Weekly Stocktake

23 May 2023

Key Indicators

Source: Iress

Weekly Stocktake with Danyaal

The Business of Football: The Economics Behind the Game

From groceries to semiconductors to football, numerous businesses cater to the supply of goods and services for people. While some businesses offer essential products, others provide entertainment. Regardless of the nature of the goods or services, consumers need to pay for them. Sometimes these are directly, and other times these are indirectly. Football teams have a fascinating approach to generating revenue, and their expenses are also heavily skewed towards specific items.

Revenue

Football clubs earn their revenues in various ways such as: through branding rights, the transfer market (which is extremely difficult), and matchday tickets (normally a small percentage of total revenue). However, the main way of earinng an income, in football, is through leveraging their branding rights. They can do this through a number of ways:

• Earning fees from TV rights that are negotiated by the unions to which they belong e.g. FA (Football Association), UEFA (Union of European Football Associations), and SAFA. These unions are responsible for negotiating with TV broadcasters, who in turn compensate the football clubs depending on the number of games they play in which are televised.
• Clubs also sign deals with clothing companies like Nike, Adidas, and Puma, receiving either lump sum payments or a percentage of merchandise sales.
• They also earn fees from advertising, either at their home stadium or as logos on their sportswear.

Within Branding rights: broadcasting rights is the biggest driver of revenue. For e.g. UEFA are set to distribute €2.032 billion to teams participating in the Champions League, Europa League, and Super Cup this season. And Manchester City, the recent Champions League winners, are expected to earn around €60 million from their Champions League campaign, alone.

Costs

Football clubs incur various costs, including salaries for staff such as players, coaches, and administrative personnel. Additionally, they are responsible for maintaining stadium infrastructure. Intangible assets (such as player contracts) also require impairment adjustments over the duration of the contract. In the case of Manchester City’s 2021/2022 season, their largest expense was wages, totalling £353 million, which accounted for 55% of their total operating expenses and encompassed all staff (including players) of the club. The second largest cost item was the impairment of intangible assets (22% of operating costs). This was primarily the re-assessment of the value of players’ contracts as their contract durations decrease over time. Some clubs, like Juventus, prefer to acquire players whose contracts are nearing expiration, avoiding the need to pay exorbitant fees to other clubs to buy the players out of their contracts.

Grander Scheme of Things

The eye-catching figures spent by football clubs on players do not provide an accurate representation of their financial size. Player salaries and transfer fees constitute a significant portion of their expenses. Despite the global broadcast of sports events and widespread fan support, football clubs do not generate as much revenue as other globally recognized businesses. For instance, during Manchester City’s 2021/2022 season, they earned £613 million in revenue and £42 million in profit. In comparison, Puma, Man City’s kit sponsor, recorded €8,456 million in revenue and €354 million in profits for their 2022 financial year.

Owners of football clubs often have deep pockets to be able to afford the investments required to make the club successful. Some do it to hopefully earn a decent return on their investments; while others, arguably, do it for ego.

23 May 2023

Key Indicators

Source: Iress

Weekly Stocktake with Danyaal

From Downward Dog to Upward Profits, Lululemon’s revenue surges!

Yoga-pants, women’s running shoes, and increasing margins. Lululemon, the high-end athleisure designer brand held by Lunar Capital, recently unveiled their Q1 2023 financial results. The company recorded a 24% increase in revenue compared to the same quarter in the previous year, reaching $2 billion for the quarter. In addition, Lululemon experienced a surge in its net income, which increased by 52% to $290 million. The company’s performance can be attributed to several factors. Firstly, the revival of the Chinese market following the lifting of lockdown restrictions this year contributed to Lululemon’s increased revenue and net income. Furthermore, the company benefited from reduced airfreight costs this quarter compared to the same period last year, which resulted in their cost of sales decreasing.

Lululemon operates via physical stores as well as well as through on-line stores. Approximately 42% of sales is via direct channels, i.e. on-line. They currently have a total of 662 stores worldwide, with three key locations accounting for 82% of their store presence:

• The United States with 357 Lululemon stores,
• China with 119 stores, and
• Canada with 69 stores.

Sales breakdown from the various regions in this quarter is as follows:

• The USA with $1 315 million;
• Canada with $253 million, and
• China with $249 million in sales.

Lululemon’s strategy has 3 pillars: Product innovation, guest experience and market expansion.

On product innovation, Lululemon’s Align yoga pants are highly sought after by yogis, as its fit allows them to feel free and light while they practice. The Align pants alone generates over a billion dollars in sales per year. Whilst yoga wear was Lululemon’s original product focus, they now have products covering many other sports codes, and these also include shoes and accessories.

Lululemon operates within a fiercely competitive landscape, facing competition not only from other athleisure brands but also from established luxury brands like Luis Vuitton (owned by LVMH.) It is worth noting that athleisure and luxury brands often rely on public personalities to promote their products. However, this strategy can sometimes lead to adverse effects if the public figure faces criticism for their actions or statements. A prime illustration of such collateral damage can be seen in the case of Adidas and Kanye West, where negative associations with the Kanye West impacted Adidas’s reputation. Lululemon use product ambassadors and influencers in their marketing efforts too.

Lululemon is held in the Lunar BCI Worldwide Flexible Fund and by Lunar Capital’s Offshore Portfolio Management clients. And LVMH is held by Lunar Capital’s Offshore Portfolio Management clients.

