drive the majority of revenue. Berry brought more focus on key brands and new innovations including premium cookies, capturing 40% of the healthy snack market with its biscuit brand Nutrichoice (with variants such as Oats & Millet based biscuits, sugar-free crackers and diet biscuits). With enhanced nut content and crunchiness in Rs5-pack, rural school kids are observed to be excited by the innovative new Good Day products that they pool money with their friends to pick up larger packs of premium cookies so they can try them. Britannia’s plan is to be present across all villages in India by 2018. Good-Day, which has a 70% share of the premium cookies market, had a new logo resembling a smile and packaging design in Aug 2015, as well as a new ad film that highlights the newness of the cookie brand and urges people to enjoy the small moments in everyday life and to spread optimism and happiness.

A key operational strategy to widen its moat is to…

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Read more at the Moat Report Asia: http://www.moatreport.com/updates/

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In the Soup, Nancy, the CEO of Soup Inc, hand out a wooden spoon to every employee and every family member, reminding everyone that to be a great company, they needed everyone in the room to stir the pot. If they did it together and poured their heart and soul into making great soup, they would accomplish amazing things:

“Who stirs the pot is the most ingredient in the soup. Just do your best and stir the pot with love!”

People are hungry for positive change and a fresh sense of purpose and passion. In the story at both the Soup and Brittania, the value investor will find themselves doing well in sensing an important observation: whether the stirrer of the soup pot is able to put the recipe together and bring together the key ingredients to unite, engage, and inspire his or her team and create a culture of engagement and greatness.

Are you able to see the empowered soup-stirrers holding their wooden spoons in Britannia and the wide-moat compounders that you wish to invest in with high conviction?

PS: We also like to share with you an article “Scouring Accounting Footnotes to Prevent Tunneling” which we penned for our local newspaper Business Times Singapore that was published on 19 Aug 2015: PDF article link on SMU website. We are honoured to be able to have the opportunity to make an upcoming presentation on 23 September to the senior management of the regulatory authorities in Singapore about the fact-based forward-looking fraud detection framework.

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 September, we investigate a listed Asian family business that has persevered for over fifty years since 1962 in this high-electricity-rates emerging country to sell something that seems risky – air-conditioners and refrigerators to consumers and commercial clients. Led by the capable, down-to-earth third generation leader Mr. C who believe in making available to his countrymen products and services that used to be affordable by only the rich as his family and personal SWFF, [Company’s name] is now the #1 market leader in air-conditioner (36.7% market share) and refrigeration (25.6% market share) which are under-penetrated appliances in the country, with household penetration rates at 6% and 35% respectively, amongst the lowest in Asia where its neighbours have at least twice the penetration rate, representing significant untapped market potential.

Amongst the white good appliances that are disrupted by ecommerce, the sale of aircon and refrigerator remain resilient because they require installation and aftermarket service support. [Company’s name] provides unmatched end-to-end solutions from production to distribution to aftersales services network that spreads across the logistically-challenged country. [Company’s name] has over 90% appliance store coverage nationwide and its unrivalled aftersales service business is supported by over 170 accredited installer companies; over 130 accredited service centers; over 2,000 technicians; rapid sales facilitation and service turnaround from over 1,000 merchandisers deployed at the point of sale; and 8 dedicated parts stores; and a centralized in-house call center, distribution, parts availability/support as well as regional field personnel. Its robust logistics network ensure speedy delivery and fast service response.

In terms of business nature, margins and profitability, [Company’s name] is comparable to India’s Voltas (NSI: VOLTAS), India’s #1 aircon company who is an affiliate of the Tata Group with a 20% market share. [Company’s name] has a much higher and more stable market share than Voltas and generates higher ROE at 23.1% as compared to Voltas’ 18.1%. Yet, [Company’s name] trades at a 140% valuation discount in terms of EV/EBIT and EV/EBITDA at 9x as compared with 21x for Voltas. We think [Company’s name] deserves to command a higher valuation premium for its market leadership in an under-penetrated domestic market, its strong portfolio of synergistic businesses, and its visible long run way to reinvest its profits back into the core business to extend its market leadership and widen the moat. The company has a healthy balance sheet with net cash comprising 26% of book equity due to its integrated business model that has enabled the generation of steady, resilient and growing margins, profits and cashflow and the efficient employment of capital with a 23.1% ROE.

