VCS Agency

12 May 2023

Key Indicators

Source: Iress

Weekly Stocktake with Danyaal

Hungry Munger and a Buffett of Wisdom

Lunar Capital’s investment philosophy draws core features from Warren Buffett and Charlie Munger’s emphasis on investing in high-quality businesses for the long term, a strategy that has proved successful for their company, Berkshire Hathaway. As of May 12th, 2023, Berkshire Hathaway, our largest holding in the Lunar BCI Worldwide Flexible fund, had a market cap of $707 billion. According to their 2023 Q1 report, Berkshire Hathaway’s top three security-investments were in Apple, American Express, and Bank of America. Berkshire Hathaway also owns private business such as Geico, an insurance business; See’s candies; BSNF, a railway company; Duracell; and many others.

Buffett and Munger are renowned for their insightful quotes and words of wisdom. Here are some of our favourites:

“In the short run, the market is a voting machine, but in the long run, it’s a weighing machine.” – Warren Buffett. In other words, in the short term the market behaves based on sentiment or popularity, but it’s only in the long term does the real value emerge.

“A great business at a fair price is superior to a fair business at a great price.” – Charlie Munger. In other words, stick to investing in quality businesses rather than trying to get an average business at a bargain.

“Time is the friend of the wonderful company, the enemy of the mediocre.” – Warren Buffet. This one is self-explanatory.

“Never invest in a business you cannot understand.” – Warren Buffet. If you don’t understand what drives a business rather don’t invest in it.

“A great business is one that over an extended period of time earns a very high return on capital and ploughs most of that back into the business.” – Charlie Munger. A great business is one that can continue to grow at a high rate over a long period of time, and especially if it is able to re-invest its profits in growing the business at a high rate of return.

05 May 2023

Key Indicators

Source: Iress

Weekly Stocktake with Danyaal

Long Life Novo Nordisk

Over the last few decades, the average life expectancy in developed nations has been increasing. This has been due to a number of factors such as advancements in medical technology, improved public health measures, and a greater focus on preventative care. However, some consequences of people aging, is that they are more likely to develop chronic health conditions such as heart diseases, cancer, and diabetes – all of which require ongoing medical care.

Novo Nordisk, a Lunar Capital holding, is a Danish pharmaceutical company that specialises in the development and manufacturing of treatments for diabetes, obesity, and other chronic diseases. Novo Nordisk, along with Eli Lilly (another Lunar Capital holding) are two of the leading players treating chronic medical-conditions.

Ozempic, a popular treatment developed by Novo Nordisk, was initially used to treat type-2 diabetes. However, it was discovered that Ozempic influences weight loss as well. The medication produces a digestive hormone called glucagon that ultimately reduces appetite, leading to weight loss in patients. In the United States, Ozempic is currently only FDA-approved drug for use in treating type-2 diabetes. However, some physicians may prescribe Ozempic for off-label use, which allows them to prescribe the medication for other conditions, such as treating obesity. Some studies indicate that approximately 40% of people in the USA are obese, providing a large market for drugs such as Ozempic.

Pharmaceutical companies operate in a highly regulated industry with country-specific requirements that can be challenging to navigate. Developing new treatments is a lengthy and costly process with no guarantees of success, but these companies invest heavily in research and development to remain competitive. However, the industry’s public-facing nature means that any negative outcomes or unintended consequences from treatments could result in significant reputational and financial losses. Nonetheless, if pharmaceutical companies can navigate these challenges successfully, they can be compensated well for it.

28 April 2023

Key Indicators

Source: Iress

Weekly Stocktake with Danyaal

Scaling Up: Microsoft’s Growing Revenue and Expanding Margins

Microsoft, one of Lunar Capital’s holdings, provides a strong example of a business whose growth has resulted in expanding margins. For the most recent quarter, Microsoft recorded a gross margin of 69% and a net margin of 35%. In comparison, during Microsoft’s 2018 financial year, they recorded a gross margin of 65% and a net margin of 15%. On top of the expanding margins, Microsoft has been growing its revenue too. Microsoft has three primary business segments: Productivity and Business Processes (Office products and other tools), Intelligent Cloud (Azure and other cloud services), and More Personal Computing (Windows operating systems.)

