Inter-Varsity Stock Research Challenge 2018 Building a League of Hidden Champions
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.
i Preface “Strive not to be a success, but rather to be of a value.”
- Albert Einstein Impact.
Impact is created when one strives to be of value to They will be passing on the plaque to the next craft insightful research reports on outstanding champion which will be unveiled in our 2nd companies to leave an indelible mark of benefit to Intervarsity Stock Research Challenge. It will be held the business and investment community. within the 7th Value Investing Summit (VIS), a two- day event which attracts a 1,500-strong community Impact is delivered by Warren Buffett, long before of like-minded value investors to participate and is he was the billionaire Chairman of Berkshire held on 27-28 January 2018 at the Singapore Expo. 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 The Challenge’s mission is to promote the study of of Buffett, who applied the business and investing value investing, to foster intelligent research on approach outlined in the research to go on to build Hidden Champions in Asia, and to allow students to the conglomerate Berkshire Hathaway with a cultivate the portable lifelong skill-set of critical staggering market value of $500 billion, more thinking ability. This booklet publication is a valuable than the annual GDP output of Singapore. culmination of the dedication put forth by the students to apply what they have learnt into the In our first inaugural stock research challenge, we messy world of reality by forming quality analytical had an uplifting experience assessing the well- research output that has timely relevance and balanced presentations put forth by the usefulness to the wider business community. participating teams. The judges crowned Latent Capital who presented Keyence Corporation Who are Hidden Champions? Like GEICO and unanimously as the inaugural champion. Berkshire Hathaway when they were at an earlier
ii undiscovered, overlooked and underappreciated rewarding. Entrepreneurs and the wider business stage in their corporate lifecycle, Hidden community could also find inspirations in the Champions are the indispensable companies Hidden Champions in scaling up their business impacting the well- being of our daily life. models. The difference between a businessman and an entrepreneur is that a businessman can always You wear them, the Crizal lens on your eyewear. make money for himself but an entrepreneur Essilor International is the world’s leading focuses on building an idea larger than himself to ophthalmic optics company behind the Crizal, serve others with Purpose and carry more people Transition, Varilux lens and the company is on board the bus. For Buffett-Munger, their idea powered by a unique owner-oriented corporate larger than themselves is manifested in the creation culture with its inclusive plan to enable 50% of of a focused vehicle Berkshire Hathaway, which employees worldwide become shareholders, compounds not only wealth for shareholders but compared to 20% currently. Its share price has more importantly, compounds values and virtues as compounded 2,000% since 1986. an exemplary role model in the way business is conducted and how they live their life in a simple You touch them, the ASSA Abloy system for your and frugal way. The Berkshire Hathaway Bus carries door. ASSA Abloy AB, the global leader in innovative more passengers and supporters who get positively door opening solutions to improve our lives energized towards the right direction in the journey through security, safety and convenience, is up of Life in the increasingly harsh and pretentious 10,000% since 1994. world. Hidden Champions believe commerce is not merely about the measurement of the weight of You cook with them – peep inside a professional profits collected in multiple clever transactions to kitchen and you can find a Rational intelligent build measurable wealth, fame and power, but cooking system on a Norwegian submarine, a Saudi rather it should be defined by the immeasurable prince’s yacht, as well as in hospitals and integrity and virtue. Only in the endeavor to restaurants around the globe. Rational AG perform first for customers, and serve them with commands a global 54% market leadership in the the highest possible integrity and character, can world’s professional kitchens that include the commerce find its foundation for durable business Buckingham Palace and the White House, and is success and create society’s abundance. behind the success of such famous culinary names as Gordon Ramsay. Rational AG is up 1,000% since After a rigorous selection process, we have picked 2000. nine teams to advance into the semi-finals. Apart from it, we have picked up additional three reports You may even use them in emergency care from other groups. Together, their research reports situations, the Ambu bag for manual resuscitation are edited and compiled in this booklet. in hospitals, by ambulance services – in fact in all kinds of emergency environments all over the We hope that the unearthing of Hidden Champions world. Ambu A/S, the company whom millions of will be an enduring endeavour for lifelong learners patients and healthcare professionals worldwide in value investing, entrepreneurs and the student depend upon the functionality and performance of community and that this booklet by these its products, is up 6,000% since 1992. promising varsity students has made an impact to contribute to this continuous pursuit. Essilor, ASSA Abloy AB, Rational AG and Ambu A/S are the successful yet relatively low-profile Hidden Warm Regards, Champions who are focused market leaders in sophisticated, hard-to-imitate niche products and Kee Koon Boon valuable critical niches that are largely invisible to Chief Investment Officer & CEO the average consumer yet are indispensable and Hidden Champions Capital Management 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
iii TABLE OF CONTENTS
1. HAMAMATSU PHOTONICS K.K.(TSE:6965) 1
2. MASAN GROUP HOLDINGS (HOSE: MSN) 7
3. RYOHIN KEIKAKU CO. LTD (TSE:7453) 16
4. NCSOFT CORP (KRX: 036570) 27
5. NIHON KOHDEN (TSE: 6849) 37
6. BATA SHOE COMPANY (BANGLADESH) LTD (DSE:BATASHOE) 48
7. TIME TECHNOPLAST LIMITED (BSE:532856) 55
8. AEROSPACE INDUSTRIAL DEVELOPMENT (TSEC:2634) 67
9. XINYI SOLAR HOLDINGS LTD (SEHK:968) 75
10. TEIJIN LIMITED (TSE:3401) 81
11. TOKYO ELECTRON (TSE:8035) 88
12. TOTO LIMITED (TSE:5332) 113
iv 1. Hamamatsu Photonics K.K.(TSE:6965)
Company Research & Report
Quick Stats Date 15/12/17 EBIT/R&D (x) 1.94 EBIT/Employee No. Filing Currency JPY (USD/px) 40K Share Price 3,730 EV/EBIT (x) 22.8 No. of Shares (Mil) 157.6 EV/EBITDA (x) 15.8 Market Cap (USD Mil) 5,214.8 EV/CFO (x) 19.9 Daily Value Traded (USD Mil) 24.3 P/Sales (x) 4.5 GPM (%) 49.7% P/E (x) 25.7 EBIT (%) 17.5% P/B (x) 3.2 Net Debt (Cash) / VQ1: EV/EBIT/ROE Equity (%) -36.25% (x) 1.9 VQ2: EV/EBIT/ROA ROA (%) 9.55% (x) 2.4 ROE (%) 12.22%
Team Members
Justin is a penultimate year student at Singapore Management University, specializing in finance. He has experience in global consumer banking at Citibank. He is interested in corporate finance, M&A advisory and investment banking. He is currently the president of the SMU Run Team & YogiSMU.
Kim Chye is a second-year student at Singapore Management University specializing in finance. He has prior experience in full-stack development and as a financial research analyst. He is currently the vice-president of the SMU Eye Investment Club.
Crystal is a final year student at Singapore Management University specializing in finance. She has prior experience in private equity and venture capital. She is currently the president of the SMU Asia Private Equity Club.
1 Business Background & Overview
Introduction
Hamamatsu Photonics (Hamamatsu) manufactures and sells photomultiplier tubes, imaging devices, light sources, opto-semiconductors, imaging and analyzing systems. These electronic parts are then used in a range of products such as medical equipment, test and inspection systems, microscopes, automobiles, bank Investment Considerations note identification and even in baggage screening detectors at the airports. Globalisation means a rapid sharing and replication of information and ideas that often includes business Albeit this wide range of product types, its expertise in strategy and product offerings. A valuable unique trait is the Photomultiplier tube segment has been affirmed by hence one that is able to maintain its barrier of entry the industry with its 90% market share. This market amid the intense competition from across the borders. leadership has since contributed to the largest bulk of their revenue by application. Medical instruments such As such, it is our belief that Hamamatsu’s application of as PET/CT scanners for brain research and cancer innovative technology has created a strong formidable detection is one example of this application amounting competitive advantage through the following; to an income of USD$332m. - Strong reputation within their highly niche industry Revenue breakdown by Product & Geography Hamamatsu has provided its devices and modules to several Nobel Prize winning projects such as the Hamamatsu has a broad product mix with three main Super Kamiokande. Some of its products are business segments by application. They are; i) Medical; unrivalled such as its MicroPMT which is the world’s ii) Production & Industrial; iii) Imaging & Measuring. smallest and lightest PMT with 1/7th the volume and 1/9th the weight of a conventional module. This advancement of technology builds trust amongst stakeholders and positions the company to capture greater market share. - Effective use of Patents Apart from protecting their products with patents, they have successfully patented a production method in 2015 for MicroPMTs that carries a high level of functional accuracy while maintaining low labour requirements. This patent serves two purposes that is; i) to increase profits and reduce Revenue breakdown by Geography costs; and ii) maintain its relative position amongst Hamamatsu’s competitors by eliminating any Headquartered in Hamamatsu City, Japan, it also imitation possibility. operates in Europe, Asia and the US through its subsidiaries. They include Hamamatsu Photonics Hamamatsu’s comparative advantage further escalates Deutschland Gmbh; Hamamatsu Photonics France with the international network that comes along with its S.A.R.L.; Hamamatsu Photonics UK Limited; Beijing extensive global footprint. With operations and Hamamatsu Photon Techniques, Inc.; Photonics recognition built across Asia, Europe and the US, Management Corp. These overseas venture have since Hamamatsu is able to effectively capture industry contributed to USD$815m in revenue in FY 2017. tailwinds while maintaining a high barrier of entry.
Overview of Business Performance 2017 Management Leadership
Hamamatsu has experienced a consecutive 6 years of The company believes in the advancement of profitability growth at a CAGR’11-17 of 4.88%. It is technology – and especially in the art of being one step currently trading at ¥3805 per share (USD$33.51), with ahead in seizing opportunities when they arise. Founder a P/E ratio of 35.37x, a Market Capitalization of Heihachiro Horiuchi pioneered this vision in 1926. USD$5,276m and an Enterprise Value of USD$4,620m. Hamamatsu has been consistent in working towards this
2 vision and they have even pursued photoelectric conversion technology since the 1950s. Today, they spend an average of 9.8% (FY12-17) of their revenues on R&D as they strive to manufacture high-value products that are backed by high advanced technology.
However, what complements this vision execution is the current era’s Father-son pair who is the two most current CEOs of Hamamatsu.
Stability in Shareholding Structure and fuel for innovation Nikkei Business Publications described Teruo Hiruma to be a social-oriented leader. This personality has steered Toyota Motor Corporation, which holds 5.3% of Hamamatsu towards many collaborative opportunities. Hamamatsu’s shares, has been actively involved in R&D The partnership with Toyota Motor Corporation was one project with Hamamatsu. There are several joint of the most notable. His son Akira, and the current CEO, researches conducted since 2015. Toyota Motor and places more emphasis on the firm’s technological Hamamatsu has been actively involved in discovery of advancement. He graduated with a Computer Science new technique in the field of laser and heating degree and led the firm to capture 40% of the global mechanism for fusion fuel which bolsters Hamamatsu PMT tubes in 2009, recording a positive profit even R&D capabilities (Nishimura, Yoneyoshi & Yoshitaka during the global financial crisis which allowed them to 2015). Such collaborations also show that its major eventually capture 90% of the PMT world market share shareholder, Toyota has vested interests in keeping a with the fall of its competitors. good working relationship with Hamamatsu and will be unlikely to divest which brings stability to the This pair has thus created a unique synergistic teamwork shareholding structure. This is supported by the recent that provides Hamamatsu an edge over others. For one, appointment of Ken Koibuchi, Executive General they have lived out their vision of going one step ahead Manager/Advanced R&D and Engineering Company of in terms of technology as well as seizing opportunities Toyota, as an independent director of Hamamatsu. (through partnerships). More importantly, they have successfully avoided, and thrived, a major obstacle for Incentives for management through stock holdings most family businesses – effective succession planning and execution. Employees of Hamamatsu hold a combined total of 4.9m shares (3.2%). This is more concentrated towards the The management has also revealed in their latest 2017 higher management with the President Akira Hiruma December shareholders meeting that they are and Vice-President Haruji Ohsuka holding 2.4m and 2m increasing the firm’s transparency along with the shares respectively, with a trend of the President taking number of independent directors. These efforts can be up more shares over the years. With higher vested perceived as an attempt to scale up and move out of a interests, there will be a greater incentive for better family business mould. A higher degree of transparency management and reduced likelihood of negative agency also suggests a substantial degree of confidence in the behavior that threaten firm value. Retiring management company’s progress. such as former CEO Hiruma Teruo, also see their shares proportionately reduced over the years which indicates Shareholding Structure a robust system of corporate governance in terms of i. Authorized: 500,000,000 shares stock incentives to allow the focus of the vested ii. Issued: 167,529,968 shares (including interests to lie with the current management. 10,728,486 shares of treasury shares) iii. Number of shareholders: 24,254
3 (MarketsAndMarkets 2016). This is in favor of Hamamatsu as it has product applications in monitoring and safety such as Baggage screening, Cargo & Vehicle screening and Mail & Parcel inspection. Moreover, for diagnosis of cancer and other diseases, Hamamatsu’s PMT modules is used in almost 100% of all Positron Emission Tomography (PET) systems and hence will further benefit from this growth with strong performance, and Hamamatsu’s execution of its three- pronged approach as mentioned above. Moreover, Hamamatsu had already declared ordinary cash Insights into the Corporate Culture dividends on September 2017 and hence this share As an innovator, R&D is critical for Hamamatsu and the repurchase is not necessary, but rather is a bonus to backbone of R&D is employees and knowledge. their payout policy. Hamamatsu hence has a very strong corporate culture Therefore, given the empirical evidence of expected of taking care of its employee’s health and their performance post share buybacks, plus the supporting development. Hamamatsu being a company that background at the time of the repurchase, we believe innovates to create new products to improve quality of that this repurchase can be seen as a strong signal that life, has an interest to have strong ties to the society and the managers of Hamamatsu believe that its shares are being an environmentally safe and responsible underpriced, which makes this a good catalyst to invest company. It embarks on several CSR projects such as in Hamamatsu now. through education with the “Graduate School for the Creation of New Photonics Industries” and medical Economies of Scale in R&D research with the “Hamamatsu Positron Medical Hamamatsu has a strong track record for innovation and Centre”. This in turn would attract new talent from has very established R&D facilities to do so. It has three society and further foster its R&D efforts. research facilities, the Central Research Laboratory, Tsukuba Research Centre and Industries Development Business Model Quality Analysis Center and has spent a 5-year average of ¥11,425m per year on R&D. In 2017 it has produced three ground- How Scalable and sustainable is the growth? breaking innovative products this year which is shown in Global Industry Growth favoring Hamamatsu Table 10. Such differentiating products cannot be Hamamatsu’s strong R&D and product mix allows it to replicated easily without both the know-how and means be positioned to take advantage of global trends. In of productions that Hamamatsu possesses. terms of the global growth, the three main business segments of Hamamatsu - Production Technology, Competitive Advantage in Unique Product Offerings Medical Technology & Life Science, and Measurement & Hamamatsu’s R&D has allowed it to capture market Image Processing, has a CAGR of 7.0%, 7.2% and 4.2% share through product offerings that rivals cannot respectively (OpTech Consulting 2017). Below we follow. Hamamatsu has a unique business proposition of analyse two specific global trends that are in favour of being able to offer a customized support to match the Hamamatsu. specific customer usage conditions and environments. - Growing Demand for Homecare Medical Equipment For example, Hamamatsu is the only company that can The homecare medical equipment market is estimated offer both light emitters and light sensors in Gas Analysis to be worth ¥2,940 billion by 2020 (Fujiwara 2016), and applications and Light Detection and Ranging (LIDAR) manufacturers are demanding smaller portable devices systems. This offers huge advantages to customers who that still retain high functionality and reliability which by purchasing the packaged set, can be ensured of the Hamamatsu is positioned to be the top provider through expected performance due to no incompatibility issues its MicroPMT’s which is the world’s smallest and lightest with different brands and troubleshooting is easier modules. which shortens the customer’s product development - Growing Demand for Radiation detection, period. This competitive advantage is difficult to Monitoring and Safety devices replicate due to the large development costs and risks in Due to growing incidence of cancer and number of investing in R&D in both light emission and sensors of PET/CT scans, safety concerns from the post Fukushima which Hamamatsu already has a wide moat in. Disaster and growing threat of security concerns (e.g. Hamamatsu also has a large number of patents. Just terrorism), the market for global Radiation detection, from 2016 to date, it has 229 patents filed which allows Monitoring and Safety devices is estimated to grow at a it to defend its unique product proposition and market CAGR of 5.6% (2016-2021) to reach ¥246 billion in 2021 share.
4
Economies of Scale in Production and Distribution Improved Production Capacity In terms of production, Hamamatsu has a competitive Hamamatsu’s management has anticipated the edge in using its in-house inventions allow it to improve increased opportunities demands for opto- the speed and efficiency of the manufacturing processes semiconductors, imaging and light technology back in of other devices. 2016 and will be now able to reap the benefits through its completion of the construction of two factories at Implications is that, unlike other firms, Hamamatsu’s can Shingai and Miyakoda in 2017. easily mass produce certain products like PMTs with its exclusive know-how and support technologies. This allows it to remain as the market leader by meeting the demand for high-volume & cost-effectiveness from its customers.
Moreover, this competitive edge is amplified in the fact that Hamamatsu has 7 factories and 6 sales offices within Japan alone. Offshore, it has the Langfang factory in China, and 23 foreign offices. Hence Hamamatsu has an economic wide moat in terms of economies of scales for production and distribution that is hard to match for any new entrants or even existing competition which gives us confidence in expecting continued growth and strong performance.
Vision to expand through a three-pronged approach Hamamatsu is a technology firm that aims to be “one Strategic Investments step ahead”. This is by no means empty words as the In September 2017, the Hamamatsu signed an company has proven that it has the vision to expand agreement to acquire Energetiq Technology Inc. This with a three-pronged approach through new provides expertise into light emission like extreme innovations, improved production capabilities, and ultraviolet (EUV) light sources. This not only allows strategic acquisitions. Hamamatsu to diversify its products and meet the market demand for UV light products, but also enables New Innovations it to combine its existing technologies to improve In 2017 alone, Hamamatsu has released five of its own efficiency in developing newer innovative products for in-house developed products, of which three of them greater future growth (Holton 2017). are ground-breaking innovations. This highly differentiates its products and allows the firm to Hamamatsu also invested in Lagunita Bioscience, an position itself for higher profits due to the large quality America Venture Capitalist firm, which will provide gap and difficulty in replication from its competitors. synergies in Hamamatsu’s product offering in biotechnology and medicine. With the medical 5 instruments by application contributing the highest Risk 3: Economic and Transaction Exposure revenues, investing in Lagunita Bioscience which incubates and invests into early stage clinical solution Hamamatsu has vested interest in America, Asia and providers, will facilitate the discovery of new technology Europe. It will face tremendous foreign currency applications to maintain its competitiveness in the long exchange risks when exporting goods and translating run. profits back into its domestic currency. This is especially the case should its currency pairs move in an Top 3 Risks unfavorable direction against its position. To mitigate this, Hamamatsu has entered into foreign forward Risk 1: Erosion of market share due to medical demand contracts and in the current short-term, Hamamatsu has trends largely benefited from foreign exchange, recording an average annual positive FX adjustment gain of ¥658m Hamamatsu biggest proportion of business by yen for the past 6 years. application is into modules for PET/CT technology for medical screening of cancer and diseases whereby it Economic exposure may also be mitigated as dominates the market and generated ¥37,538m in 2017. Hamamatsu has production and distribution presence in However, there is a rise in Magnetic Resonance Imaging its global regions through its subsidiaries, along with (MRI) that uses magnetic energy instead and do not emit strong R&D and product differentiation, with its ionizing radiation unlike Computed Tomography (CT) products having less elastic demand which may scans which makes it a safer choice for patients and a translate into less exchange rate risks, and we can threat to replace Hamamatsu’s market share. However, expect more stable cash flows instead. MRI have higher costs and low practicality, taking a long time to complete as compared to CT scans to justify the reduction in a small risk, and CT scans are more effective (TSE:6965) Hamamatsu Photonics k.k.FY2013 FY2014 FY2015 FY2016 FY2017 FY2018LTM Share Price JPY 2,102.50 2,890.00 3,335.00 3,075.00 3,730.00 3,730.00 in scanning bone structures (William 2013). Hence in No of Shares (mil) 160.8 160.8 161.1 157.3 157.6 157.6 MCAP (mil) USD 3,218 3,892 4,454 4,143 5,215 5,215 comparison, CT scans are expected to grow at a CAGR of Net Debt (Cash) JPY (60,981) (70,112) (68,572) (59,140) (67,770) (67,770) Enterprise Value (mil) USD 2,328 3,154 3,003 4,148 4,097 4,557 7.5% (GIA 2016) while MRI at a CAGR of 5% Revenue (mil) JPY 102,156.0 112,092.0 120,691.0 121,852.0 130,495.0 130,495.0 (ResearchAndMarkets 2015). Moreover, both CT scans EBITDA (mil) JPY 25,455.0 29,618.0 33,114.0 31,092.0 32,893.0 32,893.0 EBIT (mil) JPY 16,783.0 21,666.0 23,597.0 20,545.0 22,850.0 22,850.0 and MRI are usually used in conjuncture with PET to NPAT (mil) JPY 11,529.0 15,155.0 16,598.0 14,419.0 17,777.0 17,777.0 NPAT (Ex.Xtra + Dis.Ops) (mil) JPY 10,589.0 14,582.0 15,754.0 15,123.0 17,291.0 17,291.0 improve imaging resolution and hence, Hamamatsu’s CFO (mil) JPY 14,688.0 23,135.0 16,046.0 24,160.0 26,154.0 26,154.0 PET detection technology will still be in demand. CAPEX (mil) JPY (8,433.0) (15,036.0) (14,779.0) (9,144.0) (13,773.0) (13,773.0) EPS JPY 65.9 90.7 97.8 96.1 109.7 109.7 Revenue (mil) USD 1,041.0 1,021.8 1,008.0 1,203.2 1,158.9 1,158.9 EBITDA (mil) USD 259.4 270.0 276.6 307.0 292.1 292.1 Risk 2: Corporate Governance Risks EBIT (mil) USD 171.0 197.5 197.1 202.9 202.9 202.9 NPAT (mil) USD 117.5 138.1 138.6 142.4 157.9 157.9 CFO (mil) USD 149.7 210.9 134.0 238.6 232.3 232.3 Hamamatsu has largely kept a low debt-to-capital ratio. CAPEX (mil) USD (85.9) (137.1) (123.4) (90.3) (122.3) (122.3) GPM (%) 50.1% 52.3% 52.3% 50.1% 49.7% 49.7% This may not optimize the firm’s value from interest tax EBIT (%) 16.4% 19.3% 19.6% 16.9% 17.5% 17.5% Net Debt (Cash) / Equity (%) -39.6% -41.7% -38.1% -35.0% -36.3% -36.3% shields and the hoarding of cash increases the ROA (%) 8.5% 10.1% 10.4% 9.5% 9.5% 9.5% probability of bad agency behaviour such as excessive ROE (%) 10.9% 12.9% 13.1% 12.1% 12.2% 12.2% CFO/TA (%) 7.4% 10.7% 7.1% 11.1% 10.9% 10.9% executive perks or empire building. However, we believe EV/ Sales (x) 2.7 3.5 3.9 3.5 4.0 4.0 EV/ EBIT (x) 16.5 18.2 19.9 20.7 22.8 22.8 that as Hamamatsu is a R&D and growth driven EV/ EBITDA (x) 10.9 13.3 14.2 13.7 15.8 15.8 EV/CFO (x) 18.9 17.1 29.2 17.6 19.9 19.9 company, having the debt capacity and availability of P/Sales (x) 3.3 4.1 4.5 4.0 4.5 4.5 cash, allows it to take on positive NPV projects or P/EBIT (x) 20.1 21.4 22.8 23.5 25.7 25.7 P/B (x) 2.2 2.8 3.0 2.9 3.2 3.2 investments in the future when the opportunity arises VQ1: EV/EBIT/ROE (x) 1.5 1.4 1.5 1.7 1.9 1.9 which might offset any resulting agency costs and we VQ2: EV/EBIT/ROA (x) 2.0 1.8 1.9 2.2 2.4 2.4 can expect to see a positive impact for Hamamatsu’s growth instead.
Moreover, with regards to the acquisition of Energetiq Technology that done using a Special Purpose Vehicle (SPV), there might be a concern of the possibility of creative accounting similar to the 2001 scandal of Enron transferring debts to its SPV (Wharton 2006). However, we believe this is largely mitigated by the fact that with Hamamatsu’s low debt ratio (3.72%) and strong credit rating of ‘A+’, it is unlikely that Hamamatsu would need to abuse its SPV to manage it debt.
6 2. Masan Group Holdings (HOSE: MSN)
Company Research & Report
Quick Stats Date 15/12/17 EBIT/R&D (x) 17.31 EBIT/Employee Filing Currency VND No. (USD /px) 20K Share Price VND71,700 EV/EBIT (x) 22.6 No. of Shares (Mil) 1047.5 EV/EBITDA (x) 14.9 Market Cap (USD Mil) 3306.5 EV/CFO (x) 32.8 Daily Value Traded (USD Mil) 9.6 P/Sales (x) 1.8 GPM (%) 30.3% P/E (x) 15.8 EBIT (%) 11.7% P/B (x) 6.1 Net Debt (Cash) / VQ1: Equity (%) 139.8% EV/EBIT/ROE (x) 0.9 VQ2: ROA (%) 7.2% EV/EBIT/ROA (x) 3.1 ROE (%) 24.9%
Team Members
Joel is a junior at Nanyang Business School majoring in Accountancy and Finance. He previously interned with the opportunistic credit team at Apollo Global Management and the investment banking team at J.P. Morgan.
Yu Xin is currently an undergraduate at Nanyang Technological University taking a double degree in Accounting and Business. She previously interned with the opportunistic credit team at Apollo Global Management and the Real Estate Finance team at GIC. Currently, she is interning with the Asian Affluence Fund at Thirdrock.
7 Investment Summary opportunity for investors to buy into MNS long-term growth story of the consolidation of Vietnam’s attractive We are of the view that MSN has a wide moat business meat market at a reasonable valuation. and industry dynamics will act as a tailwind to MSN’s success. The team has three key investment theses Investment Thesis #2 - Inventory de-stocking: Short term which are variant from current market view and hence pain, Long term gain: In 1H17, MCH’s inventory have not been priced in. rebalancing exercise resulted in sacrificed sales of VND 1,000bn and VND 250bn of EBITDA, with SG&A expenses Selection of the Vietnam market: Vietnam was the only increasing by VND 400bn. This resulted in a sell-off as the frontier market within the list. Frontier markets tend to inventory rebalancing exercise created a larger-than- be more inefficient than their developed and emerging expected dent as compared to Street forecasts. counterparts, and as such offer more compelling risk- However, the team believes that the Street is being adjusted returns. Vietnam has extremely favourable myopic and overly focused on the one-off expenses fundamentals – a young labour force, rapidly-growing incurred while ignoring the long term benefits of the GDP, rising consumption levels, growing credit inventory rebalancing exercise. penetration levels, and a trend towards urbanization. These drivers bode well for a consumer-focused Investment Thesis #3 – Geographical expansion: company, and we selected MSN as we believe it is best Accessing both urban and rural: On 25 December 2015, positioned to capitalize on these accelerating tailwinds. Masan Group announced the signing of a strategic partnership with Singha Asia Holding Pte Ltd (“Singha”). Masan – A Wide-Moat Business: The Company’s The strategic partnership with Singha provides both sides relentless focus has allowed it to establish itself as exclusive rights to distribute each other’s products. By Vietnam’s strategic consumer growth proxy and build up tapping on Singha’s brewing expertise, there is huge a wide moat, allowing it to sustain its edge over opportunities for geographical diversification, allowing competitors. Firstly, as a business with high operational Masan Group to unlock strong growth in the coming leverage, MSN is able to derive value from scale. years. The potential has not been fully appreciated by the Secondly, MSN’s exclusive distribution network is an Street. invaluable and difficult-to-replicate asset that has enabled its success. Thirdly, MSN’s working environment MSN – Vietnam’s Strategic Consumer Growth Proxy, A and reputation has allowed it to attract the best industry True Hidden Champion talents. Fourth, as a virtuous cycle, MSN’s size and Over the years, MSN has achieved great success while reputation has allowed it build strategic partnerships never losing sight of the bigger picture which resulted in with market leaders allowing it to maintain market share the Company continuously building up its competitive and continue to grow. Lastly, stringent capital allocation advantage. The team believes that the sell-off which allows MSN to maintain a healthy capital structure, resulted from the pork price collapse and inventory de- resulting in the firm not just achieving fast but also stocking has presented an attractive entry-point to buy sustainable growth. into a great, fast-growing business with visible catalysts for positive re-ratings, presenting clear upside potential Quality Management – Steering MSN to Success: The making it a true hidden champion. “win-win” proposition that Masan has built into its culture, and management’s calibre will allow Masan to Business Overview successfully execute its 2020 ASEAN expansion plans and achieve targeted revenue of USD 5bn. The quality of MSN is a Vietnam-based diversified conglomerate MSN’s management is supported by the oversight from focused on the consumer, natural resources, and major institutional investors, additional governance financial services sectors. It operates in four key committees apart from what is prescribed by Vietnam segments: law, attainment of awards for MSN’s commitment to • Masan Consumer Holdings (“MCH”) – 56% of FY16 sustainable business practices, as well as Management’s revenue increased focus on shareholder friendly initiatives.
- Leader in some of Vietnam’s largest consumer Investment Thesis #1 – 3F Model: Consolidation of staple categories such as seasonings and Vietnam’s attractive meat market: In 1H17, the animal convenience foods, with a fast growing beverage feed segment (Masan Nutri-Science, or “MNS”) suffered business from the collapse in pork prices (running 27% below 2016 - Includes Masan Consumer and Masan Brewery levels). However, we believe that the recent sell-down is (partnership with Singha) attributed to short-term noise and provides a golden - Manufactures a range of F&B products including
8 sauces, noodles, coffee, and mineral water, protein, and greater spending on more premium food among others products. MSN is well-positioned to take advantage of - Key brands include Chin-Si, Nam Ngu, Tam Thai this trend through MNS and its market leadership in Tu, Omachi, Kokomi, Komi, Wake-Up, Quang many of its consumer food products. Hanh, and Su Tu Trang Rising consumption: Vietnam’s level of consumption-to- • Masan Nutri Science (“MNS”) – 34% of FY16 revenue GDP stood at 74% in 2016, placing it as one of the highest - One of the leading animal feed producers in in the world. Moving forward, consumption spending is Vietnam that has expanded into pig farming and expected to track GDP and income growth. Euromonitor branded meat to become a complete “3F” forecasts real GDP to grow at 6% CAGR through 2026, platform while consumption-to-GDP is expected to remain fairly - Owns three key brands – ANCO, Proconco, and constant during the same period. Bio-Zeem with combined sales volume reaching more than 2.5Mt Low credit penetration: Consumer credit more than doubled over the past 5 years, with gross lending • Masan Resources (“MSR”) – 9% of FY16 revenue growing from VND 281tn in 2012 to VND 637tn in 2017. Euromonitor forecasts suggest that gross lending will o One of the largest private sector natural grow at 6.0% CAGR to reach VND 853tn by 2022. Through resources companies in Vietnam, amongst its stake in TCB, MSN will be able to capture growth from the leading producers of tungsten and this massive opportunity. fluorspar o Currently developing a world-class Nui Phao Urbanization: Even though Vietnam’s urbanization polymetallic project in North Vietnam level has increased from 28.5% to 34.2% in the past 10 years. Projections from Euromonitor suggest that the • Techcombank (“TCB”) urban population will continue to grow from 32.4mm o One of the largest commercial banks in to 42.0mm between 2016 and 2026, on the back of Vietnam with a technology driven retail rising urbanization levels (40.6% by 2026) and strategy to capture the growth of financial population growth. Currently, the average urban inclusion consumer spends 1.7x more than his/her rural o MSN owns a 36.4% stake in TCB and counterpart. This, coupled with the high demand for accounts for it as an associate convenience food by busy urbanites, will continue increasing the market size for MCH and drive growth Favourable Macro Drivers in Vietnam for many years to come. rd 3 -most populous nation in Southeast Asia: Vietnam rd boasts the 3 -most populous nation within Southeast MSN – A Wide Moat Business Asia, with its current population of 94.6mm. According to By having a clear understanding of Vietnam’s Consumer the World Bank, this figure is projected to grow to Sector as one which is fragmented and overpriced, 103.5mm by 2026, indicating the huge and expanding Masan Group has identified the white space in which it market opportunity for MSN’s consumer-focused and can create its own market, and shift the market from banking segments. unbranded to branded products. The focus on structural transformation to benefit consumers is evident in its Young labor force: Vietnam also has one of the youngest various segments. For animal protein, the Company aims populations in Southeast Asia. At the end of 2016, 48.5% to consolidate the fragmented value chain to achieve of Vietnam’s population was below 30, higher than the better safety standardization. For Food & Beverage, the Southeast Asia average. A young population indicates a Company aims to target the lack of innovation and to potentially large workforce, which will drive provide good quality products at a reasonable price. In consumption in the country. the financial life, the Company aims to reach out to the underserved rural areas. The Company’s relentless focus Rapidly growing income levels: Euromonitor data shows has allowed it to establish itself as Vietnam’s strategic that the median disposable income per Vietnamese consumer growth proxy and build up a wide moat, household grew at 12.5% CAGR from 2006 to 2016, and allowing it to sustain its edge over competitors. is expected to grow at 8.4% CAGR through 2026. As the Vietnamese population becomes wealthier, we will likely Deriving Value from Scale: As a business with high see a shifting of dietary habits towards more animal operating leverage, Masan becomes more profitable as
9 it scales, which allows the huge size of the business to act chosen to make the optimization of the balance sheet a as an advantage. This can be observed in its financial priority by reducing debt and swapping out expensive results from 2015 to 2016. As the Company experienced debt. Prudent balance sheet management has resulted 41.4% growth in net revenue in 2016, selling expenses as in stronger credit metrics at year end 2016. Management a percentage of revenue declined from 13.2% in 2015 to has continued to reduce debt, allowing debt balance to 11.5% while general and administrative expenses as a decline from VND 41,091bn in Dec 2016 to VND percentage of revenue declined from 5.4% in 2015 to 33,148bn in Sep 2017. This has allowed for enhanced 4.5%. Masan is able to experience improving margins as profitability margins. Management’s discipline gives the it grows, and hence its market size acts as an advantage team’s comfort that balance sheet management will not that is difficult to replicate. be sacrificed and Masan Group is well set for strong growth ahead. Exclusive Distribution Network: As Masan is aiming to reach Vietnam’s consumers, it is important for the Management Expertise: Masan’s focus on doing well by Company to have a good distribution network. This is doing good, and by making it a good working because the points of sale are where consumers environment has enabled the Company to attract leaders purchase most of their basic daily essentials, particularly who are consumer-centric entrepreneurs. In order to in the rural areas. Masan has built up its network from deliver on promises to consumers, the people make it a the ground up over the course of 15 years, investing focus to find innovative solutions. Management tends to through their banking and F&B platforms. This has be industry experts in their respective fields, allowing resulted in Masan having developed the most robust, them to not only grow the business effectively but also nationwide route to the market covering 180,000 points manage the different risks present across each of the of sale for food and 110,000 for beverage daily. Company’s respective businesses.
This has allowed Masan to simply plug and play, saving Management Quality Analysis time and money as they do not have to invest a huge The team has confidence in the success in the execution amount of capital to create separate physical networks of Masan Group’s 2020 ASEAN expansion plans and it to reach consumers and can instead rely on its strong achieving the targeted revenue of USD 5bn. The team exclusive distribution network. To entrench its believes in the “win-win” proposition that Masan has competitive advantage, Masan has invested in built into its culture, and the quality of the management mobile/digital technology to supplement the Company’s that will guide Masan to greater heights. physical points of sale, making it cheaper to serve more consumers. Masan’s exclusive distribution network is Masan’s “Win-Win” Proposition difficult to replicate. It not only allows the Company to “Our greatest achievement will come on the day we make constantly interact with their end customers to gain quality, innovative and affordable daily basic goods and deeper insights on how to better meet their daily basic services universally available.” - Dr Ngyuen Dang Quang, needs, but also allows the Company to focus efforts on Chairman marketing and R&D. Masan Group believes in doing well by doing good, Partnership with Industry Leaders: Masan has been able exemplifying the Company’s commitment to sustainable to maintain market leadership and strong growth owing business practices and has underpinned Masan’s success to its strategic partnerships with industry leaders (e.g. over the years. For Masan, success is not only the Singha, Vissan), allowing the Company to build up a well- Company’s financial results but also from the positive known portfolio of brands. This has allowed Masan to social impact created. The Company’s ultimate mission is achieve #1 position in soy sauce, fish sauce, instant to provide better products and services to the 90 million noodles, and animal feed. The mutually beneficial people of Vietnam, so that they can pay less for their partnerships with industry leaders are built up due to daily basic needs. The Management believes in the trust in Masan’s reputation, and it is hard for competitors meaningful purpose that Masan can achieve, and this is to replicate. reflected in the business’s future vision of achieving a “win-win” proposition for their customers, employees, Stringent capital allocation and capital structure: Despite shareholders and Vietnam. the various ambitious growth initiatives that Masan Group has taken on, the Management is cognizant to not Experienced and High Quality Leadership over-leverage and instead aim for sustainable growth. Masan Group’s member companies and associates are The Company has historically had a negative interest industry leaders in meat, packaged food and beverage, spread on interplay of investments and short-term resources, and financial services, altogether borrowing. With that understanding, the Company has representing segments of Vietnam’s economy that are
10 experiencing the most transformational growth. Masan below 2016 levels). The total pig feed market shrunk by Group has dedicated and experienced management with nearly 35-40% as small scale farmers were squeezed out extensive experience across global MNCs and strong of the market and minimal investments were made for local expertise. the next pig herd cycle. With MNS being highly reliant on pork feed (c.60% of total animal feed), this resulted in MCH is led by CEO Truong Cong Thang, who has over 17 1H17 NPATMI dropping 52% yoy owing to 10% yoy lower years of experience in the F&B industry and served as revenues, 26% yoy higher SG&A expenses and reduction Marketing Director for P&G Vietnam for 7 years. in in financial income.
MNS is led by Chairman Pham Phu Ngoc Trai, who was With the market expecting the deterioration in farm President and CEO of PepsiCo Vietnam and Southeast economics to continue to create headwinds for pig feed Asia, and Pham Trung Lam, who was Masan Consumer’s demand, it resulted in a sell-down of the share price. Head of Sales prior to becoming the CEO of Proconco and However, we believe that the recent sell-down is ANCO. attributed to short-term noise and provides a golden opportunity for investors to buy into MNS attractive MSR is led by CEO Craig Bradshaw, who has over 23 long-term growth story at a reasonable valuation. years’ experience in the mining business, spanning mining and processing operations, logistics, and sales Collapse in pork prices allows MNS to strengthen and marketing in Australia, Thailand and Lao PDR. foothold in feed market The collapse in pork prices has resulted in the Group’s Management Quality supported by various other performance to be negatively impacted, however a factors significant contributor to the poor performance is also Oversight from Major Institutional Investors: GIC and KKR attributed to the 26% yoy higher SG&A expenses. The are the two largest foreign shareholders in Masan Group. higher SG&A spending is actually attributed to support These companies are highly skilled and well-resourced programs to farmers and distributors that Management and would make informed use of their rights and proper has deemed to be better positioned to emerge from the analysis of information, this promotes good corporate recovery as market consolidators. The additional price governance in Masan. support and loyalty programs resulted in sales expense to increase by VND300 bn. Additional Governance Committees: Masan Group is committed to good governance, best-in-class procedures This sets a firm foundation for MNS’s future and policies and corporate transparency. Apart from the performance. Despite the short-term increase in governance committees prescribed by Vietnam law, such expenses, the firm was actually being long-term greedy as the Board of Directors, Supervisory Board and as they were able to lock up future farmers and dealers Management Board, Masan has additional committees as a result. This puts them in a better position to achieve to ensure higher governance standards. their set targets of: • 2017 target: Exit market share increased from Awards: Masan’s commitment to sustainable business 30% in FY2016 to 39% in 9M2017, on track to practices over the years has allowed the Company to gain achieve exit market share of 50% by year-end third party recognition by both domestic and • 2018 objective: Achieve average market share of international agencies. Masan Group won an award for Investor Relations in 2016 for “Best Information 51% for pig feed; Dominant Champion Disclosure,” as voted by the Vietnam Association of Financial Executives. Management has guided that over the next 3 years, meat products will comprise a larger percentage of MNS’ net Shareholder Friendly Initiatives: In 2016, Masan Group revenue, resulting in improved gross margins to c.30%- not only did a buyback but also paid out the first ever 35% over the medium term. dividend in Masan’s 20 year history. This is beneficial for shareholders, and management has guided for more Masan’s 3F Model shareholder friendly initiatives in the future. The animal feed segment is just a piece that fits into MNS’s bigger ambitions. MNS has ambitious goals to Investment Thesis take a bigger bite out of Vietnam’s attractive meat #1 3F Model: Consolidation of Vietnam’s attractive market. Given the relatively fragmented nature of meat market Vietnam’s meat market, there are abundant In 1H17, the animal feed segment (Masan Nutri-Science) opportunities for F&B companies to redefine categories suffered from the collapse in pork prices (running 27% and build brands.
11 • Feed: >60% feed mills have capacity below 10k/year, expertise through its stake in PT Japfa Comfeed resulting in low productivity. Indonesia (one of the leading agri-food companies in • Farm: 90% of 3 million pig farming households with Southeast Asia), to accelerate the process and manage any potential operational risks. This reaffirms MNS’s <50 pigs, as a result there is poor health standards. attractive long term growth story that has been • Food: 99% of meat consumed is unbranded, overshadowed by short term volatility. unstandardized, and unsafe. This results in safe, branded, and standardized meat being 2x more #2 Inventory de-stocking: Short term pain, Long term expensive. gain In 1H17, MCH lost potential net revenue of VND 1,055bn. Lack of adherence to quality and health standards has For 2Q17, revenues in MCH dropped to the lowest often created issues at the expense of smaller players quarterly reading since 2013. The inventory rebalancing and can provide consolidation opportunities for larger exercise resulted in sacrificed sales of VND 1,000bn and companies. MNS sees an untapped opportunity in this VND 250bn of EBITDA, with SG&A expenses increasing by space and expects farming to gradually evolve into large VND 400bn. This resulted in a sell-off as the inventory integrated farms, as opposed to the prevailing practice rebalancing exercise created a larger-than-expected of domestic farming by low income households. dent as compared to Street forecasts. However, the team believes that the Street is being myopic and being The firm’s vision is to build an integrated animal protein overly focused on the one-off expenses incurred and business, to have a unique platform to directly service ignoring the long term benefits of the inventory the significant demand for safe and traceable meat. MNS rebalancing exercise. expects to complete its meat production complex and pig farm by 1H2018, establishing its 3F business model Concerns about market share loss overplayed (feed-farm-food) allowing it to de-risk impact of livestock MCH’s market share position remains intact across commodity pricing and position itself to grow across categories, as sales from distributors to consumers platforms. Apart from allowing MNS to strengthen its remained stable and only shrunk 7% yoy in 1H17, foothold in the USD 6bn Feed market (gross margins: 20- suggesting that market share losses have been 22%), MNS will be able to venture into a larger and more restricted. Management has confirmed that the attractive USD 9bn Pork market (gross margins 35-40%). inventory reduction exercise has been completed and normalization will occur from 2H17 onwards. ‘3F model’: Consists of feed, farming and food. The longer term vision is to have a reliable source of raw Improved distribution system with growth drivers for material for processed meat manufacturing. The 3F Consumer segment model is a consumption-driven one and targets Past the short term pain, the exercise has allowed the Vietnam’s meat and protein segment. group to develop a more efficient and healthy distribution network to better serve consumers and to MNS’s recent acquisitions marks another step in the prepare for its innovation pipeline across categories vision to become a vertically integrated player in the where eight new products are in the pipeline. It will animal protein chain. In 2016, there was the purchase of better allow for Masan to achieve its aim to focus on its additional 30% stake in one of its feed subsidiaries core, consumer-related business, and allow the (ANCO) resulting in total holding to reach 100%, and Company to disrupt the current market dynamics increase in stake of VISSAN to 24.9% from 14%. The through innovation, deep consumer insights and making Group’s effective stake in other animal feed subsidiary products and services available to every Vietnamese (Proconco) currently stands at 72%. citizen.
Supported by strong strategic partners This puts them in a better position to achieve their set In 2017, KKR became one of the largest foreign targets of: shareholders of Masan Group with the investment of • 2017 target: Inventory days reduced from 2 months USD150 mn primary capital into MNS, resulting in an to <4 weeks; Stock level reduced from VND 2,200bn implied valuation of USD$2 bn. KKR’s investment is a to VND 900bn strategic bet on Masan’s ability to build-out an • 2018 objective: Maintain stock level under 30 days; integrated meat platform to transform MNS from a pure Optimize product quality of innovation launches commodity business into a branded consumer player with direct access to Vietnam’s largest consumer segment of USD18 bn. KKR will bring in international expertise through its global network, and industry 12 Apart from the eight new products in the pipeline, the consumer sales by 2018E (from 5%) and serve as a key Management has opined that the Energy Drinks and driver of growth. Processed Meat segment will emerge as long-term growth drivers, allowing MCH to continue to experience Expansion into Thailand strong growth. Masan’s strategic partnership with Singha has allowed Masan to gain entry into a whole new market, Thailand. Energy Drinks: With a total market size of over USD 1bn, Using the tried-and-tested strategy of spending on Management’s guidance of nationwide market share of brand-building activities which has succeeded in 5% by the end of FY17 will mean that energy drinks will Vietnam, Masan aims to gain success in the Thailand be a strategic growth driver for Masan looking forward. market as well. MCH’s energy drink, Wake-up 247, has been performing well, delivering 72% net revenue growth in 1H17 and is Masan’s initial venture with the introduction of fish on track to be a USD 45-50mn power brand by year end. sauce is indicative of its future success. To prepare for This falls in line with Masan’s strategic vision to develop the launch, Singha set up a subsidiary in Thailand, and into a 50/50 food and beverage business and will allow conducted product formulation for the fish sauce. There MCH’s growth to be rejuvenated. were strong R&D efforts, with the management getting pre-launch reviews. Masan Consumer has unveiled its Processed Meat: Vietnam’s processed, value-added fish sauce product in Thailand, named ‘Chin-Su Yo Thong’ meat market represents only 1% of total meat which is being stocked in Bangkok and other Northeast consumption, similar to China 10-15 years ago. areas of the country using Singha’s distribution network. Management expects processed meat penetration to be A dedicated sales force has been established. Masan has 15-20% of total meat consumption by 2022, growing into demonstrated its ability to understand adapt to different a USD 1.5-2.0bn market which is on par with China’s markets as observed by its strategy for the introduction current meat market structure. of its fish sauce by targeting wet markets and smaller shops in selected provinces. #3 Geographical expansion: Accessing both urban and rural Financial Analysis On 25th December 2015, Masan Group announced the Revenue growth: MSN has a history of driving growth signing of a strategic partnership with Singha Asia both organically and inorganically, in large sectors with Holding Pte Ltd (“Singha”), Thailand’s #2 beer company. extremely favorable industry dynamics. In 2011, it Accordingly, Singha will invest a total of USD 1.1bn as acquired control of Vinacafe, Vietnam’s largest instant new capital in which USD 1.05bn is to own 25% of Masan coffee producer, and has grown its beverage segment to Consumer Holdings (MCH) and USD 50mm to hold 33.3% become one of the largest local mineral water companies of Masan Brewery (MB). This results in an implied as well. In 2014, MSN made its first appearance in the valuation for MCH of USD 4.2bn (VND 95.5tn), valuing local beer market by launching Su Tu Trang, which MCH at 2016 P/E of mid 33-35x. This is a premium as became the fastest growing beer brand in Vietnam the compared to the Vietnam market as a whole, which following year. In 2015, it entered the animal feed reaffirms MCH’s superior business model. The strategic industry through its acquisition of Proconco and ANCO, partnership with Singha provides both sides exclusive and is today one of Vietnam’s largest local animal rights to distribute each other’s products. By tapping on nutrition business. We expect MSN to continue growing Singha’s brewing skills and expertise, there is huge its revenue both organically and inorganically as it has opportunities for geographical diversification, allowing done in the past. Masan Group to unlock strong growth in the coming years. Profitability: MSN’s gross margins declined significantly Venturing into the untapped areas in Vietnam in FY15 as a result of MSN’s entry into the lower margin The average Vietnamese has a strong fondness for beer animal feed business. However, there was a less than and consumption has been rising at 10%, touching 60.1 proportionate decline in EBITDA margins due to the litres per capita in 2015. Masan Brewery is able to use lower operating costs related to the feed business. Singha’s R&D expertise to strengthen their presence in Moving forward, margins are expected to stabilize and the attractive beer market in Vietnam. Currently, the improve as MNS builds out its food business and which is beer (Su Tu Trang) of Masan Brewery is only present in expected to deliver higher, “FMCG-like” margins. the Mekong Delta, a very small fraction of Vietnam. The potential for geographic expansion has resulted in Management’s guidance for Beer to make up 21.7% of
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Return on capital: ROA improvement since FY13 has Catalyst #4: With the inventory de-stocking exercise been driven by improvements in asset turnover and net causing a larger-than-expected dent, Masan’s 4Q17 margin. A gradual increase in financial leverage results will be important as investors would need to contributed to the rising ROE. observe that the expenses incurred are truly one-off and there will be normalization. This could result in the Leverage: MSN’s debt-to-assets ratio has increased overhang on the stock price to ease, as investors shift gradually throughout the years as it has optimized its their focus on the long term benefits of the inventory capital structure and taken on debt for acquisitions. rebalancing exercise. However, debt / EBITDA has improved as EBITDA has grown more quickly than the additional debt taken. Catalyst #5: Another concern from the inventory de- stocking exercise is the decline in revenue, resulting in Catalysts, Events, Tipping Points the Street being concerned that MCH has lost market There are many potential positive catalysts that will share permanently. Hence, if the eight new products in potentially trigger the Street to recognize MSN’s strong the pipeline, as well as energy drinks and processed meat fundamentals and growth potential, resulting in a segments are successful, it would convince investors that positive re-rating. MCH’s growth is not stagnating and it can continue to experience strong growth. Catalyst #1: As Vietnam is a frontier market, there is potential upside if it gets upgraded to Emerging Market Catalyst #6: Geographical expansion is also a way for status, which will trigger a huge amount of international MSN to continue to achieve strong growth, successful fund inflows. MSN will be a natural beneficiary as it is one execution will allow the Street to appreciate MSN’s of the largest listed companies in Vietnam. ability to tap on the potential presented to it in other parts of Vietnam and also in Thailand. This will result in a Catalyst #2: As management has guided on more positive re-rating as it will present huge growth potential shareholder friendly initiatives, the introduction of a for MSN. payout policy can act as a trigger for re-rating. This is not unlikely especially since MSN distributed its first dividend Key Risks at the start of 2017. Despite the acknowledgement and understanding of the attractiveness of MSN as an investment, there is a need Catalyst #3: Masan’s 3F model will be a key growth story to have a thorough understanding of potential risks faced that shareholders will be keenly observing, the successful by the business to result in a more rigorous testing of our execution of its meat production complex and pig farm investment recommendation. by 1H2018 will provide upside as investors are more persuaded of Masan’s ability to consolidate Vietnam’s Risk #1: Conglomerate discount attributed by investors attractive meat market. A potential lifting of China’s ban as a result of future acquisitions in unrelated segments. on pork imports will also be a huge boost, as pork prices This is commonly done by Management to allow for are c.60% higher in China than Vietnam. MNS’s empire-building, however MSN has been disciplined in its consolidation of the pork industry and implementation acquisitions so far. Hence, we believe that this risk is of stringent safety standards may accelerate the lifting of unlikely to play out due to strong management discipline the ban. thus far. However, it is an area that should be monitored and changes in management quality might call for a reassessment of the buy recommendation.
