value and opportunity

Would you consider to invest into a company which at every occasion states the following:

AQ possesses no amazing patents or other security, we rely on having the best crew.

For a “Buffett/Munger” style value investor, this would be tough as there is clearly no moat or anything close and according to Buffett, the business economics always win in the long run, no matter how well a company is run.

Welcome to AQ Group, a Swedish “non moat” manufacturing company

 

If you would have invested in them when they went public in 2001, you would have realized a compound annual return of 28,4%, or in other words: A “42-bagger” over 15 years. Quite an achievement without having any kind of observable moat.

AQ group is a Swedish company founded in 1994 which basically assembles and manufactures electrical components for industrial clients such as ABB, Siemens etc.

The stock is not super cheap (no surprise after increasing 42 times in 15 years) but also not expensive:

P/B 2,2
P/E  14,4
EV/EBIT 11,8
Market cap 2,7 bn SEK or 290 mn EUR.10 year avg. profit margin 5,1%
10 year avg. ROE 16,9%
10 year ROCE 14,3%

Interestingly, not a single sell side analyst is covering the company.

Around 60% of the shares are held by the 2 founders. One of them Claes Mellgren is the CEO, the other Per-Olof Anderssen Chairman of the board. There are a few institutional shareholders, Fidelity seems to hold close to 10% of the company.

The business:

“Production is what we sell” is their slogan. AQ Group provides global manufacturing capacity to companies who, for some reason or another do not want to manufacture those things themselves. AQ Group has posted a couple of videos on Youtube where one can have a look into their different facilities around the world (Sweden, Bulgaria, China, India).

They report two segments: One called systems, where they manufacture more complex stuff like Electric Cabinets, the second one is called components which covers the “simpler stuff”.

Why were they so succesful ?

I didn’t find much about them on the internet, however one very interesting and long article in Swedish. Although Google Translate created some funny sentences, I try to summarize the article in my own words:

• they started the company with a buyout of a small unprofitable division of ABB when Sweden was in a deep recession in the early 90ties
• One of the founders pledged his house to secure the deal, both founders are engineers, not financial guys
• early on, they saw that the opening of European borders led to fierce competition in manufacturing from countries with lower wages, so they decided to move early and invested in 1995 in Bulgaria
• over the years they specialised in buying manufacturing businesses mostly out of bankruptcy cheaply and managed to turn them around quickly. Recently for instance they bought an Italian company for a token price of EUR 100.
• They IPOed the company in 2001 very cheaply at a P/E of ~3,4
• They seemed to have brought in an external CEO in 2009, but in 2010, Mellberg again took over and is running the business since then
• both are clearly hard workers. They quote that their major hobby is their “net margin”

 

So working hard and buying assets cheaply is clearly part of the explanation for their success. However I do think also that their company culture plays a big role.

AQ Group has a wonderful document on their webpage called “Core Values”.

I can only recommend to read this document. I am also pretty sure that those guys did not come up with that because they had a consultant who told them that you need to have something like this (one of their core values is to avoid external consultants). Some of their values are quite unique such as:

Simple is beautiful
Do not make things complicated.

Gut feeling can be enough for decision

First we make money then we invest
AQ should not be dependent on creditors

Every AQ company is driven like an entrepreneurial company
A small number of things are centralized such as financing and insurance. Specialist competencies are available for all. AQ companies like to cooperate and help each other.

Question the need for external help
Dare to say no to consultants, reports, advertisement, meetings with vendors etc. Rely on your own ability and use internal help where possible.

Be proud to be cost-efficient also with small expenses
Cost efficiency in big and small things, air tickets, office and workshop supplies , hotels, conferences etc- it is a culture, “walk the talk”.

Support employees that try their best
We feel safe in trying new ways of doing things. Employees that try hard but fail should be given a second chance.

Overall one gets the impression of a highly decentralized, customer focused and flexible organization which however seems to be very succesful in achieving a common goal, to be reliable. Without having the ultimate proof for this, I am still pretty sure that such a company culture, especially when it comes from the founders who are still in charge, contributes a lot to the pretty obvious success of a “company without moat”.

Of course they also seem to be pretty smart “capital allocators” or in this case rather “bargain buyers” and turn around specialists. But I guess without their strong core values, they would have not been so succesful.

Company / Corporate culture as a basis for future moats

That brings me to a more general point. I do think that Corporate Culture is maybe underrated (very much) as a source of corporate success.

Let’s look at the classic moats. Commonly the following characteristics are considered a moat:

1. Size advantage
2. Cost advantage
3. Switching Cots
4. Intangibles (Brand, patents)
5. Network effects

With the exception of maybe a handful companies however, very few companies start their existence with a moat. Usually, a moat develops over time and as Buffett has said is either expanding or contracting.

There are many companies that are very succesful and have relatively wide moats and a very strong Corporate Culture, for instance Deere, Fastenal or Google just to name a few.

The big question for me is: What was first ? Did they gain the moat early on and developed the culture or was the culture first and then led to the moat ?

Looking at AQ Group, I would argue that in many cases the moat is a product of a strong company culture and mostly instilled by their founder. Aldi is a very good example for this. They didn’t start with their cost advantage but managed to achieve it through an almost religious devotion to saving costs. This is also one of the reasons that M&A strategies that simply go for size often fail because the corporate culture is not deeply focused on the goal.

In AQ Groups case, I could easily imagine that at some point in time, when they further expand the variety of stuff they are doing, the industrials who rely on them will have higher and higher switching costs because it might be not that easy to find another company which produces with the same costs and reliability than AQ Group.

So is AQ Group a “buy” now ?

Now that’s a good question. To be honest, I think they are somehow on the expensive side right now. Although they had a really good first quarter in 2016 and they seem to list on the “Big board” in Sweden at some point later this years.

So one could easily imagine a scenario where the stock could go up once more institutional investors get interested. On the other hand, especially compared to my own portfolio holdings like G. Perrier or Silver Chef, the stock is clearly trading at significant higher multiples.

So for the time being I will put AQ Group on my watch list, I think I would buy it if  I could buy it at/below 10x EV/EBIT, which would be the case at around 120 SEK.

Summary:

From what I have seen at AQ Group so far, it seems to be a very interesting company with a very strong company culture. However, especially compared to my other portfolio holdings, it looks relatively expensive.

However one of the big learning experiences for me is that a strong Corporate Culture can make a big difference. In AQ Group’s case this led to an incredible 41 times Stock performance over 15 years without having any kind of “classic moat”.

The challenge is clearly to find similar companies at an early stage, before they become actual “Moat” companies.