Unearthing Hidden Champions · The theme of the Challenge is “Unearthing Hidden Champions ......

Inter-Varsity Stock Research Challenge 2017

Unearthing Hidden Champions

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Preface

“Strive not to be a success, but rather to be of value.”

- Albert Einstein

Impact.

Impact is created when one strives to be of value to craft insightful research reports on outstanding companies to leave an indelible mark of benefit to the business and investment community.

Impact is delivered by Warren Buffett, long before he was the billionaire Chairman of Berkshire Hathaway and the world’s greatest investor, when he wrote his research article “The Security I Like Best” on auto insurer GEICO which was published in The Commercial and Financial Chronicle in 1951 – when Buffett was only 20-years old. Buffett’s comment that “the major portion of growth lies ahead” for GEICO was audacious; GEICO had already experienced supercharged growth since 1935 in increasing its base of policy holders by over 38-fold to 143,944 and premiums written by over 77-fold to $8 million. A trading or speculative mindset would have resulted in one to sell the shares and take profit – and miss a critical lesson about value investing and business building. GEICO went on to compound growth even further, to 14 million policy-holders and premiums written to $23.3 billion. As Buffett illuminates the evergreen wisdom in value investing back then which still holds true today, “Of course the investor of today does not profit from yesterday’s growth.” And the research article proved instrumental in the years ahead in impacting the long-term career trajectory of Buffett, who applied the business and investing approach outlined in the research to go on to build the conglomerate Berkshire Hathaway with a staggering market value of $400 billion, more valuable than the annual GDP output of Singapore.

We hope there will be a positive impact from the launch of Singapore’s first Intervarsity Stock Research Challenge that is held within the 6th Value Investing Summit (VIS) 2017, a two-day event which attracts a 1,600-strong community of like-minded value investors to participate and is held on 14-15 January 2017 at the Singapore Expo. The Challenge’s mission is to promote the study of value investing, to foster intelligent research on Hidden Champions in Asia, and to allow students to cultivate the portable lifelong skill-set of critical thinking ability. This booklet publication is a culmination of the dedication put forth by the students to apply what they

Disclaimer

1. The booklet and its contents contain the opinions and the ideas of its authors. It is not a recommendation to purchase or sell the securities of any of the companies or investments herein discussed. The booklet is sold with the understanding that the authors and the organisers are not engaged in rendering legal, accounting, investment or other professional services. If the reader of this booklet requires expert financial or other assistance or legal advice, a competent professional should be consulted. Neither the authors nor the organisers can guarantee the accuracy of the information contained herein the booklet and its contents.

2. The organisers are not in any way related to the companies mentioned in the booklet.

3. The authors and organisers specifically disclaim any responsibility for any liability, loss or risk, professional or otherwise, which is incurred as consequence, directly or indirectly, or the use and application of any of the contents of the booklet.

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have learnt into the messy world of reality by forming quality analytical research output that has timely relevance and usefulness to the wider business community

The theme of the Challenge is “Unearthing Hidden Champions”. Who are Hidden Champions? Like GEICO and Berkshire Hathaway when they were at an earlier undiscovered, overlooked and underappreciated stage in their corporate lifecycle, Hidden Champions are the indispensable companies impacting the well-being of our daily life.

You wear them, the Crizal lens on your eyewear. Essilor International is the world’s leading ophthalmic optics company behind the Crizal, Transition, Varilux lens and the company is powered by a unique owner-oriented corporate culture with its inclusive plan to enable 50% of employees worldwide become shareholders, compared to 20% currently. Its share price has compounded 2,000% since 1986.

You touch them, the ASSA Abloy system for your door. ASSA Abloy AB, the global leader in innovative door opening solutions to improve our lives through security, safety and convenience, is up 10,000% since 1994.

You cook with them – peep inside a professional kitchen and you can find a Rational intelligent cooking system on a Norwegian submarine, a Saudi prince’s yacht, as well as in hospitals and restaurants around the globe. Rational AG commands a global 54% market leadership in the world’s professional kitchens that include the Buckingham Palace and the White House, and is behind the success of such famous culinary names as Gordon Ramsay. Rational AG is up 1,000% since 2000.

You may even use them in emergency care situations, the Ambu bag for manual resuscitation in hospitals, by ambulance services – in fact in all kinds of emergency

Preface

environments all over the world. Ambu A/S, the company whom millions of patients and healthcare professionals worldwide depend upon the functionality and performance of its products, is up 6,000% since 1992.

Essilor, ASSA Abloy AB, Rational AG and Ambu A/S are the successful yet relatively low-profile Hidden Champions who are focused market leaders in sophisticated, hard-to-imitate niche products and valuable critical niches that are largely invisible to the average consumer yet are indispensable and impactful to our well-being in daily life. From a value investing perspective, investing at an earlier stage in the long-term growth trajectory path of these Hidden Champions - in Asia - should prove rewarding.

Entrepreneurs and the wider business community could also find inspirations in the Hidden Champions in scaling up their business models. The difference between a businessman and an entrepreneur is that a businessman can always make money for himself but an entrepreneur focuses on building an idea larger than himself to serve others with Purpose and carry more people on board the bus. 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. Hidden Champions believe commerce is not merely about the measurement of the weight of profits collected in multiple clever transactions to build measurable wealth, fame and power, but rather it should be defined by the immeasurable integrity and virtue. Only in

Preface

Warm regards,

Kee Koon BoonChief Investment OfficerInvestment: Public Markets8I Holdings Limited

the endeavor to perform first for customers, and serve them with the highest possible integrity and character, can commerce find its foundation for durable business success and create society’s abundance.

After a rigorous selection process, we have picked eight teams to advance into the semi-finals and their research reports are edited and compiled in this booklet. We also included some brief comments on further research that is needed to investigate certain critical business, corporate governance and accounting related risks for some of these companies that did not make it into the finals.

We hope that the unearthing of Hidden Champions will be an enduring endeavour for lifelong learners in value investing, entrepreneurs and the student community and that this booklet by these promising varsity students has made an impact to contribute to this continuous pursuit.


1Inter-Varsity Stock Research Challenge 2017Unearthing Hidden Champion

Content

Alpha TaurusREA Group Ltd

Bobstein KonsultingNippon Flour Mills Co., Ltd.

Geo-InvestorHeveaBoard Bhd

Enceladus CapitalISOTeam Ltd

Latent CapitalKeyence Corporation

The Net-NetsDomesco Medical JSC

MinervaVinamilk

Team GoldNandan Denim Ltd

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2 3Inter-Varsity Stock Research Challenge 2017Unearthing Hidden Champion

Inter-Varsity Stock Research Challenge 2017Unearthing Hidden Champion

Alpha TaurusTeam Members

Edison Hon is a fi rst year double degree in Accountancy & Business student at Nanyang Business School, NTU. Prior to NBS, he has worked in the areas of accounting and fi nance at tech giant, Ingram Micro and DBS Bank. He is currently doing an internship as an investment analyst at Stirling Fort Capital. Edison Hon aspires to be a M&A Investment Banker.

Joel is a fi rst year business student at Nanyang Business School, NTU. Prior to NBS, he has worked at Ernst and Young as an Advisory Intern and created his own start-up, OneBiteCo. He currently interns as a fi nance writer for Wallstreetoasis.com and is the Director of Competition for the Asian Business Case Competition.

Chuan Hoe is a fi rst year, double degree (Accountancy and Business) student at Nanyang Business School. He is currently a winter intern at Taiger Singapore Pte Ltd, an artifi cial intelligence start-up. Prior to NBS, he studied at Hwa Chong Institution and graduated with a diploma with distinction. Chuan Hoe also did an internship under the Energy & Chemicals division at IE Singapore.

REA Group Limited

Quick Stats

Date 5 Jan 17

Share Price 56.17

No. of Shares (Mil) 131.7

Market Cap (USD Mil) 5,381

Daily Value Traded (USD Mil) 10.0

GPM (%) 78.3%

EBIT (%) 49.6%

Net Debt (Cash)/Equity (%) 52.3%

ROA (%) 14.9%

ROE (%) 31.0%

EV/EBIT (x) 24.9

EV/EBITDA (x) 24.3

P/Sales (x) 11.7

P/E (x) 33.4

P/NTA (x) (30.8)

Company Research & Report

Business background and overview

REA Group Limited is a global digital advertising company specialising in property. They own and manage multiple websites across the globe, such as Real Estate (www.realestate.com.au, Australia), iProperty (www.iproperty-group.com, Southeast Asia), Casa (www.casa.it, Europe) and Realtor (www.realtor.com, USA).

Revenue breakdown by segment:

The Group’s revenue streams come from property advertising as well as property related services. These can be split into four main segments: Agent fees (64% of revenue), advertising fees, ancillary services, and other income. Advertising fees, ancillary services, and other income make up roughly 25% of revenue. Revenue from ancillary services include commission fees from linking consumers with mortgage loan providers and utility providers; revenue from advertising range from banner advertisements, pay per click advertisements, and providing advertising insights to ancillary businesses.

REA Group has two main models for agent fees, namely, a subscription based model and a per-listing model. Recently, the group phased out the subscription-based model in favour of the per-listing model, with a focus on depth advertising products which give property agents the opportunity to pin their property to the top of search results, in exchange for a premium price. This tactic has been highly successful, with depth-based products now contributing 73% to the Group’s Australian revenues. This has been a key driving factor driving EBITDA growth to more than 20%.

Revenue breakdown by geography:

The Group advertises property and property-related services on websites and mobile applications. Australia accounts for 88% of the group’s revenue, with Europe making up 8%, and Asia contributing the remaining 4%.


Source: REA Group Analyst Presentation FY16

Source: REA Group Analyst Presentation FY16




Network Effect

REA Group has signifi cant moats over its closest competitor. Like many internet service and software companies, REA Group’s business model enjoys signifi cant network effect. Each additional user is able to add value to existing users by providing them with a larger variety of listings or a larger pool of buyers. The company sees far more property listings on its website than its competitors. As a result, more people visit its site than any other, which perpetuates the virtuous cycle of more listings and more visits. As the dominant site, REA attracts more than 2.1 times more visits, with consumers spending more than 6.1 times as long on their site. Part of the reason their portals attract more customers is due to the company’s ability to offer additional services through its proprietary products and partnerships with key complementary service provider.

Bargaining Power

The realty market is highly fragmented as individual agents lack bargaining power and are inclined to compete on agency fees between its competitors, affording REA substantial pricing power as the leading property portal. This translates to REA Group being able to command high margins and fees from agents and advertisers. This market-leading position gives REA greater pricing control over their competitors, meaning more real estate agents are prepared to pay a premium to list on REA’s website, given the stiff competition in the real estate industry. Such pricing power contributes greatly to REA’s bottom line.

Analysis of corporate culture, management quality, shareholding structure and business group structure

CEO

Ms Tracey Fellows has been the Chief Executive Offi cer at REA Group Limited since August 20, 2014. She brings over 20 years of experience in the tech Industry, having served executive roles at Australian Postal Corporation and Microsoft Corporation, as well as senior roles at Dell and IBM. We believe that Ms Fellows is an excellent leader for REA given her expertise in strategic planning for technology companies. Her earlier executive role at Microsoft APAC (Vice President and Marketing Director before that) gives her the right skill sets required to take REA forward as a powerhouse in the real estate online media industry.


Ms Fellows aims to evolve REA Group’s products into a comprehensive experience for customers by investing in new technologies to create a complete buying, selling, and renting experience for consumers. This vision of creating a holistic experience for customers aligns with our growth expectation for REA Group. Ms Fellows’ vision will strengthen REA Group’s existing economic moat.

Source: REA Group Annual Report 2016

How did you originate this Idea and why did you choose this company?

We fi rst sourced out sectors which we felt had huge growth potential or showed good historical growth. After discussing at length, we selected the logistics and technology sectors. We observed market leaders within these sectors and then studied the value chain in search of companies which benefi ted from increasing user-led demand based on structural changes which are likely to further increase and arrived at realestate.com.au, and its parent company, REA Group Limited.

We analysed REA Group based on three key criteria:

1. Healthy Financials with no suspicious accounting and no bad debt.

This is to avoid companies that might have shady dealings, or engage in any form of potential misdeeds. This fi rst tier of funneling and fi ltration aims to prevent risky investments.

2. A Strong & Competitive Business Model that will maintain their local leadership and even grow to be a global leader.

There must be solid and strong reasons why this company is the market leader, and we must be certain that the company can maintain its position as leader and fend off potential competitors and threats in the industry.

3. Excellent Management Team with clear vision and mission rather than purely focused on profi ts, and focuses on growth instead of just wealth preservation. (our observation of companies in Japan and South East Asia)

We felt this was crucial as agency theory tends to be an issue at APAC fi rms, where executives focus too much on raising profi ts, potentially at the expense of long term growth.

Another observation we had was that Asian-based companies are more likely to focus on wealth preservation, i.e., they focus on

optimizing production and maintaining healthy cashfl ows – this is optimal for bond holders but not for stockholders as the lack of growth translates to a low probability of the company’s value increasing in the future.

As REA Group was did well for all 3 broad criterion, it was selected as our hidden champion – Indeed, REA Group is the local champion for the Australian property sector.

One sentence investment thesis?

Backed by a stable key market (Australia), REA Group is well positioned to double in value over the next 3 to 5 years with aggressive expansion into markets with huge potential (e.g. Asia) as their strong management team leads the company to integrate its horizontal value chain, giving it a strong edge over competing platforms.


What makes it a wide-moat business? Fundamental dynamics behind 31.0% ROE

Horizontal Value Chain Integration

The main competitive advantage REA Group has over its competitors is its comprehensive business model. REA Group offers consumers the convenience and transparency of comparing property listings online while still providing full coverage in home loans through partnership with Australian Finance Group (AFG) and other services. By bundling necessary services and removing unnecessary ones (personalized service from property agent), REA Group creates value by providing a lower one-stop package cost to consumers. At the same time, agents can take advantage of their online portals to reach out to a wider base of property buyers and sellers in a shorter amount of time, without incurring huge advertising cost.




Commentaries by the Public Markets Investment Team investing in Hidden Champions

1. Team Alpha Taurus needs to provide further analysis and commentary on the business model and valuation impact of their entry into the new business of home loan, including the risks involved, especially when REA does not have the core competencies for the three critical aspects: credit origination, credit evaluation, credit collection & recovery. Is it likely that the company will raise capital in secondary equity placement given the new business?

