The following article is extracted from the Bamboo Innovator Insight weekly column about the process of generating investment ideas among wide-moat businesses in Asia. Each month, an in-depth presentation on one such business is featured in The Moat Report Asia.
Why are Hidden Champions “hidden”? If they are “hidden”, will they become successful companies? Aren’t the successful ones always prominently visible?
An oblique reply: Have you been to a restaurant kitchen? Did you notice what is the brand of the kitchen equipment the professional chefs are using? Would you think a company that makes the equipment produce a good investment?
Often, eyes roll and heads shake – until we share with them the inspiring story of Rational AG, which has compounded over 1,200% since 2000 to a market cap of US$5.9bn, and how its reclusive billionaire founder Siegfried Meister became an Original, a trailblazer in choosing to go against the grain, battle conformity and buck outdated traditions to launch its innovative product. More than 87% of Rational AG’s sales are exports. You can find a Rational AG intelligent cooking system on a Norwegian submarine, a Saudi prince’s yacht, as well as in hospitals and restaurants around the globe. This intelligent cooking equipment system commands a global 54% market leadership in the world’s professional kitchens that include Buckingham Palace and the White House and is behind the success of such famous culinary names as Gordon Ramsay and Paul Bocuse.
Rational AG Stock Price Performance, 2000-2016, at the Shanghai Value Investing Program 2016
Hidden Champions such as Rational AG aren’t well-known to the public and their existence are often taken for granted, although their target customers (e.g. professional chefs) will swear to only use their innovative products or/and excellent services and nothing else. They are the brand behind the brands and they are essential to the well-being and success of our everyday life.
So we were naturally excited when we have the opportunity to meet up close and personal with not one or two, but a whole lot of these global Hidden Champions beyond Rational AG at the Food & Hotel Asia 2016 on 12-15 April at Singapore Expo. Of course, our investment team was also focused on visiting the exhibitor booth of an Asian Hidden Champion who is one of our portfolio stocks and speak to the GM of its overseas business office (photo on the right) – and their customers visiting their booth. This Asian Hidden Champion in our portfolio has 70% domestic market leadership and a dominant 90% overseas market share in automatic machine for a particular food segment. The founder is an Original, a thought leader and pioneer in inventing the world’s first food robot in 1981 because he wanted to bring this particular food – once considered a luxury food – to the masses. The perseverance of the founder is inspiring – he took five years to invent and launch the machine. Till today, this low-profile Hidden Champion is 54.5% majority-owned by the founding family.
This overlooked Hidden Champion generates a ROE of 14.6% and trades at a compelling valuation at EV/Sales 0.41x, EV/EBIT 2.71x and EV/EBITDA 2.33 and has a healthy balance sheet with 54% cash (zero debt) as percentage of market cap. More importantly, we believe it is on the cusp of a tipping point in its business model with 20% of its overall sales coming from overseas with the growing global popularity of the food. Its aftersales consumables and parts business has broke-even in FY13 and is now stable as a profit contributor.
Upon further interaction, we found out that its robotic machines are at least 30-50% more expensive than its rivals, yet customers who were hunting for price bargain in its competitors’ machines have switched back to this Hidden Champion. The reason? Due to the food-science nature of this food segment, there is a certain know-how in producing them in large quantities speedily on a consistent reliable basis, something which their rivals cannot match after some use. Almost 90% of the machine parts are designed in-house and their customers are able to perform maintenance themselves through phone call support or the company’s technical personnel will perform a store visit to solve their customers’ problems.
When we go for the killer question in why can’t Chinese or Indian machine makers buy their robots, tear everything apart and reverse engineer a cheaper version? The GM shared that it is quite impossible as their machine contains several moving machinery parts which is difficult to source and a software designed in-house to make it work. Copycats can imitate a machine that looks alike in the outer hardware casing but it cannot be consistently reliable and fast in producing quality tasty food.
Like their customers, we were amazed that the food produced by the robotic machines taste just as good, if not better, than the handmade food by the professional chef. They were softer in the texture and bite and had a human temperature, unlike the hard version that we thought it might be from a robot. We discovered the secret lies in how the robot is able to inject tiny air pockets at the right point in time to enhance the quality and taste of the food. Through this Hidden Champion, we learnt that it’s not simply about automation; it’s the pursuit of quality exceeding that of handmade food. Most of the initial machines’ ideas originated from the founder himself. Increasingly, the features of a machines are being initiated and suggested by the customers themselves. Every month, in their HQ, the sales team would meet the Research & Development team to discuss and consider implementation of features.
