Weekly Stocktake - Lunar Capital

Good prices and good margin, How has Costco managed it?

Cost Conscious Costco

Costco has cultivated a devoted customer base in the US by appealing to price-sensitive consumers, addressing recession concerns, and focusing on selling products at lower margins than competitors. As of Friday, the retailer’s price-to-earnings (P/E) ratio was just under 60, compared to Walmart (41) and Target (16).

Over the last five years, Costco’s share price has risen by just over 200%. Examining the company’s financials, Costco reported revenue of $149 billion and a net income of $3.7 billion in 2019, resulting in a net margin of 2.5%. By 2024, the revenue grew to $253 billion, with a net income of $7.4 billion, reflecting a 2.9% margin.

In its most recent quarter, Costco achieved a gross margin of 11%. For comparison, Walmart’s latest quarter showed a net margin of 2.7% on revenue of $169 billion, with a gross margin of 25%.

Costco has managed to keep product prices low while maintaining respectable net margins through several strategies:

Membership model: Customers must have a Costco membership to shop, encouraging repeated purchases, and allowing Costco to collect personalised client purchasing data.
Bulk purchasing and limited selection: This approach allows Costco to negotiate lower prices and streamline inventory management, reducing costs further.
No-frills operations: By minimizing operational expenses, Costco maintains its ability to sustain a relatively healthy margin.

Given the high P/E ratio, Costco must adhere strictly to its reputation as an “extremely well-run, no-frills business.” Notably, the company’s membership fees are nearly equivalent to its net income, indicating that membership growth is important for overall expansion. Any significant misstep by Costco could lead to a substantial decrease in its stock price.

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Disclosures
Lunar Capital (Pty) Ltd is a registered Financial Services Provider. FSP (46567)
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The Lunar BCI Worldwide Flexible Fund Fact Sheet can be read here.
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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Zara Fit Check

Weekly Stocktake / By VCS Agency

Inditex, the Spanish business which owns of fashion brands such as Zara, Bershka, Oysho, and Massimo Dutti, published its H1 2024 results last week. Net sales for the period reached €18.1 billion, reflecting a 7.2% increase year-over-year. The cost of sales rose slightly slower than net sales, leading to a 7.5% rise in gross profit to €10.5 billion. Net income climbed by 10.5%, reaching to €2.8 billion. This translated to a net margin of 15.3% for the period, up from 14.9% during the same period last year. The improvement in margin was mainly attributed to amortization and depreciation remaining unchanged from the previous year.

Zara represented 72% of Inditex’s sales for the first half of 2024. Zara’s sales increased by 5.4% compared to the same period last year. While most other brands experienced double-digit growth, their smaller size relative to Zara meant that Inditex’s overall net sales only rose by 7.2%.

Inditex places a strong emphasis on logistics, planning to invest €900 million annually over the next two years. This extra expenditure increases Inditex’s usual annual capital expenditure of €1.8 billion by 50%. Part of the capital expenditure will deployed to increase store space by approximately 5%.

Zara, famous for its quick turnaround time; has the ability to design, manufacture, and stock new items on store shelves within two to three weeks. The company maintains low inventory and has structured its manufacturing to ramp up production when certain items sell well; unlike competitors, who can take months to respond to trends.

Inditex operates in a highly competitive market. Despite having an efficient supply chain model that allows them to compete on design, they are susceptible to supply chain disruptions, such as those witnessed during Covid-19 and the conflict arising from Russia’s invasion of Ukraine.

Zara also believes that driving sales can be accomplished by attracting customers to their physical stores. To entice visitors, they lease historical and cultural buildings to add a unique appeal to their brand. However, if demand for their brand suddenly drops, they could end up paying higher-than-usual costs for unused space.

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Check(ers) Mate

Weekly Stocktake / By VCS Agency

Shoprite, South Africa’s largest retailer, released its 2024 full-year results last week. The company reported total revenue of R240.7 billion, reflecting a 12% increase year-over-year. Their trading profit also saw an increase of 12.4%, reaching R13.4 billion, which translates into a trading margin of 5.5% for the year. Shoprite’s gross profit rose by 11.7% to R57.8 billion, resulting in a gross margin of 24.0% for the year.

