The elevator and escalator industry has been a great place to invest and has created a very significant fortune for the Finnish Herlin family through their holding in KONE.
It is also a great example of the kind of businesses we are attracted to;
- It is relatively simple to understand and we feel it is within our circle of competence
- It is a great business with high returns, significant scope to grow and strong governance; we really feel comfortable being invested together with the family
- There is downside protection through the resilience of revenues, a flexible cost structure and a very strong balance sheet
Let us take a closer look at each of the above elements.
Circle of competence
We only invest in businesses where we feel we understand the product offering, how the company makes money and the most important earnings drivers, the financial reporting, the values and ambitions of major shareholders and management etc.
The elevator and escalator industry is one we feel comfortable investing in; there is moderate technology risk (although this risk can never be eliminated entirely), relatively stable market dynamics between the four major players etc. KONE specifically is also a very focused company where we can understand the economics of the business, identify the key earnings drivers etc.
KONE ticks a lot of boxes when it comes to business quality with high returns and strong organic growth.
We believe there are a number of reasons for the consistently high returns of this business, e.g. the critical nature of the product, the relatively low share of customers’ spending that KONE’s products and services account for, a supportive market structure with stable market shares, opportunities to capitalise on hardware sales through highly profitable aftermarket activities, low capital intensity etc.
”Organic growth is driven by supportive demographic trends”
Organic growth is driven by supportive demographic trends (urbanisation, ageing populations, growth of EM middle class etc), product innovation, the opportunity to sell additional products and services etc.
In addition to this, we often find ourselves invested alongside families that take a long-term approach and that treat minority shareholders well; this description certainly fits the Herlin family. All in all, this should enable KONE to grow earnings and intrinsic value for a long time to come.
Our first priority when committing capital to an investment is not to lose money.
We focus on this both at the company-specific level and at the portfolio level. Looking at KONE, these are some of the layers of protection that we identify:
This is partly a result of the contract structure, where KONE is able to generate recurring revenues from providing maintenance and spare parts to customers, and partly a result of regulatory requirements to have elevators and escalators inspected at regular intervals. In addition, the business is diversified across geographies and customer types.
Limited operating leverage protects earnings in a scenario where revenues decline, e.g. due to a cyclical downturn or external shocks like CoVID-19. In KONE’s case, this is due to the flexible cost structure based on a business model that involves a high degree of outsourcing; KONE is effectively an assembly operation when it comes to its new equipment business.
Strong financial position
In addition to a resilient earnings profile, KONE has a very solid balance sheet which means it can withstand and even take advantage of challenging environments that may put pressure on less strong competitors e.g. through acquisitions or an acceleration of investment levels.
KONE has all the qualities we look for in a business and we are very happy to invest alongside the family. We like to think that this is a ‘…great company at a fair price…’ and that growth in earnings power and intrinsic value will continue for a long time to come. Having celebrated its 100th anniversary recently, we feel this business is only getting started.