When Rational AG launched its Combi-Steamer in 1976, only very few immediately recognised the revolutionary effects that this innovation would have: from its base in Germany, this multifunctional cooking technology has now firmly established itself throughout the world, via Europe, America, Asia and Australia. A veritable revolution for working processes in large and industrial kitchens all over the world: the combination of dry heat in the form of hot air and damp heat (steam), and the possibility of combining them in any way for the cooking process represented the ideal solution for thermal food preparation, enabling most cooking processes to be performed using one device. For instance, the device recognizes how big and how cold the chicken pieces are, and adjusts the cooking process accordingly. And all this on a very small floor area – a great step forward in using space economically.
Rational AG not only created the market, but has always dominated it. Initially they offered, like 120 other competitors, better air ovens at. But with the invention and introduction of the combi steamer, which allowed cooking with hot air and steam without pressure, the breakthrough came. That was the foundation for the development of a new market. Noteworthy is that Rational AG billionaire founder and electrical engineering entrepreneur Siegfried Meister consciously killed off the firm’s existing product line, which generates 40% of the company’s revenue, for this new intelligent oven. This was a result of his awareness that there was no future in quality conventional convection ovens. The future would be in new technology. By shutting down the entire production of the convection oven line, this high-risk move ensured that every employee concentrated and focused on making the new technology a success.
Siegfried Meister, a qualified electrical engineer who has spent many years in the management divisions of several large and medium-sized companies, feels that the immense success of his product concept would have been unthinkable if they had not always paid a great deal of attention to the needs of the customer and the marketplace: specialisation, yes, but not on a product, but a problem area – in other words, customer benefit. Both Rational AG and this Asian wide-moat innovator have an unrelenting urge to innovate and put customer benefit first. Rational AG equip its Combi-Steamer technology over the years with a series of new developments, many of them patented, continually optimising them and improving quality.
The success of Rational AG is based on tinkering and a lot of discipline. A few milestones: Vario-Steaming (1986), automatic self-cleaning (1989), programmable devices (1990), ClimaPlus Series with moisture measurement and control (1993). The launch of the ClimaPlus Combi Series marked a quantum leap in cooking technology (1997), followed by the IQT technology for the CPC range (1999) allowing continuous and automatic management of the entire cooking process, CleanJet and CalcDiagnosis (anti-scaling) System (2000), CombiCheck and UltraVent (2001). True to the corporate goal of always offering maximum benefits to the customer, in 2004, Rational launched another spectacular innovation: the “Self Cooking Centre“, which is designed to reduce the chef’s workload and is self-cleaning, thus providing him with more time for culinary creativity and his guests.
Everything about Rational AG is focused on the customer: the professional chef. Sales and marketing trainee spend three weeks working directly for customers in hospital, hotel and restaurant kitchens. Rational AG employs 300 chefs working in different processes who demonstrate the company’s products and act as “lawyers for the customers”, presenting the customer’s point of view to everyone inside the company
Market saturation is relatively low despite Rational AG market leadership. The customer potential is estimated at more than 3 million commercial kitchens worldwide – from simple innkeeper about fast-food chains and hotels to hospitals and prisons. We were surprised when we realize that the Rational AG intelligent self-cooking center cost around the same price as the robotic machine of this Asian Hidden Champion who also has a similar addressable market potential of at least a million restaurant and hotel kitchens, supermarkets, etc. We are an existing Top 20 shareholders in this Asian Hidden Champion and we look to continue to build up our portfolio position in its stock.
We are inspired by Rational AG’s incredibly high work standards that are hanging on the factory walls in posters that read: Gut Genug? Der Kunde Entscheidet (Good Enough? The Customer Will Decide). We are proud to learn that this Asian wide-moat innovator has similar high work standards since its founding days in 1981.
