VCS Agency

Weekly Stocktake with Danyaal

24 February 2023

Key Indicators

Source: Iress

What Flavour Chips Do You Sell?

Nvidia, a semiconductor (computer chip) development company that primarily focuses on designing graphic processing units (GPU), released their FY2023 results last week. If we were to look only at the numbers, we would think that Nvidia is in a market-losing position. Revenue remained flat; gross profit decreased by 12%; and net profit decreased by a staggering 55% compared to the previous year. So why did the stock price increase by over 8% during the week?

During the earnings call, Nvidia highlighted that they were well-positioned to take advantage of the recent Artificial Intelligence (AI) boom. GPU’s are used extensively in the infrastructure for AI applications. GPU’s use a method of computing called parallel

processing. This allows these chips to run multiple “simple” tasks at the same time; compared to central processing units (CPU) that are able to run more complex tasks, but they can only do those sequentially. GPU’s are used in multiple applications. They were initially used in computers to help process graphic output for computers. But then they were found to have a wider range of uses in cloud-computing, crypto-mining, and AI computing.

Nvidia have adapted their semiconductors to suit different uses over time. “When there’s a gold rush, it’s good to be in the business of spades.” However, this approach has led to fluctuations in their earnings, as evidenced by the significant decrease in their net profit from FY2022 to FY2023. During the crypto-mining boom, Nvidia’s GPUs were in high demand, with some chips on the second-hand market selling for more than their official retail price due to stock shortages. However, when the crypto market crashed, Nvidia were caught with a surplus of unsold chips, causing their gross margin to drop from 65% in FY2022 to 57% in FY2023.

Nvidia are still likely to be in a good position though. According to Jensen Huang (their Founder and CEO) Nvidia have been able to increase their AI processing power a million times over the last decade. No small feat. We are already seeing AI applications like ChatGPT in use. Depending on how far the AI revolution goes, Nvidia could likely be positioned to benefit from it.

Nvidia is held in the Lunar BCI WW Flexible Fund

Weekly Stocktake with Danyaal

17 February 2023

Key Indicators

Source: Iress

Gucci’s Gang

Last week Wednesday, Kering, the owner of luxury brands including Gucci, Yves Saint Laurent, Bottega Veneta, and other houses published their annual results. Their revenue and net profit for the year increased by 15% to €20.35 billion and €3.72 billion, respectively.

The performance of the different brands under in Kering’s portfolio differed. Gucci, which accounts for approximately 50% of Kering’s revenue, experienced an 8% increase in revenue compared to 2021. In contrast, Yves Saint Laurent (YSL) and Bottega Veneta, which together make up 25% of Kering’s revenue, saw revenue increases of 31% and 16%, respectively. Both YSL and Bottega Veneta have healthy operating margins. Gucci has higher operating margins than YSL and Bottega Veneta, but this has been declining over a 5-year period.

Luxury brands face a delicate balance between increasing revenue, which can be achieved by boosting their product offerings, versus preserving the exclusivity of their brand. If they flood the market with too many products too quickly, it can dilute the scarcity value and erode their brand. Despite this, the materials and resources used to create luxury items are not necessarily scarce. This is evident in the high gross margins luxury brands enjoy. Kering, for example, maintained an average gross margin of 74% over the past five years.

Gucci has faced a bit of difficulty over the last few years. China, which is one of Gucci’s biggest markets only came out of Covid lockdown this December. Gucci also abruptly lost their creative director, Alessandro Michele, in November last year. Sabato De Sarno is set to take over as creative director in Q2 later this year. The effect of his creative vision will only be seen in next year’s results.

When the Covid pandemic hit, Kering made the decision to reduce their marketing expenditure, which differed from the approach taken by other groups, like LVMH Moet Hennessy Louis Vuitton (LVMH). Consequently, LVMH’s brands were able to capture a considerable market share in recent years (through increased consumer spend, and acquisitions.) Additionally, athleisure brands also seized a portion of the luxury-spending market during the pandemic.

Kering has faced setbacks recently. Nonetheless, the company still owns strong luxury brands in its portfolio. With the reopening of China and the imminent arrival of Gucci’s new creative director, Kering may have an opportunity to turn their business around.

