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Saft Groupe In May, we bade farewell for the last time to Saft Groupe, a battery manufacturer that we have owned for a majority of the life of our fund. It is to be acquired by Total, the French oil giant that formed a renewable energy division in April. We felt it worthwhile to review Saft’s performance over the last decade, as it reveals an invaluable yet under-appreciated skill: succeeding while at a competitive disadvantage. Competitive advantage is one of the holy grails of modern management theory. Michael E. Porter’s book of that name was called “the most influential management book of the past quarter century” by the Financial Times. But, by definition, competitive advantage is relative. For each company with an advantage, another business must be at a disadvantage. Battery manufacturing is a diverse and growing industry. Batteries in consumer electronics have become ubiquitous with the proliferation of smart phones; passenger vehicles have used “SLI” (start-light-ignition) batteries to start their internal combustion engines for decades, while the Tesla Model S is the posterchild for fully battery powered vehicles. Batteries serve in many other lower profile applications. In transportation, they serve in marine, rail, aerospace, space and niche vehicles such as forklifts and airport tractors, which move aircraft into position. They provide backup power in areas where the damage from a loss of power can be severe, including medical facilities, oil & gas platforms and data centres. They also power stationary devices that lack access to a power source, such as utility water or gas meters. One emerging application that Saft competes in is “grid storage”, also known as energy storage systems (ESS). The growth of wind and solar power is making it harder to match electricity supply and demand. Not only are these sources intermittent, as weather conditions vary, but, in the case of Solar in particular, production is concentrated at certain hours, namely the middle of the day, that often do not align with demand. By storing electricity, batteries resolve this mismatch. All these applications require very different capabilities. For example, batteries for space and aerospace must survive extreme vibration and temperatures. Batteries for meters that are in the field for a decade or even two must deliver long lifespans. Saft competes within this industry with two clear disadvantages. It has higher labour costs, as a French manufacturer competing with Asian peers. It also has lower economies of scale. Its revenue never exceeded $900m. Johnson Controls, the king of the SLI battery, has sales of over $6b almost exclusively in that field. Samsung SDI, the battery arm of the Samsung empire, which competes more directly with Saft, has revenues exceeding $3b. Saft responded to this reality with a clear and disciplined strategy. It invested heavily in R&D, spending around 9% of sales in 2015, to achieve a technological edge; and it focused on niche applications, where its larger peers would not be deploy to bring their economies of scale. The execution of this strategy is clear in the company’s reports in several ways. Saft does not compete in volume applications where economies of scale count against it, such as consumer electronics or passenger vehicles. Instead, it sells into a variety range of high-end niches, often to marquee customers:

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Source: company presentation As important, however, is the glacial pace of sales growth. Saft’s sales grew at just 3.0% per year between 2005-15, barely above the pace of inflation (and about 0.5% of this reflected the depreciation of the euro, primarily in 2015).

Source: FactSet Note: Saft IPO’d in June 2005, but previously was part of Alcatel, a listed business, till January 2004. In the interim it was owned by the private equity firm Doughty Hanson As Saft’s list of high-end applications shows, slow growth wasn’t due to a lack of innovation. It reflected a refusal to compete in applications that become commoditised. For example, in 2012 Saft exited its Small Nickel Battery business. This had accounted for 9% of group revenue in 2011. But the company had lost competitiveness in that particular niche, and so the company exited it.

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One might imagine that a company that invests heavily yet grows slowly would perform poorly. Yet Saft performed more than respectably. It consistently achieved a double digit return on equity.

Source: FactSet Note: 2015 adjusted for an asset restructuring programme While its returns declined after 2009, in context those returns are more impressive. 2009 marked the beginning of Saft’s investment in its lithium-ion business. Although lithium-ion is growing quickly and has a promising future, even today it remains a start-up business that is not profitable. The fact that Saft was able to generate a double digit return on equity while a growing share of its capital base was making losses demonstrates that on its established business the company remained very profitable. As a reference, Samsung SDI’s battery business had an operating loss in 2014 and an EBITDA loss in 2015.

President Obama speaks at Saft’s flagship Lithium-ion plant, in Jacksonville, Florida, in February 2016. Construction of the plant received funding from the American Recovery and Reinvestment Act of 2009, also known as “the stimulus”. In 2015 the plant welcomed Florida Governor Rick Scott

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From a shareholder perspective, it has delivered a strong total return since its IPO, well above that of the SBF 250, the broad equity French index:

Source: Bloomberg We would always prefer to, and do, own companies that have competitive advantages. Yet Saft has demonstrated a route to business and shareholder success in the face of competitive disadvantages via disciplined execution of a strategy that mitigates those challenges. Nanuk Asset Management 10 June 2016

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