• 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.

The Energy Bus: Lessons for Value Investors in the Transformational Story of Ajanta Pharma

“I am not bound to win, I am bound to be true.

I am not bound to succeed, but I am bound to live up to the light that I have.”

– Abraham Lincoln, sixteenth President of the United States of America who saved the Union during the American Civil War and emancipated the slaves

Battling clinical depression. Two bankruptcies. Death of fiancée, son and father.

A seeming failure at the age of 51, one cannot help but marvel at the man who summoned his courage and strength to overcome all these adversities to take on the responsibilities as the President of the United States and unify the country.

No one goes through life untested and the answer to these tests is Energy. In his inspiring book “The Energy Bus”, Jon Gordon shared the story of Abraham Lincoln waiting for Civil War battle reports to come in, not knowing if his country was one step closer to unification or destruction. Gordon likened Lincoln’s feeling of time inching by to that of us wondering and waiting who will board our Energy Bus in the journey of Life and who would stay off it. An important rule, Gordon illustrates, is to “Drive With Purpose”. Purpose is the ultimate fuel for our journey through life. When we drive with purpose we don’t get tired or bored and our engines don’t burn out. Abe’s opening quote “I am bound to be true; I am bound to live up to the light that I have” illuminates his Purpose to emancipate the slaves and unify the country. Rather than vilify people opposed to slave emancipation, Lincoln sought to comprehend their position through empathy; the Purpose was not to defeat his opponents but to heal them of their false beliefs. Purpose is the fuel that energizes himself and the people around him to board his Energy Bus to drive transformation.

Ajanta Pharma (NSI: AJANTHPHARM) vs Nifty – Stock Price Performance, 2000-2015

Reading The Energy Bus obliquely reminded me of the transformational story of India’s Ajanta Pharma (AJP IN, MV $1.87bn). In The Energy Bus, the life of the protagonist George was in shambles: his marriage was at risk, his job was threatened. Similarly, when the Agrawal brothers joined their family firm, it was in shambles, like the life of George. Like Lincoln’s empathy – the ability to put himself in the place of another, to experience what they were feeling and to understand their motives and desires – which gave him the power to forecast with uncanny accuracy what people were likely to do, the value investor will be able to better appreciate the deeper thoughts expressed by Rajesh Agrawal, the second generation leader who joined the family business in 2000 when the company was listed in the same year. Rajesh said, “When I joined Ajanta in 2000, and realised what was going on, I wanted to run away. I thought to myself, ‘Why did I return from the US? I could have had a job there. It was tough in the beginning, especially the situation with creditors and debtors.”

The Mumbai-based Ajanta — set up in 1973 by three brothers, Mannalal, Purushottam and Madhusudan Agrawal — had been incurring huge losses for many years. In 2001-2002, it reported a consolidated loss of Rs 1 crore ($0.15m) and by the following year, it was reeling under a debt burden of Rs 130 crore ($19.6m). Together, Mannalal’s sons Rajesh and his elder brother Yogesh, transformed the debt-laden Ajanta into an extraordinary compounding story that has seen an over 60-fold growth in market value. How the second-generation Agrawal brothers drive transformation by getting everyone on board their Energy Bus offers timeless lessons for value investors to also board the Energy Bus early to participate in the compounding journey.

