|Shares Out. (in M):||67||P/E||15.5||0|
|Market Cap (in $M):||4,129||P/FCF||15.5||0|
|Net Debt (in $M):||1,305||EBIT||345||0|
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Helpful background material:
https://www.youtube.com/watch?v=Huh8kHuo-h4 start at 01:56:37 mark
A consensus has recently emerged that COVID-19 is a tailwind for sales of traditional bicycles and e-bikes (see broker research snippets below):
“Interest in cycling has grown sharply due to the pandemic. Some governments in Europe are promoting cycling as a mode of transport that avoids close contact with others, and potential global bicycle market growth is increasing. Shimano plans to capture this demand by maintaining a high level of R&D spending via its new technical innovation center (completed this year), and we look for sales growth for products like STEPS e-bike components.” – June 15, 2020 SMBC Nikko Securities report re: Shimano (7309 JP)
“Background: Founded in 1989, Kuei Meng International (KMC) is the world’s largest supplier of bicycle chains, with a 70-80% shipment market share. Major clients for its bicycle chains include Shimano (Japan), Giant (Taiwan) and Merida (Taiwan). 1Q20 revenue breakdown by segment: bicycle OEM (53%), bicycle aftermarket (22%), motorcycles (12%), garage door openers (GDO) (7%) and automobile timing systems (ATS) (6%)… Boosted by the measures to prevent the spread of COVID-19, KMC said it has seen strong orders for commuting and entry-level bicycles in China from April, and the US and Europe markets should follow suit from May to July. Management believes high-end sport and e-bike demand will also pick up from 3Q20 and expects this product category to return to YoY revenue growth from2H20, thanks to the gradual easing of lockdowns in most cities in the US and Europe… KMC believes the post COVID-19 era will be positive for global bicycle demand. The cycling participation rate has dropped in recent years from the peak during 2010-14, with most people shifting to other sporting activities (jogging, yoga, weight training, indoor-bicycling); however, there is high possibility of them turning back to cycling sports given the social-distance awareness, in KMC management’s view. In addition, governments’ related policies should support demand, such as subsidy programmes for bikes and parts purchases, as well as establishing and widening bicycle lanes.” – June 22, 2020 Cathay Securities report re: KMC Kuei Meng (5306 TT)
“Expanding TAM. We believe COVID-19, having altered many aspects of life, has expanded the global TAM for bicycles, as consumers increasingly switch from indoor sports to outdoor cycling and to commuting by bike to avoid public transportation. Meanwhile, Europe and the US are offering subsidies and reallocating more road space to encourage cycling. In light of the bicycle boon, Merida now has a more bullish outlook, guiding 2020F EPS to likely reach NT$9-10, up 10-20% YoY, versus our previous estimate of 6% decline. Merida’s upbeat comments echo those of KMC (5306 TT, NT$152.5, NR), the world’s top bicycle chain maker, which said capacity is fully booked till year-end, with lead time now extending to six months from the usual two months. KMC now guides 2020F revenues to grow YoY, versus initial guidance of 8-10% contraction.” – July 7, 2020 KGI Securities report re: Merida (9914 TT)
“Led by the concept of social distancing, we believe COVID-19 has boosted demand for bikes, especially for commuting bikes and entry-level sports bikes in China, Europe and the US. Giant said it is also observing rising demand for mountain bikes and e-bikes in the US.” - June 6, 2020 Cathay Securities report re: Giant (9921 TT)
Though most bicycle stocks we know of have already re-rated to reflect the above consensus, decorative decals maker Transart Graphics (short for “Transfer Art Graphics,” Taiwan ticker: 8481, https://www.transart.com.tw/) is a quiet niche dominator that – despite a history of +20% cash profit margins, +15% returns on total assets, and +80% dividend payout ratios – has a stock price that’s only increased 6% YTD. In our opinion, Transart trades at significantly lower proforma EV multiples (i.e. TTM 8x EV/EBITDA, 4.8% dividend yield) than other bicycle-related peers for two reasons.
First, Transart’s stock has no real sell-side analyst coverage and basically trades by appointment (individual insiders own most of it due to a management culture that encouraged over 80% of Taiwan employees to buy shares).
Second, little-noticed disposals of mainland Chinese factory properties in Shenzhen and Tianjin over the last year – with the profit recognition and cash scheduled to come in by the end of August 2020 – means Transart’s proforma enterprise value is much lower than it seems in the latest financials. So, a company with no history of ever hoarding too much cash (almost all profit has been paid out as dividends) has at least 32% of the market value in net proforma cash (i.e. at least NT$1.3 billion) while the business continues to attract new clients (i.e Easton baseball bats and e-bikes).
Transart’s shares deserve some illiquidity discount with the above peers, but that doesn’t mean it can’t still produce a double-digit annualized total return over the next few years once a) other investors realize how much proforma distributable cash the company is sitting on, and b) the COVID-19 tailwinds for bicycle demand become apparent in the coming quarterly reports.
Our company visits and research suggest Transart’s behind-the-scenes role in the bicycle manufacturing industry is unique and unlikely to be dislodged in the near future. Transart’s best clients (high-end bike and bike parts companies) generate ~50% of sales or more each year from new models. Those new models need to justify their high prices, so a specialist labeling company with adhesive application knowledge like Transart that can provide a speedy/scalable/comprehensive non-paint “coatings” solution (from R&D to manufacturing) can earn a consistently high profit margin. Why? Because Transart’s selling price for their decals/labels is a) only a tiny fraction of the final product’s selling price and b) viewed by clients as a necessary decorative investment. Transart’s management is very focused on solidifying their niche, so if the proforma cash from property disposals wasn’t eventually paid out to shareholders we would expect them to acquire a decorative/coatings-related business like a producer of certain niche inks.