Most people will not be able to sense and appreciate the obsession and commitment of the Originals like Rational AG and this Asian Hidden Champion in the pursuit of excellence and craftsmanship to serve with love. After all, as Adam Grant, author of “Originals: How Non-Conformists Move the World”, observe shrewdly, “In the quest for happiness, many of us choose to enjoy the world as it is.” The Originals Rational AG and this Asian Hidden Champion move food with their innovation – and in the process, they move the world:
“Originals embrace the uphill battle, striving to make the world what it could be. By struggling to improve life and liberty, they may temporarily give up some pleasure, putting their own happiness on the back burner. In the long-run, though, they have the chance to create a better world. And that – to borrow a turn of phrase from psychologist Brian Little – brings a different kind of satisfaction. Becoming Original is not the easiest path in the pursuit of happiness, but it leaves us perfectly poised for the happiness of pursuit.”
PS1: We like to share our presentation slides in Value Investing Shanghai on March 18-20, 2016 where we highlighted high-conviction investment in Hidden Champions to navigate the volatile markets and that such an investment approach has enabled us to outperform with positive absolute returns vs -15% for the MSCI Asia Index, and our highest portfolio-weighted stock at 36% of our portfolio NAV is up more than 16% in SGD:
PS2: We like to share our Investor Day Presentation held on 1 December 2015 for our shareholders. The presentation material is available for download on the ASX website:
http://www.asx.com.au/asxpdf/20151102/pdf/432nk9r3hhw4nf.pdf (pg 10-14)
and our Value Investing Summit 2016 presentation “Quietly Innovating Value with Hidden Champions”:
PS3: We had also recently presented in the Asian Investing Summit 2016 as one of the instructors:
A new monthly issue of The Moat Report Asia is now available!
Access the in-depth idea presentation:
In the month of March/April 2016, we investigate an Asian wide-moat innovator who commands a dominant 50-60% domestic market share leadership in a consumer healthcare device and is also the global #3 player and #2 in China (22% market share) where its first China plant in over 80 years is operational in March 2016 after building up strong demand from successful sales in leading online marketplaces JDmall and Alibaba’s Tmall.
Since the launch of its game-changing innovative new consumer healthcare device premium product in April 2015, its TTM Dec 2015 (YE March) sales is up 7.2% and EBIT soared 67.6%. Under the motto of using science to enrich everyday lives, [Company’s name] is a quiet innovator in leveraging upon its accumulated deep material science and chemistry know-how to continuously launch innovative new products, from consumer healthcare device to a pad that helps heal wounds by absorbing moisture, a technology that it adapted from its popular food wrapping film household product, to protective film-coated lining for motorcycle seats where it commands a 90% market share in US.
ROE of this world-class hidden champion is 14.2% and it trades at EV/EBIT 11.7x, EV/EBITDA 8.8x, EV/Sales 1x, a steep discount to its local consumer goods peers who trade at an average of EV/Sales 2.1x, EV/EBIT 20.2x, EV/EBITDA 14.5x, a 64-110% premium over [Company’s name]. Its consumer healthcare device peers trade at an average of EV/Sales 4.36x, EV/EBIT 19.7x, EV/EBITDA 17.2x, a 69-96% premium over [Company’s name]. We think that this steep valuation discount is unjustified given the technical excellence and innovative profile of [Company’s name] and it deserves to trade at a higher premium once there is greater investor awareness when they continue to deliver quality earnings growth with higher ROE which has soared from 6.7% in FY13 (YE March) to 14.2% in the latest TTM Dec 2015 and is expected to climb higher from its underappreciated price premiumisation strategy.
Sales has increased 24% in the past 3-4 years since FY13 and EBIT and OCF (operating cashflow) growth is faster at 168% due to the price premiumisation strategy. With the upcoming China plant operational in March 2016 and the tipping point in its US factory in automotive interior material, we believe [Company’s name] can build on the momentum to generate $120m operating profits and OCF in the next 4-5 years, similar to the profit scale of its domestic consumer goods peers with market cap of $2.2-3.4bn, thus spurring an upward valuation re-rating towards a potential tripling in market cap to cross $2.4bn based on EV/EBIT 20x from its present $850m market cap.
[Company’s name] embodies the best of patient sacrifice and stable capital for longer-term profound investments in business and people, with relentless and eternal pursuit of excellence in perfecting its offering, institutionalizing its craftsmanship and codifying the knowledge to pass from one generation to another. We believe [Company’s name] has hit a tipping point in its business model transformation into a complete integrated global producer of innovative rubber and plastic products with long product lifecycle with both engines in household & lifestyle division and industrial division (automotive interior) revving up to compound growth in a long runway.