One of the factors that has contributed to Microsoft’s expanding margins is their ability to bundle products together. Microsoft Teams demonstrates how Microsoft leveraged their scale and product reach to encourage businesses to use their products instead of alternatives like Zoom. During the pandemic, Microsoft bundled their Teams’ product with Office 365, allowing companies to access both products without having to pay for an additional service. This bundling strategy helped Microsoft increase their market share and strengthen their position in the productivity services space.

The Intelligent Cloud segment is another example of how Microsoft has successfully scaled its operations and improved its margins. It has been the fastest-growing segment in terms of revenue and operating income between 2018 and 2022, with the operating margin increasing from 36% to 43% during this period. Microsoft has also leveraged its scale to encourage businesses to use its cloud products, which are designed to be easily compatible with the company’s other products and services.

Companies that can rapidly scale and improve their margins, often attract intense competition. Microsoft is not only competing against Amazon and Alphabet in the cloud space but also against smaller companies, such as Slack and Canva, that specialize in specific products. Microsoft is also entering the AI space where they are competing against Alphabet and other companies. Microsoft plan to integrate ChatGPT into their Office 365 products, such as Word, Excel and PowerPoint. If executed well, this could allow Microsoft to further build on their large network to increase their dominance in the computing space.

Microsoft and Amazon are held in the Lunar Capital BCI World Wide Flexible Fund.

21 April 2023

Key Indicators

Source: Iress

Weekly Stocktake with Danyaal

ASML – Light Me Up

Last week, one of Lunar Capital’s holdings, ASML, announced its Q1 2023 results. ASML has been part of the Lunar Capital BCI Worldwide Flexible Fund since July 2020. ASML is a key producer of lithography equipment, a crucial component in semiconductor manufacturing. Their EUV machines, which use extreme ultraviolet light to create intricate patterns on silicon, are sold for around $150 million each. ASML’s lithography equipment has enabled the production of microchips with billions of transistors on them.

For the Q1 2023, ASML recorded net system sales of €5.32 billion, compared to net system sales of €4.75 billion for the previous period. ASML sold 17 EUV units this quarter, which accounted for 54% of their net system sales. With regards to sales by region, Taiwan accounted for 49% of the total sales, while South Korea made up 26% of the sales. Notably, the USA’s contribution to ASML’s net system sales increased from 7% in the previous quarter to 15% in the latest quarter, reflecting the country’s push towards domestic chip production and reducing its reliance on Taiwan. TSMC (based in Taiwan) accounts for roughly 55% share of the global semiconductor fabrication market last year.

Over the past 12 months, ASML has recorded a gross margin of 51% and a net margin of 28%, with a return on assets of 20%. From 2019 to 2022, the company’s revenue has grown at a compound annual growth rate of 18%, while net profits have grown at a rate of 21% per year. ASML currently holds an effective monopoly on lithography machinery, with demand for their products exceeding the capacity they expect to produce this year.

ASML is held in the Lunar Capital BCI World Wide Flexible Fund.

14 April 2023

Key Indicators

Source: Iress

Weekly Stocktake with Danyaal

Next Level Platform Companies

Apple, Microsoft, and Amazon are companies that facilitate the exchange of goods and services between buyers and sellers. These are known as platform companies. They provide products and services that allow other businesses to grow and scale using their platform or product. Each company has a unique way of enabling this exchange; whether it is through creating an app-store ecosystem, or facilitating a large scale e-commerce market-place.

Amazon has two unique ecosystems, with the more well-known one being its e-commerce business. Third-party sellers can use Amazon’s website to sell their products to customers, with Amazon providing the warehousing and transport services in exchange for a fee. Because Amazon operates at such a large scale, it can offer customers competitive prices, which in turn attracts more potential customers to its platform. This creates further incentives for businesses to sell their products on Amazon, leading to increased competition and even more competitive pricing.