Bicycle industry background:
If you were to chat with the management of a company like KMC (~70% OEM market share of bicycle chains globally), they would describe the bicycle industry as follows.
In any given year there are roughly 120 million bicycles produced and sold worldwide. By production volume, the geographic split is: China (80 million), Taiwan (3-4 million), India (15-20), Europe (10 million), and Southeast Asia (5 million). By sales volume, the geographic split is: China (15-18 million, which implies exports of >60 million), Japan (8 million), Europe (25-30 million, and many of these are high-end models), North America (15-25 million), and Indonesia (8-10 million).
The bicycle industry is hundreds of years old, yet there hasn’t been a single dominant company to emerge. The company with the #1 production volume today is Tianjin Fushida (http://www.tianjinfujita.com/) with annual capacity of 10-12 million units. But Fushida’s are mostly low-priced products, so their actual revenues are likely lower than Taiwanese peers like Giant (5-6 million annual sales volume) or even Merida (2 million annual sales volume).
The real profit in bicycles is made from “high-end” bikes, defined as those with >US$250 price tags. There are about 25 million high-end bikes sold annually around the world (with Europe being the most important market). High-end bikes have 3 main components to their cost structure and retail price. First, the frame: this is 1/3 of the cost structure, and Giant/Merida/Trek/Specialized are key competitors. Second, the transmission: this is another 1/3 of the cost structure, and this is dominated by Shimano, SRAM, and to a lesser extent Campagnolo (a niche player). The last 1/3 of a high-end bike’s cost structure comes from all components like wheels, handlebars, saddles, decals, etc. produced by a variety of suppliers.
So, when you buy a high-end “Giant” branded bike, you’re really just buying an assembly of specialized parts produced by upstream suppliers that a) have all the intellectual property or brand loyalty and b) hog the majority of the industry’s profits (see chart below). Shimano, SRAM, KMC, and – we feel, Transart Graphics – are all examples of consolidated upstream bicycle component suppliers that, thanks to their scaled-up domination of various niches that truly matter to the performance or appearance of high-end bicycles, consistently earn outsized profit margins while their fragmented customers (Giant, Merida, etc.) only get paid for lower value-add quasi-assembly work.
Transart Graphics was founded in Taichung, Taiwan in 1973 by Mr. Hong Zhaoyi (洪招儀), a former farmer and self-made entrepreneur who is remains Chairman and #1 shareholder today. Hong’s children (all over 40 years old today) struck us as very unassuming, each of which work in different company departments (including investor relations). Transart’s CEO Mr. Li Yupei 李煜培is a “professional manager” with skin in the game (i.e. US$2 million of stock, much of which he acquired with his own savings on the market). Almost every Transart employee in Taiwan owns shares of the company, which went public in 2016 purely to enhance branding and recruiting status.
Transart was the first company in Taiwan to manufacture water transfer decals (a technology they learned from Japan), and their first big break came when they struck a deal to supply Giant at scale. As word of their quality and customer service spread, Transart became the go-to decals supplier for nearly all major bicycle companies, especially Taiwanese companies that since the early 2000s were shifting away from high-volume / low-priced bikes towards low-volume / high-priced bikes. Transart now manufactures tens of millions of decals a year and the company accounts for at least 50% of Giant’s volume, 100% of Merida’s volume, and 80% of Trek’s volume.
There is no single reason why Transart has continued to earn high profit margins and keep at least 10% global market share (60% Taiwan market share) to themselves. Aside from the fact that high-quality decorative decals can literally multiply the final selling price of a bike, baseball bat, or golf club, customer service seems to be a big factor in Transart’s success. Though Transart has no “after-market” business, their customers lean on them a lot for a lot of hand-holding assistance even after a decal is designed/printed with proprietary colors, adhesive mixes and other performance features (i.e. the ability to withstand wide temperature ranges and last for two years). Once customers receive a Transart decal, there is an intense nitty gritty process of learning how to mass-apply the decals within the client’s production processes, within budget, one product model at a time. An example of hand-holding that Transart mentioned in an investor presentation involved the American baseball bat manufacturer Rawlings (see the 02:19:30 mark of this video https://www.youtube.com/watch?v=Huh8kHuo-h4). According to Transart, they sent a small team to the States to help Rawlings redesign their baseball bat production process (annual production volume: 200,000), and the result was a significant reduction in manufacturing costs.
Why can’t downstream clients take the decal manufacturing process in-house? Giant tried back in the year 2000 but they quickly gave up. What Giant learned the hard way was that, while the production line equipment for decals is not expensive, the main barrier to entry is the experienced understanding of production process. When the decal production/application process is unstable, the product yield will be too low, which defeats the whole purpose of manufacturing decals in-house in the first place. Given how little the price of a decal as a percentage of a bike’s final price, Giant figured it would be easier to just outsource decal production to the experts.
Moreover, Transart can now afford to invest at least than 2-3% of sales per year in R&D thanks to their high market share. Without that scale spread across so many clients, they wouldn’t be able to come up with the absolute dollars to keep innovating proprietary colors, adhesives, and performance standards.