VCS Agency

1 September 2023

Key Indicators

Source: Iress

Weekly Stocktake with Danyaal

Lululemon: Stretching Legs Internationally

Last week, Lululemon released their Q2 2023 results. Despite the slowdown in consumer spending due to the tough economic environment worldwide, Lululemon increased their revenue by 18% compared to the same period last year. For the quarter, sales in the US accounted for 64% of total sales. The gross margin and net income margin for Lululemon came in at 58.8% and 15.4%, respectively. Lululemon’s price to earnings ratio closed at 52.5 on Friday. This is still quite a high valuation.

Lululemon is an athleisure retailer and has a more established presence in the US compared to other parts of the world. However, their growth outside the US is much higher at 52% versus 11% in the US. The international sales surge was primarily fuelled by a notable revenue increase in China, which witnessed a 61% growth rate. China currently boasts the second-largest number of Lululemon stores, totalling 126 as of the end of July 2023. These stores in China tend to be smaller, and the company offers its products at lower prices in response to the smaller average wallet size of customers in the region. Consequently, the average revenue per store in China is lower, currently standing at $2.2 million per a store for the quarter, compared to the US, where the average is $3.9 million.

The stores serve as essential platforms for Lululemon to showcase their products and create unique user experiences for customers. Notably their direct-to-consumer segment has become increasingly significant, accounting for 40% of their total sales. Revenue derived from this segment increased by 15% compared to the same quarter last year, while revenue from their physical stores grew by 21%. The operating income margin for the direct-to-consumer segment is higher at 42%, whereas the stores segment has an operating income margin of 30%.

Lululemon operates in a highly competitive landscape, facing rivals such as Nike and other legacy luxury fashion companies such as Louis Vuitton (LVMH). Both Nike and LVMH boast well-established positions and robust balance sheets. Nevertheless, Lululemon’s relatively focused product line-up provides them with the potential to expand into diverse product categories. The barriers to entry in the retail world are comparatively lower than in other industries, meaning new potential competitors are coming into the market every day. Despite these challenges, Lululemon maintains a dedicated and loyal customer base. Customers repeatedly return to purchase their products due to the consistent quality they offer.

Lululemon is held in the Lunar BCI Worldwide Flexible Fund. Lululemon and LVMH are held by Lunar Capital’s Offshore Portfolio Clients.

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25 August 2023

Key Indicators

Source: Iress

Weekly Stocktake with Danyaal

Nvidia: Where to from Here?

Nvidia released the most anticipated results of the earnings season last week. Since the beginning of the year, Nvidia’s stock price has increased over 220% which resulted in their market capitalisation reaching $1.1 trillion by Friday last week. During the year, the market became ever-more optimistic about Nvidia. For the recent quarter, revenue increased by 101% to $13.5 billion compared to the same quarter last year, with the gross profit margin reaching 70%. Nvidia’s quarterly net profit increased by 843% to $6.18 billion.

The primary cause behind these results largely stemmed from Nvidia’s sales of Graphic Processing Units (GPUs) used in AI (Artificial Intelligence) data centres. The main buyers of these products include Alphabet, Microsoft, and Amazon; all of which already had extensive data centre infrastructures. The most sort after chip for AI infrastructure is Nvidia’s H100 chip, which costs around $40,000. Since ChatGPT’s debut last year, companies have been adjusting their budgets to accommodate AI expenditure. These tech companies have been allocating substantial resources to acquire these chips so that they can try get ahead in the AI race.

Although Nvidia performed strongly this quarter, there are concerns about the sustainability of these results, and the strategies that companies will implement to provide AI services. Microsoft, who owns a stake in OpenAI (the creators of ChatGPT) have recently incorporated Large Language Models (LLMs) in some of their products such as Office365. In terms of hard numbers, the long-term implications of this implementation still remains unclear. Investors will be looking for concrete returns on investment on AI spending. Without adequate returns, AI infrastructure spending will reduce, impacting the share prices of companies like Nvidia.

