Description

Hanssem (009240 in Korea) is one of the best companies in Asia and is trading at an attractive valuation today.  The company is the largest furniture retailer in Korea with a near monopoly in branded kitchen products and a growing business selling other home goods through its distribution network.  Hanssem has consistently taken market share in a fragmented industry, generates high returns on invested capital and lots of cash flow, has a meaningful competitive advantage due to its scale and strong brand, is well managed with insiders owning over 25% of the company and has a long run way for growth.  The stock has traded at forward P/E ratios in the 30’s and 40’s in recent years but has been cut in half since 2015 despite the company continuing to grow at a double-digit rate.  Shares are currently available at 20x 2018 earnings, a reasonable level for a business that we believe will compound at attractive rates of return for a long period of time.  

Company Overview

Hanssem was founded in 1970 and has been the leading seller of branded kitchen goods in Korea since 1986.  Changgeol Cho, a former architect, founded the company after seeing an opportunity to modernize kitchens in South Korea.  He remains chairman and owns 20% of the shares today.  CEO Yang-Ha Choi owns another 4% and has been with the company since 1979.  The company manufactures and sells kitchen and other home goods through a variety of channels, including large company operated stores, franchised stores and individual contractors who use Hanssem’s materials for remodeling projects.  The company is several times larger than any competitor and its scale gives it cost, brand and distribution advantages that it is increasingly using to launch new products through its distribution network (bath, closet, etc.).  

Hanssem has a dominant share of the branded kitchen market, and the branded space itself is growing steadily as a % of the overall market.  A large reason for that has been Hanssem’s success working with local contractors to whom Hanssem can supply high quality, branded products at prices that are similar to non-branded products.  The company has been steadily taking share of a growing pie but has lots of room to grow given the large % that remains non-branded:   

If you look at home furniture, Hanssem remains the leader in the branded space although is not as dominant as in kitchen with 12% of the overall market.  That market is highly fragmented with thousands of small, non-branded competitors from whom the company will continue to take share.  Between its growing share of both kitchen and home products, Hanssem is steadily gaining share of the overall furniture market in Korea:

Another tail wind working in the company’s favor is the aging of the Korean housing stock which will lead to steadily increasing demand for remodeling.  There was a building boom in Korean apartments in the 90’s and as those reach 20+ years old many will need the services of Hanssem:  

Hanssem’s growth has allowed it to steadily increase its moat by creating more efficient manufacturing and distribution channels while increasing the quality and lowering the prices it can offer to its customers.  Its brand consistently ranks at the top amongst kitchen and overall furniture companies in Korea and is #36 overall in the country according to this ranking: http://interbrand.com/wp-content/uploads/2017/03/Best-Korea-Brands-2017-TOP-50-Ranking-Table.pdf

Overall, it’s clear the company has a large lead over the competition and we believe it will continue to grow that lead in the future.    

Valuation

Over the last three years Hanssem’s forward P/E has averaged close to 30 and hit the high 40’s in 2015.  Despite double-digit growth in sales and earnings since then, the stock has been cut in half due to a softer overall housing market which led to slower growth than the bulls paying 47x forward earnings expected.  We view this as a short-term issue – the company has continued to execute well and take share from disadvantaged competitors and we believe 20x 2018 earnings is an attractive price for such a high-quality company.  

Nitori is a Japanese company that is the closest comp to Hanssem.  It too has an impeccable track record of growth going back several decades, which accelerated in the early 2000’s when it was at a similar stage to Hanssem today.  Despite being in a market with no population growth it has grown its revenue and EBITDA every year since at least 1993 which is as far back as I can find data for.  It did this by adding new product lines and taking share from non-branded competitors, which is the playbook that Hanssem is following today.  Nitori’s history also suggests that Hanssem may be able to continue increasing its margins as the business continues to scale:

Hanssem’s balance sheet has meaningful net cash and the company has a negative cash conversion cycle which will continue to allow cash to build on the balance sheet.  The company has bought back shares several times over the years – it aggressively bought back shares between 2008-2012 at much lower levels, paused buybacks for a few years when valuation multiples were high, and bought back a small amount of shares earlier this year for the first time since 2012 at meaningfully higher prices than where they trade today.   

Based on consensus estimates Hanssem is trading at just over 20x 2018 earnings and 17x 2019 earnings.  At these levels, we believe an investment will generate returns in the double digits from the company continuing to grow with lots of potential upside from Hanssem exceeding expectations or from a multiple rerating  (for example Nitori trades at 25x forward earnings despite lower growth and returns on invested capital).  Overall, we think it is a reasonable price to pay for an extremely high-quality company.    

Risks

• Competition – Ikea recently entered the Korean market, has had success with its first store and plans to open more.  There are also local competitors trying to get into the space.  Overall, we think there is room for more than one player to thrive in the market and Hanssem’s multi-decade lead positions it well despite the competition.  It’s also worth monitoring potential online competition in the coming years although Hanssem is investing into that business as well, including augmented reality technology that will allow customers to view products in their home.  Regarding Ikea, here is one analyst’s work comparing the prices available from Hanssem and Ikea, which he found were similar:

Source: https://www.slideshare.net/duckjukang/hanssem-009249-ks-equity

• China Expansion – the company is spending money to expand into China and just opened its first store there in Shanghai.  China is a competitive market where Hanssem is unproven.  It’s also a huge market that management believes could be a major part of its business over time, particularly as the relatively younger housing stock in China ages and requires more remodeling.  We’re comfortable with this risk given management’s decades of strong execution and capital allocation plus the large potential upside if this works.     

• North Korea/War – We don’t have much to add here but if you think there are meaningful odds that a nuclear war could break out on the Korean peninsula, this probably isn’t for you or the position should be hedged with other Korean risk assets.    

• General economic risk – Hanssem’s end markets are cyclical so the company’s results will have some degree of cyclicality as well.  This will lead to short term fluctuations in its growth rate and likely it’s valuation multiples, but we view this as a short-term risk.  The company’s strong balance sheet and cash flow should allow it to survive and continue to take share in a market downturn from disadvantaged competitors.  

Catalyst

• Continued growth from market share gains and scale advantages