Not Investment Advice. Read Disclaimers.

To understand Lululemon, one must detach themselves from all that is corporate and touch the “soul” of what it means to be athleisure.

LULU’s problem is one that has plagued retail brands across time — it has become Big Corporate. What was once a homely, beloved brand that energized the souls of its customers has become a hunking, monolithic machine, slowly being crushed under the weight of shareholder expectations and profit updates. In its search for greater scale, it has lost its way from the cool, innovative, founder-led spirit that made it into what it is today and turned into just another silent, uninspiring machine that reliably churns out profits but is gradually losing its meaning amongst those who first fell in love with it. In the process, Lulu echoes its dying throes from the void of irrelevance as customers slowly fall out of love with it.

But there is a remedy, and fortunately for shareholders, the medicine is highly recognizable. Lululemon just needs to become what it fears most — Alo & Vuori. Far from just churning out sweatpants, Lulu needs to recover the stature of its brand to what it lost a long time ago and is now being represented by its closest competitors — the cool, Grease Lightning factor that embodies relevance in an age where stale, replicable fast fashion has become the norm. The lighthouse is clearly visible, and Lulu simply needs to chart its course to collide with what Alo & Vuori are already doing so well — connect with influencers, sponsor athleisure events, revive that grassroots spirit which makes a brand feel alive. This is not something you can map out on a spreadsheet — it’s subjective, fun, almost human in its composition, but it’s exactly the medicine that Lululemon needs.

In analyzing Lululemon, it is tempting to simply analyze it as a business and determine the operational levers that ticks its boxes. However, what Lululemon needs is a brand overhaul, more specifically, to rediscover what it had lost and what its closest competitors are now doing so well with. This “spark” is much more subjective, but ever so important to understand in order to solve the jigsaw of what is necessary to revive the Lululemon brand. In this vein, this article will help you understand not just what LULU is as a business, but even more what the shot in its arm needs to look like to bring the brand back to its roots.

The Need for a Brand Overhaul

As a retail brand operating in the athleisure category, Lululemon doesn’t exist in a vacuum. It faces extensive competition from two of its main competitors in the leggings and sweatpants world — Alo and Vuori. If you analyze their products from the bottom-up by watching organic product reviews on Youtube and Tiktok, you can get a sense of who the target customer is and what makes them come back for more.

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Not Investment Advice. Read Disclaimers.

To be clear, I arrived at an EV/EBIT of 2x by also including their short & long-term investments into their Net Cash. PDD holds a huge part of its asset base in both short & long-term time deposits and government bonds, and I included these into its Net Cash position when calculating its EV. Having said that, it’s true that after deducting the value of these cash-like investment assets from its market cap, PDD trades at a mouth-watering 2x EV/EBIT.

PDD should be familiar to most readers, being the 3rd largest e-commerce app in China. Most analysts will try to impress you concerning its “group-buy” feature that gamifies the e-commerce experience and gathers customers together to enable its Customer-to-Manufacturer (C2M) feature, which generates economies of scale and eliminates the middleman from the retail value chain. While we will explore this below, the investment thesis for PDD doesn’t rely on its business outperforming significantly. The investment thesis is simple — PDD is almost a net-net, and it simply holds too much cash for investors to ignore. At the current Enterprise Value of the company, the stock is practically screaming at investors as they are getting close to a 50% EBIT yield after cash.

Having said that, it remains instrumental to understand this still-growing business and the risks to the cash flow that exists, since PDD doesn’t return the cash to investors in the form of share buybacks and dividends. Why does PDD hold so much cash? Where does the business ultimately land? And why are investors not paying more attention to the stock when it is so clearly undervalued?

Business Model

Pinduoduo is China’s 3rd largest e-commerce app, after Alibaba and JD.com. Unlike most e-commerce sites in China which focus on Tier 1 and Tier 2 cities, PDD focuses on mostly Tier 3 and below cities where the rural communities live. This gives it a niche that the other e-commerce giants like Alibaba and Meituan have tried and failed to penetrate.

Pinduoduo also has a separate app called Temu which focuses on international markets. We shall explore below how PDD uses much of the same customer strategies that made it successful in China inside the Temu app to court the international customer. Currently, Temu’s geographical expansion includes the likes of North America, Western Europe and Southeast Asia.

Western e-commerce consumers who are familiar with Amazon will find a lot different in Pinduoduo’s approach to courting customers. Firstly, much of Chinese e-commerce strategy revolves around “gamification”, which turns the e-commerce experience into a game that rewards consumers with discounts on products. Pinduoduo also participates in this sort of customer strategy, where it ropes in friends and family members to participate in “group buys”, which rewards customer groups who buy in bulk purchases.

This creates a few strategic competitive advantages as compared to traditional e-commerce sales, which tend to involve individual purchases spread out over a large number of suppliers. Firstly, it creates economies of scale by allowing manufacturers to keep utilization rates at their assembly lines high, as they can predict with high accuracy how many products need to be manufactured. This allows them to spread the fixed costs of their operations over many more products, thus allowing them to pass the savings onto customers. Secondly, manufacturers who can now expect high purchase volumes from these “group buys” can subsequently skip the middlemen distributors who typically form 2 to 3 layers of the value chain and get their products straight to customers. This Customer-to-Manufacturer (C2M) approach significantly drives down unit costs and therefore prices, making it a win-win approach for both PDD’s customers and manufacturers.

Thirdly, both manufacturers and PDD can avoid holding costly inventory through these “group buy” approaches, since it creates ready-made demand for products straight out of the assembly line. Indeed, PDD famously has zero inventory days, which is unheard of in the Retail industry and even bucks the trend amongst e-commerce giants where 3rd party Fulfillment services are the norm. Holding such little inventory makes PDD a suitable channel to fulfill e-commerce grocery sales, which tend to be perishables and therefore have a low shelf life. PDD’s grocery arm, DuoDuo Grocery, is a huge business in China with operations spanning the entire countryside delivering products such as chicken, corn, cabbage and carrots to households all across China.