2. The team needs to provide further analysis and commentary on the business model and valuation impact to the company with their exit from Europe.

3. The team needs to provide further analysis and commentary on the iProperty acquisition and potential goodwill impairment.

4. The team needs to provide further analysis and commentary on the business model and valuation impact of their thrust into the depth-based ad model, the earnings sensitivity of the pricing premium.

5. The team needs to research more on the accounting of customer acquisition cost; has there been an increasing or decreasing trend?

reported decrease in cash reserves. The cash and short term investments of the company decreased to AUD78.8 million in FY2015 (from AUD253.7 million in FY2014). This led to a marginal defi cit in its working capital.

Due to defi cit in working capital, REA Group may face problems meeting short term obligations, which could be a cause for concern. This is becoming evident with iProperty entering a AUD14m working credit facility in February 2016, and another AUD4m in May 2016. At end June 2016, the full amount of AUD18.0 million was drawn. This could suggest poor working capital management, and may result in a further increased use of revolving credit which may increase the interest expense to an amount greater than forecasted, which ultimately impacts profi tability.

Issues on Steep Price Hikes

One contributing factor to REA Group’s increasing bottom line is its increasing prices. In 2014, according to the Australian Financial Review (AFR), the company faced a serious challenge from real estate agents in Melbourne, with 300 agencies appointing a third-party representative to negotiate fairer advertising prices with REA Group as the agencies felt that the prices were too exorbitant. With the increasing competition and dull outlook, unions and agencies might exert pressure on REA Group to reduce or stop price increases. This may hinder the company’s profi tability as the rate of increase in revenue cannot match the rate of increase in expenses.

REA Group’s dominant position has given the company the ability to push through price rises. It is in the agents’ interests that competitors to realestate.com.au exist. If real estate agents should boycott REA Group, the company could lose its competitive advantage. Rising competition and new entrants requires REA Group to closely monitor its competitors, including those focused on niche segments, such as rent.com.au, which could erode REA Group’s overall competitive advantage.


Changing Internet Landscape

The inherent risk of REA Group lies in the nature of the business. The continually-changing internet landscape can be fi ckle, favouring new or superior market entrants. For example, search giant Google is a material threat to the relevance of domestic online classifi ed providers. This online brand corrals large audiences which could erode the relevance of smaller domestic brands such as REA Group. Therefore, there remains an increasing pressure for REA Group to innovate to stay ahead of the game, to keep relevant to end users despite a constantly changing internet landscape.

This remuneration structure ties management interests with shareholders’ interests, since management is rewarded based on both short term and long term performance, reducing the agency risk from occurring in the fi rm.

In addition, the LTI helps to incentivise management to focus on long term growth, rather than forsaking stable growth for short term performance improvements to attain high bonuses and performance-related compensation. In addition, by vesting equity instead of cash compensation, incentives are ownership-aligned.

Why do you think the market value of the company can double in the next 3-5 years?

Backed by a stable Australia market outlook, REA Group is well positioned to maintain its leadership ranking as the #1 real estate online listing platform. In addition, their overseas expansion to global markets hold signifi cant growth potential. The combined result of the comparative competition valuation and current market view of REA’s share price suggests that REA Group’s shares are attractive given the company’s growth prospects. The undervaluation of its shares represents an opportunity to invest in high growth potential businesses in the Australian Media sector. After determining REA Group’s exposure and mitigation of investment risks and evaluating the corresponding impacts on valuation, we think that REA has a stong base with which to double their market value in the next 3 to 5 years.

It should be noted that it may be early on in Ms Fellows’ tenure at REA Group to correlate her leadership and visionary capabilities and the company’s performance. With that said, we still feel that her fi t with the company is an good one. Along with her team, we are optimistic for REA Group’s high performance under Ms Fellows’ leadership.

Remuneration Structure

REA Group’s Remuneration structure focuses on four aspects:

(1) Ownership Aligned(2) Rewards for above threshold performance (3) Consistency and Transparency (4) Simplicity

These four guiding principles form REA’s remuneration structure which consists of Fixed Annual Remuneration (“FAR”), Short Term Incentive (“STI”) and Long Term Incentive (“LTI”) portions.


Source: REA Group Annual Report 2016

What are your top 3 dislikes? What are the toxic factors?

Declining Working Capital

REA Group saw a negative working capital in FY2016. In FY2016, the company reported a negative net working capital of AUD9.6 million (AUD59 million in FY2015). This decrease is was due to the increase in current liabilities. Total current liabilities increased 135%, from AUD99 million in FY2015 to AUD233 million in FY2016. This is due to the increase in contingent considerations from acquisitions by REA Group.

REA Group also reported decline in working capital in FY2015. In FY2015, the company reported a net working capital of AUD59 million (AUD219 million in FY2014). Working capital decreased due to the decrease in current assets. Total current assets decreased 50.5% to AUD158.5 million in FY2015 (from AUD319.9 million in FY2014). This led to a marginal decline in working capital. In FY2015, the company






6. The team needs to further examine the valuation dynamics of Google at the various stages of its corporate lifecycle and compare its relevancy in valuation with REA.





Nippon Flour Mills (NFM) was founded in Tokyo on September 26, 1896. It is part of Mitsui Group, one of the largest conglomerates (‘keiretsu’) in Japan and the world.

NFM operates in Japan’s Food and Drink sector, dealing primarily in consumer staples. Its core business is in fl our milling, where NFM are the fi rst industrial fl our milling company to adopt western-style machinery for production.

Today, the company is also in the business of selling and manufacturing health foods, cosmetics, and pet foods. The company also engages in sports facilities management, and its bioscience business includes a Research and Development Division. Upon the completion of its 8th wheat silos plant, NFM will own the largest wheat storage facility in Japan.

The company also operates overseas for diversifi cation. NFM’s overseas operations can be found in Thailand, Indonesia, China, and the United States. Overseas enterprises manufacture premixes and pasta products, which are sold to nearby countries in the region where these products are manufactured.Revenue breakdown by product:

NFM’s goal is to be a multifaceted global food enterprise. Its food segment contributes a signifi cant 57% to sales. Flour milling generates 33%, followed by other businesses (healthcare, cosmetics, etc.), which contribute 10% to sales.

The food segment has experienced signifi cant increment in sales over the years and remains an important growth driver. In the food segment, the company is a market leader in frozen foods with its “Oh’my” brand of frozen ready meals. Net sales have been increasing yearly thanks to rising sales from all of NFM’s segments.

Overview of 2016 Business Performance:

In 2016, sales gained 4.4% year-on-year to JPY ¥311.6 billion (from JPY ¥298.5 billion in 2015). Operating income on the other hand gained 32.0% year-on-year (from JPY ¥8.4 billion in 2015 to JPY ¥11.0 billion). Business expansion within each segment of NFM’s food businesses has directly impacted profi tability.

This suggests the company is getting more profi table and owes its performance to business expansion within each segment of their food business. Despite the fl our milling being its core competency, the company’s involvement in food and other businesses has demonstrated strength and potential in generating revenue. These two segments will continue to be a key contributor to the company’s success together fueled by its research and development (R&D) division’s innovation to capture the growing demands of consumers.


How did you originate the idea and why did you choose this company?

The team wanted to pick a company that was selling easy to understand products or services and operating in a familiar environment. Firstly, we eat every day and all of us are familiar with food. Hence, we decided to choose a company that was operating in the food and drink industry.

Secondly, we decided to choose a company in Japan because Japanese people are known for being conscientious and dedicated in whatever they do. Therefore, the 3 words, “Made in Japan” portrays an image that a Japanese product is of superior quality and exceptional design.

Darren Ong is a fi rst-year Business Management student at Singapore Management University. He has worked at ING Investment Management Singapore Pte Ltd, undertaking projects for the Operations Team and Sales Team. He also did his internship with GIC Pte Ltd in the Investment Operations Department as a Data Analytics Intern.

Lim Yi Chang is a fi rst-year Accountancy student at Singapore Management University. He has worked at CapitaLand Retail Management in the Finance Department handling accounts. He did his internship with Deloitte Singapore as an Audit Intern during his school term.

Bobstein KonsultingTeam Members

Quick Stats

Date 5 Jan 17

Share Price 1,672




GPM (%) 26.7%

EBIT (%) 3.7%


ROA (%) 3.6%

ROE (%) 6.6%

EV/EBIT (x) 14.8

EV/EBITDA (x) 9.0

P/Sales (x) 0.4

P/E (x) 15.2

P/B (x) 1.0

Nippon Flour Mills Co., Ltd.





Strong Foundation in Flour Milling

NFM is one of the big four fl our milling companies in Japan, ranking second in terms of market share – after NFM’s biggest competitor, Nisshin Flour Milling. NFM owns 22% of the total fl our milling market in Japan. The Flour Milling segment offers wheat fl our, wheat bran, buckwheat fl our, and other items, which are ingredients for daily consumer staples.

To spur growth in its core business in fl our milling, NFM has taken several initiatives via capital investments to strengthen

never grown in Japan. However, this R&D breakthrough by NFM has broken boundaries, making NFM to be the fi rst ever company to manufacture domestic pasta. It opened the potential for Japan to manufacture 100% of its pasta and increase self-suffi ciency rate.

Results from trials / tests show that bread made from Setodure stays softer for longer periods of time, compared to breads made with other wheats in the market. This is due to a special starch that contains a slow aging compound which makes confectioneries made with NFM’s newly developed wheat softer, and last longer.

This gives NFM a competitive advantage as consumers and suppliers are likely to prefer the company’s wheat and fl our products over competitors in the fl our milling business. Currently, only NFM has this technological knowhow; competing companies continue importing from overseas.


Use of Functional Foods to Enhance Products

Japan’s aging population in Japan has presented the opportunity for NFM to venture into health foods with the use of functional food ingredients such as Flaxseed. Functional foods are ‘enhanced’ with vitamins, herbs, or nutraceuticals to deliver additional benefi ts, or enhance health benefi ts beyond their basic nutritional value.

By 2030, 31.6% of the Japanese population will be aged 65 years and older. Hence, the senior market becomes increasingly important for businesses as consumers’ consumption preferences move toward ‘healthier’ options.

An example of functional food that NFM has developed is through integration of Flaxseed in their products. Originated from the fl ax plant, its seeds are rich in Alpha-Linolenic acid (omega-3 fatty acid, lignin and dietary fi bre). It aids in building cell membranes in the brain, can help to reduce joint pains from arthritis and improve mobility. All of which are problems facing an aging population.

Since the introduction of Flaxseed to NFM’s products in 2013, sales of fl axseed products experienced strong growth the fi rst quarter of 2015. The size of the fl axseed oil market is expected to grow.

NFM also supplies almost every possible business-use ingredient based on market needs to create consumer staples (such as bread and pasta) in the delicatessen market. Across Japan, deli operators, supermarkets, and convenience stores order supplies from NFM. The company then produces ingredients like premixes, wheat fl our, and pastry dough via its plants and sells them to these businesses. Japan is the leading ready-meal consuming country in the APAC region; the ready-meal market in Japan is expected to grow at a CAGR of 2.25% to reach USD 4.08 billion in 2020.

Through omnidirectional sales and marketing, NFM is able to provide and produce a wide range of products that targets every segment of the food industry. This strategy enables NFM to establish strong infl uence, and capture a large market share of the industry.

Development of New Type of Durum Wheat – Setodure

In a joint research program with its R&D partners, Western Region Agricultural Research Center and National Agricultural Research Organisation (NARO), for the fi rst time ever in Japan, NFM successfully developed Setodure, a new variety of durum wheat.

Durum wheat is used to make pasta; currently fl our milling companies in Japan imports durum wheat from overseas (e.g., the US). Due to the unsuitable climate, durum wheat is almost

One sentence investment thesis

Nippon Flour Mills is a company run by quality management with strong fundamentals in multiple segments of the food industry, that can produce highly differentiated products through innovation in research and development, giving the company its competitive advantage.


Ubiquitous Supplier of Choice

NFM’s strategy is to have its products stocked on shelves of major supermarkets and convenience stores, as clearly demonstrated in its Delicatessen Business.

Lastly, Nippon Flour Mills was chosen by us because its shares were inexpensive and was trading cheaper relative to its size as compared to its peers. It deals with consumer staples, has an established business groundwork and a management that focuses on creating value for the shareholders in the long run.





Corporate Governance

NFM’s management places strong emphasis on responsibility to shareholders from its whistleblowing policy, and a strict code of conduct for employees. NFM has in place a “System for Crisis Management”, for risk/crisis management to reduce or manage risk of loss or loss.

NFM has its own auditing team and internal control department to oversee compliance of fi nancial reporting as well as operating procedures, to manage fraud and operational risk.

Business Group Structure


New Products to Enter the Market


With the aging Japanese population, NFM’s R&D division introduced new functional foods in 2016. Apart from fl axseed products, the company launched “Koikoi Yasai Koikurenai” and “Shinryoku Aojiru”, leveraging the benefi cial nutritional value of carrots and kale. They used fl axseed to create Flaxseed Oil & Vitamin E healthcare products.

competitiveness and enhance earnings power. By shifting operations to complex plants and concentrating on its coastal mills complexes, NFM was able to increase production effi ciency by 93%.

At the same time, with automation of production lines, investment in energy-saving equipment and construction of its new wheat silos facility, NFM can maintain cost control in a challenging operating environment.

Key Capital Partnerships

Barilla Group is an Italian food company and is the world’s leading maker of pasta and pasta products today. The company recorded a revenue of EURO €3.382 billion for 2015 (up 2% from 2014). Barilla has a total of 14 brands in meal solutions and has almost 180 bakery products.


The brand can be found in over 30 countries in Europe, the Americas, and Asia Pacifi c. In 1982, Barilla signed a licensing agreement with NFM to produce pasta in Japan. The pasta products will be sold and marketed under the Barilla brand name, according NFM exclusive rights to distribute and sell the famous ‘Barilla’ brand pasta in Japan.

The company also acquired Yamato Foods Co., Ltd, which operates franchise restaurants (such as Mister Donut and MOS Burger) in March 2016. The acquisition was made via NFM subsidiary NIPPN Donuts Holdings, strengthening NFM’s ties with Duskin Co., Ltd (operator of Mister Donut restaurants), and expanding its food and donut businesses. Today, NFM owns 107 Mister Donut restaurants and 13 MOS Burger outlets in Japan.


