VCS Agency

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.

30 June 2023

Key Indicators

Source: Iress

Weekly Stocktake with Danyaal

Millennials Stamp their Economic Authority

At Lunar Capital, we look at local and global macro themes that we believe will unfold over the long term. From these themes, we discuss which industries stand to benefit from these trends. We ask ourselves if these are industries we understand and like. If we do, we then look for the market leaders and/or disruptors in the industry and consider whether we think they are worth investing in. Below is a breakdown of one of our themes.

Investment Theme

Millennials Stamp their Economic Authority

Millennials, born between 1982 and 1994, are widely recognized as the first generation to grow up fully immersed in digital technology. With the advent of the internet and widespread phone usage, many individuals in this cohort were born into a world where these technologies were already prevalent. As a result, millennials have developed a strong inclination towards instant responses and gratification, a phenomenon often referred to as the “Amazonification effect.” They have become accustomed to the convenience of ordering goods with a simple click and receiving it within a day. Similarly, millennials gained access to instant and affordable connectivity with others early in their lives. Furthermore, this generation exhibits heightened concerns about environmental sustainability and quality of life, as they prioritize decisions that impact their own well-being.

Impact

As millennials increasingly move into the mainstream, we anticipate a continued increase in the demand for online services. Given their emphasis on quality of life, we also expect further growth in the demand for experiential offerings. Additionally, as millennials transition into more settled lifestyles, they will wield greater economic power and exert a substantial influence on the overall economy. This generation could also play a pivotal role in shaping consumer behaviour, determining the extent of online shopping, expenditure on experiences, and influencing housing market demands.

Investment Considerations

Among the sectors we believe are poised to benefit from the increasing prominence of millennials in the economy are e-commerce, social networks, travel, lifestyle, innovative financial services, and online education. For instance, within the lifestyle sector, we would explore opportunities in companies specializing in athleisure wear. As millennials’ disposable income rises, a significant portion of them has demonstrated a preference for buying high-quality athletic apparel. Notably, companies like Nike and Lululemon have already capitalized on this trend. In the case of Lululemon, we see potential for further growth due to their focused and high-quality product range. When they release a new product, it tends to have a significant impact on their business. If the product sells well – the overall company does really well. However, the reverse is also true.

We use different investment themes to find businesses that we believe will succeed in the long term. The increasing economic authority of millennials is just one of these themes that helps us identify companies that we would like to own.

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

23 June 2023

Key Indicators

Source: Iress

Weekly Stocktake with Danyaal

Zara: In the Fast Lane of Fashion

When it comes to fast fashion, Zara is undoubtedly one of the first names that springs to mind. Unlike many clothing companies and even other fast fashion brands, Zara, owned by Inditex (which is held by the Lunar Capital Offshore Portfolio Clients), operates at a rapid pace. They focus on the quick turnover of clothing cycles. The result is that Zara generally has new products on their shelves every few weeks.

How do they do it?

Vertical integration

Zara employs the vertical integration model. The company has ownership and control over a significant portion of its production, distribution, and retail operations. This approach grants Zara with a heightened level of authority within the supply chain. It enables them to effectively manage product quality and specifications; and bring their offerings to market at an accelerated pace. Notably, a substantial portion of Zara’s manufacturing operation is situated near their headquarters in Spain. This geographical proximity facilitates swift operations while also yielding cost savings by minimizing third-party shelf space expenses.

Limited Inventory

Zara maintains a deliberately low inventory level in their stores. By avoiding excess inventory, Zara avoids the need to sell products at discounted rates, safeguarding their profitability. Additionally, this strategy creates a sense of urgency among customers. Knowing that desired items may not be available during their next visit, customers feel compelled to make immediate purchases when they encounter products they like.

Fashion Shows, Influencers, and Customer Data

In the past, Zara traditionally dispatched teams to fashion shows to identify the upcoming trends for each season. They utilized this knowledge to develop their own products to sell. However, as social media rose, Zara shifted their focus towards monitoring influencer fashion choices and emerging trends. This transition provided them with a more profound understanding of current fashion movements. Zara leverage their rapid production process to have some of these new products available to sell within 5 weeks.