PDD also gamifies the consumer experience in other ways. For instance, they don’t have a shopping cart, and prompt customers to make impulse purchases by encouraging them to make purchases one item at a time (in bulk volumes). Pinduoduo’s app is also not designed like a traditional e-commerce app such as Amazon or Alibaba, which prioritize storefronts and displays products siloed within them. Instead, the app combines all stores into a giant “warehouse” that prioritizes time-sensitive discounts and turns the retail experience into somewhat of a video game, rewarding “players” with discounts on products independently of which seller it comes from. This once again triggers the dopamine-inducing sales mindset in the customer and encourages them to impulsively hit the Buy button on their app in order to rack up group buy volumes.

As PDD generates such high volumes, it makes sense for the company to sell its own white-labeled products. PDD famously has a much lower Average Order Value than competitors like Meituan or Alibaba, as most of the products it churns are daily necessities like food items, tissues, kitchen utensils and the like; it eschews higher priced items like electronics or clothing in favor of SKUs which can be massively mass-produced. These items can subsequently be white-labeled under the PDD brand, which turns the company into a retail giant larger than the likes of Walmart China or Costco China. It also has a significantly lower SKU count at about 1,500, compared to the latter which holds inventory for over 10,000 SKUs. This keeps operations lean and focuses sales around a limited number of best-selling items as opposed to providing the widest assortment of inventory.

As you may have observed, PDD’s operations create a flywheel which generates economies of scales across all business segments. It firstly encourages group buys through the gamification of its app design, drawing in friends & family to participate in impulse purchases of single-item transactions. This design encourages volume sales which keeps utilization rates at manufacturers high, thus allowing them to pass on fixed cost savings in the form of lower prices to customers. PDD subsequently leans on such large volumes to form its own white-label brand around a relatively small selection of SKUs, thus pinching margins from the value chain and allowing them the heft to compete against other e-commerce giants. It also helps that it focuses on a customer niche of Tier 3 or below cities, where the bigger e-commerce companies have a lower footing in and where PDD can muscle its way around.

Temu, which is Pinduoduo’s international arm, operates on a very similar concept of encouraging impulse purchases on products manufactured by its partner suppliers in China. The higher logistics costs of transporting items overseas means that it has a slightly higher AOV, but the underlying principle is the same — keep the flywheel spinning by encouraging volume purchases that can be grouped together across the world thus generating economies of scale across the value chain. The app frequently has discounts to encourage such impulse purchases geared to hit a Minimum Order Quantity that allows suppliers to produce such SKUs economically and affordably.

Aside from their structural C2M advantages, the algorithm for achieving retail success overseas is the same as anywhere else. Do a big splash of marketing to gain users in order to drive Big Data-driven marketing analysis, invest marketing dollars further, do promotions and advertising where appropriate, and seek a balance between gaining market share and keeping retail dollars. The flip side of the double-edged sword of being in a commoditized industry is that there’s low barriers to entry and it’s a game of survival of the fattest, which benefits PDD given how much excess cash it has on its balance sheet. While nobody is claiming that Temu will overtake Amazon anytime soon, it helps that there’s a reliable formula for Temu to rely on in order to gain mindshare and take American and European retail spend, which in no way restricts itself from operating purely in China.

As such, PDD and Temu’s huge war chest is a structural advantage in terms of marketing dollars. Given that they effectively have an unlimited marketing budget, what matters is a return on A&P activity which can be measured by S&M expense as % of revenues. The rest is to simply to rely on organic traffic being driven by having a robust & competitive inventory stack, which PDD already has plenty of experience offering in China and can simply replicate for the rest of the world under Temu.

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Charter is the 2nd largest provider of broadband internet in the US, after Comcast. Currently, its equity is yielding in excess of 28% at 3.5x PE, and investors rightfully want to know what’s the catch. In this article, we’ll explore:

• Charter’s business and its debt situation

• The Cox merger and the post-merger valuation

• Why its Internet business is NOT the melting ice cube to be concerned about

First things first. There’s a good reason why Charter’s PE is so low — it has a lot of debt. As of FY25, Charter held about $95B in Net Debt, which is humungous relative to their market cap of $16B. It’s probably worth pointing out that CHTR bought back its shares at a 9% CAGR since FY21, so their market cap could’ve been nearly double what it is today even at the prevailing share price.

However, this debt is highly manageable. Firstly, 90% of the debt is fixed rate in nature, so there’s very little interest rate risk. Secondly, most of the debt is maturing in staggered stages, with the exception of two balloon payments in 2030 and 2031 (which will likely be refinanced), so the debt payback visibility is high and there’s little risk of bankruptcy. We can see below how CHTR’s debt is easily managed (FY25 FCF: $6.6B) and can be refinanced to further stagger out the debt stack as they have done before.

The chart above shows how CHTR’s Net Borrowings are very manageable relative to both their FCF and EBITDA. Furthermore, EBITDA as % of Total Debt has been quite stable, hovering at between 16-17% over time.

The implication here is that CHTR is able to service its debt, and is not taking on more debt over time in order to service past debt obligations. The debt load is simply a static fixture of the capital stack. This demonstrates how unlikely it is that things will come crashing down anytime soon as far as the heavy debt load is concerned.

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Why AI Won’t Disrupt Intuit

Intuit owns the No. 1 brands in the US in two stronghold businesses: the Quickbooks brand of accounting software, and the tax filing brand Turbotax. INTU is one of the rare large-cap businesses on sale which is still growing fantastically — revenue growth was 15% YoY in 9M26, resulting in 20% Net Profit growth. The share price has collapsed on fears that AI will disrupt its seat-based business model, which if true has been completely invisible from its financial statements.

