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

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

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

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

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

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

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Siegfried Meister became an Original, a trailblazer in choosing to go against the grain, battle conformity and buck outdated traditions to launch its innovative product.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

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

Rational1

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

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

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

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

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

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

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

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

Rational2

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

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

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

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

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

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

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

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

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

Value Investing ShanghaiValue Investing Shanghai Photo

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

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

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

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

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

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

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

Warm regards,

KB

The Moat Report Asia

www.moatreport.com

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

Access the in-depth idea presentation:

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Tool

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

Tool2

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

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

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

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

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

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

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

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

Value Investing Shanghai

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

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

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

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

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

Warm regards,

KB

The Moat Report Asia

www.moatreport.com

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

Access the in-depth idea presentation:

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

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

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

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

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

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

Follow the “OQ” (“Obsession Quotient”) to Invest with Conviction – Bamboo Innovator Weekly Insight

“Bamboo Innovators bend, not break, even in the most terrifying storm that would snap the mighty resisting oak tree. It survives, therefore it conquers.”
BAMBOO LETTER UPDATE | April 4, 2016
Bamboo Innovator Insight (Issue 121)

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

Follow the “OQ” (“Obsession Quotient”) to Invest with Conviction

“How do you decide how to invest with conviction in a company when sizing up the bet to become a Top 20 shareholder as disclosed in their annual report?”

We were asked this question by a fellow value investor when we shared that our largest portfolio stock at 35% of the NAV of our Hidden Champions portfolio, a wide-moat innovator with dominant market leadership as the largest provider of nation-wide tourism and transportation services generating record profitability, is up over 15% from our cost during a period when markets were volatile and the MSCI Asia index is down around 15% over the past year.

“We follow the ‘OQ’, or the ‘Obsession Quotient’, to overcome the asset size barrier to investment returns in allocating funds productively and to mitigate potential concentration risk.”

Think of Steve Jobs famous obsession with the perfect screws on the inside of the original Mac.

Think of the early Bill Gates who would “be in the middle of a line of code when he’d gradually tilt forward until his nose touched the keyboard. After dozing an hour or two, he’d open his eyes, squint at the screen, blink twice, and resume precisely where he’d left off — a prodigious feat of concentration.”

Ray KrocThink of Ray Kroc’s obsession with quality and cleanliness with his oft-quoted motto: “If you have time to lean, you have time to clean”, leading to the automation of as many operations as possible and the institution of rigid training programs at “Hamburger University” for McDonald’s franchise owners, whom he required to manage their own stores.

SKBThink of the late Mr Sim Kee Boon, one of Singapore’s pioneer top civil servants, best known for overseeing the construction of Changi Airport and turning around the fortunes of Keppel Corporation after succeeding the servant-leader Mr Chua Chor Teck, who was said to check toilets at Changi Airport at night.

OberoiWe were also inspired by M.S. Oberoi, founder of the Oberoi Group, a chain of luxury hotels in India, who obsessed about every frontline detail in his hotels that might affect the customer experience and would scrawl responses on customer comment cards even at the age of 94 when he could barely see and had to hold the cards an inch away from his eyes. The elderly Oberoi would visit his hotels to make sure employees were getting everything right, and in doing so he established a culture by which all employees shared in his obsession.

ElsenerThe late Carl Elsener III (1922-2013), the entrepreneur perhaps most responsible for the unprecedented success of the Victorinox Group behind the world’s most recognizable Swiss Army knife, had lived close to the factory and, until age 86, rode his bicycle to the office every day, and was obsessed with preparing the 4th generation to be competent managers of this worldwide successful, traditional Swiss enterprise.

We have obsessed all along with identifying entrepreneurs with the focus and sense of urgency to build something with Purpose and commit to an idea larger than themselves to care for and serve others with love. “Wealth creation” would then take on a Purpose and meaning, as opposed to opportunistic money gathering through short-term business transactions, complex financial engineering schemes and worse, tunneling fraud that eventually unwind to harm others. While these people are able to make money, the wealth “created” is at the expense of others and benefits themselves. How to quickly tell them apart? They “energize” themselves not from work, but from the pursuit of short-term pleasures.

