March 28, 2016 Leave a comment
|“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 | March 28, 2016|
|Bamboo Innovator Insight (Issue 120)
Can You Guess This Asian Wide-Moat Company?
“Work That Is Not Profitable Is The Most Lucrative!”
CEO Mr. O: “Through our founder’s experience and spirit, we understood that wealth earned through hard work, dedication and years of persistence, and through courageously correcting mistakes in trials in experiments and research, is the most valuable of all. Our founder has inspired us to think that ‘work that is not profitable is the most lucrative’. If we persist in doing what people think is difficult or foolish or dislike to do, the road to sustainability will open up… Our founder believes in addressing seriously real-world customer problems and if there is a demand out there even without immediate profitability, we will still diligently tackle it with earnest. [Company’s name]’s mission is the use the power of science to build the future with our years of accumulated experience, our proprietary technology honed and accumulated over the decades, our trusted reliability, our ceaseless research, our development that constantly pushes boundaries and our inquisitive spirit that endlessly seeks out challenges.”
The stunning insight “Work that is not profitable is the most lucrative” comes from Mr. O, the second-generation business leader of a successful family business established in 1934 that 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).
In this month of March/April 2016, we investigate this Asian wide-moat innovator who has built its first China consumer healthcare device plant in over 80 years that is operational in March 2016, a bold step that has relatively low capex risk 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.
For its YE March 2015, its industrial division contributes 59.1% of total sales and 48.3% of operating profit while its household & lifestyle division contributes 40.77% of sales and 48.7% of operating profit. The lifestyle division spans a wide range of general consumer items, including its flagship consumer healthcare device product, dehumidifying agents, heating pads and gloves. The core products in the industrial division are vinyl and PVC films used in a broad range of applications in industries such as construction, automotive, food, agriculture and medicine, as well as high value-added automotive interiors. In 2011, [Company’s name] started full operation at its factory in US and this business has hit a tipping point after four years in 2015/16 in making a significant contribution to earnings after persistence in deepening its expertise in product design and product development and building a complete supply chain for its automotive clients.
There has been annual share buybacks in recent years and treasury stock is also retired at varying intervals, which [Company’s name] can afford to do because of its strong free cash flows and healthy net-cash balance sheet with $81.3m net cash that has increased 50% from FY13, equivalent to 17.5% of book equity (9.5% of market cap) which could provide some short-term downside protection.
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. [Company’s name] stood above most family businesses who have entropized into contentment, conservatism and reluctance to embrace relevant change, due to “stability” in its customer base or industry, insensitive and too late in recognizing trends and too sluggish in responding to changes in the business environment, and are scared of losing whatever they have earned so far if they change from their old ways.
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.
Who is Mr. O and this Asian wide-moat innovator?
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:
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:
and our Value Investing Summit 2016 presentation “Quietly Innovating Value with Hidden Champions”:
The Moat Report Asia
A new monthly issue of The Moat Report Asia is now available!
Access the in-depth idea presentation:
In the previous month of February 2016, we investigate an Asian wide-moat innovator who is the CNN/Bloomberg of weather as the world’s largest and most comprehensive private weather information services company, providing customized mission-critical weather information with a recurring-income “toll-gate” business model to help its worldwide customers to access accurate and timely weather information to make better decisions in a world with abnormal weather accelerating.
In its B2B (business-to-business) segment (57% of sales), [Company’s name] provides Total Fleet Management Service (TFMS) with optimal ship routing, performance monitoring, safety status monitoring for over 2,000 shipping companies from 31 offices around the world and commands a 90% domestic market share and 35% global market share (7,000/20,000 vessels). According to CEO Mr. K, “Cargo movement has slowed in the last fall of the Lehman shock, but demand for TFMS is increasing” with the company growing its market share from 5,000 to 7,000 vessels.
The B2B business also helps multiple industries that range from sea (shipping, fishery, oil & gas) to land (road management, railway, logistics, retail, local government) and sky (aviation). For example, in the construction industry, [Company’s name] offers advice on when to build a roof, while Disneyland pays for counsel on how to stage its fireworks shows when the winds are stiff. [Company’s name] tells gas stations when to advertise tire chains in advance of snowy weather and instructs 7-Eleven on when to stock up on certain types of beer as sales vary according to changes in humidity and temperature. This deep accumulated and insight becomes more valuable over time and creates a long-lasting relationship with their customers.
In its B2C (business-to-consumer) segment (43% of sales), [Company’s name] designs and produces weather programs for radio, TV, digital media, including digital signage with original weather content for train stations, airports, elevators building lobbies, vending machines and restrooms. [Company’s name] provides content for over 90 commercial broadcasting stations in its country (80% share of the domestic market) and for over 200 cable television station in its country reaching 15 million households, as well as for Hong Kong and Taiwan satellite broadcasts. The B2C business also co-creates user-generated and crowdsourced weather information for its 20m users/”supporters”, of which 2.5m pay around US$2-3 per month for premium version of the service. As a result of this powerful crowdsourced and user-generated social data, [Company’s name] has been able to build a mechanism, such as putting out a warning forecast alert via smartphone service to occur 30 minutes to an hour before the local thunderstorm and has succeeded in capturing more than 70% of local thunderstorms since 2008. This network of users has created a network effect in that the system of localized content becomes more accurate and the usefulness attracts even more users to participate in the co-creation process, and the network becomes a valuable intangible property and competitive asset of the company.
Mr I.’s family and management continues to own 44.6% of the company which was listed since 2000 and its shares outstanding has reduced by 4.4%, demonstrating its prudence in capital management policy, and its net cash has also more than doubled since 2013 that is now 18% of its market capitalization. The company generates ROE of 27.2% and trades at an attractive EV/EBIT 9x, EV/EBITDA 7.5x. Sales has increased 12% in the past four years and EBIT and OCF (operating cashflow) growth is faster at 23% and 53% respectively due to the scalability of its toll-gate business model in launching higher value-added innovative services and effective cost management. We believe the company can build on the growth momentum in the next 4-5 years, spurring an upward valuation re-rating towards a potential doubling in market cap.