The general idea behind these fears is that a well-funded new entrant will somehow be able to vibe-code a Quickbooks alternative and start selling it for a lower subscription price. Firstly, INTU is no stranger to cheaper competition, with the likes of Xero and Zoho already competing with it in the more affordable accounting software category; and FreeTaxUSA and H&R Block literally offering free alternatives in the tax filing category. So the worry that Quickbooks or TurboTax will lose their pole positions to a cheaper AI vibe-coded alternative is just nonsense.

Secondly, there are high switching costs involved if a small business which has already been using Quickbooks for years wants to shift to an alternative. The small business owner, who is already strapped for time and resources, would have to reinsert years worth of accounting data into the alternative provider before they could start using it. Couple this with how time-sensitive and accuracy-sensitive such data is, and you can begin to see how it would be a nightmare to switch providers, whether AI is involved or not.

Thirdly, small businesses tend to pay for Quickbooks precisely because they don’t want the hassle of having to maintain their own accounting in an Excel sheet. The idea that they will suddenly shift to using AI to do their own accounting sits somewhere in the realm of fantasy, which anyone who has tried to do their own corporate accounting before will attest to. The probabilistic nature of AI transformers also suffers from hallucination, and is not well-suited for precise, exact tasks like filling in accounting or tax forms.

Fourth, TurboTax provides a 100% accuracy-guaranteed clause where they will pay your tax penalties if they file your taxes wrongly on your behalf. This sort of “soft” service is not replicable by AI, nor is the liability management that Turbotax offers.

Fifth, Intuit is already taking initiative on AI by partnering with Claude and OpenAI to embed AI solutions into Quickbooks, Turbotax, and Credit Karma. Far from waiting for a competitor to disrupt it, Intuit is readily disrupting itself with AI as the system-of-record to enable AI-assisted services for its customers. This means that not only would a competitor need to replicate all the private data stored on Quickbooks, it would also need to garner a similar partnership with Claude and OpenAI just to be competitive.

Finally, investors should not think of INTU as a Tech company that is ready to be disrupted by AI. In the same way that Apple is a Retail business, Quickbooks and TurboTax get their moats not from their technical capabilities but because of their brands. It’s the same phenomenon as Coca-Cola, as they’re the first names to pop into customers’ minds in their space when it comes to accounting software or tax filings.

>20% Growth at <20x PE

Despite its scale as a $80B market cap company, Intuit still has a large TAM opportunity to pursue. In fact, their opportunity is so large that analysts and investors of INTU typically do not give them brownie points based on their absolute revenues (as many “value” factor stocks tend to be measured) but in terms of how fast their revenue growth is. INTU today actually represents quite the opportunity for “value” investors, who are not used to seeing their companies post torrid revenue growth like this.

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Not Investment Advice. Read Disclaimers.

What if I told you that there was a stock with a similar valuation & growth profile as ADBE, but with none of the AI risk? GDDY, the world’s largest domain registrar, is precisely such a stock — trading at a similar 14x PE as Adobe, with a similar 10% revenue growth, but without any of the catastrophic AI risk. Relative to an investment in Adobe, GDDY offers the opportunity to have your cake and eat it too.

The stock is down -50% over the past year and -22% YTD alone, largely reflecting analyst re-ratings from higher growth projections gone awry. In essence, the stock is normalizing back to historical levels as its Applications & Commerce (A&C) revenue fails to deliver on initial sky-high expectations — more on that below.

However, Core platform revenue is still growing healthily, and more importantly Annual Recurring Revenue (ARR) represents a whopping 87% of total FY25 revenues. The business is not difficult to understand — people need domains to start websites, and once they sign up they typically don’t shift registrars (I’ve personally been with GoDaddy for over a decade). And while there aren’t a lot of switching costs in the industry, people also don’t tend to change hosts just because of an infinitesimally small price hike, which GoDaddy is still pushing strongly as evidenced by ARPU growing by 10% in FY25.

Crucially, this is a management team focused on growing LTV/CAC, by investing in marketing in a methodological, data-driven way. From reading the earnings call transcripts, you get the feeling that management has a map of where they are going and the “GPS” of how to get there. We’ll discuss this further below about how it shows up in the Gross Margins and operating leverage of the company, as well as the KPIs we should monitor going forward.

Investors already entrenched in ADBE will find a lot to like in GDDY. Unlike the former, GoDaddy has significantly less AI disruption risk, yet possesses all the investment trademarks of the Photoshop giant from a valuation & capital growth standpoint. It also benefits from the same recurring sales business model, with none of the seat-based risk that AI can disrupt. The company has plenty of cash, and is diligently reducing outstanding shares at a mid-single digit rate annually. Combined, there is a decent expectation for 20% normalized EPS growth, reflecting a potentially underpriced asset at its current 14x trailing multiple.

Business Model

While GDDY reports its revenues under two separate segments — Applications & Commerce (A&C) and Core — they are both the same set of experience to the customer and should be seen as two parts of a bundled offering. Core represents the domain registrar and hosting parts of the business, while A&C represents the Websites + Marketing add-ons that so-called high-intent customers (those with >$500 in ARPU) sign up for in addition to the Core offerings.

Management measures success based on 5 KPIs: 1) Traffic, 2) Conversion, 3) Attach rate, 4) Activation and 5) Renewals. Traffic represents the top of funnel that GoDaddy uses to attract new users via its domain signups, while Conversion represents how many people actually sign up for a new domain. The Attach rate represents customers who sign on for a website or marketing add-on where the real ARPU uplift comes from; while Activation measures high-intent customers via their actions such as setting up a new website or first login. Finally, the four KPIs combine to inform how successful GoDaddy is at encouraging customer Renewals.

