Weekly Stocktake

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.

Weekly Stocktake with Danyaal

10 March 2023

Key Indicators

Source: Iress

ShopFight

Shoprite has multiple businesses under its portfolio, including Shoprite (which targets the lower-income market), Usave (which sells a limited range of products to the lowest-income market), and Checkers (which originally focused on the medium-income market but has now expanded into the upper-income market). Together, these brands serviced 33.8% of the SA market during H1 of Shoprite’s financial year, representing a markets share gain of 1.4% compared to the same period last year.

Shoprite’s philosophy is to aggressively pursue market share, which means they end up competing with multiple businesses that target different groups. In the current financial year, Shoprite plans to spend R6.3 billion on capital expenditure. They aim to open 425 new stores, including refurbing 94 stores recently acquired from Massmart. Shoprite’s Checkers Sixty60 platform is a good example of the company’s aggressive approach. The platform saw an 87% growth in sales compared to the same period last year, following a 250% increase in the prior year. The Sixty60 platform (which launched at the end of 2019) currently operates in 394 locations across South Africa, further expanding the company’s reach and market share.

Shoprite is not short of competition. Their competitors include Pick ‘n Pay, Spar, Massmart, and Woolworths. As retail customers are typically price sensitive, food retailers compete heavily with each other on price. However, during periods of high inflation, these businesses can be put under pressure as they seek to gain market share by trying to offer inflation-beating prices to customers while also maintaining healthy margins for their investors.

Shoprite’s H1 interim results, released last week, showed a 17% increase in revenue to R106 billion for the period. Load shedding forced Shoprite to spend R560 million on diesel during the period, impacting their trading profit. Their trading profit was only up 9% to R6 billion. Gross profit was R25 billion, representing a gross margin of 22%. The net profit margin for the period was 2.9%, a marginal decrease of 0.1 percentage points. Nonetheless, Shoprite was still able to increase its overall market share in the tough environment.

Shoprite is held in the Lunar BCI Worldwide Flexible Fund

Weekly Stocktake with Danyaal

3 March 2023

Key Indicators

Source: Iress

Can We Bank On It?

Last week, FirstRand released their results for the six months ending 31 December 2022. Normalised earnings for the group increased by 15% to R18 billion compared to the same period last year. Return on Equity (ROE) was 21.8% – at the higher end of their target range of 18%-22%. The strong increase in normalised earnings was primarily a result of new business origination in their portfolios, growth in deposits from both existing clients and new clients and a reduced credit provision from last year.

Let’s take a closer look at the two major segments of FirstRand (FNB and RMB), which made up 87% of their normalized earnings for the period. FNB earned R11.1bn during the period, representing a 17% increase over the previous year, while active customers for this segment increased by 5% to 11.22 million. FNB recorded an ROE of 42.9% which is also impressive. The credit-loss ratio (which is the total impairment charge per the income statement expressed as a percentage of average core lending advances) for FNB was kept low at 1.28%. This was done by primarily by targeting middle- to high-income customers. This customer group is typically better able to withstand interest rate hikes than lower-income customers.

During the period, RMB, which is FirstRand’s investment banking division, reported normalized earnings of R4.7 billion, representing a 28% increase over the same period last year. RMB achieved a ROE of 22.4% and maintained a credit loss ratio of 0.01%. The core advances for RMB rose by 25% compared to the previous year, with a focus on low- and medium-volatility sectors. Real estate accounted for 21% of the total core advances, while the other segments each ranged from 5% to 8% of the total advances.

Compared to the same period last year, RMB’s total drawn exposure to the renewable energy sector increased by 4.3%. However, the government announced, during the budget speech, that businesses could qualify for a 125% tax deduction for all renewable projects in the first year. RMB and other investment banks could benefit from these schemes as companies will likely seek financing for these projects.

Despite the weak macro environment in South Africa, certain companies like FirstRand are currently demonstrating strong performance. They offer essential services to people while also creating value for their shareholders. The performance of these companies could be dampened by the poor SA macro-environment unless these conditions improve or management successfully navigate through this.

FirstRand is held in the Lunar BCI Worldwide Flexible Fund

Weekly Stocktake with Danyaal

24 February 2023

Key Indicators

Source: Iress

What Flavour Chips Do You Sell?

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

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

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

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

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

Nvidia is held in the Lunar BCI WW Flexible Fund

Weekly Stocktake with Danyaal

17 February 2023

Key Indicators

Source: Iress

Gucci’s Gang

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

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

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

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

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

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

LVMH is held in our Lunar Offshore Portfolio.