Amazon’s cloud service AWS, is also a platform company, but from a different perspective. It provides a wide range of services such as computing power, storage, and databases, as well as various other tools and services to help businesses build and scale their applications and services in the cloud. With AWS, businesses can create their own infrastructure without having to invest large amounts of capital to build servers. Due to the scale of AWS, businesses can also scale their operations more seamlessly, without worrying about website and operational system downtime. This offers a level of reliability that can be difficult and expensive to create on their own.

Platform companies require a significant amount of capital to invest in building new capacity and maintaining their infrastructure. To be successful, they also need to attract a large number of users to interact on their platform. Competition for users’ time on the platform can be intense. Breaking into this type of business can be difficult, but if successful, can be quite lucrative. For example, Amazon’s AWS segment had an operating margin of 28.5% last year. Similarly, Apple charges businesses a 30% fee on revenue derived from the App Store.

At Lunar Capital we hold Amazon, Berkshire Hathaway (which owns a portion of Apple) and Microsoft in the Lunar Capital BCI World Wide Flexible Fund.

06 April 2023

Key Indicators

Source: Iress

Weekly Stocktake with Danyaal

SA’s Heavy-Weight Champion

This week, is about SA’s heavyweight, Remgro, an investment company listed on the Johannesburg Stock Exchange (JSE). As Remgro has multiple businesses under its umbrella, investors need to assess it from a different perspective. They need to consider the company as a whole, and compare it to the weighted-average market price of the individual stocks. This is known as the Net Asset Value (NAV) valuation method.

Let’s examine Remgro’s portfolio, as of their recent 31 Dec 2022 results. Mediclinic, Outsurance, and CIVH (Community Investment Venture Holdings) accounted for 47.5% of their portfolio, with other notable businesses including FirstRand and Discovery. Remgro’s total NAV was R125.9 billion, with an NAV per share of R223.86. However, the share price on that day was only R133.03, representing a discount of 40.6% compared to the NAV per a share.

It’s not uncommon for investment companies to trade at discounts to their NAV, and this can happen for several reasons. For instance, investors may not believe that the businesses in their portfolio are valued accurately at current market levels; corporate costs, including the salaries or fees of the investment managers may also be high. Additionally, the price of shares is influenced by supply and demand. If there’s greater demand for individual stocks than for the investment company’s stock, a discrepancy is created.

At Lunar Capital, we hold Remgro in our BCI Worldwide Flexible Fund. Remgro invests in businesses for the long term, which aligns with our investment approach. Furthermore, we find their underlying portfolio quite attractive, with the relatively high discount to NAV.

Weekly Stocktake with Danyaal

31 March 2023

Key Indicators

Source: Iress

“Just Do It” Or “Be All In”

In the past two weeks, two athleisure brands that we follow, Nike and Lululemon, released their results. What’s interesting is the contrast between where each company is, in their respective lifecycle, particularly with regards to their product journey. Nike, founded in 1964, started selling footwear before branching out into other apparel. They now offer a wide range of products, from athleisure wear to team-sports clothing and accessories. On the other hand, Lululemon was founded in 1998 and initially designed yoga clothing for women. They primarily target the upper-income bracket. And have only recently expanded into designing athleisure-wear for men.

Nike and Lululemon’s respective journeys can also be shown by their progress in sponsorships with sport teams and stars. Nike is widely known as the premier sponsor across multiple sports. They pay top-of-the-market rates for sponsorship deals and are the go-to-choice for many sports stars. In contrast, Lululemon is relatively new to this space and currently focuses on certain sports such as yoga, running, tennis, and golf.

In the trailing twelve months, Nike’s revenue increased by 8% to $50.6 billion, while Lululemon’s revenue increased by 30% to $8.1 billion. Last year, both companies faced inventory pressure due to overstocking under global supply chain constraints. Nike’s gross margin decreased from 46%, for the previous 12-month period, to 44% for the current 12-month period. Lululemon’s high gross-margin decreased from 58%, last year, to 55%, this year. Both companies had a net margin of around 11%. On Friday, Nike’s market capitalization was $190 billion, with a price-to-earnings (PE) ratio of 35. Lululemon, on the other hand, had a market capitalization of $46 billion and a PE ratio of 54.