Hence, the business model is simple: first, get people into the top of funnel via discounts or promotions, then convert them into paying customers for domains & hostings. From there, data is collected on customers to see who might be potential high-intent customers, and then marketing investments are made targeting those high-intent customers with the goal of upselling and cross-selling secondary offerings. Finally, a high-intent customer is more likely to engage in persistent renewal of services, which represents ARR to GoDaddy.

As aforementioned, the high-intent customer is someone who spends an ARPU of $500 or above. Given that average firm-wide ARPU was only $242 in FY25, there is real revenue uplift from targeting and gaining each new high-intent customer.

Subsequently, GoDaddy uses its AI solution Airo to surface high-intent customers by shepherding small or micro business owners through their product inventory. Airo helps customers not just by automating day-to-day work tasks; but also provides direct agentic advisory through its Airo Care function, which helps small business owners through providing business insights via the 30 years of data inventory that they have on small businesses. This process aims to surface high-intent customers as customers gradually recognize that GoDaddy is able to do more than just host domains and build websites, resulting in higher average order size, higher attach, higher retention and higher renewal. For example, nearly 10% of new bookings in FY25 was attributable to a customer having a touch-point with Airo Care.

Hence, attaining ARPU expansion is a mechanical process of surfacing solutions for high-intent customers via appropriate pricing and bundling. This is done by asking questions like: how to add incremental value to the customer, or what is the right bundle of products they should have for their stage in the business? What are the different attached products that make sense for what they’re trying to do? In this way, GoDaddy expertly bundles business solutions with the domain product driving not just ARPU but ARR growth too.

On retention, there is plenty of data showing that when a customer signs up for a second product, their retention is significantly higher than normal. Hence the tertiary objective is to get the high-intent customer to sign up for a third or fourth product, whereupon the retention rate skyrockets.

In summary, the business objective of GoDaddy is to attract, retain and renew the high-intent customer with an ARPU of $500 and above. This is achieved by reeling in new customers through the sales funnel of domains and hosting, then surfacing further sales intent using a methodological, data-driven approach which tests the waters over what customers want and where to invest incremental marketing dollars. Subsequently, they upsell value-added services to targeted customers by bundling attractive solutions for the entrepreneur, and further cross-sell products in order to encourage retention. Finally, they build on the retention of multiple products to get the high-intent customer to renew in the form of high ARR. These efforts are ultimately expressed in the financial performance of GDDY, which tells the story of how the business model as described above is performing and will continue to perform.

Financial Analysis

download Excel model below

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Not Investment Advice. Read Disclaimers.

Amidst record-high valuations in equity markets today, it can be hard to find stocks which are valued appropriately. Comcast is one of them, with the stock trading at just 5x trailing PE and down nearly -50% over the past 5 years.

The investment case is simple: as long as they’re able to service their debt adequately, the stock is priced at a straightforward 20% earnings yield, which is hard to beat. By comparison, NVDA which trades at 40x PE only yields 2.5%, which needs to grow by 800% (11% CAGR over 20 years) just to match CMCSA’s current yield today. Or put another way, at 20% yield you’d be breaking even on your investment in just 5 years. That’s some serious math.

Perhaps more importantly to shareholders: what’s stopping CMCSA from dropping another -50% from here? That’s what our “risk-first” value investing analysis aims to answer. If investors can put a floor on losing money in CMCSA, I think many will agree that the current valuation is highly tempting. Hence, we’ll do a financial deep-dive of CMCSA in this report to analyze what the downside could look like for Comcast.

This CMCSA analysis will apply a margin of safety approach to the valuation, and identify which are the biggest needle-movers for the stock that could impact its mouthwatering 20% earnings yield. Given the super-low valuation, this eschews the need to look for needles in haystacks and simply reduces the analysis to “what else could go wrong from here?”. It will be a very risk-based analysis and simply aims to preserve the straightforward 20% shareholder yield thesis, by identifying problem areas and without having to make any heroic assumptions about growth.

The Important Math: Debt

As aforementioned, the general thesis is to ensure that CMCSA manages to deliver its headline 20% yield without there being any nasty surprises up its sleeve to disappoint shareholders down the road. In this sense, debt serviceability is paramount and we want to ensure that their debt load has no potential for turning into trouble sometime in the future.

Firstly, it’s heartening to see that like-for-like Total Revenues are actually still growing. This demonstrates that CMCSA actually has other healthy businesses, despite its Broadband business (20% of revenues) getting all the headlines for being a melting ice cube.

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Executive Summary:

AGCO represents an incredibly unlikely high-growth innovation story in the Ag sector, with clear and ambitious operating targets to be achieved by 2029. The world’s No. 3 AgEq supplier after Deere and CNH presents a masterplan to penetrate the lucrative North American market, by targeting historically untapped farmer segments and reimagining the legacy dealership model. Its dedicated mixed-fleet approach to high-growth Precision Ag lays the foundation for a differentiated value proposition which its competitors are unlikely to replicate, and enables previously unconceived sector operating models. AGCO’s base-case valuation supports the existence of substantially asymmetric risk:reward — whether it achieves its highly ambitious operating targets or not.

Unlike CNH’s largely macro-driven growth in Part 2, AGCO’s fundamental-based growth is very much business-driven and within management’s control. Hence, this AGCO analysis in Part 3 is not a rehash of the largely macro-driven CNH analysis in Part 2. Instead, it will build on the Ag + AgEq sector outlooks found in both Parts 1 & 2 and focus on analyzing AGCO’s fundamentals purely from the bottom-up.

