Our summer period was busier than usual. We have been adding four new positions to the fund, two of which we added in the third quarter. We believe them to be of excellent value and see them having a great future in the fund. A quick glance over world stock indices shows we are generally still at high to record-high levels. However, for certain companies the share price has declined, sometimes substantially, in anticipation of an economic slowdown, the impact of a trade war or company-specific problems. This is fertile ground for our fund and we found more opportunities than we have for a while. We invested in the shares of Tyman PLC and Shinoken Group Co Ltd. In this letter we will describe both new companies.

Tyman PLC

Tyman PLC (Tyman) is listed on the London Stock Exchange (LSE). Tyman is a leading international supplier of engineered components for the door & window industry. In plain English; if you take away  the glass and frame, everything else needed to create a modern, efficient, safe, sustainable product, that is what Tyman supplies. While Tyman is a UK company, they only generate 16% of revenue domestically. The US and Canada account for 65% of the business, with the balance coming from mainland Europe. Tyman supplies all this hardware to the new build (40%) as well as the remodelling markets (60%). More than 70% of revenue is generated by selling directly to the main branded manufacturers. A Tyman competitor would need to put forward serious credentials in production capabilities and efficient supply chain management before they could engage with the major door & window manufacturers like Masonite, Jeldwen or Andersen. When looking at the actual business activity, we were also attracted by the fact that the parts supplied by Tyman represent just a small percentage of the overall cost of manufacturing a door or window, specifically when compared to the cost of the frame or the glass. We like being the producer of a small but indispensable cog in a big wheel. Other elements we found to be valuable in our investment case were the quality and regulatory standards that have been introduced in modern construction. For doors & windows, this translates into warranties and energy ratings that the industry needs to offer and adhere to. To Tyman’s advantage, these assembled end-products are put to test and changing some components would require costly re-testing. Because changing these small hardware components is time-intensive and complex to implement, it also makes it more difficult to quickly change your supplier. To be clear, we are not talking about a process where changing for example just one of the substances in the composition of a medicine invalidates the whole FDA approval. It is less dramatic, but in the case of Tyman, their hardware is used in a tested process and changing the component would incur complexity and costs. Generally, when Tyman’s products are part of the initial design they remain the main supplier over the approx. seven-year lifecycle of said door or window. These characteristics are reflected in the high operating margins (approx.14%) and high returns on tangible capital (five-year average of 38%).

The share price has declined from a peak of 380p to 250p today on a combination of fears for a slowdown in construction activity, Brexit anxiety and company-specific problems which we believe to be temporary. Tyman has been expanding its footprint aggressively in the US, acquiring large businesses into their AmesburyTruth division. Around the same time, they initiated a cost-saving exercise by reducing the manufacturing facilities from 15 to 4 large, fully automated sites, with a further 3 hubs. This has not gone without some disruption and the projected initial cost-saving has been somewhat underwhelming. However, with the transformation now behind them, the new facilities have ramped up and production is getting to cruising speed. We accept these issues can occur with a large transformation and see them as part of the opportunity for the fund. Their second setback was entirely of their own doing when the company transitioned to a new type of door seal, without properly analysing how customers would respond to the introduction of the new product. The result was subdued demand for the new product, increased demand for the product they discontinued and worst of all, customer attrition. Thankfully, Tyman is a preferred supplier in multiple areas of their customer’s operations and they are hopeful they will be able to claw back some lost revenue by re-installing the old seal production facilities and supplying the products their customers actually want. Tyman is the only US manufacturer of all components for doors and windows, except for the glass and frames. Their customers benefit from efficiency gains by reducing the number of suppliers. This helps to increase the chance for Tyman to regain the lost revenue. Tyman has two divisions outside the US; ERA in the UK and SchlegelGiesse in Italy. These European divisions focus more on home safety (ERA) and sealing systems for aluminium and PVC doors & windows (SchlegelGiesse). Together with AmesburyTruth in the US, they form a complementary set of hardware producers, and we believe they can grow sales organically by 1-3% p.a.. When looking at the competitive landscape, there are a good number of tuck-in acquisitions available, but the company confirmed that currently no large acquisitions are planned until they have fully integrated the current set and reduced Net Debt/EBITDA from 1.5-2.0x to 1.0-1.5x. Historically, organic revenue growth was 1% if we include the crisis and just under 3% in more recent times. Over the five-year period to 2018, EPS have grown by 15% p.a. driven by some organic revenue growth and improving operating margins. However, acquisitions still account for the largest growth driver. Tyman has a market cap of £386ml when we added the name to our portfolio at a normalised P/E of 8x.