LVMH is held in our Lunar Offshore Portfolio.

Weekly Stocktake with Danyaal

11 February 2023

Key Indicators

Source: Iress

Rebuilding the House of Mouse?

Disney has been expanding its IP catalogue through strategic acquisitions over the years. They have acquired companies such as Pixar, Marvel, and Lucasfilm. These acquisitions have allowed Disney to tap into new markets and reach a wider audience; and helped Disney to solidify its position as one of the leading players in the family-entertainment industry.

But what do the numbers say, and what else has the House of Mouse acquired and focused on?

Disney released its Q1 2023 results last week. Revenues for the quarter increased by 8% to $23.5 billion compared to the same quarter the previous year, resulting in a net income of

$1.28 billion and a profit margin of 5.4%. As of Friday, the market valued the company at $197 billion with a price to earnings ratio of 59. In the earnings call, Disney announced plans to reduce operational costs by $5.5 billion by the end of 2024 financial year. The company will also be reorganized into three core business units:

• Disney Entertainment;
• ESPN
• Disney Parks, Experiences and Products.

Each unit will have increased creative and operational control.

Acquisitions at the right price, that deliver appropriate returns is good for both clients and shareholders. The opposite however can be very painful.

Disney acquired the majority of 21st Century Fox’s assets for $71.3 billion in 2019. The amount they paid was over four times what they paid for Lucasfilm, Pixar, and Marvel combined. Revenue from content providers primarily comes from new content. New content attracts new subscribers and puts people in cinema seats. The question is how effectively can Disney generate new content off their 21st Century Fox assets, given how much they’ve paid for it.

Disney faces another challenge.

They own two-thirds of the streaming service Hulu, with the remaining third owned by Comcast. Under their agreement, Comcast can require Disney to buy out their remaining stake for $27.5 billion by early 2024. This is not a great situation to be in when you’re trying to be focused on cost-cutting. Firms that rely heavily on acquisitions for growth often face challenges, including a tendency to pursue larger and riskier deals at increasingly high costs, at the expense of shareholders.

Disney is not held by the Lunar BCI Worldwide Flexible Fund.

Weekly Stocktake with Danyaal

3 February 2023

Key Indicators

Source: Iress

Amazon: The Behemoth

Last week Thursday, Amazon released their full year results, with revenue growing by 12.8% to a staggering $501.7 billion. However, their net income took a hit and decreased from a $33.4 billion profit in 2021 to a net loss of $2.7 billion in 2022. This was mainly due to a loss in the “other income” line item of $16.8 billion. Amazon is a company made up of multiple businesses that serve multiple different sectors, including their retail ecommerce platform, the highly profitable AWS cloud-computing service, and various investments, like electric-automaker: Rivian.

When looking at Amazon, it’s helpful to examine each segment separately. The retail e-commerce business drives Amazon’s revenue but it only recorded a net margin of -2.4% for the year. On the other hand, AWS brings in less revenue ($80.1 billion) but has a whopping 28.5% margin. Most of the company’s profit comes from the AWS segment. Amazon uses this segment to subsidize their ecommerce business and gain market share by lowering product prices and undercutting their competitors.

There’s still some noise in Amazon’s income statement, mainly from the “other income” line item. This is due to Amazon’s 20% stake in Rivian. Rivian is listed on the Nasdaq, and its share-price movement directly affects Amazon’s “other income” line item. Amazon invested just over $1.3 billion to acquire this stake, with most of it being acquired pre-initial public offering. In 2022 – Rivian’s stock price decreased over 80%. As of Friday 3 Feb 2022, Rivian’s market cap was just under $18 billion.

As Amazon operates in multiple areas, it faces competition from various industries. For example: the e-commerce division competes with other retailers like Walmart; the AWS cloud service faces competition from Microsoft and Google; and Rivian faces competition from automakers such as Tesla. This highlights the need for Amazon to constantly innovate and stay ahead of the competition to maintain their market position.

Amazon, Walmart, and Microsoft are held in the Lunar BCI Worldwide Flexible fund.