TABLE OF CONTENTS:

1. AGCO: Historically Outperformed Deere & CNH

2. Big 3: Not The Same

3. AGCO LT Outlook: High-Growth Innovator

4. AGCO 2025: ST Outlook

5. Asymmetric Valuation: Base-Case & Bear-Case

Bloomberg Interview: AGCO CEO Sees 2025 as the Bottom of the Farm Slump

Interview Summary: 

AGCO's CEO anticipates 2025 as the bottom of the current farm industry slump, citing positive indicators despite a 2024 downturn. The CEO downplays tariff impacts on AGCO directly, but expresses concern for potential effects on crop demand and farmer profitability. AGCO's strategy to counter industry cycles centers on "smart farming" through advanced technology in machinery, aiming to boost output while minimizing input. Significant investments in R&D and strategic partnerships are driving this. The company is also focused on expanding its high-end Fendt line to gain market share in North and South America, emphasizing its technology and farmer satisfaction.

Click here to read full transcript

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AGCO: Historically Outperformed Deere & CNH

Summary: 

AGCO has demonstrated historical outperformance compared to CNH and Deere, with a 10-year average net margin of 5% similar to CNH's. Its capital allocation and asset turnover ratios exceed peers' averages by 2x, while its ROA edges out even the larger Deere's. Deere's trailing P/S ratio stands at a significant 4x premium over AGCO and CNH.

AGCO has demonstrated historical outperformance as compared to both CNH and Deere. Its 10yr average Net Margin of 5% over a full-cycle is similar to CNH’s — even though both Deere and CNH have almost 10x higher average gearing than AGCO:

AGCO also vastly outperformed its peers in capital allocation. Its 10yr average Asset Turnover (over a full-cycle) was over 2x both of its peers; and it even manages to edge out the 10yr average ROA of the larger Deere (with greater economies of scale):

While intuitively this could be attributable to AGCO being a smaller business than both CNH and Deere, the latter two should have benefitted from greater economies of scale, thus somewhat offsetting the former advantage. Hence, AGCO’s unit outperformance here seems to be genuine.

As indicated earlier, AGCO has significantly more room to increase its financial leverage. This can be demonstrated by AGCO’s similarly superior 10yr average ROIC below, despite its far smaller economies of scale:

This led me down a rabbit hole to investigate the reasons behind AGCO’s superior outperformance. The performance drivers behind AGCO’s and CNH’s businesses are actually very different, with AGCO’s growth being largely fundamental-based while CNH’s growth is more sector macro-based. So rest assured that this AGCO deep-dive is not going to be a rehash of the preceding CNH report in Part 2.

The main reason why I’m not analyzing Deere in this report is because it has significantly higher trailing multiples, both in terms of P/E and P/S. AGCO’s trailing 0.6x P/S is similar to CNH’s 0.7x. By contrast, Deere’s trailing P/S is 2.5x (4x higher).

I’m using P/S here because of AGCO’s artificially high trailing PE owing to the prevailing Ag downcycle. Also, those interested in analyzing Deere can simply start from my earlier CNH analysis in Part 2 and make adjustements from there, since their businesses bear more similarities

Big 3: Not The Same

Summary: 

AGCO's outperformance compared to peers may be due to its non-overlapping market segments with Deere and CNH, each targeting distinct value propositions. Deere's "walled-garden" approach to its AgTech favors large farms with full Deere tractor fleets. CNH offers a mid-tier option with a more flexible approach to AgTech, but has faced integration challenges due to its "hands-off" approach to mixed-fleet configurations. AGCO provides premium Fendt tractors with a dedicated mixed-fleet dealer network, supporting smaller farmers' incremental adoption of 3rd party AgTech solutions. This reduces the entry barrier to Precision Ag and allows smaller farms to enjoy greater yields at lower upfront costs ($20,000 vs $1M).

Perhaps one reason for AGCO’s outperformance relative to its larger peers (Deere and CNH) is because it doesn’t compete head-on with them. The Big 3 AgEq suppliers each represent different value propositions to farmers, hence targeting somewhat non-overlapping market segments:

Deere

Known for being the expensive turnkey supplier. It has a “closed-source” approach to Precision Ag, enforced by having them factory-installed in their tractors. This means farmers cannot gain access to Deere’s AgTech without a Deere tractor, but it also makes activating solutions as simple as signing up for a subscription. This makes Deere the equipment supplier of choice for large farms with entire Deere tractor fleets, but puts off smaller farmers with existing mixed fleets or those who prefer to incrementally bolt-on equipment from different brands.

CNH

Known as the mid-tier, more affordable option — but has a somewhat clumsy approach to Precision Ag. CNH practices a “mixed-fleet” approach, which allows 3rd party AgTech solutions to be bolted onto their tractors. This naturally excludes larger farmers with existing full Deere fleets, making it a closer competitor to AGCO. However, the lack of any dedicated mixed-fleet support makes configuring different equipment brands to work together somewhat of a jigsaw puzzle, which has introduced integration challenges in Precision Ag.

AGCO

Best known for their premium Fendt tractors. AGCO not only practices a mixed-fleet approach, it’s building a dedicated mixed-fleet dealer network tasked with supporting mixed-fleet configurations. This means that a small farm can incrementally bolt-on 3rd party AgTech solutions to their existing tractors, significantly reducing the entry barrier to Precision Ag. Some of these only start at only $20,000; in contrast to having to buy an $1M Deere tractor just to enjoy the benefits of AgTech. This allows smaller farms to immediately enjoy greater yields from Precision Ag without having to break the bank.

While they are most definitely competitors, each of the Big 3 appear to deliberately focus on different market segments to cultivate differentiation. Each of their current market focuses demonstrates relatively low overlap — thus implying relatively low competitive intensity between the Big 3. This implies that AGCO isn’t at a serious competitive disadvantage relative to Deere or CNH despite being smaller.