Shinoken Group Co Ltd

At the end of Q3, we started buying shares in Shinoken, a Japanese real-estate developer based in Fukuoka-shi in the South of Japan and active in the main metropolitan cities of Japan. Shinoken is a property developer offering services to both owners & occupiers; it sources and buys the land, applies for planning permission, builds apartments and condominiums, sells them as an investment and finally for the lifespan, Shinoken offers a whole range of property management services. We usually don’t see real-estate developers as high-quality businesses for our fund, but Shinoken piqued our interest for two reasons. Firstly, they develop but also manage the properties. Services offered include property management, finding tenants, collecting rent, provide rent guarantee, insurance, electricity and gas etc. This creates a recurring revenue stream that grows at more than 20% p.a. with a high profit margin and high returns on capital. The main drivers of growth in these management services have been increased penetration, increase in services offered to the new build properties. We believe these growing management services are very attractive and today represent 25% of operating profit. The second reason we got involved with Shinoken, was due to its very low valuation after the industry exposed three cases of fraudulent malpractices on a national scale. Certain competitors from Shinoken consorted with mortgage-banks and falsified loan applications by inflating the borrower’s income. While this was of no concern to Shinoken, their market valuation still dropped by 2/3 in less than six months. We invested 18 months after these facts, at a time when the property development market was finding its footing again. While the industry was facing severe scrutiny, we found no indications that Shinoken was involved in this malpractice. On the contrary, management explained to us in detail the procedures and measures taken to avoid the malpractices that affected some of the industry participants. The scandals made lenders review their lending practices and this has slowed down property development at Shinoken and therefore the current profit declined. We invested in Shinoken at a valuation that implies less than 6x this year’s depressed after-tax profit. With lending activity normalising, the company has increased land purchases again. Shinoken is also planning to launch a REIT in order to diversify its customer base. This will also help to reduce the impact on its businesses in case we see changes in lending practices similar to the crisis of 2018. Even if the normalisation of the development business does not materialise, we feel protected by the value of the properties owned by Shinoken (85% of our cost) and the value of the management services (102% of our cost at P/E 14x). We have made Shinoken a high conviction position in the fund (7% at cost).

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Summary of the five largest positions of the fund:

Boustead Projects Ltd & Boustead Singapore Ltd (BP 5.87% and BS 3.86%):

We own both the holding company, Boustead Singapore, and its 51% owned real-estate entity, Boustead Projects (together Boustead). During the year, we increased the position to make it the fund’s largest holding with a combined weighting of approx. 10%. The key value driver is a portfolio of industrial properties in Singapore and an asset-light design & build business in the construction industry. After a few years of price declines, the property market in Singapore has been stabilising and Boustead recently announced a record order book including design & build as well as design & build-to-lease projects. This bodes well for future profits for Boustead and ensures that the portfolio of investment properties will soon reach the critical size required for Boustead to launch its own REIT. Today, Singapore REITs trade close to Net Asset Value thereby valuing the underlying properties at the appraised market value. Based on our analysis the share prices of Boustead Projects and Boustead Singapore imply a discount of more than 50% on the appraised market value of their property portfolio thereby offering both downside protection and substantial upside if management can execute its strategy and launch a REIT. Recent developments and a tripling of the order book increased our confidence in a successful outcome.

Sporton International Inc. (8.28%):

Sporton holds the global market leader position for international certification and testing of smartphone and wireless communication devices. Testing and certification include compulsory and compliant testing services for electronic devices. Sporton is one of the few companies that can provide both.  The main types of products tested are smartphones (44%), products such as keyboards, monitors and peripherals (34%) and the Internet of Things (22%). Most sales are generated in Taiwan and China, which is also where most products are developed and manufactured for the global market. Sporton also has the largest market share of US FCC filings for personal communication systems and is the only firm focused on this type of testing and certification. Its main competitors are smaller subsidiaries of much larger established companies such as Bureau Veritas, SGS, UL and Intertek. These smaller competitors generally test the lower-end smartphone and Wi-Fi equipment. New entrants face substantial barriers to entry; the testing industry is a capital and technology-intensive industry that heavily relies on its engineers and high-tech labs. No new meaningful competitors have entered this industry for over a decade. The smartphone industry is currently in a period of transition between maturing 4G technology and a nascent race to adopt 5G technology. The last waves of technological advances (3G & 4G) allowed Sporton to increase revenue and profit margins and the company expects the same to happen this time around. Other than the expected growth of 5G over the recent 4G, mostly due to the complexity in the new technology (and testing), Sporton expects to see a further driver of revenue growth with the Internet of Things (IoT) devices and smart cars. Management expects revenue growth of 8-10% p.a. over the medium term. The capacity increase that came online in H2 2018 should further boost revenue growth to over 10% in 2019 and 2020. The current operating margin is 27% and Sporton believes it can increase this to 35% when 5G testing takes off. The company’s CEO & Chairman still owns 27.1% of the business and takes no salary. Additionally, the risk of bad capital allocation is reduced as the company makes no acquisitions and sets a policy of paying out most of the profits through dividends. The dividend pay-out ratio is 79%. Sporton’s share price had been suffering from poor market sentiment. We see this partly due to the still relatively small quantity of 5G smartphones being certified, combined with a concern of a slowing Chinese economy and an unfriendly trade tariffs environment. We purchased shares at 15.2x trailing earnings or 12.8x net of the excess cash on the balance sheet. The dividend yield is also attractive at 5.3%. At this valuation, we do not need the company to reach management’s targets to achieve an attractive return. Over the last five- and ten-year periods, revenue grew at approx. 10% p.a. with average operating margins of 29% versus 27% today.

