Weekly Stocktake - Lunar Capital

Sweet and Sour Lululemon

The premium athleisure brand Lululemon has gone through a rough patch this year. Last week the company released their third quarter 2024 results, sending the stock just under 16% higher on the day. However, year to date, the stock is down 14%, compared to the S&P 500 index, which is up just under 28%.

The two main issues Lululemon recently faced are:

Earlier this year, Lululemon released a selection of leggings that did not meet customer preferences. The range lacked sufficient colour options and had incorrect size quantities, resulting in missed sales in key locations such as the US.
Another challenge that Lululemon encounters is the highly competitive market in which they operate. If customers are dissatisfied with the products, they can easily switch to other brands. Given the premium pricing of Lululemon items, customers tend to be particularly discerning and may readily choose alternatives.

During the earnings call, Lululemon stated that they will focus more on their existing customers in the US, rather than significantly expanding the total number of stores to gain new customers. Of the total revenue of $2.4 billion in Q3 2024, America accounted for 79% of the revenue. One of the strategies Lululemon is implementing is increasing the percentage of new products to total products in their stores as a way of encouraging current customers to spend more at their stores. The next few quarters will indicate the success of this strategy.

Despite some challenges in the US market, Lululemon’s international segment has shown significant growth. The segment in China grew by 39% to $318 million, while revenue from regions outside the Americas and China increased by 27% to $308 million.

Internally, the company maintains healthy margins. The gross margin for Q3 2024 was 58.5%, an improvement from 57% in the same quarter of the previous year. Furthermore, Lululemon’s operating margin for this quarter was 20.5%, compared to 15.3% in the same period last year.

Lululemon primarily sells through its stores, giving it greater control over its brand. This strategy allows for quicker adjustments. However, challenges remain, and only time will tell if they regain customer favour.

This is the last Stocktake of the year. Have a great festive season and travel safely. The Weekly Stocktake with Danyaal will resume in January.

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Disclosures
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This stocktake is prepared for the clients of Lunar Capital (Pty) Ltd. This stocktake does not constitute financial advice and is generated for information purposes only.

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CrowdStruck

Weekly Stocktake / By VCS Agency

On July 19th, a faulty update, from cybersecurity firm CrowdStrike, caused a global outage on Windows devices, leading to major IT disruptions worldwide. Businesses and governments faced operational issues, with losses estimated in the billions. CrowdStrike’s share price dropped by over 40% after the incident.

CrowdStrike has addressed the issue and claimed to have implemented more robust internal processes to ensure the proper functioning of their updates and products. The company has also engaged extensively with its customers to reaffirm the quality of its products in terms of protection, ease of use, and cost-effectiveness at scale. Post-outage, CrowdStrike’s customer retention rate was 97%, slightly lower than the 97.5% reported in the same quarter last year. The company attributed this decline primarily to the outage.

Despite the outage, CrowdStrike’s revenue for the third quarter of the 2025 financial year reached $1.01 billion, marking a 29% increase compared to the same quarter in the previous year. Their annual recurring revenue was $4.02 billion, reflecting a 27% increase year over year. CrowdStrike noted that customers are seeking to consolidate service providers. Currently, 66% of customers use 5 or more security modules on CrowdStrike’s security platform, Falcon. The platform allows customers to manage their cybersecurity from a single platform.

With ongoing geopolitical tensions globally and ever-increasing connectivity, cybersecurity has become crucial for governments and organisations. Cybersecurity firms have benefitted from this trend as more organisations seek to protect themselves from online threats. Despite the July outage, CrowdStrike’s stock has risen by over 40% year-to-date. Although still about 11% from its peak.

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Nvidia: Friend or Foe

Weekly Stocktake / By VCS Agency

Nvidia designs state-of-the-art Graphics Processing Units (GPUs) which are among the most advanced available in the market. Their GPUs are essential for handling and processing extensive workflows required for training and operating Artificial Intelligence (AI) applications. Nvidia’s latest Blackwell chip is priced at approximately $35,000 each. These chips are primarily sold to Big Tech companies such as Google, Amazon, Microsoft, Meta, and other AI providers with the financial capacity to procure them.

Competitors like Intel and AMD have been attempting to challenge Nvidia’s dominance in the GPU market. Nvidia’s revenue for the recent quarter was $35.1 billion, an increase of 94% year over year. This growth was mainly driven by their data centre segment, which accounted for 87 percent of Nvidia’s revenue this quarter. In comparison, AMD’s data centre revenue was $3.5 billion for the quarter.