Shoprite has been expanding. They have been continuously striving to capture a larger and larger share of the retail market. Since 2021, the group has increased its number of stores by 25.7%, reaching a total of 3,639 outlets. Their Xtra savings loyalty card membership has also surged by 10.7 million members since 2021 to 31 million members at the end of their 2024 financial year. This has greatly aided their data-driven AI strategy to better understand and serve their customers. The expansion and insights have resulted in their sales growing by 43% compared to the 2021 levels.

The brands under Shoprite’s umbrella include Shoprite, Usave, Checkers, Uniq, Medirite, and others. Shoprite caters to both affluent and low-income customers and is present in rural and urban areas alike. The graph below illustrates how Shoprite perceives its brands and their positioning in South Africa. Notably, last year, Checkers, Shoprite’s premium brand which yields slightly higher margins, was the fastest growing brand in the premium supermarket space. The growth was fuelled by the success of their delivery service Checkers Sixty60.

Source: https://www.shopriteholdings.co.za/docs/results-presentation-2024.pdf

Shoprite employs a hub-and-spoke model. When establishing a supermarket like Shoprite or Checkers in a new area, they subsequently set up other branded stores nearby, such as their pharmacy chain Medirite or clothing store Uniq, creating a complementary shopping ecosystem that attracts customers to these auxiliary outlets.

Last week, Shoprite’s share price fell by just over 3%, amid market expectations for slightly stronger results. Shoprite trades at a price-to-earnings (PE) ratio of around 24, which is higher than Pick ‘n Pay’s PE ratio of -11 (due to major write-offs) and Woolworths’ (Woollies) PE ratio of 18. This indicates the premium investors are willing to pay to hold Shoprite shares.

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Nvidia: Priced to Perfection

Weekly Stocktake / By VCS Agency

Over the past two years, Nvidia’s stock price has increased nearly 700%, bringing its market capitalization to $2.9 trillion as of Friday. This remarkable growth has made Nvidia one of the largest companies in the world, trailing only behind industry giants like Apple and Microsoft.

Nvidia’s success is largely driven by the sale of its high-performance graphics processing units (GPUs) and AI platforms, which are crucial for training data-intensive AI workloads. As companies and organizations increasingly focus on developing artificial intelligence models, they seek processing power and energy efficiency—areas where Nvidia’s GPUs are currently unmatched in the market.

Last week, Nvidia’s Q2 2025 results were among the most anticipated of this earnings season. The company reported an impressive $30 billion in revenue for the quarter, marking a 122% year-over-year increase. Operating income also saw significant growth, rising 174% year-over-year to $18.6 billion.

Nvidia’s gross margin came in at 75.1% for the quarter, down from 78.4% in the previous quarter but up from 70.1% in the same period last year. Despite this slight dip compared to the previous quarter, both gross and operating margins have been on a strong upward trajectory since early last year, driven by the immense demand for Nvidia’s AI platforms. The graph below shows the change in Nvidia’s margins since the beginning of last year.

The slight downturn in margins this quarter was primarily attributed to delays in the launch of their new AI platform, Blackwell, which is now expected to ship in Q4 this year. During the earnings call, CEO Jensen Huang reassured investors that Nvidia remains committed to releasing new platforms on a yearly rhythm, emphasizing the company’s focus on delivering faster and more energy-efficient chips.

Despite Nvidia’s impressive performance, several questions remain. How much additional efficiency is AI bringing to companies adopting the technology? Will the major tech players, who are heavily investing in Nvidia’s platforms, continue to spend at this rate? And could other companies be developing chips that might eventually surpass Nvidia’s offerings?

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Snowflake Melting?

Weekly Stocktake / By VCS Agency

Snowflake is strategically positioned to leverage the growing importance of high-quality data in powering AI applications, including both machine learning and generative AI. The premise is simple: the better the input data, the more effective and accurate the AI output.

Snowflake enables organizations to manage and structure their data in the cloud, offering secure and efficient data querying and sharing capabilities. Snowflake has recently invested in integrating a generative AI layer into its platform. This innovation allows users to interact with their data without needing specialized coding knowledge.

