01 May Scuttlebutt of Our Investment Ideas
Scuttlebutt research is a classic trademark of Warren Buffett’s mentor Philip Fisher’s value investing style. Fisher’s commitment to fundamental research, as detailed in his classic book, Common Stocks and Uncommon Profits published in 1958, was focused on accumulating data covering a broad and diverse range of areas including customers, suppliers, and competitors.
Fisher’s approach included identifying a company’s four most relevant competitors and then asking managers at each company to evaluate the strengths and weaknesses of the other four.
When done carefully, this approach is likely to produce a useful picture of all five companies. This approach benefits from a more objective cross-section of insights, compared to directly probing a company’s employee about its own operations.
Fisher would study a company’s intangibles that don’t show up on financial statements – things like management integrity, openness to change, supplier relations, and customer awareness. We appreciate the information and perspective you can get by talking to people and we think one of the most important parts of scuttlebutt is talking to the customer.
To understand and assess durability, we need to understand customer behaviour. For instance, one of our favourite scuttlebutt questions is:
“Does the management have a determination to continue to develop products or processes that will still further increase total sales potentials when the growth potentials of currently attractive product lines have largely been exploited?”
Our team had the opportunity to get 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 the 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 speaking to the GM of its overseas business office (photo below), as well as the 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 machines for a particular food segment.
The founder is a thought leader and pioneer who invented the world’s first food robot in 1980’s because he wanted to bring this particular food – once considered a luxury – 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.
Our investment team with the GM of the overseas business unit of one of our portfolio stocks at the Food & Hotel Asia 2016 at the Singapore Expo. This overlooked Hidden Champion generates a ROE of 14.6% and trades at a compelling valuation of 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 tipping point in its business model with 20% of its overall sales coming from overseas with the growing global popularity of the food. Its after-sales consumables and parts business has achieved breakeven 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 local and overseas rivals, yet customers who were hunting for price bargains 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 required to produce them in large quantities quickly and on a consistently reliable basis, something that their rivals cannot achieve.
Almost 90% of the machine parts are designed in-house and their customers are able to perform maintenance themselves through phone call support or a store visit by the company’s technical personnel. This still leaves the killer question: “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 machines contain several moving parts that are difficult to source for and a software and controller 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.
We saw how and understand why one of their repeat customers, CP-All which operates the 7-Eleven convenience retail store franchise in Thailand, ordered more of their industrial food robot machines.
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 a professional chef. They were softer in texture and bite, and had a human temperature, unlike the hard version we thought might come from a robot. We discovered the secret lies in how the robot is able to inject tiny air pockets at the right time to enhance the quality and taste of the food.
Through this Hidden Champion, we learned 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 machine’s features 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 in the automated food equipment.