Saturday, July 14, 2007

The Importance of Sustainable Competitive Advantage

When a value investor screens companies, he is not only looking for companies with good earnings and revenue growth including high ROE, but another intangible factor is whether the company has a sustainable competitive advantage. Under Porter's 5-Forces, we discussed the importance of "Threat of New Entrants", which referred to the barriers to entry for a new company trying to enter a particular industry. If a company has a strong competitive edge, this will make it difficult, if not impossible, for the competitor to get a solid foothold and steal market share away.

Thus, the strict definition of sustainable competitive advantage is a company which has a strong product, service or brand which no one else can replicate or perform as well; such that the company can offer a better value proposition to its customers/clients. This competitive strength has to be sustainable, meaning it has to be strong enough to last many years; insulating the company from external threats and allowing it to have pricing power and significant market share.

For the companies in my portfolio, each has its own competitive advantage, which is why they were chosen in the first place. They are as follows:-

a) Ezra Holdings - Ezra has a fleet spanning many a broad range of offshore support vessels spanning transportation, production and construction which can provide services to tne entire oil field cycle. These consist of medium AHTS, AHT, Pipe-Laying vessels and soon, an FPSO. This is in contrast to most other companies who only supplies support vessels for one aspect of the oil field cycle. By promising a one-stop solution, Ezra is able to deploy its own vessels at any phase in the cycle in order to minimize disruptions and to lower costs (avoidance of using third-party vessels); something which its competitors find hard pressed to do.

b) Pacific Andes (PAH) - PAH is a fishing specialist company which owns 63.9% of China Fishery Group (CFG). CFG, in turn, owns exclusive fishing licences to fish in the waters of Peru in order to harvest Peruvian anchovies to process into fishmeal. Since there is a limited supply of fishing licences due to over-fishing, there are thus strong barriers to entry for CFG's competitors. In addition, PAH and CFG are vertically integrated which means they cover the entire value chain (using SCM principles), thus reducing reliance on third-party fish sources which tend to ramp up costs. This positions them to be in a unique competitive position even as worldwide fish consumption continues to grow.

c) Global Voice (GV) - GV owns an extensive European metopolitan fiibre network which was built during the dot.com era. They bought over this network at a fraction of the original construction cost due to the lack of demand for such services back in the late 1990's. In addition, GV has also purchased a long-haul network and undersea cable system from Viatel to augment its fibre network capabilities. Thus, the company is in a unique position to offer solutions to customers spanning many countries and linked through many cities; something which other companies lack because they do not have the physical infrastructure.

d) Swiber - Swiber owns a fleet of small to medium AHTS vessels as well as a crane barge and pipe-lay vessel which are similar to Ezra; but the difference is that the company provides services to the EPCIC industry. This is a niche industry and they are one of Asia's more prominent operators. Most of the competition is located in America and for those companies to set up a representative office here would mean higher costs. Thus, Swiber offers a strong value proposition and is able to charge lower prices (cost advantage) due to their Asian roots. The business is also gaining traction as they expand their vessel fleet and diversify their customer base into key markets such as India, The Middle East and Brunei. Their competitive strength is their niche focus, which avoids putting them in direct competition with the larger rig buildings and support vessel owners.

e) Boustead - Boustead has three business units (see their Annual Report or website at http://www.boustead.sg/) and has expertise in managing Industrial Real Estate Solutions, and their expertise is renowned over the world just by looking at the recent projects which Boustead Projects had secured. Also, their 100% owned unit Salcon is a world leader in water and waste-water solutions, and is part of the Singapore Water Solutions Alliance organized by IE Singapore to explore opportunities in the Middle East. Their Maxitherm and Controls & Electrics division (engineering division) has also successfully completed projects in countries as diverse as Philippines and South America. Thus, Boustead has an almost complete suite of competitive advantages; and they are led by a capable Management team which has grown the business successfully for the last five financial years.

Taking the above into account, it is important for the reader to understand that many companies do seem to have a strong advantage and tout themselves as "market leader" or "trend movers". But by looking closer and thinking harder about their business model (as well as applying the 5-Forces), one can see that their so-called competitive position can be eroded very quickly should the business environment change. Industries like alternative fuels are subject to constant change and no company has the upper hand right now (e.g. Wilmar). Solar panels are also all the rage but since everyone is jumping on the bandwagon, no one knows who the dominant player will be.

Sometimes, it pays to be patient and observe the companies involved in an industry in order to determine which is the market leader. By analyzing the competitive strengths of the market leader, we can start to see why the company is able to command such a premium position. However, it is still up to ourselves to ask whether this is sustainable as we need to have a long-term perspective. It is not easy to do, admittedly; but it's not rocket science either ! Most laymen and retail investors should be able to get a grasp of things from reading the papers and business publications. All one needs to do (and please find time to do it !) is to sit down and think through the issues, and you will gain more understanding and clarity eventually.

For tomorrow, I will be doing my mid-July 2007 review of my portfolio, so stay tuned !

12 comments:

Anonymous said...

Competitive advantage needs a competitor to start with, e.g. your erza and swiber, never the nuance you mentioned, as business changes are quick. Look at labroy going into rig biz to compete with keppel corp or sembcorp. Competition erodes profits, and one may not see it fast enough. I can't name a competitor for pacific andes, at least not in asia or china where it has a big portion of their biz. Do you know of one?

Anonymous said...

also vested in pac andes. another point to note, fish is not something that is easily replaceable. unlike land animals as food, fish is just fish. u cant replace fish with chicken or beef or pork.

and fish is healthy, pending no major outbreak of disease or pollution etc as risk factors. i sold my CFG at a lost. the stock kept sliding... i guess maybe cuz it is majorly owned by pac andes and pac andes trades at a far better price.

