Insights from being on the ground: Useful cases

April 20, 2023

As we approach the second anniversary of our Emerging Markets Small Cap Fund, our team has been actively discussing investment ideas across 24 countries. In Global Alpha, we follow a well-established investment process, similar to our strategies in developed markets. We believe that complementing our analysis with on-the-ground visits to our holdings and prospects, including factories and other sites, is essential. These visits allow us to enhance our investment thesis and validate or revise our perspectives. In this note, we highlight the main takeaways from our recent trip to Asia and provide some examples of how we incorporate our findings into our portfolio.

During our visit to Mumbai, India, we had the privilege of conducting close to 30 one-on-one meetings and attending a local conference. Two things immediately stood out. First, the heavy traffic, cars honking and bustling crowds signaled a high level of activity, with no signs of recession. Despite potential consumption deceleration during a downturn, the sheer size of the population helps ensure that activity continues.

Second, every company we met with signaled strong, double-digit growth for at least the next three years. This common mindset among the companies we met was striking and seemed almost psychological. None of them anticipated a slowdown in fiscal year 2024. When companies share a common optimistic outlook that deviates from consensus, it often becomes a self-fulfilling prophecy. Each company we visited had a medium-term mindset, with growth as their main focus.

India currently comprises approximately 20% of our Index, making it the second most important country after Taiwan. Valuations of India-based companies have been a challenge for us, as many of the quality players are expensive. However, we believe that investing in India is more for long-term structural growth and our recent visit provided confirmation of this perspective. For example, we visited one of the largest real estate projects in India called Thane, developed by the company Oberoi. Seeing the dimensions of the project in person rather than just in a presentation was illuminating and provided us with new perspective. Another example is the Mulund project of Prestige, one of the company’s flagship developments. Prestige (PEPL IN) is a company we currently own in our portfolio. Over the last decade, the Prestige Group has firmly established itself as one of the leading and most successful developers of real estate in India across all asset classes. The company is based in Bangalore and recently entered Mumbai with better than expected results.

Prestige Group development

In India, we also visited one of our most significant portfolio holdings, CreditAccess Grameen (CREDAG: Natl India). CREDAG is the largest non-banking finance company/microfinance institution (NBFC-MFI) in India with consolidated AUM of approximately INR150 billion, indicating an industry market share of over 5% (16.3% within NBFC-MFI) and a recorded 52% assets under management (AUM) CAGR over fiscal year 2014-2022, with a strong presence in Karnataka, Maharashtra and Tamil Nadu.

The company is a market leader in an underpenetrated business with immense, multi-year growth potential. Driven by its strong management and track record, the company is in a privileged position to capture India’s secular trend of the emerging low-middle-class population. Moreover, there is a massive underpenetration of MFIs in rural areas where CREDAG has its largest AUM. CREDAG maintains strong returns on equity driven by a low cost of risk. There was also a spread cap for this business that was recently removed, creating larger opportunities for the company. In this case, we also received confirmation from the management expecting growth. Their expectations are to increase its AUM by at least 20% for the next three years, driven by strong demand from the rural population and underpenetration. It’s different to understand the drivers of that growth in a lengthy face-to-face meeting than just over a Zoom call. We incorporated all the inputs in our model.

As explained in our previous weekly note, we visited Indonesia, where we took advantage of the opportunity to see the willingness of authorities to attract foreign investors. In another recent weekly note, we highlighted our approach to choosing companies and our preference for Mitra Adrapekasa (MAPI), our top pick in Indonesia. We visited MAPI’s top management and got validation about their significant growth potential. It was a reassuring confirmation check for us. As part of our process, we need to know the management of our core holdings and hear their strategy in person. Thus, this meeting was useful to maintain our conviction in this position, as explained in our previous weekly note. Our main takeaway is that the company is poised for strong top-line growth with sound profitability for many years.

These visits are also relevant to challenge the management teams of our holdings. For example, we own Prodia (PRDA: IJ), Indonesia’s biggest independent lab. The company is a market leader in an underpenetrated business with significant growth potential for many years. Current market share is about 40%. Prodia enjoys superior unit economics, strong returns and profitability indicators. Nevertheless, PRDA maintains conservative top-line growth at high single digits.