Top Notch Management

NFM’s top key offi cers, Mr Hiroshi Sawada (CEO) and Mr Masayuki Kondo (COO) both possess the necessary experience to lead NFM, with 14 and 6 years of experience respectively under their belts. The company is also led by 28 other Managing Directors and Executive Offi cer.

Mr Hiroshi Sawada was previously COO and Representative Director of NFM (since June 2002), while Mr Masayuki Kondo was NFM’s Managing Executive Director for 5 years (from 2010) becoming Senior Managing Executive in 2015, and President in 2016. Both have demonstrated their management prowess in leading NFM to meet its goals, as demonstrated by the company’s outstanding performance.

NFM’s management has been constantly meeting the company’s fi nancial goals while employing effective strategies to combat and improve its products and services. The management team excels at identifying market trends, allowing NFM to take calculated risks and make sound investment decisions, an example being the decision to produce functional foods to cater to an aging population.

NFM’s profi t margin has risen consistently thanks to such initiatives, coupled with effective cost reduction. The management success and effectiveness is seen in NFM’s strong growth in share price, improved EPS, and profi tability over the past fi ve years.

Shareholdings Structure

i. Authorised Shares Issued: 696,590,000ii. Outstanding Shares: 165,048,018 (including

4,290,141 Treasury Shares)iii. No. of Share Holders: 18,467





shares on the open market to gain controlling interest. NFM may be seen as a ‘sleeping beauty’ and a potential takeover target. NFM is currently looking into countermeasures to overcome this. However, NFM is backed by the larger conglomerate, Mitsui Group.

Lack of International Presence/Visibility

NFM’s goal is to be a multifaceted global food enterprise. While it has achieved the multifaceted aspect through strategic diversifi cation into different segments of Japan’s food sector, NFM still has work to do to increase its international presence, with limited presence of operations outside Japan. The company currently operates in Thailand, Indonesia, China and the US.

In a recent report by OCBC Bank, economists are positive about the outlook for Indonesia (the 16th largest economy in the world, with growth rates among Asia’s top fi ve). With Halal Certifi cation, and having established its Indonesian subsidiary, PT. NIPPN Foods Indonesia, in 2014, NFM has identifi ed Indonesia as a possibility for rapid growth and plans to expand sales in Asia.


1. Team Bobstein Konsulting needs to elaborate more on their integrated value chain from production to distribution/customer relationship and its relevancy to their competitive edge. Elaborate on the “ubiquitous supplier of choice” business model and strategy and link it to the customer segment and revenue model.

2. The team needs to provide further analysis and commentary on the capex plans, their fl our milling capacity and effi ciency as compared to Asia’s largest single-location fl our milling plant Bogasari owned by Indonesia’s PT Indofood Sukses Makmur.

3. The team needs to elaborate on the business partnerships with Barilla, Yamato Foods, Mister Donut, etc.

4. The team needs to provide further analysis and commentary on the diversifi cation risk into the non-core business activity of real estate.

5. The team needs to provide further analysis and commentary on their shareholder structure and business group & corporate structure. Does their keiretsu structure result in a corporate governance discount to the valuation?


Expansion of Wheat Silos Facilities

The company has made a capital investment to construct its 8th Wheat Silos Facility (to be completed FY2016). Upon completion, NFM will have the largest wheat storage facility in Japan. Storage capacity for raw wheat will increase by 50% to 300,000 tons. The new silos will bring in storage fee income, suction fee income and reduction in raw material pick-up costs. Thus, improving overall profi tability and revenue in the long run.

The R&D division continues to create new products to meet market need, in line with expectations, tastes, and preferences of changing consumers’ demographics.

Strong Research and Development Capabilities

NFM keeps ahead in their food business due to their ability to identify market trends, and leveraging on their strong R&D capabilities.

0R&D improves food products and creates new items to promote healthy eating, enhance nutritional value, improve taste and wellness.

With the successful development of its new durum wheat, and the company’s venture into biosciences, immunochromatography business, and the lactic acid market, we can expect NFM to introduce new products that will be in demand in the very near future.

Expansion to South East Asia

NFM acquired Halal Certifi cation in 2012 and announced (Q4 2016) that it would start to expand its business across South East Asia. The company plans to market its products to Muslim consumers, beginning with Indonesia.


Over Diversifi cation to Other Industries

NFM’s strength lies in its food business and established competitive advantage in the food and drink industry. In 2015, NFM announced their participation in a joint development project of a new offi ce building in the North District of 5-chome, Sendagaya, Tokyo with Mitsubishi Estate Co., Ltd. The project is expected to commence in April 2017 and complete by August 2019. NFM plans to enter the real estate leasing business once the project is completed.

We feel that the company should focus on doing what it does best – food, rather than entering the risky real estate sector where it is not a dominant player and lacks expertise. The capital invested could otherwise be used to boost weaker performing food segments and create new products.

However, with the current bullish Japanese property market and the management’s consistency in making good investment decisions, venturing into the real estate business may pose a potential catalyst that could enable NFM to double its market share and revenues, since it already manages sports facilities. Currently, no further news has been released by the management regarding this investment plan.

Defences Against Hostile Takeovers

In a report from the Tokyo Stock Exchange, it was reported that NFM has no defence against hostile takeovers. This means that another company or individual could acquire enough





HeveaBoard is a family business owned by the Yoong family. Yoong Tien Seng, whom is one of the founding member of HeveaBoard, is also the father of current group Managing Director Yoong Hau Chun.

HeveaBoard and its subsidiaries manufacture, trade and distribute a wide range of particleboard and particleboard-based products.

HeveaBoard’s subsidiaries are involved in downstream particleboard based Ready-to-Assemble furniture manufacturing, trading and distribution of particleboard and wood panel related products.

In a nut shell, Heveaboard is in a business which turns timber into particleboard for making furniture. These products are then exported to various countries including Japan, China and Malaysia.

Revenue breakdown by product:

Ready-to-Assemble Furniture and particleboard makes up 56% and 44% of HeveaBoard’s revenue respectively. However, the EBIT Margin for particleboard is signifi cantly higher than RTA Furniture segment.


Japan and China has always been the main market for HeveaBoard. The 6 year compounded annual growth rates (CAGR) for China and Japan are 24.3% and 9.0% respectively.


In 2016 (Annualized), revenue gained 5.6% year-on-year (yoy) to RM531million from RM503 million in 2015. Net Profi t after Tax gained 9% year-on-year to RM73 million from RM67 million in 2015. The increase in revenue and net profi t are mainly due to the development of higher margin (lower formaldehyde) product, development of mobile chipping technology and constant growth of business performance in the Japan and China market.


Alan Ng is a fi nal year Petroleum Geosciences student at Universiti Teknologi PETRONAS, Malaysia. He is inspired after attending Millionaire Investor Programme, and continues to learn and gain knowledge on value investing.

Nicholas Goh is a fi nal year Petroleum Geosciences student at Universiti Teknologi PETRONAS, Malaysia. As science student, he also took the interest in fi nancial accounting and began to learn and gain new knowledge about Value Investing.

Geo-InvestorTeam Members

Quick Stats

Date 5 Jan 17

Share Price 1.56


Market Cap (USD Mil) 173


GPM (%) 23.4%

EBIT (%) 16.4%

Net Debt (Cash)/Equity (%) -23.7%

ROA (%) 16.2%

ROE (%) 18.9%

EV/EBIT (x) 7.1

EV/EBITDA (x) 5.5

P/Sales (x) 1.3

P/E (x) 9.7

P/B (x) 1.8

HeveaBoard Bhd





From the year 2012 to 2015, the Board of Directors’ remuneration average about 10% of the NPAT which is acceptable. However, in 2011, the Board of Director’s remuneration is on a higher side at 52.3% of NPAT. The team is of the view that the high remuneration in 2011 was due to a one off payment to Mr Yoong Tien Seng for his years of contribution to the company over the years.

conventional way of harvesting is chopping down a tree with a timber saw and then collecting the chopped wood with an excavator which leave 20% to 30% of residue in the plantation, but mobile chipping will only leave less than 10% of residue.

With mobile chipping, HeveaBoard can increase effi ciency in gaining more raw material per tree which increases the overall gross profi t margins. The gross profi t margins since 2012 has been increasing which proves that mobile chipping technology is improving the business. Most importantly, with the usage of mobile chipping, the traditional way of open burning the residue after harvesting is redundant.

With the extensive research and development into producing greener products which are benefi cial to end users, HeveaBoard has moved a step further in ensuring harvesting the rubber wood raw material in the most responsible and environmentally friendly way.


Family Run Business

The current Group Managing Director, Mr Yoong Hau Chun is the son of Mr Yoong Tien Seng, who is one of the founding members of HeveaBoard. Mr Yoong Hau Chun joined the business since 2000, and was appointed as the Group Managing Director in June 2012. Based on his qualifi cations, a First Class Honours Degree in Mechanical Engineering with Business Management and MSc in Wood Industries Technology, he is well equipped with the skills to run the business.

Ms Yoong Li Yen, the Executive Director, who is also the sister of Mr Yoong Hau Chun, joined HeveaBoard as a Marketing Executive in 1998. Throughout the years, she had gained extensive experience in sales, marketing, and logistics. She was also the General Manager in Commercial of HeveaBoard and is the director of HeveaMart Sdn. Bhd., a wholly-owned subsidiary and marketing arm of HeveaBoard.


Mr Yoong Hau Chun is passionate with his family business. According to his BFM interview, he quoted saying that he takes a lot of pride to be in the particleboard industry. He even started getting involved in the business before he graduated. This family business is very meaningful to him and he also would like to continue the legacy of his father and other founding members.

Ever since he was elected to be the Group Managing Director, HeveaBoard business performance has improved considerably. He leads the company by emphasizing on adding value to its manufactured product by going ecofriendly. An example introducing mobile chipping to eliminate open burning and leading his team to modify and upgrade the production line to produce higher quality, lower formaldehyde emission particleboard.

Remuneration

Year Remuneration Net Profi t Total %

2015 4,522,000 73,571,000 6.15%

2014 3,146,000 30,176,000 10.0%

2013 2,714,000 22,459,000 12.1%

2012 1,925,000 15,477,000 12.4%

2011 1,749,000 3,341,000 52.3%



We fi rst got to know about HeveaBoard through a university mate. In early 2016, he shared that he had invested in HeveaBoard and had very good return, but I did not pay much attention to it. It was only till MIP tutorial group, when my group was assigned to research on HeveaBoard that I started doing more in-depth research on this company.

Particleboard is a need in our daily life to be use as household furniture and even construction material. The fact that HeveaBoard can produce high quality, low formaldehyde particleboard and eliminate open burning of wood residues by introducing mobile chipping, shows that it can add more value to the society. Furthermore, HeveaBoard is a family business whereby the Yoong family is the largest shareholders. In addition, HeveaBoard has successfully turnaround from a net debt to a net cash position with a healthy balance sheet. Therefore, we believe that HeveaBoard is a Hidden Champion.



HeveaBoard is a turnaround company, which successfully turned into a net cash position company in year 2015, and fully paying off its US Dollar loan in year 2016. It has the capability to produce low formaldehyde emission particleboard while taking care of the environment.


High Quality Product

HeveaBoard can produce high quality and ecofriendly particleboard. Ecofriendly means that the particleboard produced has low formaldehyde emission. Formaldehyde is classifi ed as a human carcinogen which can cause cancer. New furniture tends to

have an odor. This odor which is due to the formaldehyde emission which can be harmful to users. However, HeveaBoard manages to manufacture its particleboard to be odorless.

With the capability of producing ecofriendly particleboard, HeveaBoard can have a better selling point. However, it is only applicable to countries like Japan, China and Australia but not for other countries like Malaysia. In Malaysia, people tend to choose price over quality mainly due to lack of education on safety awareness, resulting in Malaysians not being well informed on the danger of formaldehyde. Fortunately, the management in HeveaBoard realizes the issue and started to educate the people through a new furniture product line, KREA Kids.

Even though HeveaBoard can produce the highest grade of particleboard, Melamine Faced Chipboard (MFC) in the industry, there still strong players globally who can produce the same grade of boards. Hence, HeveaBoard can only be considered as one of the strong players instead of the strongest player.

Management Know-How – Research and Development

Yoong Hau Chun, the Group Managing Director of HeveaBoard, graduated from Sussex University, UK with a First Class Honours Degree in Mechanical Engineering with Business Management, and an MSc in Wood Industries Technology from UPM. He is responsible for the operation of the particleboard plants and the group of companies under HeveaBoard. The team can design, develop, re-engineer and customize the machines. An example is that they had modifi ed their machineries to increase its effi ciency.

Ever since Yoong Hau Chun was elected as the Group Managing Director in 2012, he has introduced mobile chipping of the whole tree in the plantation. With the right method and equipment through mobile chipping, the harvesting process leaves very little, or no residue and wood fi ber in the plantation. The





Revenue Overly Relied on US Dollar

HeveaBoard has most of its cost denominated in the ringgit while more than 90% of its revenue is denominated in US Dollar (USD). Fortunately, HeveaBoard has Cash and bank balances in USD to reduce the forex risk of USD.


HeveaBoard management realized the need to educate Malaysians on the safety awareness on formaldehyde. Only when people have awareness, the exposure to formaldehyde emission can be lowered and increase the growth for HeveaBoard.

Formaldehyde is a denser substance as compared to air, which means it will settle down in the air. This formaldehyde substance will tend to be harmful to children who are still crawling because they are in lower elevation and having a weaker immune system.

As part of HeveaBoard’s expansion plan, a new furniture product line, KREA Kids is introduced. KREA Kids is a member of HeveaBoard group of companies that focus on the health of kids and the protection of the environment. Their products undergo stringent manufacturing controls that ensure the safety, reliability, and affordability of their furniture line.

With eco-friendly particleboard which has lower formaldehyde emission, KREA Kids will also be promoting safety awareness on formaldehyde as a growth plan.

Source: http://www.mykreakids.com/

Introduction of KREA Kids During the third and fourth quarters in 2015, the US Dollar had appreciated signifi cantly against the Malaysian Ringgit (MYR) which resulted in the huge increase of quarterly revenue for HeveaBoard.

During the earlier year of 2016, the USD depreciated against MYR. This has impacted and masked the performance of HeveaBoard’s business. In terms of revenue, 2016 (Annualized) yoy growth stands at 5.5% as compared to yoy gowth of 2015 at 19.2%, clearly indicating how the fl uctuation of the USD will impact the profi tability of HeveaBoard.

