Asia’s next MUJI: “A place where you are able to allow the heart to seek solace, to explore your mission in life.” – Bamboo Innovator Monthly Riddle
June 15, 2016 Leave a comment
|Asia’s next MUJI: “A place where you are able to allow the heart to seek solace, to explore your mission in life.”
Can You Guess This Asian Wide-Moat Company?
Can Hidden Champions co-exist and even thrive to compound value together with mighty giants?
Consider Amazon which had compounded into a $336-billion-market-cap ecommerce juggernaut, with a market value exceeding that of Singapore’s $300-billion GDP. It has been estimated that of every additional $1 Americans spent for items online, Amazon captured 51 cents. Since Amazon Prime was launched in 2007, the annual membership program had grown to 5 million members in 2011, scaling up to over 54 million members in 2015 with average member estimated to spend over $1,100 annually. Notably, Amazon was up 300% since the end of 2011, outperforming the 63% rise for the S&P 500 index and 18% gain for Wal-Mart over the same period.
As Amazon obliterates the conventional physical retailers, there is an Asian Hidden Champion that compounded 600% over the same period to a market cap of $6.7bn. This Hidden Champion is Ryohin Keikaku (7453 JP), owner of MUJI. MUJI stands for Mujirushi Ryohin (無印良品), which translates to “No Brand Quality Goods” and “All Value No Frills”. None of MUJI’s 7,500 “minimalist” products, including household products, apparel and food products have a logo or are wrapped in fancy, distinctive packaging. Plain but not generic, MUJI’s products have a simple aesthetic that appeals to certain customers. In fact, it is the lack of a name brand that many find enticing. With more than 700 stores worldwide (284 directly-managed and 117 licensed stores in Japan), including 301 stores overseas (130 in China), the Japanese specialty retailer has a cult-like following. We had written earlier about the story of MUJI in “Brand It Like Buffett in Asian Wide-Moat Consumer-Brand Innovators” and how MUJI illustrates that wide-moat innovators can co-exist to compound value alongside the powerful giant.
In this month of June/July, we investigate another Asian Hidden Champion whom we believe strongly is “Asia’s next Muji” as the pioneer in creating an innovative retail management platform leveraging upon the commercial value of its specialty stores to attract customer flow and monetize the flow through retail management. This Hidden Champion commands a strong brand equity with a huge loyal customer flow in which over 180m visitors visited their stores annually, out of which 15m+ are foreign tourists. Their specialty stores have become major tourist attractions and cultural icons for visitors with strong brand recognition. Similar to Muji, this wide-moat innovator is able to thrive despite the disruption of ecommerce. Notably, since FY2012 to TTM Mar 2016, its sales, EBIT and EBITDA have grown 34.5%, 143.3% and 77.2% respectively, one of the rare few Asian departmental/ specialty retail operators to be able to generate double-digit growth and with a visible long runway.
[Company’s name] operates an asset-light concessionaire sales model and its core competency is its deep know-how in conceptualizing, planning, designing and managing the store and retail spaces and earns fixed based rent and percentage of sales to participate in its tenants’ growth. [Company’s name] generally does not own properties but rents from landlords and sublets retail space/booths to selected chosen smaller vendors who are creative brand owners, enabling them to scale up the selling of their artisan products to the targeted customers. [Company’s name] strong brand value in attracting customer flow translates to strong bargaining power in rental contract terms (typically 15-20 years) and is a key tenant to attract long-term retail partners (eg Starbucks, 7-Eleven, McDonald’s) in the retail space managed by the company. As a result, [Company’s name] has one of the highest asset turnover (sales/total assets) at 90%, far higher compared to the 20-40% for well-managed Asian departmental rivals including Philippines’ SM Investment, Thailand’s Central Pattana due to its asset-light business model. MUJI’s asset turnover is probably the highest in Asia at 153%.
Thus, in evaluating the investment merits of specialty/departmental retail operators in an online ecommerce era which is disrupting conventional physical retailers, we first examine whether the business has demonstrated resilient double-digit growth in sales and EBIT from FY2012, and generated strong recurring cashflow from healthy cash conversion cycle and balance sheet. Next, we looked into its asset turnover, cash conversion cycle and debt leverage to assess whether the business has the ability to expand and scale up without onerous use of capital and with a healthy net-cash position.