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.

A true goal needs to become an obsession. We observe the following about “OQ”, or “Obsession Quotient”, over our years of interacting with entrepreneurs, innovators, and hidden champions.

  • They view themselves as business insurgents, fighting on behalf of an underserved customer, a persistent idea, mission, duty, calling and vocation that preoccupy/absorb/dominate their every thought and dominate their desires every second of every day and make them approach each moment, decision, action and day with this level of fixation. They are completely captivated by an obsession that they simply cannot imagine conducting their life without. They always find their work more fulfilling than those who find themselves in a profession because it was expected of them. For those who are obsessed by this pursuit, there is no separation between life and work. It is much easier to endure all the setbacks, reversals and frustrations of management when you deeply enjoy your work. All of the High OQ entrepreneurs, innovators and hidden champions whom we observed have witnessed first-hand the problems that beset the masses and wanted to build a business to provide useful products and services. And they are not contented to stop at $10m, $100m, or even $1 billion, like most businesspeople who rush to buy fancy property and cars for themselves. They want to build and scale their businesses so that they can give more. Only when we have the desire to give, then can we want to persevere in building something meaningful. This urge to build in order to give is the magnetic north to scale a business and they work obsessively to realise this vision. Imbued with a perception where everything from telephony to music distribution to consumers’ relationships with technology is being disrupted, Steve Jobs felt there was simply no time to lose. This understanding has fueled the rapid-fire pace of his actions and his obsession with “what’s next?” in products (although he would never rush to market a product he thought imperfect). It may have also fed his often harsh, dictatorial, and somehow still-inspiring management style.
  • They have an obsession with the economics of customer loyalty and have this deep curiosity for what is going on at the front line, where the business meets the customer. They have an obsession to cultivating a culture of decentralization, trust and cooperation to foster innovative experimentations, including investing in a system to cascade decision rights throughout the organization;
  • They foster an owner’s mindset, which keeps them fast, bold, and infused with a deep sense of responsibility for long-term results. They do things with a long-term approach because they strongly believe that is the only way to build a truly durable and excellent business.
  • They are obsessed with staying grounded to their values. Carl Elsener Jr., the fourth-generation business leader and CEO of Victorinox commented of the values uphold by his beloved father Carl Elsener III: “Despite his success, my father has stayed grounded. The most important values in his life have always been mutual respect and trust, courage, gratitude and humility. I have also learned from my father that the company who wants to stay successful in the long-term basically needs to concentrate on three things: the people, the customers and the products. He embraced that concept very nicely.”

In essence, they are the single-minded monomaniacs with a mission to accomplish. They are ruled by spirited behavior, by the vigorous pursuit of a worthwhile competitive idea. Peter Drucker highlighted also the importance of being single-minded in the passionate pursuit of one’s quest in life:

“The single-minded ones, the monomaniacs, are the only true achievers. The rest, the ones like me, may have more fun, but they fritter themselves away. They carry out a ‘mission’; the rest of us have interests. Whenever anything is being accomplished, it is being done by a monomaniac with a mission.”

The interaction with their clear goal and single-mindedness is an essential factor for their stamina and perseverance. Success and the achievement of goals inject new energy into these leaders. Nothing energizes an individual or a company more than clear goals and a grand purpose.

They do not cling on to the idea that work should be fun, exciting, entertaining and invigorating – every day. Operating a business is a serious, rugged, flaw-ridden demanding task. The inevitable fluctuations and vicissitudes of an industry’s affairs, as well as in the general level of economic activity, often seem to compel painful decisions and trade-offs to meet the exigencies of the day. But operating a business is also thrilling, challenging, and rewarding. Work is like life: sometimes fun, sometimes moving, often frustrating, and defined by meaningful events. Those who found their place don’t talk about how exciting or how stimulating their work is. Their language invokes a different troika: meaningful, significant, fulfilling.

