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Hidden Champions As A Source Of Wide Moat Investment Opportunities

Summary Hidden champions are market leaders in specific niches that are off the radar of most investors. U.S. hidden champions include companies like Columbus McKinnon, the domestic market leader in material handling products; and Gaming Partners International Corporation, the world’s largest seller of casino chips. Asian hidden champions hold even greater promise than their U.S. counterparts, due to their relative obscurity and longer growth runways. Background On Hidden Champions A hidden champion is defined as a market leader either globally or in any specific continent in terms of market share, with sales under $4 billion, and operating out of the public limelight. The term “hidden champions” was first coined by Professor Hermann Simon, chairman of Simon-Kucher & Partners Strategy & Marketing Consultants, in his 1996 international best-seller of the same name. He went to published an updated version of his book in 2009 titled “Hidden Champions of the 21st Century, Success Strategies of Unknown World Market Leaders.” In a 2010-2011 survey done in German-speaking countries, Professor Hermann Simon was voted the most influential management thinker after the late Peter Drucker. Hidden champions are potential sources of wide moat investment ideas, since both high market share and high Return on Invested Capital (NASDAQ: ROIC ) are indicators of sustainable competitive advantages. However, while it is possible to screen for high ROIC stocks, hidden champions boasting high market shares require significant digging by investors on their own. Examples Of Hidden Champions I have written extensively about hidden champions in several Seeking Alpha articles. They include companies such as Columbus McKinnon (NASDAQ: CMCO ), PGT, Inc. (NASDAQ: PGTI ), Gaming Partners International Corporation (NASDAQ: GPIC ), Knowles Corporation (NYSE: KN ), EnerNOC, Inc. (NASDAQ: ENOC ) and Generac Holdings (NYSE: GNRC ) among others. I will elaborate in greater detail about the moats and growth runways of three of these stocks below. Columbus McKinnon holds the largest domestic market share (46%) in material handling products, representing 74% of its fiscal 2014 U.S. sales. Its largest product category comprises hoists, trolleys and components. Columbus McKinnon benefits from high customer switching costs, since its material handling products improve efficiency, enhance productivity and maximize profitability for its client, but yet cost a fraction of their customers’ total product costs (80% of its revenues are generated from products that are sold at under $5,000 per unit). Also, stealing market share from competitors is not Columbus McKinnon’s only growth avenue, since its largest installed base of hoists in North America allows it to cross-sell complementary and new products to its existing customers and benefit from after-market sales for replacement units and components and repair parts. Gaming Partners International Corporation is the global market leader in casino currency and boasts approximately 90% market share of the casino chip, plaque, and jeton sales in Macau. Given that casino operators place a strong emphasis on the quality of casino currency and the need to minimize the threat of counterfeit gaming chips, they are likely to stick with trusted players like Gaming Partners International Corporation. There is a razor-and-blade model at play here, as Gaming Partners International Corporation can cross-sell ancillary products and consumables like playing cards, table layouts, dice, and table accessories as an integrated supplier of casino table gaming equipment. PGT has approximately 70% market share of impact resistant window and door market in Florida. PGT’s moat is derived from the strength of its WinGuard branded products, which are now synonymous with quality, built upon a three-decade long track record of zero reported impact failures. Its growth drivers are the strength of the Florida housing market and the increase in penetration rates of impact resistant window and door market in Florida. Moats Of Hidden Champions While individual hidden champions might have their respective competitive advantages and diverse moats, a recurring theme is what Morningstar terms as the efficient scale moat. Hidden champions typically have significant market share in a niche where the market is sufficiently small, making it uneconomical for new entrants to compete. So what can potentially narrow or even destroy an efficient scale moat for hidden champions? If either the niche market experiences faster growth, or larger ancillary market segments experience slower growth, it might attract new competitors like bees to honey. Customer preferences and switching costs could also change, leading to greater ease of grabbing market share from the incumbent hidden champions. Growth Potential Of Hidden Champions Growth is another interesting topic for hidden champions. Most hidden champions will find it difficult to grow significantly by gaining market share from competitors, since they are usually already the outright market leader. Similarly, the organic growth prospects for the niche market tend to be modest (which deters new entrants). On the other hand, moving to ancillary market segment tends to expose them to competition from larger players and entrenched incumbents in other markets. As a result, hidden champions possessing either pricing power or the ability to cross-sell complementary products under a razor & blade model are favored. Asian Hidden Champions There are no shortcuts to identifying hidden champions. I seek hidden champions by starting with the As in a list of sub-$1 billion market capitalization stocks and paying attention to details on market share and unique niches based on the industries they operate in. My own experience is that Asian-listed hidden champions tend to have a higher probability of remaining off the radar of most investors. Firstly, Asian stocks in general have a lower concentration of stocks enjoying sell-side analyst coverage, due to the relatively lower market capitalizations and liquidity of a wider spectrum of companies listed on Asian stock exchanges. Secondly, since certain Asian companies neither report their financial results in English nor feature themselves in English media, a great proportion of international investors are unable to access these names. On the flip side, it is precisely because Asian hidden champions are relatively more “hidden,” their potential for outsized investment gains will be higher. More importantly, as these Asian companies are smaller, lie at an earlier stage of their corporate lifecycles and are still working hard at penetrating the broader yet fragmented pan-Asian market, their growth runways are also longer. This compares favorably with most other U.S. hidden champions already in the mature stage of their corporate lifecycles with limited growth drivers. As a special bonus for my subscribers, they will get access to the names of five (5) Asian-listed hidden champions in a separate bonus watchlist article. My December 2015 Stock Idea meant exclusively for subscribers also happens to be an Asian hidden champion with leading domestic market shares in certain money handling equipment. Note: Subscribers to my Asia/U.S. Deep-Value Wide-Moat Stocks exclusive research service get full access to the list of wide moat investment candidates and value traps, which include “Magic Formula” stocks, wide moat compounders, hidden champions and high quality businesses, that I have profiled.