Nvidia, Microsoft and Amazon are held in the Lunar BCI Worldwide Flexible Fund. They are also held by Lunar Capital’s Offshore Portfolio Clients.

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18 August 2023

Key Indicators

Source: Iress

Weekly Stocktake with Danyaal

Adyen: Growth at All Costs?

Adyen is a Dutch financial technology platform specialising in helping businesses with payment processing, financial management, and business analytics. They have recently undertaken an expansion initiative. In the first half of the year, they hired 551 full-time employees (FTE), bringing their total workforce to 3,883 FTE. The majority of these new hires were in technical roles aimed at enhancing Adyen’s existing platform and supporting new projects. This expansion does not align with the “cost optimization strategies” observed by Adyen’s competitors and among the businesses they service.

Adyen recently unveiled its H1 2023 financial results. In this period, their net revenue reached €739 million, marking a 21% increase compared to the same period last year. However, due to escalated wage and salary expenses associated with their growth strategy, the operating income for Adyen was €279 million for H1 2023, reflecting a 16% decline compared to the previous year. During the week, Adyen’s stock price experienced a substantial drop of 45%. The company ended the week with a Price to Earnings (P/E) ratio of 48.

The market appears to be displaying apprehension regarding Adyen’s current strategy. Adyen has been significantly expanding their workforce, despite a deceleration in their revenue growth. Several factors may be contributing to this trend.

1) Their clientele seems to be prioritizing cost optimisation and profitability over market expansion, impacting Adyen’s revenue growth.

2) The presence of well-established fintech giants like PayPal and Stripe in the US has intensified competition more than initially anticipated.

3) There might be a lagged effect between their recent hiring initiatives and the actual impact on revenue. It’s possible that Adyen will only fully experience the consequences of their expansion program in a few quarters from now.

Adyen management have been consistent that they are building for the future and that any investments that they make in people and their platform will only yield results in a few year’s time. Pursuing expansion in the current economic climate does carry inherent risks. Nonetheless, if Adyen successfully executes their expansion strategy, they have the potential to emerge from the recession in a notably better position compared to their competitors.

Adyen is held by Lunar Capital’s Offshore Portfolio Clients.

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11 August 2023

Key Indicators

Source: Iress

Weekly Stocktake with Danyaal

Novo Nordisk: The Hype Around Semaglutide

Novo Nordisk, owned by Lunar Capital and its clients, is a global pharmaceutical company headquartered in Denmark. The company specialises in the treatment of diabetes, obesity, and rare blood diseases. Among their recent advancements, they introduced Semaglutide, a medication catering to type-2 diabetes and obesity. These drugs emulate the actions of the natural hormone glucagon-like-peptide-1 (GLP-1). This emulation aids in the regulation of blood sugar levels by promoting insulin production, curtailing glucagon production, and slowing down the emptying of the stomach. Last week, Novo Nordisk indicated that the recent trial for the Semaglutide 2.4mg treatment demonstrated a 20% reduction in major adverse cardiovascular events in adults suffering from obesity. This announcement pushed their share price up by approximately a 16% on the day.

The recent financial performance of Novo Nordisk can primarily be attributed to the surge in GLP-1 treatment sales. Revenue for Novo Nordisk during the first half of 2023 increased by 29% compared to the same period in the previous year, reaching Danish Kroner (DKK) 107.7 billion. Their gross margin increased from 84.4% last year to 85.1% in the current year. All contributing to a net profit increase of 43%, totalling DKK 39.2 billion for the period. The USA is their largest market, with revenue growing by 44% and contributing just under 60% of Novo Nordisk’s total revenue.

Pharmaceutical companies can enjoy robust profit margins, as seen by Novo Nordisk’s gross margin of 85% and net margin of 36%. Nonetheless, the industry itself is fraught with risks. The stringent (understandably) regulations that govern pharmaceutical companies requires a series of trials often over many years. To sustain their existence, pharmaceutical companies allocate a considerable portion of their revenue towards research and development efforts to counter the treatments in their pipeline that come off patents. For instance, during the first half of 2023, Novo Nordisk spent DKK 13.8 billion on research and development, which amounts to 12.9% of their revenue. In instances where the effectiveness of treatments fails to yield positive outcomes, the potential repercussions could lead to losses and possibly more dire long-term consequences.