Low Barrier of Entry

HeveaBoard operates in particleboard manufacturing industry which has a lot of competitor and a low barrier of entry. There are a lot of particleboard manufacturing companies in the ASEAN region and Europe.

To remain competitive, HeveaBoard must constantly invest in research and development to build a wide and deep moat.

Low Safety Awareness

The revenue in Malaysia, India and Indonesia have been decreasing over the past fi ve years due to low safety awareness on the formaldehyde emission from the particleboard. People tend to select the cheapest particleboard instead of a higher quality as there is no difference between expensive and cheap particleboard.

If these markets continue having low safety awareness, HeveaBoard will lose market share in these countries. However, the management has started to put in effort to educate and promote safety awareness to the people through a new furniture product line, KREA Kids.


HeveaBoard is a family business whereby the Yoong family is the largest shareholder holding with ownership of 35% through HeveaWood Industries Sdn. Bhd., Firama Holdings Sdn. Bhd., and others.

As the Yoong family members hold most of the key management position, this will ensure that the management interests are in line with shareholders’ interest.


Source: https://www.fi npro.fi /web/eng/biomass-power-plants-to-japan


In the Japan Market

Ever since Japan Tsunami in 2011, Japan government has cut down on nuclear power plant and switch to other alternative power plants such as biomass power plant. The raw material for biomass power production is fi bre wood, which is the same raw material for particleboard manufacturing. With Japanese government strongly encouraging development of biomass power plant, the resources for fi bre wood will be very limited resulting in much higher costs.

In the China Market

Source: http://www.illegal-logging.info/sites/fi les/chlogging/ForestTrendsChinaLoggingBan.pdf

In China, due to the logging ban, the availability of raw material for particleboard manufacturing has declined greatly, resulting in soaring demand for imported particleboard.

Besides, Chinese particleboard manufacturers are uncompetitive as their wood residues are from expensive woods, such as poplar, eucalyptus and pine. This is unlike HeveaBoard which uses rubberwood as wood residues and cost only half

In addition, China has also started enforcing strict standards of its mandated minimum E1 standard for furniture whereby E2 being the lowest standard and E0 being the highest standard. This has resulted in the closure of many smaller low-quality domestic particleboard producers.

Furthermore, China government has implemented one-child to two-child policy on October 2015. With increasing population in China, the demand for household furniture will increase as well, hence benefi ting HeveaBoard. All these drivers will continue to strengthen the position of HeveaBoard in the China market.

HeveaBoard Bhd

HeveaPac Sdn Bhd HeveaMart Sdn Bhd

BocoWood Sdn Bhd Hevea OSB Sdn Bhd

100% 100%

100% 100%

Furthermore, strong demand for particleboard is also expected due to the Tokyo 2020 Olympic build-out. Thus, HeveaBoard will benefi t from these drivers.






1. Team Geo-Investor needs to elaborate more on the overseas distribution channels from the prospectus and footnotes, examine why selling and distribution expenses are unusually low as compared to its peers such as Evergreen who has a higher gross margin as compared to HeveaBoard.

2. The team needs to examine the related party transactions (RPTs) of the company and the potential of material undisclosed RPTs.



29Inter-Varsity Stock Research Challenge 2017Unearthing Hidden Champion


Founded in 1998, ISOTeam is an industrial leader in the building maintenance and estate upgrading in Singapore. The company was incorporated in Singapore on 12 December 2012 under the Companies Act as a private company limited by shares under the name of ISOTeam Pte Ltd. It was then listed on the Singapore Stock Exchange (SGX) on the 12 June 2013, where its name was changed to ISOTeam Ltd.

Their IPO offered 32,200,000 Placement Shares comprising of 30,730,000 New Shares and 1,470,000 Vendor Shares. Each Placement Share was priced at S$0.22 and its market price as of 15 December 2016 is S$0.38. Its current market capitalisation as of Q4 2016 is S$1108.63M (US$769.68). The fi nancial years end in 30 June.

It mainly offers services in the Repair & Redecoration (R&R), Addition & Alteration (A&A) and Coating & Painting (C&P) segments – serving both the private and public sectors. Till date, they have completed more than 300 R&R and A&A projects involving close to 3,000 buildings.

ISOTeam’s clients base include town councils, government bodies and statutory boards such as HDB from the public sector. The private sector includes property owners and developers, and main contractors.

Revenue Breakdown by Services

R&R has been the largest revenue constituent over the last 4 years, from FY 13-FY 16 at an average of 56%. A&A, C&P and ‘others’ segment follow thereafter, amounting to 35%, 8% and 1% of the total revenue respectively.

Overview of Business Performance in FY 16

As of latest FY16, R&R is still the biggest revenue driver, except; it has decreased to 42.79% of the total revenue. In contrast, A&A, C&P and the ‘others’ segment has experienced

tremendous growth. They currently amount for 25.91%, 12.48% and 18.86% of ISOTeam’s total revenue.

Revenue Composition (FY16)


Revenue Composition (FY 13-16)

Low Wei Cong is a third year undergrad student at Singapore Management University pursuing a degree in Business Management and Economics. He is currently interning at Allianz Consulting, and prior to that, interned at a automotive start-up in Atlanta, US.

Chua Swee Woon is a third year Economics & Finance Double Major Undergraduate from SMU. He did an internship at TRG as a Private Equity Intern handling portfolio company fi nancial analysis

Crystal Lim is a fi nal year student at the Singapore Management University. She did an internship at Ernst and Young and Asia Finance.

Enceladus CapitalTeam Members

Quick Stats

Date 5 Jan 17

Share Price 0.39




GPM (%) 25.7%

EBIT (%) 9.3%


ROA (%) 8.2%

ROE (%) 14.5%

EV/EBIT (x) 9.7

EV/EBITDA (x) 6.9

P/Sales (x) 1.2

P/E (x) 14.3

P/B (x) 2.3

ISOTeam Ltd


28 Inter-Varsity Stock Research Challenge 2017Unearthing Hidden Champion





ISOTeam’s founders are conferred ‘Distinguished Award Category Champion 2015’ in recognition of their individual and organizational entrepreneurial performances. Moving beyond this individual assessment of the founders, the following evaluates the management as one – and more specifi cally in their stewardship of shareholders capital.

ISOTeam’s Key Competencies

ISOTeam’s Strategic Advantages

Potential Opportunities for ISOTeam

Return on ISOTeam

- Only listed construction company on the SGX with a stellar track record of delivering good quality painting projects for the past 18 years

- Strong corporate relationship with the Town Councils

- There is an increase in 16,727 new HDB fl ats in 2014, translating into an increase in 16, 727 new fl ats up for repainting

- Awarded tender bids despite not being the lowest bidder

- Exclusive contractual relationship with Nippon Paint

- ISOTeam enjoys a 20-30% procurement discount with Nippon Paint

- ISOTeam is able to leverage on Nippon Paint’s extensive network in Myanmar

- Myanmar’s GDP growth in the construction sector is expected to grow by 0.6%; from 7.7% in 2014/15 to 8.3% in 2015/16. There is an increase in 16,727 new HDB fl ats in 2014, translating into an increase in 16, 727 new fl ats up for repainting

- Awarded more tender bids

- Awarded fi rst painting job in Myanmar within 4 months of joint venture with Nippon Paint

- Able to provide cross-selling strategies in the areas of solar panel installations and rooftop maintenance

- Strong corporate relationships and crucial bridge between the government (offering the tender bids) and Sun Seap (solar panel manufacturer)

- Able to offer installation and maintenance services for solar panels

- Singapore government is increasing niche industrial spaces

- There will be about 3 million square meters of incoming industrial spaces from 2016 to end 2017

- Awarded bid to install solar panels on HDB roofs


Table 1.1: Key Management

Table 1.2: Management Remuneration Structure

Source: Company, DBS Bank

Source: Company, DBS Bank


Uncovering Hidden Gems

Benjamin Graham, a pioneer value investor, once shared that “a market may be a voting machine in the short run, but a weighing machine in the long run”

Focusing on the long run, this weighing machine does not merely consider a company’s fi nancials. The market’s confi dence, otherwise known as the market’s perception of the company, is a crucial point of consideration.

In other words, it is insuffi cient for a company to be deemed valuable if the market does not recognize its future valuation regardless of its current healthy fi nancials.

DNA of a ‘Valuable Stock’

As such, the key DNA of a ‘valuable stock’ is one that carries the greatest disparity between the market’s perceived value and the company’s real current and potential value - with the former being lower in value.

ISOTeam – The Chosen Gem

ISOTeam is a leading R&R, A&A and complementary niche specialist services in Singapore with a proven track record in eco-conscious solutions. Founded in 1998, it has been on the Singapore Stock Exchange since 2013.

However, despite its steady fi nancial growth, it is noted that there are currently only two brokerages covering the ISOTeam stock, and this highlights the market’s unfamiliarity with ISOTeam, the hidden gem.


ISOTeam is able to enjoy a resistant recurring income model from its venture into local government painting and solar panel installation projects as well as its penetration into the Myanmar market.


Current Economic Landscape

It is reported that Singapore’s GDP growth came in at a mere 0.6% year on year (y-y) for Q3 in 2016, the lowest since 2009. This is in tandem with the negative global economic outlook – with a reported global GDP growth of 2.4%, the lowest since 2012.

This global economic slowdown creates a domino effect as most of the countries and industries suffer either a standstill or a slower growth. Despite such economic pessimism, it has to be acknowledged that there are still economies and industries that are experiencing potentially faster growth. In other words, there is defi nitely still a demand for certain sectors amid a global economic slowdown.

Matching Core Competencies with High Demand Sectors

With demand come reward, but only when they are met skillfully and realistically. Without in-depth industrial understanding, experiences and resources, the cost may outweigh the profi ts, bringing about greater debts and reputational harm.

As such, ISOTeam is commended for its ability to make optimal use of its core competencies by riding on sectors that enjoy high potential growth amid the negative economic circumstances.





Case Study

Some examples are as follows;

- TMS Alliances Pte LtdPartnership with Nippon Paint that specializes in painting project management

- ITG-Green Technologies Pte LtdUse of green infrastructure products as a sustainability practice

- ZARA @ ISOTeam Pte LtdInterior Design Company

- ISOTeam Access Pte Ltd: Sale of Boom lifts, Scissor lifts and other industrial material handling machineries

Analysis

ISOTeam’s main investment strategy has always been to grow organically by continuously building on their core competencies. As seen from the list of acquisitions above, the service offerings belong to the same industrial chain. This echoes the management’s efforts to strengthen their industrial brand position as well as be closer to their vision – that is Singapore’s No. 1 and Preferred Partner for Total Maintenance Solutions.

A contrast to conglomerate building, this moat-widening strategy is more steady and realistic as the management aims to leverage on their areas of expertise. It is thus not far fetched to be optimistic about ISOTeam’s market share position and financial returns that they stand to reap.

A more striking quality from this observation, however, is the management’s consistency in aligning their investment calls with their vision. It exemplifies their conviction in achieving their mission, suggesting that the management values a sense of purpose and passion more than its revenue generating abilities.



ISOTeam is able to enjoy a Steady Recurring Income Model amid the negative economic outlook

Current Progress

ISOTeam’s first core competency positioning has enabled it to successfully clinched many tender project from government related organizations. This has resulted in a steady improvement of financial position.

Potential Upside

CEO Mr Koh echoes this optimism in this statement in FY 16 Annual Report – “We will remain focused on our core R&R and A&A business by riding on government initiatives and regulatory requirements by increasing our market share in these segments.”

On the other hand, the government also affirms ISOTeam’s potential growth in this segment too by consistently inviting ISOTeam to participate in exclusive tender bids. One significant example would be the release of four tenders with respect to HDB’s Home Improvement Programme (HIP). Each project is worth S$20 million to S$40 million and tender bids are strictly by invitation only.

ISOTeam is able to create a new revenue stream from its venture into the Myanmar market

Current Progress

ISOTeam’s second core competency positioning has allowed them to not only further their strategic partnership with Nippon Paint, but also helped themselves increase a new overseas income stream.

It can thus be trusted that the selection processes for investment calls would be more strictly looked into. This understanding is crucial from the lenses of investors since it reduces the probability of a careless investment decision.


made in the reports have not only seen through completion during the next financial year, but also consistently outperformed their initial plans.

In FY 13, the Executive Director and Chief Executive Officer, Mr Anthony Koh, announced that the Group was the aiming to grow its “green solutions business and is(was) proactively exploring opportunities with strategic partners”.

Today, they have achieved the following accredidation;

- BizSAFE Level Star by WSH Council- ITG – GREEN - Green Building Council - ITG – GREEN – Green Label

Investments wise, they have fulfilled their promise by strengthening their shareholder partnership with Nippon Paint in 8 December 2014. They have doubled their stake to 5.93% since their first inception in FY 14. In FY 15, Mr Koh once again proved this strategic partnership to have reaped good results when Nippon Paint helped ISOTeam clinch their first painting project in Myanmar.

Analysis

Besides delivering their promises, the above case study highlights the management’s aims to grow in both financials and their brand identity in the industry. The latter deserves credit since it represents the management’s innate desire and focus on building ISOTeam’s long-term performances instead of a short-term profit driven sprint.

The Alignment of Investments with ISOTeam’s Core Competencies

Fact

ISOTeam has always prided itself with its active acquisition activities – some of which are done through strategic partnerships with their shareholders.

Corporate Structure - Alignment of founders’ interest with shareholders

Facts

- Founders are each compensated up to S$750,000 annually and are collectively the single largest shareholder in ISOTeam (42% stake)

- ISOTeam is managed by its three founders who are namely the Chairman, CEO and Executive Director

- The professional management team as shown in table 1.1 is reported not to share any ties with the founders

Analysis

Wearing the hats of both a shareholder and founder, it can be concluded that they are incentivized to act in the interest of both the company’s long-term prospects as well as their shareholders.

ISOTeam started off as a Small and Medium Enterprise (SMEs) and considering the context of the construction industry, it is more common for these companies to be family run. With the absence of family ties, it is inferred that the management is less motivated to misuse shareholder capital for personal reasons.

Management Accountability to Shareholders – Completion of Plans

Facts

ISOTeam provides annual press releases as a mean to account for their current and future plans. These press releases are public information, which encompass that particular year’s financial highlights. More importantly, it includes specific plans that the management is undertaking in preparation for the next financial year.