Brazil Stocks, ETFs Ignore Slump: Rally On Rousseff Issues

Recession is not new to the Brazilian economy as for the last three quarters the economy has not shown any growth. The Brazilian economy contracted 1.7% in the third quarter of this year, preceded by 2.1% GDP decline in Q2 and 0.7% contraction in Q1. The persistent decline flared up the country’s worst recession in 25 years . Year over year, GDP is off 4.5%. In the first nine months of 2015, the Brazilian economy shortened 3.2%, the largest decline ever, per trading economics . Investment declined for the ninth successive quarter and household spending dropped for the third straight quarter, making the recession acute. A persistent slump in commodity prices has badly hit the commodity-rich Brazilian economy. If this was not enough, China – one of the key trading partners of Brazil – is suffering from a prolonged manufacturing slowdown leading to further woes in Brazilian exports. This once-growing emerging nation – a pillar of the BRIC bloc – has been buckling under dual pressure of slower growth and heightened inflation for long. Inflation in Brazil reached a 12-year high in October and hovered around the 10% level – way above the central bank’s target of 6.5%. The Brazilian currency is down over 30% against the greenback so far this year and is likely to head toward decline once the Fed shoots the lift-off this month. The budget deficit widened the most in at least two decade. Joblessness soared to 8.9% in Brazil during Q3, up from 6.8% a year ago. This left consumers cash-parched and the household spending was down 4.5% in the quarter. Political corruption is also rampant in Brazil. The key interest rate at Brazil is at a nine-year high of 14.25%. In addition, a stagflation-like situation (where measures adopted to tame inflation will halt growth and vice versa) is prohibiting the central bank to hike the rate further to contain inflation. All in all, things are so chaotic, both at home and outside, that any easy way out of this vicious cycle of recession appears impossible. Is There Any Hope for the Market? Quite expectedly, the outrageous economic backdrop called for impeachment proceedings against President Dilma Rousseff on December 2. Charges against her include the violation of Brazil’s fiscal laws and the mishandling of government finances to pursue her re-election campaign in 2014, as per the Capital Economics report. Since Dilma Rousseff’s public support rating is now at record-low, Brazilian stocks rose on December 2. Since last year, we have seen that any news against Rousseff turns out favorable for the stocks as her administration is known to implement excessive red tape in the private sector. The investing world is now betting on an expulsion of the president, though this will take months if it all materializes. Moreover, UBS analysts commented that the political surroundings could be better off in 2016 to promote growth-oriented reforms and hence took a neutral stance on Brazilian stocks and sovereign debt (despite Brazil’s credit rating was slashed to junk in September) and even the currency real. However, bearish views are there as well. Experts like JP Morgan believe that no matter what happens to Rousseff, this impeachment process will delay government work and ‘paralyze the government’s fiscal agenda during the next month’ as the spotlight will be entirely on the political movement now, which might translate into a deeper recession. Whatever the case, the markets cheered the expected end of the prolonged political deadlock and pushed up these Brazilian stocks and ETFs, though we are unsure about the sustainability of these gains. Stocks to Watch Itaú Unibanco Holding S.A. (NYSE: ITUB ) The company functions through commercial bank, retail, consumer credit retail and wholesale bank segments in Brazil and overseas. As financial stocks moved up, this Zacks Rank #3 (Hold) banking giant advanced over 6% in the last two days (as of December 3, 2015). The stock has a Momentum score of ‘A’. Petróleo Brasileiro S.A. – Petrobras (NYSE: PBR.A ) The largest publicly-traded Latin American oil company has long been fraught with corruption scandal. Its high-profile officials were allegedly involved in multi-billion dollar laundering and bribery. Also, the Brazilian government, the company’s majority shareholder, has a history of political interference in Petrobras’ affairs. Thus a probe into Rousseff’s government sprung sweet surprises for this company. PBR has a Zacks Rank #3 and added 8.6% in the last two days. PBR has a Zacks Value score of ‘A’. Centrais Elétricas Brasileiras S.A. – Eletrobras (NYSE: EBR ) The company funcations in the power utility sector and together with its subsidiaries, generates, and distributes electricity in Brazil. In the last two days, the stock advanced about 12.6%. ETFs to Watch The ultra-popular large-cap MSCI Brazil Index Fund (NYSEARCA: EWZ ) added about 5.9% in the last two days (as of December 3, 2015) on blows against Rousseff and also advanced about 0.1% after hours. However, the fund is down 34.6% so far this year. EWZ has a Zacks ETF Rank #4 (Sell) with a High risk outlook. However, due to slumping activities in Brazil, it is wiser to stay away from small-cap ETFs like Market Vectors Brazil Small-Cap ETF (NYSEARCA: BRF ) and iShares MSCI Brazil Small Cap Index (NYSEARCA: EWZS ) as small-cap stocks are tied more to domestic economic activities. Still BRF and EWZS were up over 3.6% and 5.9% respectively in the last two days on calls for Rousseff’s impeachment. Both BRF and EWZS carry a Zacks Rank #5 (Strong Sell) and are down respectively 43.3% and 45.5% so far this year. Original Post