Furthermore, Zara collects valuable customer data from in-store purchases, enabling them to swiftly scale up production for popular items. Their streamlined inventory management practices minimized the financial impact of such adjustments.

The Other Side of Fast Fashion

Zara and other fast fashion retailers face valid scrutiny due to environmental and ethical concerns. Fast fashion heavily relies on resources like water, energy, and land, while also involving the use of hazardous chemicals. Additionally, there have been many cases of inadequate working conditions within the industry. These negative impacts can result in penalties and consumer aversion towards fast fashion companies like Zara.

16 June 2023

Key Indicators

Source: Iress

Weekly Stocktake with Danyaal

South Africa’s National Health Insurance (NHI) Bill

What does the NHI propose?

The National Health Insurance (NHI) Bill was recently passed by Parliament, with the aim of providing universal health insurance to all individuals in South Africa. The bill proposes pooling the resources of all citizens in the country to achieve this goal. However, it should be noted that the Bill still requires approval from the National Council of Provinces and subsequent signing by the President before it can be enacted. According to the government, the bill intends to ensure that every citizen has access to high-quality healthcare, regardless of their income or health condition. Under the proposed system, the government will take charge of purchasing all necessary health services for the population. This includes determining the types of services available, the placement of health facilities, and the allocation of health professionals.

Funding

The specific details of the funding structure for the NHI initiative are currently uncertain. However, it is suggested that the funding will rely on the existing tax plan, with additional taxes or rates imposed on those who have the financial capacity to afford them. It is important to note that South Africa currently faces one of the highest unemployment rates globally, resulting in a relatively small tax base. The implementation of the bill in its entirety could potentially place a substantial burden on taxpayers, further straining the already challenging economic landscape.

What does this mean for SA Health Insurers?

Health insurers in South Africa, such as Discovery, Momentum and many others, currently serve around 9 million individuals. However, under the NHI bill, these insurance schemes will only be allowed to provide coverage for procedures that are not included in the bill. This could potentially render them obsolete or significantly reduce their scope of services. The complete implementation of the NHI bill is estimated to take approximately 10 to 15 years if everything goes according to plan. Nevertheless, it is important to note that there is a possibility of legal challenges being raised against the bill, which could potentially impact its timeline and implementation.

The NHI bill raises numerous unanswered questions regarding coverage, funding, impact on current medical aid schemes, implementation timeline, legal validity, and unintended consequences. Only time will reveal the true outcomes and effects of the bill as it progresses and more details emerge.

23 May 2023

Key Indicators

Source: Iress

Weekly Stocktake with Danyaal

The Business of Football: The Economics Behind the Game

From groceries to semiconductors to football, numerous businesses cater to the supply of goods and services for people. While some businesses offer essential products, others provide entertainment. Regardless of the nature of the goods or services, consumers need to pay for them. Sometimes these are directly, and other times these are indirectly. Football teams have a fascinating approach to generating revenue, and their expenses are also heavily skewed towards specific items.

Revenue

Football clubs earn their revenues in various ways such as: through branding rights, the transfer market (which is extremely difficult), and matchday tickets (normally a small percentage of total revenue). However, the main way of earinng an income, in football, is through leveraging their branding rights. They can do this through a number of ways:

• Earning fees from TV rights that are negotiated by the unions to which they belong e.g. FA (Football Association), UEFA (Union of European Football Associations), and SAFA. These unions are responsible for negotiating with TV broadcasters, who in turn compensate the football clubs depending on the number of games they play in which are televised.
• Clubs also sign deals with clothing companies like Nike, Adidas, and Puma, receiving either lump sum payments or a percentage of merchandise sales.
• They also earn fees from advertising, either at their home stadium or as logos on their sportswear.

Within Branding rights: broadcasting rights is the biggest driver of revenue. For e.g. UEFA are set to distribute €2.032 billion to teams participating in the Champions League, Europa League, and Super Cup this season. And Manchester City, the recent Champions League winners, are expected to earn around €60 million from their Champions League campaign, alone.