Before investigating the story of Ajanta, we have the privilege of interacting recently with a thoughtful, low-profile and accomplished Indian value investor Mr. M. Through our conversations, we are able to sense Mr. M’s values towards investing and life and he also provided value investors a powerful thought-provoking insight and a potential structural mispricing opportunity that bears emphasis:

“I have come across quite a few instances, where in initial days, management may have resorted to some not so kosher practices but as it grew in size / found the runway much bigger than it anticipated, grew in confidence, grew in management bandwidth, and gradually became very professional, transparent and dependable.”

Interestingly, Mr. M went on to cite various such examples, including Ajanta Pharma and five other companies in his investing universe. In an earlier Weekly article “Keepers of the Flame: Revisiting the Origins of Compounders in India and Asia”, we had previously discussed about Mr. M’s idea – in the opposite light, in that there are increasingly groups of entrepreneurs who did not start out wanting to be fraudulent, but turned to the dark side as things got tough. This is the opposite scenario of Mr. M’s insight of entrepreneurs emerging from the dark side of Extractors to the warm glow in the land of the Compounders:

“Value investors in Asia cannot look purely at quant “valuation” metrics since many business models and moats are “permanently impaired” and these stocks are the fertile ground for momentum traders and nefarious insiders who have the incentive and power to manipulate prices and volumes. Value investors who attempted to invest in these statistically cheap stocks in Asia have found themselves facing deadweight losses in their portfolio. We observed firsthand how some business owners grew to become either contented with what they have achieved or disillusioned with their core business, straying to seek “growth” for their private interests such as property development, or simply numbing/”exciting” their senses with destructive lifestyle at the casinos while treating both their listed business vehicles as a personal ATM and their employees as disposable expenses rather than as valuable intangible assets. The listed companies belonging to the latter group become dangerous value traps; some even slipped into conniving with “syndicates”. Financial numbers were “propped up” artificially with the prospects of sexy growth projects to lure in funds from investors and the studiously-assessed asset value has already been “tunnelled out” or expropriated. Western-based accounting fraud detection tools and techniques have not been adapted to the Asian context to avoid these traps. And we have seen how the perpetrators go away scot-free and live a life of super luxury on minority investors’ hard-earned money. When investors have knowledge in their hands, we have a choice to stay away from these people and away from temptations and do the things that we think are right. With knowledge, we have a choice to invest in the hardworking Asian entrepreneurs and capital allocators who are serious in building a wide-moat business.”

Before we explore the story of Ajanta to sieve for the timeless insights to identify similar compounders, below is a reproduction of some excerpts of our conversation with Mr. M:

—–Original Message—–

From: Kee Koon Boon

To:

Sent: Thursday, 10 September 2015 11:27 PM

There is one word that I have learnt from the Godrej Group management when I visited India (Mumbai/Delhi/Pune) in 2013: Antevasin (अंतेवासिन्). It is a Sanskrit word for “border-dwellers”, a term used at Godrej where the leaders refer to the Group’s position today as “antevasin”, border-dwellers walking the line of trust, integrity and humility on which they have built their credibility. Antevasin is about learning which is far from the safe horizons, a learning which brings you face front to the ground reality. Antevasin is about leaving the bustling center of worldly life to go live at the edge where the Truth dwells closer. That simmering line between your old thinking and new understanding, always in a state of learning. An antevasin is also a scholar who lives in the sight of two worlds, but is looking towards the unknown, just as the value investor is cognizant of the two worlds of the wide-moat Compounders Vs the fraudulent Extractors and is guided by knowledge and teamwork to distinguish between the value creators and destroyers.

Sent: Friday, 11 September 2015 10:37 PM

From:

To: Kee Koon Boon

Wonderful to get your very insightful mail. “Antevasin” is a concept known to me for a long time …. It is a person who is neither fully a family / household / material man nor a fully transcended and self-realised individual, but a person constantly seeking for higher truth, more integrated truth and truth about his “believed and socially conditioned moral codes” with honesty, dedication and hard work. Trust in self, trust in his spiritual teacher and simplicity are the key characters of a true “antevasin”, the dwellers in the border of material and eternal truth.