[Company’s name] sales have increased 17% in the past 3-4 years since FY13 and EBIT and operating cashflow growth is faster at 51% and 105% respectively due to a rising network effect and execution success in overseas expansion and growth in membership to over 1m. Total floor space of over 280,000 sqm is up 36% from 2011 and expected to increase another 45% by 2020, setting the strong foundation to at least double profits in the next 5 years.
[Company’s name] has a visible long run way to reinvest its profits back into the core business to extend its market leadership and widen the moat to provide long-term downside protection in terminal value. [Company’s name] has a healthy balance sheet with net cash that has increased 39% from FY13, 53.3% of book equity (11% of market cap) which, coupled with its decent 4.08% dividend yield, could provide some short-term downside protection. This Hidden Champion has a ROE of 24.7% and trades at EV/Sales 1.87x, EV/EBIT 17.8x, EV/EBITDA 11.6x while MUJI trades at EV/Sales 2.43x, EV/EBIT 21.7x, EV/EBITDA 17.7x, a 22-52% premium over [Company’s name]. We think that [Company’s name] 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 increased from 19.5% in FY13 to 24.7% in the latest TTM Mar 2016 and is expected to climb higher from its underappreciated expansion plan.
Importantly, the burning sense of mission forged by the founder Mr W and now succeeded by the second-generation leader is visible as the moving thrust for the [Company’s name] employees and business partners who entered into an interaction with the customer with a sense of purpose and demonstrating care in serving the customers, forming the intangible culture of excellence. We believe this is rare in Asian firms and deserves a valuation premium.
As Mr W elucidated:
“[Company’s name] uses the creative combination of ‘human, space, activity’ to engineer and engender a unique cultural ambience and atmosphere… We understood that our core expertise is our retail management know-how which we have accumulated over the years. We are aware that the world’s retail industry underwent different phases of development. The first stage is to buy things, to shop. The second stage is to have a retail experience. [Company’s name] instead enters into the third stage, not only about shopping and retail experience, but also about co-involving and co-engaging with our customers to participate in our activities, whether they are art exhibition, dynamic dance performance, culinary workshops, lectures or even a space where people can hear your views. People crave the human interactions that can happen at [Company’s name], something that might be absent in office environments. [Company’s name] is an intellectual sanctuary. They also might be seeking an escape from family squabbles at home, or even looking for love.”
The entrepreneurial story of Mr W is also inspiring and uplifting and below are some excerpts:
Q: “What is your motivation, drive and confidence behind your long-time dedication in building [Company’s name] despite the risks and losses?”
Mr W: “Confidence comes from determination and a strong belief in one’s original purpose and intent. I have spent my longest period away from work in the ICU (Intensive Care Unit). I have always held a heart filled with gratitude to face illness. The pain from the sickness forced me to face my inner worth and purpose. Actually, life is lonely. Sickness brought me a new understanding of life. A work colleague sent me a card that says, ‘Mr W, God wants to give you a special medicine, that’s why you fell sick.’
When I am feeling depressed during my sickness, I will ask, ‘Why me?’ Actually, we should not only ask, ‘Why me?’ which would lead to feelings of indignation, unwillingness, and the soul will be in a negative state, but rather we should think deeper, ‘Why not not me?’. Nobody has the right to declare that poverty should not belong to me, pain and sickness should not be borne by me. The sickness is my mentor who gave me an important lesson to see myself. Rather than say [Company’s name] is a business, it is more a life journey – to explore, to learn and to understand life. The second time I saw myself was when [Company’s name] incurred 15 years of losses; I saw my own earnest attitude towards my life, how I persisted despite the odds.
I believe money and power come and go, but to be able to serve others is meaningful and of value in life and of the proper nature. [Company’s name] had walked into the everyday life of people, enabling anyone to be able to extend their hand to reach out to a beautiful lifestyle experience.
The value of an enterprise is more than its bottom line because there are many people who know how to turn a buck, what matters is an enterprise’s positive impact on customers and the industry. We are in the service industry so we have to think about whether we can first benefit others, benefit the public, benefit the industry, and only then can this enterprise survive in the society and it will be in its proper place.
Till now, I do not think I am the boss; I am just working for the society, it’s just that everyone’s role is different. Everyone understands that we have to die eventually and we cannot carry anything in our death. Hence, what we can create, what we can leave behind for society, is the most important starting point to keep caring.
Any business has risks, what I want to do is to offer society some positive momentum regardless of the risk. Everyone in life have their own ‘homework’ to do, you have to be willing to do it and enjoy doing it.