Costs

Football clubs incur various costs, including salaries for staff such as players, coaches, and administrative personnel. Additionally, they are responsible for maintaining stadium infrastructure. Intangible assets (such as player contracts) also require impairment adjustments over the duration of the contract. In the case of Manchester City’s 2021/2022 season, their largest expense was wages, totalling £353 million, which accounted for 55% of their total operating expenses and encompassed all staff (including players) of the club. The second largest cost item was the impairment of intangible assets (22% of operating costs). This was primarily the re-assessment of the value of players’ contracts as their contract durations decrease over time. Some clubs, like Juventus, prefer to acquire players whose contracts are nearing expiration, avoiding the need to pay exorbitant fees to other clubs to buy the players out of their contracts.

Grander Scheme of Things

The eye-catching figures spent by football clubs on players do not provide an accurate representation of their financial size. Player salaries and transfer fees constitute a significant portion of their expenses. Despite the global broadcast of sports events and widespread fan support, football clubs do not generate as much revenue as other globally recognized businesses. For instance, during Manchester City’s 2021/2022 season, they earned £613 million in revenue and £42 million in profit. In comparison, Puma, Man City’s kit sponsor, recorded €8,456 million in revenue and €354 million in profits for their 2022 financial year.

Owners of football clubs often have deep pockets to be able to afford the investments required to make the club successful. Some do it to hopefully earn a decent return on their investments; while others, arguably, do it for ego.

23 May 2023

Key Indicators

Source: Iress

Weekly Stocktake with Danyaal

From Downward Dog to Upward Profits, Lululemon’s revenue surges!

Yoga-pants, women’s running shoes, and increasing margins. Lululemon, the high-end athleisure designer brand held by Lunar Capital, recently unveiled their Q1 2023 financial results. The company recorded a 24% increase in revenue compared to the same quarter in the previous year, reaching $2 billion for the quarter. In addition, Lululemon experienced a surge in its net income, which increased by 52% to $290 million. The company’s performance can be attributed to several factors. Firstly, the revival of the Chinese market following the lifting of lockdown restrictions this year contributed to Lululemon’s increased revenue and net income. Furthermore, the company benefited from reduced airfreight costs this quarter compared to the same period last year, which resulted in their cost of sales decreasing.

Lululemon operates via physical stores as well as well as through on-line stores. Approximately 42% of sales is via direct channels, i.e. on-line. They currently have a total of 662 stores worldwide, with three key locations accounting for 82% of their store presence:

• The United States with 357 Lululemon stores,
• China with 119 stores, and
• Canada with 69 stores.

Sales breakdown from the various regions in this quarter is as follows:

• The USA with $1 315 million;
• Canada with $253 million, and
• China with $249 million in sales.

Lululemon’s strategy has 3 pillars: Product innovation, guest experience and market expansion.

On product innovation, Lululemon’s Align yoga pants are highly sought after by yogis, as its fit allows them to feel free and light while they practice. The Align pants alone generates over a billion dollars in sales per year. Whilst yoga wear was Lululemon’s original product focus, they now have products covering many other sports codes, and these also include shoes and accessories.

Lululemon operates within a fiercely competitive landscape, facing competition not only from other athleisure brands but also from established luxury brands like Luis Vuitton (owned by LVMH.) It is worth noting that athleisure and luxury brands often rely on public personalities to promote their products. However, this strategy can sometimes lead to adverse effects if the public figure faces criticism for their actions or statements. A prime illustration of such collateral damage can be seen in the case of Adidas and Kanye West, where negative associations with the Kanye West impacted Adidas’s reputation. Lululemon use product ambassadors and influencers in their marketing efforts too.

Lululemon is held in the Lunar BCI Worldwide Flexible Fund and by Lunar Capital’s Offshore Portfolio Management clients. And LVMH is held by Lunar Capital’s Offshore Portfolio Management clients.

23 May 2023

Key Indicators

Source: Iress

Weekly Stocktake with Danyaal

Artificial Intelligence: Beyond the Hype or Just Another Illusion?

