The Art of making noodles and motorcycles
As we had indicated last month, we expected August to be a good month for the fund, and were not disappointed, with the fund closing August +4% MoM bringing its performance since inception (24 March 2006) to +9.6%, against the MSCI Far East Free (ex-Japan), which ended August +2.5% MoM, or +3.7%, over the same period. The strong performance came despite a poor IPO debut for one of our hopefuls, DSGT TB. It just goes to show, the stockmarket can never be too predictable.
Despite the superb 2Q06 results so far, we remain quite optimistic on the outlook for the 2H06 as seasonally, 2H06 is still a stronger half than first half of the year for more than half the companies in our portfolio. As such, we remain positive on the outlook for the fund in the 2H06 of the year. After our recent trip to Philippines and Indonesia, we have identified several prospective investments on which we are currently doing more due diligence work. Our initial assessment is positive and we believe by the end of September, we are likely to put all the remaining uninvested funds to work. With investor concerns and nervousness starting to calm after earlier months’ sell-offs, share prices for some of the stocks that we have been monitoring have started to recover.
Plant visits: DSG International, Indofood and Astra-Honda Motorcycle plant
I love plant visits because visiting a plant is like being invited to visit the home of a business contact. It can be difficult to tell the personality of a company from its office (especially after only one or two meetings) but once you’re in the factory, you’re in effectively in someone’s home, and someone’s home can tell you a lot about his/her personality with one glance. In addition, talking to the factory or plant manager can quite often be more enlightening than meeting with the usual Investor Relation contact.
What struck me as quite funny was how similar the production process for making a diaper was to making a packet of noodles! I kid you not. So how do they compare as investments? The great thing about both, being consumables, is that consumers always have to come back for more. Average consumption for noodles for a person in Asian countries averaged around 3-4 packets/month, although the figures for diapers is much lower, although from personal experience, I thought my kids were going through at least 3-4 diapers a day! Different target groups but same concept. So the answer, consumable companies in my opinion are great companies to invest in because not only do consumers tend to stick with the same brand but they have to keep coming back to buy regularly. Still everything has a price, so if a consumable company such as DSGT is trading at 69% discount in terms of PER to Indofood, we think there’s no argument as to which is better value. That brings me to my next point and advantage for having your own brand, price increases.
The great thing about having your own brands is that it gives great flexibility for the company to adjust prices. In these periods of volatility, with commodities and raw materials’ price moving like yo-yos, it is extremely important for companies to be able to not only react quickly to either lock in prices or to pass on costs. Inability to do either quite often results in a particularly bad quarter, and unwanted volatility in its share price.
It is here where a company with its own brands really comes into its own, and we believe to a certain extent why our portfolio has been relatively resilient in recent months despite volatilities in materials’ prices. Based on our estimates, around 62% of the portfolio’s weighting is in companies with their own brand. An OEM manufacturer has very little ability to pass on unexpected cost increases, because every piece it makes for its customers is up to a certain specification. Its customer is not going to be very happy if it was sent an order that had 10% less pieces or cheaper materials specification for the agreed price. On the other hand, end consumers are a much more forgiving, or perhaps just plainly more ignorant bunch (that includes me, being a typical consumer). A brand owner has a multitude of tricks to slip in price increases, including smaller products sizes, cheaper packaging, ingredients, amounts, and additional frills for higher prices. So many, in fact that the consumers are quite often confused whether they are getting better value or not (which is probably the idea). A good example is DSGT, which has been able to raise prices for the third time over past 12 months without suffering any significant decline in sales volume, a feat which may be challenging for any OEM manufacturer.
Obviously some OEM manufacturers have cost plus manufacturing, and others have the ability to adjust, but still, it can’t beat the flexibility of your own brand. Own brands don’t come cheap though, as A&P costs can be significantly higher than OEM manufacturers. But longer term, I believe in the power of branding and smarter manufacturers looking to move up the value chain have been implementing more ODM (OEM with design capability, or effectively what I would like to term as pro-active OEM). Once you start designing, you’re just one step away from effectively creating your own brand. As Asian manufacturers mature and try to move up the value added chain, I believe more and more OEM manufacturers will increase their ODM proportion.
A good way of looking at this ‘food chain’ is by ranking manufacturers in different countries in Asia, according to their level of R&D (includes both A&P and pure R&D), which also show the level of development of a particular country. This is purely my own views and is probably a gross generalization and may be unfair to certain companies within a particular country, who may be global leaders in their own right. But still, I think this is a good summary of the picture in Asia. The Japanese are widely acknowledged to be the highest quality manufacturers in Asia with the highest corresponding prices. There is no doubt that this quality doesn’t come automatically and is also the result of significant investment in R&D & A&P over the last decade. The Koreans are aggressively trying to catch up and realize the importance of research and development in keeping them moving up the value added ladder and to keep ahead of the Taiwanese, whom are to the Koreans, what the Koreans are to the Japanese. I was quite impressed with most of the Korean manufacturers I met, who all invest a significant proportion of their revenue in R&D, which is significantly higher than what most Taiwanese manufacturer invests. On the other hand, even the lower R&D spending (if any) at Taiwanese companies are much more than the amount of investment made by manufacturers located south of Taiwan in Asia.
From what I have seen, most manufacturers in China or Indonesia pretty much compete on same basis. In this scenario, the lowest cost producer will always eventually win. Problem is, even if you are China, someone is bound to become lower cost (Vietnam now claims to be one of the lowest cost producers in the world). If as a manufacturer you are not investing in either your brand or your production capability (i.e. R&D), it’s just a matter of time before someone undercuts you. Invest or bust. That is hitting quite close to home as I seem to be hearing that from my partners quite often. In the end, different clothing, same sheep. Until next month.