Because Nike has a diverse range of products across multiple categories, the impact of any single product’s performance on their income statement may be muted. If a single product performs well, it may not have a significant positive-impact on the overall income statement. Conversely, if a product performs below expectations, the negative-effect on the income statement may also be less significant. In contrast, Lululemon’s income statement is more sensitive to the performance of their products due to their narrower focus. Therefore, the performance of a single product or category may have a higher impact on Lululemon’s overall financial performance.

Lululemon is held in the Lunar BCI Worldwide Flexible Fund

Weekly Stocktake with Danyaal

24 March 2023

Key Indicators

Source: Iress

How Quick Can a Bank Run?

Banks generate revenue through Net Interest Income (NII) and Non-Interest Revenue (NIR). NII comes from charging interest on loans to customers and paying less interest on deposits. NIR is earned through transaction facilitation, general fees, and commissions. Banks borrow short and lend long; by taking deposits which can be withdrawn in the short term and investing funds and issuing loans for longer periods. To enable banks to be able to repay deposits, they are required to maintain some of their assets in liquid form. This enables customers to withdraw funds without requiring the bank to sell its assets. However, if depositors demand funds more than the bank’s liquid assets or reserves, the bank would need to raise funds quickly to be able to repay depositors.

Central banks increasing interest rates beyond expectations and maintaining them for longer periods can also lead to problems. This is because higher interest rates cause bond prices to drop. Banks, holding these bonds, incur non-cash losses as they still hold the same number of bonds. If customers perceive that their deposits are at risk and withdraw funds in large amounts, it can force the banks to sell their bonds to meet the withdrawal demands. This leads to further losses for banks. As losses mount, more customers tend to withdraw their funds, and the bank is forced to sell more of its assets.

Silicon Valley Bank (SVB) experienced a similar situation. SVB mainly served the tech industry, and as investments in tech slowed down, companies had to withdraw their own funds to operate. This led to larger cash withdrawals from these companies, without SVB gaining new deposits. The tech industry is closely connected, and news travels fast. So, when companies began withdrawing funds, the news spread quickly, resulting in a faster-than-usual acceleration in withdrawals and ultimately a run on SVB.

Weekly Stocktake with Danyaal

17 March 2023

Key Indicators

Source: Iress

Rev Your Engines

Last week, three major German automakers; Volkswagen (VW), BMW, and Mercedes-Benz; announced their results. BMW (which also owns Mini Cooper and Rolls Royce) and Mercedes cater to the upper-income market by primarily selling luxury vehicles, while VW attempts to sell to both the broad market and the premium market. VW’s in-house brand offers a variety of vehicles to different groups. Its other brands, including Porsche, Bentley, Audi, and several other vehicle manufacturers, are primarily focused on selling premium products to higher income groups.

In the 2022 financial year, VW reported a sales revenue of €279.2 billion, a 12% increase from the previous year. Their operating profit was €22.5 billion, resulting in an operating margin of 8.1%. The volume brands, including VW, Skoda, and Seat, had the largest revenue of €113.8 billion, but it only had an operating margin of 3.6%. The premium brand segment, which consists of Bentley, Audi, Lamborghini, and Ducati, had a revenue of €61.8 billion and an operating margin of 12.3%. In contrast, BMW had a revenue of €142.6 billion in the 2022 financial year, with an operating margin of 9.8%. Meanwhile, Mercedes-Benz recorded a revenue of €150 billion and an operating profit of €20.5 billion, resulting in an operating margin of 13.6%.

These vehicle manufacturers face the challenge of dividing their capital expenditure between two key areas – the Internal Combustion Engine vehicles (ICE) and Electric Vehicles (EV). Investment is split between maintaining and developing the ICE segment, which is crucial to retain their existing customer base; and investing in the future of EV, which is important to attract new customers. This could be one of the reasons these companies are trading at quite low earning multiples. The table below compares the historic earning multiples of these vehicle manufacturers.

Source: Iress

In contrast, Tesla’s sole focus is on EV production, giving them an advantage in how they allocate their capital expenditure. This is one of the reasons why Tesla has gained significant market share in the EV space. Their earnings multiple is also significantly higher than the other companies.

VW and BMW are held in the Lunar Capital Offshore Portfolio.