01 Mar Hidden Champions: Our North Star Investment Strategy to Navigate Turbulent & Fragile Markets
“Governing with excellence (德) can be compared to being the North Star: The North Star dwells in its place, and the multitude of stars pay it tribute.”
– Confucius, Analects 2:1
Your funds in listed Asian equities have achieved a -4.7% 12-month rolling return (in SGD terms) against declines of 11.3% for the MSCI Asia Pacific Index, 11.7% for the Australia All Ord Index, 12% for the Nikkei 225 Index, and 17.6% for Singapore’s FTSE STI Index over the same period.
This out-performance is buttressed by an 11.2% absolute positive return (in SGD terms) from our investment cost of the revamped portfolio in the second-half since September 2015 against market index decline, powered by a double-digit gain from our high-conviction top position, ASX-listed Sealink Travel Group, 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 aim to be a Top 20 Shareholder disclosed in the Annual Reports of the companies we invest in as a demonstration of our conviction and transparency in the investment process. As will be detailed in the tables and descriptions in the section below, we are a Top 20 Shareholder in 7 world-class wide-moat companies out of the 18 portfolio stocks (we added 4 stocks in April after the Financial Year ended which were up 10.8% as of 29 April). We are looking to accumulate more and becoming a substantial shareholder with a 5% stake as they continue to deliver in their business fundamentals.
This out-performance is possible because of our multi-manager team-based investment process implemented in September 2015. This teamwork greatly strengthens our ability to invest with high conviction in wide-moat companies, making an architectural shift from time telling to clockwork with a build-to-last structure for our shareholders.
As Jim Collins, author of the Built to Last and Good to Great, puts it aptly, “Imagine you met a remarkable person who could look at the sun or stars at any time and state the exact time and date. But wouldn’t the person be even more amazing if, instead of telling the time, he or she built a clock that could tell the time forever?”
We would like to acknowledge our heartfelt thanks to our 8IH team as all of us put forth energy when and where it was needed and yet were careful stewards of organisational energy by painting a vision so beguiling and inclusive that it riveted the attention and harnessed the energy of everyone into something exponentially valuable.
This teamwork culture resembles the Angklung, a traditional Indonesian musical instrument made from joint pieces of bamboo. The tubes are carefully whittled and cut by a master craftsperson to produce certain notes when the bamboo frame is shaken or tapped.
Each tube of the Angklung produces a single note or chord, so several players must collaborate in order to play melodies. It symbolises how humans cannot stand solitary; one needs others in life. Angklung is Harmony in a Bamboo Orchestra.
“Explorers depend on the North Star when there are no other landmarks in sight. The same relationship exists between you and your right life, the ultimate realization of your potential for happiness. I believe that a knowledge of that perfect life sits inside you just as the North Star sits in its unfaltering spot… Your life follows your attention. Wherever you look, you end up going.”
– Martha Beck, author of Finding Your Own North Star
The clock that we are building together as a team to tell the time forever is the Inner Compass and systematic investment process that leads us to our North Star to navigate increasingly turbulent and fragile markets to the Hidden Champions.
Our approach to value investing is to invest in the Hidden Champions like 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 customers’ 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 customers’ needs, which is only possible in our view when there is a purpose and values system guiding the firm.
The Hidden Champions have their roots in 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 to their business model, given that some German states were smaller than two football fields.
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, eyewear specialist Fielmann, specialty chemicals specialists Brenntag and Lanxess, high-end cleaning equipment Kärcher, Würth group (the “Fastenal of Europe”), auto gasket maker Elringklinger, flavour and fragrance specialist Symrise, lab solution specialist Sartorius, medical vision technology specialist Carl Zeiss Meditec, packaging and bottling machine maker Krones, wound medical products Paul Hartmann, and so on.
From a value investing perspective, investing at an earlier stage in the long-term growth trajectory path of Hidden Champions in Asia will prove rewarding, as highlighted in an investment case insight into Rational AG.
Investment Case Insight into an Archetypal Hidden Champion: Rational AG
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 produces a good investment?
Rational AG Stock Price Performance, 2000-2016
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.
It’s reclusive billionaire founder, Siegfried Meister, became a trailblazer when he chose to go against the grain, battle conformity, and buck outdated traditions to launch its innovative product that enables most cooking processes to be performed using one device.
For instance, the device recognises 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.
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 like Gordon Ramsay.
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 (i.e. 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.
Everything about Rational AG is focused on the customer, the professional chef. Sales and marketing trainees spend three weeks working directly for customers in hospitals, hotels, 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.
True to the corporate goal of always offering maximum benefits to the customer, in 2004, Rational AG launched another spectacular innovation: the “Self-Cooking Centre“. This new product is designed to reduce the chef’s workload and is self-cleaning, providing him with more time for culinary creativity and his guests.
Siegfried Meister, a qualified electrical engineer who spent many years in the management divisions of several large and medium-sized companies, felt 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 benefits. We are inspired by Rational AG’s incredibly high work standards that hang on the factory walls in posters that read: Gut Genug? Der Kunde Entscheidet (Good Enough? The Customer Will Decide).
Rational AG not only created the market, but has always dominated it.
Market saturation is relatively low despite the market dominance of Rational AG. The customer potential is estimated at more than 3 million commercial kitchens worldwide – from simple innkeepers and fast-food chains, to hotels, hospitals, and prisons, providing a visibly long runway to compound growth in difficult market conditions.