Offshore Portfolio Clients

Netflix: The Saga Continues

By the end of 2024, Netflix had over 300 million subscribers in 190 countries. Netflix estimates that this translates to an audience of roughly 700 million people. Last week, Netflix released their Q1 2025 results, reporting revenue of $10.5 billion, up 12.5%. Operating income was $3.3 billion, representing an operating margin of 31.7%, up from 28.1% in the same quarter last year. Netflix has set a goal of doubling its current revenue by 2030.

Over the last few years, Netflix has steadily increased the prices for their services. In the US, the price of the standard plan rose from $13.99 in 2019 to $17.99 this year, a 28% increase. Netflix has also kept its content spending relatively stable, which has allowed the company to increase profitability substantially. Two years ago, Netflix cracked down on password sharing. According to Netflix, this had a net positive impact, as more people created their own accounts compared to those who left the platform entirely.

A core pillar of Netflix’s strategy is to fund and create original content. This approach gives them full creative control and rights, enabling them to produce more content centred around their intellectual property without incurring substantial leasing costs. Netflix has had significant success with this strategy, creating shows like Stranger Things and Squid Games, which have become culturally significant shows with large fanbases. Netflix has also refused to lease its content to other platforms. This strategy has helped Netflix draw in and retain customers despite the intense competition.

However, Netflix still faces stiff competition from other streaming platforms, linear TV, and the entertainment industry as a whole. The risk is that Netflix might lose its ability to engage subscribers, leading to non-renewals. However, as it stands, the company is in a strong position. The market values Netflix highly, with a price-to-earnings ratio of over 45.

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Disclosures
Lunar Capital (Pty) Ltd is a registered Financial Services Provider. FSP (46567)
Read our full Disclosure statement: https://lunarcapital.co.za/disclosures/
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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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JP Morgan – Banking on Volatility

Weekly Stocktake / By VCS Agency

JP Morgan Chase & Co. reported their financial results for the first quarter of 2025. The company posted a revenue of $45.3 billion, marking an 8% increase year over year. Net income for the quarter reached $14.6 billion, up 9% from the same period last year. JP Morgan’s return on equity was 18% for the latest quarter. The company also reported an overhead ratio of 52% for the quarter. Despite the market volatility, JP Morgan’s share price has decreased by just under 2% since the beginning of the year.

The significant growth in revenue was primarily driven by the company’s Markets & Securities Services division, which saw a 19% increase to $10.9 billion. Notably, revenue from equity markets increased by 48% to $3.8 billion, the highest ever recorded by the company. This stand-out performance was attributed to increased market activity and trading volumes, which boosted revenue.

JP Morgan also capitalized on the increased market volatility through its derivatives business. Derivatives are financial contracts whose value is derived from the price of an underlying asset, such as stocks, bonds, or commodities. As volatility increases, the prices of the actual derivative contracts increase, and vice versa.

In his prepared remarks, CEO Jamie Dimon highlighted the dual nature of the current economic landscape. On the positive side, potential tax reforms and deregulation could provide significant benefits. However, challenges such as tariffs, trade wars, persistent inflation, high fiscal deficits, and asset price volatility remain considerable risks.

JP Morgan’s strong balance sheet continues to be a cornerstone of its stability. The company achieved a Common Equity Tier 1 (CET1) Capital ratio of 15.4%. The CET1 ratio is a measurement of a banks available capital expressed as a percentage of a bank’s risk weighted assets. The higher the CET1 ratio, the higher the loss absorbing capabilities. JP Morgan has a total loss-absorbing capacity of $558 billion.

As the global economy navigates through uncertain times, JP Morgan’s “fortress balance sheet” gives the company the potential to manage future volatility and capitalize on emerging opportunities.

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Not Tariffic

Weekly Stocktake / By VCS Agency

Last week, the US Government released a list of tariffs and levies to be applied to all countries. These tariffs will range from 10% to 50% on 185 countries, significantly higher than what analysts and commentators had anticipated. The effective tariff rate, which is the customs duty revenue as a proportion of goods imported, is expected to range from 20% to 25% for 2025. The last time the effective tariff rate for the US was this high was nearly 100 years ago.

What is the USA, through the Trump presidency, trying to achieve?

Trade Balance
In 2024, the US had a trade balance (Exports – Imports) of -$1.2 trillion. US consumers have benefited from better and cheaper products from other nations, while US companies have externalized a large portion of their manufacturing to countries with a lower cost base. Big Tech companies such as Apple and Nvidia design their products in the US but outsource many components to companies like TSMC in Taiwan, which manufactures highly sophisticated semiconductors.