Nvidia’s customers are significantly increasing their demand for Nvidia’s chips. They are all expanding their capacity and raising their capital expenditure to build platforms for training and running models. Nvidia’s customers are determined not to fall behind in the AI industry. As it currently stands, over the next five years, Big Tech companies plan to invest over $1 trillion in AI.

The Big Tech companies are increasingly dissatisfied with the costs and “single point of failure” risk associated with Nvidia’s products. Consequently, many companies are developing their chips to reduce their dependence on Nvidia’s technology. Amazon, for instance, is planning to integrate its suite of products with Nvidia’s offerings. Unlike Nvidia’s versatile chips, Amazon’s products are designed for specific tasks, which can help lower the expenses of running certain AI applications.

Nvidia continues to hold a significant share of the market. Their operating margin for the quarter was 62%, highlighting the premium their customers are still willing to pay for their products.

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What’s Up Walt

Weekly Stocktake / By VCS Agency

The Walt Disney Company holds a diverse portfolio of brands and assets. These include Disney, Marvel, Star Wars, Pixar, 21st Century Fox, sports broadcaster ESPN, and Disney Experiences. Since the onset of the pandemic, Disney has faced challenges in maintaining its previous level of success. The segments have not always done well simultaneously.

Disney’s multiple business segments that drive the revenue for the company:

Experiences – includes their theme parks and Disney cruises.
Entertainment – includes their streaming platforms, linear tv assets, and box office hits .
Sports – includes their ESPN assets.

During the Covid pandemic, Disney’s streaming service, which was in its early stages, contributed to the company’s growth. The strategy was to leverage its extensive catalogue of creative and entertainment Intellectual Property (IP) to attract more users to its brand and transition users from its traditional linear television business to a more streaming-focused model.

Its Direct-to-consumer business (DTC) which includes Disney+ and Hulu, currently have just under 175 million paying subscribers globally. Average revenue per user (ARPU) per month in the United States for Disney+ is $7.70, compared to Netflix, which has an ARPU of $17.06. Netflix’s streaming service also boasts 282 million subscribers globally, over one hundred million more than Disney’s streaming platform.

Growth at Disney for its DTC business has slowed significantly since the peak during the Covid period. Revenue for the quarter for its DTC business increased by 16% to $5.8 billion. A notable development is that Disney’s operating income for their DTC platform was positive at $0.3 billion for the current quarter, an improvement from a peak loss of $1.5 billion in Q4 2022.

Disney’s parks and experiences business had the highest operating income among its segments, reaching $1.7 billion for Q4 2024. The segment performed well following the COVID-19 pandemic due to increased demand. However, with consumers facing financial pressure, the experiences business saw a year-over-year growth of only 1%, totalling $8.2 billion for the the quarter.

Disney’s CEO Bob Iger has stated that the current focus of Disney is to return creative control to their various brands and segments. He asserts that producing quality content for audiences encourages engagement with related content, whether from their streaming platform or their experiences business. It remains to be seen if Disney can effectively compete across all its business segments in the extremely competitive entertainment industry.

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Mercado Libre – Seeking Credit

Weekly Stocktake / By VCS Agency

Mercado Libre (Meli), meaning “Free Market,” is an e-commerce and fintech company operating in Latin America. Revenue is primarily generated from its presence in Brazil, Argentina, and Mexico. Mercado Libre’s vision is to service parts of the market that weren’t traditionally being serviced.

Initially established as a marketplace platform for individuals to sell and trade second-hand items, Meli has evolved into a comprehensive e-commerce and fintech platform. It currently has over sixty million unique active buyers on its e-commerce platform, and over fifty million users on its finance platform.

Meli’s Q3 2024 revenue rose 35% to $5.3 billion, fuelled by more online activity. E-commerce revenue jumped 47% year over year to $3.14 billion, while fintech revenue increased 21% to $2.2 billion. Mercado Libre’s gross profit grew 16%, impacted by higher sales costs and finance expenses.

Meli has been aggressively expanding their fintech business, which has the potential for higher net margins if managed effectively. They have leveraged their e-commerce platform to support this growth. Meli believes that the richness of the data they receive will enhance their understanding of their customers. The percentage of monthly active sellers on their e-commerce platform who have obtained financing through Meli has increased from 9.9% last quarter to 21.8% this quarter.

Operating income for the company was $0.56 billion, down 29% year over year. Meli’s aggressive approach to grow their fintech business has resulted in them taking on a higher provision for bad debts. The risk of servicing markets that haven’t previously been serviced before is that there are a lot of unknown risks that the company takes on.