Weekly Stocktake with Danyaal

27 January 2023

Key Indicators

Source: Iress

Open AI

One of the hottest topics at the moment has been Open AI and its application – Chat GPT. And I thought it would be quite interesting to try have it write an article about Microsoft’s recent Q2 2023 results. I plugged in certain information about Microsoft’s Q2 2023 results because OpenAI has only collected certain data from 2021 and before. I then prompted it to structure the article in a certain way. And this was the result:

“Microsoft had a strong quarter, with a 2% increase in revenue to $52.7 billion. This is compared to the same period in the previous fiscal year. Despite this growth, the company saw a decrease in net income, which came in at $16.4 billion, a 12% decrease year over year. Earnings per share (EPS) also decreased, coming in at $2.20, a drop of 11% compared to the previous year.

One of the biggest drivers for Microsoft’s success this quarter was their Intelligent Cloud division. The division saw a significant increase in revenue, coming in at $21.5 billion, an 18% increase. This growth was driven by strong demand for their cloud offerings, including Azure, Dynamics 365, and LinkedIn.

Microsoft operates in a very competitive industry and their success is driven by their ability to adapt to the changing technology landscape. The company’s focus on cloud computing has been a major factor in their success, and they are constantly looking for ways to improve their offerings and stay ahead of the competition.

However, Microsoft is not without its risks. The company operates in a rapidly changing industry, and they must continually innovate in order to stay ahead of their competitors. They also face increasing competition from both established technology companies and new entrants, which can impact their ability to maintain their market share.

Microsoft and OpenAI have a strategic partnership, where the two companies collaborate on research and development of AI technologies. Microsoft provides OpenAI with cloud computing resources, allowing the research organization to scale its research and development efforts.”

It was really fun playing around with Chat GPT, and seeing how far chat-based AI has developed in the recent years. As it develops more over the coming years, it could have the potential to enhance the way people interact with the vast amount of information that is out there. AI bias and the accuracy of information it provides are still some of the major challenges applications like these face. And it will be vital to see how these challenges are dealt with over time.

Microsoft is held in the Lunar BCI WW Flexible Fund.

Weekly Stocktake with Danyaal

25 January 2023

Key Indicators

Source: Iress

Weekly Stocktake with Danyaal

The success of Netflix over time

Netflix have been a company that has been able to pivot their business model quite successfully over their lifetime.

• Netflix, the streaming service that most of us use, initially started their business by delivering physical copies of Videos and DVD’s to people.
• They then transitioned to streaming, where members pay a monthly subscription fee to watch content, they licensed from others, online.
• Netflix then took a swing at producing their own content, that they would exclusively show on their platform. The reason for this was that popular content can be expensive to license from third parties. In 2019, it cost Netflix $100 million to secure the exclusive streaming rights for the popular sitcom, Friends. And this was just for one year.

But now, Netflix have been looking for more ways to increase their revenue. Along with gaming and live shows, they believe the below will help them increase their revenue.

• Netflix have piloted a cheaper, ad-based subscription-service in 12 countries. They believe this will allow them to gain more revenue from advertising companies and new subscribers who want to use their service for a lower price.
• They have also been trying to crack down on password sharing. They’ve piloted password crackdowns in a few Latin American countries. In the pilot, Netflix charged “add-on” fees to subscribers who have multiple accounts on one subscription. They believe this will initially hurt their revenue in the short term, but over the long term they will be able to gain more additional revenue from the “add-on” subscribers.

Last week Thursday – Netflix released their Q4 2022 results. During the year, Netflix added 8.91 million subscribers to their platform, bringing the total number of subscribers to 230.8 million. Netflix’s revenue for the year was $31.6 billion, up 6,5% since the previous year. Netflix’s cost of revenue for the year, which is primarily made up of what they pay for producing their own content and what they pay to license 3rd party content equated to $19,17 bn. Netflix also recorded a net profit of $4,5bn. This represents a net margin of 14,2%.

Netflix, and other streaming services pay lot of money for content. The risk, particularly with content, is that it won’t necessarily always be a hit. Streaming companies operate in a very competitive industry. Streaming services compete for screen time. They also compete with platforms such as YouTube, linear tv, gaming etc. The life of the content, more often than not, depreciates relatively quickly and so, it can become quite tough to draw revenue from the same asset over multiple years. With multiple streaming services and platforms out there, the fight for top-tier content can become particularly expensive to produce. There is also no guarantee that the content will be a hit.