The intention with tariffs is to make the cost of goods imported to the US higher, which will then make manufacturing these same goods in the USA more viable. Ultimately, someone must pay the additional costs of the tariffs, and these will be consumers in the USA unless the companies selling these products absorb some these costs. Establishing complex manufacturing capabilities is not a trivial matter and could take years to do.

US Dollar as Reserve Currency
The US dollar is the world’s reserve currency. This creates a natural demand for US Dollars thus keeping its price elevated. This is a major contributor to the trade deficit in the USA, making it cheaper to import than to manufacture in the USA.

The reserve currency status of the US dollar has provided the USA with significant power over the international financial system, for example by limiting access to the international financial markets with sanctions or even through confiscating the funds of countries that it deems are enemies.

US National Debt
The US national debt reached just over $34 trillion last year, rising from $395 billion in 1924. Since the 1980s, the debt as a percentage of GDP has increased from just under 40% to over 120% in 2024. As the debt-to-GDP ratio gets higher, it becomes more challenging to pay off the debt, because the interest bill continues to take up a larger portion of the national budget.

As one would expect, the creditors of the USA, i.e. the institutions funding the USA by buying their bonds, have started expressing deeper concerns about the sustainability of this huge growth in debt.

How could you respond to this?
At Lunar Capital, our view was that the US markets have been over-priced since last year. We have maintained a slightly higher position in cash and have increased our exposure to businesses outside of the US, such as Alibaba, Naspers, MELI and Anglogold.

There are still high levels of uncertainty in the markets, which are been reflected in the drop in share prices and the markets around the world. At some stage, some great companies will present good buying opportunities.

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De-Lululemon

Weekly Stocktake / By VCS Agency

Lululemon, the Canadian athleisure brand, released their Q4 2024 results last week, reporting a revenue of $3.6 billion, up 13% year over year, and an operating income of $1 billion, up 14% year over year. For the full year, net revenue in the Americas increased by 4%, while net revenues from their international segment surged by 34%. The international segment accounted for 25% of Lululemon’s total sales for the year, while the US accounted for 61%.

Despite these strong results, management indicated signs of a more frugal consumer. Over the past three years, consumers have faced high inflation, and recently the looming threat of tariffs on the US’s trading partners could potentially decrease Lululemon’s gross margin. Year-to-date, Lululemon’s stock price has decreased just over 23%.

Known for selling $100 yoga pants, Lululemon recorded a relatively high gross margin of 60.4% for the most recent quarter. A high gross margin often allows a company to handle sudden increases in input costs without necessarily having to increase the prices of their products suddenly.

However, Lululemon is in a challenging position. Last year, they released a collection of products that didn’t resonate with US consumers. A company that prices its goods extremely high but fails to deliver on its original appeal to its customers, even the most loyal, could easily lose them to competitors offering similar products at lower prices. It is then extremely difficult to win those customers back.

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Tencent – Gaming and Beyond

Weekly Stocktake / By VCS Agency

Tencent, the Chinese technology and entertainment company, has multiple business ventures in entertainment (primarily gaming), financial technology, and other internet services. One of Tencent’s most popular services is WeChat, an all-in-one app used for messaging, social media, payments, and other applications. Additionally, Tencent has a variety of investments in gaming companies, such as Riot Games, which publishes the popular League of Legends franchise, which has 150 million active accounts.

Last week, Tencent released their Q4 2024 results. Revenue for the quarter was RMB 172.4 billion (1 USD = 7.25 RMB), up 11% year over year. Gross profit for the quarter increased by 17% to RMB 90.6 billion, while operating profit rose to RMB 51.5 billion, up 24% year over year. Tencent’s gaming division grew 14% year over year, accounting for 46% of their revenue in Q4 2024.

Tencent has seen its share price increase by over 20% this year. However, the gaming division hasn’t been the primary driver behind Tencent’s stock price increase. Earlier this year, a Chinese company called DeepSeek released a Large Language Model (LLM) called R1, which appeared to have capabilities similar to those of OpenAI, Google, and Meta’s LLMs. DeepSeek claimed they spent a fraction of the cost to train their AI model compared to their US competitors.

Tencent plans to integrate DeepSeek’s AI-powered search into Weixan, Tencent’s domestic version of WeChat, rather than use their own proprietary LLMs. To support their AI cloud strategy, Tencent is still increasing their capital expenditure to accommodate the necessary networking requirements. In the most recent quarter, they spent RMB 36.5 billion in capital expenditure, 4.8 times more than they did in the same quarter last year.

Tencent’s recent business strategy has focused on making acquisitions to gain market share. However, there is a risk that Tencent may overpay for acquisitions that do not result in a significant increase in revenue and net profit. Time will tell how capable Tencent is at generating revenue with its AI strategy.