Not investment advice. Read disclaimers.

Ambitious Targets To 2x Sector Growth By 2029

Deere’s roughly 10x larger market cap ($130B) implies a much larger business than CNH ($16B) or AGCO ($8B). However, Deere’s trailing revenues are actually only 2.5x larger than CNH and 4x larger than AGCO. Their total revenues are also not apples-to-apples comparison — AGCO is an Ag pure-play, while both Deere and CNH have Construction business segments.

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Not investment advice. Read disclaimers.

Interview Summary: 

AGCO's CEO anticipates 2025 as the bottom of the current farm industry slump, citing positive indicators despite a 2024 downturn. The CEO downplays tariff impacts on AGCO directly, but expresses concern for potential effects on crop demand and farmer profitability. AGCO's strategy to counter industry cycles centers on "smart farming" through advanced technology in machinery, aiming to boost output while minimizing input. Significant investments in R&D and strategic partnerships are driving this. The company is also focused on expanding its high-end Fendt line to gain market share in North and South America, emphasizing its technology and farmer satisfaction.

Full Transcript (slightly edited for clarity)

Interviewer:
What's your outlook? At the moment, is 2025 going to be the bottom?

Eric Hansotia, AGCO’s CEO:
Yeah, we expect ‘25 to be the bottom. Our whole industry went through a very significant downturn in 2024. This happens in our industry. It happened about a decade ago. There's always one year where there's a big correction — that was ‘20, ‘24. Oftentimes then, the industry somewhat hovers around that low point for a bit and then starts working its way back up. We watched two indicators. One is the Purdue index for North America and one is CEMA for Europe. Both of them are already starting to move up. That's usually a future predictor of demand that's coming down the pipe. So we think ‘25 is the bottom.

Interviewer:
I wonder how you expect President Trump to shake things up here. He has obviously a big take on tariffs. There's a lot of machinery coming in from Asia. On the other hand, crop demand out of Asia, crop demand in China is really important as well. So what are the changes that you see in the next administration?

Eric:
Couple of things. I would say, you know, the Trump administration has a lot of support from the U.S. farmer. A large portion of the U.S. farmers voted for Trump in this last election, as they did before. Trump has also historically been a supporter of agriculture as an industry. So those are both positives.

Additionally, Asia is not a huge market for the big farming equipment that we make. We really focus on high tech machines for very productive farmers as our target. And so Asia is not a huge market. We don't bring in a lot from China to the US. So, you know, in that regard there's some positives to look at and the issues that you raised are somewhat muted.

Interviewer:
So to that end, what do you see in terms of the aggregate impact? If you think about the community of farmers across the country, what is the biggest kind of headwind here? Do you think that there could be demand pressures elsewhere, notwithstanding the Trump administration's moves?

Eric:
Well, at the end of the day, the world still needs to eat a certain amount of green. So what happens in one market likely could shift demand to another market. We're a very global company, so it may, you know, maybe there is one less farmer benefitting from that demand, while another farmer like in South America or in Europe does.

Specifically to your question on North America. I think that the tariffs is probably the bigger question about what is the impact of follow-on tariffs to the demand of corn, soybeans, wheat — the primary products that drive farmer profitability. So that's the thing that we're watching for most closely. I would also say that the world doesn't like vacuums. They don't like uncertainty. So whatever change happens, farmers and we can manage around that. And so I think just getting clarity and certainty, and getting into the new environment is a good thing.

Interviewer:
Well, I want to talk about how you are navigating some of these headwinds, specifically at AGCO, because AGCO shares and your industry peers, they tend to be very closely tied to the industry cycle and the peaks and valleys that you have there. I know that you're working hard at AGCO to sort of divorce the share price from the cyclicality of the industry itself. If you could give us more detail on how you're actually trying to do that, that would certainly be helpful.

Eric:
Yeah. At the heart of our company, our vision is to be the trusted partner for industry-leading smart farming solutions. And essentially, what we say is smart farming is making a machine with sensors on it and onboard intelligence so that it can look at variations of the soil or variations of the crop to have the machine automatically do things for the farmer.

Essentially, think of an airplane being on autopilot mode, we want the machine to be in autopilot mode, handling tasks for the farmer. The reason for that is that the world needs more grain. The world needs more grain to feed more mouths, use more and biofuel, and have more meat in their diet, which is a multiplier for more green. So there's we need more output.

But society also wants less inputs, less fertilizer and chemical and herbicide and pesticide. The only way to solve that equation is technology, these smart machines. And so we have invested heavily in that. We've doubled our patent portfolio over the last five years. We've increased our engineering budget since I took over by 60%. We closed the biggest AgTech deal in the history of our industry this year, and we created a joint venture with a company called Trimble, a leader in GPS systems. All of that is to try and accelerate our ability to bring solutions to farmers to solve the toughest problems in agriculture. And we've got a lot of momentum in that direction. 2025 will be another big year with a lot of launches for machines that can do things for farmers.

Interviewer:
I'm actually surprised at the pop culture references, looking at Luke Bryan's Facebook page and he says, “The rain hit us in Ohio last night. Good thing we had our Fendt tractors here to pull out all of our gear”. And I know that you have spent time with Luke Bryan on the farm. What is your high-margin, higher-end line of products? You're hoping to take market share from Deere with those from the big spending farmers. How are you doing in that effort?

Speaker 2
You know, Fendt is the best machinery line in the marketplace. It's the best-of-the-best for the most demanding farmers. It's highest in technology, highest in quality, highest in operator comfort and has the best support network surrounding it. So we've been step-by-step working Fendt into the North American & South American market. It was historically more of a European brand. The last few years we've been bringing it to the other markets. We've been growing steadily from ‘21 to ‘23. We almost doubled the business and we're aiming to double it again. And the reason being that once farmers get to taste and experience the Fendt product line and the overall Fendt experience, they love it. It's very sticky and they don't like to go back.