I am fully aligned to your approach of separating wheat from the “ocean of chaff” prevalent in the Indian equity market. My 18 years of investment experience in Indian market has taught me that Indian market is quite fast in recognising the wheat and value it appropriately in a very short span of time. Conversely, a chaff, however fancied, slowly falls back to the place it actually deserves. But at the same time, I must say, I have come across quite a few instances, where in initial days management may have resorted to some not so kosher practices but as it grew in size / found the runway much bigger than it anticipated, grew in confidence, grew in management bandwidth, and gradually became very professional, transparent and dependable. I can site quite a few examples like Shilpa Medicare (SLPA IN, MV $553m), Welspun India (WLSE IN, MV $1.3bn), IFB Industries (IFBI IN, MV $274m), Avanti Feed (AVNT IN, MV $388m), Suprajit Engineering (SEL IN, MV $243m), Ajanta Pharma (AJP IN, MV $1.87bn) and few more from my own investment universe. One needs to have patience, understanding of the business and feel from the ground to be really successful in Indian market.

And yes, like an “antevasin” one need to remain away from the crowd, clutter and noise but not so far away as to miss the news, developments, changes happening in society, in business, in invested companies and new emerging opportunities.

********

Second-generation leaders Rajesh and Yohesh Agrawal transformed Ajanta by driving with Purpose, adopting a slightly unconventional approach of not following time-tested business models. The Agrawal brothers…

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Read more at the Moat Report Asia: http://www.moatreport.com/updates/

********

In The Energy Bus, the life of the protagonist George was in shambles: his marriage was at risk, his job was threatened. When his car had a flat tyre, George was forced to take the bus to work. And he meets with a unique kind of bus driver called Joy and an interesting cast of characters who shared with him the rules for approaching life and work and transform him. As the author Jon Gordon says,

“Everything happens for a reason. Don’t forget that. Every person we meet. Every event in our life.  Every flat tire happens for a reason. You can choose to ignore it or ask what the reason is and try to learn from it. Every problem has a gift for you in its hands as my man Richard Bach says. You can choose to see the curse or the gift. And this one choice will determine if your life is a success story or one big soap opera.”

When the Agrawal brothers joined their family firm, it was in shambles, like the life of George. Perhaps the crisis happens for a reason – it forces change and transformation. The brothers choose to be the driver of their bus, re-energizing Ajanta with a Purpose, adopting a slightly unconventional approach of not following time-tested business models.

Jon Gordon illuminated the insight that for the Energy Bus to keep moving forward and expand so as to always be able to add more people, it is important to “Love Your Passengers”. Love takes time. It’s a process not a goal. Love focuses on bringing out the best in each person on your team. When you love someone you want the best for him. You want him to shine. Gordon shared five ways to love your passengers:

1. Make time for them
2. Listen to them.
3. Recognize them.
4. Serve them. – A great leader once said, the higher you get in an organization the more it is your duty to serve the people below you rather than having the people below serve you.
5. Bring out the best in them.

Value investors will do well to identify and invest in wide-moat compounders by hopping on their Energy Bus early to enjoy the ride by evaluating whether the driver drives with a Purpose, that he or she has the desire, vision and focus to move the bus in the right direction and above all, they love their passengers.

PS: We also like to share with you an article “Scouring Accounting Footnotes to Prevent Tunneling” which we penned for our local newspaper Business Times Singapore that was published on 19 Aug 2015: PDF article link on SMU website. We are honoured to be able to have the opportunity to make an upcoming presentation on 23 September to the senior management of the regulator in Singapore about the fact-based forward-looking fraud detection framework.