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Hala Zara

Weekly Stocktake / By VCS Agency

Consumers in the clothing (fashion) industry are fickle. At times, they show strong loyalty to a brand, only to lose interest shortly thereafter. Their purchasing decisions often follow changing trends and are also influenced by other factors such as quality, price, and product range. This presents a challenge for clothing companies to achieve sustained growth over the long term, as creating products that consistently appeal to customers can be difficult.

Inditex, listed in Spain and the owner of Zara, is one of the few players that have been able to sustain growth over long-term. In 2024, the company generated €38.6 billion in revenue, up 7.5% year over year. Gross profit increased 7.6% to €22.3 billion, and net income increased 9% to €5.9 billion, representing a net margin of just over 15%.

The single-digit sales growth can be attributed to multiple factors. Zara, Inditex’s flagship brand, accounted for 72% of the company’s sales and grew at 6.6%, while the second-largest brand, Bershka, accounted for 7.5% of sales but grew 11.8% year over year. At the end of 2024, Inditex operated over 5,500 stores worldwide, showcasing just how wide their reach already is.

Recently, the company has focused on increasing its logistics capacity. Last year, Inditex spent roughly €900 million on additional capital expenditure to enhance its logistics, with plans to spend a similar amount this year.

The company is also working on increasing profitability by streamlining its business. Inditex is known for its quick turnaround time, from design to store shelves within weeks, compared to other companies that can take months. Inditex doesn’t keep high levels of stock but uses a data-driven approach to track which items are selling faster than others and then automatically ramp-up or scale-down manufacturing accordingly.

Inditex’s success can be attributed to its ability to quickly adapt to changing consumer preferences, efficient logistics, and a data-driven approach to inventory management. However, the company faces several risks, including intense competition from both established brands and emerging online retailers, economic instability that can affect consumer spending, and the need to continuously innovate to stay ahead of fashion trends.

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ShopRite on Track

Weekly Stocktake / By VCS Agency

Shoprite, South Africa’s largest consumer goods retailer by revenue, has continued to expand its market share, outperforming competitors such as Pick ‘n Pay, Woolworths, Spar, and others. For the 26-week period ending December 29, 2024, Shoprite Group increased its merchandise sales by 9.6% to R128.6 billion, higher than its competitor’s growth rate of 3.1%. The gross margin for Shoprite improved by 30 basis points to 23.9%, while profit for the period rose by 11.9% to R3.7 billion, representing a 2.8% profit margin.

Shoprite’s growth strategy revolves around its three core businesses: Checkers, Shoprite, and OK. It also has businesses in 10 countries outside of South Africa. These brands target different market segments based on customer price sensitivity and product range. Shoprite leverages its core businesses to venture into new products and services, ensuring that each new initiative is anchored to one of its established brands. For instance, the delivery service Sixty60, is an add-on service to the Checkers brand, and has recently also been added as a service to the Shoprite brand.

Given the low margins that Shoprite commands, the company exercises caution when entering new markets. Their approach involves opening stores in select locations and expanding based on the traction those ventures get. The success of the Checkers Sixty60 service has prompted plans to extend the delivery service to Shoprite-branded stores. Additionally, the Group has diversified into pet stores, baby stores, clothing stores, and other retail ventures.

Shoprite faces the risk of over-investing in its quest for market share and growth. In a stagnant economy, this could lead to riskier ventures. One such venture that has not met expectations is their furniture business. Recently, Shoprite decided to sell its OK Furniture and House & Home business, which had a merchandise sales growth rate of 6.2%, below Shoprite’s overall growth rate of 9.6%. The trading margin for the furniture business also decreased by 30 basis points to 4.8%.

Shoprite is known for its diligence. The company’s price-to-earnings ratio trades at a premium of 30%-40% compared to Woolworths and Spar. Any operational missteps could result in significant adjustments to its stock price.

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In the Amazon-e

Weekly Stocktake / By VCS Agency

In 2000, Amazon, primarily known as an online bookstore, had built one of the world’s biggest websites from the ground up. However, they found that whenever they needed to add new features, their software developers spent most of their time building elements that any software project would require. This made it extremely time-consuming and resource-consuming to scale their site.

To address this, Amazon built a shared layer of website infrastructure that all their teams could use. With the internal success of these layers, Amazon took these services to market, and Amazon Web Services (AWS) was born. AWS has since become Amazon’s most profitable business. In 2024, AWS generated $39.8 billion in operating profit, out of a total operating profit of $68.6 billion for Amazon.