So that's our mission. We have a great product line from planters & sprayers, tractors, combines, and then we measure that up with top-quality dealer support with our dealer organization. And we're trying to really bring this Fendt experience. The technology I talked about also comes to market and Fendt as our technology leading brand. So we have a tech business that serves directly to farmers in what we call “retrofit”, where we'll put it on any brand of equipment, regardless what they had and almost any age. But then we also have our Fendt business, which is our machines coming from our factories that bring the latest technology to the market.

Disclaimer: This document does not in any way constitute an offer or solicitation of an offer to buy or sell any investment, security, or commodity discussed herein or of any of the authors. To the best of the authors’ abilities and beliefs, all information contained herein is accurate and reliable. The authors may hold or be short any shares or derivative positions in any company discussed in this document at any time, and may benefit from any change in the valuation of any other companies, securities, or commodities discussed in this document. The content of this document is not intended to constitute individual investment advice, and are merely the personal views of the author which may be subject to change without notice. This is not a recommendation to buy or sell stocks, and readers are advised to consult with their financial advisor before taking any action pertaining to the contents of this document. The information contained in this document may include, or incorporate by reference, forward-looking statements, which would include any statements that are not statements of historical fact. Any or all forward-looking assumptions, expectations, projections, intentions or beliefs about future events may turn out to be wrong. These forward-looking statements can be affected by inaccurate assumptions or by known or unknown risks, uncertainties and other factors, most of which are beyond the authors’ control. Investors should conduct independent due diligence, with assistance from professional financial, legal and tax experts, on all securities, companies, and commodities discussed in this document and develop a stand-alone judgment of the relevant markets prior to making any investment decision.

Executive Summary:

This CNH deep-dive will demonstrate how Einhorn’s description of his thesis in the CNBC interview below doesn't do any justice at capturing how deep the research rabbit hole actually goes. It will reveal how the business trajectory of the world’s No. 2 AgEq supplier is one with strong risk:reward asymmetry — as well as having a highly defensive stance amidst the prevailing short-term Ag downturn. Contrary to popular expectations, CNH has managed to grow its full-cycle operating income by 2.0x since the last cycle peak in 2019 (15% CAGR), and its full-cycle net income by 1.6x over the same period (11% CAGR). The devil is truly in the details, and this report will analyze its business with a fine-tooth comb to provide all of the granular drill-down detail necessary to understand CNH’s factors of performance. By the end of this report, readers will be able to assess for themselves what CNH’s future trajectory looks like, as well as appreciate the true extent of the detail underlying Einhorn’s thesis.

Not investment advice. Read disclaimers.

This part of Einhorn’s conversation is only 70 words long, yet to the astute industry observer it’s actually overflowing with insight. This entire deep-dive can basically be described as an expanded version of it that provides significantly more context. That’s how crystallized his CNH thesis is.

In our preceding Part 1 report, we saw how famed value investor David Einhorn had acquired a medium-sized position in CNH, the world’s 2nd largest Ag Equipment supplier. Ostensibly, his thesis simply amounts to CNH being a low-risk asset with 10% yields in a world where long-term risk-free rates are 4%. While on the surface that seems like a reasonable argument, it’s what Einhorn didn't say that is particularly striking. To someone familiar with CNH, the company is actually so much more than that.

The current environment for the wider Agricultural Equipment (AgEq) sector is a classic example of how LT and ST outlooks for the same thing can diverge significantly (i.e. markets not being efficient). At first glance, it’s true that the industry will likely underperform in 2025. Following the record-breaking Ag upcycle of 2022/23 (which we covered in Part 1), industry supply:demand dynamics normalized with a vengeance — resulting in plummeting row crop spot prices throughout 2024. This occurred amidst a backdrop of still-elevated input costs — with fertilizer and natural gas prices being impacted by the Russia-Ukraine war, GMO seed costs rising amidst high inflation, and financing costs going through the roof owing to artificially high US policy rates.

However, what’s missing from the 2025 sector consensus is how the LT outlook for the wider Ag industry remains bright. Global population growth will continue unimpeded until 2050 when it hits 10 billion people, driving secular demand for arable crops in pursuit of greater harvest yields and food security. In Europe, environmentally-sustainable agriculture policy such as the Farm to Fork Strategy in the EU Green Deal and the Common Agricultural Policy (CAP) will place cost and pricing pressure on farmers — and companies who can help farmers navigate the new regulatory regime have an opportunity to add immense value to them. Growing AgEq markets in Asia-Pacific like China and India are still starting from a relatively low base as far as mechanization rates are concerned, and there is ample room for organic secular long-term growth to develop there. Finally, frontier markets like Africa and Southeast Asia still mainly farms by hand, serving as right-tailed upside optionality for global AgEq incumbents.

That’s before we get to the difference between companies. While developed markets like North America and Western Europe are widely seen as mature AgEq markets, smaller incumbents like AGCO have plenty of room to take market share from their larger brethren. AgTech is seen as a massive growth lever for the AgEq sector, with AgTech developments like autonomous tractors and electrification stealing the limelight. Far from being the sleepy old-world industry that it is typically characterized as, the Agriculture industry is actually teeming with innovation — with high-margin solutions that would rival those found in the Tech sector. Just ask some of the Tech firms who are trying to penetrate the Ag software industry.