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Alphabet(ting) on AI

Weekly Stocktake / By VCS Agency

Alphabet Inc., the parent company of Google, generates a substantial amount of cash. The Google Services segment, encompassing Search, YouTube, and other platform subscription services, reported a revenue of $76.5 billion for the most recent quarter. After accounting for all operating expenses, Google Services achieved an operating profit of $30.9 billion, resulting in an operating margin of 40%.

Alphabet has leveraged this profitable segment to reinvest in its products, explore new ventures, and strengthen its balance sheet.

At the beginning of 2023, as interest in generative AI was increasing, Alphabet was among the companies with sufficient resources to invest significantly in developing generative AI infrastructure and offering products to customers.

Google Cloud has maintained its position as the fastest-growing segment for Alphabet over the last few years. Google Cloud’s revenue for the current quarter increased by 35% year-over-year to $11.4 billion. This growth was mainly due to the expansion of Google Cloud Platform (GCP) AI infrastructure, Generative AI solutions, and other GCP products. Additionally, Google Cloud has become profitable due to increased scale of operations. For Q3 2024, Google Cloud generated $1.9 billion in operating profit, compared to $0.3 billion for the same quarter last year.

To support the growth of its cloud business, Alphabet has invested heavily in its infrastructure. Since the beginning of this year, Alphabet has spent $38.3 billion on capital expenditure, compared to $21.2 billion over the same period of time last year. It is estimated that 80% of this year’s capital expenditure has been allocated towards data centres, which are used to compute data and power intensive AI workloads.

After all the spend in capital expenditure, Alphabet still had a cash and cash equivalents on hand worth $93 billion at the end of the current quarter.

Alphabet is expected to see its margins compress on its income statement next year when the depreciation on their capital expenditure reflects for the full year. There are concerns that Alphabet, along with their competitors, have been over-investing in generative AI products, without having a real gauge on what the AI market will look like in the medium-long term future. As it stands, Alphabet plans to continue spending on AI infrastructure, arguing that they do not want to be left behind in the AI race.

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Luxury Wars

Weekly Stocktake / By VCS Agency

Over the last two weeks, luxury fashion houses LVMH, Kering, and Hermes released their revenue figures for the third quarter. The companies reported weaker demand from various regions around the world as consumers show less inclination to purchase luxury items during tighter economic conditions and rising costs. Consumers are more selective with their purchases. The graph below shows the revenue for Q3 2023 compared to Q3 2024 from these luxury houses.

LVMH oversees numerous luxury brands, including Louis Vuitton, Christian Dior, Moet & Chandon, Hennessy, and Sephora. The company’s revenue dipped by 4%, mainly due to declines in its Wine and Spirits and Fashion and Luxury segments. It was partially offset by a rise in its Perfume and Cosmetics segment. The company operates globally, with an expanding presence in Asia. The depreciation of the Japanese Yen has led to consumers purchasing more in Japan, making Japan one of LVMH’s best-performing regions this year.

Kering, which owns Gucci and Yves Saint Laurent, has a more concentrated portfolio than LVMH. Gucci made up over 40% of Kering’s revenue this quarter but saw a 26% sales drop from the same quarter last year. Facing macroeconomic challenges and a lack of consumer resonance with their products, Kering has changed Gucci’s leadership to try to revitalize the brand. Overall, Kering’s sales declined 15% year over year.

Hermes, which has an even tighter portfolio, has experienced significant growth in the luxury sector in recent years. It has seen its sales this quarter increase by 10% year over year. The company targets ultra-high-net-worth individuals. Some bags sold by Hermes have year-long waitlists and can be priced around ten thousand euros. The company strategically limits the number of items sold to create higher demand for its products.

Consumer preferences can be unpredictable, significantly impacting the success of companies. Luxury brands not only compete with each other, but also compete with athleisure brands like Lululemon, which traditionally were not considered direct competitors.

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Chipping Away

Weekly Stocktake / By VCS Agency

Last week, TSMC (the semiconductor/chip manufacturer) and ASML (semiconductor-equipment manufacturer) released their respective Q3 2024 results. The outcomes illustrate contrasting scenarios regarding how each company is navigating the AI boom.

TSMC manufactures the semiconductors on behalf of companies such as Nvidia, Apple, and other designers. While ASML makes the advanced lithography machinery that is used in the process of making this machinery. It essentially uses light to etch the circuits onto the silicon to make a semiconductor. ASML sell their machinery to the semiconductor manufacturers such as TSMC, Intel, and Samsung.