Novo Nordisk is held in the Lunar BCI Worldwide Flexible Fund. It is also held by the Lunar Capital Offshore Portfolio Clients.

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04 August 2023

Key Indicators

Source: Iress

Weekly Stocktake with Danyaal

Amazon: Manic Obsession over the Customer

Many companies profess a commitment to customer-centricity. They seek to develop products adored by customers and use phrases such as “the customer is always right.” However, few can rival Amazon in this regard, who consistently from its inception has an obsession with customer experience. Amazon’s businesses include a global E-commerce enterprise, AWS (their cloud infrastructure division), as well as its media business Prime and MGM Studios, amongst others. They continuously expand their influence across other business domains. At the core of Amazon’s business lies the principle: “customer obsession rather than competitor focus.”

Amazon Prime, a membership program tailored to benefit Amazon customers, stands as an example of Amazon’s dedication to enhancing the customer experience. Amazon Prime members pay $139 annually, entitling them to two-day shipping for eligible items, access to Amazon’s Prime Video streaming service, early access to e-commerce deals, and other perks.

While Amazon diligently seeks to refine its offerings, some investors contend that the company’s intense focus on customer experience may, in some instances, overshadow the pursuit of profitability across its business divisions—particularly evident in Amazon’s ongoing efforts to reduce delivery times. Notably, some investment analysts assert that the cost incurred may not justify the potential gains. Nevertheless, Amazon remain steadfast in their belief that, over the long term (another core principle of Amazon’s), “customer obsession” will build shareholder value. In fact, Amazon has noted an increase in the number of items clients purchase as they deliver faster.

Where has customer obsession taken Amazon. Last week, Amazon released their Q2 2023 results. For the quarter, Amazon reported net sales of $134 billion, marking an 11% increase compared to the same quarter last year. Amazon operates with relatively narrow operating margins. Changes in revenues or costs can lead to notable shifts in their operating margin. Amazon managed to lower the growth rate of their operating costs compared to their revenue. In Q2 2023, Amazon’s operating income reached $7.7 billion, up 133% compared to the same quarter in the previous year.

Amazon is held in the Lunar BCI Worldwide Flexible Fund. It is also held by the Lunar Capital Offshore Portfolio Clients.

28 July 2023

Key Indicators

Source: Iress

Weekly Stocktake with Danyaal

Enphase: New Power on the Block

Enphase Energy, a business held in the Lunar BCI Worldwide Flexible Fund and by Lunar Capital’s Offshore Portfolio clients, is an energy technology company that operates in the Americas, some European countries, and Australia. They specialize in selling solar generation and storage equipment, with all their devices seamlessly connected to the cloud for users to monitor their electricity usage, generation, and storage. Among Enphase’s products is the micro-inverter, which distinguishes itself from central inverters by having each micro-inverter being linked to separate solar panels. This setup ensures optimal panel performance as a whole, even when one panel is inactive or has been shaded by a leaf or something else. In contrast, a centralized inverter would convert energy less effectively if those same panels failed.

Last week, Enphase disclosed their Q2 2023 results. During the quarter, their net revenue amounted to $711 million, indicating a notable 34% growth compared to the same period last year. However, this Q2 revenue was slightly below the revenue of $726m in Q1. Enphase achieved a gross margin of 45.5% for the quarter, an increase of 4.2 percentage points compared to the same quarter last year. The net income for the period stood at $157 million, translating to a net income margin of just under 22%. In contrast, during the same quarter last year, Enphase’s net income margin was just below 15%. This performance not only reflects their ability to reduce product manufacturing costs but also highlights their ability to improve their operational efficiency. Most of Enphase’s manufacturing operations are in India and Mexico, where labour costs are lower than in the USA and Europe.