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 September, we investigate a listed Asian family business that has persevered for over fifty years since 1962 in this high-electricity-rates emerging country to sell something that seems risky – air-conditioners and refrigerators to consumers and commercial clients. Led by the capable, down-to-earth third generation leader Mr. C who believe in making available to his countrymen products and services that used to be affordable by only the rich as his family and personal SWFF, [Company’s name] is now the #1 market leader in air-conditioner (36.7% market share) and refrigeration (25.6% market share) which are under-penetrated appliances in the country, with household penetration rates at 6% and 35% respectively, amongst the lowest in Asia where its neighbours have at least twice the penetration rate, representing significant untapped market potential.

Amongst the white good appliances that are disrupted by ecommerce, the sale of aircon and refrigerator remain resilient because they require installation and aftermarket service support. [Company’s name] provides unmatched end-to-end solutions from production to distribution to aftersales services network that spreads across the logistically-challenged country. [Company’s name] has over 90% appliance store coverage nationwide and its unrivalled aftersales service business is supported by over 170 accredited installer companies; over 130 accredited service centers; over 2,000 technicians; rapid sales facilitation and service turnaround from over 1,000 merchandisers deployed at the point of sale; and 8 dedicated parts stores; and a centralized in-house call center, distribution, parts availability/support as well as regional field personnel. Its robust logistics network ensure speedy delivery and fast service response.

In terms of business nature, margins and profitability, [Company’s name] is comparable to India’s Voltas (NSI: VOLTAS), India’s #1 aircon company who is an affiliate of the Tata Group with a 20% market share. [Company’s name] has a much higher and more stable market share than Voltas and generates higher ROE at 23.1% as compared to Voltas’ 18.1%. Yet, [Company’s name] trades at a 140% valuation discount in terms of EV/EBIT and EV/EBITDA at 9x as compared with 21x for Voltas. We think [Company’s name] deserves to command a higher valuation premium for its market leadership in an under-penetrated domestic market, its strong portfolio of synergistic businesses, and its visible long run way to reinvest its profits back into the core business to extend its market leadership and widen the moat. The company has a healthy balance sheet with net cash comprising 26% of book equity due to its integrated business model that has enabled the generation of steady, resilient and growing margins, profits and cashflow and the efficient employment of capital with a 23.1% ROE.

• 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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Rising Strong: Lessons for Value Investors in The Turnaround Story of Bata India

“The truth is that falling hurts. The dare is to keep being brave and feel your way back up.”

– Brené Brown in Rising Strong

Fall. Get up. Try again. Rising strong after a fall is how we cultivate wholeheartedness. The process of regaining our footing in the midst of struggle is where our courage is tested and our values are forged. It’s the process that teaches us the most about who we are. This is the inspiring message in the new book “Rising Strong” by Brené Brown, author of “Daring Greatly: How the Courage to Be Vulnerable Transforms the Way We Live, Love, Parent, and Lead”.

As economic conditions in China and emerging markets worsen, more Asian companies turned into the dreaded “earnings torpedo” in investors’ portfolios with weaker than expected results that led to plunges in share prices. How companies can bounce back to turnaround with sustainable performance is of paramount importance to “value investors” who tend to succumb to the disposition effect of riding losers for too long (because firm valuation metrics were thought to be getting “cheaper” as prices fell, but were in fact value traps) and selling winners too early.

The turnaround story of Bata India (NSI: BATAINDIA, MV $997m) after three consecutive years of losses to generate over 1,000% returns when it regained its footings bears timeless lessons for value investors to distinguish between the alluring value traps in which the cheap gets cheaper and the sustainable turnaround story.

Bata India (NSI: BATAINDIA) vs Nifty – Stock Price Performance, 2005-2015

Why is Bata India an interesting case? We have received feedback from some institutional investors about our Monthly Riddle article last week in which we investigated a listed Asian family business who is a wide-moat HVAC (heating, ventilation and air-conditioning) specialist that dominates in its domestic market and continuously innovates to “make available to the masses expensive products and services that used to be affordable by only the rich”. Our astute successful subscribers, who care very much about the knowledge and process that generates investment returns, pointed out the compounding power of investing in wide-moat companies that bring a rich man’s lifestyle, products and services affordable to the masses: Wal-Mart, Ford/Toyota, Charles Schwab, etc.