There are several other stories of Amazon identifying financial-, resource-, and time-consuming aspects of their business, then finding and developing solutions, which could then be sold as services to others. Another example is logistics; Amazon uses a combination of third parties like UPS and the American Postal Service (previously) and its own in-house delivery services to deliver to Amazon’s clients. The US Postal Service stopped delivering on behalf of Amazon, and recently, UPS also announced their intention to stop delivering on behalf of Amazon. The rates demanded by Amazon were not profitable for these companies. Amazon found a way to deliver more cheaply, ultimately reducing the costs of delivery to their clients and then selling their logistics services to others who don’t use their marketplace.

In 2025, big tech companies such as Alphabet, Amazon, Meta, Microsoft, and Tesla are planning to collectively spend $300 billion on capital expenditure, primarily on artificial intelligence infrastructure projects. Amazon has indicated that they plan to invest $100 billion in capital expenditure this year. However, not all of this will go towards AI.

Building products in-house can bring a lot of risk, especially if those products don’t sell as well as anticipated. However, when the product meets market needs, it can generate a significant amount of income while reducing costs as that part of the business scales.

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Apple Doesn’t Fall Too Far from the Tree

Weekly Stocktake / By VCS Agency

In 1998, Compaq Research introduced the first “Personal Jukebox.” Although the device was bulky and could only store the equivalent of one CD, it represented a significant advancement in portable music technology. Recognizing its potential, Apple procured exclusive rights to affordable 5GB disc drives developed by Toshiba, which were capable of storing up to 1,000 songs. Apple subsequently redesigned the media player with a sleek and user-friendly interface and launched the iPod in 2001.

Apple is known for observing market trends before developing its own products. The company waits to see which products become popular and, if there is potential for further growth, it creates its own versions with Apple’s distinctive design and sells them to the market.

In the realm of generative AI, Apple has taken a unique approach compared to other major technology companies like Alphabet, Amazon, Meta, and Microsoft. Unlike these firms, Apple has not significantly increased its capital expenditure on building data centres.

Instead, Apple opted for its more patient strategy, aiming to develop an AI of the highest quality. Initially, this method presented some challenges for Apple, such as delays and bugs in the AI features on its devices. Now, in cases where Apple’s AI is unable to generate responses for users, it utilizes ChatGPT to provide the necessary responses.

Apple’s strength lies in its highly valuable consumer distribution platform, designed to create a seamless experience for users centred around the iPhone. In Q4 2024, Apple’s products and services generated a revenue of $124 billion, with an operating income of $42 billion. This robust distribution to a highly valuable customer base is a key strength and could position Apple as one of the significant beneficiaries in the AI race.

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Net Flicks on Flicks on Flicks

Weekly Stocktake / By VCS Agency

Three years ago, Netflix’s stock price experienced a significant decline of more than 70% from its peak reached at the end of 2021. This decrease was driven by the loss of subscribers for the first time in Netflix’s history. Analysts also argued that Netflix was unable to maintain its market leadership and effectively counter the competition. Concurrently, inflation in the United States was rising to levels not seen for decades.

However, last week, Netflix achieved new stock price highs, with the stock closing at $977 on Friday. Netflix ended the week with price-to-earnings ratio of just over 49 and a market capitalization of $417 billion.

Netflix saw an increase in their number of subscribers by nearly 20 million in Q4 2024, reaching just over 300 million subscribers worldwide. Revenue for Netflix rose by 16% to $10.24 billion, while operating profit grew by 52% to $2.3 billion. The significant rise in profitability was attributed to operational leverage. Netflix managed to expand its subscriber base without a proportional increase in operating costs. The below graph shows the change in profitability for Netflix over the last two years.

Why is there so much positivity behind Netflix’s business?

Netflix is uniquely positioned to concentrate their efforts exclusively on streaming, unlike competitors in the entertainment sector who balance their newer streaming initiatives with their currently-profitable legacy assets.

Other competitors, such as YouTube (a subsidiary of Alphabet) and Amazon Prime, have primary businesses in areas such as search and e-commerce that demand extensive company resources in terms of effort and capital. Consequently, these companies may not place a high enough priority on their streaming business, potentially resulting in a loss of market share.

Netflix also has an extensive lineup of new shows and movies scheduled for release this year, as part of its strategy to further expand its revenue base. The company has also introduced advertising packages in numerous markets and plans to scale these efforts throughout the year. Following the success of live events such as the Jake Paul vs. Mike Tyson fight, Netflix is exploring opportunities to develop its live events segment, focusing on occasional events rather than expensive, year-long sports leagues.

However, despite their recent successes, Netflix faces significant competition, increasing costs, and shifting consumer preferences. A few missteps could considerably impact the company’s performance.

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