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Risk #2: Food safety, both in terms of disease outbreaks among animals and health concerns regarding food products, which can potentially tarnish MSN’s reputation. This risk is mitigated by the stringent requirements MSN expects its suppliers to adhere to, its world-class facilities that manufacture products at high standards of hygiene and safety, and strong management team with relevant industry expertise. In addition, the firm’s focus on “doing well by doing good” also indicates high priority on food safety.
Risk #3: MNS margin volatility, as MNS is currently heavily dependent on feed sales and is susceptible to volatility on input as well as feed prices. However, this risk is expected to decline over time as the development of the 3F model de-commoditizes MNS, thereby improving and stabilizing margins.
(HOSE:MSN) Masan Group Corporation FY2013 FY2014 FY2015 FY2016 FY2018LTM Share Price VND 64,666.67 50,000.00 47,333.33 47,050.00 71,700.00 No of Shares (mil) 1,102.4 1,103.7 1,120.1 1,133.6 1,047.5 MCAP (mil) USD 3,382 2,563 2,378 2,344 3,307 Net Debt (Cash) VND 9,717,443 14,350,585 26,954,451 26,157,165 26,677,597 Enterprise Value (mil) USD 3,826 3,862 4,189 3,635 4,744 Revenue (mil) VND 11,942,533.0 16,119,894.0 30,628,410.0 43,297,064.0 40,600,292.0 EBITDA (mil) VND 2,616,802.0 3,817,052.0 5,914,676.0 8,358,272.0 7,246,714.0 EBIT (mil) VND 2,128,170.0 2,696,235.0 4,099,750.0 6,023,201.0 4,758,954.0 NPAT (mil) VND 451,200.0 1,080,169.0 1,478,292.0 2,791,444.0 2,156,630.0 NPAT (Ex.Xtra + Dis.Ops) (mil) VND 347,308.0 (76,157.0) 1,261,553.0 2,946,730.0 2,304,477.0 CFO (mil) VND (315,922.0) 333,147.0 3,822,772.0 4,118,601.0 3,285,859.0 CAPEX (mil) VND (3,840,386.0) (2,708,702.0) (3,856,825.0) (2,920,583.0) (2,364,707.0) EPS VND 315.1 (69.0) 1,126.3 2,599.3 2,200.0 Revenue (mil) USD 566.5 753.8 1,364.0 1,901.2 1,786.7 EBITDA (mil) USD 124.1 178.5 263.4 367.0 318.9 EBIT (mil) USD 101.0 126.1 182.6 264.5 209.4 NPAT (mil) USD 21.4 50.5 65.8 122.6 94.9 CFO (mil) USD (15.0) 15.6 170.2 180.8 144.6 CAPEX (mil) USD (182.2) (126.7) (171.8) (128.2) (104.1) GPM (%) 41.9% 39.8% 32.0% 29.9% 30.3% EBIT (%) 17.8% 16.7% 13.4% 13.9% 11.7% Net Debt (Cash) / Equity (%) 67.3% 95.6% 162.2% 171.2% 139.8% ROA (%) 4.6% 5.1% 5.7% 8.2% 7.2% ROE (%) 14.7% 18.0% 24.7% 39.4% 24.9% CFO/TA (%) -0.7% 0.6% 5.3% 5.6% 5.0% EV/ Sales (x) 7.5 4.7 3.0 2.0 2.7 EV/ EBIT (x) 42.2 28.4 22.1 14.0 22.6 EV/ EBITDA (x) 34.3 20.0 15.3 10.1 14.9 EV/CFO (x) (284.3) 229.5 23.7 20.5 32.8 P/Sales (x) 6.0 3.4 1.7 1.2 1.8 P/EBIT (x) 33.5 20.5 12.9 8.9 15.8 P/B (x) 5.6 4.4 6.1 6.7 6.1 VQ1: EV/EBIT/ROE (x) 2.9 1.6 0.9 0.4 0.9 VQ2: EV/EBIT/ROA (x) 9.2 5.6 3.9 1.7 3.1
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3. Ryohin Keikaku Co. Ltd (TSE:7453)
Company Research & Report Quick Stats Date 15/12/17 EBIT/R&D (x) 31.45 EBIT/Employee No. Filing Currency JPY (USD /px) 50K Share Price JPY35,550 EV/EBIT (x) 22.9 No. of Shares (Mil) 26.3 EV/EBITDA (x) 18.6 Market Cap (USD Mil) 8,290.2 EV/CFO (x) 31.5 Daily Value Traded (USD Mil) 49.0 P/Sales (x) 2.6 GPM (%) 49.7% P/E (x) 23.6 EBIT (%) 11.2% P/B (x) 6.5 Net Debt (Cash) / VQ1: EV/EBIT/ROE Equity (%) -19.1% (x) 0.9 VQ2: EV/EBIT/ROA ROA (%) 18.2% (x) 1.3 ROE (%) 25.2%
Team Members
Ye Ying is a second-year double degree undergraduate at Nanyang Business School, specialising in Accountancy & Business Analytics. She has also joined the largest investing community in school to further her interest.
Xin Yi is a second-year double degree undergraduate at Nanyang Business School, specialising in Accountancy & Business Analytics. She is currently doing an internship in the Commercial Banking division at HSBC Singapore. Prior to HSBC, she has done an internship at StarHub implementing the new Financial Reporting Standard.
Shan Shan is a penultimate business student in Nanyang Technological University. Taking a keen interest in investing, she has joined the largest investing community in school to further her interest.
Vania is a penultimate student at Nanyang Business School, planning to major in Banking and Finance. Having developed a keen interest in markets, she strives to learn more about capital market instruments and is currently interning at CitiMarkets.
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How Did You Originate This Idea and Why Did You Choose This Company?
Taking a top-down approach, the team first looked at companies who are expanding in economies that are fast-growing, such as Southeast Asia. When narrowing down the list, MUJI stood out as a company that the team is familiar with, where its’ business is one in which the team understands. Its business also fulfilled our initial analysis that it should be a business that is Selling, Scalable and Sustainable.
More importantly, the team finds MUJI a “hidden gem” in which MUJI is at a very interesting stage in its business: even though MUJI is still seen as a regular retail business by most investors, it is quietly expanding its business beyond retail into other areas such as cafes and hospitality by 2019 (Garfield, 2016). Moreover, MUJI is vigorously expanding its business beyond Japan and into fast-growing economies such as India (Marlow, 2017) and Southeast Asia, specifically Philippines and Vietnam by 2018 (Tani, 2017).
Business Background and Overview Ryohin Keikaku Co., Ltd. is a Japanese company that operates in the retail industry. It mainly engages in the sales of its house brand goods under the name MUJI and operates direct retail stores. Excluding MUJI Cafe and IDÉE, it currently has 418 stores in Japan and 403 stores overseas in US, Europe and Asia (Ryohin Keikaku Co., Ltd., 2017). After its successful entry into China, MUJI is accelerating its pace for global market expansion into other economies such India, Philippines and Qatar (Ryohin Keikaku Co., Ltd., 2017). It is also diversifying into the hospitality industry with the launch of ultra- minimalist hotels in Tokyo and Shenzhen by 2019 (Garfield, 2016). The domestic market remains the major source of revenue for MUJI followed by the East Asia market. Revenue Drivers: MUJI is also steadily expanding in South & West Asia and Oceania as indicated by the increase in percentage sales.
One Sentence Investment Thesis MUJI’s diversified portfolio, strong retail strategy and design-driven business allows MUJI to retain its competitive advantage, further global expansion and market share in the retail business.
What Makes It a Wide-Moat Business? Womenswear and furniture are consistently within the To analyse whether MUJI possesses the competitive top 3 best-selling product categories while health & advantage that makes it difficult for competitors to rival, beauty overtook linens & interior goods in FY2014 in we approached MUJI’s business in terms of 3 “S”: terms of percentage of sales. Interestingly, sales of health & beauty products have been consistently 1. Saleability: Can MUJI’s products sell well? increasing in the past 5 financial years indicating 2. Scalability: Can MUJI’s business grow well? potential in this product line. 3. Sustainability: Is MUJI’s business growth sustainable? 17
Saleability: Focus on Customer Satisfaction out more about products before making an in-store MUJI recognises that “selling” is fundamental in its retail purchase, MUJI was able to garner interest by business and customer satisfaction is at the core in introducing a free sign up credit incentive and making selling. Thus, MUJI has put in much effort in developing membership discount redemption a seamless its sales capabilities. MUJI has enhanced its sales experience. The launch of push notifications that capabilities through providing two “E”s - Expert and informed consumers about discounted products also Experience. resulted in a surge in foot traffic the during sale days and
discounted items were wiped off the shelves within For “experts” aspect, MUJI has trained its sales staff to hours (App Annie, 2016). be specialized in specific areas such as Interior Advisor
Consultation Service, Organizing Consultation Service, Wall Storage, and Styling Advisor, offering detailed By offering bonus points to their almost 8 million MUJI lifestyle suggestions for its customers. members, they were able to exponentially increase foot By revamping its store environment and including the traffic to their stores despite the recent consumption tax Fragrance Studio, Stamp and Gifts Corner, Wood hike (App Annie, 2016). This was a testament of MUJI Environment Play Area within its stores, MUJI provides Passport’s ability to drive traffic to brick and mortar its customers with the experience of discovery. MUJI’s stores and its capacity to be used as a channel to customers are able to see, touch and feel to discover maintain customer connections and relationships. their own style at each MUJI store. Collectively, these have enabled MUJI to better cater to its customers with Today, MUJI Passport offer members personalised its wide range of products, thereby increasing customer discounts and product launch updates to keep satisfaction and hence, sales. themselves relevant and up to date with their consumers (Marian, 2015). In Japan, the app is These initiatives have been rewarded with concrete continually updated and expanded to increase results. For example, after implementing its Interior convenience and services. In other markets such as Advisor Consultation Service in 2013 (Chen, 2016), there Hong Kong and Korea, the app is awaiting revision in is an obvious increase in furniture sales from 2013-2016 as shown below, contrasting with its relatively stagnant terms of how it rewards shopping points and loyalty furniture sales from 2010-2012. program structure (Ryohin Keikaku Co., Ltd., 2017).
Scalability: Integrated Supply Chain Management Asset-Light Business Model MUJI adopts the asset-light business model as it outsources its manufacturing capability instead of owning/controlling any manufacturing facilities. This not only brings about greater flexibility in terms of quicker response to changes (such as changing demand, technology advancements, new market opportunities, and supply chain disruptions) but also allows MUJI to scale at a cheaper cost (The Boston Consulting Group, On top of these, MUJI’s extensive efforts in engaging n.d.). Being asset-light, MUJI is able to grow its business customers through its events, large social media without incurring huge spending on capital assets, presence and app development have resulted in high allowing MUJI to do more with less. customer loyalty. It also employs big data analytics to provide a personalised experience for customers on its Comprehensive Supply Chain online platform such as real-time and context specific One major competitive advantage MUJI has over its recommendations. competitors is its comprehensive supply chain management which allows it to manage its cost and MUJI’s Online and Passport Mobile App Strategy quality efficiently. MUJI has its own distribution and For instance, MUJI Passport was created to drive in store procurement subsidiaries - RK TRUCKS Co., Ltd. and traffic and to enable MUJI to be clear and consistent MUJI Global Sourcing Private Limited handling Asia’s with their communication with consumers through all supply chain; and a new distribution center in channels. Working like a loyalty card, it is a bridge Netherlands to manage its Europe supply chain. This between MUJI and its consumers. start-to-end supply chain management enables it to Despite its underwhelming success during its inception, reduce its delivery lead time to stores, ensuring items MUJI took action to understand their consumer thought are not out-of-season, particularly for apparels which process, enabling them to better serve them. By are sensitive to changes in trends. understanding that consumers were on their site to find 18
In 2013, MUJI has installed a global merchandising simply could not match up to the high rental costs. For system to manage information on sales and inventory example, a MUJI retail store located in an underground for its product. In FY2014, the company began building shopping mall beneath the Paris Louvre Museum had a a global supply chain management system (GSCM rent-to-sales ratio of 40%. The average ratio in Japan is system) to automate merchandise orders, linking stores, 10%, while the typical figure for Europe is around 15% regional distribution centres (DCs), global DCs and (Beyond Proxy, 2015). factories. The GSCM system are divided into 3 phases as shown in the picture below. As of FY2016, MUJI finished Learning from its past experience, MUJI now adopts the introduction of the systems in all phases and is “second-best spot in a prime location” retail strategy to beginning to improve system accuracy. The system has lower rent expenses and to offset remodelling costs generated results, for example when it was introduced (Horie, 2015). This retail strategy of settling for “second- in South Korea in April 2014, it helped reduce inventory best” enables MUJI to keep its pricing competitive and stockpile by 30%. Overall, MUJI has also managed to operating expenses manageable. reduce the logistic cost by a cumulative of 2.7 billion yen or almost 24 million USD. As MUJI continues to improve Diversified Portfolio on the GSCM system, there will be more cost-savings Though the retailing of MUJI products still makes up bulk and tighter control on supply chain. of the business, MUJI hosts a well-diversified portfolio consisting of retail (MUJI), restaurants (The Cafe and Meal MUJI), recreational activities (MUJI Campsite), property (MUJI House) and design (IDÉE).
Global HR Management A global HR system and a global incentive system were set up earlier this year as part of MUJI’s Mid-Term Business Plan (FY17-FY20) to focus on employee proficiency (Ryohin Keikaku Co., Ltd., 2017). MUJI stock options and performance based bonus are extended to the company’s non-Japanese directors, executives, and employees (in the form of point system, where points will be converted into MUJI shares), motivating them to The team believes that with a sound and tightly act in the interest of MUJI in overseas tenures (Rhyohin controlled supply chain management system, MUJI is Keikaku Co., Ltd., 2017). This will also help to encourage able to control its own cost and quality while expanding long term recruitment overseas, and achieve sales goals at a fast rate, without being subjected to any volatility or lapses by third parties in the supply chain.
Standardisation of Processes On top of the extensive tight control on its supply chain, MUJI also employs standardisation of processes and products, such as the standardisation of all bed legs, to drive down production costs such that it can pass on cost savings to increase customer base without hurting its profit margin. This is evident from its move to slash price by 14% on 40% of products sold in Japan in 2018 (Nikkei, in view of overseas expansion. 2017). Brand Equity Sustainability: Sustainable Business Model Although MUJI products do not have brand logo which Retail Strategy is a psychological tool often used by businesses to help MUJI begun its huge success in the 1990s. However, it promote strong affective associations (Association of adopted an aggressive expansion strategy that Psychological Science, 2016) this in turn has the effect of eventually outran the speed of its own product shielding MUJI against the rise of anti-consumerism. development. This was further exacerbated by a poor Furthermore, MUJI actually solicits a growing loyal cult- overseas expansion strategy, where MUJI competed for like customer base where it is actually perceived as a the hottest local spots to build its retail space. The great brand with sensible and simple products that are eventual consequence was that MUJI’s sales volume continuously innovating. 19
This brand equity is built with MUJI’s dedication towards As MUJI sells a wide variety of items in several coming up with new unique products continuously categories, this means that despite expanding overseas, which can be seen from it winning more than 100 top- the order lot size remains small. As such, it is tier design and innovation awards. This attitude is fundamentally difficult for MUJI to optimise its lot size reflected in its persistence in finding a way to mass- to reduce cost. manufacture the more durable and comfortable “right- angled 90-degree socks” instead of the conventional Product localisation catering to the diverse cultures and socks at a 120-degree angle (Glader, 2014). MUJI also body types etc fundamentally impedes MUJI’s efforts to adopts the open-innovation method, engaging external cut costs because even smaller lot sizes have to be used. designers who identify and pride themselves with For instance, the flagship store in Singapore had to MUJI’s design value. These designs are evaluated with a source for Chinese strainers in efforts to localise group panel to ensure consistency of style (Beyond decorative ornaments (Lee, 2017). Proxy, 2015). These together contribute to high quality MUJI-brand products, and allow MUJI to produce best In order to overcome this, MUJI overhauled its logistics sellers consistently. processes to reduce procurement costs and introduced simplified packaging while increased sales volumes have Collectively, these have laid the foundation for MUJI’s helped to aid this reduction (Inside Retail Asia, 2017). brand equity which is: affordable, simple, sleek, For instance in early 2017, MUJI cut costs by limiting minimalist products designed well for a specific task outsourcing factories and material suppliers and better (Vulcan Post, 2017) which helps ensure MUJI’s product specifications. This allowed MUJI to launch 200 sustainability on the back of the rise of customers items at discounted prices and a campaign “Yutakana- conscious about waste reduction and eliminating tei-kakaku (“rich life at low prices”)” highlighting their commercialism. success.
Environmentalism & Corporate Social Responsibility MUJI’s reaction to this toxic factor has so far enabled the With a rise of global activism, consumers are becoming company to add to its brand value of minimalism and more aware and vocal about their consumption choices. generated new sales alongside repeat customers. MUJI’s long established focus on environmentalism and However, the team acknowledges that continual cost corporate social responsibility will safeguard it against reductions are not sustainable in the long run and that any potential consumer boycott. CSR is not a one-off MUJI has to find other ways to continue to garner thing for MUJI, whereby it incorporates CSR into many renewed interest and sales. aspects of its business model. In order to increases the source of products for its supply chain management, External: E-commerce MUJI has trained 300 women in Cambodia in sewing and Since 2012, the global retail sector has seen lacklustre dyeing techniques, working towards empowering the performance relative to other sectors due to the rise of female population (Asian Development Bank, 2016). ecommerce (Gjerstad & Papp, 2017). As such, in an industry landscape overrun by convenience, accessibility MUJI’s programs such as ReMUJI (recycling of and advanced technology offered by E-Commerce, brick consumers’ unwanted clothes) (Ryohin Keikaku Co., Ltd., and mortar stores cannot simply still rely on being a one- n.d.), investment in eco-friendly dyeing and sewing plant stop shop to stay competitive. Instead, companies need in Cambodia, and sourcing products from Kenya and to focus on the how to get customers excited when they Kyrgzystan instead of outsourcing to known walk into stores via an experiential shopping experience conglomerate of sweatshops all exemplify MUJI’s (The New Paper, 2016). True enough, the opening of central value of “Conscience and Creativity”, creating a physical stores by E-Commerce giant Amazon in a bid to sustainable business (Quito, 2016). provide a more personal shopping experience further stresses the important role experiences play in shopping What are your top 3 dislikes? What are the toxic (Team, 2016). factors? Internal: Limited Cost Control Ability MUJI’s central focus has always been providing such an MUJI has a high stock keeping unit (SKU) count of over experience as the company believes its physical store 7000 items but it does not own or control its own experience conveys the MUJI story of “MUJI is enough”, manufacturing facilities. While this makes MUJI asset- “Without thought” and “Just right”. This experience light and avoids issues such as managing capacity helps to build the brand value and heighten MUJI’s utilisation, it also means that MUJI has limited control emphasis on minimalism and the idea of compact living over its product cost. (Fukasawa, n.d.). Furthermore, the introduction of 20
interior consultants and styling consultants in stores External: Erosion of MUJI’s Unique Branding make up the brand experience that sets MUJI apart. MUJI prides itself as - “no brand, good quality”, which is the literal translation from its Japanese name Mujirushi Despite their strong brand value and ability to deliver a Ryōhin. However, in the past 5 years, there has been a good experiential shopping experience; MUJI does rise of “copycat” companies which erodes the unique recognise the threat and opportunity due to rising e- minimalism concept MUJI stands for. commerce. As such MUJI had launched online store in 2008 and MUJI Passport in 2013 in order to defend its The most notable amongst them is MINISO, a Chinese market share against rising e-commerce giants as well company which emulates MUJI’s (and Uniqlo and Daiso) as to drive sales to physical stores. As seen below, branding, where there are many similarities - from the online store sales revenue has been consistently focus on the concept of minimalism, the wide-range of increasing over the years, showing positive growth over products (from apparel to furniture), to even similar red the years. logo and Japanese labels (Liu, 2017). Online reviews have also found that the similarities are close enough such that some customers mistake MINISO as another brand under MUJI (Hong Kong Economic Journal, 2016).
However, the close similarity of branding can only be said to be “coincidental” in MINISO’s CEO’s words, and thus is insufficient to amount to a legal pursuit (Liu, 2017). Therefore, this competition cannot be stifled and will see an even greater increase, as MINISO expands at a faster rate (1,800 stores since 2013) than MUJI and in places MUJI is focusing on - China, India and US (Liu, 2017).
Furthermore, realising the appeal of minimalism to MUJI also increased its efforts in developing its omni- consumers, many Chinese companies are jumping on channel sales and marketing. For instance, the company the minimalist bandwagon. Examples include Vancl constantly engages their customers via campaigns and (apparel business) and NetEase YanXuan (lifestyle online frequent, thoughtful updates on their social media retailer) which emulate MUJI’s style of simple designs platforms such as launching fashion look books, online and have garnered a huge base of consumers (All China exclusive offers and pre-launch items etc. This not only Tech, 2016). This further dilutes MUJI’s unique selling keeps their consumers engaged but also enables MUJI point of minimalist designs. to drive traffic to both their online and offline stores
(The New Paper, 2016). Currently, MUJI has been relying on its brand equity to
defend against the invasion of these competitors. The MUJI has also shown its commitment to continual inability to safeguard its unique minimalism branding improvement of its online experience, for instance MUJI which is the fundamental basis MUJI prides itself on, will has recently temporarily closed its online store in be a significant risk factor MUJI has to address, in order Singapore and will be relaunching it in Jan 2018 with a to protect its market share and profit margin. new enhanced site that will enable a more comprehensive and immersive shopping experience for Management Quality Analysis consumers (Rhyohin Keikaku Co., Ltd., 2017). It is also looking to launch an ecommerce site in India alongside Corporate Culture its plans to expand physically in the nation as it Japanese companies have long been known for the recognises its appeal especially in such a big country like overwork culture which is so prevalent and entrenched India (Shah, 2016). that the word “Karoshi” is created to describe the common occurrence of occupational deaths due to Moving forward, the team recognises that MUJI still has overwork. a long way to go in terms of its efforts to drive sales to its ecommerce platform, however we feel that with The toxic overworking culture has caused the Japanese MUJI’s current efforts to combat this toxic factor, the advertising firm Dentsu to come under fire in 2015 for company is not in jeopardy in the medium term. overworking its employees and subsequently it paid S$29 million in overtime wages to its workers (Sim, 2017). In contrast, MUJI has been making efforts to 21 change the overwork culture such as conducting checks through standardisation of supply chain management to ensure employees do not prolong working after work system and store layout (Hiura, 2013) Satoru Matsuzaki hour (Nikkei, 2016). This helps to ensure MUJI is able to also stresses that MUJI will maintain the MUJI way and avoid possible backlash that could result from any not repeat the same mistake of detracting from MUJI “Karoshi” controversy. concepts (IE School of Architecture & Design, 2017). Satoru Matsuzaki’s management philosophy is also In addition, at MUJI, employees can raise problems focused on the long term value of its business, in which encountered and provide solutions to the company. for MUJI’s global expansion, Satoru Matsuzaki has These inputs help to modify and refine Mujigram, a stated that MUJI’s priority is to set up a strong base comprehensive directive manual that provides guidance with its joint venture partner Reliance before rapid covering various aspects of work processes from expansion in India. This strategy has already received product display to customer service (Kiuru, 2016). This prior success in expansion in China, in which MUJI only creates an employee-focused corporate culture that had one store in China for three years from 2005 to encourages participation and nurtures a sense of 2007 before embarking on rapid expansion of up till belonging for the employees. 200 stores by 2017 with a targeted increase of 40 stores per year (Shah, 2016). As MUJI is only in the Management Quality & Philosophy initial stage of expansion globally, with only less than Earlier this year, MUJI announced organisational and 10 stores in many of its ventures such as India, Saudi personal changes. One major change is the appointment Arabia, Bahrain, Vietnam and Philippines; the value of of more executive officers for RK’s large affiliates its global expansion has not been reaped but will likely outside Japan (Ryohin Keikaku Co., Ltd., 2016). This is a be realised in the coming future, as evidenced by its move by MUJI towards greater decentralisation of expansion in China. management power and responsibility, in line with its goal towards global market expansion to facilitate Shareholding Structure company growth. • Authorized Shares Issued: 112,312,000 • Outstanding Shares: 28,078,000 These changes may potentially create difficulties for • Number of Shareholders: 9,818 MUJI to implement group policy uniformly due to (Ryohin Keikaku Co,. Ltd., 2017) problems of coordination. However, this can be mitigated by MUJI’s strong focus on internal Corporate Governance communication. Every manager in the Tokyo Japanese companies are known for cross-shareholding headquarter will be seconded overseas to better to cement business relationships. Cross-shareholding understand MUJI’s overseas operations. Similarly, often compromises corporate-governance as companies overseas management staffs are sent to Tokyo to better tend to take a hands-off approach on each other’s understand group policy decision-making process management, weakening managers’ sense of (Rudlin, 2013). accountability (Kodaira, 2015). MUJI is making effort to dismantle this practice. In 2015, MUJI sold of its 1.7 Currently Ryohin Keikaku is million shares in apparel giant Onward Holdings, to helmed by Satoru Matsuzaki who improve asset efficiency. MUJI also has its own internal took over as the President and audit department that is recently split into Store Audit CEO of the company in 2015. Office and Global Audit Office to reinforce corporate Satoru Matsuzaki was appointed governance and increase audit efficiency (Ryohin for his decades of experiences Keikaku Co., Ltd., 2016). overseeing international operations in 25 countries Business Group Structure (Takahashi & Katano, 2015). His extensive experience will be particularly useful at this juncture, as MUJI is rapidly building up its global presence by expanding into various countries. In terms of management philosophy, Satoru Matsuzaki shares the same belief as his predecesor Tadamitsu Matsui the man behind MUJI’s turnaround in the early 2000s. Tadamitsu Matsui turned around MUJI from losses by bringing back the MUJI way (the focus on simple, functional and innovative product) and reducing inconsistencies
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FamilyMart’s investment in MUJI is reflected in its another avenue for guests to have first hand experience business where there is a dedicated section for MUJI using MUJI products in everyday life. products in its stores and online site. Upon FamilyMart’s MUJI’s global flagship store “MUJI YURAKUCHO” is merger with UNY Group, MUJI products are now another prime example of how MUJI has used available at FamilyMart, Circle K and Sunkus stores. This diversification to enhance the consumer’s experiential is a welcome development for MUJI as it increases the shopping experience as well as market their products. company’s reach by 1.5 times and enables MUJI to take Within the store, there is fresh produce, MUJI Cafe and up greater consumer mindshare (Ryohin Keikaku Co., MUJI Hut. (MUJI Hut is a life size display of a living space Ltd., 2016). Although this move might be seen as a furnished with MUJI fittings) MUJI draws more traffic by dilution of MUJI’s brand image, this move actually creating a comprehensive flow in the customer enables MUJI to reinforce its image of being functional experience (Ryohin Keikaku Co., Ltd., 2017). For yet affordable. instance, the introduction of MUJI Cafe pushes more traffic towards its fresh produce section (fresh produce Changes in Dividend is used in the MUJI Cafe) to entice consumers to stay longer at MUJI stores and hence make more purchases. MUJI also takes advantage of this increased traffic by showcasing its MUJI Hut in the middle of the store. All of their actions show that MUJI is actively trying to garner
more mindshare in consumers by creating opportunities Clear from the table above, dividend payout has been to enforce the concept of “MUJI is enough” and showing consistently increasing. Year on year and excluding how MUJi seamlessly integrates into one’s lifestyle. extraordinary items, dividend per share growth enjoys However, MUJI’s management time, energy and an increase of 19.11% (The Financial Times, 2017). The resources are still concentrated on designing and consistent increase in the dividend payout signals MUJI’s confidence in its future growth especially only some developing quality products which are showcased in its companies in the Retail (Department & Discount) diversification effort which minimises diversion from industry pay a dividend. Its five-year annualised dividend MUJI’s ore retail business. per share also outperforms its peers in the industry. Furthermore, there is a share buyback of 4475 million Though its diversification strategy is commendable, it yen in the fiscal year 2016 (Ryohin Keikaku Co., Ltd., should be noted that this strategy has not yet proven its 2017), this may imply that the MUJI management thinks return on investment due to the high initial setup costs that their share is undervalued. and a long lead time to break even.
Global Expansion Catalyst and Events With foreign operations accounting for more than 40% We believe the following factors will help MUJI in its of total profit, MUJI continues to pursue its vision of growth and potentially leading MUJI to double its market value in the next 3-5 years becoming a global brand by increasing its store network and taking up new opportunities. (Nikkei, 2017) Diversification MUJI has diversified its retail business by: Even though both domestic and overseas sales have been increasing, the increase in overseas sales is more • Opening up cafes - 23 in Japan and 15 overseas instrumental to the increase in total revenue. This can • Selling fresh produce be seen from the graph below, the increase in total sales • Venturing into hospitality by opening 2 hotels in is accompanied by the increase in the proportion of Tokyo and Shenzhen (Garfield, 2016). overseas sales out of total revenue.
Although it might seem that MUJI is spreading itself too thin on the surface, MUJI has mitigated its potential diversification to turn into “diworsification”, by retaining focus on its core retail strategy. If one takes a closer look, one can observe that MUJI’s diversification into food and beverage, fresh produce and hospitality are all means to showcase and market MUJI’s iconic minimalist branding. For instance, MUJI hotel is simply
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The growing middle class has been fueled by lifted Chinese incomes and rapid economic growth. The values of Chinese customers are also set to change from vanity to practicality as the Chinese consumer market matures (Mishima, 2016). With a population size of 1.37 billion, the Chinese market still shows great potential for MUJI to tap on despite its incumbent presence in the market.
Regional Geopolitical Tensions Moreover, it is comforting that China-Japan relations have improved over the past few years. More notably, it has reached a new high in positive relations, where both leaders have agreed their meeting in November 2017 marks a “fresh start of relations” (The Straits Times, 2017)and that Shinzo Abe was the first Japanese PM in 15 years to attend the Chinese embassy in Tokyo’s National Day celebration (Gao, 2017).
This improvement in positive relations is reassured through the continued governance by Shinzo Abe, following his successful re-election in November 2017.
This is especially important because consumer spending To do that, MUJI is focusing on aggressive global market in Mainland China can be greatly affected by national expansion into South/West Asia, as seen from the graph issues, as noted by the boycott by Mainland Chinese due above. It targets to increase the number of its MUJI to the THAAD missile issue which has resulted in South stores from the current 821 to 1138 by FY2020. Korea’s Lotte Group having to inject US$318million and (excluding MUJI Cafe and IDÉE) (Ryohin Keikaku Co., subsequently sell all its stores in China in September Ltd., 2017) 2017 to prevent further losses (The Straits Times, 2017)
MUJI’s Regional Segmentation India • Japan The company currently has three stores in Mumbai, • East Asia: China, Korea, Taiwan, Hong Kong Bangalore and New Delhi and aims to open another store in Noida (the national capital region) before • West/South Asia & Oceania: Thailand, India, opening its flagship store in Mumbai in 2018. President Malaysia, Singapore, Australia and owner of MUJI - Satoru Matsuzaki-san has • Europe & Americas: USA, UK, France, Germany, expressed his high expectations for the Indian market Italy, Canada, Spain, Portugal and cites the similarities between the Chinese and
Indian markets such as consumer demographics and Mainland China, Taiwan and Hong Kong strong growth as the reason for his forecasts (Marlow, In early 2014, MUJI converted MUJI (Taiwan) Co., Ltd 2017). into a subsidiary to further solidify its position in the region by directly owning the stores in Hong Kong and India’s economy continues to be one of the fastest China. (Ryohin Keikaku Co., Ltd., 2014) After doing so, growing in the region with a GDP growth of 7% (Mishra, MUJI has continued to aggressively open new stores in 2017) and its exploding middle class shows high these countries which has resulted in increased sales potential for MUJI to build customer loyalty in the early and local profits. (Ryohin Keikaku Co., Ltd., 2017) stages of this growth (Keith, 2016). Evidence of this can
be seen from its sales per shopper in India which already MUJI’s focus has always largely been in China and exceeded that of Japan. (Hayakawa, 2017) continues to expand in the market, aiming to open 40 new stores annually, reaching 360 stores in China by Singapore 2021 in order to gain better name recognition among MUJI recently opened of its flagship store Plaza the growing Chinese middle class. (Nikkei, 2017) Singapura Outlet - its 423rd outlet outside Japan. This
move signifies the company’s commitment to expansion
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in Southeast Asia and South Asia, moving its focus away functional products as their economic situations from East Asia. improve. (Marlow, 2017).
MUJI sees its presence in Singapore as a showcase for Financial Analysis regional expansion and as a testbed to pique interest Evaluation of Financial Ratios and Figures from overseas investors by allowing them to experience the brand in Singapore. For instance, the Plaza Singapura outlet is only the second outlet to house the “MUJI Cafe&Meal” concept and MUJI hopes to bring this concept to other parts of Southeast Asia like Kuala
Lumpur. (Tomomi Kikuchi, 2016) Apart from that, being in Singapore has also allowed MUJI to learn more other Revenue CAGR=12.09% countries such as India and the Middle East (Tani, 2017). NPAT CAGR=18.71%
Other Emerging Markets - Vietnam and Philippines The CAGR for revenue and net profit are both healthy at With GDP growth of 6.2%, MUJI has also marked 12.09% and 18.71% respectively. Revenue growth Vietnam for expansion and plans to open its first store slowed to 8.4% in FY 2016 due to strong yen which in the country via a Joint Venture in 2018 (Nguyen, 2017) depresses the overseas revenue. Furthermore, the European & USA market has been creating losses for In the Philippines, MUJI currently has 7 outlets and has MUJI and has a sluggish revenue growth (revenue only embarked on a similar Joint Venture with Stores increased to 17603 million yen from 17124 million yen). Specialists Inc. (SSI Group) - a leading Filipino specialty In FY2014, it is noted that there is NAPT growth is at - retailer that has an extensive portfolio of established 2.8%. This is due to a slightly lower NPAT in FY2014 international brands - under the name: MUJI Philippines despite higher revenue in FY2014. However, this is due Corp, to build up its retail business network. This enables to gain on step acquisition (an extraordinary income) in MUJI to directly operate locations instead of franchising FY 2013, therefore if the extraordinary income is them (Nikkei, 2017). disregarded, MUJI was more profitable in FY2014 than in FY2013. In the partnership, SSI will provide the operational knowledge and apparel and retail sales for the Filipino market whereas MUJI will provide brand management expertise (Saulon, 2017). Furthermore, the partnership will enable MUJI Philippines Corp to carry more merchandise and lower pricing in their stores (Gonzales, EPS CAGR=19.03% 2017) EPS has been generally increasing, indicating it is profitable for shareholders to hold on to MUJI’s stock. Increasing Popularity of Minimalism Apple’s minimalist approach has led to not just its huge success today but also a design revolution. It has proven that simplicity appeals to customers and people are buying into the design language. Similarly, with the motto of “no brand, good quality”, MUJI bases its entire MUJI’s gross profit margin has been consistently hit selling point on being minimalist. Its products are “plain above 45% in the past 5 financial years and is in the without being forgettably genreic - special, and just increasing trend. This is an impressive number and boring enough” (Sherwood, 2014). In the recent 2 years, shows that MUJI most likely enjoys a market leader there has been increasing popularity of minimalism, position or at least a premium spot in the industry particularly amongst millennials, and as more millennials aged 20-36 today enter the workforce in the next 3-5 years, the increased purchasing power they gain will have a positive impact on the sales of MUJI (Weinswig, 2016). Net debt has been consistently negative, indicating a stable and healthy financial strength. As for the emerging market, a growing middle class has also spurred the trend towards minimalism as more people steer towards owning simpler and more 25
(TSE:7453) Ryohin Keikaku Co., Ltd.FY2013 FY2014 FY2015 FY2016 FY2017 FY2018LTM Share Price JPY 8,000.00 11,160.00 20,330.00 24,850.00 28,330.00 35,550.00 No of Shares (mil) 26.7 26.5 26.5 26.6 26.4 26.3 MCAP (mil) USD 2,087 2,903 4,336 6,004 6,719 8,290 Net Debt (Cash) JPY (31,070) (23,777) (16,238) (28,539) (27,643) (30,059) Enterprise Value (mil) USD 1,516 2,192 3,400 5,271 5,492 8,057 Revenue (mil) JPY 188,350.0 220,619.0 260,254.0 307,532.0 333,281.0 354,553.0 EBITDA (mil) JPY 21,693.0 25,263.0 29,696.0 42,289.0 46,879.0 48,830.0 EBIT (mil) JPY 18,352.0 20,915.0 23,847.0 34,440.0 38,278.0 39,655.0 MUJI’s inventory turnover is rather low and inventory NPAT (mil) JPY 10,970.0 17,096.0 16,623.0 21,718.0 25,831.0 28,700.0 NPAT (Ex.Xtra + Dis.Ops) (mil) JPY 11,759.0 12,782.0 14,313.0 23,001.0 25,922.0 25,941.0 number of days are high. This is mostly due to MUJI’s CFO (mil) JPY 13,176.0 15,117.0 14,619.0 26,133.0 19,742.0 28,863.0 CAPEX (mil) JPY (3,856.0) (10,474.0) (16,490.0) (7,527.0) (8,468.0) (8,445.0) strategy of expanding its product line-ups (staple EPS JPY 441.0 482.8 540.0 866.0 982.4 986.9 products only, excluding seasonal products) to prevent Revenue (mil) USD 2,039.2 2,161.1 2,174.9 2,724.5 2,975.9 3,218.2 EBITDA (mil) USD 234.9 247.5 248.2 374.7 418.6 443.2 opportunity loss such as stock-outs and rise in EBIT (mil) USD 198.7 204.9 199.3 305.1 341.8 359.9 NPAT (mil) USD 118.8 167.5 138.9 192.4 230.6 260.5 production cost. But stocking inventory may lead to CFO (mil) USD 142.7 148.1 122.2 231.5 176.3 262.0 CAPEX (mil) USD (41.7) (102.6) (137.8) (66.7) (75.6) (76.7) issues such as higher storage expense as seen from GPM (%) 46.4% 46.1% 47.2% 48.9% 49.8% 49.7% increasing leasehold & office rents expense. EBIT (%) 9.7% 9.5% 9.2% 11.2% 11.5% 11.2% Net Debt (Cash) / Equity (%) -33.1% -22.0% -12.9% -20.4% -18.0% -19.1% ROA (%) 15.4% 14.9% 12.8% 17.1% 17.8% 18.2% ROE (%) 19.6% 19.3% 19.0% 24.6% 25.0% 25.2% CFO/TA (%) 11.0% 10.8% 7.8% 13.0% 9.2% 13.2% EV/ Sales (x) 1.0 1.2 2.0 2.1 2.2 2.6 EV/ EBIT (x) 10.1 13.1 22.0 18.4 18.9 22.9 EV/ EBITDA (x) 8.5 10.9 17.7 15.0 15.4 18.6 EV/CFO (x) 14.0 18.2 36.0 24.3 36.6 31.5 P/Sales (x) 1.1 1.3 2.1 2.1 2.2 2.6 P/EBIT (x) 11.6 14.1 22.6 19.2 19.5 23.6 P/B (x) 2.4 3.1 4.8 5.2 5.3 6.5 High receivable turnover ratio and low days sales VQ1: EV/EBIT/ROE (x) 0.5 0.7 1.2 0.7 0.8 0.9 outstanding. This means that MUJI has a strong credit VQ2: EV/EBIT/ROA (x) 0.7 0.9 1.7 1.1 1.1 1.3 collection policy, collecting cash quickly, aiding in healthy cash flow for short term capital requirements.
Owing to its asset-light business model, MUJI has a moderately high ROA. This far surpasses its competitor Isetan whose ROA hovers around 1-2% and is comparable if not higher than Fast Retailing Co. Ltd (whose primary subsidiary is Uniqlo) as seen from table above. MUJI has a strong ROE which have been sustained at a 2-digit figure over the past 5 financial years. This far surpasses the industry average where the average ROE for retail industry in Japan is only 5.19% (Damodaran, 2017).
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4. NCSoft Corp (KRX: 036570)
Company Research & Report Quick Stats Date 15/12/17 EBIT/R&D (x) 2.79 EBIT/Employee Filing Currency KRW No. (USD /px) 21K Share Price KRW482,000 EV/EBIT (x) 18.0 No. of Shares (Mil) 21.3 EV/EBITDA (x) 17.0 Market Cap (USD Mil) 9,410.5 EV/CFO (x) 21.5 Daily Value Traded (USD Mil) 64.2 P/Sales (x) 6.8 GPM (%) 86.8% P/E (x) 20.6 EBIT (%) 32.9% P/B (x) 4.3 Net Debt (Cash) / VQ1: Equity (%) -53.0% EV/EBIT/ROE (x) 0.9 VQ2: ROA (%) 15.7% EV/EBIT/ROA (x) 1.1 ROE (%) 20.3%
Team Members Ang Kai Wei is a second-year student from Nanyang Business School enrolled in Double Degree in Accountancy and Business, specializing in Banking and Finance. He enjoys investing and aspires to be a Financial Planning Analyst in the future.
Daryl is a second-year accountancy student at Nanyang Business School, NTU. He enjoys investing and participated in POEMS Stock Challenge and CIMB-ASEAN Stock Challenge.
Benjamin is a second-year accountancy student at Nanyang Business School, NTU. He previously worked at PricewaterhouseCoopers and did an internship with TauRx Pharmaceuticals as a Finance Intern.
Yan Zhi is a second-year accountancy student at Nanyang Business School, NTU. He previously worked at the Inland Revenue Authority of Singapore as a Tax Officer. He has participated in the UOB NUS Case Competition, POEMS Stock Challenge, CIMB-ASEAN Stock Challenge and the UOB Top Trader competition.
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Investment Thesis
NCSoft Corp (NCSoft) was selected by the team while researching on stocks in Korea. Korean stocks currently have one of the lowest P/E Ratio, with the average stocks trading at just around 10x 2017 PE compared to 13x-19x of most other major markets in the world. The team believes that there are potential gems with high ROEs to be discovered.
Narrowing down to companies with high ROEs and low Their operating segment mainly includes Massively Price-Earnings-Growth (PEG) ratios, the team chanced Multiplayer Online Role Playing Games (MMORPGs). upon NCSoft. It is determined to be a potential Hidden NCSoft has developed popular games such as Lineage, Champion after subsequent analysis of its quantitative and qualitative characteristics. Guild Wars 2 and Blade & Soul. With the increase in the online gaming market and mobile device gaming, NCSoft has been enjoying tremendous growth of >20% NCSoft’s maiden leap into the mobile games industry per annum in sales while maintaining net profit margins has been a success with the recent release of Lineage M. over the past decade. The constant revenue growth The main asset for NCSoft is its Intellectual Property (IP) shows that NCSoft is an extremely successful company. comprising its main game franchises. Apart from The current buzz is focused on competitor Netmarble, developing games, NCSoft also partners with third after its recent IPO and announcement on its KRW 4.8T parties for publishing in other countries. The company (USD 4.4B) acquisition plans this year, while NCSoft is also licenses its IP to overseas developers. (Refer to left out of the spotlight. Taking into account its expected Section 3.4 for the list of license partners) growth rate, NCSoft, being one of the top three market leaders in Korea, enjoys strong brand recognition in its Revenue Streams domestic gaming market. NCSoft’s main revenue streams come from in-game NCSoft’s IP offers unique game designs that appeal to sales of its PC and mobile games, with a small the dedicated gamers segment. They place ample focus contribution from royalties from licensing its IP. Its on only a few game franchises, mostly in Role-Playing revenue breakdown is as follows: Games (RPGs), and expands on them to preserve the core game concept and players’ interest in their games. With their expertise in developing quality RPGs, they have fortified their position as one of the top online game developers in Korea.
Details on its competitive advantages and value drivers will be addressed in subsequent sections. Qualitatively, the company’s ability to maintain the profitability of its IP has enabled it to enjoy high ROE and low cost of sales.