Case Study

The reports released in FY 14, FY 15 and FY16 are common in echoing the management’s reliability and trustworthiness. The statements




For example, in the event when the government tightens its budget allocation for the upgrading of old neighbourhoods and precincts, it will result in a lower supply of R&R and A&A projects in the public sector

Scarce Supply of Foreign Labour

Due to scarce supply of local manpower, ISOTeam is highly dependent on foreign workers and is vulnerable to the shortage and high employment costs of foreign workers.

Singapore’s construction industry faces a perennial problem of skilled labour shortage at all levels. The availability, requirements and cost of housing for foreign labour is subjected to government policies – which in turn affects the supply of foreign manpower. For example, MOM imposes a quota on the number of foreign workers and this tightening can affect ISOTeam’s business operations and financial performance.

Potential loss of B1 status

ISOTeam is registered with BCA as a B1 contractor. This allows for tender for public sector contracts of up to $40.0 million. However, ISOTeam has to secure projects with aggregate values of at least $40.0 million over a three-year period and maintain paid-up capital and net capital worth of $1.0 million.

The failure to adhere to this will disqualify ISOTeam from tendering for public sector contracts of value up to $40.0 million. This will have an adverse impact on the Group’s financial performance.

Commentaries by the Public Market Investment Team investing in Hidden Champion

1. Team Enceladus Capital needs to examine the accounting treatment of the solar panel installation business classified under “others” and its potential parallel in accounting concerns with SolarCity. In addition, given the significance of the “others” business to the contribution to revenue and profit, why is there no proper segmental classification of the business? Also examine the accounting treatment in the percentage-of-completion method for the revenue.

2. EBIT has been stagnant for years, and even if they do expand overseas, they will need to get as many projects as they currently have in Singapore just to double up in the next 3-5 years. Does the business gets easier as it gets bigger?

3. The team needs to comment on why the number of shares for the company doubled over the years.




Changes in Government Budget on Building Maintenance and Estate Upgrading

Most of ISOTeam’s revenue come from building maintenance and estate upgrading business in Singapore. Any changes in government budget, legislation, regulations or policies will hence directly or indirectly affect such business sector.

Potential Progress

However, the most interesting factor of these projects is the public dissemination of the financial value these contracts are worth. Realistically speaking, it cannot be concluded that such projects will definitely bring about high profits on the basis that the contracts are highly expensive. Solar Panels and Hydrogen Fuel Cells are new technologies that are not yet weaved into Singaporeans’ lifestyles.

It has to be acknowledged that ISOTeam may undergo relatively higher risks should the following take place

- Reputational harms since any mistake will be up for public scrutiny

- The government putting these plans to a halt should these new technologies prove that they are financially unsustainable in the long run, and the conventional means are still more efficient

Conclusion

However, while considering these risks, the current public hype about this relatively new energy sector has garnered ISOTeam great publicity among the local Singaporeans. In the eyes of the government, ISOTeam’s increasing involvement will only do the company more good than bad. Therefore, while acknowledging that share prices may backfire in the event of a mishap as elaborated above, it is still maintained that their share prices will enjoy growth in the near term.

They won their first painting job within four months of setting their branch office in Myanmar. As elaborated above, the chances of ISOTeam increasing their revenue is high due to the booming construction industry in Myanmar.

Potential Upside

However, the key indicator of a potential increase in share price lies in ISOTeam’s current abilities – and how they can convince the public and their shareholders about this optimism.

The following are their basis of arguments;

- ISOTeam’s strategic partnership with Nippon Paint eliminates most of the risks in pioneering into a new market

- ISOTeam’s success in setting up a branch office and clinching their first project within four months of penetration highlights their efficiency

- Most importantly, their plans to replicate their existing business model in Singapore highlights their ability to leverage on their economy of scale that can only drive costs down and maximize profits

ISOTeam is able to effectively penetrate into the Solar Panel Industry

Current Progress

The third core competency positioning has given ISOTeam a name in the renewable energy sector.

ISOTeam has successfully completed installing solar panels for 33 HDB blocks in Tampines, and earned their first brand identity in the energy sector. This is seen in the local authorities’ mentioning of ISOTeam’s name with Sun Seap in the wide numbers of local news publication. This is a result of the government’s aggressive efforts to increase solar panels installation around Singapore.

A less hyped up business offering that ISOTeam is currently doing also includes the provision of Hydrogen Fuel Cells as back up batteries for the lifts of HDB flats.






Keyence Corporation (“Keyence”) operates in the vision automation industry. Vision automation has been a game-changing automation tool that has enabled computers to replace human vision in high-speed and high-precision manufacturing and non-manufacturing applications. Vision products are critical to improving product quality, reducing scrap rate and product recall, and increasing effi ciency. Keyence is a global leader in the vision industry with a market share of 21% as at 2015.



Taking a top-down approach towards idea generation, the team started by analysing the attractiveness and growth potential of different industries. Narrowing down to industries dealing with technology, we zoomed into vision automation as a sub-sector given its attractiveness in terms of growth potential. Finally, Keyence was shortlisted due to its unique business model and its position as a market leader.


Keyence: Unlocking Disruptive Potential within Global Markets.

On the global front, Keyence’s progress has been remarkable. Ex-Japan revenue has driven 67% of Keyence’s total growth from 2011 to 2015; ex-Japan share of total revenue has increased from 27% to 49%.


In FY2016, sales increased 13.4% year-on-year to JPY379.3 billion (JPY334.0 billion in 2015). Operating income also gained 14.6% year-on-year to JPY201.3 billion (JPY175.7 billion in 2015). Strong growth of the company is attributed to Keyence’s continued expansion into overseas markets, as well as upselling made possible through new product development. Across the different regions, sales attributed to Japan increased 14.4% year-on-year, while sales attributed to overseas markets increased 12.6%.

It is worth noting that Keyence offers the broadest product mix in the industry.


Jie Xuan is a penultimate year double degree student at Nanyang Business School specialising in accounting and fi nance. He has prior experiences in market-related roles in both the buy and sell-side.

Kimberley is a second-year double degree student at Nanyang Business School specialising in accounting and fi nance. She conducted due diligence for new Commercial Bank clients during her summer internship with HSBC.

Lawis is a fi nal year double degree student at Nanyang Business School. He has interned with many hyper-growth tech companies.

Latent CapitalTeam Members

Quick Stats

Date 5 Jan 17

Share Price 82,890




GPM (%) 80.4%

EBIT (%) 51.0%


ROA (%) 12.3%

ROE (%) 12.9%

EV/EBIT (x) 21.9

EV/EBITDA (x) 21.6

P/Sales (x) 13.0

P/E (x) 36.7

P/B (x) 4.7

Keyence Corporation







Rapidly Growing Vision Industry Skewed in Keyence’s Favour

Contrary to conventional industry lifecycles, the rapidly evolving vision industry is continuously unlocking new stages of growth. The advancement and proliferation of vision technology is constantly unlocking new applications of vision automation in many industries. This industry evolution pattern is advantageous for Keyence, which has the broadest product mix. Vision industry growth will also be amplifi ed by countries which are in earlier stages of industry growth. Keyence, with the largest global footprint and accumulated expertise, is also ideally positioned to meet the needs in these growing industries.

Protected Home Market and Growing Global Presence

Keyence dominates its home market in Japan (55% market share). On the global front, Keyence’s progress has been even more remarkable. Ex-Japan revenue has driven 67% of Keyence’s total growth from 2011 to 2015, with ex-Japan share of total revenue increasing from 27% to 51%.

The same cannot be said for companies trying to break into the Japanese market, which currently comprises 20% of the global vision market. Foreign companies have traditionally faced diffi culty in entering Japan due to the strength of local competitors and Japan’s unique business culture. These barriers have allowed Keyence to grow globally while sustaining a stable revenue base in Japan.

Corporate Governance

Transparency and accountability are expected to improve as a result of Abe’s “Third Arrow”, which consists of both the Corporate Governance code and the Stewardship code. The Corporate Governance code incentivises increased shareholder engagement, board independence, and reduced confl icts of interest. The Stewardship code incentivises return of shareholder profi ts in the form of dividend payouts.

Keyence has demonstrated commitment to comply with these new codes, increasing dividend payouts by more than 230% since the introduction of these new reforms - a considerable feat, considering that Japanese companies historically had problems with hoarding excessive cash. We expect improved transparency from Keyence in the near term, and positive disclosures would bolster shareholders’ confi dence in the company.

Holdings Equities % Valuation (USD)

JUSTSYSTEMS CORPORATION (4686)

28,234,000 44.00 268,600,206

KEYENCE CORPORATION (6861)

163,800 0.27 112,458,415

NIDEC CORPORATION (6594)

264,264 0.09 23,748,856

Mitsubishi UFJ Financial Group Inc (8306)

747,010 0.01 4,391,134

Noevir Holdings Co Ltd (4928)

118,000 0.33 3,707,403

Resona Holdings Inc (8308)

255,765 0.01 1,234,775

Mizuho Financial Group, Inc. (8411)

343,670 0.00 611,062

Dai-ichi Life Holdings Inc (8750)

7,000 0.00 112,638


Capable Management Team

Keyence has a capable management team with a track record in growing the business. Keyence existed long before the vision industry existed. When the vision industry came into existence, Keyence’s leadership ensured that the company quickly established itself as the leader in this new industry. The company has also been able to consistently develop new proprietary innovations over the past decade.


I. Authorised Shares Issued: 150,000,000II. Outstanding Shares: 60,801,921III. Number of Share Holders: 5,222




Leads Industry in terms of Product and Service Quality

In terms of quality, Keyence leads the pack by a signifi cant amount, backed by its strong commitment to R&D spending. This has allowed Keyence to offer highly advanced software, know-how, and other proprietary innovations that are not easily replicable. Furthermore, the requirements for vision automation differ vastly from industry to industry, and Keyence’s accumulated industry know-how and experience strengthens its competitive advantage. This prevents competitors from achieving the broad-based growth that Keyence is enjoying.

Nature of Product Protects Keyence from Price Competition

Investments in vision automation have high ROI for the customer. Such investments typically require only 6-18 months for complete return of investment, and are relatively inexpensive (1 to 3% of annual revenue).

Higher quality vision systems also incur lower recurring costs compared to lower quality systems. As a result, vision automation customers are less price-sensitive.

Shareholders Equities %

Takizaki Family 9,367,993 15.40

Takemitsu Takizaki 4,688,618 7.71

First Eagle Investment Management LLC

1,397,185 2.30

OppenheimerFunds, Inc. 975,778 1.60

Fidelity Management & Research Co.

935,974 1.54

Dai-ichi Life Holdings, Inc. 898,000 1.48

The Vanguard Group, Inc. 891,935 1.47

Norges Bank Investment Management

808,820 1.33

Koichi Okamoto 738,000 1.21

Nomura Asset Management Co., Ltd.

669,783 1.10






1. Team Latent Capital needs to elaborate on the growth drivers in the “others” segment which contribute 35% of their revenue and their “ex-Japan” markets. Provide some time series analysis.

2. The team needs to evaluate the fact that 3D printing trend has disappointed in its adoption rate thus far, will this affect the valuation of Keyence?

3. The team needs to provide further analysis and commentary on Keyence top customers and how the company adds value with their solutions.

4. The team needs to elaborate further on the management’s capital allocation plan in the use of cash in M&As e.g. Cognex, Yasakawa.

5. The team needs to provide further analysis on why Keyence has or has not carried out strategic business partnerships with factory automation players such as Fanuc, Kuka, Yasakawa, etc.

Keyence has seen positive growth annually since 2002 (except in 2009).

Corporate Governance Risks

Similar to many Japanese companies, there is a lack of disclosure. Traditionally, Japanese companies are known for their lack of dividend yield, and hoarding of cash. In these two aspects, Keyence is no different.

Nonetheless, the Japanese government has published two new codes in recent years – a Stewardship Code (goal of “promoting sustainable growth of companies through investment and dialogue”) and a Corporate Governance Code (hopes to make its markets more palatable to foreign investors) which aim to improve shareholder returns from Japanese-listed companies, and increase transparency in decisions taken.

As a result, companies are slowly shifting to a more ROE-oriented management style, driven by Abe’s “Third Arrow” which aims to make structural reforms. In fact, we have seen companies such as Fanuc, another company in industrial automation, raise its dividend yield in 2015, showing that such a trend is possible. Should such a change happen, it would be a positive catalyst for Keyence’s valuation.


Future Growth Trajectory Affi rms Keyence’s Ability to Double Market Value

Doubling the current market value of Keyence at USD34 billion may seem daunting. However, referencing a proxy of a general industrial automation company which have reached maturity in its growth, we can project Keyence’s market value to reach a similar scale in the future. In this case, we look at Honeywell, given that its position in the general industrial automation industry mirrors that of Keyence in the vision automation industry. To date, Honeywell has a market capitalisation of USD85 billion, having doubled from about USD40 billion since 2011. To draw a parallel, we might infer that Keyence has the potential to double its market value in the next 3 - 5 years.


External: Erosion of Market Share and Sustainability of Margins

The threat of new entrants competing based on price can potentially erode Keyence’s market share and disrupt profi tability. Given Keyence’s high margins, this is defi nitely a point for concern. Yet, it is worth noting that the industry is already highly fragmented (top 5 players take a 43% market share) and there is no lack of competition. Keyence differentiates itself through its technological abilities, proprietary software and customized solutions. As the product technology and quality gap between Keyence and its competitors widens with increased R&D investments, Keyence has been able to maintain its margins and market share.

Moreover, given that investments in vision automation products are relatively small compared to sales (1 - 3% of sales), and given that return on investments typically only take 6 - 18 months, customers of the industry are usually less price-sensitive, and place more emphasis on reliability and reputation. This puts Keyence at an advantage.

External: Cyclicality and Reduction in Global Capex Spending

As a sector that is closely tied to the industrial automation industry, any economic slowdown and reduction in capex spending is likely to negatively impact growth of the sector. The vision automation industry is also not immune to cyclicality.

Nonetheless, during times of reduced capex spending, companies are likely to spend on “upgrade investments” such as vision products to extract even more effi ciency from existing capacities. Because of the broad industry applications, and the growth from geographic expansion, a cycle normally just means higher or lower growth rates, rather than growing or shrinking businesses for vision companies.