In its Q2 2025 results, Snowflake reported a 28.9% year-over-year increase in revenue, reaching $869 million. However, despite this growth, the company’s gross margin declined slightly to 72%, down from 74% in the same period last year. Additionally, Snowflake recorded an operating loss of $355 million; 41% of the company’s revenue. This was marginally down from an operating loss margin of 42% last year.

One of the persistent challenges for Snowflake, as with many smaller tech companies, is the competition for top-tier talent. Unlike Big Tech with their vast financial resources, Snowflake must find alternative ways to attract and retain skilled professionals. Stock-based compensation has been a key strategy, offering equity in the company as a significant part of an employee’s compensation package. While this approach is effective in attracting talent, it comes with the risk of diluting the company’s share base, reducing each share’s claim on future earnings.

Snowflake faces the delicate balancing act of incentivizing its workforce with equity while managing the potential long-term impacts on shareholder value through dilution. Navigating this fine line is crucial for Snowflake as it continues to scale. Snowflake’s share price dropped by around 10% after the announcement of their results, reflecting shareholder’s desire to see a better balance between shareholder returns and stock-based-compensation.

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Moving ON

Weekly Stocktake / By VCS Agency

On Holdings, owners of the On Cloud sports brand best known for its distinctive running shoes, recently released its Q2 2024 results. The company reported a revenue of CHF 567.7 million, marking a 28% increase year-over-year. Operating income rose by 20% to CHF 47.3 million. The brand has a strong presence in the U.S., where 65% of last quarter’s sales originated, showing a growth of over 24% compared to the same period last year. Although the Asia-Pacific region was the fastest-growing market with nearly 74% growth, it only accounted for 10% of the company’s net sales for the quarter.

The bulk of On Holdings’ revenue (95%) comes from its shoe sales, which grew by nearly 27% year-over-year. As a relatively small brand compared to giants like Nike and Adidas, On Holdings faces both opportunities and challenges. The company has significant potential for growth by expanding into new regions and diversifying its product range.

One of On Holdings’ recent innovations is a new shoe that is sprayed onto a person’s foot, weighing just 158g for the women’s version. Helen Obiri, a renowned Kenyan middle- and long-distance runner, trained in these shoes for the recent Olympics and was so impressed that she wore them during the Paris Olympics marathon, where she won a bronze medal. This reflects On Holdings’ strategy of collaborating with athletes to design products that cater specifically to their sports.

Source: https://www.on.com/en-us/lightspray

On Holdings does however operate in a highly competitive market, facing rivals ranging from smaller brands like Deckers, which owns the popular Hoka brand, to industry giants like Nike and Adidas. Fashion trends can shift rapidly, and consumer preferences are fickle, posing a constant challenge. For now, On Holdings is capitalizing on current trends, but the landscape could change quickly.

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Weighing In

Weekly Stocktake / By VCS Agency

Eli Lilly and Novo Nordisk are leading pharmaceutical companies known for their innovative diabetes and obesity treatments. Both companies have developed drugs—Tirzepatide by Eli Lilly and Semaglutide by Novo Nordisk—that mimic the glucagon-like peptide-1 (GLP-1) hormone.

Originally designed for type-2 diabetes to control blood sugar by increasing insulin release, these GLP-1 drugs were later found to significantly aid in weight loss. In a recent study, Eli Lilly’s Zepbound has been shown to reduce patient weight by 21%. Associated with obesity, are a variety of other health issues – including cardiovascular diseases. Novo Nordisk’s Wegovy treatment decreased the risk of major adverse cardiovascular events by 20%.

Both Novo Nordisk and Eli Lilly are investing heavily in research and development, and in manufacturing capacity. For their recent quarter, Novo Nordisk increased their R&D spending by 127% to DKK 16.2 billion (1 USD = 6.95 DKK on 30 June 2024). This accounted for 24% of revenue, roughly in line with Eli Lilly’s R&D to revenue ratio. Both companies are pushing to gain an edge over each other and the other competitors in the industry.

The pharmaceutical industry requires extensive testing of drugs and treatments before they can be sold to patients. Some of these treatments, especially the ones related to cardiovascular diseases, can take multiple years for the treatments to be approved by the relevant authorities.