Bata’s shoe empire and brand heritage dates back to 1894, the year it was founded in Zlín, Moravia, (then the Austro-Hungarian Empire, today the Czech Republic) by Tomáš Baťa, his brother Antonín and his sister Anna, whose family had been cobblers for generations. Bata’s India operations commenced in 1931 and is India’s oldest and largest shoe retailers. Despite its illustrious brand heritage, Bata India struggled to regain its brand relevancy amongst consumers who increasingly find the brand to be stale. Bata India suffered three consecutive years of losses from 2002-04: Rs74m in 2002, Rs261m in 2003, Rs629m in 2004. What used to be a stable ship is sinking.

How did the Bata India management turnaround the company with key initiatives in 2005 to compound over 10-folds to a market value of nearly a billion dollars? During the initial years of Bata India in embarking the turnaround plan, many investment experts say it is a typical case of too little and too late and that the company is doomed. Understanding the fundamental dynamics and assessing the management ability of such “Rising Strong” companies in turnaround situations is important in our journeys to become better value investors. To do so requires traveling back in time to the company’s history to uncover its “Beginner’s Mindset”, which is also the underlying source of the economic moat and the origination power to overcome adversities and bounce back stronger each time round.

The “complete value investor” – a term that Tren Griffin used to describe Charlie Munger in his thought-provoking book “Charlie Munger: The Complete Investor” illustrating how Buffett’s influential partner and Berkshire Hathaway’s visionary vice-chairman utilizes a set of interdisciplinary mental models to avoid the common pitfalls of bad judgment – would discover that the Bata Shoe Company faced multiple challenges and setbacks in its early days and yet it was able to rise stronger each time round. But what exactly was that origination power?

It is the summer of 1895 and Tomáš Bata found himself facing financial difficulties, and debts abounded. To overcome these serious setbacks, Tomáš decided to sew shoes from canvas instead of leather. This type of shoe became very popular and helped the company to grow. Four years later, Bata installed its first steam-driven machines, beginning a period of rapid modernization. In 1904 Tomáš Baťa introduced mechanized production techniques that allowed the Bata Shoe Company to become one of the first mass producers of shoes in Europe. Its first mass product, the “Batovky,” was a leather and textile shoe for working people that was notable for its simplicity, style, light weight and affordable price. Value investors, check the box in the Mungerian mental model: does the company continuously innovate to make available to the masses expensive products and services that used to be affordable by only the rich?

In the global economic slump that followed World War I, the newly created country of Czechoslovakia was particularly hard hit. With its currency devalued by 75%(!), demand for products dropped, production was cut back, and unemployment was at an all-time high. Tomáš Baťa responded to the crisis by cutting the price of Bata shoes in half. The company’s workers agreed to a temporary 40% reduction in wages; in turn, Bata provided food, clothing, and other necessities at half-price. Importantly, he also introduced the industry’s first profit sharing initiatives transforming all employees into associates with a shared interest in the company’s success (today’s equivalent of performance-based incentives and stock options). Consumer response to the price drop was dramatic. While most competitors were forced to close because of the crisis in demand between 1923 and 1925, Bata was expanding as demand for the inexpensive shoes grew rapidly.

Soon Baťa found himself the fourth richest person in Czechoslovakia with his value-for-money shoe empire. In 1932, at the age of 56, Tomáš Baťa died in a plane crash during take off under bad weather conditions at Zlín Airport. Control of the company was passed to his half-brother, Jan, and his son, Thomas John Bata, who would go on to lead the company for much of the twentieth century guided by their father’s moral testament: the Bata Shoe company was to be treated not as a source of private wealth, but as a public trust, a means of improving living standards within the community and providing customers with good value for their money.