23 May 2023

Key Indicators

Source: Iress

Weekly Stocktake with Danyaal

Artificial Intelligence: Beyond the Hype or Just Another Illusion?

The rise of generative Artificial Intelligence (AI) products like ChatGPT has led companies in most sectors to seek ways to incorporate AI into their businesses. On the flip side, investors are wondering how they can make the most of this trend. They’re asking themselves who stands to gain from this wave and whether it’s a long-term phenomenon or just another hype?

Nvidia, a company held by Lunar Capital, recently released their Q1 2024 results and outlook. Nvidia designs semiconductors and develops software for AI programmes and services to run on. This allows companies like Microsoft and Open AI to build AI-products and services using Nvidia’s chips. Clients like banks and retailers then build AI-based solutions to service their clients and support their businesses.

While Nvidia’s revenue for the quarter dipped 13% to $7.2 billion compared to the same quarter last year; their net income increased by 26% to $2 billion. What really caught the eye of investors was their projection for the next quarter. Nvidia guided that they expect to earn $11 billion in revenue. If they hit that mark, it’ll mean roughly 50% increase in revenue from the current quarter. And it’s not just the revenue that’s climbing, as seen from the current quarter, their net margin has expanded too. As a result, Nvidia’s stock price soared by 24.6% last week, making them the 6th most valuable public company in the world with a market cap of $963 billion as of Friday last week.

Is AI another case of market-hype causing fluctuations, similar to what we’ve seen with crypto and the metaverse booms and busts? Or is this technology here to stay? Investors have high hopes for Nvidia. Looking at their rolling twelve month period, their price-to-earnings ratio stands at 203. In theory, if an investor were to buy the stock at these prices and the yearly earnings remained unchanged, it would take them 203 years to recover their investment. The expectations for Nvidia in the coming years are high, but it will take time to see if the company can live up to them.

Nvidia and Microsoft are held in the Lunar BCI Worldwide Flexible Fund and by Lunar Capital’s Offshore Portfolio Management clients.

19 May 2023

Key Indicators

Source: Iress

Weekly Stocktake with Danyaal

Walmart: Competing on all Shop Fronts

Walmart, a business owned by Lunar Capital funds and clients, recently announced its Q1 2024 results. Notably, the company recorded a revenue of $152 billion, a 7.6% increase compared to the same quarter last year. Operating income saw a significant rise of 17.3% to reach $6.2 billion. However, Walmart had to make adjustments to the fair value of its investments, resulting in a $3 billion line-item decrease on the Income statement. Consequently, the diluted net income per a share decreased by 16.2% compared to the same quarter last year. During the quarter, Walmart achieved a gross margin of 24.3% and an operating margin of 4.1%.

Walmart has long been recognized for its focus on affordability and customer satisfaction. In a high-inflation environment consumers tend to “buy down”, i.e. they look for cheaper alternatives. Walmart could benefit from this trend. However, this is not the only front they are battling on. Walmart has recently ventured into the realm of e-commerce. In their latest financial results, Walmart experienced a noteworthy 26% growth in global e-commerce sales. Although e-commerce currently represents a relatively small portion of their total sales, it is growing at a faster rate compared to many of Walmart’s other business segments. The advertising segment is the only other segment exhibiting similar growth, with an increase in sales of 30% compared to the same quarter last year.

Walmart is strategically expanding its reach beyond its traditional competitors and targeting businesses that were not historically in direct competition with them. In the e-commerce realm, they are notably aiming to compete with Amazon, despite Amazon holding a significantly larger market presence. For the most recent fiscal year, Amazon’s e-commerce business recorded sales of $375 billion, while Walmart recorded e-commerce sales of $82 billion.

Walmart is also making strides in growing its advertising segment, which typically offers higher profit margins compared to many other industries. This could potentially contribute to Walmart increasing its operating margin. However, it is important to note that Walmart faces fierce competition in this arena from other advertising platforms such as Alphabet, Meta (formerly Facebook), and Amazon, again. This competitive landscape presents a challenging battle for Walmart. Nevertheless, their recent growth in the advertising sector suggests that businesses are choosing to allocate a portion of their marketing budget to Walmart, indicating a positive trend for Walmart’s advertising endeavours.

Amazon and Walmart are held in the Lunar BCI Worldwide Flexible Fund and by Lunar Capital’s Offshore Portfolio Management clients.

12 May 2023

Key Indicators

Source: Iress

Weekly Stocktake with Danyaal

Hungry Munger and a Buffett of Wisdom

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

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

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

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

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

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

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

05 May 2023

Key Indicators

Source: Iress

Weekly Stocktake with Danyaal

Long Life Novo Nordisk

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

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

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

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

28 April 2023

Key Indicators

Source: Iress

Weekly Stocktake with Danyaal

Scaling Up: Microsoft’s Growing Revenue and Expanding Margins

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

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

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

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

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

21 April 2023

Key Indicators

Source: Iress

Weekly Stocktake with Danyaal

ASML – Light Me Up

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

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

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

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

14 April 2023

Key Indicators

Source: Iress

Weekly Stocktake with Danyaal

Next Level Platform Companies

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

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

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

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

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

06 April 2023

Key Indicators

Source: Iress

Weekly Stocktake with Danyaal

SA’s Heavy-Weight Champion

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

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

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

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