Weekly Stocktake

18 August 2023

Key Indicators

Source: Iress

Weekly Stocktake with Danyaal

Adyen: Growth at All Costs?

Adyen is a Dutch financial technology platform specialising in helping businesses with payment processing, financial management, and business analytics. They have recently undertaken an expansion initiative. In the first half of the year, they hired 551 full-time employees (FTE), bringing their total workforce to 3,883 FTE. The majority of these new hires were in technical roles aimed at enhancing Adyen’s existing platform and supporting new projects. This expansion does not align with the “cost optimization strategies” observed by Adyen’s competitors and among the businesses they service.

Adyen recently unveiled its H1 2023 financial results. In this period, their net revenue reached €739 million, marking a 21% increase compared to the same period last year. However, due to escalated wage and salary expenses associated with their growth strategy, the operating income for Adyen was €279 million for H1 2023, reflecting a 16% decline compared to the previous year. During the week, Adyen’s stock price experienced a substantial drop of 45%. The company ended the week with a Price to Earnings (P/E) ratio of 48.

The market appears to be displaying apprehension regarding Adyen’s current strategy. Adyen has been significantly expanding their workforce, despite a deceleration in their revenue growth. Several factors may be contributing to this trend.

1) Their clientele seems to be prioritizing cost optimisation and profitability over market expansion, impacting Adyen’s revenue growth.

2) The presence of well-established fintech giants like PayPal and Stripe in the US has intensified competition more than initially anticipated.

3) There might be a lagged effect between their recent hiring initiatives and the actual impact on revenue. It’s possible that Adyen will only fully experience the consequences of their expansion program in a few quarters from now.

Adyen management have been consistent that they are building for the future and that any investments that they make in people and their platform will only yield results in a few year’s time. Pursuing expansion in the current economic climate does carry inherent risks. Nonetheless, if Adyen successfully executes their expansion strategy, they have the potential to emerge from the recession in a notably better position compared to their competitors.

Adyen is held by Lunar Capital’s Offshore Portfolio Clients.

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11 August 2023

Key Indicators

Source: Iress

Weekly Stocktake with Danyaal

Novo Nordisk: The Hype Around Semaglutide

Novo Nordisk, owned by Lunar Capital and its clients, is a global pharmaceutical company headquartered in Denmark. The company specialises in the treatment of diabetes, obesity, and rare blood diseases. Among their recent advancements, they introduced Semaglutide, a medication catering to type-2 diabetes and obesity. These drugs emulate the actions of the natural hormone glucagon-like-peptide-1 (GLP-1). This emulation aids in the regulation of blood sugar levels by promoting insulin production, curtailing glucagon production, and slowing down the emptying of the stomach. Last week, Novo Nordisk indicated that the recent trial for the Semaglutide 2.4mg treatment demonstrated a 20% reduction in major adverse cardiovascular events in adults suffering from obesity. This announcement pushed their share price up by approximately a 16% on the day.

The recent financial performance of Novo Nordisk can primarily be attributed to the surge in GLP-1 treatment sales. Revenue for Novo Nordisk during the first half of 2023 increased by 29% compared to the same period in the previous year, reaching Danish Kroner (DKK) 107.7 billion. Their gross margin increased from 84.4% last year to 85.1% in the current year. All contributing to a net profit increase of 43%, totalling DKK 39.2 billion for the period. The USA is their largest market, with revenue growing by 44% and contributing just under 60% of Novo Nordisk’s total revenue.

Pharmaceutical companies can enjoy robust profit margins, as seen by Novo Nordisk’s gross margin of 85% and net margin of 36%. Nonetheless, the industry itself is fraught with risks. The stringent (understandably) regulations that govern pharmaceutical companies requires a series of trials often over many years. To sustain their existence, pharmaceutical companies allocate a considerable portion of their revenue towards research and development efforts to counter the treatments in their pipeline that come off patents. For instance, during the first half of 2023, Novo Nordisk spent DKK 13.8 billion on research and development, which amounts to 12.9% of their revenue. In instances where the effectiveness of treatments fails to yield positive outcomes, the potential repercussions could lead to losses and possibly more dire long-term consequences.

Novo Nordisk is held in the Lunar BCI Worldwide Flexible Fund. It is also held by the Lunar Capital Offshore Portfolio Clients.

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04 August 2023

Key Indicators

Source: Iress

Weekly Stocktake with Danyaal

Amazon: Manic Obsession over the Customer

Many companies profess a commitment to customer-centricity. They seek to develop products adored by customers and use phrases such as “the customer is always right.” However, few can rival Amazon in this regard, who consistently from its inception has an obsession with customer experience. Amazon’s businesses include a global E-commerce enterprise, AWS (their cloud infrastructure division), as well as its media business Prime and MGM Studios, amongst others. They continuously expand their influence across other business domains. At the core of Amazon’s business lies the principle: “customer obsession rather than competitor focus.”

Amazon Prime, a membership program tailored to benefit Amazon customers, stands as an example of Amazon’s dedication to enhancing the customer experience. Amazon Prime members pay $139 annually, entitling them to two-day shipping for eligible items, access to Amazon’s Prime Video streaming service, early access to e-commerce deals, and other perks.

