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Tooling Up the World With Mastery – Bamboo Innovator Monthly Riddle

“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 | Jaunary 5, 2016
Bamboo Innovator Insight (Issue 114)

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

Can You Guess This Asian Wide-Moat Company?

Tooling Up the World With Mastery

Do you have the right tools to succeed in your work?

The Scottish historian Thomas Carlyle, who coined the term “the dismal science” for economics, once said famously that “Man is a tool-using animal. Without tools he is nothing, with tools he is all.”

In this month of January 2016, we investigate an Asian-listed wide-moat innovator who is the world’s largest ODM producer of an important tool with multiple applications for automobiles, aerospace and homes with a global market share of 20-25%. Its 18.9% operating profit margin and 18.5% ROE is higher than that of its branded clients because of its negotiating and pricing power, technological prowess and vertically-integrated business model from upstream tooling design/ manufacturing to downstream final assembly. Yet this world-class innovator trades at PE 7.5x and EV/EBIT 10.8x.

Its deep vertical integration allows the company to achieve high precision standards in each part of the production process, and enhances its design ability to innovate lighter but stronger tool products. Technology ownership of key components raised quality and lower cost at a structural level, with production yield raised to 95% and costs reduced by 15%. Due to its mastery of critical end-to-end know-how, the company also utilize its magnesium alloy die casting technology in tools to produce aluminium-magnesium alloy bicycle frames for all top 7 global bicycle manufacturers. In 4Q15, the company also penetrated into the supply chain of possibly the most important American customer in a game-changing private label partnership that provides a long visible runway for the company. The company started shipping industrial-level tools to this American MNC in 4Q15. This private label order yields a higher gross margin of 50-60% as compared to the typical 10-40%.

The company was co-founded in 1983 by Mr. L after his retirement as Chief Judge in his local region and the L family controls 30-35% of the company.

Since the 2007/08 Global Financial Crisis, we like how the company has emerged stronger with major positive transformations to its business model resiliency: (1) Shifting to higher-margin industrial-level tools; (2) Successful new growth in auto tools which grew from 6% of total sales in 2006 to 37% in FY14; (3) Penetration into Europe, which contributed from 11% of total sales in 2006 to 33% in 1H15; (4) Client concentration risk reduced: its top 2 clients used to contribute 64% of revenue in 2006 and that proportion was down to <20% in 1H15.

This is possible because of the leadership by Mr. L and his brother who have demonstrated grit and foresight in a series of critical business decisions, ranging from (1) building  a vertically integrated ODM business model to invest in developing innovative new products, (2) insisting on 100% ownership of the ODM design and manufacturing know-how by continuously building up its capabilities in tool technology from die-casting, coasting, painting, firing pin heat treatment, mold production, and plastics injection; the know-how accumulated over the years is not easily replicated, thus giving rise to our long-term profitability and a win-win partnership with our customers who stayed loyal; (3) resisting the institutional imperative to focus on designing and producing higher-end products while its peers rushed into China, (4) expanding during the 2007-08 Global Financial Crisis to (5) grooming its own group of talents in design and operations who are able to point out from a systems perspective the detailed continuous improvements needed in each production process.

The company has been prudent and shareholder-friendly in its capital allocation decisions. In particular, the company announced a capital reduction plan in Aug 2015 and shares outstanding will decline 10% to return excess cash to shareholders and improve its ROE. As at Sep 2015, the company has a healthy balance sheet with net cash at 54% of book equity (21% of market cap), which could provide some short-term downside protection when coupled with its 5.3% dividend yield.

Sales has increased 32% in the past four years and EBIT and EBITDA growth is faster at 41-74% due to effective cost management in its vertically integrated strategy and higher weightage of higher-margin products in product mix. We believe the company can build on the momentum to at least double its profits in the next 4-5 years, pointing towards a potential doubling in market cap.

We like how the L brothers have cultivated a decentralized culture of mastery, empowerment and growth at the company to keep winning loyal customers and innovating new products. On its culture, below are some excerpts of the conversation shared by Mr. L:

Q: “What is the culture like at [Company’s name] and what is your management philosophy and style to guide your leadership?”

Mr. L: “Although [Company’s name] is globally number one in its field, I am the company’s driver. Whenever there are clients coming by to visit us, either my brother or myself will drive the company car to receive them. Our culture is such that everyone at [Company’s name] are familiar with my slogan of exceeding targets, challenge the limits, and stay grounded and pragmatic in executing. Our culture is that we treat our products as important as our lives. 

If the real estate industry has its maxim in ‘it’s all about the location, location, location’, our golden maxim to guide us is ‘it’s all about the product quality, product quality, product quality.’ This is why in our 32 years of establishment, we have not been afraid of losing customers and we have quality customers continuously coming in.

Our culture is aligned to our blue ocean strategy which is simple: to focus on innovation and quality in product and R&D. This strategy has been my unshakeable belief all these years. In order to pursue excellence in quality, as long as it can be changed and improved, I will constantly remind and demand my staff to seek breakthroughs and mastery. Do you know why the word ‘quality’ in the written Chinese is formed by three ‘kous’ ? The reason is because with two kous as the foundation, there is always a higher kou on top or mastery waiting to be reached.

Our management philosophy is ‘Integrity, responsibility, and steadiness in innovating. Constantly demand improvement in product quality, stay focused and loyal to the core business, and never stray and mal-invest.’

As shared, I was in the legal arena for 25 years. When I retired, I was the Chief Judge of…. I have gone past the age of striving for fame and fortune. The most important thing in the jump from the legal scene into entrepreneurship is to recognize oneself, to be self-aware of my role and responsibilities. To operate and manage a business is really tough work. Most of us who pressed on are using our hearts, our entire lives to operate.

Although I am [Company’s name]’s Chairman, I believe very much in empowerment and authorized decision rights to my team, in accordance to the Taoist philosophy of ‘managing with wuwei’ 无为而治 or governing by doing nothing that goes against nature.”

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

PS1: 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

PS2: We will issue an additional Monthly Moat Report Asia in 1Q16.

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/

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About bambooinnovator
KB Kee is the Managing Editor of the Moat Report Asia (www.moatreport.com), a research service focused exclusively on highlighting undervalued wide-moat businesses in Asia; subscribers 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. KB has been rooted in the principles of value investing for over a decade as an analyst in Asian capital markets. He was head of research and fund manager at a Singapore-based value investment firm. As a member of the investment committee, he helped the firm’s Asia-focused equity funds significantly outperform the benchmark index. He was previously the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. KB has trained CEOs, entrepreneurs, CFOs, management executives in business strategy, value investing, macroeconomic and industry trends, and detecting accounting frauds in Singapore, HK and China. KB was a faculty (accounting) at SMU teaching accounting courses. KB is currently the Chief Investment Officer at an ASX-listed investment holdings company since September 2015, helping to manage the listed Asian equities investments in the Hidden Champions Fund. 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. All articles in the website reflect the personal opinions of the writer.

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