For the quarter, TSMC reported a revenue of $23.5 billion, marking a 36% year-over-year increase. Their gross margin rose by 3.5 percentage points to reach 57%, and their operating profit was reported at $11.6 billion, reflecting a 58% year-over-year growth.

The surge in demand for specialized AI chips, which are critical for processing large volumes of data in AI applications, has resulted in a significant number of orders from TSMC. Notably, the high-performance computing segment grew by 11% quarter-on-quarter, accounting for 51% of TSMC’s total revenue.

It is estimated that TSMC produces 90% of the worlds super-advanced semiconductors. Intel Samsung, and other fabrication players have not been able to keep up.

In contrast, ASML recorded a revenue of €7.47 billion, representing a 10.6% year-over-year decline. Their gross margin remained stable at 50.8% compared to the same period last year, while their net income fell by 8.8% year-over-year to €2.1 billion.

ASML’s results have not correlated with TSMC’s due to delays in building new fabrication plants, particularly by Intel and Samsung. Despite grants and tax incentives from the Biden administration designed to “near-shore” semiconductor production, these delays have reduced orders for ASML’s advanced lithography machines.

Although ASML maintains an effective monopoly on the sale of advanced lithography machines, their sales can exhibit significant fluctuations due to the cyclical nature of setting up new plants, leading to considerable variability in their revenue streams.

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JP Morgan: Bank On It

Weekly Stocktake / By VCS Agency

JP Morgan, known for its fortress balance sheet, released its Q3 2024 results on Friday. The bank reported net revenues of $42.7 billion, representing a 7% year-over-year increase. Net income for JP Morgan was $12.9 billion, a decline of 2% compared to the previous year. The bank’s return on equity (ROE) for the quarter stood at 16%. This was partly driven by efficiencies from tech investments and lazy deposits (customers who settled for lower returns on their deposits than they would get in other accounts.)

The discrepancy between the rise in net revenue and the decline in net income was attributed to higher provisions for credit losses, which amounted to $3.1 billion, an increase of 125% from the same period last year. Despite this, JP Morgan’s balance sheet is well-positioned to withstand such financial pressures.

Following the 2008 Global Financial Crisis, the Basel III framework was introduced to enhance banking regulation. One significant part of the regulation requires banks to maintain a common equity tier 1 (CET 1) ratio of at least 4.5%. Regulators may require higher ratios from specific banks. The CET 1 ratio reflects a bank’s core capital, comprising common shares, retained earnings, and additional paid-in capital. It is considered the most secure form of capital, essential for enhancing a bank’s financial resilience and safeguarding depositors during financial shocks. JP Morgan’s CET1 ratio is 15.3% on risk weighted assets of USD1.8tn, giving it an estimated loss-absorbing capacity of USD544bn.

With such a large asset and capital base, and broad product suite; JP Morgan services over 82 million US consumers, 6 million small businesses and 40 thousand large- and medium businesses around the world. JP Morgan’s strong balance sheet also allows it to take advantage of growth opportunities when the market goes through a downturn.

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Nike: Will they Do It?

Weekly Stocktake / By VCS Agency

Nike, which was expected to be ideally positioned for “running mania”, released its Q1 2025 results. Revenue for the quarter declined by 10% year-over-year, reaching $11.6 billion. Gross margin improved by 120 basis points to 45.4%, while net profits fell by 26%, amounting to $1.05 billion. Nike’s share price has dropped over 22% this year and more than 50% since its peak in November 2021.

Nike, renowned for its innovative products, memorable advertising campaigns, and strong athlete partnerships, has been losing market share to both established and emerging brands such as New Balance, On, and Hoka.

Under the previous CEO, John Donahoe, the company concentrated on expanding its direct-to-consumer business model. This included increasing capacity for its e-commerce channel and further developing Nike-run stores. The goal was to gain better control over sales and improve the bottom line by avoiding consignment fees to wholesale retailers. However, this strategy strained relationships with wholesale partners, leading some to remove Nike products from their stores.

This approach seemed adequate during the COVID-19 pandemic when online shopping surged. However, as demand for Nike’s products began to decline, the company struggled to maintain growth.

The new CEO, Elliott Hill, has placed a strong emphasis on mending relationships with wholesale partners and acknowledged that Nike had deviated from its core strengths of product innovation and designing athletic footwear. Hill believes that that Nike will only be able to generate strong demand for their lifestyle products after they accomplish the feat of designing great athletics wear.

While turnarounds are challenging to implement, especially in a highly competitive fashion and high-performance sports sector, Nike possesses a relatively strong balance sheet with $8.5 billion in cash. Time will determine if they can Do It.

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