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Can You Guess This Asian Wide-Moat Company?

The Asian Innovator’s DNA Powering Robots, Drones, Automobiles, Medical Equipment, Smart Grid and Green Energy

Amazon’s mobile army of KIVA cargo-carrying robots cruising in the complex automated warehouses need this product inside them in order to function. So too for Amazon’s hordes of unmanned aerial vehicle (UAV) or drones to deliver packages – without this product, airplanes, spaceships cannot fly, the best electronic device cannot function.

This month of November/December, we investigate an Asian-listed wide-moat innovator who is the leading designer and maker of this product that is critical for Amazon’s robots and drones, and wide-range of high-value-add end-applications, from medical equipment, automotive, green energy (wind power generator/turbine and solar power), industrial control, communications products to internet-of-things, to function properly.

Clients are very strict about product quality as this product is critical in transmitting signals and power and hence they have to be highly reliable; shock-resistant; and withstand high voltage, fire, water, bending/extension, UV rays, grease, chemical solvents, and low temperature; in order to operate for extended periods of time, resulting in long-term customer loyalty and representing high market entry barrier.

Customers are mainly global MNC leaders. Top client is GE, contributing 5.1% of sales in FY14. 70% of GE’s medical equipment already uses its products and solutions. Top ten clients account for <30% of sales and a well-diversified quality MNC customer base reduces the operational risk from dependence from having a single key client. New high-growth products include robotics products used in automated warehouses which have seen an increase in construction due to the rise in online shopping and customers include Amazon and Alibaba. The company was founded in 1989 by Mr. W who was a former math teacher and had honed his skills as a sales manager for the American MNC who is the world’s largest maker of this product.

The company offers a one-stop solution for R&D, design, vertically-integrated manufacturing capabilities in molding, in-house tooling, component sourcing and assembly of finished goods, similar to giant Hon Hai’s famous eCMMS model. It is capable of taking orders for customized products, turnkey projects and a total solution from international brand-name clients and its flexible production facilities and know-how offer customers high-mix & low-volume services.

The company’s industrial business has received notable orders and long-term contracts from a major US client for FY2016-17 for power-saving equipment and will start shipping smart-grid monitoring module application orders in FY2016. [Company’s name]’s smart-grid devices enable distribution feeder voltage regulation control and power-saving mode, detecting user’s utilization of electronic energy, and help them save about 20% of electricity use per year, taking power from low-use clients and supplying more to higher users. The system saves on power waste for the end-users too; for example, in a shopping mall, the equipment detects where there are fewer people and can adjust air-conditioner temperatures automatically. Overall, the electronic power-saving system saves energy for both the power company and the end-user, and also provides electronic data for analysis, part of the Internet-of-Things (IoT) concept. As the systems will be installed outdoors, devices are deigned to prevent water and dust ingress and offering erosion protection, allowing operation in harsh environments.  This client has signed contracts with power companies in the US, India, Saudi Arabia, and the Philippines, and is looking for new companies to break into, boosting strong prospects for long-term business development due to the need for growing energy-efficiency.

The company plans to enter the supply chain of aerospace electronic components in the Asia-Pacific region with an joint investment in Aug 2015 with a European firm with Boeing, Airbus and GE Aviation being its major customers. It has received the AS 9100 certification for its manufacturing facilities in China for aerospace applications and the construction of the factory started in 2H15 and is scheduled for production in 2016.

For a 19.4% ROE business with visible long run-way in higher-margin applications and solutions, the company has a reasonable valuation: In terms of EV/Sales, it trades at 0.99x, a 180% discount on average to its peers. In terms of EV/EBIT and EV/EBITDA, it trades at 11.5x and 9.6x respectively, a 42% discount on average to its peers. There is short-term downside protection with over a healthy net-cash balance sheet (~10% of market value) and consistently high dividend yield (4.5%). With the continued improvement in operating profit margin due to the higher value-add products and solutions, it has the potential to double its operating profit in the next 3-5 years, pointing towards a doubling in share price.

Led by founder and chairman Mr. W and his team of 500 R&D talent out of around 5,000 employees, the company has transformed its business model three times successfully. Mr. W attributed the success of the company’s continued renewal and transformation to the “Innovator’s DNA” and his role as the “teacher, not the boss” in cultivating a corporate culture that fosters innovation. Below are some excerpts of the conversation with Mr. W:

Q: “Chairman W, you mention about that having an ‘Innovator’s DNA’ is the key factor that determine whether the business model transformation succeeds or fails. Can you elaborate more on how you cultivates and develops this ‘Innovator’s DNA’ and corporate culture in [Company’s name]? What personal role do you play in fostering the innovative corporate culture?”