I wish everyone in the city can find their smiles, warmth and friendship in [Company’s name]… a place where you are able to allow the heart to seek solace, to explore your mission in life. Life requires the bearing of a heart filled with humility and gratitude. Everyone has his mission in the world, I carry out mine with all my heart and energy. A man can’t live without dreams. Quoting Emerson, we need to ‘hitch your wagon to a star.”
Who is Mr W and this Asian wide-moat innovator and Hidden Champion?
The Moat Report Asia
A new monthly issue of The Moat Report Asia is now available!
Access the in-depth idea presentation:
PS: We will be working on the Monthly Report in the upcoming weeks ahead and we will replace the weekly articles with some occasional write-ups, including our upcoming Year End Letter for the Hidden Champions portfolio. Since Sep 2015, Asian market indexes were generally down and our Hidden Champions portfolio had generated positive absolute returns of around 15% (in SGD terms as at 14 Jun 2016). This outperformance is powered by a double-digit gain from our high-conviction top position which comprised around one-third of our portfolio NAV. We are also a Top 15 Shareholder in this world-class wide-moat company with dominant market leadership as the largest provider of nation-wide tourism and transportation services generating record profitability with a visible long runway ahead to compound growth with resilience. We do not engage in market-timing by darting in and out of the markets on a short-term trading basis and our portfolio turnover ratio is low at under 15%. Our portfolio standard deviation is below 10%, significantly lower than the MSCI Asia market index standard deviation of 22%. We aim to be a Top 20 Shareholder disclosed in the Annual Report of the companies we invest in as a demonstration of our conviction and transparency in the investment process. We adopt a high-conviction concentrated investing approach with a targeted 20-25 stocks and we currently have 18 Hidden Champions in our portfolio.
At the moment, we are managing permanent capital for the Hidden Champions portfolio. We are partnering with an established and reputable Indian asset manager in setting up a licensed and regulated fund structure to tap external funds from potential external institutional investors and accredited high network investors. The Fund will be registered with regulators and agencies in various jurisdictions for distribution permission in US, UK, and HK. For US investors, the administrator to the Fund will be handling regulatory reporting requirements such as issuing PFIC statements. The Fund will be tax-free for both capital gains and dividend distribution. The Fund will be in compliance with regulatory standards and the external custodian & banker is Standard Chartered Bank, auditor is KPMG), and the administrator is Trident Trust.
Through this partnership, we will have our own DEMAT account and legal stock ownership in our name when investing in Indian equities, as opposed to other funds purchasing stocks through a nominee which suffer the risks associated with forgery and due to damaged stock certificates. This process required stringent KYC checks due to Indian regulation which required more time as opposed to the regular entity. We believe that this time-demanding process is worthwhile as we are positive on the Indian market as a fertile ground for the emergence and growth of Hidden Champions. India is also a unique vibrant and versatile hub for “frugal innovations”: cost-effective and affordable solutions of various varieties that cater to price-sensitive consumers. Our Hidden Champions portfolio has recently invested in an Indian frugal innovator at 4% of our NAV and it has since rose over 30% from our investment cost.
Personally, I will never forget how during one of our business trips to India, a senior Tata executive handed me the Keepers of the Flame: A Century of Trust, a limited-copy DVD film on the life and times of the three great Tata stalwarts – Jamsetji, JRD and Naval – and shared with me over lunch this belief:
“A person or an organization may be down temporarily due to circumstances beyond himself or herself. But he or she may rise up from the values they held fast as keepers of the flame”.
Tata Group, with a total revenue of over $100 billion, is special among all MNCs in the world. Its mission is more than just economic. What makes Tata different is that its societal purpose powered its economic progress. The inspiring story of S Ramadorai who transformed Tata Consultancy Services (TCS) from a US$155 million operation when he inherited the company as CEO in 1996 into a wide-moat compounder with sales of US$16 billion and a market value of US$74 billion employing over a quarter million people in 42 countries has also touched our hearts deeply. The Godrej Group is also part of this core group of Hidden Champions which have the “highest order of competitive advantage” that is beyond fitting them into the usual Porter-style matrix of “low-cost” or “differentiation” strategy, as shared with me by Mr. G Sunderraman, the Head of Innovation and EVP at Godrej & Boyce, the holding company of the reputable Godrej family at their corporate headquarters at Vikhroli in northeast Mumbai. This “highest order” of competitive edge is having the trust and support amongst its community of customers, suppliers and employees and the learning ability to sense and respond with agility to the emerging and evolving needs of the customers.
|“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 | Jun 14, 2016|
|Bamboo Innovator Insight (Issue 125)