Fast forward to 1973 in India. Tomáš visited India in the late 1920s to source rubber and leather for his footwear factories. He saw a number of barefoot Indians and realized there was a huge market in the subcontinent, too. The Indian shoe market in the 1930s was dominated by more expensive Japanese imports. He vowed to make affordable footwear for the masses. So the Bata shoe organization set up a factory in Konnagar, near Calcutta, in 1931, and later moved to Batanagar near Kolkata. The first India-made shoe machine was produced by Bata in 1942. In 1952 it set up one of the largest tanneries in Asia. When Bata listed stock in its India unit in 1973, it was the subcontinent’s market leader, churning out more than 40 million pairs of rubber, canvas and leather shoes and employing 22,000 people, including craftsmen, designers and chemists. The 1973 prospectus proclaimed that Bata’s mass production had brought about “a standardization in size, quality, pricing, etc., which was unique in India. Shoemaking … had become scientific, modern and sophisticated.” It even exported its shoemaking machines. The Indian market was promising. Per capita footwear consumption had soared all the way from 0.35 pairs in 1961 to 0.52 pairs in 1971.

But by the 1990s, as India was finally opening up to the rest of the world, the trusty Bata brand was besieged by labor union troubles, intense competition from smaller players and a misguided strategy to offer higher-priced footwear–took a battering. Reports of nepotism and corruption were rife. Headquarters tried turnarounds to repair an image that by the early 2000s was marred by shortened store business hours (stores closed at 7 p.m. and were not open on Sundays), rude retail staff and sparse merchandising, but Indians walked away. The problems worsened with the “earnings torpedo” and three consecutive years of losses during 2002-04.

Bata India now sells 50 million pairs a year and has doubled revenues in the last five years to $349m through store additions and renovations plus brand extensions to scarves, bags, sunglasses and belts. Last year it opened India’s largest–at 20,000 square feet–footwear store at Mumbai’s upscale Viviana Mall. The quality of retail ambience has upgraded; the stores now look contemporary and the product range has expanded. Bata India also has a strong distribution network with a footprint of nearly 1,300 stores across 500 cities where dealers buy from Bata on cash-and-carry basis and no inventory is owned by the company. Bata has around 8% share in the organised footwear market in India. The organised sector accounts for 30% of the total footwear industry.

India is back among the top three revenue-generators for the $2.5bn-revenue Swiss parent Bata. South Asia, including India, Pakistan, Bangladesh and Sri Lanka makes up more than $600m in total revenues for Bata and accounts for more than 40% of the stores in the Bata universe. While it has 1,300 stores in India it counts up to 410 stores in Pakistan: 264 in Bangladesh and 65 in Sri Lanka. Bata India is currently 53% owned by the privately-held Swiss parent, which runs 5,000 stores across 90 countries. The founder’s grandson–Thomas George Bata–chairs the global corporation.

Spearheading the growth of Bata India is Rajeev Gopalakrishnan: ”We are making Bata young, fresh, trendy and affordable. I want Bata India to be at $1bn in revenue in the next five years”. This means a tripling in revenues, capitalizing on India’s rapidly growing middle class, the increasing number of women in the workforce and an evolving rural market. Per capita footwear expenditure is expected to go from $6.3 in 2013 to $11.6 by 2017. Bata in India now sells footwear ranging in price from $5 to $160 and Gopalakrishnan also consciously pushing it upscale–practically removing lower-end rubber slippers in favor of leather. Sports shoes is a promising niche in smaller towns, where the first-time buyer is more likely to try on a Power (Bata’s brand) rather than Nike or Adidas. Geographically, too, Bata is filling out its presence in central India after years of strength in the north and south.