An asset-light business model allows NCSoft to scale while minimizing the increase in costs, giving it a It is commendable that several of its IP franchises, such competitive advantage. as Lineage and Lineage 2, continue to be profitable and generate cash flows, decades after their release dates Business Model Quality Analysis (1998). Looking forward, the company’s main engine for growth lies in extending its IP into mobile platforms. Business Model
NCSoft is a South Korean video game developer which develops and publishes online computer (PC) games as well as mobile games. Its focus is on creating high- quality, fun, persistent online gaming experience for players to enjoy across different platforms and in a variety of ways. The games in each platform are as follows:
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Currently, much of NCSoft’s revenue source is focused increase their playtime for the games instead of on their domestic market in Korea with influence in switching to NCSoft’s competitors. several countries such as Taiwan, Japan, US, Europe, and However, unlike WOW and other popular MMORPGs China. Looking forward, the company intends to extend that still use a subscription-based or sales revenue its reach into other regions through their PC and mobile model to generate revenue, NCSoft sets itself apart by games. converting its MMORPGs from subscription-based to free-to-play to attract more players at a faster rate. Market-proven IP Assets Accumulated over the Past 18 Instead, NCSoft adopts two main recurring revenue Years streams, royalties from licensing of game titles to other developers and in-game purchases. Although free-to- NCSoft’s market-proven IP assets serve as the play games may seem to diminish player retention rates groundwork for future pipeline at both platforms. While as players do not have any obligation to stay with these gaming IPs are mostly intangible, they are desirable due free-to-play games, NCSoft makes up for this with its to the positive free cash flows that they generate. well-designed, expansive MMORPGs to create a large NCSoft's IP continues to generate cash flows for the fan base as explained earlier on. Thus, the free-to-play company decades after the franchise's debut. This is MMORPGs allow NCSoft to rapidly increase its total evidenced by its Lineage franchise, whose first iteration player base with every new content or game release and was in the late 1990s, and which still remain popular retain them at the same time. Coupled with significant today. total-playtime from their MMORPGs and the lengthy amount of time already invested in the games by Powerhouse of the Gaming Industry in Korea existing players, this also prevents competitors from NCSoft is known to release highly popular and pulling away its players. revolutionary PC MMORPGs in Korea and have expanded its games across the Asia Pacific as well as the Furthermore, to complement its free-to-play game US. It also recently started to venture into Mobile business strategy, NCSoft also ensures that the games MMORPGs given the brighter future prospects of the are inclusive and fair to all players whereby their mobile gaming market and has successfully captured a philosophy is to ensure that no player is able to “pay-to- large market share of the mobile MMORPG industry. win”. This philosophy is advocated through “NCoins” and “Premium Memberships”. Players are limited to NCSoft mainly specialises in the development of purchase only in-game cosmetics and convenience MMORPG genre type of games with 8 MMORPGs items, which does not put any player in an unfair developed up to date. Of which, the Lineage, Blade & competitive advantage over others. Furthermore, the Soul, Aion and Guild Wars franchises have remained premium membership is tiered in nature which scales dominant in the market for a lengthy period of time with the amount of money spent. The more the money despite the conventional belief that online games spent, the more the player is awarded with cosmetics, become obsolete within a few years. The success of convenience items and privileges. This ensures that NCSoft’s MMORPGs is due to it great synergy between NCSoft’s in-game purchase revenue model aligns well its business strategy, strong market penetration, and with its business strategy of implementing free-to-play unique game design which set itself apart from its games. competitors. As such, with synergised business strategies Existing Business Strategy complementing each other, NCSoft is able to generate a steady revenue and net income stream from its existing NCSoft’s business strategy focuses on quality over games and promote sustainable growth throughout the quantity MMORPGs to create a large fan base to drive years. Furthermore, the powerful business strategy of its revenue. It does so by placing ample focus on only a few game franchises and expanding on them to preserve emphasising quality over quantity also established a the core game concept and players’ interest in their strong brand recognition in its game franchises over the games. NCSoft’s quality game design business strategy years which facilitated its market penetration and tackles the obsolescence issue mentioned above by expansion strategy explained below. constantly updating their MMORPGs with major expansions of their existing games to implement Strong and Rapid Market Penetration significant new content. This strategy is one of the best practices adopted by large video game developers such Apart from being an excellent game developer, NCSoft as Activision Blizzard, on their most popular MMORPG in also sets itself apart from its competitors with their the world, World of Warcraft (WOW). This ensures that game publishing expertise. NCSoft’s market expansion existing players could continue to explore the games and and penetration strategy across the Asia Pacific, Europe,
29 and the US involve in-house development of games and matches between players which attracted many licensing of its legacy game titles to other developers to competitive players and audiences. expand its game series. The licensing of its legacy game Furthermore, NCSoft was able to sustain in the titles which include Lineage, Blade & Soul, Aion and competitive scene with its MMORPG while Activision Guild Wars is only possible owing to its strong brand Blizzard has failed to do so with WOW due to WOW’s recognition unique to NCSoft from its years of market lack of excitement in its PVP aspect. Their venture dominance in the MMORPG market. turned out to be a big hit with over KRW 371m (USD 0.34m) raised for its 2017 Regional Championship prize NCSoft also exercises precaution when it selects pool. developers to develop games that utilize their game titles to avoid tarnishing their game franchise Peers reputation. Licensed developers including Tencent, Snail games, Gameforge, Netmarble and Gamania are established game developers within their own geographical regions in China, Taiwan and Europe.
By having a licensing strategy on top of its in-house game developments, NCSoft is better able to accelerate the spread of its game titles across the Asia Pacific, Headquartered in Tokyo, Japan, NEXON Co Ltd (TYO: Europe and America to raise brand awareness compared 3659) (Nexon) is a close competitor to NCSoft, being a to its competitors. Moreover, the licensing of game titles developer of several free-to-play and online games as to established developers aligns well with their quality well. The company developed the first graphics- based over quantity business strategy which further builds on massively multiplayer online game (MMO) and their brand recognition. As a result, this licensing pioneered the concept of micro-transactions and the strategy not only facilitates rapid expansion of game free-to-play business model. However, despite having a titles globally but also creates an opportunity for NCSoft first-mover advantage, its NPM and ROE fare worse to smoothly set up its in-house development entity in compared to that of NCSoft. It is currently also facing these regions since NCSoft has secured a strong foothold problems with growing its bottom line. in them in terms of its brand recognition established Netmarble Games Corp (KRX: 251270) (Netmarble) is a through the licensees. Korean game developer and distributor for online
mobile and computer games. Being a relatively new company, its IP comprises mainly mobile games like Magumagu, Modoo Marble, and L2R. Netmarble has similar ROE figures to NCSoft. However, it is unable to achieve the same NPM figures as NCSoft, suggesting that NCSoft is able to maintain favourable margins with its IP franchise. Netmarble also follows a slightly different business strategy. In 2017 it has unveiled its plans to embark on a KRW 4.794T (USD 4.4B) acquisition plan in the next few years, funded mainly from its 2017 IPO proceeds.
Unique Game Design NCSoft has been in a partnership with Netmarble since Lastly, NCSoft has the capability to develop MMORPGs 2015. In 2015, NCSoft and Netmarble acquired shares of with unique features to set itself apart from its one another, to prevent facing a possible hostile competitors and enable NCSoft to expand further into takeover by competitor Nexon. Netmarble is mainly a the game industry. NCSoft is one of the pioneers mobile game publishing company. Although the developing MMORPG presence in the Esports partnership is not without its challenges, with NCSoft competitive scene which may be surprising given that suing its partner and ally Netmarble for infringing its MMORPGs lack the element of competitiveness. Lineage 2 IP in 2016, the relationship with NCSoft is overall beneficial for NCSoft, with NCSoft gaining NCSoft broke into Esports through Blade & Soul, which exposure in the mobile games segment. possesses a unique combat system that is not found in most MMORPGs. This unique combat system created NCSoft also benefits from accelerating IP value coming opportunities for exciting Player-vs-Player (PVP) from its partner Netmarble’s global expansion. L2R enjoyed decent positioning in Western markets, and 30
Blade & Soul Revolution received very positive feedback With the surge in the advancement of technology of from gamers on its gameplay at G-Star gameshow. smart devices as well as an increase in smart devices These bode well for NCsoft’s accelerating IP royalty penetration rate, NCSoft has tapped onto this monetization in 2018. Hence, NCSoft’s expected surge opportunity and placed emphasis on their online mobile in royalty revenue in 2018 is also driven by royalty games. The release of their new online mobile game revenue from Netmarble next year. Lineage M in June lured a 488% increase in the revenue of their online mobile games in 3Q 2017 from 2Q 2017. Separately, Netmarble launched its new mobile game offering, Tera M, 28 November 2017. This event is As such, NCSoft’s focus on online mobile games will be expected to have limited impact on NCSoft’s Lineage M able to generate more revenue apart from its online PC games providing the company with a huge untapped ’s revenue figures in December, due to a different target market especially when RPG genre games are starting to segment. dominate the mobile gaming platform.
NCSoft is smaller compared to its larger international peers. Furthermore, Activision Blizzard, Nintendo and EA have diversified game offerings, unlike NCSoft which specializes in MMORPGs. With a special focus on RPGs, the company is able to generally enjoy higher NPMs and ROEs than its peers which have ventured into other businesses. One example is Nintendo which is continuing to struggle with its Wii U sales. EA has been enjoying decent margins and profits, but its high ROE is due to its high debt levels, with a debt to equity ratio of 90.1%, compared to NCSoft’s 24.5%.
Overall, NCSoft has managed to build a strong follower Figure 7: Top 10 Grossing Mobile Games on App Store base with its IP by focusing on the RPG genre specifically. & Google Play. Source: NCSoft IR May Presentation Its strong market share in Korea has allowed it to fortify its position as one of the top 3 developers in Korea, The online mobile games market displayed an increase competing alongside its closest peers Nexon and in RPG with 8 and 6 out of 10 games being RPG in the Netmarble. However, even among these 3 companies, App Store and Google Play respectively. NCSoft’s focus there are great differences in their IPs and game on MMORPGs not only gives them the comparative offerings, which allow NCSoft to maintain a strong advantage on the quality of the MMORPGs they following in its own IP and niche. produce, but also allows them to ride on the trend on Global Development Opportunities on Online Mobile the mobile market demand for MMORPGs. Games Industry Demand for Online Mobile Games 2.2.2 Overseas Presence
The market for online gaming has seen an increase in the NCSoft has established a strong presence in the global growth in revenue of mobile online games since 2015. mobile games market such as in Taiwan, Japan, US, The market is expected to experience a Compound Europe and China. In the 3Q 2017, 13% of the online Annual Growth Rate (CAGR) of 12% from 2015 to 2019. mobile games revenue came from their overseas presence.
Figure 6: CAGR of Mobile Games Market Revenue. Figure 8: 2016 Mobile Games Market Revenue Per Source: NCSoft IR May Presentation Country. Source: NCSoft IR May Presentation
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NCSoft’s revenue is largely derived from its domestic companies in the same industry. This implies that market. Based on 2016 results, Korea’s mobile games NCSoft has capabilities for mergers and acquisitions in market revenue only makes up 5% of the global mobile the future to increase its market share or expand its games market revenue. This shows that NCSoft has a business. great opportunity to venture and scale in overseas market. Consequently, NCSoft has extensive plans in NCSoft holds a substantial amount of investments in expanding its market reach into the global market. other companies in the same industry. This is indicative Lineage M was released in Taiwan, Hong Kong and of its strategy to invest in such companies that have Macau on 11 December 2017 and the company has growth potential. With NCSoft’s decades-long expertise future plans for release in China and Japan which makes in developing and publishing games, they have a keen up 27% and 18% respectively of the global mobile games eye for promising investments. (Refer to Section 3.4 for revenue. As such, NCSoft can potentially enjoy a large a full list of NCSoft’s subsidiaries and associated and steady revenue stream from both its domestic and companies.) overseas revenues given their increasing presence in the Based on the nature of their acquisitions in global market. It can enjoy large growth rates as it shareholdings in these associates, the transactions are carries out its expansion plans. made in the ordinary course of business. These holdings are unlikely to indicate presence of tunnelling of assets. 2.2.3 Game Development Venture
To cater to the different overseas market segments, NCSoft has also ventured into Virtual Reality (VR). They have demonstrated a VR based Massively Online Battle Arena (MOBA) game, Blade & Soul: Table Arena in the 2017 Game Development Conference (GDC). This venture captured the attention of the US and Europe market in which there is strong interest in VR. The VR game allows for a 360-degree gaming experience with the use of their Oculus Rift and Samsung Gear VR. This Figure 9: Notable Acquisitions by NCSoft in 2014 to venture into VR is the company's first step in reaching 2017. Source: NCSoft 3Q17 FactSheet out to the VR market and community. 2.4 Risks, Toxic Factors, Top 3 Dislikes Gaming preferences vary in different regions. For 2.4.1 Piracy, Imitations and Risk of Leaks of NCSoft’s IP instance, Guild Wars 2 is famous in US and Europe but Lineage is famous in Korea, China and Taiwan. As such, This is a risk factor specific to the gaming industry. In NCSoft’s adaptation to cater to different markets would some jurisdictions, there could be an increased heighten their revenue stream with a larger grasp of the occurrence of piracy. If the jurisdiction has weak IP market. NCSoft’s well-received game demo of Blade & enforcement, imitation games might surface as well Soul: Table Arena demonstrates strong evidence that it which replicate the game mechanics of NCSoft. The will be able to sustain its revenue growth, via replication of their games may potentially erode their adaptations of its games through their venture projects. sales. These are potential factors that NCSoft should
consider when expanding into new markets 2.3 Financial Stability backed by Strong Cash position and Constant Revenue Generation Furthermore, in 2007, the source code for Lineage 3, a game in the pipeline, was leaked by ex-employees. NCSoft has a history of being in a favourable cash NCSoft may have won the legal suit, but this case position over the years. This is attributable to highlighted the importance of NCSoft’s need to ensure continuously profitable business as seen from the proper internal controls are in place. Potential leaks constant growth in annual revenue over the past 18 could undermine the marketing efforts dedicated to years, amounting to 25% CAGR. Capital expenditure also building hype for the game, as well as dissipate the remains low in the past few years, at below KRW 20B, competitive advantage of its games. hovering at around 5% of 2016’s net income. Maintaining a strong operating cash flow has allowed 2.4.2 Increasing Labor Costs due to Increasing NCSoft to procure R&D capabilities and repay its long- Headcount of Developers to Support a Larger Number term debt. of Mobile Projects Having excess cash on hand has also granted the NCSoft is planning to expand its offerings further, company the opportunity to acquire shares in especially in the mobile segment. This could potentially 32
require increased spending on development costs, such closely to their core values is paramount to the success as increasing the headcount of developers specializing in of their company given the fierce competition from mobile games. Development costs and expense has other gaming companies. At the core of their values, been taking up a larger percentage of sales in recent sticking to their principles (integrity) ensures that the quarters. The largest concern is the uncertainty company continues to strive forward with minimal associated with the development of its newer games. hiccups and disruption. Having the passion for what they The company runs the risk of incurring unexpected do emphasises on the quality of work produced. development costs and going over budget if it Constantly trying to improve is tantamount to their encounters roadblocks and delays in game progress especially in the online gaming industry to development. ensure that the company constantly innovate and produce quality and efficient products. 2.4.3 Reliance on Constant New Content
In the gaming industry, there is a need to constantly 3.2 Management Philosophy generate new content to keep their IP fresh and 3.2.1 Growth Seekers interesting for its existing fan base, as well as to attract The management philosophy of NCSoft is seen to be new players. While NCSoft has exhibited successful signs aggressive in seeking growth. In 2000, despite the fact of keeping their IP fresh, they need to ensure that their that 3D games were difficult to develop due to the lack offerings are in line with current trends and not fall of technology and expertise back then, the management behind the curve. Weaker-than-expected traction for existing games is a potential downside risk. It was team was still determined to push for the development highlighted that there was a faster-than-expected of such games and was one of the first movers in 3D revenue drop from Lineage M. Although NCSoft enjoys games development. In addition, the management team strong brand recognition, this is something they always also seek growth in areas of the gaming industry that are need to consider as the initial success of a game release untapped with room to grow. This includes NCSoft being is often largely determined by the hype generated to the one of the pioneers to venture into the MMORPG release as well as the initial reviews, and the subsequent Esports scene which turned out to be a big success for it. success is determined by the company's ability to Knowing that the mobile gaming industry is booming, maximize retention. the management team was also quick to venture into this area with the porting of its PC MMORPGs over to the NCSoft needs to ensure sufficient gaps between mobile gaming platforms which almost doubled its subsequent releases of games and sequels. revenue for the FY2017. Such hunger for growth and Furthermore, its IP offerings must target different ambition allows NCSoft to remain competitive and segments of the markets which will minimize relevant in the gaming industry and secure its position cannibalization of sales. as one of the market leaders.
3 Management Quality Analysis 3.2.2 Adaptive Outlook
3.1 Corporate Culture & Management Philosophy NCSoft has continued to portray its adaptive culture with its swift and precise advancement in the Vision: Strive to bring joy and provide fun for everyone, development of their new games. For instance, to match everywhere. up with the fall in revenue in their US market largely due Mission: To make everyone in this world happier. to the low popularity of Blade & Soul in US, they have Format: Small, strong, substantive. boldly ventured into VR to keep up with the trends and Spirit: To do the right thing. likings of the different culture. On top of that, the company was able to seize the opportunity in the recent increase in demand for online mobile games and swiftly innovate mobile games to adapt to the current market trend. In addition, when, the recent launch of Master X Master in June did not achieve the target revenue they had expected, they were quick to adapt to the current market and decided to shut down the game in January 2018. Having an adaptive outlook in their management serves to ensure that the company continues to innovate and stay up to date with the market trend as NCSoft’s corporate culture lies firmly in their core values well as keep the company in check for any potential of Integrity, Passion and Never-ending Change. Sticking downturn.
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3.2.3 Resilient in Nature
NCSoft’s journey has not always been smooth sailing with its survival largely attributed to their resilient nature. The explosive growth of the “PC bang” (internet cafes) as a result of the extensive popularity of StarCraft and Kingdom of Winds caused a plunge in NCSoft games due to their lack of user immersion. In view of the threat from opposing competitors, NCSoft’s introduction of castle siege and guide systems consequently maximizing competitive and community experience attracted a huge number of players. This allowed Lineage to become the dominant game that replaced the immensely popular StarCraft as the leading MMORPG in Korea. The imminent piracy issue and strict government policy in China also did not stop NCSoft from its continued effort of venture into the China Markets. This resilient management culture translates to a solid ground for future improvement in the long term.
3.3 Ownership Structure Figure 13: List of NCSoft’s Subsidiaries and Associated Outstanding shares issued: 21,939,022 Companies. Source: NCSoft 3Q17 FactSheet
4 Catalysts, Events & Tipping Points 4.1 Company Direction, Growth Plans and Recent Activities
NCSoft is shifting its focus towards its online mobile games such as the creation of new content and the porting of their PC games into online mobile games. Additionally, the company continues to develop future expansion for both their mobile and PC games in order to retain their player base by releasing new and exciting content.
NCSoft is primarily owned by retail investors including The company has also set its sight on capturing a larger its foreign counterparts. Notably, Netmarble Games global market presence through their development of Corp (refer to Section 2.1.7 Peers) owns a considerable games overseas as well as royalty revenue. Some of its portion of 8.90%. NCSoft also owns a sizable portion of future plans include their VR venture for Blade & Soul: Netmarble. Table Arena to capture the US and Europe market with future plans to adapt VR into their current line of games 3.4 Business Group Structure as well, e.g. the Lineage series.
NCSoft has also announced Lineage Project TL for the next Lineage flagship release to continue their growth in the online PC games. The long-anticipated release of their online mobile games Blade & Soul 2, Lineage 2 M, Aion Tempest and Aion Legions will be the next in line of their exciting line of development. The future plans for release of games are largely kept away from the public and hence, growth plans are not visibly known. However, the company’s direction of focus and release Figure 12: NCSoft’s Developer, Publisher and Licensee of trailers reveal plans to retain and capture more Partner Network. Source: NCSoft IR May Presentation players through expansions of their current line of games.
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The company has undergone recent activities including Gross Profit Margin has improved considerably over the the release of Lineage M in Korea in June as well as in years, suggesting that the company is able to grow its Taiwan, Hong Kong & Macau in December with plans to sales while minimizing its increase in cost of sales. continue to expand over in Japan and China. L2R was NCSoft managed to maintain its net profit margin progressively rolled out worldwide since December despite incurring higher development costs for its new 2016 in Southeast Asia, Europe, North America and games. Japan. NCSoft has managed to increase its revenue and profits 4.2 Why invest now? over the past few years while maintaining a decent ROE From NCSoft’s existing business point of view, NCSoft percentage in the low 10s. has a well-established brand recognition from its global reach and has been able to retain and expand much of their player base from around the world due to their innovative game development over the years. Furthermore, NCSoft’s strong cash position and investment in many firms show an increase in the global market influence in the industry and manifold opportunities which the company can gain from. With these two business strengths, NCSoft is fundamentally in a solid position to pursue its growth plans to compete with its competitors.
From NCSoft’s management perspective, as mentioned earlier, the management team possesses suitable characteristics required to ensure the relevancy and competitiveness of NCSoft in the rapidly-evolving gaming industry. Moreover, since its incorporation in Asset turnover and equity ratios have remained 1997, the management team has constantly proven its consistent over the years. capability in taking calculated risk with its ventures into new areas of the gaming industry and overcoming Overall, ROE and NPM are very decent compared to its threats posed by its competitors. peers (Refer to Sections 2.1.7 Peers).
From the industry perspective, the recent surge in the 5.1.1 Large Increase in Assets and Net Income in market for mobile games and the shift in popularity 9MFY2017 towards mobile MMORPGs show promising prospects for NCSoft since it specialises in developing MMORPGs. There was a 33% spike in NCSoft’s asset levels, from FY2016 to 9MFY2017 ended 30 September 2017. These With these 3 factors complementing each other, it is the are mainly due to fair value gains in its investments in right time to invest in NCSoft. The company has shares and investments in associated companies. Other tremendous growth potential. The venture into the VR contributing factors include profit contributions during community as well as their plans for future expansion, the 9 months ended 30 September 2017 and a large accompanied by the company's ability to develop and increase in current liabilities. The large increase in efficiently publish quality games will reel huge volumes current liabilities is mainly due to increase in accrued of revenue with each release. expenses, advance billings, and current tax liabilities.
5 Financial Analysis & Valuation The fair value gains in marketable securities are likely to be within industrial norms. Netmarble’s investments increased over 100% as at 30 September 2017 (including new acquisitions funded by its recent share sale). Netmarble has also announced in 2017 that it will be setting aside KRW 4.794T (USD 4.4B) for acquisitions, in light of the positive outlook in the gaming industry. All these indicate signs of a bright outlook in the industry which is reflected by the fair value gains of securities in the industry.
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The large increase in the net income in the third quarter ended 30 September 2017 is due to the initial sales of Lineage M. Sales of the game are expected to normalize and taper off after the initial hype. However net income is expected to continue to increase due to the subsequent release of 3 games in 2018.
5.1.2 Intercompany Loans
NCSoft currently has provided intercompany loans of KRW 10B to NC Dinos, its wholly owned baseball team, for franchise purposes, and KRW 200M to Araso Pandan, an associate company which develops mobile games. The size of the loans does not have a significant effect Revenues are expected to grow faster than the usual on the company’s earnings, as since the company historical growth rates. In line with the market receiving the loans are closely related to parent’s expectations of the three upcoming new games in 2018, business, the intercompany are unlikely to be fraudulent growth rate is estimated to be 30% for that year. in nature. In subsequent years, the growth rate is expected to
moderate to historical rates at 25%. This rate could be Changes in Korean tax laws which impose more conservative as it does not take into account any stringent requirements regarding intercompany loans, unannounced games in the pipeline. effective 7 February 2017, will minimize the chances for NCSoft’s intercompany loans to be questionable. NCSoft is expected to retain its dedicated customer base, and recent launches from competitors, such as 5.2 Historical Growth Rates Tera M from Netmarble, is not expected to affect NCSoft’s revenues materially, due to different target Historically, the company has enjoyed 25% CAGR for its segments. Furthermore, Lineage M in Taiwan attracted revenues. more than 2.5 million pre-registrations before its official launch on 11 December 2017, indicating high levels of interest and hype in the game.
(KOSE:A036570) NCsoft Corporation FY2013 FY2014 FY2015 FY2016 FY2018LTM Share Price KRW 218,000.00 181,500.00 253,500.00 305,000.00 482,000.00 No of Shares (mil) 15.9 20.0 21.2 21.2 21.3 MCAP (mil) USD 3,267 3,269 4,737 5,795 9,411 Net Debt (Cash) KRW (627,533) (843,367) (888,437) (820,450) (1,296,163) Enterprise Value (mil) USD 3,178 2,589 2,808 3,757 8,214 Revenue (mil) KRW 756,655.7 838,718.2 838,297.6 983,556.9 1,510,015.5 EBITDA (mil) KRW 239,365.0 312,596.8 272,446.6 361,307.6 528,217.1 EBIT (mil) KRW 203,957.1 275,863.9 237,471.4 328,902.3 497,478.5 NPAT (mil) KRW 158,755.9 229,958.4 165,393.4 272,268.8 390,051.7 NPAT (Ex.Xtra + Dis.Ops) (mil) KRW 162,933.5 234,657.5 184,084.2 274,183.3 367,695.1 CFO (mil) KRW 236,187.7 263,580.9 241,337.2 112,022.5 416,928.9 CAPEX (mil) KRW (102,398.5) (19,493.5) (17,672.7) (16,632.2) (28,299.3) In 2016, year-on-year: EPS KRW 10,231.9 11,757.3 8,666.7 12,908.5 17,302.9 Revenue (mil) USD 716.7 768.4 712.4 817.0 1,320.3 EBITDA (mil) USD 226.7 286.4 231.5 300.1 461.8 1. Revenue increased 17% EBIT (mil) USD 193.2 252.7 201.8 273.2 435.0 NPAT (mil) USD 150.4 210.7 140.6 226.2 341.0 CFO (mil) USD 223.7 241.5 205.1 93.1 364.5 2. Operating Profit increased 38% CAPEX (mil) USD (97.0) (17.9) (15.0) (13.8) (24.7) GPM (%) 70.8% 73.7% 75.8% 80.9% 86.8% 3. Pre-tax Income increased 44% EBIT (%) 27.0% 32.9% 28.3% 33.4% 32.9% Net Debt (Cash) / Equity (%) -55.0% -62.0% -50.2% -43.5% -53.0% 4. Net Income increased 66% ROA (%) 13.8% 16.2% 10.7% 13.9% 15.7% ROE (%) 17.9% 20.3% 13.4% 17.4% 20.3% CFO/TA (%) 16.0% 15.5% 10.9% 4.7% 13.2% EV/ Sales (x) 3.8 3.3 5.4 5.8 5.9 With ample catalysts in 2018 and beyond, NCSoft is EV/ EBIT (x) 14.0 10.1 19.0 17.2 18.0 EV/ EBITDA (x) 12.0 8.9 16.6 15.7 17.0 expected to continue to enjoy supernormal growth EV/CFO (x) 12.1 10.6 18.7 50.6 21.5 P/Sales (x) 4.6 4.3 6.4 6.6 6.8 rates. P/EBIT (x) 17.0 13.1 22.7 19.7 20.6 P/B (x) 3.4 2.9 3.2 3.5 4.3 VQ1: EV/EBIT/ROE (x) 0.8 0.5 1.4 1.0 0.9 5.3 Projected Growth VQ2: EV/EBIT/ROA (x) 1.0 0.6 1.8 1.2 1.1
Revenue:Projections will take into account the launch of Lineage M in Taiwan, as well as new games in 2018. The launch of Lineage M in Taiwan is expected to bring in initial revenues of 3 to 4 billion KRW, assuming its launch in Taiwan would track revenue momentum seen in Korea. The list of projected game release schedules does not take into account unannounced games.
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5. Nihon Kohden (TSE: 6849)
Company Research & Report
Quick Stats Date 15/12/17 EBIT/R&D (x) 1.98 EBIT/Employee No. Filing Currency JPY (USD /px) 20K Share Price JPY2,543 EV/EBIT (x) 14.7 No. of Shares (Mil) 85.7 EV/EBITDA (x) 11.5 Market Cap (USD Mil) 1,932.5 EV/CFO (x) 15.4 Daily Value Traded (USD Mil) 5.2 P/Sales (x) 1.3 GPM (%) 47.4% P/E (x) 17.0 EBIT (%) 7.6% P/B (x) 2.2 Net Debt (Cash) / VQ1: EV/EBIT/ROE Equity (%) -28.5% (x) 1.2 VQ2: EV/EBIT/ROA ROA (%) 8.9% (x) 1.7 ROE (%) 12.2%
Team Members
Pinzhang is a first-year Industrial & Systems Engineering student at NUS. He is also doing his final papers for an Oxford Brookes degree in Applied Accounting. He began investing at 13 and never looked back.
Ting Wei is a first-year double degree student at NUS majoring in Business Administration (Accountancy) and Industrial & Systems Engineering. He has worked at EY and is a Vice-Team-Lead of Predictive Analytics team in the Business Analytics Society, NUS.
Yi Ming is a first-year student at Yale-NUS College reading the liberal arts & sciences. He is also a Student Venture Capitalist with Protege Ventures.
Jiong Yang is a first-year Chemical Engineering student at NUS. Recipient of the Singapore Industrial Scholarship (Global Foundries).
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Business background and overview Revenue breakdown by geography
Tokyo-based Nihon Kohden was founded in 1951 by Dr. Yoshino Ogino whose goal was to "combine medicine and engineering". Starting off with the production and marketing of hearing aids, the notable achievements of Nihon Kohden over the years include developing the world's first completely AC-powered direct-wiring electroencephalogram (EEG), and also inventing the world's first pulse oximeter, contributing to anaesthesia safety via the monitoring of patient blood oxygen levels. Today, Nihon Kohden Japan's leading developer, manufacturer and distributor of front-line medical electronic monitoring equipment. Their ecosystem of products encompasses the entire cycle of a hospital visit, Domestic sales make up 73% of net sales compared to from pre-hospital, to the emergency room, the 27% of overseas sales. Of overseas sales, the Americas makes up 46%, Europe 17%, Asia 30%, and other areas operation room, the intensive care unit, the ward, < 1%.1 doctor's office, research laboratories and also home healthcare. These include brain, muscle and heart Overview of 2017 Business Performance and its electrical activity sensors (EEG, EMG, and ECG), patient consistency monitors and clinical information systems, and other treatment equipment like defibrillators and AEDs. Nihon Kohden’s sales performance has seen a consistent Outside of Japan, Nihon Kohden has an established 7 years growth and it has remained first in ranking in the global presence with subsidiaries in the U.S., Europe and sales of monitoring equipment in its domestic market as Asia. The company's products are now used in more well as successful increase in sales in overseas market. than 120 countries, is the largest supplier of EEG The Japanese government has also worked on products worldwide, and is a recognised technological healthcare system reform and each prefecture drew up leader of wireless patient monitoring. a regional health vision for the enhancement of medical treatment systems by 2025. Given Nihon Kohden’s strong dominance in the Japanese medical electronics system market, it is likely to ride in with the increased sales and demand as the Japan switches over to better healthcare systems.
How did you originate this Idea and why did you choose this company? Why is it fit to be a Hidden Champion?
We recognised the impending surge in demand for healthcare products, and noticed that healthcare equipment companies have generally stayed low- profile. This is especially so for Nihon Kohden, given its Revenue breakdown by product restructuring activities in the last few years, leading to lower profit per share ratio. Further research proved
to us that Nihon Kohden checked all the key boxes for The company’s revenue stream of 166,285 million yen a Hidden Champion. comes from 4 main segments: physiological measuring equipment (EEGs, electrocardiographs, diagnostic One Sentence Investment Thesis information systems, etc.) - 23%, patient monitors (central, bedside, wireless monitors, etc.) - 34%, The company’s existing advantage (via superior treatment equipment (defibrillators, AEDs, anaesthesia technology & market dominance) and effective business strategic plan puts it in pole position to ride machines etc.) - 18%, and other medical equipment on the uprising global healthcare demand for a rise in (analyzers, basic laboratory equipment and profit in the next 3 years. consumables) - 25%.
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What makes it a wide-moat business? and Neurofax™ EEG product lines, which cater to the high-end market, low-end market, and even mobile Nihon Kohden's sustainable competitive advantage transport. It’s broad range of products allow them to that secures market share and profit is evidenced develop their own proprietary hardware connectors through several characteristics: that simplify the synchronisation of different Dominant Market Leader in Domestic Patient Monitoring & Global ECG-EMGs equipment, simplifying the procurement process for hospital, especially for emerging markets equipping As at FY2016, Nihon Kohden is the largest provider of their hospital with more sophisticated monitoring patient monitoring equipment in Japan (40% of total systems. As compared to their competitors such as GE company sales). As seen in Table 1 below, the company Healthcare who develop their product lines through is the domestic market leader in several key segments acquisition of specific manufacturers, the greater including multi-sign, wireless mobile, heart, brain and 7 synergy and compatibility of Nihon Kohden’s product muscular activity monitors and diagnostics . Despite serves as a strong competitive advantage, and draws a recent headwinds in the domestic market, Nihon greater volume of sales due to the ease of procurement Kohden has still managed to maintain its strong position, evidenced from a 2.3% domestic market sales as a package. increase. This success in adapting to changing The commitment to innovation is evidenced in the domestic market conditions signals its healthy position increase of research and development cost, which to maintain market share in the coming years. currently stands at 6467million yen (3.9% of sales)13. Nihon Kohden has focused on developing products in line with the current market trends in the medical device industry. One such trend is the adoption of monitoring device configurations that emphasize on patient comfort and mobility across different care setting. This increased demand of non-invasive, portable medical devices is reflected in the expected annual growth rate of 7.8% for the market15. Examples of innovations include proprietary technologies focused on the development of non- Additionally, Nihon Kohden is the global market leader 9 invasive, patient-oriented monitoring technology such in EEGs and EMGs , which market size is expected to as cap-ONE, the world's smallest and lightest nearly double from USD 1.3 billion in 2015 to USD 2.4 6 mainstream CO sensor , and esCCO, a continuous, billion by 2024. Nihon Kohden's subsidiary in North 2 noninvasive cardiac monitoring technology16. These America also won a major USD 35 million deal with US technologies have translated into more advanced Department of Defense in providing patient monitoring products focused on mobility, a flagship of which is the systems on October 2016, with possible 8 more 1-year extension to the contract8. Life Scope G3, a mobile wearable vital sign telemeter to support patient monitoring on-the-move. More Enduring Product Differentiation through Quality & recently, 2 major mobile product launches in the past 4 Innovation in tandem with healthcare trends months are the mobile transmitter ZS-640P to transmit 4 types of vital signs data in August 2017, and the new Beyond guaranteeing top quality through life span EEG Head Set AE-120A, a new simple-to-use and reliability, precision of data and accuracy of wireless device for quick and easy EEG monitoring in 17 measurements6, Nihon Kohden leads the market with its October commitment on innovation. Innovation has allowed Nihon Kohden to develop very strong core Strong Value-adding Services via Creation of Advanced competencies and proprietary technologies that are not IT Solutions easily replicable. For example, Nihon Kohden has strong proprietary sensor technology and led the world in inventing the principle of the pulse oximetry sensor in 1974. Furthermore, Nihon Kohden's accumulated industry know-how with the entire 'care cycle' ecosystem of products makes it hard for competitors to Beyond medical equipment, Nihon Kohden continued to match its broad-based expertise. Only Nihon Kohden has strengthen its strong relationship with the hospitals by such an extensive product line includes the CNS-9701™ providing not only hardware but also the software. and I™ for central monitoring, the I™ product line of bedside monitors, I™, AirEEG WEE-1000™, 39
Prime Partner is a cloud-based software that stores electrodes, equipment servicing and maintenance for medical records on a secure cloud server. Nihon Kohden from 35% in FY 2009 to 43% in FY2016. Complemented with Lavita, a network system that In all product category, any decrease in sale of hardware transmit data from synced-devices to the cloud is countered by an increase in sales of consumables and automatically, it allows hospitals to closely monitor information system associated with it. For instance, patients remotely even when they are alone at home. It the patient monitor market sustained modest growth of allows hospitals to provide better homecare services domestic sales of patient monitor segment despite a which has particular relevance in the context of Japan’s decrease in sales of hardware equipment, for there was aging population. Nihon Kohden has also helped an increase in sales of clinical information systems and hospitals improvement its management system with the consumables such as sensors such as the cap-ONE CO2 introduction of Prime Vita Plus and Prime Gaia. Prime sensors and pulse oximetry finger probes. Similarly, for Vita Plus is an award-winning software system that the treatment equipment category, overall sales centrally manages waveform and image information increased in the AED product category through sales of generated from physiological or endoscopic consumables such as pads and batteries that are examinations. This enables the integration of multiple required for regular maintenance, despite falling unit types of ECGs, ultrasound, and various endoscopes sales of AED. This business model is made possible results for a more efficient and standardised work because of the nature of the medical equipment that process. Prime Gaia is a software system designed for Nihon Kohden specialise in; finger probes for patient patients under critical care. Through integration of monitors are for one-time usage only, disposable patient’s perioperative information and critical data electrodes to for ECG, and AEDs require regular from other devices, it greatly enhances ease of replacement for the gel pads that will expire. In information sharing allowing hospitals to provide quality comparison, medical diagnostic equipment such as the care especially for patients with critical conditions. MRI or CT scanners lack similar consumable after sale. Furthermore, these systems are compatible with Thus, despite increasing budget constraints on hospitals other external devices like its Smart Cables and that results in cut back on capital spending, increasing Gateways. This strong compatibility across its own wide equipment upkeep spending such as range of products strengthens Nihon Kohden’s market equipment servicing and consumables required for the dominance via a closed-loop ecosystem. operation of these medical devices will allow Nihon These have allowed Nihon Kohden to gain revenue, Kohden to achieve sustainable growth in sales and a and make its product become more “sticky” to its steady income stream. customers, creating a sustainable demand of their products regardless of economic prospects. With the Lacklustre Domestic Competition entry of low-cost foreign products, Nihon Kohden product system consolidation and service focused Fukuda Denshi is the second-leading competitor in the approach serve a strong defence against mere unit Japanese patient monitoring market. Yet, Nihon Kohden price competition in its home turf. Indeed, Nihon maintains a wide-moat advantage through superior Kohden's strength in Japan has been attributed to their technology translating into better product functionality offerings. One example will be wireless patient vital-sign strong local sales force & healthy relationships with 7 transmitters, where Nihon Kohden's ZS-640P hospitals . transmitter is capable of measuring blood pressure, Diversified & steady income source from consumables whilst Fukuda Denshi's offering the LX-7230 does not. & maintenance services This was accomplished via Nihon Kohden's proprietary iNIBP Linear Inflation Technology. Also, Nihon Kohden's product has a battery lifespan of 4 days while Fukuda Denshi's operates only for 2.5 days. Thus, Nihon Kohden differentiates itself through its integrated product ecosystem, technological advantage, exclusive proprietary hardware, and also its value-adding services and sales platforms. Nihon Kohden not only has Prime Partner that consolidates data from different types of devices of its brand, but also user-friendly viewing software that allows for remote viewing (NetKonnect) and viewing on mobile devices (ViTrac). In comparision, There has been an increase in percentage of sales from Fukuda Denshi develop separate softwares for viewing consumables and services such as finger probes and information for different medical devices. There is a 40
relatively low threat of new entrants due to a high with elite establishments like Harvard, MIT and other barrier of entry to the domestic market for foreign research institutions based in Boston. The Advanced competitors, a key factor being the lengthy Japanese Technology Center in Saitama, Japan was launched too. regulatory process14, thus Nihon Kohden's pole position It also has 4 international manufacturing bases outside is relatively secure domestically. of Japan in Shanghai, Malaysia, Italy and India to ensure stable, timely supply of product at lower cost to the Healthy Overseas Growth from Widening Global targeted regions10 . Research, Production & Distribution Network Nihon Kohden has a wide distribution network around The recently-concluded Strong Growth 2017 mid-term the globe with sales offices strategically located in business plan expanded global operations to attain major cities of America, Europe, China, India and Africa, sustainable growth. Global R&D facilities were enhanced with 5 new sales offices established in the past 4 years. via establishing the Nihon Kohden Innovation Centre in For instance, in 2016 it established a new call centre in Boston, USA, which allows for collaboration with elite New Pennsylvania to strengthen its technical support establishments like Harvard, MIT and other research call centre in the US13. Beside strong presence in institutions based in Boston. The Advanced Technology developed countries, Nihon Kohden has strengthened Center in Saitama, Japan was launched too. It also has 4 its service operations in emerging markets through the international manufacturing bases outside of Japan in reorganization of sales subsidiaries in Central & South Shanghai, Malaysia, Italy and India to ensure stable, America in 2016, and a new sales branch in Kenya in 11 timely supply of product at lower cost to the targeted November 2017 to enter the East Africa Market . regions10 . Nihon Kohden has a wide distribution network around This integrated approach to global distribution and the globe with sales offices strategically located in major production has led overseas sales to grow from 16.8% cities of America, Europe, China, India and Africa, with 5 of total sales in 2013 to 25% in 2017, with strong new sales offices established in the past 4 years. For growth in major markets, China, Europe (15% instance, in 2016 it established a new call centre in New increase), and America (16% increase) on a local 12 Pennsylvania to strengthen its technical support call currency basis . Sales from Other (countries outside centre in the US13. Beside strong presence in developed of Americas, Europe, and Asia) increased by an countries, Nihon Kohden has strengthened its service impressive 38% in FY2017 Q1 with large orders from operations in emerging markets through the Egypt. These diversify Nihon Kohden's revenue base reorganization of sales subsidiaries in Central & South and positions it to ride the global healthcare America in 2016, and a new sales branch in Kenya in modernisation wave. November 2017 to enter the East Africa Market11. This integrated approach to global distribution and Strategic Acquisitions of Subsidiaries production has led overseas sales to grow from 17.9% of total sales in 2010 to 25% in 2016, representing a 2.1x Over the past decade, Nihon Kohden has been growth in sales from 2010 – 2016, with strong growth in involved in strategic acquisitions of companies in-line major markets like China, Europe (15% increase), and with expanding its wide-moat advantage in the America (16% increase) on a local currency basis12. healthcare equipment industry. To enhance vertical integration of manufacturing, Sales from Other (countries outside of Americas, 35 Europe, and Asia) increased by an impressive 38% in Nihon Kohden acquired Labnova Italy in 2006 , and full ownership of former joint-venture firm SPAN FY2017 Q1 with large orders from Egypt. These diversify 36 Nihon Kohden's revenue base and positions it to ride the Nihon Kohden Diagnostics India in 2015 , both of global healthcare modernisation wave, with the target which manufactured hematology analyser reagents to increase the share of overseas sales to 35% by 2019, for the company's hematology analysers. reducing its reliance on a stagnating domestic market. This strengthens its supply system by giving freedom of management to enforce direct control over quality Widening Global Research, Production & Distribution and quantity. To advance technological expertise, Nihon Kohden acquired Neurotronics in 2008 to Network 37 strengthen its position in the neurology business . The recently-concluded Strong Growth 2017 mid-term Finally, to capture market share overseas, business plan expanded global operations to attain Nihon Kohden acquired Defibtech LLC in 2012 to enter the U.S. resuscitation market sustainable growth. Global R&D facilities were 38 enhanced via establishing the Nihon Kohden Innovation via Defibtech's AEDs .
Centre in Boston, USA, which allows for collaboration 41
Strong Growth Strategy – Addressing Specific Demands in corporate role. Mr Tadashi Hasegawa has helmed the of Developed & Developing Markets role of Corporate director and senior operating officer in Moving beyond Strong Growth 2017, starting from April Saitama Bank before moving to Nihon Kohden as an 2017, the Transform 2020 plan swung into action, Operating officer and finally Corporate director and transitioning from the previous investment phase to the senior operating officer in 2017. Having managed 13 phase of profit maximising, targeting a ROE of 12.0% . Saitama Bank overseas operation, Mr Tadashi Hasegawa This will be done through two basic policies: will be a valuable asset for Nihon Kohden in their oversea expansion.
1. Creation of high customer value via developing new products by leveraging core Human- Management Philosophy Machine Interface technologies in tandem, and establishing a global sales and service network The management philosophy is to contribute to the to create greater value for customers and global battle for health whilst ensuring a good life for its develop new businesses. employees. It's internal goal is three-fold, to be at the 2. Strengthening the global supply chain and technological forefront, to achieve the highest level of improving production & logistical efficiency to quality, and to attain top market share in the relevant achieve further growth in core businesses and global markets. Externally, Nihon Kohden also adopts a by region. uniquely Japanese customer service attitude termed “Omotenashi” - Omote means public image one wish to In addition, Nihon Kohden aims to increase market present, and “Nashi” means “nothing”, combining them share beyond high-end markets, in emerging economies means that every service interaction is honest, with no through differentiated regional strategies, by offering hiding or pretence. Such whole-hearted service is both high-end integrated products made in Japan and explained well by the President of Nihon Kohden, Mr low-end volume-based medical infrastructure products Hirokazu Ogino, as we quote: “We are meticulous in how made in China and Malaysia. For example, for countries we work with clients, which is innate to the Japanese with less-developed medical infrastructure, Nihon culture. While important, sales volume is not our Kohden’s equipment was more focused on consumables primary consideration. What matters most to us is and on-site monitoring systems, providing more basic identifying what people need, whether we are working and practical equipment at a lower cost whilst with doctors or nurses or caregivers and patients. Once maintaining high-quality standards6. we have identified a need, we diligently work to satisfy it. In summary, Nihon Kohden's existing strengths and Based on this approach, Nihon Kohden has not only current business plans are very much in-sync with global expanded its market share in major market but built healthcare modernisation trends, thus we are confident long-lasting relationship with the stakeholders. This can that Nihon Kohden is on the path to meet this rising be seen from Nihon Kohden America achievement of demand. number 1 ranking in customer satisfaction by for patient 6 Long-time Veteran Management monitoring systems for 10 consecutive years. This is made possible both infrastructure investment in new Nihon Kohden's executive management possess service support centre in Pennsylvia to provide 24/7 tremendous internal experience in leading the service support, and the launch of Nihon Kohden company. Mr. Hirokazu Ogino has been the President of University, a global education and training platform to Nihon Kohden Corporation since June 25, 2015 and has provide training of healthcare professionals for their customers. been its Chief Executive Officer since June 28, 2017. Mr. Nihon Kohden also changed its corporate fundamentals Ogino was re-elected as a director in June 2017 due to into one that is more globalised, efficient profitable and his proven track records and his vast expertise. He was fast-paced as well as implement CSR activities aimed at a key figure in setting the agenda for Nihon Kohden’s sustainable growth and strengthen its human resource mid-term business plan “strong growth 2017” as well as development initiatives. Its focus includes establishing the long term “the change 2020”. a global supply chain to improve efficiency and reduce
cost as well as to regionalise head office operations by Most of the directors are promoted based on past merits appointing local management staff and developing local and experience within the company, with most serving employees, thereby speeding up decision making at least 20 years before reaching the directorship role. A process. notable mention is Tadashi Hasegawa, who joined the company in 2014 and is currently holding a directorship
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Corporate Governance could only be achieved by understanding our customer’s needs and adapting our products to the demand.". A diverse range of shareholders could provide valuable feedbacks and suggestions on Nihon Kohden's methodology at breaking the overseas market. Given that Unites States is the second biggest market after Japan, having State Street Corporation, an American based financial holding company as the largest shareholder will prove invaluable in their understanding of the overseas market. The biggest group of shareholders are the investment advisors, where most of which are experienced traders who have built a portfolio around the company and find it profitable before investing. We believe that the large proportion of investment advisors provide a good gauge on the health and earning capabilities of the company. Nihon Kohden places great emphasis on its corporate governance to ensure transparency and fairness. Its Credit rating of company internal control system provides great assurance for investors that the company is well poised and a trustable Nihon Kohden has consistently maintain a zero-debt company. In 2016, the addition of 2 independent financing policy. Most of its financing are done through director into the Audit and Supervisory activities reduce its past year profits instead of borrowing. The corruption and ensures that the director’s fees are company’s debt currently stands at 660 million yen based upon merits. A limit on the total fees allocated to while its cash is at 28,753 million yen. This ensures that the directors in one year is also capped by the company the company can access to large liquidity quickly and policy. Meetings of the upper management is held 3 easily due to its low debt servicing ratio. times a month to validate and ensure efficiency of decision making, as well as to create a flexible business Why do you think the market value of the company can operation which can respond to changes and crisis double in the next 3-5 years? quickly. Nihon Kohden also introduced an operating officer system that segregates managerial decision Overdue-growth and Profit-maximising Stage of making into a supervisory division and an operation Company Business Plan division, thereby reducing corporate corruption and ensuring accountability. Nihon Kohden has just come off a 3-year strategic plan of strong growth ending in April 2017, via investments in Shareholding Structure technology and overseas expansion. However, earnings fell below predictions due to unfavourable market headwinds, including prolonged healthcare reforms in Japan and poor market conditions in emerging markets. Despite that, Nihon Kohden still did achieve its goals of enhancing its technological know-how and strengthening its presence in overseas markets. Since April 2017, the company transitioned from this previous investment stage to the current phase of improving profitability by fully leveraging the business foundations established in the past 3 years. This sets it up to achieve these previously unrealised growths in the coming quarters.
Strong Global Market Tailwinds in Patient Monitoring & According to Mr Hirokazu Ogino (CEO), one of the EEGs greatest limiting factors that the company face is the The healthcare market trends with regards to Nihon limited understanding of consumer outside of Japan. Kohden's main specializations of patient monitoring Quoted by Mr Hirokazu Ogino (CEO), " After years of equipment and EEGs are projected for a steady upturn expansion, we realized that true internationalization in the next 5 years, as summarized in this list: 43
expanding the applications of brain monitoring in medicine and technology at large. Thus, the convergence of Nihon Kohden's prior technological and market expansion investments, profit- maximising business plan, and favourable market trends leads us to believe that Nihon Kohden is due for a uptick in growth in the next 3-5 years. Growth Strategy mirroring a successful case study: Sysmex Sysmex is also a Japanese company mainly involved with haematology analysers and consumables such as reagents required for blood test. With share price originally at JPY 3,160 at January 2014, it almost tripled in value to JPY 8,870 as of December 2017. There is an impressive increase of overseas sales from 67.5% in 2008 to 82.6% in 201739.