Historically, Enphase has typically experienced higher Q2 revenues compared to their Q1 revenues. However, this year, it was not the case. They attributed this anomaly primarily to the high interest rates in the US and reduced consumer spending across the economy. This resulted in a 12% decline in revenue for Enphase’s US operations. Despite the challenging global macro-economic conditions, their operations in Europe showed a significant improvement, with a remarkable 25% increase in revenue quarter on quarter. This growth can be attributed to Enphase operating from a lower market-share base in Europe compared to the US. As of last week Friday, Enphase’s market capitalization was just above $21 billion.

Enphase will likely benefit from a move to green and cleaner sources, residential clients reducing their dependencies on energy utility companies, European clients reducing their dependencies on hostile foreign countries (read Russia) for their oil and gas requirements; and also the move to electric vehicles.

21 July 2023

Key Indicators

Source: Iress

Weekly Stocktake with Danyaal

Tesla: No Margin for Error

The Earnings Season is underway in the US, and various companies have begun releasing their quarterly results. Tesla, led by Elon Musk, recently disclosed its Q2 2023 performance. Tesla recorded revenue of $24.9 billion for the quarter, marking a 47% increase compared to the same period last year. Additionally, the company’s vehicle deliveries during Q2-2023 reached 466 thousand units. This was up 83% compared to the same quarter last year. Tesla is actively pursuing market share, but this growth is coming with certain costs.

Over the past two quarters, Tesla has been reducing the average selling price of its vehicles, primarily due to a decline in overall demand within the US market and greater competition in China. Despite witnessing enhanced efficiency and increased vehicle production at their factories in the US, Shanghai, and Berlin; Tesla is facing challenges in maintaining the same profit margins as seen in the corresponding quarter of the previous year. While the revenue experienced a 47% growth, the gross profit only managed to grow by a modest 7%. The gross margin was already relatively tight compared to other industries. Specifically, in Q2-2022, Tesla’s gross margin stood at 25%, but for the most recent quarter, it dipped to 18.2%. This signifies the impact of their pricing strategy and the current market conditions on their profitability. Tesla’s share price fell approximately 10% since they released their results.

Tesla finds itself in a fascinating position within the market. With their vehicles priced towards the upper-income segment, they could have pursued a strategy of limiting supply to create a sense of exclusivity, as is common in luxury brands. However, Tesla has chosen a different path. Instead of focusing solely on exclusivity, they are striving to be more “innovative” than their competitors. Their approach involves allowing their cutting-edge technology and innovations do the talking. Tesla was one of the first companies to produce autonomous vehicles to the general public at scale.

Another factor at play is Elon Musk. While some people strongly dislike him, others are huge admirers. He has cultivated a cult-like following of individuals who are willing to buy practically anything he endorses. This devoted fan base plays a crucial role in boosting Tesla’s sales and brand loyalty. However, his polarizing nature also attracts criticism and scepticism from certain quarters. Overall, Elon Musk’s influence on Tesla’s success is complex, shaping the company’s unique position in the automotive industry.

14 July 2023

Key Indicators

Source: Iress

Weekly Stocktake with Danyaal

US vs China: Battle on the Semiconductor Front

Semiconductors are vital components found in virtually every electronic device. They serve as the “electronic brain” in various gadgets, ranging from smartphones and cars to data centres and TV remotes. In fact, a single vehicle may contain numerous chips. While some chips perform basic functions like controlling window movements, others perform more intricate functions like controlling fuel and air mixes and providing vital feedback to the driver or in fact even controlling the vehicle..

Today, more and more powerful chips perform highly complex and sophisticated functions Artificial Intelligence (AI) applications, precise military weaponry, and robotic functions, amongst others.

Tensions between the US and China are intensifying in the realm of AI and military applications. In October of last year, the US implemented export controls aimed at effectively barring China from manufacturing or acquiring advanced semiconductors. This move seeks to prevent China from gaining further technological advantages in the development of surveillance and military systems.

There are four important factors at play in the Semiconductor industry that could render the US’s export controls effective.