Domesco Medical Import-Export JSC is a Vietnamese healthcare company that produces, trades, imports, and exports medicine, pharmaceutical products, processed food, and dietary supplements. Domesco’s core business is in producing and distributing drugs in the Special Treatment segment, and has recently expanded to producing herbal and dietary supplements. It prides itself on producing only the highest quality products and has distributed nearly 100 products to 25 markets in Asia, Africa, and Latin America. Within Vietnam, Domesco boasts 14,000 points of sales across all 64 cities and provinces, and is currently the third largest pharmaceutical company in Vietnam with a market cap of USD 107.59 million.

We believe Domesco has a solid plan of action to grow and go global through the guidance of a highly effective management team in collaboration with strategic partners.

Revenue breakdown by product lines:


Domesco makes a large portion of its revenue (63%) from selling pharmaceutical products in the Special Treatment segment. Special Treatment drugs prevent or suppress the effects of Non-Communicable Diseases (NCDs) such

as Diabetes, Cancer, and Heart Disease. In particular, the two largest revenue contributors for NCD drugs were for Metabolic Disorders (20%) and Cardiovascular Diseases (16%). From 2016 to 2020, Domesco will continue to focus on managing and expanding its Special Treatment drugs portfolio, particularly the cardiovascular, diabetes, and endocrine drugs.

Revenue breakdown by customer group:

Domesco’s strength lies in marketing and selling via over-the-counter distribution channel (OTC). As seen from the chart, OTC sales account for majority (71%) of total sales, while hospital distribution channel (ETC) only make up 29%. We expect Domesco will keep expanding its OTC channels, as past track records have shown that sales from OTC channels have risen from 60% (in 2011) to 64% (in 2013), and to 71% (in 2015).

Khinwai is a fi rst-year Business student at the National University of Singapore. He taught himself the art and science of Value Investing since the early age of 18 and has been applying its principles to his life ever since. Follow him on his journey at www.khinwai.com.

Hui Ling is a second-year student with a double major in Accountancy and Finance at the National University of Singapore. She is also an equity analyst in NUS’s Investment Society, where she analyses securities and publishes industry standard equity research reports with her team.

The Net-NetsTeam Members

Quick Stats

Date 5 Jan 17

Share Price 71,900




GPM (%) 36.8%

EBIT (%) 16.6%


ROA (%) 16.2%

ROE (%) 19.1%

EV/EBIT (x) 11.1

EV/EBITDA (x) 9.6

P/Sales (x) 2.0

P/E (x) 15.5

P/B (x) 3.2

Domesco Medical JSC






As a market leader, Domesco can produce drugs of higher quality that can fetch higher prices, and concurrently keep costs low thanks to substantial economies of scale by focusing on producing specialty drugs with customized machineries and carefully curated skilled labor. This has led to an increasing gross and net margins that closely mirror those of Domesco’s larger competitors.

To prevent risks from price fl uctuation of raw materials or exchange rates, Domesco imports from suppliers in India, Malaysia, and Europe. This diversifi cation strategy has been effective at keeping cost of raw materials low.

Wide Global Distribution Networks & Dedicated Support of Powerful Strategic Partners

Within Vietnam, Domesco’s distribution system covers 14,000 points-of-sale in all 64 cities and provinces, majority of which are OTC sales channels (such as wholesalers, retailers, hospitals, and clinics). Understanding that OTC distribution channels are highly profi table and growing at a rapid pace, we think Domesco’s decision to focus on expanding this channel is a wise one.

Domesco has managed to undercut competitors by producing Special Treatment drugs and selling them at 30 to 40 % cheaper than imported drugs. This is due to three strongholds, namely (1) being a market leader in these niche segments, (2) having an excellent grasp of its target customers’ needs, and (3) having expert know-how and specialized labour skills.

Not resting on the laurels of past successes, in 2014, Domesco announced a restructuring in its product portfolio to focus on products with higher gross profi t margins, dropping less profi table products. This resulted in an increase of 3.8% on gross profi t margin from 25.5% (in 2014) to 29.3% (in 2015), and an increase of 23.1% in net profi ts from the previous year.

Lastly, because of its deeply entrenched expertise in Special Treatment drugs, Domesco owns around 280 valuable drug patents and brands, with 210 in the Special Treatment drugs segment. This focus, expertise, and branding has worked well thus far, and will be even more important for growth as Domesco expands its distribution network into other booming markets.

Market Leader with Resource & Cost Advantages

As at FY2015, Domesco is the third largest domestic drug company in general pharmaceuticals Vietnam in terms of both market share and revenue, behind DHG and TRA.



We were aware of Vietnam’s fl ourishing pharmaceutical industry and wanted to uncover a hidden gem that was well-positioned to take advantage of this trend.

The largest player in this industry, Hau Giang Drugs (DHG), is a market leader in producing generic drugs, but we believe they would face an eventual growth ceiling due to the infl ux of larger foreign brands into Vietnam.

The second largest, Traphaco (TRA), highly specializes in producing and distributing traditional medicines. However, Traphaco’s success is limited to only within Vietnam and the company faces challenges in exporting its products into global markets.

We feel that the third largest player, Domesco, hits the sweet spot as it has the best of both worlds (and more). Domesco has good track records of being able to grow both domestically with a presence (depth), as well as in offshore markets (breadth).


Despite sharing the domain with two larger drug companies, Domesco has the distinct competitive advantage of being the dominant player in the Special Treatment drugs segment, as well as the ability to leverage on strong support for growth from Abbott (its sole strategic partner). Domesco is a hidden champion poised for success, as can be seen from its fl ourishing fi nancials.


Being Highly Specialized in the Special Treatment Drugs Segment

Unlike its other bigger peers in the Pharmaceutical industry, Domesco focuses on a niche drug segment where there exists a high (and increasing) demand for specialty drugs. This increase in demand is evident from the chart of increased mortality from cardiovascular diseases, cancers, and communicable diseases.

Vietnam 98%, Overseas 2% (of which, exports to Myanmar & Philippines account for 39.5% and 37% respectively).

Furthermore, Domesco has checked off all our boxes – namely, right business focus, right management, sound fi nancials, and possessing the resources to take advantage of opportunities. These four “pillars” will enable Domesco to safely navigate the rapidly growing Vietnamese pharmaceutical market, to double their company value in the very near future.






In recent years, there has been movement within Domesco’s management, most notably in 2014, Ms. Luong Thi Huong Giang of CFR International was introduced as the CEO, and in 2016, CFR International replaced two directors.

We remain optimistic about these changes for two reasons: (1) This shows that CFR International is stepping up their involvement in Domesco, which serves to prevent the threat of acquisition after Domesco’s Foreign Ownership Limit (FOL) was raised to 100%; (2) CFR International has been supplying valuable talents to the team. For example, Ms Luong Thi Huong Giang has over 25 years of experience in Vietnam’s pharmaceutical industry, and is well-positioned to steer Domesco to greater heights.

We also think the management has employed a suitable accounting treatment to prevent common frauds (i.e. cut-off error). Although there is the existence of ‘Other Accounts’ (i.e. Other Receivables, Other Payables etc.), the amounts are relatively small (<1% of revenue) and are thus immaterial.

We note that the individual salaries of their Key Management Personnel are not disclosed in their notes, violating International Standard of Accounting (IAS) 24. We believe this is of little concern as there are no cash fl ow issues and Domesco has paid above-average dividend pay-outs thus far. Hence, it is unlikely that Domesco’s leadership compensations are unreasonable to the extent that it causes a disbenefi t to shareholders.

Shareholdings & Business Group Structure

The two major shareholders of Domesco are CFR (Abbott) and State Capital Investment Corporation (SCIC), which is the sovereign wealth fund of Vietnam.

In 2016, CFR (Abbott) increased its stake in Domesco from 45.9% to 51.7%, after Domesco had its FOL lifted.

Summary

We think Domesco’s management stands in good stead going forward for four reasons: 1) The increased involvement of CFR International introduces fresh perspectives to the team and prevents possible disruption of long-term plans, 2) The management remains honest and agency problems are highly unlikely, 3) Creation of value for both users and shareholders due to alignment of goals between employees and management, and 4) The management is able to deliver what it promises.



Corporate Culture

Domesco’s vision is to become a prestigious group in the region and all over the world in providing high quality products to the community.

Fully aware that their products have a direct effect on the user’s health, Domesco has attained multiple international standards from organizations like World Health Organization (WHO), ISO 9001 Quality Management System (QMS), and clinched good practice certifi cates in storage, manufacturing, and distribution.

Besides tending to users, Domesco actively strives to create value for shareholders. For example, in 2014, Domesco restructured its product portfolio, leading to a whopping 23.1% increase in net profi ts in the same period. In 2015, the Board of Management set out to train the Sales Representatives themselves, boosting staff morale and sales revenue. Domesco also invests heavily in motivation programs and continual training for its younger workforce.

Domesco is also big on giving back to the community, often organizing free medical checks, giving out free drugs to underprivileged families, and scholarships to needy students.

Management Quality

Domesco’s management has a consistent track record of meeting targets, with the chart below showing Net Profi t targets and results over the years.

Besides fi nancial results, Domesco’s management is also able to deliver on its commitments, e.g., the building of its new Non-Betalactam factory. Although discussions in 2013 anticipated completion in 2018, execution and good leadership have resulted in the factory opening ahead of schedule, in 2017.

Externally, Domesco has penetrated offshore markets in Southeast Asia (Myanmar), Chile, and South American markets (such as Peru and Venezuela). This resulted in surging export revenue, from USD 0.73 million in 2010 to USD 1.8 million in 2013 (+34% per year growth over a 3-year period). This revenue continues to grow as Domesco lays out plans to enter into more markets in the near future.

Domesco is also backed by very strong partners – CFR (Abbott, one of the largest diversifi ed global healthcare companies, acquired CFR in September 2014). CFR International SpA, one of the largest Pharmaceutical companies in Latin America, has been Domesco’s largest shareholder since December 2011, and has supported Domesco’s growth by helping it to expand distribution to offshore markets. Domesco can tap on Abbott’s resources and access special drug formulations previously unavailable in Vietnam, enabling Domesco to gain an advantage in terms of R&D and product differentiation.

It is also clear that Abbott recognised the value in Domesco, when the former increased its stake in Domesco to 51.7% (from 45.9%) in September 2016. Abbott also helped Domesco clinch a EU-GMP and FDA-US certifi cation (the highest certifi cation tier for any pharma factory in Vietnam) for its upcoming Non-Betalactam (Special Treatment) drugs factory, with its expertise in drug manufacturing process. This will benefi t Domesco as it participates in distribution tenders in ETC (hospital) channels.

Summary

We believe that so long as Domesco remains focused on (1) differentiating itself by intensely focusing on its Special Treatment drugs segment, (2) expanding its product portfolio and entering new markets, and (3) containing manufacturing costs and mitigating other business risks by improving its manufacturing processes and maintaining a strong fi nancial position, the company will be able to sustain its stellar growth for a long time to come.






Strict Legal Regulations from the DAV

The Drug Administration of Vietnam (DAV) continues to tighten regulations on drug manufacturers. For example, Circulars 01 and 36 have constantly been used against Domesco during drug biddings for ETC channel distribution. These two circulars essentially state that drugs with low prices are favoured, regardless of product quality. Thus, Domesco’s products which are mostly priced at a premium range, and can only compete based on their high-quality standards, face a losing battle in the ETC (hospital) channels, and lose out on this revenue channel.

Furthermore, the DAV has enforced stricter management of new drug registrations and dietary supplements, which means Domesco will face challenges fi ling for new drug patents which could lead to delays in Domesco’s marketing and a loss of some revenues and profi ts.

Stiffer Market Competition

Competition in Vietnam’s pharmaceutical industry is becoming tougher in terms of quality, payment time, and mainly, price. This is due largely to the infl ux of foreign drug brands into Vietnam such as Sanofi , GSK, and Novartis. The popular tendency of late payment from customers also negatively impacts business. Even though Vietnam’s government has banned foreign drug companies to set up in Vietnam, these companies continue to bring in their products through local distributors, collaborating with local drug fi rms (e.g. Domesco/Imexpharm), or by building factories in Vietnam.

However, domestic drug companies can still compete by identifying and fi lling specifi c drug niches by producing these drugs at a lower cost than imported foreign brands (like Domesco with its Specialty Treamtent drugs, or


1. Team Net-Nets needs to provide further analysis of their R&D expenses as a % of revenue and profi t to their peers. Given that the R&D of cancer and specialty drugs can be high and hence usually the pharma giants have the resources to undertake such activities, is Domesco business model in researching and developing its own specialty drugs viable?

2. Quick comments on the market structure to trade in the Vietnam stock market and stock liquidity risks of Domesco.

Imexpharm with its bio-pharma lines). Domestic drug companies would also have import tax benefi ts and the advantage in Vietnam’s domestic distribution networks.

Diffi culties Encountered in Data Sourcing

As it is a Vietnamese stock, we are unable to access or understand every single piece of news or data about this company, which is a common risk when investing in value stocks within emerging markets. Unlike companies in the limelight, Domesco’s information are from various sources and places, requiring more sourcing and cross-checking efforts. Through a thorough google search of fi nancial websites (Reuters, Morningstar, Financial Times etc.), the Bloomberg terminal, and Vietnam’s English news websites, we have amassed a considerable amount of data on Domesco, although there still exists the chance of stones unturned.



Rapidly Growing Drug Demand in Vietnam

Vietnam’s pharmaceutical industry is one of the fastest growing pharmaceutical markets in Southeast Asia. Over the next fi ve years, it is forecast to grow at 14 to 17% CAGR despite competition from international drug companies. This is due to rapid population growth, an aging population, and higher standards of living. Currently, local production only meets 45% of the domestic demand for drugs.

Furthermore, Abbott recently signed a partnership with MOH (Vietnam) to develop Vietnam’s healthcare landscape through Domesco. This would mean an upsurge in funding, resources, and sales for Domesco in the near future.

New Non-Betalactam Factory to Double Production Effi ciency

Domesco’s new Non-Betalactam pharmaceuticals plant is currently under construction and is expected to be operational in 2017. This plant is approved for FDA-US and EU-GMP certifi cation (the highest tier for any pharma factory in Vietnam), and is expected to generate signifi cant revenue contribution in 2019. This factory will almost double

Domesco’s total capacity to 3 billion units/year (current capacity: approximately 1.7 billion units per year) and will fulfi ll the increasing drug demand in Vietnam, thus preventing Domesco from losing out on market share and provide legroom for future growth.

Tapping Undeveloped Pharmaceutical Segments in Emerging Markets

Domesco is poised to take advantage of undeveloped ASEAN markets. One instance would be the Myanmar pharmaceutical industry, where local Myanmar drug companies are only meeting 10% of domestic demand.