Despite the superb 2Q06 results so far, we remain quite optimistic on the outlook for the 2H06 as seasonally, 2H06 is still a stronger half than first half of the year for more than half the companies in our portfolio. As such, we remain positive on the outlook for the fund in the 2H06 of the year. After our recent trip to Philippines and Indonesia, we have identified several prospective investments on which we are currently doing more due diligence work. Our initial assessment is positive and we believe by the end of September, we are likely to put all the remaining uninvested funds to work. With investor concerns and nervousness starting to calm after earlier months’ sell-offs, share prices for some of the stocks that we have been monitoring have started to recover.
Plant visits: DSG International, Indofood and Astra-Honda Motorcycle plant
I love plant visits because visiting a plant is like being invited to visit the home of a business contact. It can be difficult to tell the personality of a company from its office (especially after only one or two meetings) but once you’re in the factory, you’re in effectively in someone’s home, and someone’s home can tell you a lot about his/her personality with one glance. In addition, talking to the factory or plant manager can quite often be more enlightening than meeting with the usual Investor Relation contact.
What struck me as quite funny was how similar the production process for making a diaper was to making a packet of noodles! I kid you not. So how do they compare as investments? The great thing about both, being consumables, is that consumers always have to come back for more. Average consumption for noodles for a person in Asian countries averaged around 3-4 packets/month, although the figures for diapers is much lower, although from personal experience, I thought my kids were going through at least 3-4 diapers a day! Different target groups but same concept. So the answer, consumable companies in my opinion are great companies to invest in because not only do consumers tend to stick with the same brand but they have to keep coming back to buy regularly. Still everything has a price, so if a consumable company such as DSGT is trading at 69% discount in terms of PER to Indofood, we think there’s no argument as to which is better value. That brings me to my next point and advantage for having your own brand, price increases.
The great thing about having your own brands is that it gives great flexibility for the company to adjust prices. In these periods of volatility, with commodities and raw materials’ price moving like yo-yos, it is extremely important for companies to be able to not only react quickly to either lock in prices or to pass on costs. Inability to do either quite often results in a particularly bad quarter, and unwanted volatility in its share price.
It is here where a company with its own brands really comes into its own, and we believe to a certain extent why our portfolio has been relatively resilient in recent months despite volatilities in materials’ prices. Based on our estimates, around 62% of the portfolio’s weighting is in companies with their own brand. An OEM manufacturer has very little ability to pass on unexpected cost increases, because every piece it makes for its customers is up to a certain specification. Its customer is not going to be very happy if it was sent an order that had 10% less pieces or cheaper materials specification for the agreed price. On the other hand, end consumers are a much more forgiving, or perhaps just plainly more ignorant bunch (that includes me, being a typical consumer). A brand owner has a multitude of tricks to slip in price increases, including smaller products sizes, cheaper packaging, ingredients, amounts, and additional frills for higher prices. So many, in fact that the consumers are quite often confused whether they are getting better value or not (which is probably the idea). A good example is DSGT, which has been able to raise prices for the third time over past 12 months without suffering any significant decline in sales volume, a feat which may be challenging for any OEM manufacturer.
Obviously some OEM manufacturers have cost plus manufacturing, and others have the ability to adjust, but still, it can’t beat the flexibility of your own brand. Own brands don’t come cheap though, as A&P costs can be significantly higher than OEM manufacturers. But longer term, I believe in the power of branding and smarter manufacturers looking to move up the value chain have been implementing more ODM (OEM with design capability, or effectively what I would like to term as pro-active OEM). Once you start designing, you’re just one step away from effectively creating your own brand. As Asian manufacturers mature and try to move up the value added chain, I believe more and more OEM manufacturers will increase their ODM proportion.
A good way of looking at this ‘food chain’ is by ranking manufacturers in different countries in Asia, according to their level of R&D (includes both A&P and pure R&D), which also show the level of development of a particular country. This is purely my own views and is probably a gross generalization and may be unfair to certain companies within a particular country, who may be global leaders in their own right. But still, I think this is a good summary of the picture in Asia. The Japanese are widely acknowledged to be the highest quality manufacturers in Asia with the highest corresponding prices. There is no doubt that this quality doesn’t come automatically and is also the result of significant investment in R&D & A&P over the last decade. The Koreans are aggressively trying to catch up and realize the importance of research and development in keeping them moving up the value added ladder and to keep ahead of the Taiwanese, whom are to the Koreans, what the Koreans are to the Japanese. I was quite impressed with most of the Korean manufacturers I met, who all invest a significant proportion of their revenue in R&D, which is significantly higher than what most Taiwanese manufacturer invests. On the other hand, even the lower R&D spending (if any) at Taiwanese companies are much more than the amount of investment made by manufacturers located south of Taiwan in Asia.
From what I have seen, most manufacturers in China or Indonesia pretty much compete on same basis. In this scenario, the lowest cost producer will always eventually win. Problem is, even if you are China, someone is bound to become lower cost (Vietnam now claims to be one of the lowest cost producers in the world). If as a manufacturer you are not investing in either your brand or your production capability (i.e. R&D), it’s just a matter of time before someone undercuts you. Invest or bust. That is hitting quite close to home as I seem to be hearing that from my partners quite often. In the end, different clothing, same sheep. Until next month.
posted by Kenneth | 10:33 AM
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