The rise of generative Artificial Intelligence (AI) products like ChatGPT has led companies in most sectors to seek ways to incorporate AI into their businesses. On the flip side, investors are wondering how they can make the most of this trend. They’re asking themselves who stands to gain from this wave and whether it’s a long-term phenomenon or just another hype?

Nvidia, a company held by Lunar Capital, recently released their Q1 2024 results and outlook. Nvidia designs semiconductors and develops software for AI programmes and services to run on. This allows companies like Microsoft and Open AI to build AI-products and services using Nvidia’s chips. Clients like banks and retailers then build AI-based solutions to service their clients and support their businesses.

While Nvidia’s revenue for the quarter dipped 13% to $7.2 billion compared to the same quarter last year; their net income increased by 26% to $2 billion. What really caught the eye of investors was their projection for the next quarter. Nvidia guided that they expect to earn $11 billion in revenue. If they hit that mark, it’ll mean roughly 50% increase in revenue from the current quarter. And it’s not just the revenue that’s climbing, as seen from the current quarter, their net margin has expanded too. As a result, Nvidia’s stock price soared by 24.6% last week, making them the 6th most valuable public company in the world with a market cap of $963 billion as of Friday last week.

Is AI another case of market-hype causing fluctuations, similar to what we’ve seen with crypto and the metaverse booms and busts? Or is this technology here to stay? Investors have high hopes for Nvidia. Looking at their rolling twelve month period, their price-to-earnings ratio stands at 203. In theory, if an investor were to buy the stock at these prices and the yearly earnings remained unchanged, it would take them 203 years to recover their investment. The expectations for Nvidia in the coming years are high, but it will take time to see if the company can live up to them.

Nvidia and Microsoft are held in the Lunar BCI Worldwide Flexible Fund and by Lunar Capital’s Offshore Portfolio Management clients.

19 May 2023

Key Indicators

Source: Iress

Weekly Stocktake with Danyaal

Walmart: Competing on all Shop Fronts

Walmart, a business owned by Lunar Capital funds and clients, recently announced its Q1 2024 results. Notably, the company recorded a revenue of $152 billion, a 7.6% increase compared to the same quarter last year. Operating income saw a significant rise of 17.3% to reach $6.2 billion. However, Walmart had to make adjustments to the fair value of its investments, resulting in a $3 billion line-item decrease on the Income statement. Consequently, the diluted net income per a share decreased by 16.2% compared to the same quarter last year. During the quarter, Walmart achieved a gross margin of 24.3% and an operating margin of 4.1%.

Walmart has long been recognized for its focus on affordability and customer satisfaction. In a high-inflation environment consumers tend to “buy down”, i.e. they look for cheaper alternatives. Walmart could benefit from this trend. However, this is not the only front they are battling on. Walmart has recently ventured into the realm of e-commerce. In their latest financial results, Walmart experienced a noteworthy 26% growth in global e-commerce sales. Although e-commerce currently represents a relatively small portion of their total sales, it is growing at a faster rate compared to many of Walmart’s other business segments. The advertising segment is the only other segment exhibiting similar growth, with an increase in sales of 30% compared to the same quarter last year.

Walmart is strategically expanding its reach beyond its traditional competitors and targeting businesses that were not historically in direct competition with them. In the e-commerce realm, they are notably aiming to compete with Amazon, despite Amazon holding a significantly larger market presence. For the most recent fiscal year, Amazon’s e-commerce business recorded sales of $375 billion, while Walmart recorded e-commerce sales of $82 billion.

Walmart is also making strides in growing its advertising segment, which typically offers higher profit margins compared to many other industries. This could potentially contribute to Walmart increasing its operating margin. However, it is important to note that Walmart faces fierce competition in this arena from other advertising platforms such as Alphabet, Meta (formerly Facebook), and Amazon, again. This competitive landscape presents a challenging battle for Walmart. Nevertheless, their recent growth in the advertising sector suggests that businesses are choosing to allocate a portion of their marketing budget to Walmart, indicating a positive trend for Walmart’s advertising endeavours.

Amazon and Walmart are held in the Lunar BCI Worldwide Flexible Fund and by Lunar Capital’s Offshore Portfolio Management clients.