So what really happened in 2005 for Bata India? Small outlets and bleeding properties were closed and new remodelled large-format stores were opened. A graded choice of products was offered to diverse consumer segments. And in a major break from the past, it has extended its working hours, and stays open on Sundays. But importantly, in 2005, Bata India went back to its roots to drive entrepreneurial spirit by implementing a unique “K-Scheme”….…

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Thus, the K-Scheme fosters meritocracy and creates a strong sense of responsibility and involvement across the retail network with the performance incentive structure and career progression opportunity offered to outperforming retail employees. Bata India’s Gopalakrishnan commented: “The objective of the brand has always been to deliver the contemporary and aspirational range of products to the consumers at a high quality and affordable value. It gives us immense pleasure to welcome new consumers and loyal customers at our stores and offer an enriching experience with great customer service. We aim to deliver better than the best in future as well.”

The “Rising Strong” process for value investors to evaluate the sustainability and scalability of “turnaround stocks” is illuminated by Bata’s entrepreneurial pledge: “Be courageous. The best in the world is not good enough for us. Loyalty gives us prosperity & happiness. Work is a moral necessity!” By revitalizing the entrepreneurial roots of founder Tomáš Baťa who introduced the industry’s first profit sharing initiatives transforming all employees into associates with a shared interest in the company’s success, Bata India is able to rediscover its “Beginner’s Mindset”, the origination power to stay resilient and rebound from adversities and challenges, just like the Bamboo Innovator who bend and not break, even in the wildest of storms that would snap the might resisting oak tree.

PS: We also like to share with you an article “Scouring Accounting Footnotes to Prevent Tunneling” which we penned for our local newspaper Business Times Singapore that was published on 19 Aug 2015:

PDF article link on SMU website

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 September, we investigate a listed Asian family business that has persevered for over fifty years since 1962 in this high-electricity-rates emerging country to sell something that seems risky – air-conditioners and refrigerators to consumers and commercial clients. Led by the capable, down-to-earth third generation leader Mr. C who believe in making available to his countrymen products and services that used to be affordable by only the rich as his family and personal SWFF, [Company’s name] is now the #1 market leader in air-conditioner (36.7% market share) and refrigeration (25.6% market share) which are under-penetrated appliances in the country, with household penetration rates at 6% and 35% respectively, amongst the lowest in Asia where its neighbours have at least twice the penetration rate, representing significant untapped market potential.

Amongst the white good appliances that are disrupted by ecommerce, the sale of aircon and refrigerator remain resilient because they require installation and aftermarket service support. [Company’s name] provides unmatched end-to-end solutions from production to distribution to aftersales services network that spreads across the logistically-challenged country. [Company’s name] has over 90% appliance store coverage nationwide and its unrivalled aftersales service business is supported by over 170 accredited installer companies; over 130 accredited service centers; over 2,000 technicians; rapid sales facilitation and service turnaround from over 1,000 merchandisers deployed at the point of sale; and 8 dedicated parts stores; and a centralized in-house call center, distribution, parts availability/support as well as regional field personnel. Its robust logistics network ensure speedy delivery and fast service response.

In terms of business nature, margins and profitability, [Company’s name] is comparable to India’s Voltas (NSI: VOLTAS), India’s #1 aircon company who is an affiliate of the Tata Group with a 20% market share. [Company’s name] has a much higher and more stable market share than Voltas and generates higher ROE at 23.1% as compared to Voltas’ 18.1%. Yet, [Company’s name] trades at a 140% valuation discount in terms of EV/EBIT and EV/EBITDA at 9x as compared with 21x for Voltas. We think [Company’s name] deserves to command a higher valuation premium for its market leadership in an under-penetrated domestic market, its strong portfolio of synergistic businesses, and its visible long run way to reinvest its profits back into the core business to extend its market leadership and widen the moat. The company has a healthy balance sheet with net cash comprising 26% of book equity due to its integrated business model that has enabled the generation of steady, resilient and growing margins, profits and cashflow and the efficient employment of capital with a 23.1% ROE.