They also require large sample sizes to show the extensiveness of their research. As it stands, Novo Nordisk currently has 45000 participants in trials or about to be in trials for Semaglutide. Eli Lilly has slightly more participants in trial for Tirzepatide.

Even though other pharmaceutical companies may know how GLP-1 agonists work. They may not have the required resources in terms of capital and time to go after Novo Nordisk and Eli Lilly’s market share.

Last week, Novo Nordisk and Eli Lilly released their Q2 2024 results. Novo Nordisk’s revenue was up 25% year over year to DKK 68 billion, while net income was up only 3% to DKK 20.1 billion. This was mainly due to the increase in R&D spending. Eli Lilly on the other hand had revenues of $11.3 billion, up 36% year over year. Its net income increased 68% to $3 billion. this was primarily driven by increased manufacturing capacity and pricing power.

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Big Tech, Big Spend, Big Question

Weekly Stocktake / By VCS Agency

Over the last two weeks, mega-cap stocks such as Alphabet, Amazon, Apple, Meta, and Microsoft released their quarterly results. The theme was AI, particularly how much the cloud service providers were paying to build up their capacity and try to win the AI race. Investors were concerned that the cloud service providers were spending too much without clear indications of the large-scale end use cases of AI, the value derived from it, and whether businesses and people would be willing to pay for these products and services.

Due to the long time it takes to build these data centers and the logistical challenges in securing land, buildings, and chips, the big cloud providers stated that demand still exceeds supply for their AI capabilities. Additionally, they mentioned that the data centers being built offer optionality; if generative AI doesn’t take off, the data centers can be repurposed for other uses; although it will be at a lower operating margin.

The graph below shows the difference in capital expenditure by the big tech firms this year. Everyone but Apple has significantly increased their spending to build up their capacity for generative AI workloads—whether for training or inferencing. During the earnings calls, all the big tech CEOs indicated they would continue to spend at these increased levels to ensure they don’t miss out on the generative AI opportunity.

At the moment, the company seeing a real and significant increase in revenue and earnings is Nvidia, the designer of the high-powered chips used to train and inference the data workloads for generative AI. Nvidia is expected to release their results on the 28th of August. The search is on for the companies that will utilize AI within their own operations to give themselves the edge and gain market share in their own industry and possibly beyond.

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Spotlight on Spotify

Weekly Stocktake / By VCS Agency

Spotify, one of the leading streaming services, released its Q2 2024 results last week. Revenue for the quarter was €3.8 billion, up 20% year on year. Spotify also reported an operating profit of €266 million, an improvement from the operating loss of €247 million recorded a year ago.

Spotify generates its revenue through two streams: its premium subscription and advertisements through its ad-supported subscription service. In the recent quarter, there were 626 million monthly active users, with 62% of these users utilizing the ad-supported subscription. However, revenue generated from advertisements only accounted for 13.6% of Spotify’s total revenue. Moreover, the ad-supported gross margin was 13.4%, and in some previous quarters, it has even been negative.

Spotify’s gross margin increased from 24.1% a year ago to 29.2% for the recent quarter. Despite this increase, the gross margin remains relatively low compared to other tech companies. For instance, Netflix, which funds a good portion of its own content for television, reported a gross margin of 57% for its most recent quarter.

Spotify’s low gross margin is primarily due to the high fees required by music labels. These labels generally hold the rights to the music streamed on the platform. In 2020, 78% of streams on Spotify’s platform came from four major record labels: Sony, Warner, Universal, and Merlin. Losing any of these deals could result in a significant loss of monthly active users, who might switch to other music streaming services, such as Apple Music, Amazon Music, or YouTube Music, with relative ease.

Spotify also uses AI algorithms to creates playlists and recommendations based on listeners’ preferences and play history. Anecdotally, this is better than competitor’s app recommendations.

In addition to the low gross margin, Spotify pays sales commission fees to Apple and Google, which host their apps in their respective app stores. Apple’s policy is to take a 30% commission on all in-app purchases in the first year an app is on its store, reducing the fee to 15% in subsequent years. Spotify is reliant on these app stores as they are the primary platforms through which people access their music on Apple or Android devices. This resulted in Spotify’s operating margin reducing to 7% this quarter.