They pursue virtues rather than seek instant gratifications, not because such pursuits are pleasurable (they hardly are in fact!), but because they are meaningful. They have something significant yet to achieve in their lives. Without virtue, leadership is nothing. They epitomized what Benjamin Franklin echoes: “Industry and Frugality”:

“An enterprising man not in haste to get rich, willing to run some risks, yet not willing to risk in hazardous enterprises the property of others entrusted in his keeping, careful to indulge in no extravagance, and to live within his means. Simple in his manner and unostentatious in the habits of life, not merely a merchant but a man, with a character to form, a mind to improve, and a heart to cultivate.”

Work is the ultimate seduction in life, Picasso illuminated. Indeed, the High OQ entrepreneurs, Bamboo Innovators and Hidden Champions put their work, their will and their world in the services of others. They are lit by passion, make that extra effort and demonstrate that extra commitment. They want to engage in something grand and beautiful and noble (in their own interpretation), well worth the toil and anxiety.

In the month of March/April 2016, we investigate an Asian wide-moat innovator who commands a dominant 50-60% domestic market share leadership in a consumer healthcare device and is also the global #3 player and #2 in China (22% market share) where its first China plant in over 80 years is operational in March 2016 after building up strong demand from successful sales in leading online marketplaces JDmall and Alibaba’s Tmall. We like to share excerpts of the inspiring story of the founder Mr O, whose OQ has permeated into the corporate culture and ethos of the firm, as recounted by the second-generation business leader and current CEO of this wide-moat innovator:

Q: “[Company’s name] has achieved phenomenal success since it was established in 1934 by founder Mr O to command a dominant 60% domestic market share leadership in [flagship product] and also becoming the global number three player. Can you share with us how the wonderful story of [Company’s name] started, especially the tipping points and challenges along the way?

Mr O: “…due to limitations of technology and material science, these [product] melted under hot weather and high temperature and ‘fresh’ [product] need to be produced. The [product] were also thick, 1mm thick, like a glove for the finger, and the consumer was not happy… Also, imported foreign-produced [product] cost ¥3 for a dozen; at an age when rice cost ¥0.30, these [product] are not affordable to the masses. Yet, while domestic-produced [product] are cheaper, they melt.

Our founder was a hardworking technician who started working at a rubber goods factory observing all these problems. He started working after primary school after both parents passed away when he was young. He resolved to solve this problem for the Japanese people and thought very hard how to produce a new safer and thinner [flagship product].

He also set the target of reducing the thickness of [flagship product] by ten times from 1mm to 0.1mm. It seemed an impossible task. But our founder never gave up. Our founder tried for more than seven years. For thin [flagship product] to have the strength, an intuition flashed in the mind of our founder when he was looking at the latex molecule under a microscope in the laboratory. Maybe a new binding molecule can be added? Our founder first tried the addition of branch-like resin to the molecule. However, the two do not stick at all. Since then, days and nights in the laboratory were spent in repeating countless experiments to find a catalyst material that can stick the two molecules.

A breakthrough came when our founder knocked on the door of German Bayer who had set up operations in Japan. The director representative at Bayer Japan was generous in sharing information. Our founder learnt new knowledge from the science magazines and journals at Bayer and he would experiment with new catalysts and chemicals. This repeated experimentation resulted in our founder’s knowledge to improve by leaps and bounds. This visit to Bayer took one year and a total of eight years have been spent on research. Finally, through trials and errors, the breakthrough happens and the highest quality [flagship product] was produced. Our founder was so happy that he took a [flagship product] and ran to the river to fill it up with water, which expanded many times bigger like a water balloon. He blew air into the [flagship product] balloon and watch it fly into the air.

He resigned from his work at the factory and sold off every of his possessions and furniture to establish [Company’s name]… Subsequently, he challenged the belief that the thinness of the [flagship product] has reached its limits at 0.04mm to produce 0.02mm and 0.01mm from a new material.

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. He 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 believe 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.”

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

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

Value Investing ShanghaiValue Investing Shanghai Photo

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

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

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

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

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

Warm regards,

KB

The Moat Report Asia

www.moatreport.com

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

Access the in-depth idea presentation:

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

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

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

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

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

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

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