The company meets all the criteria in our process with the only caveat being its lack of top-line growth. So we challenged its management team, comparing their situation with other lab companies we own (such as Integrated Diagnostics Holdings (IDHC LN) in Egypt). Indonesia is a huge country with 300 million people with a vastly underpenetrated healthcare system. We should expect the company to grow at double digits. We also mentioned the case of Fleury (FLRY3 BZ) when we were in Brazil, where the growth is higher with a similar population. Management was receptive to our comments and we could understand from them more about their reasoning and intention to grow more aggressively (while maintaining profitability) in the future. Its interesting because we’ve never had the chance to go deep into that conversation by Zoom. There is nothing wrong, indeed it adds a lot of value, to question some strategies of our holdings in-person with them. It helps us understand their view and incorporate their decision-making into our process. Its also useful for us as investors to provide our portfolio companies with feedback and identify opportunities for improvement.

Detailed tests in Prodia.
Prodia lab entrance.

We also had the opportunity to visit Thailand and gain insights into the country’s small-cap companies. Many of these companies are known for their conservative approach to growth, which may not always be a bad sign if they manage risks efficiently. Being on the ground allowed us to understand how the culture drives this conservative approach in various aspects, which is something we can only fully appreciate through firsthand experience.

During our visit, we met with eight companies as well as strategists and representatives from non-listed companies. Thailand is experiencing a significant influx of tourists, which contributes to around 20% of its GDP and is relevant for economic recovery across different sectors, such as consumer, banking and industrials.

In our portfolio, we own two stocks in Thailand, with Chularat Hospital PCL (CHG) being one of the highlights. CHG operates a network of nine mid-end hospitals and four clinics throughout Eastern Thailand. Its network consists of three hub hospitals (Chularat 3, 9 and 11) and 10 smaller hospitals and clinics serving nearby provinces with high concentrations of industrial zones and dense populations. CHG is well-known for its expertise in cardiology and microsurgery and is the sole operator of a heart center in the Eastern region. As such, CHG has become the main referral center for both Social Security Office (SSO) and National Health Security Office (NHSO) programs in the area. CHG is one of the leading regional hospital networks catering to the Thai middle class, with a well-balanced patient base consisting of 59% cash and 41% government program patients.

We visited one of its hospitals (Hospital 3) and were impressed with its cleanliness, spaciousness and organization, with specialized centers within the hospital. Notably, there was a dedicated floor for UAE patients. CHG stands out as one of the few companies in the Thai market that is growing faster than the overall market with good margins and a clear growth strategy. Visiting one of its main facilities allowed us to see firsthand how the company treats and manages their speciality centers, which are well developed in the country. In one of the following photos, we captured the amazing work they do in hand and finger recovery at one of their specialty centers.

Chularat Hospital 3 entrance. 
Specialist center.

During our next country visit to Korea, we spent a whole week visiting close to 30 companies. Overall, our impression was positive although it wasn’t easy to find many ideas because Korea’s small-cap market is mostly linked to memory and EV battery materials. We visited companies we already own, such as Hansol Chemical (014680 KS)and Leeno Industrial (058470 KS), but the message wasn’t very positive as inventory levels were still high and demand was weak.

We also visited other companies that we don’t own but are monitoring closely, such as Tokai Carbon Korea (064760 KS) whose CFO explicitly stated that the company expected the memory market to recover in the second half of 2023 but remain complicated throughout the whole year. We understand that we don’t have to get a positive message from every company we visit and our main job is to incorporate the inputs we receive wisely. So, we took a conservative approach in the material memory names we own and postponed the initiation of some prospects based on feedback during the visits. The beauty of being with the companies in person is that we could understand from different sources on the ground what was really happening, which served as confirmation of what we had read and discussed internally.