-- charlesming

Anonymous said...

CFG is not a competitor to pacandes, in fact it has right from the outset 2-3 years ago, vested interest and now a majority shareholder. With this relationship and intimate biz knowledge, integration process will have less hipcups.

musicwhiz said...

Hi Anonymous,

With regards to Ezra and Swiber, I do know of competitors but these are not Asian-based; thus they are not directly competing within the same space, though they are technically still competing for the same customers in the same territories. For Ezra, it's Prosafe, Tidewater and Solstad (as mentioned in my post). For Swiber, they did mention an Indian EPCIC player from whom they recruited their new VP Mr. BK, but there was no specific mention of a name. When I spoke to Mr. Raymond Goh about this, he said most of the major competitors were based overseas (i.e. non-Asian).

As for PAH's business, yes fish is not replaceable in the sense that there is no direct substitute (unlike beef, chicken, pork or mutton for example). Still, there are risks inherent in investing in PAH which are outlined in the OIS despatched with the rights issue (you can download from OPERA website).

Charlesming: I think the reason why CFG "slid" after you bought it was probably due to random market fluctuations, which had nothing to do with the underlying business fundamentals. If you had assessed the business as being good and entered at a price which offered a decent margin of safety to intrinsic value, then you shouldn't have to worry. Sorry about your loss though; we all live and learn through mistakes.

CFG and PAH are complementary businesses, in that one supports the other. They are tied togther in a value chain which is very well vertically integrated; and this helps to achieve better economies of scale. Just because PAH now owns 63.9% of CFG does not mean their business model has changed ! If it did, shareholders had better be informed ! Haha

Anonymous said...

Hullu musicwhiz,

I'm writing with reference to your post last sunday, on swissco and swiber. How do you get info on the number of contacts won, the value of contracts, the amount to be recognized in the books?

Also, where do u find info. on capacity utilization? Far as I know, u can only get the info. from the management?

Have read your posts, and thank you very much for sharing. Perhaps you can write about the "model" you personally use to conduct a FA research? e.g. re the porter's 5, its more about external factors along the supply chain, and "micro" ones at that (vs. "macro" such as industry/economic/political (gov) trends etc). What you your complete model incorporate?

thanks!

musicwhiz said...

Hi Anonymous,

All the information which I use in my computations and projections is publicly available, and is compiled by myself by chronological order as I track the business growth of each company. As for margins, I rely on the most recently released results as well as Management discussion.

Capacity utilization is reported in some business publications and also company announcements. Most of the time, companies don't disclose the exact utilization but in this industry, an idle vessel means zero revenue but high costs ! Thus, most vessels will be built with some form of charter party already identifying the potential usage of that vessel.

Just to clarify, talks with Management at AGM and EGM do NOT give me proprietary information about the company. CEOs are not permitted to disclose price-sensitive information to seleced shareholders as this is a contravention of the Company's Act and the SGX as well. What I ask are general questions about the strategies, plans, prospects and management capabilities.

The model is basically encapsulated in the research series which I am still currently writing. Have patience and I will soon finish with the macro and start on the micro.

Glad to know my blog has helped ! Thanks too for visiting !

Anonymous said...

great! thanks! =)

Anonymous said...

for cfg.. let's just say, i bought at 2.87, which was the all time high. it cheonged to that price but never made it it anywhere near again. last i checked it was 2.4. i let go at 2.60 i think. the fundamentals.. yes, surely there. but neither FA nor TA determines how the price goes. this is after all the stock market.

i made quite bad mistakes on this one which i shall not dwell on. mistakes made, lessons learnt. now i make sure my holdings on any counter is never under 15 lots. it also means i bargain hunt instead of chasing up prices, and of course, bargain hunt on counters that i can afford.

-- charlesming

Anonymous said...

Hi, on the subject of sustainable competitive advantage, have you ever considered agriculture based stocks?

I am heavily vested in a company called GMG which produces natural rubber. It takes 7-8 years for a rubber tree to mature to produce latex and for the last few years no new rubber plantations have been built.

So essentially, there is a stong competitive advantage (time) and rubber prices are off the roof.

I am not selling "ko-yo" here as regardless of what other people think, I believe in my own reasoning and judgement which is very different from typical investment crowd and it has rewarded me well over the years.

musicwhiz said...

Hi Anonymous,

I will do some analysis and take a look at GMG Global. Your mention of the company has piqued my interest and I will definitely be taking a look at it to see if there is potential to buy a good company at a price below its intrinsic value.

charlesming - I think that for all our investments, we need to have the patience to hold through down cycles. Short-term price fluctuations should not affect our long-term vision of the company, assuming it is building and growing its business effectively.

Cheers !

Anonymous said...

That is a good point on competitive advantage - boring biz. When every one is taking about pty, oil, off-shore etc, your biz is boring but essential to our lifes, am sure the mkt will adjust itself for the value it brings.

musicwhiz said...

GMG Global has released a business update this evening citing lower yield, lower field production and higher operating costs. These will negatively impact its financials for 1H 2007 as the "directors do not expect the existing level of performance to be maintained in 2007".

Natural rubber prices can be volatile and adverse weather conditions can severely hamper GMG's operations and yield; thus taking a hit to production. The risks are high for this company and they do not have an apparent competitive advantage when it comes to pricing as there are other rubber plantations/growers as well.

In addition, I cannot find their website or annual report; thus I can't really do an in-depth research into the company.

Will avoid this for now, but monitor its financials. This is my personal opinion, comments are welcome !