|Hidden Champions Year End Letter
The Hidden Champion portfolio in listed Asian equities generated positive absolute returns of +15.4% or a S$2.7m investment gain (in SGD terms as at 1 July 2016) since September 2015, outperforming Asian market indexes which decline over the same period. Some salient points on the Hidden Champions portfolio performance since our financial year end March 2016:
1) Outperformance during fragile and turbulent market conditions:
- The portfolio generated positive absolute returns of +15.4% or a S$2.7m investment gain (in SGD terms as at 1 July 2016) since September 2015, outperforming Asian market indexes which decline over the same period.
- 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.
2) Low volatility, high resilience portfolio:
- Our portfolio turnover ratio is low at around 20% and we do not engage in market-timing by darting in and out of the markets on a short-term trading basis.
- Our portfolio standard deviation is around 10%, significantly lower than the MSCI Asia market index standard deviation of over 22%.
3) High-conviction investment strategy with transparency:
- We adopt a high-conviction concentrated investing approach with a targeted 20 to 25 stocks. We currently have 18 Hidden Champions in our portfolio who command market leadership in their business field.
- 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 are a Top 20 Shareholder in 6 of our portfolio stocks.
- We make the conscious decision to not invest in and avoid stocks in cyclical industries, including commodities & energy, property & construction, and banks.
4) Portfolio stocks continue to achieve resilient structural growth in quality earnings with robust return on equity:
- As macroeconomic conditions and prospects continue to deteriorate, our portfolio stocks continue to achieve resilient structural growth in quality earnings as a result of their continuous launch of new product innovations and gaining of market share as focused quiet long-term industry consolidators.
- Our portfolio stock characteristics have a weighted return on equity (ROE) of 21.9% and weighted revenue have been growing by 9% over the recent three years, generating increasing returns to scale with a 28.2% growth in operating profit due to the scalability of the business model forged by an indestructible intangible knowhow accumulated over the years to create value for their target customer base and compound value in difficult business environment.
The outperformance of the portfolio is possible because of our multi-manager team-based investment process implemented since September 2015, led by our analyst team comprising of Kelvin Seetoh, Jackson Yeow, Sim Zhipeng and Joshua Zhang. We are pleased to welcome the addition of a new member to our investment analyst team, Ms Joyce Pang, who joins us on 9 May 2016.
Our approach to value investing in increasingly turbulent and fragile markets 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, yet are indispensable to our daily lives. 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 Purpose and values system guiding the firm.
The Hidden Champions had their roots as the esprit de corps of Germany’s Mighty Mittelstand, the more than 3.5 million small and midsize family enterprises that form the backbone of Germany’s resilient export-driven economy, employing more than 78% of workers and contributing more than half of the country’s GDP. The Mittelstand traces its roots to the Middle Ages, when the country that is now Germany was divided into hundreds of states. Competition between them created a number of industrial regions with their own educational institutions, banks and political administrations. The Mittelstand had to export early on with a global-orientation in their business model, given that some German states were smaller than two football fields.
Well-known Mittelstand enterprises that became well-known giants include BMW, Audi, SAP AG, Adidas, Hugo Boss, Robert Bosch, Siemens, consumer giants Beiersdorf and Henkel, dialysis giant Fresenius, pharmaceuticals giant Bayer, chemicals giant BASF, industrial gas specialist Linde AG, truck and engine maker MAN SE, and so on. There are also lesser-known, quiet, resilient, successful compounders, including commercial kitchen equipment company Rational AG, door technology systems specialist Dorma+Kaba, sanitary systems specialist Geberit, eyewear specialist Fielmann, specialty chemicals specialists Brenntag and Lanxess, high-end cleaning equipment Kärcher, Würth group (the “Fastenal of Europe”), auto gasket maker Elringklinger, flavor and fragrance specialist Symrise, lab solution specialist Sartorius, medical vision technology specialist Carl Zeiss Meditec, packaging and bottling machine maker Krones, wound medical product specialist Paul Hartmann, and so on.
From a value investing perspective, investing at an earlier stage in the long-term growth trajectory path of these Hidden Champions – in Asia – will prove rewarding
To read more, below is the link from our Annual Report to our full Investment Update:
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.
In the month of May/Jun 2016, we investigate an 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%.
[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.