We also visited some companies related to EV battery materials, particularly silicon anode technology, which is intended to improve battery life cycle (carbon) and energy density (in the form of oxide). Currently, silicon anode is mixed in small percentages (4% to 8%) with graphite as higher percentages (92% to 96%) cause the battery to swell. However, battery cell makers in Korea have been positive about their ongoing technology of increasing the silicon anode composition to around 15% in a couple of years. If this is achievable it could have a strong multiplier effect driven by the increase of EV sales and the higher penetration of silicon anode. Companies like Daejoo Electronic Materials (078600 KS) are aiming to have more than a million cars adopting this technology by the end of 2023, with Porsche Taycan and some models of GM being among the end clients of battery cell maker, LG Chem. There was also news that Hyundai could be starting to adopt this technology. However, it is difficult to estimate the exact number of cars that will adopt silicon anode oxide (with Daejoo) and the penetration rate.

In this regard, we think that the current rally of pure EV battery materials stocks in Korea has gone a little too far, with too much optimism for 2025-2026 onwards, where profits are still uncertain. In our portfolio, we have two companies, SKC (011790) and Hansol Chemical, that are developing (not commercialized yet) silicon anode carbon, so we feel we can indirectly participate in this technology from 2024-2025 onward. Both companies are more diversified and have other businesses, starting with silicon anode (Daejoo started to commercialize it in 2019).

One of the main takeaways from our visit to Korea is that we met a company we were researching before the trip, and got confirmation about our positive view, leading us to invest. This case is quite interesting because the company is only covered by Korean sell-side analysts, most of the information was in Korean and there was not a lot of disclosure. Nevertheless, we always found the company quite interesting and we continued our due diligence because it fit in our investment process, which we confirmed during our in-person visit.

The company is Park Systems (140860 KS), which was established in 1997 as an Atomic Force Microscope (AFM) manufacturer/supplier for academic research labs and corporate clients. AFM can observe ultra-fine structures that cannot be measured with an electron microscope with high resolution and it has future applications in industries such as new materials, energy, environment, biotech and medical diagnosis. There are several things we like about Park Systems, including its technological leadership, innovative technology that remains far ahead in accuracy and precision with IP protection, integration of hardware and easy-to-use software that stores and analyzes results, shortening training time, and its solid balance sheet, growth profile and capital allocation.

The company also has several opportunities to continue growing, such as expansion into the display products industry and launching new products for industrial AFM. We also had a very good impression of its senior management regarding their experience, industry knowledge and intentions to grow the business.

Park Systems building entrance, Seoul.

Lastly, we visited the Philippines, a country with a population of 100 million people and a young demographic. The Philippines also has abundant nickel reserves, which got us excited about potential investment opportunities in the downstream sector.

During our trip, we came across one of the most exciting stories in Indonesia, which is Nickel Asia (NIKL PM). NIKL is positioned as an EV battery play, with equity in net income from investments in two high-pressure acid leach (HPAL) plants, Taganito and Coral Bay. Looking ahead, NIKL will also be the exclusive contractor of the huge Pujada mine with a possible third HPAL plant.[1]

However, considering the young demographics, vast population and emerging middle class, we tend to favour the consumer sector. We only had one holding in the Philippines and a couple of weeks before the trip, there was a corporate event that raised questions for minority shareholders. We didn’t want to make decisions without understanding management’s view, so we took advantage of the trip to ask them directly. We were not satisfied with their response, as they literally said, “if you want to invest in us, you have our assets and these events, it’s all in the soup.” With that answer, our investment process quickly came into place and we decided to sell our position. As we have mentioned in previous examples, these trips are useful not only to confirm positive aspects but also to identify red flags more easily when you have an ongoing in-person relationship with the company.

During our visit to the Philippines we also explored other alternatives in the consumer space and will be keeping an eye on them. The country offers a wide range of opportunities and things are improving compared to previous years.

The Global Alpha emerging markets small-cap team will continue to be on the ground, integrating our on-site views with our investment process and daily analysis of prospective companies that could be included in our portfolio, as well as monitoring those we already have.

[1] Source: CLSA research.

Global Alpha Capital Management Ltd.
April 20th, 2023