We observe that Nihon Kohden has the potential to be As summarised above, down-trends in demand for the next Sysmex from 2 key business decisions that patient monitoring devices are expected to be overcome Nihon Kohden has adopted that mirrored Sysmex by rising demand from increased prevalence of diseases successful growth strategy; firstly, a spike in capital and healthcare spending. Market research has shown investment to drive overseas growth, and secondly, an that the global patient monitoring device market is increase weightage of revenue from services and expected to hit USD 27.71 billion by 2020, growing at a consumables to create a sustainable, recurring revenue CAGR of around 5.8% from 2016 through 202121. The business model. Asia-Pacific Region is viewed as the most promising region, with an ever higher forecasted growth CAGR over this period22. This higher demand is forecasted to facilitate increased investment into capital equipment & disposables, enabling increased unit sales growth to outpace pricing pressures from low-cost alternatives. Of special relevance to Nihon Kohden is the fast-growing segment of mobile wireless ambulatory telemetry monitoring. Hospitals are shifting to remote patient monitoring platforms with emphasis on patient comfort and mobility, due to the increasing trend to transfer patients out of high-acuity intensive wards earlier to free up hospital capacity. Demand is also fuelled by the home patient monitoring market, which has achieved a global annual growth rate of 15.5% from 2011 to 20162Thus, the expansion of mid-acuity monitoring, of performing invasive monitoring while maintaining a transportable size24. This is the area where the Nihon Kohden has focused its technological innovations, and thus is well- poised to offer accurate and affordable mobile devices. The electroencephalograph (EEG) market is forecasted by similar growth. The global EEG market has a forecasted growth of 7.4% CAGR to reach a valuation of Firstly, Nihon Kohden invested heavily to enhance its USD 1.8 billion in 20252. Outside the United States, global business activities similar to Sysmex. Sysmex Japan itself is forecasted to be the largest area of growth almost tripled its capital expenditure from JPY 4.54 for EEGs, followed by the wider Asia-Pacific region, with billion in 2010 to JPY 13.10 billion in 2016 to further a forecasted growth of 9.7% CAGR, from 2014 – 2021, enhance its global production and sale network, and nearly doubling in value from USD $150 million to USD subsequently saw sustained growth in both revenue and $260 million5. As seen in Table 2, this is fuelled by operating income over the same period that allowed for increasing prevalence, awareness and action on the more than proportionate increase in valuation for neurological diseases, and technological advancements Sysmex. In the same period, Nihon Kohden increased its
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capital expenditure more than 4 times, from JPY 1.80 International Healthcare Policies billion to JPY 7.71 billion, for project such as the new US constitutes the largest portion of Nihon Kohden's R&D centre at Tokorozawa, Saitama and Boston, USA as international sales. However, the US market is being met well as establishing new sales office in places such as with uncertainty following a revamp of the Affordable Kenya to target emerging markets. The increase in Care Act (ACA) under Trump's Administration. Some of capital expenditures indicates Nihon Kohden the changes to the ACA includes shorter-term insurance commitment towards its overseas expansion and their plans, omission of certain benefits in the basic coverage, acknowledgement that they require more effort to and reduction of Medicaid. It is widely believed that increase the weightage of overseas sales to total sales. this would leave many more people uninsured and drive One might consider that Nihon Kohden is late in 25 up costs of coverage . As healthcare is still regarded as implementation of their overseas expansion strategy an out-of-pocket expense and insurance coverage is upon comparison to Sysmex, but we must also consider paramount in helping patients foot medical bills, the the difference in the nature of the products the two passing of the American Health Care Act would company produces. Sysmex produce blood analysers adversely impact the affordability of in the US, that are required as emerging markets build up basic potentially affecting the sales revenue for Nihon Kohden healthcare infrastructure, whereas Nihon Kohden core expertises, patient monitors, ECGs and EEGs are part of International Competition in IT Solutions healthcare system that take care of more complicated Though Nihon Kohden currently holds the biggest share health issues that arises from the aging population, and of the patient monitoring systems in the world32 ahead also increasing prevalence of chronic diseases of big players such as GE healthcare, Philips Healthcare worldwide that are a result of increasing affluence in the and Fukuda Denshi, it still faces stiff competitions from recent decade. Nihon Kohden overseas expansion them in terms of other platforms such as cloud-based should be considered timely; their products will not be software. GE Health Cloud26, Philips Healthcare's in demand from both developing market (which has yet Healthsuite27 are platforms that utilises cloud to build up basic infrastructure) and developed market technology to integrate devices and monitors creating (which have yet to feel the pressure from aging an ecosystem for more efficient workflow. While Nihon population) if Nihon Kohden focused on overseas Kohden may lead the industry in advanced devices and expansion in the early 2000s. systems, it has only just entered the Cloud Technology Secondly, while Sysmex is a market leader in the with its Prime Partner earlier this year and it is only hematology analysers, 65% of its 2016 revenue are limited to Japan. We foresee a steep barrier to entry recurring from the sale of maintenance services and against such international players in terms of cloud- consumables such as their proprietary reagents, and based products given the additional regulatory they are venturing into high value IT solution services as frameworks it has to fulfil for products involving cyber well. As discussed previously, Nihon Kohden has also security. As such, Nihon Kohden has to play catch up to successful discovered the market for consumables and its international competitors in this trending range of services around its instruments and reduced its reliance product, which will shape its continued status as the on unit hardware sales. dominant global supplier of patient monitoring systems. Top 3 Toxic Factors (Risks)
Financial Analysis & Valuation Negative Currency Translation Gross margin increasing without a decrease in working In 2016, although the sales grew in regions such as US, capital suggests a genuine upturn in the company’s Asia and Middle East, there was a decrease in market performance, rather than a mere accounting international sales due an appreciation of the Japanese trick to inflate the financial balance sheet. Nihon Yen. This problem will become even more prominent as Kohden’s improvement in gross margin has been Nihon Kohden expands its global market share as part of accompanied by an improvement in its balance sheet as The CHANGE 2020 business plan. In addition, the well. This suggests that gross margin improvements are Japanese currency is postulated to grow stronger as likely from operating decisions and not accounting inflation is set to return after decades of deflation gimmicks. against a backdrop of a growing economy. However, as domestic sales still constitute about 75% of total sales, impact of negative currency translation is fairly limited given improvement in international sales.
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enough cash to maintain its dividend in the future, ensuring a stable dividend structure of the company.
Nihon Kohden's Gross Profit Margin has consistently stayed above 47% over the past few years. Gross profit margin is a key measure of profitability by which investors and analysts compare similar companies and companies to their overall industry. The higher the percentage, the more the company retains on each Given high upfront investment into the overseas market, dollar of sales to service its other costs and obligations. investment returns will usually be slow. The compound By comparing Nihon Kohden's GPM with other similar annual growth rate (CAGR) is the mean annual growth competitors, we find that Nihon Kohden's ability to rate of an investment over a specified period longer than reduce the cost for each dollar of sales much higher than one year. Nihon Kohden's CAGR shows that its annual its competitors. This gives us confidence that Nihon sales CAGR and its overseas sales CAGR is yielding good Kohden's management has derived a holistic cost investment returns at 6% and 11% respectively, over a formula that has allowed Nihon Kohden to lower its period of 7 years. Operating income CAGR has increased direct cost of production. 6% over the last 7 years, with a stagnation period since 2013 most likely due to its reform policies. Overall, this Nihon Kohden's R&D expense as a ratio of sales is indicates a healthy investment trend for Nihon Kohden consistently around 3.9%, which is higher than market and ensures that its investment yields high returns. average for healthcare. The company has also been propping up on its capital equipment recently, which is As covered earlier, Nihon Kohden has undergone a rapid in tandem with the CHANGE 2020 reformation of the expansion policy towards international market by company. This provides sustainability in setting up overseas facilities. It is also undergoing major its competitiveness. reforms in its supply chain management and its corporate policies. Given that such expansion usually Nihon Kohden’s current dividend is at JPY 35.02 per takes huge investment capital with low investment share, which is a dividend yield of 1.36%. Nihon return over the first few years, there was a notable fall Kohden’s pay-out on earnings is currently 32.77%, which in the Gross and operating profit. However, this drop is is higher than companies of Health Care industry, which likely a short-term trend given the high CAGR is 28.64%. The company policy also stipulates that the performance in the overseas market. dividend pay-out ratio is at least 30% or more. This Conclusion provides good investment value for long term shareholders. This also ensures that the retained Our research indicates that Nihon Kohden's drop in earnings could be used for R&D investments, capital EBITDA is due to its rapid expansion policies towards investments, M&A and development of human overseas market instead of a fundamental issue with its resources, thus reducing the reliance on borrowing and cost operation. We believe that Nihon Kohden is in the lowers the cost of capital. phase of transiting towards internationalisation and service-oriented sales structure. Nihon Kohden has The pay-out on earnings was analysed together with the increased its sales consistently over 7 years despite pay-out on cash flow since this is last amount which can headwinds. With good corporate practice and be distributed to shareholders. Cash flow per share of achievable development plan, coupled with its strong Nihon Kohden is JPY 132.73 per share, which is higher ability to derive high GPM and dividend pay-outs, we are than the dividend per share paid by the company of JPY confident that the company is able to generate higher 35.0219. This signifies that the company generates return for shareholders in the future.
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(TSE:6849) Nihon Kohden CorporationFY2013 FY2014 FY2015 FY2016 FY2017 FY2018LTM Share Price JPY 1,895.00 2,540.00 3,030.00 2,865.00 2,594.00 2,543.00 No of Shares (mil) 87.9 87.9 87.7 85.7 85.7 85.7 MCAP (mil) USD 1,678 2,203 2,172 2,390 1,978 1,933 Net Debt (Cash) JPY (23,982) (27,152) (32,452) (23,039) (25,561) (29,898) Enterprise Value (mil) USD 1,309 1,517 2,144 1,887 1,709 1,644 Revenue (mil) JPY 132,538.0 153,194.0 160,803.0 165,522.0 166,285.0 168,470.0 EBITDA (mil) JPY 16,394.0 20,788.0 19,527.0 20,063.0 17,150.0 16,397.0 EBIT (mil) JPY 13,485.0 17,548.0 15,922.0 16,439.0 13,586.0 12,810.0 NPAT (mil) JPY 9,151.0 12,346.0 11,142.0 10,516.0 9,149.0 10,007.0 NPAT (Ex.Xtra + Dis.Ops) (mil) JPY 8,224.0 10,966.0 9,739.0 11,097.0 8,967.0 8,022.0 CFO (mil) JPY 13,189.0 9,383.0 12,505.0 10,765.0 11,356.0 12,202.0 CAPEX (mil) JPY (2,131.0) (3,777.0) (3,174.0) (6,898.0) (6,304.0) (3,537.0) EPS JPY 93.6 124.8 111.1 129.6 104.7 93.7 Revenue (mil) USD 1,407.1 1,488.0 1,340.1 1,473.1 1,491.3 1,496.1 EBITDA (mil) USD 174.0 201.9 162.7 178.6 153.8 145.6 EBIT (mil) USD 143.2 170.5 132.7 146.3 121.8 113.8 NPAT (mil) USD 97.1 119.9 92.9 93.6 82.1 88.9 CFO (mil) USD 140.0 91.1 104.2 95.8 101.8 108.4 CAPEX (mil) USD (22.6) (36.7) (26.5) (61.4) (56.5) (31.4) GPM (%) 50.0% 50.0% 48.4% 48.8% 47.6% 47.4% EBIT (%) 10.2% 11.5% 9.9% 9.9% 8.2% 7.6% Net Debt (Cash) / Equity (%) -31.5% -30.7% -32.7% -23.6% -24.6% -28.5% ROA (%) 11.5% 13.4% 10.8% 11.4% 8.9% 8.9% ROE (%) 17.7% 19.8% 16.0% 16.8% 13.1% 12.2% CFO/TA (%) 11.3% 7.2% 8.5% 7.5% 7.4% 8.5% EV/ Sales (x) 1.1 1.3 1.5 1.3 1.2 1.1 EV/ EBIT (x) 10.6 11.2 14.6 13.5 14.5 14.7 EV/ EBITDA (x) 8.7 9.4 11.9 11.1 11.5 11.5 EV/CFO (x) 10.8 20.9 18.6 20.7 17.3 15.4 P/Sales (x) 1.3 1.5 1.7 1.5 1.3 1.3 P/EBIT (x) 12.3 12.7 16.7 14.9 16.4 17.0 P/B (x) 2.4 2.7 2.9 2.7 2.3 2.2 VQ1: EV/EBIT/ROE (x) 0.6 0.6 0.9 0.8 1.1 1.2 VQ2: EV/EBIT/ROA (x) 0.9 0.8 1.4 1.2 1.6 1.7
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6. Bata Shoe Company (Bangladesh) Ltd (DSE:BATASHOE)
Company Research & Report
Quick Stats Date 15/12/17 EBIT/R&D (x) NA EBIT/Employee No. Filing Currency BDT (USD /px) 10K Share Price BDT1,173 EV/EBIT (x) 9.8 No. of Shares (Mil) 13.7 EV/EBITDA (x) 9.0 Market Cap (USD Mil) 194.1 EV/CFO (x) 24.4 Daily Value Traded (USD Mil) 0.1 P/Sales (x) 1.8 GPM (%) 41.4% P/E (x) 10.1 EBIT (%) 17.6% P/B (x) 3.8 Net Debt (Cash) / VQ1: EV/EBIT/ROE Equity (%) -11.3% (x) 0.3 VQ2: EV/EBIT/ROA ROA (%) 21.4% (x) 0.5 ROE (%) 37.8%
Team Members
Andy is from Nanyang Technological University, reading Economics with specialization in Finance. He is a member of the school's student run investment club - Nanyang Capital. He is passionate about investments and previously did an internship in the Corporate Finance field. Moving forward, he is looking to venture into other areas front office roles.
Jun Leong is a final year student studying accounting in NTU. He is a member of the school's student run investment club - Nanyang Capital. He is interested in investments and previously did several financed related internships.
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We believe that the success factors that we have seen companies of worldwide Bata Shoe Organization (BSO). currently and will see moving forward can be Bata Shoe Company manufactures and retails leather, summarized as follows (also known as – MOAT): rubber, plastic, canvas footwear, hosiery and Success Factor #1 accessories items for men, women, and children. Strong Management Team that have shown strong Currently, it operates c.250 stores across Bangladesh, loyalty and expertise, which will help Bata capture strategically managed to meet minimum IRR market share throughout this transition from Third requirements. In terms of production, it has two world to First world country. manufacturing facilities, located in Tongi and Dhamrai, accounting for the production of more than 26.6 million Success Factor #2 pairs of shoe. In 2016, BATA restructured its manufacturing operation so as to achieve synergistic Bata’s unparalleled network and resources when we juxtapose it with its peers makes Bata an attractive effects with the company objectives. The revamped investment. Bata Bangladesh is able to receive help manufacturing model has a maximum production capacity at 45.46 million pairs, allowing it to meet the from Bata International’s Bata Innovation Lab, which provides them with world renowned R&D along with demand surge. strong and close working relationships with suppliers. Apart from Bata’s own brands – Bata Comfit, B.first, Power, North Star, Bubblegummers, Sandak, the Success Factor #3 company forms strategic partnership with renowned Bata, being the first established internationally known brands like – Adidas, Hush Puppies, Scholl, Nike, company to enter Bangladesh, enjoys first mover Skechers, Marie Claire and Weinbrenner (Figure 1). This advantage. This advantage allows them to enjoy strong allows Bata to achieve its competitive position as a brand equity, which is why Bata is able to maintain market leader. integrity even with entrants to the footwear industry. Bata’s revenue can be broken down further into three segments (Figure 2) – Shoes Sales (95.62%), Hosiery & Also, we believe that Bata presents high potential Accessories (3.99%) and Exports of Shoes and other upside while maintaining low downside risk. The items (0.40%). possibility of a ‘double-in-value’ can be derived from the following propagation:
Value Factor #1: Development of Bangladesh Economy moving forward. We have been seeing positive economic indicators in Bangladesh. Intuitive, the footwear industry will growth along the economic development the country. Value Factor #2: Industry growth expectations. With strong historical growth rates and future growth rate expected, we find that Bata is poised to take up market share moving forward. Value Factor #3: Strong Brand name with proven track records in different markets Value Factor #4: Alignment of Business’s Goals with those of Employees Value Factor #5: Strong Financials – Cash Flows and Balance Sheet Situation Some risk includes: (1) Frequent workers’ Strikes, (2) Possible reliance on Brand Name and (3) Threat of new entrants. However, we believe due to the Bata’s ability to stay rooted amongst these risk due to strong fundamentals that the business has. In the following report, the deeper analysis will be Overview of 2016’s stellar performance conducted on these success factors and the sustainability will be proven using figures and intuition. Revenue growth is attributable to top-line sales growth of 3.11%, which can be broken down further into ASP Business Description (average selling price) growth of 1.05% and volume growth of 2.05% (Figure 3). If we strip down on pure Bata Shoe Company (Bangladesh) Ltd (BATA), as its retail performance, Bata’s revenue seen a growth of 5% name suggests, is headquartered in Bangladesh and was over the year, contributed by successful strategic founded in 1972. The Company is one of the operating marketing initiatives. 49
Additionally, we witness margin expansion over the think is attractive yet missed, according to the industry past year, attributable to firm’s operation efficiency, characteristics. This narrowed it to consumer goods and achieving COGS streamlining. Gross Profit Margin services. We chose footwear due to the fact that (1) increased from 40.44% to 43.45%, directly benefitting shoes are a necessity, assuring a base level of demand Profit before Tax (PBT) margins (14.46% to 16.19%) and (2) able to capture upside as countries develop – we Net Income margin (10.08% to 11.87%) via spill-over considered developed countries and noticed that the effect (Figure 4). footwear industry is capable of evolving along with the Overall, these factors lead to the 21% increase in EPS, economy, with higher ASPs, better quality and from $62.99 to $76.24 (Figure 5). Worth noticing is the continuous innovation able to drive sales (3) footwear consistent dividend pay-out that Bata maintains. in the emerging markets of Asia are generally at the infant stage of development, providing some buffer for downside. Finally, we shortlisted BATA Bangladesh due to its advantageous market position and capable management.
Why is it fit to be a Hidden Champion
Hidden Champion seeks alpha with the following filters, namely (1) Entrepreneur providing valuable, indispensable products that positions for compounded growth, (2) Qualities beyond profit generation, guided by higher purposes (3) Ability to stay rooted in challenging times. After in-depth analysis, Bata clearly posses these values and proves to be a ‘hidden gem’, especially when it is under- covered and over-avoided due to its ‘perceived’ economic risk.
The makings of a Wide-Moat Business
Contributing factors to this wide-moat business’s 29.33% ROE
#1 Management Analysis – Extremely Capable Management Team Management and their business philosophy
If we look at the BATA’s Board of Directions and management team, we can understand why BATA has been able to witness consistent growth. The common characteristic of the Board members and management can be summarized in a few words and phrases – Loyalty, Wide range of experienced individuals, each with strong area of focus and expertise. Bata Bangladesh is headed by Mr Rajeev Gopalkrishnan as its Chairman – Mr Rajeev has had almost 3 decades of experience in the footwear industry and also experience in Batas of different regions and countries. Bata Bangladesh’s Managing Director is similar in profile – Mr Cjitpan Kanhasiri has almost 2 decades of experience in Investment Origination and Hidden Champion the industry and experience in multiple Batas of Properties different regions and countries (Appendix A). All these culminated in recognition of Bata being the Investment Idea Origination leader in the footwear industry. In 2016, and in fact its 4th consecutive year, BATA was awarded the BEST We took a top-down approach, first looking at which BRAND AWARD in footwear category. Additionally, economic environment in Asia-Pacific is poised for BATA was prized the Number 1 shoe brand in growth. We then drilled down to the industry which we Bangladesh. This ties in nicely with the fact that it hold
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c.25% market share in the footwear industry in simplest yet elegant designs. Some of their innovations Bangladesh. BATA Bangladesh is led by an competent are as follows: Clarino (Material Tech – special water team who are extremely experienced and have been and scuff-resistant material with premium durability loyal to Bata for many years. With their international and feel) and Cosmo (Material Tech – strong and experience and expertise in the footwear industry, the durable insoles made up of ~70% recycled material). strong leadership at the helm gives us confidence of Bata Bangladesh’s direction and management’s ability to steer the company to greater heights.
Shareholder Structure Bata, with a total of 13,680,000 shares, is largely owned by Bafin Nederland (70%), insignificant amount held by insiders (< 0.01%) and the rest by Local (5.3%) and Non- Resident Shareholders (24.7%) (Figure 6). With no executives holding shares nor any major shareholders holding more than 10% of total shares, this structure prevents any possible conflict of interest.
Thus, Bata Bangladesh has access to the highest quality R&D done at a group level, which provides a long pipe- line that is both useable and tested in emerging and growing markets. Amalgamating with Bata Bangladesh’s ground-level understanding of consumers’ preference and market trends, Bata Bangladesh perfectly positioned to not only capture the growth in the footwear industry as a whole, but also to increase their market share with such technological advancement over their competitors.
#3 Intangibles & Sustainability – Solid Brand Equity justifying pricing premium
A global company like Bata enjoys strong brand equity, Corporate Culture and Social Responsibility especially in a 3rd world country, where brands are Bata corporate culture can described in two words – scarce. This allows it to charge a premium as a company ‘accountability’ and ‘ownership’, in which they over its peers (Figure 8 , Appendix B). implement performance management system, guided by KPI measures and ‘pay-by-performance’ incentives. Additionally, Bata is heavy on social involvement programmes, namely – ‘Educational for the next generation’, ‘Bata school adoption program’ and ‘Scholarship programs for employees’ children’. These program reached out to many schools allowing them to seek a better life moving forward.
#2 Competitive Advantage & Sustainability – BATA’s unparalleled network to leverage on Bata International performs world-renowned research and development (R&D) in Bata’s Innovation Lab (BIL) where they are constantly seeking the cutting-edge technology. BATA aims to improve the life of consumers via consistent improvement in the quality of BATA shoes, which can be seen in their R & D process (Figure
7). Their progressive thinking has created some of the 51
Bata Bangladesh has achieved ASP growth steadily over the years, with no dilution to the volume growth (Figure 9). We clearly see that volume did not go through a de- growth, staying at above 0% over the past 5 years. Bata is able to charge a reasonable premium while capturing strong volume growth, representative of the premium that Bata Bangladesh is able to command. This brand equity is continuously being solidified by strong marketing and advertising fees (Figure 10). Additional, Bata Bangladesh was the first international company with to enter the Bangladesh shoe market in 1972, while peers came in only after 2006, meaning they have had a longer run-way building their brand name. These initiatives by Bata Bangladesh are help to ingrain the brand perception and customer awareness of their brand and fortifies their foothold over the shoe market in Bangladesh.
[KI1] Key Investment Risk #1 – Frequency of Strikes Bangladesh, as mentioned previously, has frequent workers’ strikes, demanding better wages and/or better working conditions. [High Probability, Small Impact]
Mitigation: Bata enforces strong labour relationship, evident from the comprehensive employee benefits by Bata. Bata places strong emphasis on loyal, long term workers, providing them multiple packages that covers both employment period and post-employment period. Additionally, Bata understand that the ST workers also plays a huge part, and therefore, they cater to them as well (Figure 14).
[KI2] Key Investment Risk #2 – Reliance on Brand Name As its business is concentrated on consumer goods, there might be over-reliance on consumer perception and branding perception. [Moderate Probability, Moderate Impact]
Key Investment Risk (Toxic Factors) Mitigation: Bata is an international company that proven its success in other countries currently The key investment risks are summarized in Figure 13, transiting from third world to first world country. showing that most of its risks, even when materialized, pose small to moderate impact on the firm.
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[KI3] Key Investment Risk #3 – New entrants coming sales growth (Figure 16). Intuitively this makes sense, into the Footwear Industry because Bangladesh is a untapped market, being a…. Particularly, we see higher growth in consumption of We acknowledge the fact that new entrants will take leather products, favouring footwear retailers with attempt to take away Bata’s market share. [Moderate leather product lines. Notably, Bata produces a wide Probability, Small-Moderate Impact]. range of leather footwear, allowing it to ride on this Mitigation: Being a brand with long-history, Bata is wave of leather consumption expansion. established itself as the trusted/go-to brand.
Additionally, the sheer size of Bata is something that entrants cannot replicate on, allowing it to maintain a higher margin as compared to the smaller players. Also, as the industry grows bigger, the impact on revenue will be minimized.
Valuation and Financial Analysis The possibility of upside is explained: Factor #1 – Development of Bangladesh economy to drive top-line sales growth As Bangladesh transit from a third world to first world country, we expect a natural expansion of the footwear industry fuelled by good economic dynamics (Figure 15). The expansion can be broken down into two areas – (1) Volume, fuelled by Real GDP Growth, boosting general consumption and (2) ASP, fuelled by inflation, boosting purchasing power (Figure 28). We expect ASP to grow along the same trend as inflation rate/GDP increment. However, we price in a lower growth rate as compared to the inflation rate as Factor #3 – Strong Brand name with proven track we acknowledge the fact that pegging ASP growth to records in different markets inflation rate/GDP growth rate is not sustainable in the long run. There are arguments circling around the influx of independent (local) stores and international competitors. However, Bata differentiates itself on three areas. (1) Strong Distribution network: Bata is the leading footwear company, with the most physical stores as company to its peers, allowing them to reach out in an effective manner. Also, Bata is able to tap on it supply chain network, allowing it to derive better margins. (2) Excellence R & D, together with expertise: With BIL’s R & D, Bata’s strong product line will be able to cover the whole spectrum of the market, from low to high end consumers, as evident from the 900 product releases in 2016. (3) Solid Brand Equity: Having a long history of 45 years and huge market share, Bata has the first mover advantage, thus creating strong brand equity (Figure 17). Boutiques and international players who has a small presence will find it hard to compete market Factor #2 – Growing Footwear Industry share with Bata. The footwear industry in Bangladesh also seen strong Additionally, we wish to emphasise Bata’s growth over the past 5 years, as a whole grew at a competitive advantage of having ‘International’ CAGR of 12% as mentioned by Bata’s senior manager expertise. They have the technical know-how and vast (Figure 16). Moving forward, Orion Group’s CEO experience to effectively capture a larger cut of the (Orion is a local footwear retailer) projects a c.15% footwear industry pie over this third world to first growth in the footwear industry, boosting top-line world country transition. 53
the thick cash cushion through any revenue decline.
Factor #4 – Alignment of Company’s goals with those of (DSE:BATASHOE) Bata Shoe Company (Bangladesh) LimitedFY2013 FY2014 FY2015 FY2016 FY2018LTM Share Price BDT 880.20 1,354.90 1,170.40 1,115.60 1,172.60 Employees No of Shares (mil) 13.7 13.7 13.7 13.7 13.7 MCAP (mil) USD 155 238 204 190 194 Net Debt (Cash) BDT (123) (130) (174) (632) (475) Bata recognizes the fact that its people are its greatest Enterprise Value (mil) USD 120 203 227 189 185 Revenue (mil) BDT 7,879.0 8,077.0 8,522.8 8,784.6 9,009.8 asset, and they clearly proved to provide strong EBITDA (mil) BDT 1,240.6 1,116.4 1,295.1 1,545.9 1,727.4 EBIT (mil) BDT 1,140.9 1,003.2 1,170.9 1,397.0 1,582.6 employee benefits via employment and post- NPAT (mil) BDT 813.1 700.7 831.7 1,043.0 1,163.9 employment benefits and bonus program (Figure 18, NPAT (Ex.Xtra + Dis.Ops) (mil) BDT 808.0 694.8 820.1 1,041.8 1,168.7 CFO (mil) BDT 563.5 644.1 591.9 1,076.5 638.8 also shown previously). Additionally, the bonus CAPEX (mil) BDT (150.6) (238.5) (123.0) (92.4) (186.9) EPS BDT 59.1 50.8 59.9 76.2 85.4 packages pegged to bonus packages will further Revenue (mil) USD 101.9 103.7 108.9 111.2 109.6 EBITDA (mil) USD 16.1 14.3 16.6 19.6 21.0 incentivize workers to work in Bata’s interests as well. EBIT (mil) USD 14.8 12.9 15.0 17.7 19.2 NPAT (mil) USD 10.5 9.0 10.6 13.2 14.2 At full effect of these incentives and welfare programs, CFO (mil) USD 7.3 8.3 7.6 13.6 7.8 CAPEX (mil) USD (1.9) (3.1) (1.6) (1.2) (2.3) revenue should growth when synergy effect is attained GPM (%) 35.1% 35.6% 37.1% 40.1% 41.4% EBIT (%) 14.5% 12.4% 13.7% 15.9% 17.6% between Bata and its employees. Net Debt (Cash) / Equity (%) -5.4% -5.1% -5.9% -17.8% -11.3% ROA (%) 24.7% 21.5% 22.4% 21.3% 21.4% ROE (%) 50.6% 39.0% 39.5% 39.3% 37.8% Bata also consistently comes up with plans to enhance CFO/TA (%) 12.2% 13.8% 11.3% 16.4% 8.7% EV/ Sales (x) 1.5 2.3 1.9 1.7 1.7 employees’ loyalty. One example is Bata’s Scholarship EV/ EBIT (x) 10.4 18.3 13.5 10.5 9.8 away, awarded to more than 7 employee’s children in EV/ EBITDA (x) 9.6 16.5 12.2 9.5 9.0 EV/CFO (x) 21.2 28.6 26.8 13.6 24.4 recognition of academic excellence. P/Sales (x) 1.5 2.3 1.9 1.7 1.8 P/EBIT (x) 10.6 18.5 13.7 10.9 10.1 P/B (x) 5.3 7.2 5.4 4.3 3.8 VQ1: EV/EBIT/ROE (x) 0.2 0.5 0.3 0.3 0.3 VQ2: EV/EBIT/ROA (x) 0.4 0.9 0.6 0.5 0.5
Factor #5 – Excellence Balance Sheet Looking at Bata’s balance sheet, we understand the strong cash position that Bata is able to maintain (Figure 19). This strong cash flows and balance sheet position allows three important possibilities. During (1) Time with good investment opportunities, Bata will be able to use its own FCF or, (2) Take on debt easily, and during (3) Periods of business cycle contraction, Bata can use 54
7. Time Technoplast Limited (BSE:532856)
Company Research & Report Quick Stats Date 15/12/17 EBIT/R&D (x) 274.21 EBIT/Employee No. Filing Currency INR (USD /px) 10K Share Price INR204 EV/EBIT (x) 17.6 No. of Shares (Mil) 226.1 EV/EBITDA (x) 12.5 Market Cap (USD Mil) 720.4 EV/CFO (x) 28.2 Daily Value Traded (USD Mil) 0.1 P/Sales (x) 1.6 GPM (%) 26.1% P/E (x) 15.3 EBIT (%) 10.4% P/B (x) 3.3 Net Debt (Cash) / VQ1: EV/EBIT/ROE Equity (%) 46.8% (x) 0.8 VQ2: EV/EBIT/ROA ROA (%) 11.4% (x) 1.6 ROE (%) 21.7%
Team Members
Ang Chi Hern is an undergraduate from the School of Accountancy in Singapore Management University who has an interest in corporate finance and analysis of stocks. He is currently doing an internship in Excide Pte Ltd, a financial management consultancy firm, where he supports the management team in providing services to clients.
Yim Yi Xiang is an undergraduate pursuing a Degree in Business Management in Singapore Management University. He is an avid reader of books related to value investing and financial analysis and is active in analysing companies listed in Singapore. He is currently interning at Credence Partners, a private equity firm as an investment
analyst. Lim Ming Sheng is an undergraduate pursuing a Degree in Business Management in Singapore Management University. His passion lies in corporate finance and valuation and has done internships in Creditsights and Tiro Capital.
Louis Quek Yi Fu is an undergraduate at Singapore Management University pursuing a Double Degree programme in Economics and Business. His interest lies in corporate finance and value investing. He has interned at Principal Global Investors and Excide Pte Ltd which are asset management and financial consultancy firms respectively.
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How did you originate this idea and why did you choose this company? Our team has approached the stock search by first screening filtering down the universe of sticks via a few metrics mainly: (1) ROE, (2) ROA, (3) Market Capitalization. Subsequently, our team will look at each company in our screen list and look for potentially interesting and good businesses. We narrow down our target list further by asking a few questions:
(1) Can we understand the business?
(2) Does the business have an economic moat?
(3) Do the macroeconomic factors allow the company to grow further? (4) Is the demand for the business inelastic and firm? After answering these questions, our team narrowed down to a few businesses which includes manufacturing, tobacco, waste management and pharmaceutical. We further funneled our target list to our final decision by looking out for growth opportunities.
Company Overview: Time Technoplast (TT) is a manufacturing company that produces polymer based industrial packaging products. They operate mainly in the B2B business focusing on industrial products. Their product lines are divided into 2 main categories known as Established Products (EPs) Time Technoplast (TT) was selected due to a few macro and Value-Added Products (VAPs) where EPs are old reasons and specific company competitive advantages. successful brands and VAPs are the company’s latest Firstly, the macro growth of industrial packaging and products. A few examples of shown below stable projected growth of the industry with lack of penetration in areas TT operate thrilled us. Secondly, with their introduction of the new composite cylinder which could potentially disrupt steel cylinders made the company poised for future exponential growth if take- up rate accelerates.
Hence, with a good mix of market growth stability and specific growth catalyst, our team selected TT as our research company.
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. TT is the largest polymer based industrial packaging producer in India with an approximate market share of 70%. The company’s revenue is split into overseas and domestic shown in Figure 1 and their product line revenue contribution is shown in Figure 2. It is also important to note that the company serves over 900 institutional customers with no single client owning more than 4% of its revenue.
Additionally, TT has a global presence through subsidiaries and joint ventures. Below is a table that summarizes the company’s various global presences.
What is your one-sentence investment thesis? Strong market leader in polymer based industrial packaging products with high growth potential from composite cylinder segment.
What makes it a wide-moat business? TT’s business has a wide moat with 4 reasons: (1) High initial CAPEX, (2) Position of factories, (3) Costly certifications and product testing (4) Thin margins for exploitation. The 4 points are elaborated below:
(1) For manufacturing companies, the initial Capital Expenditure (CAPEX) of production plants is extremely high which deters introduction of competition due to the high investment cost. (2) Additionally, the position of plants is essential to cut down transportation cost which will cut into the thin margins of this industry. TT has placed 18 plants in India which are within 300km range
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reducing transport cost. Since incumbents will already position themselves in vital geographic locations, it limits new entrants geographic space to plan their factories expansion. (3) Furthermore, production of industrial products such as Composite Cylinders, DWC pipes and other industrial products require a long process of product testing and certification which is time consuming, difficult to obtain and costly for new entrants to invest in. (4) Finally, the company’s profit margins range around 5-7% means the potential financial Why do you think the business model is unique, incentives for new entrants to cover initial cost scalable and that it gets easier as it gets bigger? is very thin making entrance trying. These factors make a manufacturing company like TT Unique: The business model of TT is unique in the sense gain an economic moat. that it produces a wide range of products ranging from plastic containers, pipes to composite cylinders. Furthermore, their customers are from a wide range of industries such as chemicals, paints, household, hotel, automotive, sewage, power plant and agriculture. The beauty of this business model is that TT’s products are essential parts of each customers’ business resulting in a rather inelastic demand across various industries. Scalability: In terms of scalability, TT can expand further due to its diversified product offerings. For instance, polymer drums are underpenetrated in Asia at only 10% while India specifically is at 55%. Furthermore, TT’s debt- to-equity ratio has dropped significantly from approximately 0.8 in FY15 to approximately 0.45 in FY17. The reduced leverage allows further CAPEX expansion once TT finds further expansion opportunities. Easier as it gets bigger: As TT expands operations, the business will experience greater efficiency such as Economies of Scale as their factories are producing more and increasing their utilization rates. As a manufacturing company, the greater order book it receives the greater the efficiency of their business as they will be milking the most out of their sunk cost of their factory CAPEX. Furthermore, with an increased demand for new products such as their composite cylinder, ~2.5 times current capacity, business operations will benefit from expansion as top line improves from greater demand and bottom line improves from better operational efficiency and utilization of factories.
What is the corporate culture, management quality and shareholding structure like?
TT is managed by key management with decades of experience in their respective roles. Table 3 below elaborates management team and their respective experience and capabilities for their roles.
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The audit department is chaired by MK Wadhwa who is a Chartered Accountant and an independent director. With regards to good practices, our team believes that regular board meetings with specific agendas and transparent meetings reports make the company forthcoming in sharing information and increasing credibility of the company’s business directions and practices.
The following table breakdown TT’s shareholding structure. Majority of the shares are held by “Promoters” which consist of 9 members and takes a 52.59% of total shares. The details of “Promoters” are found in further down.
Additionally, the board of directors are shown below. The table shows the list of directors and the specific category of each. Furthermore, it explains the numbers of directorships and cross directorships in other board committees.
The next table mentions the main shareholders in the “Promoters” portion of the company ownership. The majority shareholder is Time Securities Services Private Limited at 18.65%.
TT’s board, as shown above, is governed by 9 members. Investment Summary: The board is chaired by Mr Venkatasubramanian who is (1) Favourable Macro independent and non-executive. With regards to Make in India Initiative requirements under SEBI’s listing guidelines, TT’s board This movement is targeted at the few sectors: structure meets them which can be found in Clause 49 Chemicals, Construction, Food processing, Oil & Gas of the guidelines. TT also has ironed out essential and Pharmaceuticals. The benefits for the industries businesses committees such as are as such:
(1) Audit 1. Simplification of regulatory environments
(2) Remuneration 2. Technology acquisition and development of
(3) Investor grievance (for corporate governance) fund set up by the government to acquire
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necessary technologies to develop domestic 12th Five Year Plan. Investments will be focused in water manufacturing capabilities and sanitation management, irrigation, building & 3. Government to provide relevant vocational and construction, power, transport and retail sectors. skill training through establishment of Industrial Specifically, investments in water and sanitation Training Institute (ITI) via Public Private management and irrigation will benefit TT as HDPE pipes are likely to be demanded in these 2 sectors. A liTTe Partnerships overview of HDPE pipes is that they are flexible and The direct benefit TT enjoys is that their customers are ductile and 100% leak proof making them a preferred from these sectors and an increase of activities of these choice of product for water and sanitary management sectors in India will lead to increase demand for TT’s and irrigation projects. Secondly, the Indian government products. Specifically, industrial packaging and pipes as plans to provide homes through the “Housing for All by these are essential items needed for the initiative. In 2022” plan. It aims to provide 18 million houses for essence, “Make in India” will increase the activity of households in urban India and nearly 30 million these industries which are served by TT in which leads households in rural India by 2020. As such, the to an increase in demand for TT’s products. government will construct new homes and encourage individuals to upgrade their homes by providing a Raw Material Prices Catalyst security of tenure. Again, this will affect TT’s topline as There is currently a global oversupply of polyethylene new home constructions will demand for HDPE pipes. (PE) and polypropylene (PP). According to HIS Markit, Since HDPE pipes are relatively lower in prices compared more than 24 million metric tons (MMT) of new PE to its substitutes and also its ability to carry portable capacity will be added globally from 2015 to 2020. In water, the demand for TT’s products is likely to increase India specifically, ONGC Petro additions Ltd (OPaL) with such initiatives. started two 360 KTA LLDPE/HDPE swing lines and Reliance Industries Ltd started a 550 KTA LLDPE/HDPE (2) Drum and Pipes swing line in FY17. The oversupply in HDPE puts pressure Time Technoplast’s Solid Foundation — Polymer Drums on prices which will benefit TT as HDPE is a major raw Industrial packaging is TT’s most valuable segment, material used in many of TT’s products. contributing USD290M or 77% of its sales revenue in Now considering the steel prices in India, government FY16. TT’s industrial packaging (IP) segment, which recently imposed an additional duty on steel imports. primarily consists of polymer drums and intermediate The rule was implemented in September 2017 and adds bulk containers (IBCs), has a combined 70% of the on a 18.95% countervailing duty on some hot-rolled and market share in the polymer industrial packaging cold-rolled stainless steel flat products from China, US, market. South Korea and the European Union. This is done to curb the influx of cheaper imports and help local Polymer industrial packaging market share breakdown producers. As most of TT’s substitute products are made of steel, an increase in steel prices will result in higher costs for competitors and reducing ability to compete with TT.
In essence, favourable raw material price for the production of TT’s products and under pressure prices of main competitors’ raw material, steel, makes the out- End-User Industries to Drive Growth for TT’s Industrial look of TT positive. Packaging Segment TT’s industrial packaging segment is mainly driven by Increased Infrastructure Spending demand from its end-user industries, which are mainly in the chemical industry. Plastic products such as Firstly, the Indian government announced that they polymer drums and IBCs are crucial for storage and would invest USD 1 TN in the infrastructure sector in the transportation purposes, while jerry cans and pails are 60
required for the packaging of the chemical products for The forecasted growth in the end-user industries is sale or usage. Hence, the growth of the end-user definitely a positive sign for TT as it will benefit from the industries is key to the performance of TT’s IP segment potential increase in demand for IP products. as it will determine the future demand of plastic Nevertheless, with various industrial packaging products products in these industries’ operations. and solutions available in the market, the main determinant of whether TT will be able to capture this Growing End-User Industries — A Positive Outlook for TT incremental growth is the preference and usage of Industrial Packaging Segment polymer products over their steel counterparts. Our team believes that TT will be able to edge out their steel India’s chemical industry, which includes sectors such as competitors in the market as polymer drums have paints, petrochemicals, & pharmaceuticals, is on the rise penetrated deeply into the market over the years, and as the urbanisation continues to occur across the displaced steel drums as the preferred packaging country. Over a 6-year period, the total production product as of 2016. volume of major chemicals in India grew at a CAGR of 1.65%. Within this chemical industry, the specialty chemicals sector is a sector that will see high growth in the coming future, especially in the following major sub- segments: Paints and Coatings, and Construction Chemicals. The paint industry in India has been forecasted to grow at a CAGR of 14% from 2015 to 2020 due to rapid urbanisation and growing infrastructure contributing to high demand for paint products. Since industrial packaging products will be needed for storage and Polymer drums are very much more widely used in the packaging purposes in the paint industry, this potential domestic Indian market,as compared to the global growth in the paint industry will generate additional market, where steel drums are still more heavily demand for IP products. favoured at 84% of the total volume in the market. This Similarly, for construction chemicals, IP products will be discrepancy is largely due to the unavailability of cheap necessary for storage and transportation purposes. With steel materials in India due to anti-dumping duties the construction chemicals industry expected to grow at placed on imported steel, which results in higher a CAGR of 12% from 2015 to 2019, it will help drive the production costs and consequently selling prices for growth of IP products as demand for these essential steel drums in India. As such, despite polymer drums products rises. being conventionally more expensive than steel drums Since TT is a major player in the IP market with a due to its higher raw material cost (polymer resin), the substantial market share, these trends paint a very prices of steel drums and polymer drums differ by a positive outlook for its IP segment as the end-user minute margin. Moreover, polymer drums also have a industries will require the type of products that are longer life expectancy than steel drums as they do not available in TT’s product portfolio. Coupled with IP being corrode or rust over time, and even have a higher resale TT’s largest business segment, this potential growth in value 1 than steel drums. With better material the market may have a huge positive impact on TT’s characteristics and higher resale value, this eventually financial performance in the future, should TT be able to led to the current market situation in India, which is very capture this lucrative opportunity in the market. beneficial to TT’s core polymer IP segment going forward.
Steel Barred from Capturing Growth
While a 55% market penetration is already rather positive for TT, our team is of the opinion that this market situation will persist to a point where polymer drums have an even more substantial share of the
A Different Base in The Drum Market — Plastic market from recent development and benefit TT. In Triumphed with Time September 2017, India has imposed an additional 18.95% import duty on hot-rolled and cold-rolled
1 CRISIL Research 61 stainless steel flat products from China, the USA, South and USD46 per composite cylinder (not in commercial Korea, and the EU to curb the influx of cheaper steel use yet). When the LPG cylinder is emptied, it is replaced imports. This is very likely to keep the prices of steel by the local operating dealer at the customers’ location. drums high, while the prices of polymer drums continue Dealer sends the empty cylinders to the required to dwindle from downward pressure on polyethylene boTTing stations via truck, which are then refilled to be prices as a result of a global oversupply. With the local sent back to the dealer. market already gradually flocking to polymer drums due to its competitive price, this import duty placed on these Composite cylinders in India key steel products may enable further market The Indian government has been seeking local penetration by polymer drums, a scenario where TT will manufacturers to produce composite cylinders since stand to gain even more. Furthermore, as TT’s largest 2009. In 2009, the 3 public OMCs floated a global tender competitor in the polymer IP market, Balmer Lawrie, is for 200,000 cylinders, which garnered interest from still more focused on growing its steel drums segment, Hexagon Ragasco and Composite Scandavian (before it TT is unlikely to face intense competition in capturing was acquired by Ragasco in 2010). Subsequently, the the future growth. Hence, our team strongly believes tender conditions were modified which only local that TT’s IP segment will perform excellently in the manufacturers could participate in the tender. Due to future as the current Indian market situation and market the substantial capital expenditure required to establish forces continue to drum up more customers for polymer the factory to initiate production and the low order drums. quantity, manufacturers felt it would be unwise to put up a shop to manufacture just these many cylinders. Value Added Products (VAP) driven by composite Hence, the tender was unsuccessful. At one stage, the cylinders Petroleum and Explosives Safety Organisation (PESO), which is in-charged of domestic LPG cylinder Composite Cylinder Thesis certification, thought of importing such cylinders from Liquefied Petroleum Gas (LPG) Market segments European countries where they are popular. The then In 2016, usage of LPG in India is split into 4 main PESO chief had visited Denmark and inspected these segments – Domestic (92.3%), Commercial (3.4%), cylinders. However, the government decided to explore Automotive LPG (2.4%) and Industry (1.9%). The the possibility of identifying a local company to Domestic segment, which is the use of LPG for cooking, manufacture the composite cylinders instead. This is is a largely regulated market as it is heavily subsidized by also in line with Narendra Modi “Made in India” the government and state-owned public oil marketing campaign in 2014 to encourage national companies to companies (OMCs) to promote the use of LPG over other manufacture their products in India. dirties fuels (kerosene, dried dung cake etc). Due to the subsidies and price caps, 95% of LPG sale in the Domestic TT obtained its technology to produce composite segment is conducted by the 3 main public OMCs - cylinders through the acquisition of Komposit Praha, a Indian Oil Corp. Ltd (IOCL), Bharat Petroleum Corp. Ltd struggling European composite cylinder manufacturer, (BPCL) and Hindustan Petroleum Corp. Ltd (HPCL). in 2010. In the same year, TT set up a factory (1m capacity) in Maharashtra to manufacture composite cylinders and became the first company to manufacture composite cylinders in India.
Currently, only steel cylinders are used to distribute LPG as India’s government has not issue license for composite cylinders to be used domestically. However, TT (in 2013) and Supreme Industries (in 2015) are the only companies licensed to produce composite cylinders in India. Nearly 95% of TT’s composite cylinder Retail and distribution production are being exported, mainly to Africa, Middle In the Domestic sector, LPG is filled in cylinders and sold East Russia, Egypt and South Asia. TT’s current order through independent dealers to end-consumers. LPG book (2016) stands at 2.5x its annual capacity of 700,000 cylinders are sold by manufacturers directly to OMCs. cylinders. In May 2017, TT increased its production The cylinders are owned by the OMCs and rented to capacity to 1.4m cylinders, just behind that of Ragasco, consumers free-of-charge for LPG distribution. the leading manufacturer of composite LPG cylinders Consumers need to pay deposits on the LPG cylinders which stands at 2m but larger than Supreme’s 500,000 that they use, which stands at USD23 per steel cylinder cylinders.
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Pilot test of composite cylinders in India In Oct 2016, the 3 public OMCs began the pilot test of the composite cylinders with the sales of 30,000 cylinders initially in the states Ahmedabad and Pune. These cylinders will be obtained from both TT and Supreme, the only 2 companies producing composite cylinders domestically. Upon completion of the pilot Benefits of LPG vs other cooking fuels study, which is proposed for a period of two years and Despite the higher cost of LPG, the energy produced per basis the findings, other OMCs — Bharat Petroleum and kg of LPG is the highest among all other fossil fuels. Indian Oil — will finalize the roll out to other parts of the However, cost has been the most significant obstacle in country. the adoption of LPG among poor Indian households. With the help of the PMUY scheme, it will help remove This development comes at a time when the number of the high cost barrier for these households and increase LPG users has spiked thanks to the government's LPG connections in India. Pradhan Mantri Ujjwala Yojana (PMUY) which envisages Additionally, the team believes that PMUY scheme will to provide LPG connections to 50m women belonging to not be a temporary initiative by the government as LPG the below-poverty-line category. Since the launch of the is seen as the permanent fixture in cooking fuel due to scheme in May 2016, the number of beneficiaries has its low pollution and harmful effects to people. already crossed 25m. According to a World Health Organisation report, smoke from such fuels inhaled by women is equivalent to Sub-thesis #1: Larger adoption of LPG among Indian burning 400 cigarettes in an hour and causes several households expected respitory and other diseases.
