Central to Arisaig’s investment thesis is that dominant consumer businesses that can compound earnings in a steady manner over the very long-term are great long-term investments for allocators looking to capture emerging Asia’s rise. These businesses sell everyday essentials to billions of people and, given consumption levels are a fraction that of developed markets, there will be room to run for decades to come from a growth perspective.
We have always known that short-term PE ratios do not reflect the long-term story – these are like timing a marathon runner on a 100m sprint. A key tool that we had to develop in the mid 2000s was how to effectively value the duration of growth that these businesses offered. The outcome from our deliberations was our “Arisaig Crystal Ball” (ACB) a discounted cashflow model that gave us a long-term internal rate of return (IRR).
Given our portfolio now includes businesses that we have owned for over a decade, it is useful to look back on one of these and consider how on earth our 20-year assumptions have stacked up.
Let’s take Philippines Seven, which runs the “7-11” brand that has become the dominant convenience store retailer in the Philippines. We invested back in this business in 2011 when it had 690 stores and a market capitalisation of USD900m. However, its profitable business model run by long-term minded management with a 70% market share (within modern small-box operators) in a largely informal but fast-growing category is exactly what we like.
Intuitively, we knew this was going to be a country where convenience store retailing would take off. Growth in the Filipino economy is in no small part driven by Business Process Outsourcing (BPO) workers in the country’s call centres. These workers often work night shifts and rely on convenience stores during their long commutes (see video for a first-hand view). But the question for us as long-term investors was, how big could this business be and were we prepared to pay a PE of 70x for it?
Our ACB picture painting exercise forecast that sales would increase by over 20x to USD6,300m over the next 20 years based on our S curves of convenience retail consumption. We also expected Philippine Seven to have to fight with its peers to maintain dominance, resulting in a market share decline from 70% to 50%. We assumed margins would be maintained and free cash flow would continue to improve. Under these assumptions, our ACB forecasted an IRR of 12% at the time.
|
2011 Assumptions |
Current |
||
|
2011 |
2031 |
2022 |
2042 |
Stores |
690 |
|
3,600 |
|
Market Share |
c.70% |
c.50% |
c.70% |
c.50% |
Sales (USDm) |
260 |
6,300 |
1,100 |
9,000 |
EBITDA Margin |
8% |
9% |
12% |
13% |
FCFF / Sales |
1% |
4% |
4% |
3% |
Source: Arisaig Partners
As we hit the 12-year mark of our ownership, Philippine Seven is performing far ahead of the expectations we had back in 2011. Despite the curve ball of Covid – where stores were shut intermittently for nearly 2 years – this is a business that has been able to maintain its 70% market share, in part thanks to the strength of its supply chain outside of Metro Manila where competitors have suffered. A phrase we often use is “the strong get stronger” and this is certainly apt in the case of Philippines Seven.
In addition to maintaining market share, the company has been able to increase margins, thanks to operating leverage that has come from scale. The cookie cutter roll-out has meant that the management has been able to support expansion to 3,600 stores using its own cash and increasingly had some to spare. Today, 15% of the company’s market capitalisation is cash.
As we look to the future, the business is far from done. The equivalent “7-11” business in neighbouring Thailand has an addressable market that is 30% smaller than the Philippines but has USD11bn of revenues from its 15,000 stores.
Buying great businesses and then doing nothing isn’t as easy as it sounds. Firstly, investing in a business in a nascent category at 70x is not a decision to be made lightly. Nor was the decision to hold on to our stake during the pandemic when stores
were shut. But when the runway is clear, the management is strong, and the dominance is established, our strategy can be incredibly rewarding. Today we are looking at a strong double-digit USD returns on top of the 3x we have made on this investment. The future is bright.
Source: “The daily struggles of a commuter, what its like to commute in Manila, the Philippines’ capital” YouTube, uploaded by Cassy R., 24th Oct 2022