Weekly Stocktake

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.

Weekly Stocktake with Danyaal

11 February 2023

Key Indicators

Source: Iress

Rebuilding the House of Mouse?

Disney has been expanding its IP catalogue through strategic acquisitions over the years. They have acquired companies such as Pixar, Marvel, and Lucasfilm. These acquisitions have allowed Disney to tap into new markets and reach a wider audience; and helped Disney to solidify its position as one of the leading players in the family-entertainment industry.

But what do the numbers say, and what else has the House of Mouse acquired and focused on?

Disney released its Q1 2023 results last week. Revenues for the quarter increased by 8% to $23.5 billion compared to the same quarter the previous year, resulting in a net income of

$1.28 billion and a profit margin of 5.4%. As of Friday, the market valued the company at $197 billion with a price to earnings ratio of 59. In the earnings call, Disney announced plans to reduce operational costs by $5.5 billion by the end of 2024 financial year. The company will also be reorganized into three core business units:

• Disney Entertainment;
• ESPN
• Disney Parks, Experiences and Products.

Each unit will have increased creative and operational control.

Acquisitions at the right price, that deliver appropriate returns is good for both clients and shareholders. The opposite however can be very painful.

Disney acquired the majority of 21st Century Fox’s assets for $71.3 billion in 2019. The amount they paid was over four times what they paid for Lucasfilm, Pixar, and Marvel combined. Revenue from content providers primarily comes from new content. New content attracts new subscribers and puts people in cinema seats. The question is how effectively can Disney generate new content off their 21st Century Fox assets, given how much they’ve paid for it.

Disney faces another challenge.

They own two-thirds of the streaming service Hulu, with the remaining third owned by Comcast. Under their agreement, Comcast can require Disney to buy out their remaining stake for $27.5 billion by early 2024. This is not a great situation to be in when you’re trying to be focused on cost-cutting. Firms that rely heavily on acquisitions for growth often face challenges, including a tendency to pursue larger and riskier deals at increasingly high costs, at the expense of shareholders.

Disney is not held by the Lunar BCI Worldwide Flexible Fund.

Weekly Stocktake with Danyaal

3 February 2023

Key Indicators

Source: Iress

Amazon: The Behemoth

Last week Thursday, Amazon released their full year results, with revenue growing by 12.8% to a staggering $501.7 billion. However, their net income took a hit and decreased from a $33.4 billion profit in 2021 to a net loss of $2.7 billion in 2022. This was mainly due to a loss in the “other income” line item of $16.8 billion. Amazon is a company made up of multiple businesses that serve multiple different sectors, including their retail ecommerce platform, the highly profitable AWS cloud-computing service, and various investments, like electric-automaker: Rivian.

When looking at Amazon, it’s helpful to examine each segment separately. The retail e-commerce business drives Amazon’s revenue but it only recorded a net margin of -2.4% for the year. On the other hand, AWS brings in less revenue ($80.1 billion) but has a whopping 28.5% margin. Most of the company’s profit comes from the AWS segment. Amazon uses this segment to subsidize their ecommerce business and gain market share by lowering product prices and undercutting their competitors.

There’s still some noise in Amazon’s income statement, mainly from the “other income” line item. This is due to Amazon’s 20% stake in Rivian. Rivian is listed on the Nasdaq, and its share-price movement directly affects Amazon’s “other income” line item. Amazon invested just over $1.3 billion to acquire this stake, with most of it being acquired pre-initial public offering. In 2022 – Rivian’s stock price decreased over 80%. As of Friday 3 Feb 2022, Rivian’s market cap was just under $18 billion.

As Amazon operates in multiple areas, it faces competition from various industries. For example: the e-commerce division competes with other retailers like Walmart; the AWS cloud service faces competition from Microsoft and Google; and Rivian faces competition from automakers such as Tesla. This highlights the need for Amazon to constantly innovate and stay ahead of the competition to maintain their market position.

Amazon, Walmart, and Microsoft are held in the Lunar BCI Worldwide Flexible fund.

Weekly Stocktake with Danyaal

27 January 2023

Key Indicators

Source: Iress

Open AI

One of the hottest topics at the moment has been Open AI and its application – Chat GPT. And I thought it would be quite interesting to try have it write an article about Microsoft’s recent Q2 2023 results. I plugged in certain information about Microsoft’s Q2 2023 results because OpenAI has only collected certain data from 2021 and before. I then prompted it to structure the article in a certain way. And this was the result:

“Microsoft had a strong quarter, with a 2% increase in revenue to $52.7 billion. This is compared to the same period in the previous fiscal year. Despite this growth, the company saw a decrease in net income, which came in at $16.4 billion, a 12% decrease year over year. Earnings per share (EPS) also decreased, coming in at $2.20, a drop of 11% compared to the previous year.

One of the biggest drivers for Microsoft’s success this quarter was their Intelligent Cloud division. The division saw a significant increase in revenue, coming in at $21.5 billion, an 18% increase. This growth was driven by strong demand for their cloud offerings, including Azure, Dynamics 365, and LinkedIn.

Microsoft operates in a very competitive industry and their success is driven by their ability to adapt to the changing technology landscape. The company’s focus on cloud computing has been a major factor in their success, and they are constantly looking for ways to improve their offerings and stay ahead of the competition.

However, Microsoft is not without its risks. The company operates in a rapidly changing industry, and they must continually innovate in order to stay ahead of their competitors. They also face increasing competition from both established technology companies and new entrants, which can impact their ability to maintain their market share.

Microsoft and OpenAI have a strategic partnership, where the two companies collaborate on research and development of AI technologies. Microsoft provides OpenAI with cloud computing resources, allowing the research organization to scale its research and development efforts.”

It was really fun playing around with Chat GPT, and seeing how far chat-based AI has developed in the recent years. As it develops more over the coming years, it could have the potential to enhance the way people interact with the vast amount of information that is out there. AI bias and the accuracy of information it provides are still some of the major challenges applications like these face. And it will be vital to see how these challenges are dealt with over time.

Microsoft is held in the Lunar BCI WW Flexible Fund.