Favorable government policies Sub-thesis #2: Success of pilot test will catalyse domestic Government policies promoting LPG consumption have composite cylinder growth propelled India to the second largest LPG consumer in As the LPG consumption among Domestic segment is the world at 19 million tonne per year. The growth is heavily subsidized by the Indian government, only the 3 largely driven by the government’s push to increase public OMCs (IOCL, BPCL and HPCL) undertake the household LPG penetration through the Pradhan Mantri distribution of LPG among domestic household. Ujjwala Yojana (PMUY), which aims to provide free LPG Currently, these 3 OMCs are undergoing the pilot test on connections to below-poverty-line households. This the commercial viability of composite cylinders. If the program was enlisted under the Guinness Book of World pilot is a success (in 2H19), the 3 OMCs will start Record for its largest cash transfer at USD 6.5 billion and distributing LPG using composite cylinders due to its is targeted to provide 50m poor households with free lighter weight, which decreases logistical costs LPG connections. Since its launch in 2016, PMUY has significantly, and its safety as it does not explode when helped 21.7m households receive LPG connections. At exposed to high heat. Since 93% of India’s LPG present, there are 198.8m active consumers, according consumption is derived from the Domestic sector, the to an official statement, which works out to an success of the pilot test accompanied by the backing of estimated 72.8 per cent national LPG coverage. The the 3 state-owned OMCs and their vast distribution government target is nearly 84 per cent. Customers network will allow TLL’s composite cylinders to capture retention on their LPG connections have been strong, a significant bulk of the LPG distribution market. with at least 85 per cent approaching dealers for a refill The made-in-India campaign will favour composite of LPG cylinders. cylinders manufactured by TLL and Supreme over foreign imports. Between them, TLL is expanding its production capacity to 1.4m cylinders per annum, just behind that of the world leader Hexagon Ragasco but way ahead of Supreme’s 450,000 cylinders. The larger production capacity will allow TLL to capture a larger market share of India’s composite cylinder market.
Sub-thesis #3: Increasing regional demand for composite cylinders, large order backlog and stronger margins TLL has license to export its composite cylinders to 48 countries and has been exporting these cylinders to 26
63 of these countries. Despite having most of its cylinders MOX Films Thesis being exported and not domestically (due to ongoing Lining Up TT’s Topline with MOX Films pilot test), TLL’s utilization rate has been running at Multi layer multi axis oriented cross laminated (MOX) 100%, with large order book at 2.5x of annual films is a new product launched by TT under the brand production capacity of 700,000 cylinders per annum as ‘Techpaulin’, on 1 April 2017, and is a whole new of 2017. product segment in TT’s product portfolio. These MOX films are similar in nature to tarpaulin (“tarp”), which With the following regulatory certification TLL’s has widespread usage across several critical sectors, composite cylinders have obtained (listed below), particularly in agriculture, and infrastructure, but are of management is expecting increasing exports to 55/56 higher quality and versatility than conventional tarp. countries in the near future. Moreover, these MOX films also yield a more positive - Approved by TUV Rhineland, Germany under the EBITDA margin for TT, making it one of the value added most stringent European Standards products that can drive the expansion of TT’s profit (EN12245:20002 and 14427:2004) and international margins in the future. Nevertheless, the success of standards (ISO 11119-3:2002)). Techpaulin is not a given, and hinges on the - Emirates Authority for Standardization and performance of its main competitor, Silpaulin; the growth of the agricultural industry in India; and the Metrology (ESMA) for use in Gulf Cooperation possible applications of Techpaulin that justifies its Council (GCC) countries. selling price. From our research, our team believes that - Liquefied Petroleum Gas Safety Association of South Techpaulin is poised to perform well in the market due Africa (LPGSASA) to service South African market to 3 main factors: and its adjoining countries. 1. Swift development to maximise a year’s worth Of the product segments TLL has, composite cylinders of time to capture market share from its peer offer the higher EBITDA margin at 20%, compared to its 2. A growing agriculture industry that recognizes plastic drums, jerry cans, pails segment at 14.2 to 14.4% the logistical benefit of tarps and Intermediate Bulk Container at 18 to 20%. The 3. Techpaulin being able to uphold its premium increasing regional demand for composite cylinders and price despite the existence of cheaper a successful pilot test in India will help boost TLL’s alternatives composite cylinder sale and improve its EBITDA margin as sales of these cylinders takes up a larger proportion. When Sil Meets Tech
Prior to TT’s entry with Techpaulin in 2017, Supreme Sub-thesis #4: Composite vs steel cylinders Industries Ltd (SIL) has a complete monopoly in the cross
laminated film market with its multi layer cross laminated U.V stabilized film (under the brand ‘Silpaulin’). As of FY2016, SIL commanded 100% of the market with USD70bn in sales revenue from its Silpaulin, and a silpaulin manufacturing capacity of 45,000MT. However, with the introduction of Techpaulin into the market, TT is looking to break up the existing monopoly, as well as capture the growth that awaits it as the end-
user industries grow.
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Challenging the Monopoly Seeding the Growth Of Techpaulin TT entered the market in the first quarter of 2017 with a The success of Techpaulin in India is dependent on the significantly lower manufacturing capacity of 6,000MT, future growth of its end-user industries, one of which is in comparison to SIL’s 45,000MT. However, TT initially the local agriculture industry. India’s agriculture industry aimed to achieve growth through 2 means: offering a has recently recovered from a sluggish drought-induced product of equal or better quality, and focus on growth of 1.2% in 2016 to a possible 4.1% growth in establishing a wide-reaching distribution network. 2017, and is expected to remain at 4% for 2018 as well2. Based on the claims made by both parties, TT’s For the industry to continue on its current track of Techpaulin is comparable to Silpaulin in terms of its further growth and the government has recognised the features and quality. Both films are made using HDPE via potential of plastic usage in agriculture, particularly for their own respective proprietary cross-laminated during and post-harvest aspects of agriculture. process, which confers favourable qualities that make these plastic sheets highly suitable for agricultural and The Rise of Plasticulture packaging applications. The outcome of TT’s wider Plastic products have widespread applications that can distribution network lends credence to the fact the benefit agriculture on the whole, such as plastic pipes Techpaulin is a serious competitor to Silpaulin in the that can be used for irrigation, plastic sheets or films in market. In introducing Techpaulin into the market, TT greenhouses, and as a lining to form water reservoirs went on the offense by appointing over 27 distributors that are a cheaper alternative to water tanks. Neelkamal across India, as opposed to SIL’s 18 distribution units in Darbari, Principal Secretary of Agriculture under the India. At that moment, due to SIL only having 18 Government of Rajasthan, has stated that the use of distribution units, it was unable to adequately meet the plastic is imperative in achieving efficient water usage demand for cross laminated films throughout India, and higher productivity. With plasticulture, the usage of which effectively helped TT in capturing SIL’s plastics in agriculture, gradually being recognised as the underserved customers in the market. This culminated way forward for farmers, there are immense in the achievement of USD1.4M in cash sales for TT opportunities for TT to leverage on to grow its MOX films within one quarter of its launch. segment. Moving ahead, TT’s management has targeted a sales revenue of USD31bn by 2019, and has already taken Tarpaulin is generally used for lining in ponds or water action by expanding its production capacity to reservoirs, protecting crop produce post-harvest, as well 12,000MT. This expansion in its manufacturing capacity as a protective shelter in greenhouses. As such, plastic is slated to be ready for utilization by end 2017. films used in such applications simply cannot be of low Meanwhile, SIL is more heavily invested in growing its or cheap quality that are often unable to withstand U.V plastic piping segment, as evident from its strategic plan. rays and have short useful lives. TT’s Techpaulin possess This effectively provides room for TT to build its MOX the necessary characteristics that make them a good film segment and encroach into SIL’s market share by choice for use in the agriculture industry as it has high leveraging on its additional 6,000MT manufacturing durability, resistant to U.V rays, and is waterproof. capacity, and its wider distribution network. Hence, Techpaulin, as a cross laminated film made from HDPE, is likely to be selected for use and protected from cheaper alternatives such as PVC films as farmers and agricultural companies start to incorporate the use of plastics in agriculture.
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Made Better with Tech economies of scale from its other products mainly being Due to the features of TT’s Techpaulin derived from its made from HDPE as well, a situation where PVC is technology that makes it a suitable and desirable selected for use in infrastructure projects may not material for use in end-user industries, TT can actually benefit TT as much. Furthermore, as SIL has a very strong charge a higher price for its product in the market. Presently, the average EBITDA margin of MOX films is foothold in the PVC pipes market, TT may not be able to 21%, and is estimated to have a sustainable EBITDA capture as much growth as its PVC pipes segment is margin of 16% in the long run, which is higher than those considerably smaller. in TT’s regular business segments (14%). Thus, the continual development of this product line will help to Risk #3: Growth of MOX films slower than expected due boost the company’s overall margins over the years as to response from SIL improvement of these MOX films can continue to differentiate it from lower quality alternatives and SIL, as the market leader who has been enjoying a justify them being priced at a premium. complete monopoly, is unlikely to allow TT to encroach Besides contributing to the expansion of the company’s too far into their market share with TT’s MOX films. SIL profit margins, this product segment also improves TT’s has initiated plans to widen their distribution network, working capital due to the current sales policy adopted and increase their production capacity for their by the management with regard to MOX films. TT’s MOX films do not cater for sales made on credit, and require protective plastic packaging segment which includes payment on supply or in advance for the goods. As TT silpaulin. As such, TT may face resistance in its bid to continues to expand this segment, it may effectively build up its MOX films segment further and have its shorten its cash conversion cycle, and utilize its competitive edge in the form of a wider distribution improved working capital to develop the business network being eroded. further at an earlier time period. Besides SIL’s response, the sheer length of time SIL has Investment Risks: been in this specialty tarp market may have contributed
significantly in building up brand loyalty and trust in Risk #1: Failed pilot test or low adoption of composite silpaulin. While TT’s MOX films may be of equal or cylinders in India If the pilot test fails to prove the commercial viability and superior quality, customers may still prefer silpaulin demand of composite cylinders, the 3 OMCs will most simply due to past experiences and purchases over the likely not increase their purchase of TT’s composite years. Hence, it may be difficult for TT to cannibalize cylinders. Even though this might dent the growth sales from SIL’s customer segments that are adequately potential for TT in the domestic market, the export served. regional market proves to be resilient enough for TT to (BSE:532856) Time Technoplast Limited FY2014 FY2015 FY2016 FY2017 FY2018LTM achieve strong cylinder sales growth, which is evident Share Price INR 46.80 51.60 49.20 159.55 204.15 No of Shares (mil) 210.1 210.1 210.1 226.1 226.1 from its 2.5x order book. MCAP (mil) USD 164 170 153 558 720 Net Debt (Cash) INR 7,911 7,352 6,759 6,565 6,489 India’s households are required to pay a deposit for each Enterprise Value (mil) USD 280 301 271 530 828 Revenue (mil) INR 21,911.2 24,796.3 24,242.7 27,566.3 28,886.4 LPG cylinder they use. Currently, the composite cylinder EBITDA (mil) INR 3,131.1 3,420.7 3,493.8 4,062.5 4,246.2 EBIT (mil) INR 2,261.8 2,546.0 2,505.4 2,907.6 3,007.8 stands at USD46 as compared to steel cylinder’s USD23. NPAT (mil) INR 954.3 1,096.1 1,381.3 1,471.0 1,578.8 NPAT (Ex.Xtra + Dis.Ops) (mil) INR 1,001.2 1,167.8 1,255.6 1,555.8 1,663.6 The start-up deposit required and cash outlay (which CFO (mil) INR 2,140.7 2,694.6 2,886.0 1,879.8 1,879.8 CAPEX (mil) INR (1,361.7) (1,051.7) (1,699.2) (2,123.6) (2,123.6) cannot be broken up into installments) when using a EPS INR 4.8 5.6 6.0 6.9 7.4 Revenue (mil) USD 365.7 396.6 365.8 425.4 442.3 composite cylinder presents a serious barrier to its EBITDA (mil) USD 52.3 54.7 52.7 62.7 65.0 EBIT (mil) USD 37.7 40.7 37.8 44.9 46.1 uptake by low-income households NPAT (mil) USD 15.9 17.5 20.8 22.7 24.2 CFO (mil) USD 35.7 43.1 43.5 29.0 29.0 CAPEX (mil) USD (22.7) (16.8) (25.6) (32.8) (32.8) GPM (%) 27.0% 25.8% 25.0% 25.6% 26.1% EBIT (%) 10.3% 10.3% 10.3% 10.5% 10.4% Risk #2: Contractors opting for cheaper PVC alternatives Net Debt (Cash) / Equity (%) 85.2% 70.9% 57.9% 49.5% 46.8% ROA (%) 10.1% 10.9% 10.4% 11.3% 11.4% instead of HDPE ROE (%) 24.4% 24.5% 21.4% 21.9% 21.7% CFO/TA (%) 9.5% 11.5% 11.9% 7.3% 0.0% EV/ Sales (x) 0.8 0.8 0.7 1.6 1.8 EV/ EBIT (x) 8.2 7.4 7.1 14.8 17.6 While HDPE pipes are generally more suitable for piping EV/ EBITDA (x) 5.9 5.5 5.1 10.6 12.5 EV/CFO (x) 8.6 7.0 6.2 22.9 28.2 systems due to its durability and capability to withstand P/Sales (x) 0.4 0.4 0.4 1.3 1.6 P/EBIT (x) 4.3 4.3 4.1 12.4 15.3 P/B (x) 1.2 1.2 1.0 2.7 3.3 high stress, they are more expensive than its PVC VQ1: EV/EBIT/ROE (x) 0.3 0.3 0.3 0.7 0.8 VQ2: EV/EBIT/ROA (x) 0.8 0.7 0.7 1.3 1.6 counterpart which is more prone to damage over extended period of use. As TT enjoys more cost savings from manufacturing and selling HDPE pipes due to
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8. Aerospace Industrial Development (TSEC:2634)
Company Research & Report Quick Stats Date 15/12/17 EBIT/R&D (x) 4.58 EBIT/Employee No. Filing Currency NTD (USD /px) 20K Share Price NTD38 EV/EBIT (x) 20.2 No. of Shares (Mil) 941.9 EV/EBITDA (x) 14.9 Market Cap (USD Mil) 1,185.1 EV/CFO (x) 17.3 Daily Value Traded (USD Mil) 2.2 P/Sales (x) 1.4 GPM (%) 14.0% P/E (x) 15.0 EBIT (%) 9.0% P/B (x) 2.9 Net Debt (Cash) / VQ1: EV/EBIT/ROE Equity (%) 98.5% (x) 1.1 VQ2: EV/EBIT/ROA ROA (%) 6.9% (x) 3.0 ROE (%) 18.8%
Team Members
Tan Shuai Zhuang Darren is a second year finance major student at Singapore Management University, pursuing a degree in Business Management. He is a senior analyst in SMU Student Management Investment Fund, a student led investment club focused on stock research and market analysis. He is currently an analyst in North Ridge Partners, an independent merchant bank that invests in and advises
technology companies within the Asia Pacific region.
Ng Jia Wei is a second-year undergraduate student at Singapore Management University, pursuing a degree in Business Management. He is currently an analyst in SMU Emerging Markets, a student-led business club focused on research of industries and companies within the emerging markets in South-East Asia. Prior to SMU, he has worked at Mizuho Bank, undertaking audit duties under the Operations Planning Department.
Teo En Quan is a second year finance major at Singapore Management University, currently pursuing a double degree in Business and Economics.
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Aerospace Industry Structure & Breakdown Business Background and Overview
Aerospace Industrial Development Corporation Tier 1 - Systems Integrators (AIDC), previously known as the Aerospace Industry Firms in this tier research, develop, manufacture, Development Centre, was founded on March 1st, 1969 modify, and market completed aircraft with their for the Taiwan Airforce. As of July, 1st 1996, AIDC was own brands. Due to economies of scale and technical transformed from a military establishment into a barriers to entry built by the minority of aircraft government-owned company, before achieving manufacturers, the aerospace market in this tier is in privatization in early 2013, and subsequently going an oligopoly situation. Main players in this tier public on August 25th 2014. include – Boeing, Airbus, Bombardier
AIDC developed its Carbon Fiber Reinforced Polymer Tier 2 - Systems Component Suppliers (CFRP) technology several decades ago when it was Tier 2 firms provide key aircraft components to tier 1 building IDF, a military aircraft made in Taiwan. After companies. This include components that are critical adopting the CFRP technology to commercial aircraft, to an aircraft functionality – avionics and engines. AIDC built a composite material plant in 4Q10, Taiwan This segment is seeing increasing consolidation Advanced Composite Centre (TACC). The new where firms are merging and integrating their composite material production plant will increase manufacturing networks with tier 1 firms. AIDC production capacity of aircraft components. Production rate is expected to double to 20 units per Tier 3 - Sub-Assembly Supplier month in 1Q18 and increased further to 30 units per Tier 2 firms would outsource some of their month to meet Airbus order rate. Despite increase in manufacturing production to tier 3 firms. Tier 3 firms output, the TACC would only be operating at 50% would manufacture less advanced components of capacity (Macquarie Research). This would enable the aircraft. This includes aircraft instruments, AIDC to increase TACC production even further to composite materials, interiors, and landing gears. meet any rise in future demand. Tier 4 - Standard Component Supplier AIDC operates in both the military and commercial These firms supply standard parts and raw materials aircraft industry. Their operations include developing, outsourced by their upper tier clients. Products manufacturing, distributing as well as the assembly of manufactured by these firms may not be unique to aircraft parts. Having a global outreach, AIDC also the aerospace industry. markets its products to commercial and military entities worldwide. Having partnerships with multiple AIDC’s Business Units leaders in the industry, such as Airbus and Boeing, AIDC is an undiscovered gem that is primed for Aircraft/vehicle Maintenance success. Military AIDC has a significant amount of experience maintaining military aircraft for the Taiwanese Military. This encompasses all aspects of maintenance required by an aircraft, from aircraft instruments and avionics to hardware maintenance. The wealth of experience AIDC has puts it at a significant advantage in maintaining its business relationship with the Taiwanese Military.
Civilian As there are many commonalities between civilian and military avionics and logistic support systems, AIDC is also able to supply avionics and logistics systems to the civilian market.
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The earnings of AIDC’s engine manufacturing segment is correlated to the number of LEAP engines that are ordered globally. With the component shortage holding the production LEAP engine production set to clear in 2018, the transition of CFM- 56 to LEAP in 2017, and the record 12200 orders for LEAP engines in 2017, LEAP engine production is expected to increase exponentially in the near future.
Industrial Technology Services Using its expertise in product design, manufacturing, maintenance, installation, and system integration, it
manufacturers commercial auxiliary power units for civilian commercial aircraft. Produced products are of high quality with manufactured parts being certified by the FAA and global commercial aircraft companies.
AIDC also steadily diversified from aerospace engineering to include the rail and automotive industry. It successfully produced rail simulators for Taiwan, Hong Kong, and Bangkok metro companies. Using its experience in developing electronics for the aerospace industry, it ventured into the automotive industry to produce electronics that are critical in the modern automobile.
The global demand for civilian air traffic is expected Armed with experience of manufacturing aircraft to grow at a CAGR of 4.7% between 2017 and 2036. engines, it broke in to the local alternative power The increase in demand for air traffic would result in generation market with the manufacturing of highly the increase in aircraft orders by airliners to meet efficient gas turbine engines as well as wind- passenger demand. Currently, there is a huge existing powered electrical systems. backlog of commercial aircraft from aircraft
manufacturers as Boeing and Airbus struggle to meet demand (Figure 4). Subsequently, as these aircrafts Client Concentration Risk are introduced into service, they would require regular maintenance as the hardware ages with sustained used. Hence, AIDC upstream position as an aircraft parts supplier enables it to take advantage of the increase in global demand for avionics and logistics systems needed to support these new aircrafts.
Aero/Industrial Engine AIDC is well recognized by engine makers for their engine case design, with quality approvals and accreditations from notable manufacturers. The world’s top 5 engine makers have AIDC as their major supplier, with AIDC being a key partner with CFM
International in the manufacturing of LEAP aircraft engines. With AIDC so integrated with these engine From 2012 to 2016, proportion of revenue from major manufacturers, some parts its supply chain have clients have been steadily increasing. This suggest an entered the realm of tier-2 aerospace. increase in the client concentration risk taken by AIDC. Although AIDC’s client concentration risk looks significantly high, we believe that this is due in part to 69 the nature of the industry, with fewer clients accounting industries that we believe will see an accelerated for a larger proportion of revenue. Despite the names of growth in the next 3 to 5 years. With the Taiwanese its major customers are not made public, we can safely government expressing great interest in increasing their assume that its largest client is the Taiwanese Military military capabilities, we saw potential in the aerospace (Customer A) as a significant proportion of its revenue is defense industry. Moreover, Taiwan was ranked 6th derived from the island’s defence budget. Additionally, globally in terms of Aerospace Manufacturing it has just clinched a huge contract to develop the fighter attractiveness in 2017, according to a report by PwC. trainer aircraft for the Taiwanese Airforce, making it unlikely that it would lose Taiwan’s Airforce as a client in the near term.
Production Sites
Taiwan Advanced Composite Centre (TACC) Location: Taichung In addition, strong recovery was shown in the global Area: 4.1 Hectares commercial aviation. Thus, we narrowed our scope to
Taiwanese aerospace companies which could best Description leverage on this trend. Following a stringent screening TACC started production late 2010. It manufacturers process, AIDC was finally chosen due to its strong team aircraft grade composite materials to meet the demand of experienced executives, deep connections with the of these materials in aircrafts. Taiwanese government and a well-developed Sha Lu/CCK Location: Taichung Area: 74.7 Hectares relationship with global companies. Furthermore, recent headways in increasing their production Description capabilities will allow AIDC to have a larger appetite to This facility focuses on Avionics & Flight Control take on more and increase their profitability. With Engineering, Harness Fabrication & Installation, Flight such developments, AIDC is poised to capitalized on a Test & Maintenance, and Aircraft Assembly & Testing. It growing market and was thus chosen as our hidden is AIDC’s largest facility and its aircraft vehicle champion. maintenance functions are being conducted here. One sentence investment thesis
Its Military Aircraft testing and production facility is also located here. Backed by a growing local defense industry and an expanding commercial market, AIDC is well-
positioned for extraordinary growth through Taichung Complex Location: Taichung Area: 29.2 considerable advancements in production capabilities Hectares and by leveraging on well-established relationships
with growing customers, giving them a distinct edge Description over their competitors. This is the home of AIDC’s headquarters, its Engineering Unit, Industrial Technology Services, which include Aircraft Parts Fabrication and Avionics Assembly & What makes it a wide-moat business? Testing. Leads Taiwan’s Aerospace Defense Industry Kang-Shan Complex Location: Kaohsiung Area: 19.2 AIDC has been in the defense industry for over 40 Hectares years, and has significant experience in the production of military aircraft. Due to multiple key Description partnerships with other global industry leaders, AIDC AIDC’s aero/industrial engine manufacturing, was able to develop their own unique production assembly, and testing units are located here. capabilities and accumulate valuable industry know- how. One notable example includes Taiwan’s indigenous defensive fighter, the ‘Ching Kuo Fighter’ How did you originate this Idea and why did you (F-CK fighter), a local variant of the F16 fighter jet choose this company? developed in a key partnership with Lockheed Martin. AIDC’s wealth of knowledge and experience Starting with a top-down approach, we looked through in manufacturing quality goods thus serves as a key 70
competitive advantage, allow them to erect high High barriers to entry barriers to entry and assert their position as an Due to the tedious and stringent certification process industry leader. This prevents competitors from for the aerospace industry, it acts as a high barrier to achieving stable growth and reduces their ability to entry for potential competitors for AIDC. This will consistently bring in orders. allow AIDC to continue to maintain their dominant position and prevent their market share from being Strong connections with government diluted. For example, Boeing’s BAC 5578 qualification AIDC’s top executives, including current Chairman for composite material tape laying, has only qualified Liao Jung Hsin, previously held high positions in 10 companies thus far. Taiwan’s military prior to joining AIDC. This ensures that AIDC would have strong connections to current How scalable and sustainable is the growth? members of the government. Given that the Taiwan military is AIDC’s biggest customer, such strong 50% of Taiwan's military budget goes to AIDC annually. governmental connections would ensure that AIDC The Taiwanese military budget is expected to increase will be able to bring in more orders and hence profit. 4% y-o-y to NT$321 billion in 2018. Hence, we forecast Moreover, as other competitors do not possess a 4% y-o-y increase in AIDC's defense revenue. similar ties, the connections would thus serve as a Forecasted growth for commercial aircraft revenue is significant competitive advantage, as strong ties will expected to be about 10% in 2018 and 7% in 2019. This able to facilitate negotiations which could be in is due to the increase in production rates and a likely AIDC’s favor. market share gain over an Austrian supplier in Airbus orders. If market share gain is successful, Austrian Possess high competency in unique capabilities AIDC supplier can double monthly orders to 60 units for its is one of the few aerospace manufacturers in Asia to new composite material plants, the TACC plants. have achieved a certain level of competence in Current TACC production rate is 10 units/month with providing a full range of service covering aerospace targets of reaching 20units/month in 2018. Moreover, R&D, system integration, testing, and manufacturing. AIDC’s Operation Expenditure is expected to remain AIDC also boast a strong core competency of airplane flat till 2019 due to declining R&D expense, indirectly body, advanced composite materials, and the world- contributing to bottom-line growth. The considerable class engineering design of avionics systems. AIDC also of length of such projects will ergo provide has strong downstream advantage due to their sustainability in AIDC’s growth for the coming years. capabilities in carbon fibre capacity. Their competitors, Toray and Toho Japan are upstream Military Arm Set for More Growth material producers, with an estimated 33% and 12% AIDC has taken up the Advance Jet Trainer (AJT) of market share of global carbon fibre capacity. Program which is spearheaded by the Taiwanese Formosa plastics in Taiwan has 7% market share of government. The project, valued at NT$65 billion, global carbon fibre capacity but it does not have begun in 2017 and is set to last till 2026. AIDC is certification for the aerospace industry yet. Thus, AIDC targeting for the first jet flight in June 2020. At the with its focus on downstream services and on aircraft same time, the delivery of the 66 training aircraft will structure parts, prove to give AIDC a competitive be spread out between 2020-26. AIDC is expected to advantage over their peers. earn NT$0.5 billion in 2017 for design, NT$3 billion in 2018/19 and NT$10 billion after delivery of all the Taiwan’s advantageous position boosts ADIC’s aircrafts. AIDC is improving their productivity to competitive advantage increase their margins. This will allow AIDC to There is a strong industry cluster support from leverage on these new projects to increase their Taiwan’s precision metal industry. Formed from two bottom line. (Macquaire, 24th Nov) major collaboration systems with 112 outsourcing partners in airplane body and engine. It enables AIDC Huge Civilian Contracts Driving up Revenue to offer better flexibilities when facing order Global demand for passenger air traffic is expected to volatilities, and also enhances the company’s ROE via grow at CAGR 4.7% between 2017 and 2036 globally higher asset turnover. AIDC will have better cost (Boeing). This will lead to an increase in demand for control, good management efficiency, better timely new passenger aircraft. In addition, there is already a delivery, and high product quality. This will allow AIDC large order backlog of commercial aircraft from big to stand out amongst a competitive global aircraft manufacturers like Boeing and Airbus in environment. addition to the substantial number of new orders. Order backlog was reported to have grown by 250% 71
for Airbus and Boeing alone. Being an upstream alliances and partnerships with its local competitors. provider of aircraft components for major aircraft By leveraging on their respective comparative and engine manufacturers, it will certainly see an advantages, as well as integrating the island’s supply increase in demand for its commercial aircraft chain. This job-sharing and joint price quotations manufacturing business, allowing AIDC to convert would enable AIDC to stay competitive and continue that backlog into revenue to capture overseas market orders.
Greater Capacity for Production Plant TACC19 Revenue Drivers Composite material production plant TACC19 is set to Replacement Demand for Fuel-Efficient Aircraft increase production capacity from 10 to 20 units per Oil prices play a huge role in an airline decision to month as of Spring 2018. AIDC then aims to further upgrade their fleet to include newer, more efficient increase its capacity to 30, to produce the necessary aircraft. Current oil prices are expected to maintain components to meet the current rate of demand of current prices above US$60/barrel with Morgan orders from Airbus. AIDC has the potentially to double Stanley raising their oil price targets by US$7 to US$9. TACC19’s output to 60 units per month, should they Additionally, an agreement between OPEC and become the sole supplier for Airbus. AIDC is projected Russia to restrict oil supply is expected to be renewed to have a market share gain as a supplier for Airbus. for another year, thus driving up the price of oil. Thus, TACC19 presents a breakthrough for AIDC to Furthermore, oil prices are also expected to remain bring in more revenue. By being able to consistently high due to a falling supply of shale oil, as a result of supply more components to airbus, AIDC will be able the current shortage of fracking crew in the US. With to boost profits. demand for oil growing faster than US shale producers Emergence of LEAP Engines in Industry are able to expand output, US is seeing their crude The LEAP engine is a high-bypass turbofan engine. inventories falling much faster than expected. Hence, Designed by CFM International for use on single-aisle crude prices are not expected to fall below current commercial aircraft, it is the modern replacement of levels in the near term. the successful CFM56 engine. With the greater use of composite materials and a higher bypass ratio of 10:1, At the current oil price of around $60/barrel, many the LEAP engine is expected to deliver up to 15% airlines are incentivised to switch to a newer fleet to reduction in oil consumption compared to the previous lower operating costs. This has led to a huge backlog generation CFM56. of new aircraft orders for both Airbus and Boeing.
With 3 variants, the LEAP engine would be able to be Fleet Expansions in Emerging Markets installed on the Boeing 737 MAX, Airbus A320neo, The Asia-Pacific Region share of global GDP is and COMAC C919. This would enable the LEAP forecasted to rise from 33% today to 40% by 2036. engine to target majority of the narrow body aircraft The increase in affluence in the region gives rise to an market. Despite the current component shortage increase in demand for air travel. As a result, it is holding back the production LEAP engines, the expected that the region would demand for over shortage is expected to be resolved in 2018. With 16,000 new aircrafts over the coming years. aircraft manufacturers transitioning from CFM56 to LEAP in 2017, and the record 12,200 orders for LEAP Strong Orders from Low Cost Carriers engines in 2017, LEAP engine production is expected 64% of the world’s jet fleet is comprised of single- to increase exponentially in the near future. aisle aircraft and is set to increase to over 75% by 2036 (Boeing). This is mainly due to the expansion of Cost Management Low Cost Carriers (LCC), which primarily uses single- With increasing competition in the global aircraft aisle aircrafts. The fleet share of LCC in the single- parts market, companies like Boeing and Airbus have aisle market is expected to grow from a quarter to a announced to suppliers their intentions of lowering third globally in 2036, totalling 11,000 aircraft in the prices of future contracts. This puts huge pressure on category. companies like AIDC as they have to compete against manufacturing firms based in lower cost, emerging These 3 factors combined showed that there is a market economies. The price reductions quoted are huge demand for aircraft in the short to medium in the range of 10-25%, severely cutting profit term. With AIDC positioned as a tier 2 supplier, it margins.To remain competitive, AIDC consolidated would benefit greatly from this future expected the Taiwanese aerospace industry by creating growth.
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Expanding Taiwanese Defence Budget Insights into the Corporate culture Taiwan's defense expenditure is expected to increase President & acting CEO – Lin, Nan-Juh at a CAGR of 4.41% between 2015 to 2020 and 6.75% Lin Nan-Juh has been with the company since 1995. between 2021 and 2026 (BMI Research). This increase Started as a Senior Engineer, before moving up to in Military expenditure is largely a response to China's Director of Technology and Services Department in double-digit growth in defense investments. With the 2007. Subsequently, he moved on to become the Senior Chinese military actively improving their hardware, Vice President of AIDC in 2009, before being finally Taiwan is hard pressed to rejuvenate their ageing promoted to President in 2017. Lin’s long- term ties military, with its frontline F16 jets pushing 20 years with the company reflect his dedication to the old. With majority of arms exporting countries betterment of AIDC. Furthermore, his continued unwilling to sell military equipment to Taiwan in the presence in the company not only proves his knowledge face of China’s diplomatic pressure, the Taiwan is of the company workings, but also the know-how in the shifting its focus to developing its local defense industry. Respected by his employees, we believe AIDC industry to meet its military needs. This is positive will prosper under Lin’s leadership, experience and news for AIDC as 50% of its revenue derives from the guidance. state’s defense budget. A growing defense budget and the shift to indigenous arms producers will benefit Management Philosophy AIDC in the long run in the form of sustainable growth. AIDC’s vision to be a world class aerospace and technology provider. Their corporate philosophy and Long Term Engagement for Maintenance of Fighter culture revolves mainly around accountability, Trainers continued innovation, dedication and customer Fighter jets require a comprehensive maintenance orientation, with the goal of achieving efficiency, schedule to ensure its combat readiness. With AIDC quality and customer satisfaction. Under its ‘Good being the sole producer of the trainer jets, it would be Faith and Integrity Policy’, AIDC declared their engaged in the jets maintenance over the long term. commitment to engage solely in ethical business Thus, a proportion of its revenue related to aircraft practices, as well as to provide goods and services of maintenance would be secured. high standards.
Management Quality As a result of their Quality Management and sound corporate values, AIDC was able to earn multiple Shareholding Structure accreditations from numerous third parties, certifying Authorized Shares Issued: 1,500,000,000 AIDC’s quality of goods. Notable parties include Outstanding Shares: 947,870,000 Number Boeing, Airbus and Rolls-Royce. AIDC also received the of Shareholders: 23,402 International Organization for Standardization (ISO9001) accreditation. Therefore, validation from Corporate Governance both internal and external parties leads our team to Under its corporate governance structure, AIDC has its believe that AIDC is under reliable management. own audit committee to eliminate any fraud and to ensure reliability in its financial reporting. AIDC also What are your top 3 dislikes? has compensation committee to evaluate and execute compensation policies, as well as the remuneration of High Dependence on Taiwanese Defence Spending directors. With currently three independent directors 48% of AIDC’s revenue comes from the Taiwanese in the committee, this ensures that the salaries of the government in the form of defense contracts. With such executives are fair and not excessive. a high dependence on the government, it would be more susceptible compared to its peers as a slowdown in the Additionally, AIDC was ranked top 20% in the Taiwanese economy would significantly hamper the Corporate Governance Evaluation TWSE listed government to provide defense contracts that AIDC is companies by the Securities and Futures Institute in relying heavily upon. However, our team believes it is a April 2016. AIDC was also awarded the 12th term “CSR double-edged sword. Given the long-term nature of Award in Traditional Manufacturers Category” by the projects AIDC has undertaken, such as the AJT, there Global Views Magazine in May 2016. These accolades exists stability in its cash flows, which is largely serve as testaments to the reliability of AIDC’s independent from government spending for the next 5 management. to 10 years. Moreover, partnerships with other companies in the
73 commercial sector serve as a form of diversification for Company direction AIDC, reducing its reliance on its defense sector and ensuring revenue. The increase in orders from both the defense and commercial aerospace industry will boost AIDC’s top- Susceptibility to Oil Prices line growth. AIDC has also seek to improve their Demand for new aircraft is also closely tied to oil prices. production capabilities by launching automated A higher oil price would increase the attractiveness of warehousing and increasing plant efficiency. This will newer, more efficient aircraft for airliners. In contrast, a allow AIDC to improve their margins. Thus, AIDC can lower oil price would dissuade airliners to upgrade their leverage on their top-line growth with wider margins to fleet as cost of financing a new aircraft would not justify increase their bottom-line. A boost in profitability will the fuel savings reaped from the more efficient aircrafts. act as a catalyst to increase the company’s value As AIDC’s revenue from its civilian aviation arm is positively correlated with oil prices, a fall in crude oil Reasons for investing now prices would negatively impact the company's bottom line. With the onset of a plethora of projects that AIDC will Fortunately, current oil prices are expected to maintain add into their portfolio, the team is positive that AIDC’s current prices above US$60/barrel with Morgan Stanley 4Q17 quarterly report that is released in 1Q18 will have raising their oil price targets by US$7 to US$9. a strong showing. Investing now will allow investors to Additionally, an agreement between OPEC and Russia to leverage on the low valuations currently to make a restrict oil supply is expected to be renewed for another larger profit later. Furthermore, as we move towards year, thus driving up the price of oil. the holiday season the commercial aviation industry will enjoy a stronger demand for their services. This Furthermore, oil prices are also expected to remain high means that suppliers of airplanes and related services due to a falling supply of shale oil, as a result of the will also see a boost in revenue. current shortage of fracking crew in the US. With (TSEC:2634) Aerospace Industrial Development CorporationFY2014 FY2015 FY2016 FY2018LTM demand for oil growing faster than US shale producers Share Price TWD 34.76 40.69 37.03 37.70 No of Shares (mil) 941.9 941.9 941.9 941.9 are able to expand output, US is seeing their crude MCAP (mil) USD 1,047 1,192 1,147 1,185 Net Debt (Cash) TWD 6,484 8,637 8,506 12,375 inventories falling much faster than expected. Enterprise Value (mil) USD 1,281 1,433 1,401 1,598 Revenue (mil) TWD 24,924.0 26,878.2 27,325.5 26,255.9 Hence, crude prices are not expected to fall below EBITDA (mil) TWD 2,243.4 2,779.4 3,422.7 3,219.5 current levels in the near term (Morgan Stanley). EBIT (mil) TWD 1,454.4 2,153.7 2,725.9 2,367.1 NPAT (mil) TWD 1,871.5 2,029.2 2,082.7 1,735.9 NPAT (Ex.Xtra + Dis.Ops) (mil) TWD 1,694.5 1,891.4 2,298.4 1,996.6 CFO (mil) TWD (5,749.7) 2,405.0 4,533.6 2,770.8 Overreliance on a single revenue stream CAPEX (mil) TWD (726.2) (362.2) (689.8) (161.1) EPS TWD 1.8 2.0 2.4 2.1 60% of AIDC’s revenue comes from commercial aircraft Revenue (mil) USD 785.3 815.1 843.2 865.2 EBITDA (mil) USD 70.7 84.3 105.6 106.1 parts, delivery schedule of which is influenced by macro EBIT (mil) USD 45.8 65.3 84.1 78.0 NPAT (mil) USD 59.0 61.5 64.3 57.2 condition. For example, during the financial crisis in CFO (mil) USD (181.2) 72.9 139.9 91.3 2008-09, there was a significant drop of aircraft new CAPEX (mil) USD (22.9) (11.0) (21.3) (5.3) GPM (%) 11.1% 12.1% 15.1% 14.0% orders and delay of delivery. This caused AIDC’s shares EBIT (%) 5.8% 8.0% 10.0% 9.0% Net Debt (Cash) / Equity (%) 63.0% 74.9% 68.8% 98.5% to fall drastically due to reported losses. ROA (%) 5.7% 7.5% 8.8% 6.9% ROE (%) 14.1% 18.7% 22.1% 18.8% CFO/TA (%) -22.7% 8.4% 14.6% 8.0% EV/ Sales (x) 1.6 1.7 1.6 1.8 Furthermore, the bulk of their clients are civilian aircraft EV/ EBIT (x) 27.0 21.8 15.9 20.2 EV/ EBITDA (x) 17.5 16.9 12.7 14.9 carriers that do not have a strong ability to raise ticket EV/CFO (x) (6.8) 19.5 9.6 17.3 prices. Given the nature of the airline industry, firms are P/Sales (x) 1.3 1.4 1.3 1.4 P/EBIT (x) 22.5 17.8 12.8 15.0 unable to raise prices given that casual travellers P/B (x) 3.2 3.3 2.9 2.9 VQ1: EV/EBIT/ROE (x) 1.9 1.2 0.7 1.1 consider air tickets a luxury good that can be easily VQ2: EV/EBIT/ROA (x) 4.7 2.9 1.8 3.0 forgone. This is especially true should a financial crisis hit. This puts pressure on AIDC, because civilian airlines would be unable to generate sufficient earnings to maintain the purchase of components.
This also mean that their clients will most probably pressure AIDC to lower their prices. AIDC will also find it difficult for them to increase prices on the products sold to clients.
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9. Xinyi Solar Holdings Ltd (SEHK:968)
Company Research & Report
Quick Stats Date 15/12/17 EBIT/R&D (x) 17.84 EBIT/Employee No. Filing Currency HKD (USD /px) 100K Share Price HKD3.0 EV/EBIT (x) 9.9 No. of Shares (Mil) 7,423.9 EV/EBITDA (x) 8.5 Market Cap (USD Mil) 2,536.7 EV/CFO (x) 58.7 Daily Value Traded (USD Mil) 4.1 P/Sales (x) 2.4 GPM (%) 36.8% P/E (x) 7.5 EBIT (%) 32.5% P/B (x) 2.3 Net Debt (Cash) / VQ1: EV/EBIT/ROE Equity (%) 55.4% (x) 0.3 VQ2: EV/EBIT/ROA ROA (%) 11.8% (x) 0.8 ROE (%) 29.5%
Team Members
Huang Hao is a second-year business student pursuing a major in Finance at NUS Business School. He is highly passionate about the financial markets and is also a global macro research analyst in NUS’s Investment Society.
Nicholas is a second-year undergraduate at the NUS Business School majoring in finance. He is an equity research analyst in the NUS Investment Society and has undertaken various internships to better ground his knowledge of the markets.
Yuchong is a first-year undergraduate at NUS Business School, planning to specialize in finance. He is also an equity research analyst in NUS Investment Society. He did an internship as an equity research analyst at Integer Alpha, a proprietary trading firm.
Nicklaus is a first-year undergraduate at the School of Computing majoring in Business Analytics. He has a keen interest in finance and is an Equity Research Analyst in the NUS Investment Society.
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Company Background HK$2,090m of revenue. Other countries, including the Xinyi Solar (XYS) is a Hong Kong based company which European Union, make up the remaining HK$357m. principally engages in the manufacturing and sales of XYS also aims to broaden overseas opportunities -- it solar glass products. It has captured an estimated 30% acquired a 60% stake in Polaron Solartech Corporation of the global market share for solar glass. XYS was spun in April 2016, and also conducted a feasibility study on off by parent company Xinyi Glass (XYG) in 2013, which a solar farm project in Cambodia. retains a significant 26.4% equity interest in XYS. PV Glass Xinyi Solar has 3 operating segments: The PV glass segment boasts a stable and diversified (1) Sales of Solar Photovoltaic (PV) glass client base, with more than 100 customers such as (2) Solar Farm Business, which includes Solar Yingli Solar and Trina Solar, among the world’s largest Farm Development and Solar Power solar panel manufacturers. XYS has many longstanding Generation and stable relationships with its customers. XYS’s (3) EPC (Engineering, Procurement, Construction) domestic market China accounts for more than 80% of services sales from this segment, with China alone accounting for more than 70% of global solar module production. Major solar glass products include: fully finished tempered anti-reflective coated pattern solar glass, ultra-clear photovoltaic (PV) raw glass, ultra-clear PV processed glass and back glass. These products are usually sold further downstream in the value chain, to be manufactured into solar panels. XYS has 3 manufacturing bases, with 2 in China (Tianjin and Anhui) and one in Malaysia (Malacca). Aggregate daily production capacity of its facilities amounts to 6,800 tons, meeting 40% of global demand for PV glass. Figure 1: FY16 Revenue Breakdown by Business Segments (Source: Company Financials) Solar Farms
Of the HK$6,007m of revenue generated in 1H17, HK$2,447m came from the sales of solar glass, HK$735m was from the generation of electricity from solar power, and HK$2,128m was from EPC services. EPC projects are mostly one-off or ad- hoc in nature, and therefore is considered to be supplementary income source but not a key growth driver of the group.
Figure 3: A solar farm owned by XYS (Source: Company)
XYS entered the solar farm business in 2014, commencing with 2 solar farms of aggregate capacity of 250MW in 4Q14. Since then, the total approved grid-connection capacity has grown at a CAGR of 85% to 1,584MW at present, with about half the plants having a weighted average feed-in tariff (FiT) of 1.0
Figure 2: FY16 Revenue Breakdown by Geography RMB/kWh (see Appendix 1). XYS currently owns 22 (Source: Company Financials) solar farms, of which 19 are grid-connected and 17 are China is the main market for Xinyi Solar, comprising in operation.
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EPC Services According to SolarPower Europe, the global PV XYS is engaged to provide EPC services for solar farms installation was 76.6 gigawatts (“GW”) in 2016, up in China. It also constructs the solar farms that it from 51.2GW in 2015, representing a year-on-year operates. XYS considers EPC services to be one-off or growth of 50%. The world’s two largest markets, China ad hoc in nature, rather than as a source of predictable and stable revenue, owing to the short construction and the United States, both saw unprecedented period for distributed solar projects and the installation levels. China added 34.5GW of grid- unpredictability of government tenders. While XYS connected installations in 2016, a 128% annual focuses mainly on solar glass manufacturing and increase. Annual installation in the US also grew constructing and operating solar farms, it takes on significantly, from 7.5GW in 2015 to 14.8GW in 2016, opportunistic EPC contracts when available. an increase of 97%.
1 Year Stock Price Chart Investment Thesis – Originality and Relevance Unwarranted Underperformance VS Hang Seng Index The team wanted to choose a company based on a few on LTM basis factors:
1. Top-down approach: Explore a growth trends and narrow down geographically 2. Companies with a wide economic moat and significant growth opportunities in high growth economies 3. Strong insider ownership and management expertise
We explored underlying growth trends in the world economy today to decide on the sector to focus on, Industry Background before narrowing down geographically. One of the key themes in today’s world is the topic of renewable energy, the market for which has been growing exponentially over the past 2 decades and has good long-term prospects. We decided to focus on renewable energy in a high-growth Asian market with increasing energy needs -- China.
The renewable energy sector in China has taken off the past decade, spurred by the support of the Chinese government toward renewable energy initiatives. This bodes well for companies linked to the solar energy
value chain, from the manufacture of components to Under the Chinese government’s 13th Five-Year Plan, a the generation of energy. 2.4 trillion-yuan package for renewable energy was unveiled, which includes a significant 1 trillion yuan Xinyi Solar encompassed all of the qualities listed investment for solar energy. Based on the latest above, strategically positioned from the upstream to guidance from the National Energy Administration the downstream in the solar value chain. It boasts (NEA), newly installed solar capacity is likely to reach market-leading technology and is poised to reap the 86.5GW over the next few years, implying overall benefits of China’s renewables drive, leveraging on the nationwide capacity of close to 200GW in 2020. This is expertise of its management and its ability to benefit likely to incite continuous demand across the solar from economies of scale due to its size. power value chain.
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Business Model Quality Analysis (NEA) has set targets for 150GW of solar power We believe that a committed management team, loyal installation by 2020, which will incite continuous customer base, prudent emphasis on R&D capabilities demand across the solar power value chain. Being the and growth prospects in the long run provides the market leader in solar glass manufacturing and PV glass impetus for XYS to stay ahead and be at the forefront of technology, Xinyi is poised to be a major beneficiary of the rapidly growing solar power industry. China’s renewable push.