Domesco entered the Myanmar pharmaceutical market in 2016, with the help of CFR (Abbott), and is expected to help fi ll the gaps for drugs in the Special Treatment segment there to boost export revenue.

Among the three largest pharmaceutical companies in Vietnam, Domesco boasts the highest revenue fi gures in exports, and is expected to continue penetrating more markets and drug segments, creating tremendous growth.

Plans to Develop Cancer Treatment Drugs & Vaccines

SCIC, Domesco’s second largest shareholder (with 34.7% stake), is working on plans to support Domesco in R&D, including building a factory for cancer treatment drugs and vaccines. If confi rmed, Domesco would be in a position to become the exclusive distributor of drugs manufactured from this facility. We believe this catalyst would bring about signifi cant growth for Domesco’s revenues if the deal were to go through.




MinervaVinamilk





MinervaVinamilk


Following the theme of this competition, one of the criteria for our chosen company is a long runway to compound growth - such that it will be projected to double in the next 3 to 5 years. It also had to have wide and durable economic moats that generate superior returns on invested capital. Vinamilk was the fi rst Vietnamese company to appear on Forbes magazine’s Asia’s Fab 50 list in September 2016, an annual list reserved for the region’s most lucrative publicly listed companies.

Furthermore, their CEO, Ms. Mai Kieu Lien, was the fi rst Vietnamese woman appearing on another Forbes list - the magazine ranked her among the top 50 most powerful businesswomen in 2012. These facts were clear indication of Vinamilk’s status as a rising star. After further analysis of Vinamilk’s fi nancials and comparing it with a list of potential companies, we decided that Vinamilk’s consistent trend of outstanding return on equity (ROE), compound annual growth rate (CAGR) and gross profi t margin, along with its low debt-to-equity ratio, made it for a strong hidden champion bound for steady, robust growth in the years to come.


Vinamilk is a young, homegrown industry leader with wide moats and strong fi nancials in a market full of potential.


Vietnam Dairy Products Joint Stock Company (Vinamilk) is the largest dairy company in Vietnam, formerly known as Vietnam Milk Company. It changed its name to Vietnam Dairy Products Joint Stock Company in November 2003 when it was listed on the Ho Chi Minh Stock Exchange. Its market capitalization is currently around USD 8.6 billion. The company was founded in 1976 and is headquartered in Ho Chi Minh City, Vietnam. Currently, it manufactures, markets and distributes a wide variety of dairy products both in Vietnam and internationally.


(Source: http://www.vneconomictimes.com/article/business/aiming-high)


Note: Vinamilk’s foreign markets include the US, New Zealand and various countries in Southeast Asia.

Yong Jia Xin is a fi rst-year undergraduate Accountancy student at Nanyang Business School in the Value Investing Program. She is a member of NTU’s InvestAcademy. Prior to NBS she worked as a Customer Logistics Management Assistant at Infi neon Technologies Asia Pacifi c Pte Ltd.

Toh Yu Xiang is a third-year undergraduate student at NTU School of Electrical Electronic Engineering. He is a member of NTU’s InvestAcademy. Prior to NTU EEE he was an intern at A*STAR (IMRE). Currently, he is an intern at Rolls-Royce Singapore.

Toh Liu Xin is a fi rst-year undergraduate student at Nanyang Business School in the Value Investing Program. She is also a member of NTU’s InvestAcademy.

MinervaTeam Members

Quick Stats

Date 5 Jan 17

Share Price 126,700

No. of Shares (Mil) 1,451.5



GPM (%) 42.4%

EBIT (%) 23.5%


ROA (%) 30.4%

ROE (%) 41.0%

EV/EBIT (x) 16.6

EV/EBITDA (x) 14.9

P/Sales (x) 4.1

P/E (x) 21.9

P/B (x) 9.2

Vinamilk





MinervaVinamilk

The fact that Vinamilk is a homegrown company also adds an element of trust as the company will be most familiar with its primary consumer market and thus will know how to tailor their products and services to best suit customers’ needs, giving them an edge over foreign brands like Dutch Lady and Nestle.

During the 2008 scandal over melamine-laced powdered milk in China, some Vietnamese dairy companies suffered a decrease in sales, but since consumers had confidence in Vinamilk’s commitment to quality control, Vinamilk was only mildly affected with a minor decrease in revenue. This is a powerful testament to their brand strength as an economic moat.


Corporate Culture

Vinamilk has an employee-oriented culture that focuses on mentoring and nurturing its people. Vinamilk held workshops to develop farmers’ skills and knowledge to increase the quality of the Company’s material supply and dairy farm productivity in the long term. In 2014, Vinamilk held 35 training workshops on “Milk quality improving techniques for farming households” which attracted very positive receptions from the dairy farmer community. Training and developing their human resources is one of Vinamilk’s strategies for further success. With training opportunities, such as these, employees will be able to enhance their required knowledge and skills.

Vinamilk has a culture that aims to inspire working passion and creativity. They attempt to create a professional, friendly and open environment to encourage each individual to voice out their creativity and discover their potential ability in order to make a difference.

Management Structure

Currently, the board of management of Vinamilk has 6 members as follows:

Vinamilk has also established 4 committees to oversee different aspects of its operations: The Human Resources Committee, Business Strategy Committee, Remuneration Committee and the Risk Management Committee.

According to the shareholder book as of 7th August 2015, the State Capital Investment Corporation, One-member Limited Company (SCIC) hold 45.06%, foreign shareholders had 49% and local shareholders have 5.94% of Vinamilk’s share capital.

Name Title Ownership with voting rights (31/12/2015)

Ms. Le Thi Bang Tam

Chairwoman, independent member

NIL

Mr. Le Song Lai Non-executive member

Representative of SCIC: 37.55%

Ms. Mai Kieu Lien Member and CEO

0.27%

Mr. Le Anh Minh Non-executive member

Representative of 6 foreign funds: 2.96%

Mr. Ng Jui Sia Non-executive member

Representative of F&N Dairy Investments Pte Ltd: 11.03%

Ms. Ngo Thi Thu Trang

Member and Executive Project Director

Representative of SCIC: 7.51%

Personal: 0.08%

Shareholding Structure

The details of the company’s shares as of 31 December 2015, are as follows:

Chartered Capital VND 12,006,621,930,000

Par value per share VND 10,000

Total listed shares 1,200,662,193 shares

Total outstanding shares 1,200,139,398 shares

Treasury shares 522,795 shares

MinervaVinamilk


Cost Advantage

Morningstar has described cost advantage as one of the most powerful economic moats a company can have. The company has established itself in almost all stages of the dairy production value chain, from manufacturing to the sale of end products. These are research and development (R&D), warehousing and transportation (i.e. logistics), and even retail stores for end customers. In Vietnam, Vinamilk has 13 factories across the country with the capacity to produce about 1.2 billion litres of milk a year, a head office in Ho Chi Minh City, 3 main branches, 5 subsidiary offices across Vietnam, 2 warehouses, and 198 retail stores. Sales have also been robust - as of 2016, Vinamilk sells 18 million dairy products each day in the local market.

Vietnam is known for its relatively low labour wages. In 2015, Vietnam’s monthly minimum wage was US$96-138 - even more competitive than that of other countries usually associated with low labour costs: Cambodia’s was US$121.90, China had a minimum wage of US$135.43 - 296.96 and Thailand’s was US$265.68. This could have been one way Vinamilk has managed to keep its production costs low. However, in 2015 the Vietnamese government announced a minimum wage hike of up to 13 percent, which could increase Vinamilk’s labour costs. Thus, the company has decided to evolve its production process to become less labour-intensive, investing in technology to mitigate the rise in labour costs and keep overall production costs competitively low to maintain their cost advantage. Vinamilk’s latest venture is its biggest one yet - a new, state-of-the-art facility, Angkormilk Dairy Factory, built at a total cost of over US$100million in Phnom Penh, Cambodia, as mentioned earlier. Milk production is almost entirely automated by a system developed by Tetra Pak and features cutting-edge technology

such as laser-guided vehicles (LGV) for goods and raw materials transportation; a site visit in 2014 by industry analysts revealed that labour is kept to a minimum, only included in non-automatable aspects of manufacturing such as quality control. Another example of Vinamilk’s investment in technology is the SSI Schaefer rail-guided vehicle (RGV) forklift system, the forefront of warehousing technology that allows the warehouse to process 188 pallets (large tray-like structures used to hold milk bottles) every hour, transporting them at speeds of up to 90m/min. Automation boosts productivity in multiple areas of Vinamilk’s value chain in terms of speed and reduction of human error, and also reduce their reliance on manual labour which will place a significant burden on the company if wages are to increase in future. Thus, Vinamilk’s recent technological developments will also be a huge contributor to their cost advantage.

Efficient Scale

Vinamilk’s sheer size and high sales volume has led to it enjoying another moat: efficient scale. Vinamilk has taken up such a huge market share that according to Kantar World Panel data released in May 2013, Vinamilk’s liquid milk is consumed by 94% of Vietnamese households. Vinamilk is also Vietnam’s top dairy brand not only in liquid milk but in other dairy products: they enjoy a market share of roughly 50% for milk, 80% for condensed milk and 90% for yogurt. Simply put, Vinamilk has come close to monopolising Vietnam’s dairy industry.

Intangible Asset (Branding)

As mentioned earlier, Vinamilk has a dominant market share not only in the liquid milk market but also in other dairy products such as yogurt, milk powder and cheese. Their business is not limited to the sale of milk products, but also includes manufacturing, logistics and even an e-clinic, An Khang Clinic, in Ho Chi Minh City. This, along with diligent advertising campaigns, and the fact that they even have their own dairy stores, has made them a household name in Vietnam.




MinervaVinamilk


Consumers have the bargaining power thus milk companies cannot raise price easily as they run the risk of losing their market share. If operating expenses and infl ation are growing at a faster pace than sales, Vinamilk’s profi t margin may diminish.

Vinamilk is highly dependent on imports; 70% of its raw materials are from foreign supply, thus exposing them to foreign exchange risk. If the raw ingredients’ prices soar, Vinamilk’s profi t margin will be heavily affected since they are unable to raise their price at the cost of losing their competitive pricing.

A majority of Vinamilk shares are owned by State Capital Investment Corporation (SCIC). Since SCIC is state owned, politics can have massive infl uence on the decision of the company. The recent sales of Vinamilk’s state-owned equity by SCIC in late 2016 failed to attract investors when SCIC announced that each investor can only buy up to 2.7% of shares which took the market by surprise. If not managed properly this could threaten Vinamilk’s equity.


1. Vinamilk has arguably the most formidable distribution network in Vietnam and penetrates deeper than any other brands

2. Team Minerva needs to provide further analysis and commentary on the business model and valuation impact to the company with their regional expansion to Cambodia and Indochina.

3. Raw material risk: Bulk of their raw milk comes from whole milk powder imported from New Zealand of which the raw milk prices are rising. As the company only lock in the rates until mid-2017, how can the company manage this risk to protect their margins and ensure the continuous growth of their EBIT?

Assuming that Vinamilk’s growth rate remains at 20% in the near future, Vinamilk can double in size in the next 4 years to:

(120%)4 = 200.736

This is roughly double its current size.

For the Fiscal Period Ending

Dec 31 2011 Dec 31 2012 Dec 31 2013 Jan 01 2015 Dec 31 2015 (LTM) Sep 30 2016

Currency VND

CAGR (Gross Profi t, %)

36.4 32.8 29.3 20.0 21.5 20.3

MinervaVinamilk


Vinamilk’s CAGR has been slowing over the years, but has managed to maintain at around 20% for the past three years.

There are 11,961 shareholders in total. Of this, 10,831 shareholders are local and 1,130 are foreign. For local shareholders, 99 of them are institutional shareholders and 10,732 of them are individual shareholders, holding 549,106,370 and 63,190,067 shares respectively. Of the Foreign shareholder, 241 of them are institutional shareholders and 889 of them are individual shareholders, holding 584,168,234 and 4,197,522 number of shares respectively.

Based on the latest shareholder listing on 7th August 2015, Vinamilk has 2 major shareholders, namely the State Capital Investment Corporation Limited Company (SCIC) and F&N Dairy Investment Pte Ltd. The State Capital Investment Corporation Limited Company (SCIC) is from Vietnam holding 541,054,080 number of shared which correspond to 45.06% of the chartered capital. F&N Dairy investment Pte Ltd, on the other hand is from Singapore holding 132,490,778 number of shares which correspond to 11.03% of the chartered capital. On 12 December 2016, Fraser & Neave (F&N) on Monday bought an additional 5.4% stake in Vinamilk, through two wholly owned subsidiaries. The deal was valued at 11.2 trillion dong or $498.9 million. That brings F&N’s stake in Vinamilk to 16.35%.

Key People

The following people have played crucial roles in the growth and development of Vinamilk:

• Ms. Le Thi Bang Tam - the current Chairman of the Board of Directors, and Independent Board Member since April 2013. She was born in 1947, and graduated from an Advanced Economic Management course in the Soviet Union and has a PhD in Economics and Credit Finance and International Finance Certifi cate from North University London. From 1974 to 1982 she was the Staff, Vice Division Head of the Financial Balance Division, Ministry of Finance, and has even helped plan Vietnam’s national budget. She previously served in many positions such as Deputy Director, Director, General Director of The Central State Treasury, Deputy Minister of Finance Ministry, Chairman of Investment Corporation and the State Capital Investment Corporation (SCIC), which until recently was a major shareholder of Vinamilk.

• Ms. Mai Kieu Lien - Chief Executive Offi cer of Vinamilk. She is a well-known business fi gure in Vietnam. After working as an engineer at confectionery and dairy factories, she joined Vinamilk in 1984 and quickly rose through the ranks when the company was still a state-owned enterprise. In 2012, Ms. Mai Kieu Lien became the fi rst Vietnamese to feature among Forbes’ 50 most powerful businesswomen in Asia. In 2008, she became the company’s CEO. She was offered to become deputy minister of the Ministry of Industry and Trade, but she turned it down as she wanted to focus on improving the quality of the company’s products, which paid off during the 2008 melamine-laced milk powder scandal of China as described earlier.





MinervaVinamilk






Headquartered in Ahmadabad, Nandan Denim is a start-to-fi nish setup and one of the biggest vertically integrated denim manufacturer in India, headquartered in Ahmedabad. It is currently the second largest denim fabric manufacturer in India and fi fth largest in the world with a current installed capacity of 99MMPA (Million Metres Per Annum).