Mr. W: “[Company’s name] has actively nurtured and cultivated organizational innovation, decentralizing the central HQ power and cascading the decision rights throughout the organization in groups. We are not stingy at all in putting down ‘power’, coordinating a performance-based way of approaching and doing things, giving every talent the platform to perform to their best potential.

Every business unit have the autonomy and power to pursue and choose their own customers, to possess the ultimate decision right to develop new markets or carry out R&D. Because [Company’s name] is willing to share, because [Company’s name] treasures talents, our small but closely-knitted team of talents are able to fully make good use of their decision rights, authority and power entrusted upon them, accelerating the speed of development in [Company’s name]’s ‘nervous system’ in intelligence to react and respond to market challenges and opportunities with speed. With the friendly internal competition, [Company’s name] is forever renewing itself and keeping itself dynamic, youthful, vibrant and energetic.

With the ‘Innovator’s DNA’ flowing through [Company’s name], we are able to make a third business model transformation in 2012 onwards, entering into the higher-margin, higher value-add product applications.. In this Industrial Age 4.0, our integrated design-manufacturing-integrated service business model ensures that we are able to innovate new products that include robotic applications for Amazon’s automatic warehouses and win the trust of our customers to foster long-term customer loyalty.

We know that our wide-moat competitive strength does not lie in mass production of standardized items. We need to be more sensitive, we need to be faster. Our focus in the higher value-add niche markets enable us to maintain and grow profit margins and growth. We believe that choosing and deepening our roots in the right niche markets and having the right strategy and risk management will result in [Company’s name] to grow steadily one-step at a time.

Tech business guru Geoffrey Moore commented: ‘The biggest trap that successful enterprises face is that they were kidnapped by their past success. Maturing companies face their stall point in growth from their core business.’

The ‘Innovator’s DNA’ enabled [Company’s name] to be courageous and meticulous in doing the right things right at the right time, to combine innovative strategy with product lifecycle management, rapidly locking in the market and ensuring customer stickiness, continuously and consistently improving the solution to ensure steady and resilient growth, making prudent capital allocation in R&D investments in new fields to seek a new trajectory growth path to strive for the best profitability and efficient use of capital resources.

Notably, by successfully transforming our business model three times over our lifecycle, this has created an intangible advantage and quality in our organizational culture and united our team towards a sense of purpose and common objective.

When our team is familiar with the footsteps of transformation, we can always keep a proactive mindset to coordinate with the market strategy, the IT system, and continuously renew our ‘Innovator’s DNA’ through the process, refine our operating model and adapt to the ever-changing environment.

Importantly, we have to change and innovate before crisis arrives, having the determination to open up new paths of growth. [Company’s name] is like a sponge, constantly sucking in various information from the external business environment, transforming them into new product innovation and new business model breakthrough, and the footsteps to our business renewal and transformation will never cease.

My personal role in [Company’s name] with regards to fostering an innovative corporate culture would be that of a teacher.

As shared, I was formerly a math teacher and the soul of a teacher never diminishes. I am the teacher at [Company’s name], not the boss. A good teacher has to teach according to the different aptitude of the student to unleash their greatest potential. It is the same principle when treating our employees. Everyone has different views on doing things. A leader has to keep an open mind and must listen to the views and feedback of our team and to encourage the team to develop their strengths and perform their best.

We [Company’s name]-ites are not afraid of setbacks and mistakes and also possess the courage to take responsibility and accountability in their work. Even during the difficult periods throughout our corporate history when we were having intense cost pressure, we never retrench any workers and we kept the M plant. We started off our business in M and we will never forsake our root and foundation.”

Who is Mr. W and this wide-moat Bamboo Innovator?

PS1: We will be doing a double issue of the Monthly Moat Report Asia in the week of 4^th January. Thank you for your kind understanding and support. We will be back with the weekly on 1 December with presentation slides of our Investor Day – we will be sharing insights on our investment strategy of our listed Asian equities portfolio.

PS2: 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 Monetary Authority of Singapore (MAS) about implementing the fact-based forward-looking fraud detection framework in a world’s first for Singapore.

Warm regards,

KB

The Moat Report Asia

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