A Strong Economic Moat Vertical integration of upstream (solar glass) and downstream (solar farms) businesses also unlocks According to JP Morgan, XYS is the largest solar glass unique synergies for XYS, enabling it to capture growth manufacturer in the world, with a market share of opportunities in a broader spectrum of the solar value about 30% and boasting an aggregate daily melting chain. It benefits from both increased demand for solar energy products, while also tapping into the lucrative capacity of 6,800 tonnes. In comparison, the second solar power generation market. largest solar glass manufacturer in the world, Flat Glass group has a market share of about 15%. Xinyi’s High IRR Solar Farm Operations industry-leading production lines are highly XYS boasts a unique integration of solar glass production automated and fully integrated, enabling economies of and solar power generating operations, which highly scale and production efficiencies to be realized, complement each other, while simultaneously translating into cost-efficient operations. Regular capitalizing on the industry’ strong growth. The current maintenance programs ensure production facilities industry average internal rate of return (IRR) for solar function at optimal efficiency and achieve consistent projects is around 8-12%, but we believe that XYS’ solar output quality. farms IRR will increase over the coming years. This Xinyi also considers R&D as one of its main priorities to higher average IRR is a result of low financing and construction costs. The former is attributed to its ability stay ahead of the competition, investing heavily in to secure offshore debt and strong backing from its research to build and maintain the competitive parent, while the latter is mainly attributed to its strong advantage in products and solutions, such as through in-house EPC team becoming increasingly efficient as cooperation with various scientific research compared to hired third-party EPC service providers. institutions to build research platforms. Solar power generation also improves the predictability The solar glass industry has high barriers to entry as a of XYS’ revenue stream. While feed-in tariffs may be result of maturity of existing companies and the high changed by the government, solar irradiation and costs of R&D to gain an initial competitive advantage. irradiation hours are approximately constant Coupled with the seamless manufacturing processes throughout the year. and continuous improvement XYS has undergone, this has built a large economic moat for XYS, thus enabling it Low Leverage Leaves Room for M&A to thrive in an increasingly competitive environment In April 2016, the acquisition of 60% equity interest in while ensuring its long-term competitiveness. Polaron Solartech Corporation, a solar power system Longstanding customer relationships with the world’s provider in Canada, has marked a successful start of the largest solar panel manufacturers also improve Group in this aspect. The Group is continuing its effort customer loyalty and retention, giving XYS the to explore other downstream solar opportunities in unparalleled edge in the industry overseas countries and it has just been granted the permission to conduct a feasibility study on a solar farm Analysis of Business & Growth Opportunities project with a capacity of 100MW in Cambodia, to further achieve strategic overseas expansion. Riding the Solar Energy Wave Furthermore, the company has been sitting on excess cash with 843M in 2016 and 2,449M in 30 June 2017 according to the Xinyi’s Interim Report 2017. This puts China’s 13th Five year plan continues to emphasize the company in a favourable position to engage in green development, a potential boon for XYS as China capital projects or capture acquisitions opportunities aims to advance the energy revolution by ramping up moving forward which will cement XYS’ position as the the exploration of clean, safe resources such as solar leading solar glass manufacturer in China. energy. Also, China’s National Energy Administration 78
Management quality analysis 4) Remuneration Structure
1) Industry Experience and Expertise Referring to Appendix 3, XYS’ remuneration structure ties management interests with shareholders’ The chairman, Datuk Lee Yin Yee joined the group since interests. Management’s compensation is based on responsibility, and a discretionary bonus is issued 2006 and has 27 years of experience in the glass based on performance. This incentivizes industry. He is also the founder of parent company management to focus on long term sustainable Xinyi Glass, which has a 26.4% stake in XYS. Vice growth, while also reducing agency risk from chairman Tung Ching Sai joined the group in 2006. occurring in the firm. Prior to his position, he worked in XYG for 27 years ever since its inception. He is currently an executive director Catalysts, Events, Tipping Point and the CEO of XYG. In the Right Place at the Right Time Current CEO Lee Yau Ching, son of Datuk Lee, has been the CEO of Xinyi Solar Holdings since Jan 2011. Mr Lee Therefore, XYS’s market position as the largest solar started his career in XYG and served as its COO prior to glass manufacturer, and its timely foray into solar his appointment as XYS’s CEO. He brings with him 18 power generation, allows it to capitalize on China’s years of experience in the solar Industry, and a 13th 5-year plan, as the Chinese government pushes thorough understanding of XYS’s operations. Mr Lee for more clean energy. Well integrated in the solar also has a 3.7% stake -- given the nature of XYS as a value chain, and a trusted supplier to the world’s family business, we expect Mr Lee to remain invested largest solar equipment firms, combined with an for the long run. established track record in China, XYS’ competitive
advantage will be well manifested when demand 2) Large insider ownership across the solar value chain takes off.
As the world shifts to more sustainable means of energy production, XYS looks poised to continue capturing new growth opportunities beyond its home market by further expanding production, achieving even greater economies of scale in the process. XYS plans to add two more 1,000-tonne production lines in Malaysia, which are scheduled for production
launch in 4Q18 and mid-2019 respectively. The new Parent company Xinyi Glass (XYG) is XYS’ largest lines are projected to be accretive to revenue in 1Q19 shareholder. XYG is itself 20.9% owned by Datuk Lee, and 3Q19 respectively. and 9.2% owned by Tung Ching Sai. Large insider ownership represents a strong alignment of Hence, we believe that the market has overlooked XYS’ management’s interests with its shareholders, and is strong position and capable management, as well as its a further reflection of the Lee family’s dedication capabilities to maintain its leading position in this period toward their business. of industry transformation. We believe that its value will be unlocked over the coming 3-5 years as the solar 3) Insider Buying - A Vote of Confidence industry in China and across the world shifts into higher gear. Members of management, in particular the Datuk Lee and Vice-chair Tung, have been increasing their stakes Risks in the company for much 2H17. Datuk Lee made a significant purchase of 475m shares in April, bringing Increased Cost of Production his total stake to to 12.6%. This speaks well about the confidence that the management has in the success XYS is highly reliant on energy and raw materials for its of the company. solar glass production. One of the main resources (refer to Appendix 2) required is natural gas, accounting for about 40% of the cost of production -- the rising cost of which poses a short-term risk. A spike in the cost of natural gas could hurt XYS’ bottom line. 79
Intensified Competition
While we expect XYS to retain its market leadership in solar glass, the possibility of new competitors entering this lucrative space cannot be ruled out. Incumbent players are likely to capitalise on the government’s 5- year plan to expand capacity and sales. We foresee that competition is likely to intensify as a result. This could potentially put pressure on industry-wide margins and a dilution of XYS’ growth and market share.
Reduction in Government Subsidies
Grid curtailment and delays in Feed-in tariff (FIT) subsidy payments could negatively affect the cash flow and liquidity of the XYS. Subsidies could also fall as a result of solar power approaching grid parity in 2020. Significant reductions in subsidies will also lower solar farm project IRR.
Foreign Exchange Risk
As the main bulk of the revenue (92% of 1H17 revenues) is derived from mainland China, and also with a majority of trade bills and receivables denoted in RMB, XYS faces considerable currency risk. Since the HKD is its reporting currency, depreciation of RMB against the HKD would result in currency translation losses. This risk is partially mitigated by the XYS’ policy of entering into currency hedges as it deems fit. Furthermore, XYS also has a factory in Malaysia, making it susceptible to foreign exchange risk against the MYR.
(SEHK:968) Xinyi Solar Holdings Limited FY2013 FY2014 FY2015 FY2016 FY2018LTM Share Price HKD 2.32 2.41 2.76 2.48 2.67 No of Shares (mil) 5,700.0 6,580.0 6,748.8 6,748.8 7,423.9 MCAP (mil) USD 1,705 2,045 2,401 2,154 2,537 Net Debt (Cash) HKD (279) 710 631 5,672 4,964 Enterprise Value (mil) USD 1,171 1,668 2,798 2,760 3,349 Revenue (mil) HKD 1,967.5 2,410.0 4,750.4 6,007.1 8,141.8 EBITDA (mil) HKD 465.9 681.9 1,570.4 2,836.4 3,094.2 EBIT (mil) HKD 368.5 589.8 1,348.9 2,440.1 2,645.9 NPAT (mil) HKD 303.8 493.0 1,205.6 1,985.6 2,124.7 NPAT (Ex.Xtra + Dis.Ops) (mil) HKD 303.6 506.1 1,144.0 1,977.4 2,117.9 CFO (mil) HKD 653.7 715.0 851.1 680.8 446.1 CAPEX (mil) HKD (239.7) (2,321.7) (3,531.7) (4,621.9) (2,640.4) EPS HKD 0.1 0.1 0.2 0.3 0.3 Revenue (mil) USD 253.7 310.8 612.9 774.7 1,043.0 EBITDA (mil) USD 60.1 87.9 202.6 365.8 396.4 EBIT (mil) USD 47.5 76.1 174.0 314.7 338.9 NPAT (mil) USD 39.2 63.6 155.6 256.1 272.2 CFO (mil) USD 84.3 92.2 109.8 87.8 57.2 CAPEX (mil) USD (30.9) (299.4) (455.7) (596.1) (338.2) GPM (%) 30.1% 31.6% 36.0% 45.8% 36.8% EBIT (%) 18.7% 24.5% 28.4% 40.6% 32.5% Net Debt (Cash) / Equity (%) -12.1% 21.5% 11.0% 91.2% 55.4% ROA (%) 13.7% 10.2% 10.6% 14.5% 11.8% ROE (%) 16.0% 17.8% 23.5% 39.3% 29.5% CFO/TA (%) 24.3% 12.4% 6.7% 4.1% 2.0% EV/ Sales (x) 6.6 6.9 4.3 3.9 3.2 EV/ EBIT (x) 35.1 28.1 15.1 9.7 9.9 EV/ EBITDA (x) 27.8 24.3 13.0 8.3 8.5 EV/CFO (x) 19.8 23.2 24.0 34.7 58.7 P/Sales (x) 6.7 6.6 3.9 2.8 2.4 P/EBIT (x) 35.9 26.9 13.8 6.9 7.5 P/B (x) 6.2 5.1 3.3 2.8 2.3 VQ1: EV/EBIT/ROE (x) 2.2 1.6 0.6 0.2 0.3 VQ2: EV/EBIT/ROA (x) 2.6 2.7 1.4 0.7 0.8
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10. Teijin Limited (TSE:3401)
Company Research & Report
Quick Stats Date 15/12/17 EBIT/R&D (x) 1.89 EBIT/Employee No. Filing Currency JPY (USD /px) 30K Share Price JPY2,401 EV/EBIT (x) 11.6 No. of Shares (Mil) 196.8 EV/EBITDA (x) 7.0 Market Cap (USD Mil) 4,191.2 EV/CFO (x) 10.6 Daily Value Traded (USD Mil) 33.0 P/Sales (x) 0.6 GPM (%) 32.8% P/E (x) 7.0 EBIT (%) 8.5% P/B (x) 1.5 Net Debt (Cash) / VQ1: EV/EBIT/ROE Equity (%) 75.2% (x) 0.7 VQ2: EV/EBIT/ROA ROA (%) 7.0% (x) 1.6 ROE (%) 17.5%
Team Members
Jia Jun is a first-year Accountancy and Business double degree student at Nanyang Business School. He intends to specialise in Banking and Finance. He is a member of NTU’s Nanyang Capital.
Joby is a first-year Business student at Nanyang Business School, intending to specialise in Banking and Finance. He is a member of NTU’s Nanyang Capital.
Yi Yan is a first-year Business student at Nanyang Business School. He intends to pursue a specialisation in Banking and Finance. He is a member of NTU’s Nanyang Capital.
Jian Rong is a first-year Accountancy student at Nanyang Business School. He is also a member of NTU’s Nanyang Capital.
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How did you originate this idea? 2. Strong Management and ESG Initiatives What differentiates Teijin Ltd from its competitors is We first researched on the sectors that we felt had that Teijin Ltd has a strong management system that strong potential growth as well as looking at growing perpetually strives to achieve their goals tagged with trends in the APAC region. After thorough research, our their intensive ESG initiatives. Hence, Teijin Ltd will be team has chosen to focus on the growing sector of able to maintain its position as a market leader and stay Electric Vehicles (EV). We studied the value chain in ahead of its competitors. Teijin Ltd believes in detail to search for companies which will benefit from sustainable development and has a heart for the society the increasing demand for EVs whilst considering if the and the environment. By including diverse workstyle, stock has already priced in the existing information. while reducing environmental impacts through their After shortlisting a few potential companies, we further intensive ESG initiatives, Teijin Ltd aims to be an analysed the company’s fundamentals and their enterprise of tomorrow. With a better organization business model and finally settled on Teijin Ltd. culture, they will be able to attract a better talent pool and aim for greater heights. Company Overview & Business Background
3. Positioning to Capture the Growing Industry Established in 1918, Teijin Ltd is a Japanese company Backed by the strong management, our team believes operating in the commodity chemicals industry and is a that Teijin Ltd will be strongly positioned to capture the constituent of the Nikkei 225 stock index. The company's potentials in fast-growing industries through plans set brand statement is "Human Chemistry, Human out by management. We reckon that the market is Solutions", where it strives to enhance the quality of currently still uncertain whether Teijin Ltd will be people's lives globally. Currently, Teijin Ltd sells its successful in their expansion plans into multiple new products in 83 countries. industries while concurrently focusing on their non- financials. However, we strongly believe that Teijin Ltd will be able to achieve great success with its wide moat Teijin Ltd's main business is materials, which provides business model and it is undoubtedly a hidden champion high-performance fibers such as Aramid and Carbon with high growth potential. Fibers, Resin and Plastics processing as well as Polyester and Polycarbonate films and sheets. Today, it also has a Business Model Quality Analysis healthcare segment providing products such as therapeutic oxygen concentrators and pharmaceuticals, Sustainable Leading Market Position as well as an Information Technology segment providing Teijin Ltd is a market leader in its own fields within the e-comics services. commodity chemicals industry. Its production of para-
aramid fibres -- Technora and Twaro commands 50% of For FY2017, revenue decreased 6.3% year-on-year (yoy) the market share for high performance materials. Teijin from JPY790.75 billion to JPY741.3 billion, largely Ltd also has the top share in the market for meta-aramid attributable to the halt of Singapore's resin production plant. However, gross profit margin and net profit fibres, textiles, resins and plastics processing. The margin improved from 32.2% to 33.5% and 3.9% to 6.8% company is also one of the world's top three respectively as a result of lower cost of goods sold and manufacturers for carbon fibres. Recently, it has also fixed expenses from restructuring initiatives. acquired CSP, the world's largest sheet molding compound manufacturer for automakers. The demand Why is this company a hidden champion? for its differentiated products is expected to grow in lieu of the increasing need for higher-performance,
1. Strong Business Model and Sustainable Growth lightweight automobile components due to tighter In the materials and healthcare industry, Teijin Ltd environmental regulations. remains as one of the top market leader. It has many patented and differentiated market-leading products With over 40 years of expertise, Teijin Ltd is also within the industry. With the management's clear successful in its healthcare business. Currently, it holds objectives, they have acquired CSP, which is the world's the largest customer base in Japan for home oxygen largest sheet molding compound manufacturer for therapy, with market share over 50%. Another automakers. Teijin Ltd is continuously seeking to further successful product it has under its belt is the Continuous enhance their business model to ensure a sustainable Positive Airway Pressure (CPAP) ventilator SLEEPMATE growth. for sleep apnea syndrome, with a market share of 40%. In addition, it has also established a top share in the market for hyperuricemia and gout treatments, in which
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it has further secured exclusive distribution agreements for its pharmaceutical division covering 117 countries.
Our team believes that Teijin Ltd's superior product offerings have not only securely cemented its foothold in the market, it also enables the company to leverage on its bargaining position for a better and continuing relationship with its key stakeholders, particularly suppliers. The diversity of its product offerings also enhances the stability and quality of the firm's earnings and cash flows by reducing the interdependency and concentration of supplier and customer base, in face of changing and cyclical market conditions.
Strong R&D and Technological Capabilities Management Quality Analysis Our team believes what distinguishes Teijin Ltd from its Shareholding and Business Group Structure competitors lies in its cutting-edge technologies in the research and development of its products. It has also I. Authorized number of SharesL 600,000,000 been at the forefront in the revolution of key industry shares segments. An example of Teijin Ltd's success is the use II. Number of Shares Issued: 196,951,733 of thermoplastic resin in carbon-fiber reinforced plastic shares (CFRP). The company was able to outsmart its III. Number of Shareholders: 83,726 competitors to mass produce the product by simplifying and reducing the manufacturing time to one minute. This is evident in its role as the manufacturer of the world’s first polycarbonate-resin pillar-less automotive front window of the Tommykaira ZZ, an electric vehicle designed by Green Lord Motors. Other successes are the development of NANOFRONT® technology, the world's first, ultra-fine nanofiber and miraim, a high- performance membrane for vapor-liquid separation usage in the automotive industry such as fuel cells.
With its strong technological expertise, Teijin Ltd has not only positioned itself strongly in a niche market where barriers to entry are high, its sheer size enables Teijin Ltd to enjoy economies of scale to keep costs low amidst Corporate Philosophy volatile periods and better customer retention to Teijin Ltd’s brand statement is “Human Chemistry, sustain revenue streams. Human Solutions”. Its long-term vision is “Teijin will become an enterprise that is essential to tomorrow’s Revenue Breakdown by Segments: society by continuously creating value”. It strongly believes in growing in a sustainable manner with the progress of society by solving social issues through innovative means and anticipating changes in the external environment. It has identified “Environmental Value Solutions”, “Safety, Security and Disaster Mitigation” as well as “Demographic Change and Increased Health Consciousness” as its core priority fields.
The company places huge emphasis on the Environmental, Social and Governance (ESG) aspect. Under the leadership of their Chief Social Responsibility Officer, Teijin Ltd promises to keep delivering real value through the development of chemical technologies that are friendly to both people and the environment with 83 their own CSR Management System. Teijin is a member Despite having higher gross margins and ROE as of the United Nations Global Impact and they adhere to compared to its peers, Teijin Ltd is priced cheaper at a international standards like the Paris Agreement to limit TEV/EBITDA multiple of 6.8x than the industry average their carbon footprint and provide assurances to the of 8.9x. We reckon that this mispricing is due to safety of their consumers on top of providing quality. As increased investor cautiousness towards Teijin Ltd's of 2012, they have reduced greenhouse gas emissions recent ability to grow its revenues in the commodity from manufacturing operations and total water chemicals industry, having decreased by 6.25% discharge by approximately 20% and chemical compared to the sector's 3.47%, as well as its ability to substance emissions by almost 40%. finance the announced JPY300 billion in capital expenditures over the next 3 years. CEO
Mr. Jun Suzuki has been the Chief Executive Officer and We differ from the market consensus as we believe that President of Teijin Limited since April 2014 and serves as the lower revenue growth was attributable to one-off a member of the advisory board. Mr. Suzuki was also events such as the recent halt of Singapore's production previously General Manager of Advanced Fibers & plant, and not from deteriorating operations. Composites Business Group since April 2013 and Chief Furthermore, our team feels that not only would Marketing Officer of Teijin Ltd since April 2012. Since his revenue grow over the next few years, Teijin Ltd will also appointment, Teijin Ltd’s gross profit and EBITDA be able to fund its capital expenditures from the margins has grown from 24.8% to 33.5% and 8.1% to potential increase in operating cash flows based on our 12.9% respectively. Identifying and anticipating investment theses. potential market growth, Mr. Suzuki recently announced a new medium-term management plan that Top 3 Dislikes clearly articulates his aspirations and actions to be taken to ensure Teijin Ltd’s future success. Our team is 1. High Cash Conversion Cycle optimistic that Teijin Ltd will achieve even higher Teijin Ltd’s Cash Conversion Cycle (CCC) has increased performance results under Mr. Suzuki’s strong drastically, up to a current CCC of 110.94 from 78.0 in leadership and visions. 2014. The growing increase in CCC is mainly attributable to an increased Days Inventory Outstanding (DIO). This was largely caused by a downturn in spending on Remuneration Structure Teijin Ltd adopts a performance-based remuneration apparel and sales of automotive interior materials and system to compensate its directors. The amount of equipment. However, Teijin Ltd's CCC is slightly below remuneration is determined according to the the industry average of 112.46 and it is not a cause for consolidated ROA and additionally based on the alarm. Our team believes that that this characteristic is consolidated ROE, improvement of operating income, due to the current market condition and it is not likely to persist over the long term. achievements relative to budgets and an evaluation of the director’s performance. The Advisory Board 2. Too Ambitious evaluates the CEO and deliberates on the specific Under the new medium-term management plan for remuneration for the CEO, which is then decided by the FY2017 - FY2019, Teijin Ltd aims to achieve many targets Board of Directors. The remuneration structure aligns in the short period of time. While trying to improve management interests with shareholder’s interests profitability with their growth and transformational since management is rewarded based on the company’s strategies, they are concurrently aiming for corporate performance and ratios, reducing agency risks from governance, diversity and reduction of environmental occurring in the firm. By rewarding directors on long impacts. Our team feels that Teijin Ltd should focus on term improvements to the company’s operations, it prioritising the success of their plan in growth and prevents management from foregoing stable long-term transformational strategies before focusing on the other growth to achieve short term gains. targets.
Why is the stock mispriced? 3. High Financial Leverage
Teijin Ltd has a higher Net Debt/EBITDA ratio of 2.3 compared to the industry average of 1.49. This impacts the company's creditworthiness and ability to take on more debt in the future, which would affect its future interest costs and access to debt. We feel that this is an important factor to consider as not only would it would affect Teijin Ltd's competitiveness, less access to capital would potentially hinder its daily activities. 84
However, this ratio has been decreasing from its peak of to strong government initiatives, the trend of switching 3.9 in 2014. Furthermore, Teijin Ltd's current Interest from conventional vehicles to EVs in China is likely to Coverage Ratio is 44.4. This suggests that the company continue in the future, where the CAGR of EVs in China does not have an issue paying off its short-term debts is estimated to be at 30%. despite it being lower than the industry average of 65.87. Though it is not ideal to have a high Net To strengthen supply chain in the Chinese market, Teijin Debt/EBITDA ratio, our team is confident that it can be Ltd acquired Continental Structural Plastics (CSP), a repaid with a projected increase in earnings over the global leader in lightweight composite solutions in 2016, long term. In addition, we also feel that it is essential for to leverage on its existing extensive production facilities Teijin Ltd to take up more financial leverage and invest in China. more in its future in order to stay ahead in this highly- competitive industry. Teijin Ltd plans to capture the potential profits from the growth of the EV market through two strategies:
Catalyst, Events and Tipping Point a) Expanding Uses of Current Products
Teijin Ltd is a global market leader in the production of 1. Meeting company earnings target and key high-performance carbon fibers which have been mainly performance index (KPI) in FY2018. Teijin Ltd has used in aircrafts. With the growth of EVs, demand for announced its 2 years management plan which various complement components used in its includes the transformation and growth strategy. manufacturing process will increase as well. As Management has given their guidance and automobiles are becoming lighter, manufacturers are estimates on KPI to be achieved by FY2018. Hitting looking to incorporate high-performance lightweight estimates and KPIs will indicate that Teijin Ltd is heading in the right direction and will continue to materials for the vehicle. The market demand for such experience strong growth under management’s automobile lightweight materials is expected to grow at guidance. 13.06%. Teijin Ltd plans to expand uses of its existing products to include automobiles. For example, its para-
aramid fibers will be used as a tire reinforcement 2. Approval of regulations for FEBURIC to be sold to material and polycarbonate resins as a lightweight other countries and launch of new drugs by 2018. alternative for glass.
Investment Thesis
1. Growth in demand for Electric Vehicles will drive revenue for Teijin Ltd One of the global fastest growing markets is Electric Vehicles (EVs). Unlike conventional vehicles that use a gasoline or diesel-powered engine, electric vehicles use an electric motor powered by electricity from rechargeable batteries.
b) Diversifying product lines to increase competitiveness
The compounded annual growth rate (CAGR) of EVs globally is estimated to be 42%. One of the largest Secondly, Teijin Ltd is entering the automobile consumer of EVs is in the Chinese economy, which takes composite materials market. By acquiring CSP, Teijin Ltd up approximately 35% of the entire global EV sales. Due can easily enter the Chinese market for automobile
85 composite materials since CSP is already a strong market marketing the system to the government and other player. A core component of an EV is the lithium-ion market players in the industry. Although sales of battery (LiB) engine. The CAGR for the demand of LiB VitalLink is still in its infancy stages, we believe that it has separator in automobiles is expected to be 22%. Teijin huge potential for growth and Teijin Ltd can expect to Ltd plans to increase its capital expenditure in LiB provide even higher quality of services to distinguish separators, the underlying technology behind a LiB itself from competitors. engine to capture the increased demand. Despite existing competitors, we believe that Teijin Ltd will Pharm aceutical Pillar capture the most growth due to its proprietary Under the pharmaceutical pillar, Teijin Ltd developed technology -- LIELSORT, the world's first coating FEBURIC, the first global hyperuricemia and gout technology for battery separators which enhances a treatment febuxostat and has already secured the top battery’s energy efficiency and lifespan, providing Teijin share in the domestic market (about 50%). Teijin Ltd is Ltd the competitive edge over its peers. securing exclusive distributorship agreements for the febuxostat drug covering 117 countries and regions By diversifying the product lines, Teijin Ltd has overseas, with plans to expand the sales area positioned itself strongly as a multi-material progressively. In 2014, the drug was sold in 42 of these manufacturer to increase its competitiveness over its countries and currently, it is sold in 67 of these peers as a solution-oriented supplier. Our team believes countries. We believe that increased health that Teijin Ltd will continue to strengthen its dominance consciousness and awareness of early prevention of to realise the potentials from increasing demand for EV diseases through targeted treatment globally will help automobile components alongside the growth of EVs. FEBURIC to grow to become a substantial revenue Furthermore, it is unlikely that competitors will be able source for business growth under Teijin Ltd’s to compete with Teijin Ltd in this field due to its pharmaceutical pillar. established competitive advantage with patented technology and expertise. Teijin Ltd has made plans to provide consumers with health monitoring products and services in new areas 2. Teijin Ltd is strengthening existing revenue drivers such as the cranial nervous system. This market is while looking to expand its products and services expected to increase by 5 times from JPY100 million in to new fields in Healthcare 2015 to JPY550 million in 2020. In October 2017, Teijin Ltd announced that they are partnering with Merz, a Healthcare Pillar global leader in aesthetics and neurotoxins and entered Under the healthcare pillar, Teijin provides home into a strategic license and co-development agreement healthcare services to over 300,000 patients inside and for the commercialization of Xeomin. Teijin Ltd wants outside of Japan and have secured the top share in Japan Xeomin to become a core product which aims to provide for the rapidly growing market for continuous positive a total solution for stroke patients with the synergistic airway pressure (CPAP) ventilators, for the treatment of effects of their stroke related products and pipeline such sleep apnoea syndrome, the same as with its home as rehabilitation devices and regenerative medical oxygen therapy (HOT) services. In therapeutic oxygen products. concentrators for HOT, Teijin Ltd will further boost rental volume by enhancing and expanding the line-up 3. Greater synergies expected to be derived through of portable oxygen concentrators as well as achieving Information Technology the same for non-portable oxygen concentrators. Teijin Ltd will be enhancing the functions of CPAP ventilators To maintain its competitive edge in the industry, Teijin to respond to patient needs by capitalizing on their Ltd must embrace rapid commoditization, raw material home healthcare call centres. price volatility and an increasingly regulatory environment. Recently, it has announced plans to Moving forward. Teijin Ltd is also looking to improve allocate JPY10 billion from 2017 to 2019 to establish an leverage on its IT services to enable IoT and AI in its integrated information platform through IoT and AI to home healthcare systems. VitalLink, a multidisciplinary support their growth and transformation strategies. collaboration and information sharing system was Examples include constructing an information-platform, established in 2015 to serve as a platform for the above- automating production process as well as digitizing mentioned healthcare services, thereby introducing and business processes and databases. linking more players into the home healthcare field. Essentially, Teijin Ltd is planning to provide the software This provides Teijin Ltd better visibility of the company’s platform for integrated home healthcare system and is progress with regards to external conditions such as real-time pricing quotes. For example, The Dow 86
Chemical Company, a US$49 billion conglomerate, was 2. Commodity price risk able to optimize its procurement strategy by The demand for oil is growing at an unexpectedly high collaborating with suppliers to combat price and supply rate, causing U.S crude oil inventories to deplete faster volatility. This has reduced their cost of goods sold, than expected. Moreover, OPEC and other oil exporters especially crude oil which is widely expected to increase are expected to reserve 1.8 million barrels which will not over the next few years. be sold in the market next year. With the reliance on shale that is growing, the limits are becoming more Our team believes that this is a step in the right direction apparent. Companies are facing issues with hydraulic for Teijin Ltd as operational excellence is key to success fracturing as the crews and equipment are frequently in this industry. Given management's track record, we booked along with the rising cost for oilfield services. expect that it would likely be able to successfully restructure its business model. Upon completion, the Teijin Ltd's Carbon Fiber are made from Polyacrylonitrile strategic shift would be difficult for competitors to (PAN) precursor, which is a product of crude oil. The replicate and catch up with. This is due to high capital increase in crude oil prices will increase the cost of expenditures and cultural problems which historically manufacturing for Teijin Ltd but our team believes that were the main reasons to its slow adoption among Teijin Ltd would be able to manage the risk and act early chemical companies. According to Deloitte, more than to hedge it. In the past, Teijin Ltd's ECO-CIRCLE system 50% of chemical enterprises do not have a digital uses oil to produce polyester material. To date, Teijin transformation strategy yet, which puts them at risk of Ltd's ECO-CIRCLE system is the world-first, closed-loop losing their competitive edge. recycling system for polyester products. This has reduced oil dependency and with continued R&D, our
team believes that Teijin Ltd will be able to manage Through the enabling of IoT and AI, Teijin Ltd can deliver commodity price risk. more tangible customer results by sensing and integrating end-user consumption patterns with supply 3. Foreign Exchange Risk chain activities. This leads to a leaner supply chain, Teijin Ltd has diversified operations across the world thereby reducing inventory storage costs, wastage of namely China, Southeast Asia, Europe and US. With the raw materials through increased operational acquisition of CSP, sales in China and US is expected to efficiencies. Management would be able to make expand. Teijin Ltd’s base currency is Japanese Yen. With decisions faster and reduce risks of product quality, the increase in global operations, there will be an reliability and safety. With less need to forecast, manage increase in foreign exchange risk as Teijin Ltd’s earnings and satisfy future demand, more resources can be will be more affected by any movement in the foreign allocated for research and development purposes to exchange market. further strengthen Teijin Ltd’s business model. (Deloitte, 2017). Following IHS Chemical Week 2016, we also (TSE:3401) Teijin Limited FY2013 FY2014 FY2015 FY2016 FY2017 FY2018LTM Share Price JPY 1,090.00 1,270.00 2,375.00 1,685.00 2,161.00 2,401.00 expect to see improvement of profit margins by 8% to No of Shares (mil) 196.6 196.6 196.6 196.7 196.7 196.8 MCAP (mil) USD 2,159 2,465 3,817 3,227 3,785 4,191 13% from this initiative. Net Debt (Cash) JPY 242,257 278,593 266,450 231,133 292,128 288,794 Enterprise Value (mil) USD 4,980 5,143 5,740 5,507 5,369 6,552 Revenue (mil) JPY 745,713.0 784,425.0 786,171.0 790,748.0 741,291.0 792,896.0 Risk / Toxicity Factors EBITDA (mil) JPY 59,235.0 63,742.0 82,116.0 106,024.0 95,843.0 110,305.0 EBIT (mil) JPY 12,358.0 18,078.0 39,086.0 67,130.0 56,512.0 67,048.0 NPAT (mil) JPY (29,131.0) 8,356.0 (8,086.0) 31,090.0 50,133.0 57,946.0 NPAT (Ex.Xtra + Dis.Ops) (mil) JPY 3,839.0 14,202.0 39,226.0 49,587.0 75,082.0 72,920.0 1. Product Quality Risk CFO (mil) JPY 64,305.0 38,587.0 76,030.0 80,641.0 79,040.0 73,325.0 CAPEX (mil) JPY (31,031.0) (30,863.0) (26,528.0) (31,895.0) (37,662.0) (40,859.0) Teijin Ltd has been positioning themselves to be an EPS JPY 19.5 72.3 199.5 252.2 381.6 370.6 Revenue (mil) USD 7,916.7 7,619.5 6,552.0 7,037.6 6,648.3 7,041.4 enterprise that provides product quality and reliability EBITDA (mil) USD 628.9 619.2 684.4 943.6 859.6 979.6 assurance. As they are venturing into the Chinese EV EBIT (mil) USD 131.2 175.6 325.7 597.5 506.8 595.4 NPAT (mil) USD (309.3) 81.2 (67.4) 276.7 449.6 514.6 market to become a multi-material manufacturer, Teijin CFO (mil) USD 682.7 374.8 633.6 717.7 708.9 651.2 CAPEX (mil) USD (329.4) (299.8) (221.1) (283.9) (337.8) (362.9) Ltd must ensure that their products are able to meet GPM (%) 25.5% 24.8% 27.6% 32.2% 33.5% 32.8% EBIT (%) 1.7% 2.3% 5.0% 8.5% 7.6% 8.5% specifications. Any product defects could negatively Net Debt (Cash) / Equity (%) 89.1% 98.6% 92.5% 76.8% 86.1% 75.2% ROA (%) 1.6% 2.4% 4.7% 8.2% 5.9% 7.0% affect customer relations since their deals are greatly ROE (%) 4.5% 6.4% 13.6% 22.3% 16.7% 17.5% based on their product quality and reliability assurance. CFO/TA (%) 8.4% 5.0% 9.2% 9.8% 8.2% 7.7% EV/ Sales (x) 0.6 0.7 1.0 0.7 1.0 1.0 Teijin Ltd has to increase quality control regulations EV/ EBIT (x) 38.6 30.2 19.2 8.6 12.9 11.6 EV/ EBITDA (x) 8.0 8.6 9.1 5.4 7.6 7.0 whilst decreasing operational costs and be able to satisfy EV/CFO (x) 7.4 14.1 9.9 7.1 9.2 10.6 P/Sales (x) 0.3 0.3 0.6 0.4 0.6 0.6 demands on time. P/EBIT (x) 17.3 13.8 11.9 4.9 7.5 7.0 P/B (x) 0.9 1.0 1.7 1.2 1.6 1.5 VQ1: EV/EBIT/ROE (x) 8.5 4.7 1.4 0.4 0.8 0.7 VQ2: EV/EBIT/ROA (x) 23.8 12.8 4.0 1.1 2.2 1.6
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11. Tokyo Electron (TSE:8035)
Company Research & Report
Quick Stats Date 15/12/17 EBIT/R&D (x) 2.43 EBIT/Employee No. Filing Currency JPY (USD /px) 170K Share Price JPY20,955 EV/EBIT (x) 14.5 No. of Shares (Mil) 164.1 EV/EBITDA (x) 13.3 Market Cap (USD Mil) 30,504.7 EV/CFO (x) 20.7 Daily Value Traded (USD Mil) 252.2 P/Sales (x) 3.6 GPM (%) 41.4% P/E (x) 15.7 EBIT (%) 22.7% P/B (x) 5.0 Net Debt (Cash) / VQ1: EV/EBIT/ROE Equity (%) -38.6% (x) 0.5 VQ2: EV/EBIT/ROA ROA (%) 21.2% (x) 0.7 ROE (%) 30.9%
Team Members
Darren Ong is in his second year pursuing a degree in Business Management at Singapore Management University. As a finance major, he has done internships with asset management and proprietary trading firms. He has experiences in the field of Data Analytics, Investment Operations and Investment Research.
Yi Chang is in his second year pursuing a degree in Accountancy at Singapore Management University. With a passion for the capital markets, he has done internships in fields related to Audit, Corporate Finance and Mergers and Acquisitions. He is currently interning as a Corporate Restructuring Analyst.
Jaylen is in his third year pursuing a degree in Economics at Singapore Management University. With a passion for finance and technology, he has done internships in fields related to Data Analytics, Investments and Investment Research. As a tech entrepreneur, he has gone on to win several FinTech competitions as well as founded his own start-up companies.
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Highlights - Strong leading market positions with proven records across business cycles as this enhances pricing power and creates the foundation for sustainable good profitability, as well as an attractive position in the value chain without being dependent on specific suppliers or customers. - Continuous innovation and R&D to achieve and ensure strong market positions, create new categories of growth and profitability over time; Long runway and addressable market to compound growth from solving pressing problems for their customers.
- - Exposure to service and after-market sales to improve the understanding of customer needs, build customer loyalty, and offers attractive profitability, additional growth opportunities and increased product penetration; - Prudent stewardship and allocation of capital; Strong balance sheet and robust cash flow generation that can be used for reinvestments into the business for example in the R&D and market expansion, lastly to capture attractive opportunities, as well as steady cash distribution to the investor.
The Selection Process We employed a 3 stage process at the industry level, sub-sector level and finally narrowing it down to our SUMMARY: chosen hidden champion. Tokyo Electron (TSE:8035) is one of the world-leading suppliers of semiconductor production equipment (SPE) Disruptive Technologies which manufactures and sells industrial electronics Firstly, at the industry level, the team went on to products, such as fabricate integrated circuits (IC), flat research on key trends that are occurring across various panel displays (FPD) and photovoltaic cells (PV). The industries. We would avoid industries that are presently company sells its products in the US, Taiwan, Europe, facing headwinds and a lack of future potential in the Korea and Japan. near term. As a result of our findings, we have identified the rise of FinTech and the internet of things (IoT) are Investment Thesis disruptive technologies that will have a drastic impact Tokyo Electron, a dominant semiconductor giant with across many industries. Disruptive technologies are best in class products, strong balance sheet and earnings expected to change the way traditional industries potential to ride industry trends and propel itself operate and change the landscape of how businesses towards a new growth era. will be conducted in the imminent future. As such, we
89 narrowed down our industry to the semiconductors learning robots are being invented to increase efficiency industry for the main reason being, all these and high speed 5G data networks are being technologies need chips to function and perform implemented to enable fast data transfer. With silicon complex tasks. wafer chips embedded in almost all electronical devices, from memory chips to CPUs in smartphones to Going Back to The Source computers, the semiconductor industry is definitely the industry that will experience a boom in business Once we had identified the semiconductors industry, we activities. proceeded to narrow it down at the sub-sector level. Interconnectivity have been on a rise in tandem with Semiconductor Industry Overview internet adoption rates across developed and emerging With the advent of the Internet of Things, many economies. As mentioned, all of these requires powerful governments of the world are increasing their chips for them to work. Chips can be found almost investment in IoT services and digitalisation. For everywhere in our everyday lives (PCs, smartphones, example, the Thailand government is implementing TVs etc.). Hence, the team decided to focus on Thailand 4.0, a nation-wide digitalisation plan. The Low semiconductors equipment (SPE) manufacturers who Power Wide Area Network (LoRaWAN), which enables provide tools and machines to create these powerful long-range communications with little power, are being chips by chip makers such as Samsung, Intel etc. implemented in countries all around the world, turning Our Hidden Champion cities into smart cities. Smaller, faster and cheaper In our stock screening process, we assessed each SPE semiconductors are also in demand to meet the manufacturer’s earnings potential, scalability of their upcoming IoT solutions and infrastructure development business, historical track record and management’s as well as in demand by businesses that are constantly ability. These will be elaborated in detail later on in the developing new electronical devices. report. Finally the team chose Tokyo Electron Limited (TSE.8035) as our hidden champion. The company is a Therefore, the governments’ initiatives to be in sync debt-less SPE giant and global player in providing with the Internet of Things trend and the increased semiconductor tools and equipment. In the past, the SPE business applications drive the demand of industry was highly cyclical, however, the range of semiconductors, causing the industry to boom. Within applications where semiconductors and chips can be the semiconductor industry, there are two important used have expanded drastically which have lessened the players, mainly the Semiconductor Equipment (SPE) cyclicality of the industry. As such, the team is confident Provider, whom produces equipment to manufacture that our pick – Tokyo Electron is well positioned now silicon wafer chips and the semiconductor with the perfect timing to enter a stage of new growth manufacturers (SM), whom produces silicon wafer where disruptive technologies are set to change the chips. traditional landscape of multiple industries in which they operate to yield higher profits and achieve Woes of Semiconductor Manufacturers operational efficiency. SM companies have the need for high capital expenditure to upgrade its semiconductor production equipment, meet ever-changing specification of electronic products as well as juggle with pricing pressures. SM have to constantly invest in new semiconductor equipment that are able to produce newer semiconductors that are smaller and faster to meet end consumers’ demand. In addition, electronic products’ specifications are constantly changing, with consumers looking out for smaller and faster devices, which SM companies have to keep up with in order to stay competitive. Lastly, although tech products are constantly being improved with higher specifications, Introduction – Entering Industry 4.0 the prices of new devices are getting cheaper, causing SM to face pricing pressures. As we enter Industry 4.0, where the concept of Internet of Things starts to emerge, many opportunities lie ahead Semiconductor Production Equipment Provider – The for companies in the manufacturing industry. Director Behind the Scenes Automation is starting to take over manual labour, self- 3D NAND 90
PE companies also foresaw the demand of higher performance semiconductor from the trend of IoT and the issues SM companies face, which led them to investing heavily in R&D to create better SPE. For example, the industry is moving from regular straight line etching to 3D NAND stacking, a new type of method in the semicon production process, which increases the processing power of the semicon.
Recurring Revenue Streams SPE suppliers are also less exposed to price pressures as shown from their profit margins, on top of that, they are able to obtain recurring revenue from the water fab’s constant need to upgrade wafer capacity and technology and after-sales service.
High Barriers of Entry The SPE industry has also high barriers of entry, as SPE companies must possess technical know-hows and specialised manufacturing tools, allowing the current players in the industry to thrive.
Low Cyclicality Lastly, the SPE producing business is less cyclical compared to in the past, which is wholly dependent on PC and the smartphone industry. Presently, SM companies are moving towards cloud computing and data centres, which creates new revenue streams for SPE companies. The Healthcare, Automotive, Oil & Gas and even Augmented Reality industry is currently opened for SPE companies to tap on, thus, reducing the cyclicality of the business. The market value of data centers and cloud market are projected to grow significantly by 14.9% and 15.4% CAGR respectively, proving that the SPE industry is very profitable. Tokyo Electron Industry Research
Investment Case: Global Semiconductor Industry Thus, we feel that the current market is discounting and In 2016, the global semiconductors market grew 3% to mispricing companies in the SPE industry as they might reach a value of US$387.6 billion from US$376.4 billion not recognise the potential profit generating in the previous year. This represents a 5.3% CAGR from opportunities and structural shifts of companies moving 2012 through 2016. The Asia Pacific region is the largest towards industry 4.0, which pose as a good investing market for semiconductors manufacturing accounting opportunity for investors compared to SM companies. for 72.4% of the global market value at US$280.7 billion and followed by the United States which makes up 12.8% of the pie at US$49.4 billion. Europe and the rest of the world accounts for 8.7% (US$33.6 billion) and 6.1% (US$23.9 billion) of the global market value respectively. The industry saw a stabilization of growth in 2016 after a global slowdown in 2014 and 2015 due to a slowdown in the PC and smartphone markets as well as an industry wide consolidation. During this time, many semiconductor companies underwent restructuring to refocus their portfolios on core and innovative technologies (Tanner, 2017). At the same time, semiconductor companies also sold away their non-core
91 business which are dragging down the overall bottom market. This affected Japan’s IDM (integrated device line resulting in massive job cuts. manufacturers) which had traditionally handled all chip making processes. The outlook for the industry remains Global Semiconductor Outlook bleak as it is expected to contract at a rate of 2.7% CAGR Growth is expected to accelerate from 2017 onwards to reach a total market value of US$22.4 billion by 2021 fuelled by the increasing use of semiconductors in the from US$27.9 billion in 2016. This represents an Internet of Things (IoT) and in the automotive industry expected decline of 12.5% in the next 5 years. In of autonomous cars which will offset the declining comparison, the Taiwanese and Chinese markets will demand for PCs. The global semiconductor industry is continue to post stable growth at 4.1% CAGR and 6% expected to grow at a stable rate of 5% CAGR in the CAGR respectively over the next 5 years. The total period of 2016 – 2021 to reach a total market value of market value for the Taiwanese semiconductors market US$495.2 billion. This represents a 22.2% growth in will reach US$67.3 billion and China will record a total of market value from US$405.4 billion by end 2017. US$152.4 billion by 2021.
APAC Semiconductor Industry Global Semiconductor Equipment Industry The industry began to garner strength and accelerate in The global semiconductor equipment market is 2016 from the previous year due to the global slowdown expected to grow 66.5% to US$64 billion by 2019 from in the PC and smartphones market that caused demand US$38.4 billion in 2014. This represents a 10.7% CAGR to shrink. The APAC semiconductors market recorded a over the period. Global sales of new semiconductor total revenue of US$280.7 billion in 2016 which equipment are forecasted to grow by 19.8% to a total of represented a 6% CAGR since 2012. China accounts for US$49.4 billion by the end of 2017 (SEMI, 2017). A 7.7% 40.5% of the APAC semiconductors market value at growth is expected for 2018 to reach a new high of US$113.6 billion, followed by South Korea at 10.3% US$53.2 billion for the global semiconductor equipment (US$28.9 billion) and Japan at 9.9% (US$27.9 billion). On market. the other hand, India and the rest of APAC accounts for the remaining 39.3% (US$110.2 billion) of the industry. In the wafer processing equipment segment, growth is In APAC, the market is heavily concentrated in China, estimated to rise by 21.7% to US$39.8 billion by the end Taiwan, South Korea and Japan. China is expected to be of 2017. On the other end, fab facilities equipment, the new driving force to drive global growth in the next wafer manufacturing and mask/reticle equipment will few years to be the leading semiconductor country. In grow by 25.6% to US$2.3 billion (Shen, 2017). Despite, a 2016 alone, the Chinese market recorded robust growth contracting semiconductors industry in Japan, the of 9.3% CAGR in market value to reach US$113.6 billon country remains one of the leading suppliers of (Marketline, 2017). The market in APAC is expected to semiconductor equipment and material globally. The continue growing at a stable rate of 5.3% CAGR from Japanese supplies over 50% of materials and around 2016 to 2021. This represents a total growth of 29.6% in 35% of new equipment used worldwide (Tanner, 2015). market value to US$363.7 from US$280.7 billion in the The semiconductor equipment industry is dominated by projected 5 years which are primarily driven by several big players globally. Japan’s Tokyo Electron innovations in technology and the demand from China. Limited is the industry leader with the largest market share at 18.5%, followed by Netherlands’s ASML Holding Japanese Semiconductor Industry N.V. at 17.1%, United States’ Applied Materials Inc. and Although the Japanese Semiconductors industry started LAM Research Corporation at 16.0% and 13.2% to show signs of growth after a sharp contraction in 2015, respectively. the gains were not enough to offset losses from previous By the end of 2017, South Korea will become the largest years. In 2016, the Japanese semiconductors market had market for semiconductors equipment manufacturers, total revenues of US$27.9 billion which was a 2.2% followed by Taiwan and China. SEMI also indicated that increase from 2015. This represented a -3% CAGR over while most regions will experience growth, Southeast the period from 2012 to 2016. The decline was primarily Asia will be the exception. South Korea will lead the due to intense competition in DRAM (Dynamic Random- industry with a growth of 68.7%, followed by Europe Access Memory) from big manufacturing players in with 58.6% and North America at 16.3% (SEMI, 2017). South Korea and Taiwan in electronics. The computer Equipment sales are forecasted to accelerate the most boom in the 2000s placed the United States positioned in China with a growth of 61.4% reaching a total value of Intel to become the market leader in the semiconductor US$11 billion by 2018. South Korea, Taiwan and China space with its microprocessors. Furthermore, from 2000 will remain the top 3 markets globally for to 2014, the industry value chain shifted towards fabless semiconductors equipment sales companies like Qualcomm started to dominate the 92
Industry Catalyst
Strong Demand from China
China will continue to be the major driver of growth for the market. Consumer demand for products containing semiconductors products are largely responsible for the increase. This is further supported by the Chinese government’s efforts to reduce reliance on foreign technology and create domestic replacements (Marketline, 2017). Most leading semiconductors companies have been directly involved in the development of the Chinese semiconductors. The Chinese market is especially flourishing due to an increasing demand for sophisticated technology which requires high levels of computing power (Marketline, 2017). Thus, demand for semiconductors specialty and services are expected to rise as China seeks to increase capital expenditures in the industry to produce its own modern electronic products and wafer fabrication plants in the coming quarters .
Internet of Things
The Internet of Things (IoT) refers to the connection of devices other than the typical computer and smartphones to the Internet (Meola, 2016). By 2020, the number of IoT devices connected to the Internet will grow more than 3-fold from 10 billion to 34 billion. Of this amount, only 30.4% will comprise of traditional computing devices such as smartphones and tablets while 70.6% will comprise of new and upcoming IoT devices. IoT will become a trillion-dollar industry which US$6 trillion is expected to be spent on IoT solutions over the next 5 years (Meola, 2016). As the industry of IoT is set to explode within the upcoming years, businesses will be the top adopters of IoT solutions in which they will employ in 3 areas: raising productivity, lowering operating expenses and expansion towards new markets or developing new products. On the other hand, governments around the world will be the second
largest adopters primarily focused on increasing productivity, reducing costs and raising the quality of life for citizens. Lastly, consumers are expected to lag behind businesses and governments in adoption rates, however, they are expected to catch up and purchase a large number of devices as well as invest significantly in IoT ecosystems. With the rise in IoT, this serves as a catalyst igniting growth for the global semiconductors industry. Semiconductors are the fundamental technology which enables the use of modern technology possible including IoT.
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from 2012 – 2017. The use of electronics in automobiles will be the single largest driver of change in both the automotive and semiconductors industry. Semiconductor content per car is expected to grow from US$315 in 2012 to US$385 by the end of 2017 (PwC, 2017) and trends have revealed that innovation in automotive are in electronics rather than mechanical. These innovations are being introduced into cars at a fast rate as costs continue to decrease as continued innovation increases and by integrating it with the IoT, auto makers seek to achieve “smart mobility”. To achieve smart mobility, auto makers are required to use ever more sophisticated semiconductors to be able to establish connectivity between vehicles and the smart devices in which they operate. These “smart vehicles” have to be able recognise traffic, manage safety and perform many other functions better than a human driver.