It is part of the Chiripal Group of Industries which started in 1972 and had multiple businesses including textiles, real estate, education and construction. The company was initially involved in the trading of textile fabrics when it started in 1994, incorporated as Nandan Exim Pvt Ltd.

In 2004, the company got listed on both the BSE and NSE with an Initial Public Offering of Rs. 120 mn. In that same year, the company set up a denim fabric manufacturing capacity and changed its name to Nandan Exim Ltd. In FY14, the company changed its name to Nandan Denim Ltd. Since then, the company has expanded its denim fabric manufacturing capacity to what it is today. On top of its denim fabric manufacturing capabilities, Nandan Denim also has a shirting fabric processing capacity of 10 MMPA.

With the capacity expansion due to complete in FY17, the expected capacity of denim fabric manufacturing is 110MMPA which would put it on par with the largest denim manufacturer in India, Arvind Ltd. With a capacity of 110MMPA, Nandan Denim will own approximately 10% market share of the denim fabric manufacturing market in India.

Nandan Denim has a well established client base in both the domestic and global market. The company exports denim fabric to over 27 countries across the globe and is a supplier to domestic brands such as Spykar, Shoppers Stop, Wrangler and also major brands such as GAP, Polo, Calvin Klein, Tommy Hilfi ger, Armani, Ralph Lauren etc.

Nandan owns a strong dealer network spread across the world to enhances its dependability and availability, enabling an easy and timely delivery across Hong Kong, Bangladesh, Egypt, Peru, Panama, Columbia and Korea with its with direct contacts.


Nandan is in good position post expansion to capture the growth of denim in one of the world’s least penetrated markets.


We were looking for simple, free cash fl ow generative businesses that are attractively priced, and we found Nandam. Stock screeners were used to aid us in the process.


Potential for growth

The western fashion & lifestyle trend has boosted the consumption of casual fashion apparel like denims, dress shirts, tees and casual shirts among both men and women consumers in all developing countries including India. The average number of denim items owned by Indian consumer is much lower compared to other markets.

Per capita denim jeans consumption in India is only 0.3 per capital compared to USA”s 9, UK”s 8, Brazil 7, Thailand 7, Japan 6 and China”s 2. This difference in the sheer number of denim jeans consumption per capita demonstrates the huge potential that exists for denim in the domestic market.

Gary is a second year Accounting and Business Double Degree student at Nanyang Business School in the Banking and Finance specialization.

Weihua is a second year business student at Nanyang Business School in the Banking and Finance specialization. He spent 6 months in Beijing for his internship as a Credit Analyst.

Shaun is a penultimate year fi nance student at Nanyang Technological University, Nanyang Business School.

Team GoldTeam Members

Quick Stats

Date 5 Jan 17

Share Price 119.45




GPM (%) 32.9%

EBIT (%) 11.0%


ROA (%) 6.3%

ROE (%) 18.3%

EV/EBIT (x) 8.4

EV/EBITDA (x) 5.5

P/Sales (x) 0.5

P/E (x) 7.9

P/B (x) 1.5

Nandan Denim Ltd






c) While the effects of China’s cotton policy could be temporary, in the long term, cotton prices in the international market is set to be constant due to China’s huge store of cotton. Nandan can therefore better forecast their production costs in the future.

Nandan has some control over their production costs and hence volatility of cotton prices would not be a problem as compared to other manufacturers

Nandan is one of the largest vertically integrated start-to-fi nish setup denim manufacturer in India. The Company invested in state-of-the-art automation technology marked by a corresponding manpower deployment considerably lower than industry peers. This uniqueness allows Nandan to have the ability to manufacture the raw material (yarn) required in the manufacture of the end product (denim fabric).

In FY14, Nandan invested to more than double their spinning capacity - from 54 TPD to 124 TPD. This increased their ability to provide raw material from 50% of their needs in FY14 to 80-85% in 2016.

The yarn manufactured within the company allows Nandan to have immediate availability of material and costs the Company about 8-10% less than the outsourced equivalent.

Nandan’s large distributor network with a diversifi ed client base

Nandan has one of the largest distributor network, allowing the company to reach many parts of India. The company’s revenue base is quite diversifi ed. It caters to 100 customers, out of which the top 10 clients contributes to about 25% of the company’s revenue.

In addition to this, Nandan has strategic tie ups with 10 fi rms to exclusively sell their denime products. 2/3 of these orders are confi rmed long term agreements involving minimum yearly quantity commitments.

Nandan Denim is hence, extremely well positioned to meet the increasing demand of the industry. The combination of backward integration and horizontal expansion paired with its competitive advantage is expected to enhance EBIDTA margin in 18-24 months.


Management

The management of Nandan Denim brings to the table an extensive experience in the textile industry. Chairman of the company, and Managing director of Chiripal Industries Limited, Mr Vedprakash Chiripal has 37 years of experience in the textile industry.

His brother, Mr Brijmohan D Chiripal, Managing director of Nandan Denim has nearly 20 years of business experience in textile processing. Furthermore, the other directors of the company all have extensive experience in the various fi elds.

Under both Mr Vedprakash and Mr Brijmohan’s leadership, Nandan was able to grow at the impressive pace from its humble beginnings in 1994 to the second largest denim manufacturer in India.

Shareholding Structure

Promoters account for 58.3% of total shareholdings as at 30/9/16. With this large amount of promoter’s stake in the company either directly or indirectly, we believe that the management’s goals are aligned with that of the shareholders and will seek to maximise shareholder wealth for the company.


Youth + Higher per capita Income

India is the youngest country of the world with more than 50% of the Indians below 25 years and 65% below 35 years. The aspirational youth (15-29 year olds) with rising spending power, accounts for 26% of the consuming population. By 2020, it is estimated that the average age in the country will be 29.

India’s per capita income has increased – from Rs 71,050 in FY13 to Rs 93,231 in FY16. At that rate of acceleration, per-capita income is estimated to exceed Rs 100,000 in FY17. The rise in spending power of the youths will likely lead to an increase in discretionary spending and boost the denim fabric manufacturing industry.

Gujarat Location Advantage

Gujarat is the largest producer of cotton in India, producing 31% of country’s total production. Located in the Gujarat textile hub of India, Nandan has easy access to its main raw materials for denim. Gujarat also has an uninterrupted power supply which allows Nandan Denim to operate without hiccups. There is availability of both skilled and unskilled labour in Gujarat resulting in a low cost of production.

The government also has textile subsidies policy such as interest subsidies, power tariffs subsidies and more which are geared towards boosting the textile industry in Gujarat, further lowering the cost of producing in Gujarat.

This makes Nandan one of the most competitive denim manufacturers in the world. Situated in a natural geographic location that produces an abundant amount of cotton with the technical knowhow and capacity to capture one of the world’s least penetrated but high growth markets makes Nandan a highly valued company in the foreseeable future.

Change in product mix to move towards higher value-added products

Denim fabric can be a commoditized product resulting in very little product differentiation. To improve the company’s margins, Nandan announced plans to move as much as one-third of its products into valued added denim (VADP) in the next 2-3 years which allows it to secure better profi ts to build sustainable growth.

To do so, the company has its own in house R&D team. The products manufactured at Nandan meet the roughest and toughest quality tests in the Fully Computerised Quality Testing Laboratory. The lab is also equipped with state-of-the-art testing equipment for cotton and yarn to ensure quality right from the start.

Stable or lower cotton prices for Nandan with China (top producer of denim) losing their competitive advantage

To shield Chinese cotton farmers from the vagaries of the market, the Chinese government introduced China’s cotton policy in the early 2010s to prop up cotton prices for China’s domestic farmers by buying and storing any excess amounts of cotton produced. This has artifi cially increased the production costs of cotton prices for Chinese manufacturers making their products less competitive as compared to India’s for many years.

As China begins to unwind its massive storage of cotton, the effects for Nandan are 3 fold

a) Cotton prices in the international market are set to fall due to increase supply which signifi es possible lower cost of production for Nandan should the company decide to source from international markets and hence better profi t margins in the near future.

b) China’s manufacturers still have to pay infl ated prices to protected farmers in China. This erodes away China’s competitive advantage in the pricing of their denim produce.






1. What’s so different between their denim and their competitors? Is it the quality of the denim (thread counts?) or are they the lowest cost producer? If it is the latter, how do they achieve this? What is the know-how behind it? An example is Toray, the hidden champion behind the success of Uniqlo with the supply of functional textile material from Heattech to Airism.

2. Team Gold needs to provide further analysis and commentary on the breakdown of their domestic vs exports sales, top customers.

3. The team needs to provide further analysis and commentary on the impact to the industry and Nandan of the Welspun scandal that erupted in Aug 2016.

4. The team needs to provide furthur analysis and commentary on the athleisure trend impacting denim sales.

5. The team needs to provide further analysis and commentary on the accounting treatment of their PPE, depreciation, capex, as well as the contingent liabilities, loan guarantees.

6. The team needs to provide details and analysis on their shareholder structure and business group & corporate structure. What are the other business interests of the Chiripal Group? Examine the related party transactions (RPTs) of the company and the potential of material undisclosed RPTs.


Demand for denim products declining significantly - As Nandan Denim’s business is concentrated in the manufacturing of denim fabric, this factor would severely harm the profits of the company and its prospects.

However, in recent years, it is slowly diversifying into processing shirting fabric with a current capacity of 10 MMPA. Furthermore, denim is a staple in most wardrobes and is extremely versatile. Therefore, this may not be a significant cause for concern.

High Debt/Equity Ratio – In its financing its aggressive expansion over the years, the company historically has a rather high debt/equity ratio averaging 1.93 over the past 5 years. However, the company has since taken measures to reduce the debt/equity ratio to the current 1.59 as seen below.

Cotton Price – Cotton is one of the largest inputs in the production of denim fabric and the fluctuation in cotton prices may squeeze the margins of Nandan and affect profitability if cotton prices are high over a sustained period of time.

With the extremely promising denim industry outlook in India coupled with an experienced management team that has led Nandan Denim’s impressive expansion thus far, Nandan Denim is a gem especially at its current price.


Corporate Culture

Passion leading to excellence – It is the driving force that prods us towards greater heights in whatever we do

Agility to stay ahead and to innovate – We are self-motivated towards being a step ahead of the competition and pioneering changes that revolutionise the industry

Aggression for growth of all stakeholders – Growth for us means collective progress for all our stakeholders – our customers, employees, investors and the community at large

Nandan Denim stays true to their commitments to these shared values as seen in the awards and certificates awarded to them, acknowledging them for their quality work and in the way they manage their employees as seen below.

Human Resource Management

The company focuses a great deal on employee development and nurturing their human capital, creating a talent pool to drive business goals as they seek to expand. They have training programs organised for employees at all levels through both internal and external faculties in order to achieve high levels of efficiency, customer satisfaction and growth.

Furthermore, the company is also increasingly focusing on attracting corporate and qualified talent with cross-industry experience for creative execution and marketing of their scalable projects. With a scalable business, they are able to showcase the career path and progression to each of their employees. This will encourage their employees to pursue excellence and grow together with the company, sharing a common goal with Nandan.

Nandan is also inculcating a culture of high-performance business outcome within the organisation through effective internal communication with stakeholders and making them highly accountable. According to Glassdoor, employees who have worked for


Our team strongly believes that Nandan Denim is currently severely undervalued as compared to its potential once its capital expansion plans are completed in FY17.

Chiripal Group affirmed that there is a good work culture with good learning opportunities and employees who perform well and take up responsibilities are well rewarded. With a motivated workforce that is well compensated for quality work, we believe that the employees’ interests are aligned with the shareholders.


70 Inter-Varsity Stock Research Challenge 2017Unearthing Hidden Champion



Acknowledgements

On behalf of 8I Education, I would like to express our heartfelt gratitude to our six Inter-Varsity Stock Research Challenge judges!

Without their expertise, the competition would not have run so smoothly.

Judge: Geoffroy Ganshof

• Head of Wealth Management, EuroFin Asia Group.

• Former Managing Director of Longitude (Singapore) Pte Ltd, a member of the Longitude Group.

• Before Longitude, Geoffroy was a Fund Manager in Unionhouse Pte Ltd and CEO of Clearinvest Asset Consulting in Geneva.

Judge: Mohammed Ali-Reda

• Founder and Managing Director of Darkhorse Capital.

• Finalist of Best Newercomer Fund – HRM Asia Performance Awards 2016

• Actively investing in Asia since 2007 and has spent over a decade in the investment industry.

• A CFA Charterholder who taught CFA prep courses, and previously served as Board Member and Treasurer at Kuwait CFA Society

Judge: Hemant Amin

• Founder, Managing Director and Chief Investment Offi cer of Asiamin Capital.

• The company is the Asiamin Family Offi ce & Investment advisor for allocating proprietary capital belonging to the Asiamin Group.

• Funds are managed in the style of a focused, 20 stocks, long only, equity portfolio via a bottoms-up company specifi c research process.

Judge: Shiv Puri

• Founder and Managing Director of TVF Capital Advisors.

• Worked at leading institutions such as Bain Capital in Boston, Crescendo Ventures in Silicon Valley and Morgan Stanley in New York.

• Recipient of the prestigious Robert E. Linneman Award for outstanding scholarship in fi nance.

• A member of the prestigious Indian Business Leaders Roundtable, founder of Ashoka University and lifetime benefactor of the Singapore Indian Education Trust.

• A member of Young President’s Organization (YPO).

Judge: Sid Choraria

• Vice President of APS Asset Management.

• Previous work experiences include Goldman Sachs, Merrill Lynch, Morgan Stanley and Bandera Partners.

• A member of SumZero and awarded the Best Analyst Excellence Award in 2015 and the Best Shorts Contest in 2014.

• A member of Value Investors Club, an exclusive community of top money managers and analysts.

Judge: Kee Koon Boon

• Chief Investment Offi cer of 8I Holdings Ltd (ASX:8IH)

• Over 13 years of experience in the Asian capital markets.

• Expertise includes investment research, risk management and accounting fraud detection.

Thank you for coming forward and volunteering your time to mentor and provide insightful advice to the students. You’ve been inspirational!

Warmest Regards

Ms Pauline TeoChief Executive Offi cer8I Education

Warmest Regards

Ms Pauline Teo

Acknowledgements


www.ValueInvestingSummit.com

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