Key Indicators

Source: iress

Company and Market News

This will be our last weekly roundup until January. Whilst the holiday mood is settling in, we at Lunar Capital will still keep our eyes and ears on the market.

One of our core investment themes is Health. We often talk about why we are invested in Healthcare companies. Our view is innovative advances in biotechnologies, people having a more acive lifestyle and fewer violent conflicts over the years are helping people to live longer as well as other socio-economic progresses. Behind these health themes are businesses that are developing and offering people products and services to help maintain and improve their lifestyles; and providing preventative and curative treatments for diseases.

Recent advances include:

• Biogen and Eisai having completed the early-stage trials for an Alzheimer’s treatment that has produced the first set of promising results in a while. The results show the treatment can help reduce the effects of dementia, if caught early enough.
• Novo Nordisk has completed late-stage trials for an obesity drug that has shown it can help patients lose weight and keep their weight off.
• Lululemon like Nike and others, creates athleisure products and promotes a healthy lifestyle.

Even though health and healthcare are good investment themes, the best investment we can make is in our own health. As we head into the holiday season, we tend to over indulge. Holiday traffic and bad driving also increase during the season.

Our final words to you are to use this extra time to reflect and take concrete actions on improving your health and staying safe. Invest in your mental health by resting, in your physical health by exercising and not over-indulging, and in your safety with safe driving.

See you in the New Year.

Lululemon and Novo Nordisk are held in the Lunar BCI WW Flexible Fund.

Key Indicators

Source: iress

Company and Market News

PHALA PHALA

Just as we were all about to get into the December spirit, an independent parliamentary panel released a report concluding that President Cyril Ramaphosa may have violated the constitution in his capacity as President. Earlier this year, evidence was released of thieves raiding Ramaphosa’s game farm (Phala Phala) and stealing around $580 000. The panel recommended that the relevant authorities and parliament do a full investigation to determine if Ramaphosa may have violated the Constitution by taking paid work outside his government role, not declaring foreign currency holdings with the exchange control; and contravening the Prevention and Combating of Corrupt Activities Act.

South African markets reacted negatively. The financial services sector (which is generally a good indicator for the economic stability of a country) decreased 5,9% during the week. And the USD/ZAR rate increased by 2,4% during the week; despite the USD weakening against other currencies. There is still quite a bit of uncertainty around what could happen from here. Below are some scenarios that we think could play out for Ramaphosa and the ANC.

1. The ANC can recall Cyril Ramaphosa. Either David Mabuza, Paul Mashatile, or someone else from the ANC could then become acting president until the 2024 general election.
2. Ramaphosa can take the findings under review and let the courts decide if the findings of the panel were sufficient to allow parliament to impeach him. If parliament does agree to go through an impeachment process, then at least two thirds of parliamentarians would need to vote to remove him from office.
3. Ramaphosa could also be charged by either the exchange control (for not declaring the foreign currency holdings,) SARS (for not declaring the income,) or by the Hawks (for not following the correct procedure for reporting the crime.) This may then require him to “step-aside” according to ANC internal rules.

All the scenarios bring about uncertainty. And this uncertainty is not beneficial for the ANC and the country as a whole. There is a high chance that the ANC could lose its majority position in the next general elections. The political parties in SA will need to form coalitions to gain seat majority in parliament. How the parties cooperate in a coalition will be its own question.

Having a reasonable level of diversification in one’s portfolio thus provides some level of protection when an event such as the Phala Phala scandal occurs. Diversification can be attained through investing in different currencies, industries and/or asset classes; thus, avoiding country specific, industry specific or market specific events from negatively impacting one’s portfolio. In the Lunar BCI Worldwide Flexible Fund, approximately 60% of the portfolio is invested offshore.