Global Flat Panel Display Industry The global flat panel display (FPD) industry is projected to reach a market value of US$110 billion by end of 2017. This represents a year-on-year growth of 9.3% (IHS
Nature of IoT devices Markit, 2016). This demand is fuelled by a booming All IoT devices requires semiconductors such as consumer electronics market for smart devices and flat transistors, microcontrollers, sensors, and memory to screen monitors. This growth also spurs a demand for connect to each other for them to perform their Human Machine Interface (HMI) technology in the functions (Semiconductor Industry Association, n.d.). As automotive industry which is expected to drive further such, semiconductors create an infrastructure that demand for flat panel displays. The FPD industry is most enables connectivity to all these devices. This would concentrated within the APAC region and emerging drive innovation in the semiconductors industry as Asian economies where many consumer electronics manufacturers compete to come up with higher manufacturers can be found. Liquid crystal displays performing and efficient semiconductors to meet (LCD) segment will remain the most dominant in the various needs of consumers in many infdustries. Hence, industry with sales expected to exceed US$116 million the rise in IoT serves as a driving force for the by 2020 and accounts for more than 75% of the total semiconductors industry fuelling demand for market (Persistence Market Research, 2017). semiconductors that can aid In the development of Furthermore, FPD have found other uses in the medical sensors that can instantly analyse data. field, advertising and education etc. These will all be Automotive Industry & Smart Mobility future growth drivers for the industry and potential for Driving growth for the global semiconductor industry the FPD market to expand. The APAC (including Japan) will come from automotive as more cars and light region is the most dominant in the global FPD industry vehicles are being produced in emerging economies and is projected to achieve a total market share of 85% than in developed markets (PwC, 2017). The BRIC by 2020 (Persistence Market Research). In APAC, China nations (Brazil, Russia, India and China) will remain the is expected to lead the industry as it is a top most important growth driver for demand in the manufacturer of consumer electronics (mostly where automotive industry representing a 5-year CAGR of 9.4% FPDs are used). On the other hand, Japan is the second largest FPD market and will be expected to grow at 1.2% 94
CAGR over the period of 2015 – 2020 (Persistence used by organisations for remote storage, processing or Market Research, 2017). distributing copious amounts of data. A corporation will always attempt to optimise cost to deliver a higher profit. Global Flat Panel Equipment Industry Hence, data storage and computational capacity should The global FPD equipment market is expected to achieve be minimised to a level that is able to support a business over US$13 billion by 2021 fuelled by the growing more efficiently. The demand for more data storage is demand for high performance displays (Technavio, also rising in tandem with a rapidly increasing data 2016). As customers are increasingly demanding higher traffic. All of which requires leading cutting-edge tools display resolution, it has become one of their key and advanced semiconductors equipment to make consideration factors during their purchase of electronic complex semiconductors and chips. goods. The APAC region has the highest concentration of display device, LCD and organic light-emitting diode (OLED) panel manufacturers globally. In addition, major consumer electronic giants such as Samsung, Sony and Apple who has their operations in South Korea, Taiwan, Japan and China will help propel growth for the FPD equipment market for the region. Industry trends are Source: Grand View Research showing that there is an increasing adoption and demand for consumer electronics with active-matrix The global data centre services market is projected to organic light-emitting diode (AMOLED). The AMOLED reach US$17.3 billion by 2025 from US$5.1 billion in segment is expected to become one of the biggest 2016. This represents a robust growth of 14.9% CAGR segments in the industry as decreasing demand of PCs over the forecast period. will reduce the demand for LCD monitors. Hence, AMOLEDs are expected to be fuel growth for the FPD equipment market over the next few years as well as a rising demand for high resolution and rich quality displays for LCD TVs (Technavio, 2016).re p
Cyclical Ills of SPE Industry The semiconductor equipment industry is characterised as highly cyclical due as its results are dependent on the primary end market – chip sector. The chip sector is in turn influenced by chip companies based on their Over the same forecasted period, the APAC region is projections for future demands. If companies expect expected to enjoy the fastest growth at 18.4% CAGR. higher demand they will order more equipment. The total market value for data centre services market Traditionally, demand tracks end-market consumer in APAC is expected to reach US$4.2 billion by 2025 from electronics (PCs, Smartphones etc.) Now, US$0.9 billion in 2016. Important Trends for the semiconductors are demanded in other fast-growing Intermediate Term: Continuing shift towards larger areas. Currently, the market has been discounting wafers (larger wafers lower manufacturing costs), semiconductors companies as they believed their profits Development of smaller geometry chip design (allows are expected to decline due to the cyclicality nature of more transistors in each integrated circuit for high the industry. As such, the team feels that companies in performance), Transition from aluminium to copper this space are presently undervalued as the market is interconnections (copper yields better device ignoring structural shifts (IoT, AI and autonomous performance due to high electrical conductivity). driving) and expansion of various semiconductors applications that will drive profit growth via higher demand and lesser cyclicality going forward (Trainer, 2017).
Beyond PCs and Smartphones: The data services market is booming. The PC and smartphones markets have witnessed a slowdown in demand in recent years. This have led to an industry shift towards high growth areas such as data centres (Tanner, 2016). The data centre is a The cloud managed services market recorded a total large group of networked computer services typically value of US$23.2 billion in 2016 and is projected to reach 95
US$82.3 billion by 2025. This represents a robust growth semiconductors are rising due to IoT trends and demand of 15.4% CAGR over the forecast period. The rising for ever more sophisticated semiconductors to perform adoption of cloud services globally by small and medium various functions for different uses would require enterprises will be attributable to benefits such as cost semiconductor equipment tools to create them. reduction and higher IT functionality overall. Hence, the team concludes that semiconductors equipment companies can be expected to ride on an upcycle caused by structural shifts that have started to disrupt many industries today. As a result, we feel the market is presently discounting semiconductor equipment companies due to their cyclical nature. However, as we can see from present trends and structural shifts in the industry, companies with capabilities to meet end market demands for high performance chips and semiconductors will be able to
successfully enter a new growth era. Over the same period, the North American region is expected to record a total value of US$22.5 billion by 2025. This is a growth of 12.5% CAGR from 2016 where the market is valued at US$8 billion. The APAC region is projected to be the fastest growing market by 2025. It is estimated that APAC will see growth of 19.9% CAGR over the forecast period to reach a total value of US20.8 billion. This growth is driven by investments made by tech giants such as IBM and Google in the Asian market as well as government policies are contributing to the rise in cloud adoption.
Expansion of Applications As mentioned, the primary cause of the cyclical ills in the semiconductor equipment industry was due to the dependence of demand from consumers for electronics devices. However, this cyclicality has been reduced as the number of applications for semiconductors have increased. In the coming future, semiconductors will find its way into various industries and uses. Some of these will include: - Autonomous Vehicles - Artificial Intelligence and Augmented Reality - Cloud Computing - IoT (5G, small cells, Software Defined Network, Network Function Visualisation) - E-payment Systems (Visa Paywave, Apple Pay, Android Pay etc.) - Drones (Military, media and production uses) - Fintech - Oil and Gas (To lower costs through efficiency) - Healthcare (Rising interconnectivity of medical devices) Source: BMI Research
As such, the landscape for semiconductors applications have changed drastically and no longer are dependent on the electronics industry, PC and smartphones markets to drive their top line. More and more uses of
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The Wafer Making Process Here are 7 key steps in the chip making process to manufacture semiconductors. Each of these processes requires semiconductor equipment to perform. Step 1: Nitride Film Deposition Firstly, a plain wafer will be placed in a hot furnace under water to go through the process of oxidation. This forces the vapour (oxygen) to diffuse into the water surface at high temperatures (800 and 1200°C) to create a protective layer of silicon dioxide. This layer protects the wafer from contaminants that can damage its electrical properties.
Step 3: Etching After the wafer is imprinted with the desired circuit
Step 2: Imprinting Circuit Patterns (Photoresist design, it now has to go through the etching process to Coating) have unnecessary materials removed so that only the The next step of creating a wafer fab is imprinting the patterns remain on the exterior. In art, etching is a circuit pattern on the protected wafer. This process process where lines are carved (etched) onto a metal allows numerous densely packed electronic plate and dipped into an anti-corrosive material components such as transistors, diodes, resistors and (etchants). capacitors to be fixed on the wafer fab itself which are crucial as they process and store electric signals. In this In the etching process of semiconductors, a liquid (wet) process there are various sub processes from coating to or gas (dry) etchants are used to remove unnecessary cleaning. parts. Functions of Each: Similarly to the process used in art, an anti-corrosive § Transistors: Acts as a power switch layer is coated on the wafer. Then the etchants remove § Capacitors: Store electric energy the undesired portion of the wafer while the circuit § Resistors: Control current flow to other patterns are coated with an anti-corrosive layer formed components during the photo process remains. The portion § Diodes: Manage direction of current flow protected by the PR remains intact while the rest is etched away to preserve the pattern structure under the Photoresist Coating (Photolithography) resist. This process allows electronic circuit patterns to be printed onto the wafer via the photolithography. Think Dry Etching of the process as printing a picture (circuit patterns/ This process uses plasma or etchant gases to remove design) onto a piece of paper (wafer). undesired materials through ionisation. Exposure and Development: Wet Etching The wafer is now coated with the additive photoresist This process uses liquid chemicals to remove materials (PR) which is highly sensitive to light. PR can be positive from the wafer. or negative. When the wafer is exposed to UV light, the Dry VS Wet positive PR will be removed while negative PR stays Although dry etching is more costly and complicated, leaving the wafer with the desired circuit patterns. with constant innovation in semiconductor technology, this process is widely used as it provides a higher yield.
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Think of it as building a power outlet in for electricity to pass through to “power” the wafer. This is achieved through the metal interconnect process. Interconnects serve as the streets and highways of the integrated circuit (IC), connecting elements of the IC into a functioning whole and to the outside world. The metal interconnect process creates metal circuits along the circuit patterns already printed on the wafer. Metal films are filled into the trench and excess metals are polished. Copper is the more preferred metal for the process due to its cost effectiveness and better conductivity properties.
Step 6: Prove Testing The semiconductor chips will then be subjected to several tests before it is shipped to customers. These tests include electrical die sorting (EDS), packaging test Step 4: Thin Film (Deposition) Process and a final quality test. The EDS test verifies that each This is the process where the wafer gets applied with a chip that leaves the facility meets the standards of the very thin film of material (few nanometres to 100 manufacturer. micrometres) with electrical properties. The cross section of a semiconductor chip is constructed by piling EDS uses electrical testing to check if chips meet the layers and layers of materials together like a skyscraper. processing centre’s required quality level. Things that This is done by repeating the photolithography and are typically checked are semiconductor elements etching process a few hundred times over. The process (transistors, diodes etc.) for their functionality. is important as contaminants on the wafer will affect Functional or repairable chips will continue processing performance and electrical conductivity. while defective chips are marked with ink dots. In order for the semiconductors to get its electrical Defective chips will be discarded. properties, it has to go through the thin film process. Materials at the atomic level with electrical 5 Stages of EDS: properties are deposited as a thin layer on the wafer. - Testing of electrical properties This layers would eventually allow electrical connections - Use of electrical signals to identify discrepancies between circuits and dielectric (insulating) layers - Using laser to repair discrepancies identified protect the wafers from contaminants. For the semiconductors to be able to conduct electricity, ions earlier are implanted onto the layers. - Laminating to protect wafer from dust and particles - Inking to distinguish defective chips easily
Step 5: Metal Contact Formation In this process, it ensures that the electrical properties Step 7: Packaging and Package Testing are well-connected and “powered” so that electrical The last process involves enclosing the integrated signals are able to pass through the wafer successfully. circuits in a form factor that can fit into a specific device.
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Using a diamond cutter, the semiconductors will be cut in the manufacture of thin-film silicon photovoltaic into a form that fits into the device so called “packaging” panels, as well as group-wide logistics services, facility the wafer into the desired shape and design. Finally, the maintenance and insurance. packaged semiconductor is put into a device to be tested for their performance and functions. Market Positioning
Strong leading market positions with proven records across business cycles as this enhances pricing power and creates the foundation for sustainable good profitability, as well as an attractive position in the value chain without being dependent on specific suppliers or customers. Exposure to service and after-market sales to improve the understanding of customer needs, build customer loyalty, and offers attractive profitability,
Business description additional growth opportunities and increased product Tokyo Electron Limited (Tokyo Electron or "the penetration. company") is engaged in the manufacture and sale of semiconductor production and flat panel display (FPD) Modular Upgrades production equipment. The company primarily operates in Taiwan, Korea, Japan, the US, and Europe. The The management is shifting Tokyo electron’s business company operates through three business segments: model from the sale of heavy machinery to that of semiconductor production equipment (94%), flat panel modular part upgrades. This move will allow the display production equipment (6%), and other. After company to keep its customer base and increase service sales and maintenance make up 26% of overall customer stickiness as it will allow both Tokyo Electron net sales which makes up a slight increase of 5% from and its customers to cut cost. The equipment that the the previous year. This is a result of Tokyo Electron company produces is also part of the wafer fab process focusing more CRM services as well as a more modular which goes into all IoT technologies. Since Tokyo approach towards selling their machines. After service Electron is APAC focus, the strong customer base sales and maintenance makes up a significant portion of captured over the years, due to first mover advantage Tokyo Electron’s overall net sales and it is important as that the company has will allow it to stay dominant in these is a source of stable recurring revenue for the the SPE industry. Shifting the business model to that of company. a modular approach will also help to retain customers as it increases the switching cost for its customers at the Products & services same time decreasing the development cost for Tokyo Electron as well new equipment cost for its consumers. Tokyo Electron’s SPE segments provides equipment for manufacturing semiconductor devices used in mobile devices, such as smartphones and tablets. The company’s product portfolio includes coater/developers, plasma etch systems, thermal processing systems, single wafer deposition systems and cleaning systems used in wafer processing. In addition, the company provides wafer probers used in the wafer testing process, electrochemical deposition systems and wafer bonders/debonders used in advanced packaging processes. The company’s FPD segment offers coater/developers and plasma etch/ash systems used in the manufacture of FPDs. The segment’s offerings are used in various products, ranging from televisions (TVs) and mobile devices, including smartphones and tablets to digital signage for advertising. The segment also Dominant Position in the Asia Pacific offers inkjet printing system for manufacturing organic light-emitting diode (OLED) panels using large-sized Tokyo Electron was incorporated in 1963, being one of substrates. The company’s other segment includes the first semiconductor equipment suppliers in the APAC include photovoltaic panel production equipment used region. Due to its first mover advantage, Tokyo Electron 99 has amassed a wealth of key institutional clients over Shareholder Structure the last five decades. Semiconductor manufacturing equipment provided by Tokyo Electron runs in the blood Out of its total outstanding shares listed, 53.22% is of huge clients like Samsung, LG, Panasonic and Texas owned by Financial Institutions and 42.01% by the public. Instruments and has been instrumental in their Top Holders of its public shares includes: Nomura Asset development over the years. As the number of Management (8.2%), Mitsubishi UFG Kokusai Asset customers of Tokyo Electrons grew, so did the demand Management – 6.93% and Asset Management One – for their products for more complex SPE equipment to 5.58%. cater to the ever-changing requirements of consumer electronics. This network effect contributed to Tokyo Private Owners Electrons growth of its complex arsenal of proprietary production equipment, which poses as huge barriers to TEL is also owned by a variety of big private investors, entry for new incumbents trying to enter the SPE with notable institutions from Tokyo Broadcasting industry. System Holdings, Mizuho Asset Management, The Master Trust Bank of Japan, Ltd, FIL Investments (Japan) With its superior manufacturing products in four crucial Limited, Mitsubishi UFJ Kokusai Asset Management Co., semiconductor production processes mainly wafer Ltd, Japan Trustee Services Bank Ltd, BNY Mellon as well washing, photo-resistive coating, etching as well as as State Street Bank and Trust Company. contact probing, Tokyo Electron managed to secure dominant market shares in these processes and with the Ownership Structure & Analysis backing of mammoth clients, became a global powerhouse. Going forward, Tokyo Electron will From the wide range of private and public investors, it continue to focus its efforts on the APAC region as they shows that investors are confident in TEL producing currently have a loyal installed based which can be positive returns on their investments. This can be seen extract more value from. from the heavy investments made into TEL by big financial institutions such as Nomura Asset Management.
Corporate Governance
Tokyo Electron’s Board of Directors is composed of three types of directors, namely outside directors, non- executive directors and executive directors. In addition, Tokyo Electron has an Audit & Supervisory Board, which audits the appropriateness and fairness of the executive directors’ decision-making processes and business execution, as well as the auditing methods and results of the independent auditors. The Audit & Supervisory Board currently has five members, three of whom are outside members. The composition of the Board of Directors enables aggressive management – allowing appropriate risk taking in order to increase corporate value – as well as effective defensive governance by monitoring the risks being taken.
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Management Analysis Assets ratio. We can see that despite rising asset values, SGA expenses are generally declining. In 2013, the ratio was 18.85% and fell to 17.40% in 2017. Hence, the team can conclude that the Tokyo Electron can continue scaling and overcome sticky variable overheads to expand their business as SGA expense have demonstrated a downward trend with rising sales and asset values. and asset values.
Strong Corporate Culture and Guiding Principles TEL’s management also set out a set of strong corporate principles, where employees and the company will have to adhere to, are laid out as a pyramid below: Corporate Philosophy – TEL strives to contribute to the development of a dream-inspiring society through leading-edge technologies and reliable service and support.
Strong Corporate Culture through Management Policies 1. Profit is Essential – TEL aims to contribute to the
development of society and industry as well as Management Analysis its corporate value while pursing profit Tokyo Electron possesses strong management with 2. Scope of Business – TEL wants to lead markets many years of experience in the company, thus knowing by providing high-quality products in leading what works and what does not work for the company. edge technology fields, focusing on electronics Investments and R&D are carefully thought out using the 3. Growth Philosophy – TEL will continue to take experience the management have gained throughout on challenges of technological innovation to the years they have been with the company and have achieve continuous growth through business generated positive returns. expansion and market creation Proven Track Record 4. Quality and Service – TEL strives to understand Also, since the inception of their current positions in needs of customers and gain consumers’ trust 2014, the 3 C-suites officers have stewarding the while improving quality and service company to greater heights, bringing the revenue of the 5. Employees – TEL employees create and fulfil company from ¥612 billion in 2014 to ¥799 billion in company values, performing work with 2017 at a compounded CAGR of 6.97%. creativity and sense of responsibility and a Supporting Metrics commitment to teamwork Using the Total Revenue/Total no. of Employee matric 6. Organisation – TEL will be an organisation that as a gauge of management performance, we can see maximizes corporate value where all employee that the number of revenue generated per employee can realize their full potential has increased throughout the years by 30%, from 7. Safety, Health and the Environment – TEL gives ¥49,754/employee in 2014 to ¥71,143/ employee in the highest consideration to safety and health of FY2017, highlighting the effective management of the every stakeholder, be it internal or external trio and the board of Tokyo Electron. 8. Social Responsibility – TEL strive to gain
society’s support by adopting a strong corporate Not Stuck by Sticky Costs social responsibility as well as to be a company To determine if the company still has the potential to where employees are proud to work at. scale, the team looked at 2 metrics to measure sticky costs. From our findings, we discovered that SGA % of TEL Values Sales have been declining year-on-year as the company TEL Values was implemented in April 2006, where all recorded higher sales each year. The ratio fell from employees have to adhere to: 29.4% in 2013 to 20.8% in 2017 as the company 1. Pride – to take pride in providing high-value recorded an increase of JPY302,420 million over the products and services same period. Similarly, over the same period, this downward trend can be observed with the SGA % Total
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2. Challenges – to accept challenge of going beyond what others are doing to pursue the goal of being number one globally 3. Ownership – keep ownership in mind while implementing strategies to achieve TEL’s goals 4. Teamwork – to respect each other’s individuality and place high priority on teamwork 5. Awareness – to be aware and accept responsibility for one’s behaviour as a respectful member of society
Mid-Term Management Plan
The medium-term management plan aims to push TEL into becoming the ultimate supplier for all IoT providers by 2030.
The current steps the management have put in place for the plan includes: 1. Infrastructure Expansion A new Miyagi Plant is also currently in construction and is set to be completed by end of August 2018. This new plant will enable TEL to conduct joint R&D with SM companies, which will lead to product improvements and joint partnerships in the future. In addition, the Miyagi plant is able to develop and produce etching equipment, catering to the demand of advanced etching processes from the 3D NAND trend.
Furthermore, Tokyo Electron Kyushu Co., Ltd., which is engaged in coating and developing equipment, will also be expanding its Cleaning Room by 1.3x, adding 1350 m² of development floor, completing in January 2018, which increases the production capacity ability of TEL
2. Focus on Field Support (After-Sales) Services on top of Sale of Equipment
The management has also recognised that while the sale of SPE brings in a large proportion of revenue, the focus should also be on after-sales service (field support), consisting of remodeling, refurbishing, parts supply, etc. This is essential as in the IoT field, there is a growing need for legacy technology, i.e. Sensors, rather than advanced processes. The application of such legacy technology is the installation of LoRaWan in various cities. With the LoRaWan market share to reach 3.97
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billion USD by 2021, it’s definitely a lucrative area in The management’s aggressive R&D spending to churn which TEL can capitalise on. growth can be seen from the past 5 year’s R&D spending, which grew at a 2.74% CAGR from 2013 to 3. Intensive Research and Development 2017, reaching ¥83.8b in 2017
Within TEL, there is also a Technology Strategy Division, which focuses on developing new Measuring Effectiveness of Business Strategy technology and processes for TEL’s SPE business. Tokyo Electron possesses strong management with many years of experience in the company, thus knowing TEL Venture Capital – TEL’s VC Arm what works and what does not work for the company. In July 2006, TEL established TEL Venture Capital, Investments and R&D are carefully thought out using the Inc. to capitalise on upcoming technologies on a experience the management have gained throughout global scale. Based in California, USA, it aims to the years they have been with the company and have gather together venture capital companies and generated positive returns. The management has also start-ups in Silicon Valley, to capture and develop led the company while sticking to TEL’s Corporate new technologies. This also allows the company Principles. to be at the forefront of leading new technologies. Using the Total Revenue/Total no. of Employee matric as a gauge of management performance, we can see that the number of revenue generated per employee Process Integration Center (PIC) has increased throughout the years by 30%, from TEL also has a PIC function, which strengthens ¥49,754/employee in 2014 to ¥71,143/ employee in worldwide development of technology. FY2017, highlighting the effective management of the trio and the board of Tokyo Electron. Currently, TEL is focusing on developing new
process tools for its Cleaning, Lithography, Incremental EBIT/Capex have also grown by 0.59% to Etching and Deposition processes. In addition, 2.06% in FY17, meaning the company is generating more it’s also developing new analytical tools for incremental EBIT with every dollar of capex. analysis purposes.
Currently, Extreme Ultraviolet (EUV) Lithography methods is close to being commercialised, which will increase production efficiency of wafers. As such, TEL has been collaborating with leading manufacturers like imec, SRC, AIST and its major customers to come up with technologies that will adopt EUV lithography methods.
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Merging of Subsidiaries – In July 2017, Tokyo Electron Yamanashi Co., Ltd. and Tokyo Electron Tohoku Co., Ltd. Merged and established Tokyo Electron Technology Solutions Co., Ltd. (TTS). Doing so, it allows TEL to pool its technology and resources to narrow its focus on the production of core SPE products as well as to conduct advanced R&D for the its future production.
The effectiveness of the consolidation of resources can be seen from the rising net sales, bringing the revenue of the company from ¥612 billion in 2014 to ¥799 billion in 2017 at a compounded CAGR of 6.91%.
Impact of Corporate Actions on Tokyo Electron A Global Company Tokyo Electron is a global company with international Mr. Toshiki Kawai, whom recently took over the baton presence in key semiconductors and manufacturing from Mr. Toshitoshi Torito on 1 January 2016, markets. As we can see, the amount of sales recorded spearheaded a medium-term management plan which from international markets have been on a rising trend was announced in July 2015. The plan was forecasted to while the proportion of domestic sales to total revenues help TEL hit sales of 900b yen and operating margin of are getting smaller. This shows that the company has 25% within five years. been successful in replicating its business model in overseas markets after being the market leader in Japan. Consolidation of Resources to Focus on Main Business The team expects, the company to grow its dominance Segments in international markets particularly Asia with the company’s expertise and intangible know-hows of the Sold off non-core business units business to ride the tides of current industry trends. To tie business operations with Internet of Things and rising SPE demand, TEL sold off its other businesses (mainly Photovoltaic Panel Production Equipment business) in 2015 to concentrate on two main business segments, Semiconductor Production Equipment (SPE) and Flat Panel Display (FPD). Currently the SPE segment contributes to 93.8% and FPD segment contributes to 6.2% of total revenue.
Reorganisation of Business Units - TEL also reorganised Flexibility to Pivot & ZERO Debt its 6 business units into four in 2017, mainly: Tokyo Electron has a diverse portfolio of production 1. Deposition Systems equipment that allows it to pivot easily and expanding 2. Etching and Dry Cleaning Systems into its surrounding industries. This lean business model 3. Coaters, Developers and Wet Cleaning Systems allows the company to adapt and change rapidly in the 4. Test Systems and FPD Dry Systems volatile, uncertain, ambiguous and complex
environments, at the same time diversifying the risks of Doing so allowed TEL to focus on Etching, Cleaning and the company. The company also has zero debt which is ALD based Coater & Developer segments, which boasts unique in the manufacturing industry with most high market share in the wafer fab production companies saddled with high debts. Hence, TEL has process. Currently, within the Etching process, TEL has plenty of capacity to leverage and capitalize on any new over 60% market share. growth opportunities that arises.
Focus on Etching to be in line with 3D NAND Trend – Revenue Channels With the industry shifting towards 3D NAND, where the Net sales in fiscal 2017 rose 20.4% year on year to yen etching process is becoming increasingly more 799.7 billion. This reflected the favourable market important, TEL is focusing on trying to dominate the environment, expanding demand for cutting-edge Etching process as it is currently the 2nd with a market semiconductor production equipment and increased share of 21%. demand for parts and used equipment sales,
modifications and maintenance services. By segment, 104
net sales in the SPE segment grew 22.3% year on year to yen 749.8 billion. Net sales in the FPD production equipment grew 10.5% YOY to 49.3 billion yen. Furthermore, net sales in the field solutions business (encompassing sales of parts and used equipment, modifications and maintenance services) rose 12% year on year to approximately 208 billion-yen, accounting for 26% of overall net sales. SPE equipment sales made up 93.8% of overall sales whereas the rest came from FPD and other products. Gross profit, SG&A expenses and operating income gross profit in fiscal 2017 was up 20.6% year on year to 322.2 billion yen, reflecting the growth in net sales. However, the gross margin rose only Key Customers Segments Some of the notable customers that TEL has includes: 0.1 of percentage point to 40.3% as profitability gains Advanced Semiconductor engineering, Inc. (TSEC:2311) from increased factory utilization were partially offset by investment in growth aimed at reinforcing product – Taiwan based manufacturers that manufactures competitiveness. semiconductor packaging, electronic chips, computer parts, automotive electrics, computer storage and Cost Channels servers. R&D expenses were up 9.8% year on year to 83.8 billion Intel Corporation (Nasdaq:INTC) – United States based yen. The main cause of this rise was the reinforcement company that manufactures and sells computer, of R&D in the fields of etch, deposition and cleaning networking and communications platform worldwide. systems, in which the company is working to expand its Its platform is used in notebooks, desktops, services, market share under the medium-term management smartphone, tablets and wired connectivity products. It plan. TSE focused on R&D aimed at enhancing the creates microprocessors and flash memory products as competitiveness of future products. This included well as machine learning based products. Intel serves developing innovative technologies to not only enhance the automotive, communications, computing, industrial the performance of individual products but optimize and consumer electronics industry worldwide. It serves entire processes as well as making products more the automotive, industrial, home and consumer intelligent, all of which are especially important in terms applications industry worldwide. of differentiating the company’s products going forward. TSE regards advanced tech prowess as the Micron Technology (TSE:8035) – United States based source of its growth. Accordingly, the company actively company that provides semiconductor systems invests in growth to produce next generation products, worldwide. It produces business storage units, servers, mainly focusing on fields in which market growth is networking decides, DRAM products for smartphones, forecast. NAND products and SSDs for computers. It also manufactures products sold under other NAND flash In the fiscal year under review, TSE released a new single suppliers’ name and provides 3D memory products. It wafer deposition system and increased its market share serves the automotive, industrial, home and consumer in all of its key product areas, making tangible progress applications industry worldwide. toward the goals of the medium -term management plan. IN FPD production equipment, TSE primarily Renesas Easton Co. (TSE:8035) – Japan based advanced development of products for new generation semiconductor technological trading company that sells 10.5/11 panels, which are expected to see rapid market integrated circuits, display devices and other electric growth going forward. parts. It also sells lasers, LED, Bluetooth and COMS sensor modules and panel PCs. The company also does Key Resources & Distribution Channels ASIC development and browser software, on top of TEL has a powerful network of global sales and customer infrared transmission systems. It serves the automotive, service channels and distribution centres as well as 4 manufacturing, industrial and consumer entertainment strong R&D plants, which allows TEL to grow its industry worldwide. corporate name globally as well as tap on local talents Samsung Electronics Co., Ltd. (KOSE: A005930) – South and technologies in countries it operates its R&D plants Korea based electronics company that produces in. consumer electronics, information technology and mobile communications for businesses and consumers worldwide. It produces TVs, monitors, printers and
105 mobile phones as well as LCD and OLED panels. Samsung also produces computer parts such as SSDs and memory cards. Samsung recently started to manufacture semiconductor equipment, repair services of electronic devices and even AI technology. The company operates in the consumer electronics, industrials and medical industry.
Siliconware Precision Industries Co., Ltd (TSEC:2325) – Taiwan based company that produces semiconductor packaging and testing services worldwide. It products testing services for logic mixed signals and RF integrated Staying Relevant with R&D circuits and services customers in the personal To stay competitive and to align itself with the industry computer, communications and memory trend, TEL has several R&D Partnership with its semiconductors market. Customers as well as Global Research Institutes such as imec, SRC, AIST, EIDEC, A*Star Singapore, EIDEC and Taiwan Semiconductor Manufacturing Company Limited College of Nanoscale Science and Engineering. (TSEC:2330) – Taiwan based company that engages in the computer-aided design, manufacture, packaging, In order to be aligned with the upcoming Internet of testing and sale of integrated circuits, colour filters and Things, TEL has also partnered several firms that semiconductor devices, primarily in Taiwan. It operates produces such technologies and manufacturing in the semiconductor and computer parts industry. capabilities such as Milpitas and Procket Networks Inc.
Diverse Customer Portfolio TEL mostly invents proprietary technology through Although being primarily a SPE supplier, TEL’s has a intensive R&D with its partners but also acquired some diverse and large portfolio of customers from various from various companies throughout the years. For industry, whom are also leaders in their individual example, in 2005, TEL and IMEC extended their industry itself. TEL’s customers are mostly in the Lithography Collaboration to EUV. TEL installed two Semiconductor Manufacturing (SM) industry, followed coaters/developers systems at Imec in 2006 to enable by Consumer Electronics. TEL also supplies SPE to 2 of its research on the commercial use of EUV. competitors, Applied Materials and Naigai Tec Corp. In 2015, TEL and Imec also demonstrated R&D results of TEL’s customers are industry leaders of individual a new discovery of etching scheme for patterning of CU industry, with the top 3 customers being the 1st or 2nd interconnects at the IEEE IITC conference. The in their individual industry. This shows that many strong collaboration was part of imec’s GLOBALFOUNDARIES companies depend on TEL to provide them with the program with various semiconductor companies such as necessary tools and equipment to create advanced Fujitsu, Sony, Panasonic, Micron Technology, Intel Corp, wafer chips. Taiwan Semiconductor and TEL.
With such strong R&D capabilities and research partners, TEL is always at the forefront of new innovations and technologies, to which it can implement in its products faster than its competitors.
The top 5 customers in its portfolio includes:
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place of the existing IPA* drying method, the CELLESTA Key Suppliers -i MD uses a new drying technology called Monolayer TEL has a list of suppliers that supplies the company its Dry. This proprietary method successfully reduces the raw materials for production of its goods and services. incidence of collapse of circuit patterns to less than one- With an exhaustive list, TEL can enjoy economics of scale tenth of those observed using conventional methods and are less affected by raw material price changes. A which can help to save unnecessary cost spending. summary of its suppliers can be seen below: CELLESTA -i was chosen from 34 products and technologies nominated for the Grand Prize in the semiconductor manufacturing equipment category across the globe. In the photoresist coating machine segment, Tokyo Electron with its Clean Track series has grabbed an as high as 90% market share worldwide. Revenues generated from the Clean Track product line account for 30% of the company's total revenues. In dry etch equipment, Tokyo Electron also has the second largest market share at 21%, and it also has the largest market share for contact probers (as of CY2013), a type Key Partnerships of equipment that examines wafer quality In order to be aligned with the upcoming Internet of Things, TEL has partnered several firms that produces Value Chain Analysis of Semiconductor Production such technologies and manufacturing capabilities such Equipment as Milpitas and Procket Networks Inc. Tokyo Electron is a world leader in the production of etching equipment to produce insulating film, which is Key Competitors critical for the mass production of 3D NAND flash Applied Lam Hanergy memory. Tokyo Electron is also a ubiquitous equipment Materials Research supplier of choice as the semiconductor chips that the KLA Tencor ASML Advantest company’s equipment can produce is being used in Holdings Corporation almost all electronic products. From HP computer, Texas instrument calculators, Panasonic home appliances as Wide Business Moats well as Samsung handphones, Tokyo electron plays an In order to be aligned with the upcoming Internet of indirect integral role in our daily lives. Things, TEL has partnered several firms that produces such technologies and manufacturing capabilities such as Milpitas and Procket Networks Inc. Tokyo Electron is Process for Manufacturing Semiconductors. also a market leader with intangible know how in the development of non-lithium semiconductor equipment. The company also has an agile business model whereby they have a diverse portfolio of complex proprietary production tools that are hard to replicate. This allows them to branch easily into the surrounding industries if there is a need to pivot. Tokyo Electron has competitive advantage in developing SPE equipment globally which is needed to develop semiconductors in all electronic products across the globe. TEL created a new division to Segment Leaders analyze its older installed base and, according to Chasey, The leaders in each of the processes are as follows wafer discover how to best support it. The business unit, called washing (Screen 54%, Tokyo Electron 23%), Photo- Field Solutions (FSBU), found a potentially immense resistive coating (Tokyo Electron 90%), Etching (dry etch opportunity: Customers were looking for help with new - Lam research 47%, Tokyo Electron 21%), Thin film configurations to meet emergent needs for IoT devices, formation (Applied materials 50%), Metal Contact and replacement parts that might not be readily formation (Teradyne 53%, Advantest 44%), Prove available. testing (Tokyo Electron 55%) and Packaging (Disco 84%).
As semiconductor devices become smaller, avoiding In the process of making a semiconductor, TEL is pattern collapse of high aspect ratio structures during dominant in 4 of the keys steps and commands 23% the post clean drying process is a serious challenge. In market share in wafer washing, 90% market share in 107 photo-resistive coating, 21% market share in dry etching dry etching process, which involves bombardment with as well as 55% market share in prove testing. ions to achieve the same ends. In dry etch equipment, Front End Process: The semiconductor manufacturing Lam Research has the top market share at 47%, followed process comprises front-end processes (wafer by Tokyo Electron at 21%. In conductor etch equipment, fabrication) and back-end processes (semiconductor Lam Research has a 53% share, followed by Applied assembly). The front-end processes start with silicon Materials at 32%, Hitachi High-Technologies at 10%, and wafer washing. Screen had a 54% share of the market Tokyo Electron at 4%. After the etching process, for auto wet stations (a type of washing equipment) and phosphorus and other foreign matter are ionized on the Tokyo Electron had a 23% share. Next is thin-film silicon substrate and infused into the wafer. Since the formation. Formation methods include physical vapour infused ions are electrically conductive, it is activated deposition (PVD) sputtering, chemical vapour deposition through heat treatment using RTP equipment. Insulating (CVD), and thermal oxidation. Applied Materials has the layers are then formed and the wafer surface is then top share of the market for thin-film formation made more even through the polishing process. equipment, dominating its rivals with shares of 50% in RTP and oxidation/diffusion equipment, 35% in CVD (including TSV) equipment, and 74% in sputtering (including TSV) equipment.
In the wafer washing process, some of the products that allow Tokyo Electron to stand out are the Cellesta – i which uses a new drying technology called Monolayer Tokyo Electron had a first mover advantage in photo- Dry. This method successfully reduces the incidence of resistive coating when scanner-type steppers using a collapse of circuit patterns to less than one-tenth of deep UV light source, usage of which grew rapidly during those observed using conventional methods. It also the early 2000s. Responding to this demand, Tokyo allows wafers to be produced at 300% the speed of Electron launched a reduced-footprint, reduced resist regular production methods. version of the CLEAN TRACK ACT™8 ahead of others. This product is now used by most major chip makers around the world. Success in raising market share in the United States helped Tokyo Electron further strengthen its leading position in the global coater/developer market. Demand for photoresist processing equipment is associated with unit growth of lithography equipment, as each photoresist coater/developer usually supports Photoresist Process: In the resist coating process (which one lithography tool. As Tokyo Electron continues to follows formation and washing), the wafer surface is innovate and provide up to date cutting technology such coated with resist (photosensitive liquid). In as extreme ultra violet lithography (EUV), it is poised to coater/developers (the type of equipment used in this remain dominant in this process. process), Tokyo Electron has by far the world’s top share in photoresist processing (track) equipment, at 90%. In Etching Process: Tokyo Electron is strong at the exposure process, infrared rays are exposed onto Globalfoundries in etching. Hence, it has significant the resist-coated wafer through a photomask (onto market share in the etching process. This trend should which the circuit pattern has been drawn), causing the continue over the next few years, driven by new chip circuit pattern to be transferred to the resist. In manufacturing processes including double patterning exposure equipment, ASML has an 82% share of the (DP) and FinFET in logic/foundry, and 3D NAND in market for steppers (including EUV), followed by Nikon memory. From a process point of view, DP uses more at 12% and Canon at 6%. Over the past 10 years, ASML, silicon etching steps than single patterning (SP), as does which achieved high throughput through twin-stage FinFET. The memory chip manufacturing process equipment, has surpassed the two Japanese companies. currently requires that 55% of etching steps are carried Next, developer is applied to the resist, dissolving the out using silicon etching technology, and this percentage portion of the resist that was irradiated with infrared is expected to rise to 60% for 3D NAND. As a result, TEL’s rays, completing the process of exposing the surface of is well positioned to capitalised on this shifting market the thin film. The remaining unexposed portion of the trends and reap more revenues. resist next acts as a mask for the etching process. Etching involves forming a pattern by using a liquid to etch away and then remove the exposed thin film. There is also a
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equipment, are likely to reap the benefits. Going forward, Tokyo Electron’s is well positioned to capitalize on the shifting market trends as film formation and etching equipment increase in demand due to a rise in Versatile Equipment: Tokyo Electron also has a lean and the usage of 3D NAND amongst semiconductor agile business model that allows it to pivot easily into companies. surrounding industries. This is made possible by their arsenal of complex proprietary production equipment. Future Pipelines Furthermore, Tokyo Electron also practices open A.I. Machines for SPE innovation as seen with their partnerships with spin The R&D team at TEL is currently researching on creating technologies to development the latest MRAM as well Artificial Intelligence (AI) Semiconductor Production as YOGOKAWA to develop stem cells for regenerative Supply Demand medicine. Tokyo Electron was also acknowledged by the 6 Feedback Upgraded and modular SPE guinness book of world records for its newspaper ad Customer… collaboration + Others After-sales service End presenting a periodic table of elements with augmented R&D 4 5 Customer 3 Consumers Partners Healthcare (Govt, Conducts Industry Businesses, reality (AR) features. intensive R&D Customer 2 Society) Smartphone Industry Suppliers 3 Tokyo Electron Customer 1 PC Industry Procure raw materials 2 1 Require Faster, Smaller, advanced Cheaper Chips SPE Equipment that is: able to self-diagnose errors, able to Back End Process: The back-end processes comprise learn on its own and autonomous control ability in the wafer inspection, assembly, and package testing. In production of the products. This will be in line with the wafer inspection equipment, Tokyo Electron has a 55% SPE industry trend, where for: 3D NAND (Flash Memory) share of the market for contact probers (as of CY2013), Higher accuracy and speed. DRAM (RAM): More storage, a type of equipment that examines wafer quality. In the Higher aspect ratio etching, Logic (Motherboard), market for SoC test equipment (used in pre-wafer Develop smaller logic boards using new materials and testing, or the testing of a chip’s electrical properties), New patterning technology for scaling. With the AI Teradyne has a 53% share and Advantest has a 44% technology being researched to create a self-learning share. SPE manufacturing equipment, we can expect TEL to be In assembly equipment, Disco has an 84% share of the able to adapt quickly to the growing demand of SPE, as market for wafer dicing saws, used in back grinding. seen from the on-going growth of global Package testing processes include pre-burn-in testing, semiconductors equipment market, which is forecasted test burn-in, and high/low temperature testing, all of to grow at a CAGR of 10.7% from 2014 to 2019, reaching which are methods for eliminating initial defects. Finally, a total market value of US$64 billion by 2019. package testing processes also includes visual inspection Nanotechnology – Nanowire field effect transistors and shipping. With its research partners, TEL is trying to utilize Nanotechnology to create Nanowire Field Effect Intangible Know How: For over thirty years, chipmakers Transistors (FET), which will allow production of better were able to lower costs in accordance with Moore’s SPE and FPD parts, reaping the benefits in particular: For Law by shrinking line widths and increasing wafer size. SPE: increased density of memory chips and reduced However, the transition to 450mm wafers has been a size of transistors in circuits, to put more power in a setback for equipment makers across the board. The smaller circuit board. This will be in line with the FPD semiconductor industry is now transitioning to mass industry trends same as above. For FPD: reduced power production of 3D NAND, in which the physical limits of consumption on display screens, reduced weight and line shrink are being approached. For that reason, in thickness of screens, nanowire will enable FPD to be recent years the film formation process and the etching more flexible. This will be in line with the FPD industry process have become more important than the trends, where: consumers are looking for screens that exposure process, and on a global level demand for the are bigger, industry is leaning towards the production of equipment made by Lam Research, Applied Materials, OLED from LCD and increased screen resolution from 4K and Tokyo Electron has surpassed demand for the to 8K from 300 ppi to 700ppi. This is in line with the FPD exposure equipment made by ASML, Nikon, and Canon. industry, which is forecasted to grow 15.8% from 2016 In logic production, line shrink through EUVL is just to 2020 reaching US$117b beginning. ASML and Tokyo Electron, key players in the industry, have a combined 100% share in such 109
Lastly, TEL also collaborates with its customers, whom becomes its R&D partners. This allows TEL to obtain real- time feedback from its customers on areas for improvement, to create products that are more customer-centric.
Financial Performance In 2013 and 2014, net profits for the company were considerably low with a reported net loss of JPY19.4 billion in 2014. This was due to the economic slowdown globally as well as in the electronics industry. During this period, the PC and smartphones market started to decline which affected the company’s bottom line as well. Tokyo Electron also underwent restructuring of its business by withdrawing from their photovoltaic panel (PV) production equipment business (TEL Solar Holding AG (formerly Oerlikon Solar Holding AG)), which lacked future potential as well as divesting from its electronic components and computer network business. This resulted in a JPY47 billion loss in write-downs for the company as management have decided to focus its resources in the SPE and FPD business segments which were set to boom with the overall marketplace demanding for better semiconductors as industry trends were leaning towards IoT and greater demand from China, Taiwan and South Korea. In 2013, the company made 3 acquisitions for TEL NEXX, Inc. (formerly NEXX Systems, Inc.), TEL FSI, Inc. (formerly FSI International,
Inc) and TEL Magnetic Solutions Ltd (formerly Magnetic Launched in 2005, TEL’s Plasma Etching Equipment Solutions Ltd.). These buyouts were part management’s ‘Tactras’ has gone through several upgrades, in 2006 strategy to strengthen and focus its business in the SPE and 2010. With the latest Tactras RLSA Etch in 2010, market for the coming expansion in this segment of the customers are able to fabricate even the most advanced semiconductor industry. The strategy paid off as the product lines. Using the newest system, production company saw its revenues grow from JPY497.3 billion to damages is minimized and it allows superior profile, JPY799.7 billion. This represented a 12.6% CAGR in uniformity and selectivity. With such advanced etching revenues over the 5 years. Net profits also saw an technology, TEL is able to dominate the etching process. impressive 1,788% growth from 2013 to 2017. Net
profits also enjoyed strong growth of 26.5% CAGR from Exclusive Technical Model That Is Highly Scalable 2015 to 2017 which was another testament of the
management’s foresight and dedication in bringing the Using its current business model, TEL is able to tailor to company through adversity. all types of customers that requires SPE. The SPE industry is driven by the demand of semiconductors by end consumers, such as government, businesses and society, who requires faster, smaller and cheaper electronical devices and applications. This in turn, creates pressure on semiconductor manufacturers as they will have to procure advanced SPE to create more efficient wafer chips to cater to the demand.
To meet the demand of its customers, TEL will then procure raw materials as well as through its intensive R&D, come up with upgraded versions of its modular SPE to sell to its customers. In addition, SPE provides after- sales service such as maintenance to customers.
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SPE & FPD Order Backlogs the company is able to convert credit sales in to cash The total SPE orders rose tremendously from JPY342 faster. At the same time, the payable period of the billion in 2013 to JPY 951 billion in 2017. This represents company has also seen a gradual increase from 44.88 a robust growth with CAGR 29.1% over the period the 5- days in 2013 to 51.32 days in 2017. This demonstrates year period. Similarly, the FPD business segment also that the company has been able to form strong reported robust growth rates of 25.1% CAGR over the relationships with its suppliers as seen from a higher same period. Sales of FPD equipment rose from JPY20 credit period given to them. The inventory turnover billion in 2013 to JPY49 billion in 2017.Tokyo Electron period has been rising gradually but this is in line with also saw the number of its sales waiting to be fulfilled in the rise in SPE and FPD order backlogs the company has fiscal year 2018 increasing from its 2 key business yet to fulfil. segments. SPE orders backlog increased by 83.2% from 2015 to 2017 to reach a total value of JPY464 billion. On Liquidity Measures the other hand, FPD backlogs also grew 29% over the The current ratio of Tokyo Electron has been declining same period to JPY37 billion yearly from a high of 4.89x in 2013 to 2.84x in 2017. Similarly, the quick ratio of the company fell from a high of 3.19x to 1.81x over the same period. This was primarily due to higher customer advances and higher inventories that the company has as a result of greater sales and a rising order backlogs from both its business segments. However, the both the company’s current ratio and quick ratio are above its industry peers of 2.49x and 1.76x. This demonstrates that the company is still able to maintain its liquidity above industry average.