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With a Side of Chips, Please

Weekly Stocktake / By VCS Agency

ASML and TSMC released their Q2 2024 results last week. These relatively unknown companies have developed key technologies that help create semiconductors, making our electronic devices smaller, more powerful, and more energy efficient.

TSMC, a semiconductor fabrication company, manufactures the actual semiconductors, while ASML builds the lithography machinery used in the fabrication process. Lithography involves using light to etch the circuits on silicon. Some consider ASML’s lithography machinery to be the most complex technology ever created. If scaled out, the machine could shoot a laser to the moon and hit a target the size of a golf ball.

For the quarter, TSMC reported a revenue of NT$673.5 billion (with $1 equalling NT$32.5), up 32.8% year on year, and an operating income of NT$286.5 billion, up 36.3%. High-performance computing, including revenue from manufacturing Graphics Processing Units (GPUs) used in AI models, accounted for 52% of TSMC’s Q2 revenue, growing 28% quarter on quarter. The second-largest segment for TSMC was revenue from smartphones, which accounted for 33% of the revenue but decreased by 1% quarter on quarter.

ASML generated €6.2 billion in revenue for the quarter, down 9.5% year on year, with an operating income of €1.8 billion, down 19%. Net bookings for the quarter were €5.6 billion, up 23.7% year on year. Some of ASML’s latest lithography machines sell for €350 million each, making the purchase not a trivial decision for their fabrication manufacturer clients. This results in ASML having lumpy earnings. ASML views 2024 as a transition year, guiding revenues and earnings to be similar to 2023, and expecting 2025 to be stronger as customers ramp up capacity.

Despite TSMC’s strong results and ASML’s mixed results, both companies’ share prices decreased during the week. President Biden mentioned considering increased restrictions on selling semiconductors and semiconductor equipment to China, due to their dual-use nature in both civilian and military applications. Presidential candidate Trump also mentioned wanting Taiwan (where TSMC is based) to fund more of its own military operations.

ASML is held in the Lunar BCI Worldwide Flexible Fund, and in the offshore portfolios of our clients. ASML maintains an effective monopoly on lithography equipment, with no other companies currently matching their success. Such a monopoly inevitably attracts competition: companies may challenge ASML directly or seek to develop alternative technologies to achieve similar outcomes.

Security Held In:

Security

Lunar Capital BCI Worldwide Flexible Fund

Lunar Capital Offshore Portfolio Clients

Security

ASML

Lunar Capital BCI Worldwide Flexible Fund

Lunar Capital Offshore Portfolio Clients

Security

TSMC

Lunar Capital BCI Worldwide Flexible Fund

Lunar Capital Offshore Portfolio Clients

Key Indicators

Index / Fund / Rate

Start of Year

Last Week

This Week

% Change YTD

Index / Fund / Rate

Lunar BCI WW Flexible Fund

Start of Year

188.33

Last Week

215.49

This Week

213.08

% Change YTD

13.14%

Index / Fund / Rate

JSE ALSI

Start of Year

76 893

Last Week

81 686

This Week

79 923

% Change YTD

3.94%

Index / Fund / Rate

NASDAQ Composite

Start of Year

15 011

Last Week

18 398

This Week

17 727

% Change YTD

18.09%

Index / Fund / Rate

S&P 500

Start of Year

4 770

Last Week

5 615

This Week

5 505

% Change YTD

15.41%

Index / Fund / Rate

Prime Lending Rate

Start of Year

11.75%

Last Week

11.75%

This Week

11.75%

% Change YTD

0.00%

Index / Fund / Rate

USD/ZAR

Start of Year

18.30

Last Week

17.97

This Week

18.28

% Change YTD

-0.11%

Index / Fund / Rate

EUR/ZAR

Start of Year

20.17

Last Week

19.63

This Week

19.91

% Change YTD

-1.29%

Index / Fund / Rate

Brent Crude ($'barrel)

Start of Year

76.97

Last Week

85.00

This Week

82.88

% Change YTD

7.68%

Source: Iress

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