Key Indicators

Source: iress

Company and Market News

Prosus and Naspers are related companies, through crossholdings with each other. Both are listed on the Johannesburg Stock Exchange and Prosus is also listed on the Amsterdam Stock Exchange. Their largest investment is a 28% stake in Tencent – one of China’s biggest technology companies. Tencent has multiple different businesses in entertainment, social media and video gaming. One of their most well-known products is the WeChat platform, that is used for chatting, but also for payments and other services. In 2001, Naspers acquired a 46.5% stake in Tencent for roughly $32 million. Today, that investment is worth approximately $95bn. An incredible investment.

The market however values Naspers and Prosus approximately 36% below the value of their assets less liabilities (Net Asset Value, or NAV). Generally, holding companies trade at a discount to NAV; but not by that high a discount value. This high discount may be due to: the high management fees, complicated crossholdings between Naspers and Prosus, potential risks associated with investing in Chinese companies and the poor performance of Naspers’s and Prosus’s other investments. At the last earnings call, Naspers and Prosus said that they were going to sell small stakes in Tencent so that they could buy back their own shares in an effort to unlock value for their shareholders. Since June this year, Prosus and Naspers have purchased a combined $5.8 bn worth of their own stock.

Naspers, released their H1 2023 results last week. A great amount of focus was put on their ecommerce businesses. Naspers has multiple investments within the classifieds, food delivery, fintech, and education technology spaces. Some of the more noticeable companies in their portfolio include: Takelot, OLX, iFood, PayU and Udemy. The ecommerce space is proving quite tricky for Naspers and Prosus to get right, requiring high levels of investments to build scale and become profitable; and operating in highly competitive environments. In all their ecommerce categories, revenue grew but all recorded trading losses. Last week, the share price for Prosus decreased by 3,35%.

Lunar Capital Weekly Roundup

Source: iress

Lunar Capital on Eastwave Radio

Every Tuesday, at 07h45, Sabir chats with Nazia from Eastwave Radio (92.2 fm, live stream on www.eastwave.co.za) on investing and the markets.

Listen to last week’s session here: https://youtu.be/ALBFYZEj89E

Company and Market News

The global markets have come down quite significantly since the beginning of the year. The US Federal reserve has been raising interest rates at a record rate to attempt to tame rapidly rising inflation. The global economy has also been facing supply chain issues that started at the beginning of the Covid-19 pandemic and was exacerbated by the Russia/Ukraine war. With higher energy costs and interest rates, consumers have less disposable income, thus reducing the demand for goods and services, which will likely result in a recession in many countries. China, which is the second largest economy in the world, has also maintained strict Covid-19 restriction policies since the beginning of the pandemic. An example of the effect of China’s strict Covid-19 policies on their economy is that Apple, earlier this year, decided to move some of the manufacturing of their iPhone 14 from China to India.

Despite all the above, last week, we saw a significant rally in the market. During the week, the S&P 500 gained 5.9% and the JSE ALSI increased by 4%. This can be attributed to several reasons. Year-on-year inflation for October in the US came in at 7.7%. The market expected 7.9% and this lower-than-expected inflation pointed to potentially lower than previously expected interest rate increases by the US federal Reserve. Other news that could have also resulted in the market rally is that Russia have been forced to retreat from the major city of Kherson in Ukraine. This indicates that the war could end and possibly alleviate the energy crisis. China has also started to relax some of their Covid restriction methods. Certain measures such as the quarantine length for close contacts has decreased from 7 days to 5 days; and people that are secondary contacts do not need to quarantine anymore. Lastly, there is hope that US/China tensions could be eased at the G20 Meeting this month when Joe Biden and Xi Jinping have a face-to-face meeting to try and resolves these tensions. Other technical issues (like short-covering by traders) may also be the reason for the rally.

China still enforces a Covid Zero policy and could reverse course if they feel that these new measures aren’t getting them the results they want. Another risk the market faces is that inflation could remain high despite October’s lower than expected inflation. In the US, housing accounts for the highest weighting (33.8%) in determining CPI. Housing inflation is generally quite sticky and is often one of the trickiest to bring down. The war in Ukraine could also carry on for longer than people anticipate, which could result in pro-longing the energy crisis and further increasing geo-political tensions.

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The Lunar BCI Worldwide Flexible Fund Fact Sheet  can be read here.
This roundup is prepared for the clients of Lunar Capital (Pty) Ltd. This roundup does not constitute financial advice and is generated for information purposes only.