Company Leverage Tokyo Electron has an extremely minimal risk of credit default as seen from its times interest ratio. The ratio . was 354.3x in 2013 and grew to 16,989.3x in 2017. This Operating Expenses shows that the company can pay its interests from debt In 2014, operating expenses rose 16.1% from 2013 to obligations 16,989.3 times over. The company currently ¥169.7 billion was due to increased R&D expenses in has zero leverage as seen from its Debt/Equity ratio of fields related to the four overseas subsidiaries acquired 0. The company has repaid all interest-bearing debts in in fiscal 2013. They were TEL NEXX, Inc. (formerly NEXX 2015 to make way for spare capacity. Systems, Inc.), TEL FSI, Inc. (formerly FSI International, Inc.), TEL Solar Holding AG (formerly Oerlikon Solar Profitability Holding AG), and TEL Magnetic Solutions Ltd (formerly Tokyo Electron is a high profitability company as seen Magnetic Solutions Ltd.). These costs also include from its ROE and ROA. The company recorded a high of amortization of goodwill, related to the acquired 19.1% ROE and 17.9% ROA in 2017. The rising trends in companies and losses from depreciation of the JPY. The both ratios as observed are indicators of the company drop in operating costs by 16.5% in 2015 was due to the getting more profitable. The APAC industry average for withdrawal from the PV business. However, operating ROE is 18.7% and ROA is 11.8%. This goes to show that costs started to increase yearly from 2015 onwards but the company is generally more profitable than its peers the sales growth outpaced the increase in operating in the Asia Pacific region. Globally, its US peers are expenses. This can be seen from the ratio of Operating recording impressive growth as well. LAM Research Expenses to Net Sales dropping steadily from 29% in (ROE: 30.1%, ROA: 16.2%), Applied Materials (ROE: 2013 to 21% in 2017 which demonstrates the company 41.5%, ROA: 20.2%) and KLA-Tencor (ROE: 91.6%, ROA: is incurring lesser costs for products in proportion to 19.3%). This demonstrates that the global SPE industry sales generated year on year. is in an upcycle now. Net Profit Margin Efficiency Ratios As the business began to pick up after restructuring Tokyo Electron has made considerable efforts to efforts by the management to propel the company into improve its operational efficiency. This can be seen from a new growth era, the company saw its net profit a gradual decline in days sales in receivables from 74 margins compounded at a rate of 10.9% from 2015 to days in 2013 to 61 days in 2017. This demonstrates that 2015. This represents a growth of 23% over the same period. The demonstrates that Tokyo Electron is getting 111 more profitable with higher net profit margins being widely used. Due to the emergence of IoT, TEL’s recorded on a year on year basis. portfolio of tools and machines have found its way into Dividend new industries where the applications of Tokyo Electron has a dividend policy to pay out 50% of semiconductors have expanded (AR, AI, Regenerative earnings and issue an annual dividend per share of not Medicine etc). As such, the industry is now less cyclical less than JPY150 as well as conduct share buyback as compared to before. Furthermore, key markets in exercises. This shows that the management is confident Asia such as China, South Korea and Taiwan are all of the company’s future performance to generate projected to experience GDP growth in the coming enough profits to issue high dividends. Dividends have years, we can expect higher consumer spending and the rose 590% since 2013 which demonstrates the strength manufacturing industries in these key economies to of the business to generate profits. Share buy backs also expand (Appendix). creates a positive signalling effect to the market because the management believes that their shares are Why Invest Now? undervalued. This will create wealth and value for Tokyo Electron is well positioned based on current shareholders. industry trends to be the number one leading semiconductor equipment manufacturer. With growing Top 3 Dislikes and Toxic Factors demand from China as well as the trends of IoT, the company is able to innovate with its expertise to create A. Steep Competition the necessary equipment to produce high performing Competition between SPE makers are stiff as the pool of semiconductors to meet the increasing needs of buyers of SPE machines are typically small and large consumers for high performance and high functionality companies like Samsung and Intel. As mentioned in the products. With its strong balance sheet as well as value chain analysis, each SPE makers are specialised in backlogs and earning abilities, we feel that the company certain processes of the semiconductors value chain and still has high potential upside for the imminent future. each maintains a dominant position in their own (TSE:8035) Tokyo Electron LimitedFY2013 FY2014 FY2015 FY2016 FY2017 FY2018LTM regions. TEL is dominant in the APAC region and 4 of the Share Price JPY 5,020.00 6,848.00 7,747.00 8,575.00 15,160.00 20,955.00 No of Shares (mil) 179.2 179.2 178.2 164.0 164.1 164.1 processes. Furthermore, the company is expanding its MCAP (mil) USD 9,064 12,116 11,287 13,697 22,143 30,505 proprietary technologies towards other applications and Net Debt (Cash) JPY (179,730) (203,166) (266,810) (181,371) (259,541) (273,323) Enterprise Value (mil) USD 5,549 9,165 10,146 8,708 15,401 27,580 future pipelines can be expected to increase market Revenue (mil) JPY 497,299.0 612,170.0 613,124.0 663,948.0 799,719.0 963,973.0 EBITDA (mil) JPY 40,320.0 61,358.0 110,141.0 137,017.0 174,201.0 238,350.0 share and allow TEL to be a highly competitive company EBIT (mil) JPY 12,549.0 32,208.0 88,113.0 116,790.0 155,698.0 219,003.0 NPAT (mil) JPY 6,076.0 (19,408.0) 71,888.0 77,891.0 115,208.0 163,910.0 in the global arena. NPAT (Ex.Xtra + Dis.Ops) (mil) JPY 2,519.0 27,717.0 74,076.0 88,763.0 123,166.0 167,282.0 CFO (mil) JPY 84,266.0 44,449.0 71,806.0 69,398.0 136,948.0 152,888.0 CAPEX (mil) JPY (19,012.0) (9,451.0) (11,898.0) (11,294.0) (17,557.0) (24,603.0) EPS JPY 14.1 154.7 415.7 541.1 750.7 1,019.5 B. Declining Orders Revenue (mil) USD 5,279.5 5,946.3 5,109.8 5,909.1 7,172.4 8,560.7 EBITDA (mil) USD 428.0 596.0 917.9 1,219.4 1,562.3 2,116.7 Downside risks to the business may be caused by a EBIT (mil) USD 133.2 312.9 734.3 1,039.4 1,396.4 1,944.9 decline in SPE and FPD equipment orders due to a NPAT (mil) USD 64.5 (188.5) 599.1 693.2 1,033.3 1,455.6 CFO (mil) USD 894.6 431.8 598.4 617.6 1,228.2 1,357.7 slowdown in the global economy or steeper competition CAPEX (mil) USD (201.8) (91.8) (99.2) (100.5) (157.5) (218.5) GPM (%) 31.9% 33.0% 39.6% 40.2% 40.3% 41.4% within SPE makers. For a ratio of more than 1.0, it EBIT (%) 2.5% 5.3% 14.4% 17.6% 19.5% 22.7% Net Debt (Cash) / Equity (%) -30.2% -35.0% -41.6% -32.2% -40.2% -38.6% indicates that the company has more orders than it can ROA (%) 1.6% 3.9% 10.1% 14.7% 16.3% 21.2% ROE (%) 2.1% 5.6% 13.7% 20.7% 24.1% 30.9% deliver which signifies higher demand and that it needs CFO/TA (%) 10.9% 5.4% 8.2% 8.7% 14.3% 14.8% EV/ Sales (x) 1.5 1.7 1.8 1.8 2.8 3.3 to invest in speeding up production. TEL’s current book- EV/ EBIT (x) 58.2 32.1 12.6 10.5 14.3 14.5 EV/ EBITDA (x) 18.1 16.9 10.1 8.9 12.8 13.3 to-bill ratio is 1.19x which tells us that there is a strong EV/CFO (x) 8.7 23.3 15.5 17.7 16.3 20.7 demand for the company’s machines and TEL is P/Sales (x) 1.8 2.0 2.3 2.1 3.1 3.6 P/EBIT (x) 71.7 38.1 15.7 12.0 16.0 15.7 expecting to fill more orders in the coming quarters. The P/B (x) 1.7 2.2 2.3 2.6 3.9 5.0 VQ1: EV/EBIT/ROE (x) 27.6 5.8 0.9 0.5 0.6 0.5 rise in orders and backlogs are also in line with a rising VQ2: EV/EBIT/ROA (x) 36.0 8.3 1.3 0.7 0.9 0.7 book-to-bill ratio for TEL. As such, we are confident that the company will not be experiencing a decline in orders in the imminent future.
C. Drop in Capital Spending The global economy affects how much semiconductors manufacturers spend on their capital expenditures. A downturn in the economy will result in steeper declines of equipment orders. However, with TEL’s diversified revenue streams, the company is no longer dependent on the electronics market for which semiconductors are
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12. TOTO Limited (TSE:5332)
Company Research & Report
Quick Stats Date 15/12/17 EBIT/R&D (x) 2.65 EBIT/Employee No. Filing Currency JPY (USD /px) 20K Share Price JPY6,220 EV/EBIT (x) 20.2 No. of Shares (Mil) 169.2 EV/EBITDA (x) 14.5 Market Cap (USD Mil) 9,334.9 EV/CFO (x) 18.9 Daily Value Traded (USD Mil) 37.0 P/Sales (x) 1.8 GPM (%) 38.1% P/E (x) 20.4 EBIT (%) 8.7% P/B (x) 3.6 Net Debt (Cash) / VQ1: EV/EBIT/ROE Equity (%) -5.4% (x) 1.2 VQ2: EV/EBIT/ROA ROA (%) 9.4% (x) 2.1 ROE (%) 16.7%
Team Members
Law Wei Siang is a third year Accounting student at Universiti Utara Malaysia. With his interest in investment, he founded Bursa Young Investor Club and started to gain investment knowledge in that platform.
Alvin Lim is a second year International Affairs student at Univerisiti Utara Malaysia. He started his investment journey since he was twelve and currently leading a research team in an investment club.
Lee Ke Qi is a third year Accounting (Information System) student at Universiti Utara Malaysia. As an accounting student, she took interest in investment and began to learn value investing.
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Company Overview
The TOTO Group was manufacturing seated flush toilets at a time when public sewage systems were not yet widespread in Japan, and it has been instrumental in promoting healthy lifestyles. The TOTO Group has opened the door to new lifestyles by creating products such as the WASHLET™, the prefabricated bathroom module, and other bathroom and kitchen plumbing products.
The second flagship product which is “Neorest”. This The TOTO Group is pursuing the development of product is a Hybrid Series equipped with toilet bowl beautiful products, focussing on design and cleaning function. This product created new revenues functionality. Emphasizing design characteristics means for the company as 2 million units were sold in a quick rising to the challenges of increasingly complex span of 3 years. It shows their products are well received manufacturing demands by overcoming production both domestically and internationally. Moving forward, issues one by one. Beauty is the crystallization of “Washlets” and “Neorest” are two critical engines. enthusiasm and ingenuity in the design of individual parts and production technology.
The TOTO Group pioneered development of the remodelling market in Japan and continues to lead its advancement by actively providing remodelling solutions that promise new lifestyles beyond customer expectations. To help customers gain a clearer sense of their options, we have established throughout Japan showrooms that let customers see, feel, and experience remodelling possibilities. Together with contractors, which are in direct contact with customers, we strive to show customers how bathroom and kitchen Origination of the Idea environments can be made more comfortable. Toilet is an inseparable and important component in The company was trying to enter the global market to every house or building. Without a toilet, it creates ensure the company’s revenue grow healthy every year. inconveniences for the human population and it causes This shows that the management team have been potential pollution of the environment. A comfortable intentional on globalising their products. The company and user-friendly restroom must be equipped with a first entered the world largest economy which is the good sanitary system to ensure good hygiene in our daily United States. In succession, after 5 years the company life. entered the 2nd largest economy, China. This shows that the company has the insights in assumption of the Today, a clean toilet reflects the personality and the potential growth market for the sales of toilet. Thus, image of the building’s owner or country. Besides that, sales from United States and China had increased the a comfortable toilet provides better hospitality to company’s revenue consistently even till today. travellers or visitors. Therefore, modern buildings, Currently, their domestic market accounts for roughly shopping malls and hotels begun to pay attention to 70% of the TOTO Group's net sales. such details, as more installation of smart sanitary system in order to impress their visitors. Besides that, it The company’s flagship product which is “Washlets”. also reflects high standard of cleanliness. This creative design utilises a warm-water washing feature. “Washlets” has achieved 40 millions shipment Behind every clean toilet is an efficient sanitary system. in 2015. This shows that the innovative nature of the Therefore, our team had chosen TOTO, the leading company is the hidden value that drives revenues Japanese sanitary system manufacturer as our research forward. company, because as living standard and cleanliness improved, the demand of a modern sanitary system will continue to grow in future.
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Besides that, TOTO Washlet product had established awareness in China and also in consumer preferences in high market presence in upscale market in both US and China trailing behind Kohler and Arrow. Therefore, we Asia, we believe TOTO’s smart bathroom solution will were able to project TOTO future earnings in Asia continue to attract high net-worth buyers which market to continue growing in the next 10 years based prioritize comfort and luxury in China and ASEAN on current market data. market. TOTO’s products are innovative, high technology and its ergonomic design showcased Japan’s design philosophy.
We believe TOTO’s plan is to expand into their expertise into other segments such as green building materials and prefabricated bathrooms will essentially reduce TOTO’s dependent on only one product. Therefore, we recommend TOTO as hidden champion as we saw the TOTO potential to benefit in future smart technology sanitary system and the adoption of prefabrication toilets in Asia countries.
Why TOTO?
Growing prospect on China sanitary markets According to Frost & Sullivan report, rapid economic growth in China had led to an accelerating urbanization process with an influx of rural inhabitants to the urban area in China. The urban population in China increased by 18.5% from approximately 582.9 million in 2006 to approximately 690.8 million in 2011. Hence, rapid urbanization has substantial impact in consumer patterns and habits of Chinese consumers.
Driven by the growth of new housing development in China and home renovation activities, sanitary ware market is expected to grow to RMB 144,848 by 2015, representing CAGR of 14.4% growth from 2011 to 2015. The target market of TOTO product segment, mid to high end ceramic ware market, accounted 47.1% total market share of China’s ceramic market. From 2011 to 2015, the mid to high segment recorded the highest growth of market share compare to low-end and premium markets with CAGR 18.5% annually. Hence, the mid to high end market was the largest market in overall China ceramic market.
Therefore, we expect TOTO to benefit from China growing sanitary equipment market based on three criteria, market share, and brand awareness and consumer preference.
In Frost & Sullivan survey, TOTO ranked No. 3 in top 10 brands in China mid to high end sanitary and ceramic markets ware in 2011. In terms of market share, TOTO ranked No. 2 among top 10 brands in China sanitary and ceramics ware market, with average retail sales of 1,510 million RMB, approximately 8.3% of total market share. Furthermore, TOTO also ranked No. 3 in brand 115
Environmental friendly sanitary products AP, leading manufacturer of key housing materials like metal bearing, interior door, lumber and aluminium TOTO’s latest product, Neorest, consumed 3.8L water windows, which formed the TDY alliance. Both Daiken compare to previous models which consumed average and YKK has international presence in building material 14L. As water resources are becoming more scarce and manufacturing market and numerous joint-venture with precious, water-saving products began to gain local company in Asia. popularity in countries which lack of consistent water supply. Besides that, more countries are more The integration with building materials company, had environmentally conscious, which offer incentive and given TOTO advantage in securing more contracts in IBS tax rebate to reduce wastage of water and carbon construction projects in Japan or overseas. As Japan footprint. Olympics’ official plumbing and sanitary equipment supplier, the boost in infrastructure projects would be seen.
Efficient Marketing Strategy In order to strengthen marketing avenues and business strategy, TOTO management adopted a three-stage strategy to enhance communications between customer and TOTO products dealers. First stage is building brand Besides that, TOTO management are committed in awareness by approaching notable properties. Second environment conservation in their corporate mission stage is to increase market penetration in domestic charter. In their management V-Plan, TOTO planned to market. TOTO opened numerous showroom and contribute to environment conservation through their lifestyle experience centres in worldwide, including business activities. We viewed TOTO’s environment establishing direct showroom in developing countries initiatives and TOTO product’s competitiveness go hand- like Vietnam. in-hand to meet the environment standards of international organization, such European Union. Such We are favourable of this strategy since customer can advantage provides TOTO the opportunity to penetrate get better insight of TOTO products rather than markets in Europe which are more environmentally traditional retail model which depend on authorized conscious. dealers. Besides that, customers can get better after- sales service and support directly from manufacturer Growing market trend of prefabricated bathroom warranty, it could increase customer satisfaction and modules also reduce the risk of parallel import. The adoption of IBS (Integrated Building System) in modern construction field had increased the utilization The third stage of implementation is to establish a luxury of prefabricated bathroom modules. Therefore, the brand. TOTO management’s approached numerous demand of pre-fabricated bathroom modules will upscale hotel chains, to promote TOTO toilet branding continue to increase to cater the need of IBS buildings. to be installed, in order to create strong brand Currently, TOTO has proprietary technology of awareness among consumer. Since TOTO products were bathroom modules, consists of unique ceramics design. engineered to provide comfort and sophisticated, TOTO is creating their own niche market among its own fans. TOTO’s specialization in bathroom floor material known as Karari floor, which feature soft texture which provides Besides that, TOTO also worked actively with greater comfort to its users. In bathtub segment, TOTO government authority to promote their marketing has the Mahobin bathtub that are highly insulated. It strategy. For example, TOTO established a TOTO gallery allows no more than a 2.5C decline in water inside Japan’s busiest international airport, Narita. This temperature over a span of hours. strategic location with high human traffic benefits TOTO Furthermore, to further strengthen their remodelling marketing through public awareness. business, TOTO had formed alliance with Daiken and YKK 116
Future Prospects Key points in Mid-Term Management Plan- WILL 2022 Company future direction The management of TOTO formulated a long-term “Anshin” Remodelling Strategy business plan known as TOTO V- Plan 2017 management plan since July 2009. The domestic housing equipment business underpins TOTO, accounting for about 80% of all sales. Following The plan reorganised TOTO strategic framework into the global financial and economic crisis, the number of two business segment - housing equipment business new housing starts in Japan plummeted, TOTO’s and developing new business domains consists of remodelling strategy plays a major role in this severe advanced ceramics business and Green Building issue. In one of the TOTO global environmental vision, materials business. Japan housing equipment business, TOTO makes a new declaration on their remodelling strategy which called The development of housing equipment business in “Anshin” remodelling strategy. TOTO has been always China, India and ASEAN countries continue become the targeting in proposing new lifestyles to its customers. main driver of TOTO growth for the next decades. As The latest declaration encapsulates TOTO’s desires to household income continues to grow rapidly in Asia help customers so that they can embark on remodelling countries, demand for higher and better qualities with peace of mind. TOTO will consider about their standard sanitary wares has soared rapidly. The amount customers’ concerns to make sure they can visualize and of residents in China and India will generate higher level understand. of sales to TOTO as they are aiming towards being the most trusted brand in China. One of the initiatives by In able to ensure continued growth, TOTO started TOTO to build strong sales network to meet changing wholesales product to the public. This is another market and customer needs is by harnessing strength of marketing strategy to prevent the company’s reliance existing building materials route in rapidly growing e- on the retailer sales. This strategy will enhance the commerce route. profitability and consistency of the revenue growth in future. TOTO also started approaching construction In able to cope the surging demand of sanitary products companies. For example, TOTO Thailand signed contract in Asia markets, TOTO increased productions lines in with V.M.P.C to use TOTO’s innovative toilets. This both Thailand and Vietnam. This strategy was in-line company has launched Atara Hotel Sriracha which with TOTO management’s aim to increase TOTO brand consists of 460 rooms. Atara Hotel chose to use TOTO’s exposure in ASEAN countries. Currently, TOTO has sanitary ware both toilets with revolutionary flushing plants in Vietnam and Thailand which will be operational system and Washelt, automatic sear and cover with in 2018. We estimated both production plants will able adjustable heated seat system, self-cleansing function, to contribute higher earnings on TOTO’s net sales. air dryer and deodorizer, suitable for all ages and Besides continue development of Washlet flagship genders. product, TOTO also actively expanding into other bathroom components such as bathtub and advanced Developing “Only One” Technologies ceramic wares. In March 2017, Straits Times Singapore reported that TOTO launched a cradled shaped bathtub, One of the business domains that proposed by TOTO is named “Floatation Tub” which bring user ultimate advanced ceramics business. TOTO creates value relaxation by inducing a trance-like state. We viewed through collaboration with customers and suppliers by this product as a positive move of TOTO to expand their introducing high- performance semiconductor portfolio in global housing equipment business. manufacturing technology and next generation high- speed optical communication devices. TOTO builds a production structure that meets new demand and replacement demand. This technology is developed by actively expanding investment in next-generation R&D. Super-hydrophilic photo catalyst can be applied to various materials and fields as mentioned above. TOTO is going to apply this technology to exterior tiles, siding boards, and mirrors. From our analysis of TOTO corporate report since 2009, advanced ceramics business recorded the highest growth in net sales, with The official shop page of TOTO on the biggest online an increase of 135% compare to other segments. shopping platform in China, TMALL. Generally, advanced ceramics business consists were 117 materials that can withstand high chemical resistance, industries field and also developing the next generation abrasion resistance and stable. Therefore, a higher sales leaders of the company. We welcome TOTO’s effort of of advanced ceramics suggest the growing market share emphasizing the importance of knowledge as it will of sophisticated bathroom equipment or component, benefit the future of company while in the journey of which bring positive impact on new business domain. expanding their overseas operations. Besides that, employees also have the opportunity to learn foreign cultures through language class, which helps them to assimilate into domestic community.
TOTO’s motto: to bring Japanese toilet culture to the world
TOTO traces its roots back in 1912, and start its humble beginnings as a sanitary ceramic maker. Today, TOTO’s brand, Washlets is part of the iconic culture of Japanese cleanliness and hospitality with the touch of futuristic technology.
TOTO’s president, Madoka Kitamura mentioned that a country’s hospitality image is based on the cleanliness of Leadership Board public toilets. This gives TOTO’s products an important role in shaping the minds and impression of visitors to Corporate culture of TOTO Japan. Furthermore, it also reflects the high standards of TOTO emphasizes on work life balance culture, by TOTO sanitary designs and spirit of incorporating three creating a sustainable working environment for elements into sanitary products, modern, comfortable, employees. Under TOTO’s work life balance culture, and quality. employees were encouraged to take paid leaves and also setting up various facilities such as nursery and child Since the launch of Washlet brand in 1980s, the special day-care centre to ease the burden of employees. We function toilet had gained popularity around the world. can conclude TOTO’s corporate culture was much differ Dubbing “the Apple of Toilet Tech” by the Fortune with traditional Japanese company which mandate magazine in 2013, TOTO Washlet brands is synonymous employees to spend more time in office. Besides, TOTO with Japanese culture that outline beauty is the new also encourage its employees to strengthen their family comfort. The Washlet redefined the sanitary market and ties because family is foundational support for its successfully create their own niche. employees. Due to its high tech specifications and ergonomic design, Besides that, TOTO also advocate for more women TOTO toilets became the cult culture for smart toilet participation in the company, which target to increase today. In 2017, CNN’s home design journalist Amanda the percentage of female managers by 10% in 2017. We Sealy, noted that smart toilets today is simply referred can also view TOTO’s move to increase female managers as TOTO, such like a vacuum cleaner is called Hoover and in company top management bode well with their work the hot tub a Jacuzzi. TOTO’s Washlet’s pioneer status life balance culture. In typical Japan, females tend to earned a constant market share in bathroom appliances encounter more career obstacles in the corporate world in the world. compared to men. Hence, TOTO’s work life balance culture relieves the burden of female employees. From brief analysis of the general perception of media Such corporate culture could inspire more female and public towards TOTO flagship product, Washlet. We employees with great capabilities to move ahead TOTO can conclude the management of TOTO took meticulous corporate ladder. effort in designing their product to ensure high standards were maintained in every Washlet they sold. TOTO also provides management training for employees The management strives to promote the unique to enhance their language skill and knowledge with the experience of Japanese toilet culture to everyone, not introduction of Open School. The purpose of Open because it is a leader in the industry, but more School is to let individuals to choose what they want to importantly, it is TOTO’s strong spirit to uphold Japan’s learn. Under TOTO management school (Keiei-Juku), image as the world most cleanliness and civilized employees can learn extra knowledge of other country. 118
company’s management base. Three of the directors have the voting right in the meeting, this type of culture is rarely seen in the world. In other companies, independent directors have no voting right. They only will provide advice to the board during the meeting.
The cross shareholdings in TOTO has declined significantly, that’s only one bank be the major shareholdings of the company which is The Bank of Tokyo-Mitsubishi UFJ with only 1.74%. The total of the shareholdings combines with bank, trust bank and TOTO Shareholding Structure Shareholding Analysis insurance company does not exceed 31.12%. This will break the traditional Japanese practice of cross- TOTO largest shareholders are mostly of financial shareholdings, which the Zaibatsu will hold more than holding companies, holding up to 44.6% of the 51% share in every single company. None of the major shareholdings. Such shareholding structure and shareholders hold more than 10% of the TOTO Group’s ownership pattern are common in Japanese Kabushiki- shares. Thus, this will decrease the accounting fraud and Gaisha, Japanese joint-stock company. As most financial related party transaction between the shareholders and holding company in Japan like Mitsubisihi USJ, Mitsui none of the shareholders have the major power to alter were Zaibatsu (conglomerate), financial company and control the company’s decision that will affect the typically hold interlocking horizontal or vertical company future plan. shareholding patterns. However, TOTO did not belong to any league of keiretsu family. But one of Japan largest TOTO Group’s established nominating advisory homebuilder, Sekisui House have a substantial stake in committee to ensure the transparency and objectivity of TOTO. TOTO’s management through activities such as TOTO’s Corporate structure deliberating on and confirming the appointment of TOTO’s Directors and Audit & Supervisory Board Members. This position will be appointed by the Board of Director of the company. The Committee shall report to the Board of Directors on proposals submitted to the General Meeting of Shareholders related to the appointment and dismissal of the candidates of Directors and Audit & Supervisory Board Members, including Outside Directors and Outside Members of the Audit & Supervisory Board. The company has two outside members of the audit & supervisory board, which are Masamichi Takemoto and Akira Katayanagi. Masamichi Rakemoto provided a wide variety of Corporate Governance opinions from a global viewpoint on quality control, risk TOTO’s management emphasize on the fairness, management and business strategies whereas Akira objectivity and independence by appointing three Katayanagi provided a wide variety of opinions from a Outside Directors who are independent of the TOTO global viewpoint on financial aspect, human Group. The number of outside directors increased from development and management on the group 2 to 3 in the year of 2016. The Outside Directors will give companies. various advice and make proposals on our overall management. This kind of practice is rarely seen in Management Philosophy Japan. Three of them will provide different opinion on the TOTO Group’s activities. The first outside director is Hiroki Ogawa, he provided a wide variety of opinion on sales activities in Japan and overseas. The second director, Kazuhiko Masuda, he provided a wide variety of opinions on distribution of management resources, business management and so on. Masatsugu Shimono, the third outside director of the company, he provided a wide variety of opinions on reinforcement of the
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TOTO’s group management philosophy was formulated Mr Kunio Harimoto- the current representative director, according to their founder’s letter, Kazuchika Okura to and chairman of the board. Born in 1951, Mr Kunio his successor, Saburo Momoki. The content of the letter obtained his degree of Commerce in University of is treasured as the Words of our founder. The words of Waseda. Mr. Kunio Harimoto served as the President of founder had become the foundation of TOTO motto. TOTO Ltd until April 1, 2014 and its Executive Officer. Mr. Harimoto has been Chairman of the Board at TOTO Ltd April 1, 2014 and serves as its Representative Director since June 2003. He has been an Outside Director of Nishi-Nippon Railroad Co., Ltd since June 2014. Besides that, he was also appointed as the honorary consulate of Finland in Kitakyusu Japan.
TOTO’s founders, similar to other prestigious traditional Japanese firm, took pride in their craftsmanship to deliver the best qualities product. While quality products may cost a bit more, the company focuses on providing product satisfaction to its customers. Therefore, we can conclude TOTO management is strict on product quality to ensure that only good products are delivered. The formation of TOTO corporate core values can be seen below;
Key Management Analysis Growth Stock Assessment
Mr Madoka Kitamura- the current president and Income Statement representative Director of TOTO Ltd. He is in-charged of global business promotion, management planning design and the secretary’s office. Born in 1957, Mr Madoka Kitamura graduated from University of Nagasaki with a Bachelor of Economics. Madoka Kitamura was appointed President and Representative Director of TOTO Ltd. in April 2014. In May, immediately following his appointment, he announced the TOTO Group's Mid-Term Management Plan. To achieve the TOTO V-Plan 2017, TOTO's long- term management plan that was announced in 2009, he presented strategies for the domestic (Japanese) housing equipment business, the overseas housing equipment business and new business domains in Japan Balance Sheet and overseas. He joined the company in 1981, and he has held key management positions in subsidiary companies of the TOTO Group. After serving as Section Manager of TOTO's Accounting & Finance Division, Deputy Manager of the Management Planning Division, and General Manager of the Management Planning Division, he was appointed General Manager of the Bathroom Division in 2008. In 2011 he was appointed Director. While he was General Manager of the Bathroom Division, he worked on developing platforms for modular bathroom for the The factories in Vietnam and Thailand will start to domestic market, and released the products in 2012. commence business and process for the toilet product in the year 2018. The future sales will be increased 120
because TOTO Group will strengthen the market of The Biggest Competitor: Geberit Southeast Asia. Other than that, the factory in Thailand The Geberit Group is a Switzerland-based multinational and Vietnam will contribute to high profit margin due to specialized in the manufacturing and supplying of the lower cost and tax expenses in both countries. This sanitary parts and related systems throughout Europe will increase the net income of the company as well as and the world. As TOTO and Geberit having similar the profit margin. product line, we will deeply discuss about the comparison between TOTO and Geberit in few Otherwise, their new business, advanced ceramics will important aspect which are marketing strategy, also contribute to the sales of TOTO Group in the future. business model, product differentiation and future As there is relatively lack of strong competitors in prospect. sanitary ware technology, we believe that TOTO will come out with a more advanced and unique technology Marketing strategy in this business to compete in the market. Eventually, TOTO applies a direct showroom strategy to attract new the future sales of the advanced ceramic products is customers, with more than 13 showrooms around the believed to grow faster than the main business of the world. Inside TOTO well-furnished showroom, each company which is sales of toilet product. customer will have first-hand experience of TOTO products and served by appointed sales personnel. The Competitive Advantages aim of TOTO’s marketing strategy is to shape TOTO Competitors of TOTO are analyzed based upon two brand awareness as the premium brand of toilet. categories to determine how high of a threat they are to TOTO’s market share as rivals. Besides, maintaining a lifestyle experience showroom, TOTO established relationship with network of TOTO is the world's largest manufacturer of plumbing authorized dealer and joint ventures across the world, fixtures. The company offers a wide array of products, notably in Asia. This grant TOTO a solid foothold in Asia ranging from restroom products to high-tech ceramic sanitary and ceramics market. Besides that, most TOTO products. Few of its top competitors are able to match overseas subsidiary operates independently, this allows TOTO's wide scope of products. For example, Grohe, more flexibility in marketing strategy to accommodate also a large manufacturer of bathroom products focuses different sanitary culture in different countries. on a niche market that mainly sells faucets. American Standards, a widely-known American brand also offers a In contrast with Geberit, Geberit pursue more proactive wide range of products, but they don't have ceramic marketing strategy which they deploy a moving toilet products like TOTO. Besides its diversified product showroom to travel around areas of targeted customer. categories, TOTO also listens to their customers to Compare to TOTO’s passive marketing strategy, Geberit determine the needs of the market. TOTO’s products embrace a push and pull strategy approach. provides affordable solutions without sacrificing performance. TOTO invests a lot of money into R&D to Under the” push and pull” strategy, plumbers were make products that are innovative and good for the educated to ‘pull” the product through wholesale environment. They understand that true value comes channel, and company sales representatives “push” the from customer satisfaction. products to wholesalers. In exchange for plumbers’ promotion, Geberit pays commission to the plumbers for their toilet installations.
Such alliance between suppliers and Geberit brings attractive profit margin for Geberit, Geberit achieved greater operating margin up to 15% compare to TOTO’s operating margin of 8%. Besides that, such business model also allows Geberit to secure up to 70% of European sanitary market share.
Geberit also employed a moving showroom tactics to display their products to their targeted customers. In promoting their Aquaclean shower toilets, Geberit moved showrooms to provide greater exposure to customers by travelling around Europe using moving
truck. Besides that, Geberit also made a mobile toilet 121 showroom available in selected concerts, sporting In both analyses of both companies’ product offering, events and other major events. our team discovered that TOTO and Geberit have both work closely with construction companies to provide In addition of traditional marketing strategy, Geberit end to end sanitary equipment integration. While TOTO also focus more on middlemen or target group established alliance with construction companies for relationship to enhance sales by providing them promotion of its remodelling business, Geberit focus on technical assistance and education. Hence, by nurturing construction of customized urinal system for hotels, friendly relationship with dealer or plumbers, plumbers stadium and buildings and also waste trap management can help to boost Geberit sales, as well indirectly market system. Our team analysis conclude that Geberit have their products to their customers. It could help to foster more expertise on sanitary infrastructure such as brand loyalty, during economic downturn when pipings, cisterns, installations systems, while TOTO has renovation and construction slowing down, plumbers great experience in bathroom interior design, friendly become the main support of Geberit business. Hence, user interface and high technology bathroom plumbers become the main pillar of Geberit business accessories. when consumer scale down on spending. In contrast with TOTO, during 2009, TOTO sales suffered major However, both companies can learn each other to losses as their product pricing was expensive and lack of improve both products and service. TOTO despite being effective contingency plans to weather economic re-owned manufacturer of cutting edge bathroom downturn. technology, TOTO’s product still lack of Geberit engineering touch on water pipes and drainage systems, Therefore, in contrast with both Geberit and TOTO and precise plumbing technical details on bathroom marketing strategy, our team concluded that due to internal installation system behind the wall. While, difference in target customer groups, TOTO put more Geberit bathroom ceramics segment and smart toilet concentration on creating a luxury brand image by functions still behind TOTO technology until their recent building direct managed showroom, in order for acquisition of Sanitec in 2014, their flagship product customers to experience their high technology product, Aquaclean series still lack of TOTO influence in Asia and while Geberit focus on minor detail by cultivating US markets. However, Geberit proved a strong relationship with plumbers because most Geberit competitor with other bathroom equipment maker after products focus on its durability than luxury. Hence, an their integration with their piping systems. easy and durable products will be recommended to customer which look for value of money compared to Business model value of comfort. In terms of corporate expansion, TOTO and Geberit took different approach in expanding their company, TOTO Product Offering Differentiation took an organic growth approach, while Geberit pursue TOTO and Geberit product offering was homogeneous M&A approach by vertical integration. Currently, TOTO which range from sanitary solutions, bathroom, faucets did not acquire any competitor, but instead focusing in and ceramics. However, TOTO and Geberit product expanding production line in Asia region. offering differentiate in both patterns as TOTO only focus more on engineering a high function toilet or However, Geberit had undertaken numerous vertical bathroom equipment, while Geberit focus on more on expansion by takeover of bathroom ceramics maker basic outdoor bathroom supplies such as highly sound Sanitec in 2014, Chicago Faucets in 2002, and Caradon insulating building drainage plunging system, cistern Terrain and FAE Fluid system in 1999. In comparison of mechanism, customized urinal system for buildings, and both companies’ business model, we expect Geberit pipes and brass fittings. market share expand in faster pace compared to TOTO organic growth. However, TOTO in-house research and TOTO puts more concentration on product design and development proved more sophisticated than Geberit. proprietary technology of Washlet technology, while Geberit focuses more on engineering of external Unlike Geberit which need to acquire companies to bathroom equipment. TOTO Washlet series established expand technology know-how, TOTO research solid market presence than Geberit Aquaclean series, department had amassed more proprietary bathroom which was only introduced in 2015. However, in terms technology such as water consumption management, of external equipment engineering, Geberit has more smart ceramics materials such as HYDROTECT tiles and experience in piping system, which was an area TOTO heat insulated bathtub. These technology placed TOTO did not have any expertise or existing product as the world leader in sanitary technology,as a result development. TOTO products were more prefer by luxury and upscale 122
market for such sophisticated detail , indirectly helped Geberit future growth prospect were largely dictate by to increased TOTO operating margin from 3% to 8 %. In their new launch of Aquaclean series, which was just contrast, Geberit only have relative technology on launched in 2015. Despite being the new kid of the installation system and piping, while smart technologies block, Geberit Aquaclean series had made new inroads bathroom appliances still in growth stages. in shower toilet market which was presently dominated by luxury bathroom equipment maker such as TOTO, Future prospect Grohe and Kohler. However, according to Geberit latest Besides than mainstream business of sanitary wares and business report, due to overwhelming demand of bathroom equipment, both companies have also Aquaclean, existing facilities line unable to cater such developed new products as new sales catalyst. For strong demand, resulted slower growth in Aquaclean TOTO, aside from their flagship Washlet product, TOTO series. developed new business domains that focus on advanced ceramics business and green building material Despite facing current obstacle in production line, our products. The advanced ceramics business consists team still positive with Geberit future prospect to range of high quality ceramics produced for the feature an integrated bathroom solution which semiconductor industries. comprise installation system, cisterns, water taps and their Aquaclean shower toilet. Besides that, we were TOTO was involved in development and research of also positive with Geberit new innovation of their piping advanced ceramics since 1984, hence TOTO has the system featuring a high technology, heat insulated and specialization on air bearings, electrostatic chunks, sound proof piping system. optical components, AD ceramic film, bonding capillaries, and precision ceramic components. Our We expect Geberit piping system will continued be the team found out that the huge growth in TOTO’s main growth driver, as demand of efficient piping advanced ceramics segment was fueled by the surge of system needed to discharge water at a higher rate, demand in electronic and semiconductor industry. especially during harsh weather condition when the volume of water increased tremendously. We foresee Our team is confident with TOTO’s advanced ceramics the demand of highly sophisticated piping systems will product especially as most of those components like surge in future, as risk of unusual weather or natural optical and precision ceramics were largely utilized in phenomena increased. communication sector and inspection and fabrication of semiconductor mould and tooling those components In comparison growth prospect of both sanitary were designed to withstand high thermal resistant, companies, our team concluded that TOTO new superior durability, and high specification. For example, business domain advanced ceramics and green building TOTO’s silicon infiltrated silicon carbide-SiSic was materials will continued to be future catalyst growth of normally used for manufacturing of FPD (flat panel TOTO. While for Geberit, Geberit new development of display) and processing and conveyance system of shower toilet, Aquaclean series, propelled Geberit into semiconductor, while TOTO’s optical receptacles were an integrated player of the sanitary market from system install in wide range of transceivers, like communication behind the wall and in front of the wall. However, in network and mobile phones. current situation, both companies’ growth prospect still in growing stage and largely dependent on sentiment of Besides that, in order to understand and customized consumer market. We hope both companies’ customer needs, TOTO had adopted 3D technology for management will have long term plan to execute and leading edge semiconductor device. Hence, we estimate implement in economical scale. as global semiconductor demand continued to move uptrend, more specialized ceramics component is needed to ensure high safety priority and inspection of semiconductor. Therefore, our team projected that TOTO’s advanced ceramics segment would continue to grow and contribute larger profit in TOTO Group revenue. We noted that the growing of global semiconductor production and fibre optic communication was behind the growing profitability of Business Risk Factors TOTO advanced ceramics department. Price fluctuation of foreign currency and raw material such Copper and aluminium.
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As a key raw material for manufacturing the “Washlets” Group faces stiff competition with brands in Europe such and “Neorest”, the copper and aluminium price keep as “Grohe” and “Kohler”. Both of these brand represent changing everyday follow by the index board. This may the flagship toilet product in Europe, so there’s a barrier adversely affect the TOTO Group's business, financial for TOTO Group to join and compete in the Europe condition and operating results. For example, if the market. Thus, to remain the competitive, TOTO Group demand in one of the quarter perform very well, the must constantly invest in research and development to price of this 2 raw material will be increased steeply in build wide and deep moat in the Europe market. the particular quarter. On the other way, when the demand decreases at the same quarter in the following Why TOTO’s price will be doubled up in 5 years? year, the price will be decreased steeply and this will make the company financial performance surge in the period. If this thing happens frequently, the financial performance of company will get affected and the public confidence for the company will drop in the future.
Secondly, TOTO Group’s conducts international business transactions, while production, sales and other operating activities overseas are handled in foreign currencies. In between currency translations, there are foreign currency risk for the company. In addition, the assets and liabilities of overseas consolidated subsidiaries are translated into yen on the consolidated balance sheets. Thus, if the Japanese Yen perform well Increase in Capex lead to higher growth of future compare with other countries, the profit of the company revenue will be decreased due to the weak foreign currency of overseas country. TOTO currently have more than 20 manufacturing sites, 36 sales offices and 13 showrooms across the globe. In TOTO FY 14-17 midterm management plan which aims High pricing of “Washlets” and “Neorest” to establish a global supply chain network, TOTO has
subsequently increased capex on existing plant in Both of these are the flagship products of TOTO Group’s. Vietnam and Thailand to double its present production Due to the high quality of the products, it may boost the capacity. revenues during good times, it may also reduce revenues during bad times. Even TOTO Group’s have According to TOTO projection, upon completion of new exported their product to India, but the country might Vietnam Plant No. 3, will be able to export 600,000 need such high quality for toilet facilities. The market pieces of sanitary per year to other Asian countries. In demand for such products is not visible as such Thailand, TOTO planned to invest approximately 2.88 companies are fighting to have the least and most basic billion baht to expand local operations by construction toilet facilities at the moment. of a second plant to be completed in April 2019. The new
plant will be able produce 420,000 units per year plus Both of these products will be installed in places with another 450,000 units from the adjacent plant, with a high disposable incomes. Thus, the company will face total combination of 900,000 units expected. this problem due to the poor demand and lack of interest for the high quality toilet products. On the other The new facilities will be installed with state of art hand, most of the company will not invest to increase technologies to reduce environmental pollution, as well the quality of toilet facilities. They might focus on the labour cost. TOTO has collaborated with Fujitsu to development of property, public transport and so on. develop a smart factory system, which provide greater Thus, the budget allocation for every country on quality management by using IC tags and barcodes improve the quality of toilet facilities is very limited. attached in products in progress and all sorts of
equipment to collect information, not only including Barrier enter into Europe market quality and progress information, but also humidity and
temperature when raw materials were mix and type of As we know that TOTO Group’s revenue is more reliant glaze applied on sanitary wares. Thus, use of technology on Asia instead of western country such as Europe. in new plant can reduce product malfunction and reduce Europe is a huge and potential market that is able to cost of human labour using automation. help TOTO to generate more revenues. However, TOTO 124
Leader of sanitary technology development
TOTO first developed the bidet toilet seat device, Washlet, which equipped with smart technology like heat warming seat, tornado flushing patterns and electric control device. Since the invention of Washlet, TOTO invented and developed numerous ground- breaking sanitary systems and bathroom equipment and In working capital, TOTO has 2.53bil yen total current most of these technologies were unique intangible asset and 1.611 bil yen of current liabilities. Thus, we know-how of TOTO. From medium range Washlet to conclude TOTO has enough capital to service their long luxury Neorest and smart bathtub that equipped with term and short- term debt. In their latest financial report smart sensors, TOTO is leading among all competitors in 2017, TOTO has a combined of 956.67 mil in both cash terms of research and development. and short term investment, which is sufficient to repay
current debt obligation and capital leases obligation Besides than its beautiful and futuristic appearance, worth 269.3 mil yen. Besides that, with cash reserve up TOTO has advantage in cutting-edge technology of to 956 mil yen, TOTO was able to finance or pursue water-saving and control panels that can adjust to suit merger and acquisitions of rival competitors, which rival your own comfort. TOTO also invented the Tornado Lixil Group had taken. flush, which saves more water than traditional flush by installing three water jets which flushes the rim in an Alternative distribution channels via joint venture innovative way. Such precise details of TOTO products has attracted high urban middle class from developing TOTO presence in Asia market is well established since countries to embrace TOTO Japanese toilet style of their first 1997 opening of overseas manufacturing hospitality. facility in Indonesia. Since then, TOTO Indonesia Surya is
the largest toilet manufacturer in the world with eight Furthermore, TOTO is also the leader in developing of production lines and also a listed company in Indonesia environment friendly technology, which was the science Stock Exchange. behind every TOTO product. Recently, TOTO developed the Hydrotect technology, which is a unique self- TOTO also formed a joint venture with Thailand Siam cleaning protective coating for building materials such Sanitary Ware Co, subsidiary of Siam Cement group in as ceramic tiles when used on outdoor surfaces and 1984 to manufacture and distribute of high quality exposed to ultraviolet light either from the sun or an sanitary wares, faucets and ceramics. Thus, COTTO was artificial source. Hydrotect active surface generates a the leading distributor of local brands and TOTO reaction that cleans the material surface by products. decomposing organic and by oxidizing nitric oxide into less harmful substance. Hence, Hydrotect technology (TSE:5332) Toto Ltd. FY2013 FY2014 FY2015 FY2016 FY2017 FY2018LTM Share Price JPY 2,018.00 2,730.00 4,412.00 4,060.00 4,290.00 6,220.00 helps to purify the air surrounding and reduce the No of Shares (mil) 171.6 168.0 168.2 169.1 169.2 169.2 MCAP (mil) USD 3,490 4,527 6,070 6,687 6,460 9,335 spread of bacteria and eliminate the bad odours in Net Debt (Cash) JPY 29,495 (1,221) 13,209 8,296 (11,462) (16,689) bathroom. Enterprise Value (mil) USD 3,062 4,387 4,715 4,886 5,954 8,813 Revenue (mil) JPY 476,275.0 553,448.0 544,509.0 567,889.0 573,819.0 589,310.0 EBITDA (mil) JPY 42,885.0 62,105.0 54,655.0 64,535.0 67,781.0 71,890.0 EBIT (mil) JPY 23,377.0 47,183.0 37,428.0 46,138.0 48,572.0 51,520.0 With strong research and development together with NPAT (mil) JPY 16,956.0 44,122.0 24,813.0 35,723.0 33,839.0 36,578.0 NPAT (Ex.Xtra + Dis.Ops) (mil) JPY 20,955.0 37,525.0 26,611.0 34,423.0 36,917.0 37,542.0 solid technology foothold, TOTO has strong competitive CFO (mil) JPY 44,498.0 48,015.0 34,713.0 58,695.0 63,738.0 55,115.0 CAPEX (mil) JPY (21,252.0) (19,217.0) (25,534.0) (27,320.0) (32,023.0) (36,800.0) advantage ahead other competitors on smart bathroom EPS JPY 122.1 223.4 158.2 203.5 218.2 221.9 Revenue (mil) USD 5,056.3 5,375.9 4,538.0 5,054.2 5,146.4 5,233.4 technology. EBITDA (mil) USD 455.3 603.3 455.5 574.4 607.9 638.4 EBIT (mil) USD 248.2 458.3 311.9 410.6 435.6 457.5 NPAT (mil) USD 180.0 428.6 206.8 317.9 303.5 324.8 CFO (mil) USD 472.4 466.4 289.3 522.4 571.6 489.5 Stable financial position with positive growth trajectory CAPEX (mil) USD (225.6) (186.7) (212.8) (243.1) (287.2) (326.8) GPM (%) 36.3% 38.2% 38.1% 38.1% 38.5% 38.1% EBIT (%) 4.9% 8.5% 6.9% 8.1% 8.5% 8.7% Despite facing heavy capex that could impact company Net Debt (Cash) / Equity (%) 14.2% -0.5% 4.9% 3.0% -3.9% -5.4% ROA (%) 5.7% 9.9% 7.2% 8.6% 8.8% 9.4% retained earnings and borrowings, TOTO managed to ROE (%) 11.3% 19.0% 13.8% 16.7% 16.3% 16.7% CFO/TA (%) 10.9% 10.1% 6.7% 10.9% 11.5% 10.1% achieve average 6.48% of annual retained earnings EV/ Sales (x) 0.8 0.8 1.4 1.2 1.3 1.8 EV/ EBIT (x) 16.3 9.9 20.4 15.3 14.9 20.2 growth from 2010 to 2017, in the same time operating EV/ EBITDA (x) 8.9 7.5 14.0 10.9 10.7 14.5 EV/CFO (x) 8.6 9.7 22.0 12.0 11.3 18.9 expenses only grow at 2% annually, which translate into P/Sales (x) 0.7 0.8 1.4 1.2 1.3 1.8 P/EBIT (x) 14.8 9.7 19.8 14.9 14.9 20.4 2 times of expenses create 6 times of value. We viewed P/B (x) 1.8 2.0 2.9 2.6 2.6 3.6 TOTO as a company with solid financial background to VQ1: EV/EBIT/ROE (x) 1.4 0.5 1.5 0.9 0.9 1.2 VQ2: EV/EBIT/ROA (x) 2.9 1.0 2.8 1.8 1.7 2.1 support itself and pay dividend to shareholders. 125
Acknowledgements
On behalf of 8VIC, I would like to express our heartfelt gratitude to our Inter-Varsity Stock Research Challenge judges!
Without their expertise, the competition would not have run so smoothly.
Judge: Professor Dr. Hermann Simon • Honorary chairman and founder of global consultancy, Simon- Kucher & Partners. • An Expert in strategy, marketing and pricing. In the German language area, he was voted the most influential management thinker after the late Peter Drucker. • Best Selling Author with over 35 books in 26 languages - Worldwide bestsellers "Hidden Champions" and "Power Pricing", as well as "Manage for Profit, Not for Market Share".
Judge: François Badelon
• Founder and Chairman of Amiral Gestion, an independent asset management firm with an AUM of €3bn of assets under management. • Over 25 years of investment experience and his single goal is sustained performance with minimum risk based on the firm’s value investing approach.
Judge: Hemant Amin • Founder, Managing Director and Chief Investment Officer of Asiamin Capital. • The company is the Asiamin Family Office & 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 specific research process.
Judge: Vishal Khandelwal • Founder of SafalNiveshak.com, a community of over 38,000 dedicated readers across over 100 countries. • He has over a decade worth of experience in stock analysis. • Vishal is a firm believer and practitioner of the principles of value investing as outlined by the likes of Ben Graham, Warren Buffett, and Charlie Munger, and these are exactly what he teaches others to be able to make well-thought-out investment decisions.
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Judge: Kee Koon Boon • Chief Investment Officer & CEO, Hidden Champions Capital Management. • An internationally featured investor, he has over a decade worth of experience as a fund manager. • He was also a lecturer at Singapore Management University where he pioneered the first-of-its-kind course on Accounting Fraud in Asia, which is now an official course in the SMU curriculum. • 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. It is a meaningful cause to provide students a platform for exposure and growth.
Lastly, I would like to specially thank our organising committee consisting of Kelvin Seetoh, Klara Lye, Joshua Zhang, Jinliang Tho and Joyce Pang Qin for working together to bring this stock research challenge to fruition.
Warmest Regards
Mr Sean Seah Chief Executive Officer 8VIC Global
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