While Amazon diligently seeks to refine its offerings, some investors contend that the company’s intense focus on customer experience may, in some instances, overshadow the pursuit of profitability across its business divisions—particularly evident in Amazon’s ongoing efforts to reduce delivery times. Notably, some investment analysts assert that the cost incurred may not justify the potential gains. Nevertheless, Amazon remain steadfast in their belief that, over the long term (another core principle of Amazon’s), “customer obsession” will build shareholder value. In fact, Amazon has noted an increase in the number of items clients purchase as they deliver faster.

Where has customer obsession taken Amazon. Last week, Amazon released their Q2 2023 results. For the quarter, Amazon reported net sales of $134 billion, marking an 11% increase compared to the same quarter last year. Amazon operates with relatively narrow operating margins. Changes in revenues or costs can lead to notable shifts in their operating margin. Amazon managed to lower the growth rate of their operating costs compared to their revenue. In Q2 2023, Amazon’s operating income reached $7.7 billion, up 133% compared to the same quarter in the previous year.

Amazon is held in the Lunar BCI Worldwide Flexible Fund. It is also held by the Lunar Capital Offshore Portfolio Clients.

28 July 2023

Key Indicators

Source: Iress

Weekly Stocktake with Danyaal

Enphase: New Power on the Block

Enphase Energy, a business held in the Lunar BCI Worldwide Flexible Fund and by Lunar Capital’s Offshore Portfolio clients, is an energy technology company that operates in the Americas, some European countries, and Australia. They specialize in selling solar generation and storage equipment, with all their devices seamlessly connected to the cloud for users to monitor their electricity usage, generation, and storage. Among Enphase’s products is the micro-inverter, which distinguishes itself from central inverters by having each micro-inverter being linked to separate solar panels. This setup ensures optimal panel performance as a whole, even when one panel is inactive or has been shaded by a leaf or something else. In contrast, a centralized inverter would convert energy less effectively if those same panels failed.

Last week, Enphase disclosed their Q2 2023 results. During the quarter, their net revenue amounted to $711 million, indicating a notable 34% growth compared to the same period last year. However, this Q2 revenue was slightly below the revenue of $726m in Q1. Enphase achieved a gross margin of 45.5% for the quarter, an increase of 4.2 percentage points compared to the same quarter last year. The net income for the period stood at $157 million, translating to a net income margin of just under 22%. In contrast, during the same quarter last year, Enphase’s net income margin was just below 15%. This performance not only reflects their ability to reduce product manufacturing costs but also highlights their ability to improve their operational efficiency. Most of Enphase’s manufacturing operations are in India and Mexico, where labour costs are lower than in the USA and Europe.

Historically, Enphase has typically experienced higher Q2 revenues compared to their Q1 revenues. However, this year, it was not the case. They attributed this anomaly primarily to the high interest rates in the US and reduced consumer spending across the economy. This resulted in a 12% decline in revenue for Enphase’s US operations. Despite the challenging global macro-economic conditions, their operations in Europe showed a significant improvement, with a remarkable 25% increase in revenue quarter on quarter. This growth can be attributed to Enphase operating from a lower market-share base in Europe compared to the US. As of last week Friday, Enphase’s market capitalization was just above $21 billion.

Enphase will likely benefit from a move to green and cleaner sources, residential clients reducing their dependencies on energy utility companies, European clients reducing their dependencies on hostile foreign countries (read Russia) for their oil and gas requirements; and also the move to electric vehicles.

21 July 2023

Key Indicators

Source: Iress

Weekly Stocktake with Danyaal

Tesla: No Margin for Error

The Earnings Season is underway in the US, and various companies have begun releasing their quarterly results. Tesla, led by Elon Musk, recently disclosed its Q2 2023 performance. Tesla recorded revenue of $24.9 billion for the quarter, marking a 47% increase compared to the same period last year. Additionally, the company’s vehicle deliveries during Q2-2023 reached 466 thousand units. This was up 83% compared to the same quarter last year. Tesla is actively pursuing market share, but this growth is coming with certain costs.

Over the past two quarters, Tesla has been reducing the average selling price of its vehicles, primarily due to a decline in overall demand within the US market and greater competition in China. Despite witnessing enhanced efficiency and increased vehicle production at their factories in the US, Shanghai, and Berlin; Tesla is facing challenges in maintaining the same profit margins as seen in the corresponding quarter of the previous year. While the revenue experienced a 47% growth, the gross profit only managed to grow by a modest 7%. The gross margin was already relatively tight compared to other industries. Specifically, in Q2-2022, Tesla’s gross margin stood at 25%, but for the most recent quarter, it dipped to 18.2%. This signifies the impact of their pricing strategy and the current market conditions on their profitability. Tesla’s share price fell approximately 10% since they released their results.

Tesla finds itself in a fascinating position within the market. With their vehicles priced towards the upper-income segment, they could have pursued a strategy of limiting supply to create a sense of exclusivity, as is common in luxury brands. However, Tesla has chosen a different path. Instead of focusing solely on exclusivity, they are striving to be more “innovative” than their competitors. Their approach involves allowing their cutting-edge technology and innovations do the talking. Tesla was one of the first companies to produce autonomous vehicles to the general public at scale.

Another factor at play is Elon Musk. While some people strongly dislike him, others are huge admirers. He has cultivated a cult-like following of individuals who are willing to buy practically anything he endorses. This devoted fan base plays a crucial role in boosting Tesla’s sales and brand loyalty. However, his polarizing nature also attracts criticism and scepticism from certain quarters. Overall, Elon Musk’s influence on Tesla’s success is complex, shaping the company’s unique position in the automotive industry.

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.