1. Semiconductors are a truly globally-manufactured product. The production of high-performance chips necessitates the seamless collaboration of multiple highly specialized businesses, around the world. Take, for instance, an Nvidia chip utilized in data centres. Nvidia, based in the US, designs the chip, which is then sent to a TSMC fabrication plant in Taiwan for manufacturing. The construction of these fabrication plants requires specialized equipment from ASML, located in the Netherlands. The sourcing of raw materials and components for all of this comes from numerous suppliers around the world. Subsequently, the finished products are shipped to Nvidia’s customers worldwide. If China were to keep up (or takeover) the US, they would need to build this all within their borders.

2. Although the semiconductor industry operates on a global scale, it is characterized by a limited number of key suppliers. ASML, for instance, holds an effective monopoly in the production of lithography equipment. Their machines, priced at around $150 million each, are as large as trucks and require dedicated teams of engineers to build and operate them within fabrication plants. TSMC accounts for approximately 30% of the world’s market for contract chip fabrication. The effectiveness of the US’s export controls hinges on the cooperation of the Netherlands and Taiwan, where ASML and TSMC are based, respectively. These countries have implemented their own export controls on China, thereby bolstering the potential success of the US’s measures.

3. If China were unable to develop its own domestic semiconductor production capabilities and resorted to acquiring high-end chips through the black market, it would encounter significant challenges. The number of buyers for chips are limited, and these buyers typically make bulk purchases to fulfil their requirements. Data centres, for instance, rely on thousands of chips to operate within their large-scale facilities.

4. Additionally, the semiconductor industry progresses at a rapid pace. According to Moore’s Law, the computing power of semiconductors doubles every two year while the costs halve. If China managed to obtain chips or the equipment required for their production, they would likely acquire technology at the trailing edge, lacking the cutting-edge advancements and cost efficiencies offered by the latest semiconductor innovations.

The race is not over yet. China is pouring money into developing their market. The US is taking a risk: if the export controls prove successful, they could effectively hinder China’s progress for years to come. However, if these restrictions fail, China may emerge even stronger with a flourishing semiconductor industry under its complete control within its own borders.

ASML and Nvidia are held in the Lunar BCI Worldwide Flexible fund. They are also held by the Lunar Capital Offshore Portfolio Clients.

07 July 2023

Key Indicators

Source: Iress

Weekly Stocktake with Danyaal

Let it Snow, Let it Snow, Let it Snow

Despite the snowfall across SA on Monday, our focus shifts to a different kind of snow at Lunar Capital: a business called Snowflake. Snowflake is a cloud-based data-warehousing company. They specialise in the storage, cleaning and management of propriety and public data in the cloud. Considering the vast quantities of data accumulated by companies during their regular operations, Snowflake effectively allows the companies to analyse their business more thoroughly. Additionally, Snowflake provides a platform for companies to offer their data for sale to other customers.

To fully leverage the potential of data, businesses often require the expertise of specialized professionals like data analysts. However, Snowflake, at the end of last month, revealed its partnership with Nvidia. Nvidia will provide accelerated computing chips to enhance the computing  power within Snowflake’s data warehouses. This collaboration will enable Snowflake to integrate large language models (LLM) into their products, enabling users to interact with the data in a more conversational manner. This approach will resemble the experience of asking questions to platforms like ChatGPT. By incorporating this technology, Snowflake could empower individuals and businesses to engage with their data using a natural and intuitive conversational style.

Nevertheless, there is still a significant journey ahead. Presently, businesses pose increasingly complex questions to their data, a process that can consume several weeks to months for teams to obtain meaningful answers. It is not as straightforward as merely integrating a large language model (LLM) onto the existing data infrastructure and letting it operate autonomously. The LLM must be carefully customized to fit Snowflake’s unique data system, ensuring that users can extract the same level of valuable insights from the data as they could before. This tailored integration is crucial to optimize the capabilities of Snowflake and empower users with enhanced data analysis and interpretation.

Snowflake and Nvidia are held in the Lunar BCI Worldwide Flexible fund. They are also held by the Lunar Capital Offshore Portfolio Clients.