Hamilton Thorne Ltd (5.01%):

U.S.-based Hamilton Thorne Ltd (HTL) is a C$100ml company that supplies equipment, software and disposables to In Vitro Fertilisation Labs (IVF), a $1bn niche market segment inside the $15bn global fertility industry. The fertility market is interesting because it exhibits characteristics of a high-quality industry, combined with long-term demographic growth potential, as the maternal age has increased over the last decennia and couples are increasingly relying on assisted reproductive technology (ART) to fulfil their wish for children. HTL is facing more regulation and increased demands on the medical standards of their product offerings and the industry consolidation has led to rising barriers to entry. This has worked well as a deterrent to potential competitors from entering this niche market. In September 2016, HTL made the first of two transforming acquisitions by buying US-based Embryotech Labs, a provider of medical device toxicology testing services for less than 5x EBITDA. This business has low capital requirements and very sticky customers. In 2017, they made a second acquisition by purchasing Gynemed GmbH, a German company that manufactures and distributes consumables for IVF labs, most importantly the cell culture media. Gynemed is known in the industry for producing the best cell culture with a shelf life double that of the competition. Gynemed supplies 98,5% of all fertility labs in Germany, Switzerland and Austria. It is a low Capex, high margin business (+75% gross) business and has very loyal customers. IVF labs that use cell culture media in their certified processes rarely switch suppliers because this requires the whole process to be re-certified. HTL’s market is expected to grow at 5-10% annually. The introduction of new products, cross-selling opportunities from the acquired businesses and gaining market-share from smaller and less competitive companies, should allow HTL to grow organically at 10% or more for many years to come. We estimate that we bought into the new HTL at 12x forward EBITDA. HTL’s only listed peer is (the much larger) Vitrolife AB, trading for 32x EBITDA.

Shinoken Group Co Ltd (4.82%): as described above.

Sberbank Rossi POA (4.56%):

The fund invested through the London-listed ADR’s in the equity of the largest bank in Russia. The opportunity presented itself following President Putin’s 2014 forays into Ukraine and the subsequent international pressure on the Russian Federation. For the record, we are not particularly big fans of financials, mainly for two reasons; we avoid leverage and we find bank balance sheets typically too opaque for our fundamental analysis. But the strength of Sberbank’s balance sheet, its exceptional historical profitability, its durable competitive advantages, it’s very strong management, its long runway for growth and finally a depressed valuation, all contributed to our conviction of investing in a very controversial situation. For the 10-years to December 2015, Sberbank’s book value per share in Euro terms compounded at 14.3% p.a., despite the financial crisis in 2008 and the Ukraine crisis. The Ruble also lost about 58% of its value against the Euro over that period. Sberbank dominates the Russian banking sector with >40% of all deposits and a retail branch network over 10x the size of its nearest competitor, resulting in a significant funding cost advantage. On the lending side, the bank focuses on higher quality borrowers. Viewed in a global context Russia remains substantially underbanked, based on the low percentage of GDP for banking products such as deposits, lending, insurance products and credit cards. We believe Sberbank is very well positioned to benefit from this long-term growth potential. We made our first investment in Q1 2014 at 4x trailing earnings and 80% of book value. We subsequently made further investments as the share price declined when the economic situation deteriorated. The shares currently trade at less than 6x this year’s earnings. Griffin Fund’s current country limit for Russia is 4% of AUM at cost.