In this Part 2 follow-up, we’ll cover every conceivable angle that matters to the global AgEq industry and CNH — by building on the AgEq + Global Ag Row Crop industry primers found in Part 1. We’ll develop new insights on the LT Ag sector outlook; in contrast to most sellside research which appear to be overtly focused on the sector’s short-term outlook. This prevailing market consensus about CNH obscures the highly visible long-term opportunities virtually sitting on its windshield, creating incredible market inefficiencies when viewed over longer time horizons. Far from being just a 10% yield instrument in a 4% world, CNH is actually standing on a precipice of highly asymmetric risk:reward at its trailing 10x multiple. Let’s unpack what Einhorn did NOT say about it, and explore what else he is still keeping close to his vest.

TABLE OF CONTENTS:

1. CNH LT Outlook: Global No. 2 Surfing Industry Tailwinds

2. Pulling It All Together: CNH’s Theoretically Ideal Scenario

3. CNH ST Outlook (2025-2026): CNH Analysis + AgEq Sector Forecast 

CNH LT Outlook: Global No. 2 Surfing Industry Tailwinds

As the No. 2 AgEq supplier globally after Deere, CNH’s future performance trajectory mirrors that of the wider global Ag sector for row crops. In attempting to understand its business, we should first gain a comprehensive understanding of the Global Ag sector (focusing on row crops) — in terms of its current state, developments and future outlook.

While on the surface Deere has 15% global market share against CNH’s roughly 7% and AGCO’s 2.5%, this high-level description obscures crucial details about the composition of the global AgEq market — such as bifurcation by equipment type, regional outlook & exposure, new vs. used equipment markets, dealer networks, brand perception by farmers, etc. These all ultimately combine to influence the sector’s most important metric, unit prices. By comprehensively segmenting the global AgEq market in this way, we can gain a map of where the future tailwinds of the AgEq sectors are blowing and therefore where CNH’s true growth levers lie.

CNH LT Outlook: Bird's Eye View

1. Market Share by Region

2. Market Share by Equipment Type

3. Average Fleet Age by Region

4. Small Farms vs Large Farms By Region

5. Brand Perception by Farmers 

6. US Farmers’ Post-Election Optimism & Trump Tariffs

7. LT Macro Tailwinds in the Global AgEq Industry

Read more

Not investment advice. Read disclaimers.

What David Einhorn is describing here is simply the reverse-blade of the double-edged sword concerning what he said earlier — about capital markets having been irreparably damaged by passive funds. When brainless passive funds auto-buy and auto-sell stocks regardless of valuation, it creates unbelievably inefficient market opportunities for value investors like Einhorn. And clearly he believes that CNH qualifies as such a candidate.

In his recent CNBC interview above, Einhorn stated that he had acquired a medium-sized position in CNH. For the uninitiated, the US Agriculture Equipment (AgEq) sector is dominated by the Big 3 with a combined market share of 40% — John Deere (NYSE:DE), CNH Industrial (NYSE:CNH) and Agco (NYSE:AGCO).

Many readers are likely unfamiliar with the old-world Ag industry, hence I thought it’d be instrumental to first bring everyone up to speed on recent developments in the sector (a lot has happened). Part 1 of this analysis will serve as industry primers for both the US Ag Equipment and the Global Ag row crops sectors respectively — the latter is where the AgEq sector has the biggest exposure. Subsequently, we will build on it in Part 2 to perform a deep-dive into both CNH and AGCO. (Why AGCO? Stay tuned to find out.)

In Part 1, we’ll explore all of the moving parts in the US AgEq sector — namely its business model, competitive dynamics, and the business differences between the Big 3 of the industry (Deere, CNH, AGCO). I’ll also be doing a similarly detailed industry primer for the wider global row crop sector, given its outsized influence on the US AgEq sector — where we’ll cover what contributed to the Ag downcycle of 2024, as well as the factors behind the immediately preceding Ag upcycle of 2022/23.

Doing this should give us a comprehensive 360° view of all of the relevant moving parts necessary for the analysis, whereupon we can pull it all together in Part 2 to finish our deep-dive analysis into CNH and AGCO next week. This side-by-side comparison of the two AgEq giants will lay bare the drivers of AGCO’s surprising outperformance vs. both Deere and CNH — and how it might fare differently going forward into the next Ag cycle. It will also help us figure out what Einhorn likes about CNH — and more importantly, what he hasn’t said about why he likes them.

The global row crop sector — and the US AgEq sector by extension — is a byzantine labyrinth of a minefield to understand, and there are a lot of prevailing misconceptions about what affects the global spot prices of row crops (e.g. did you know that high crop prices are not necessarily a good thing?). This US AgEq + Global Ag Row Crop industry primer combo should go a long way towards clarifying what matters and what doesn’t in the sector, while also adding incrementally to your mental model of wider global macro developments.

CNH vs. AGCO (Part 1): Ag Equipment + Global Ag Row Crop Industry Primers

1. Ag Equipment Industry: Business Model Primer

2. Global Ag Row Crop Industry: Macro Sector Model 

3. Macro Factors behind the 2022/23 Global Ag Upcycle (Row Crop)

4. Macro Factors behind the 2024 Global Ag Downcycle (Row Crop)

CNH vs. AGCO Deep-Dive (Part 2: Next Week)

1. Normalized LT Sector Outlook: Global Ag Row Crop + US Ag Equipment

2. CNH: Why Not Deere?

3. AGCO: Reinventing The Wheel

Ag Equipment Industry: Business Model Primer

Ag Equipment Industry: Business Model Primer

1. Big 3

2. Crop Cycle

3. Sector Inventories

4. Used Equipment Market

5. Purchasing Behavior

6. Dealer Network

7. Financing

8. AgTech!

9. iOS vs. Android

10. Permanent vs Row Crops

11. Returns: Farmland vs Crop Sales

12. Subsidies & Reference Prices

13. Tariffs

14. Geographical Exposure

Read more

Not Investment Advice. Read Disclaimers.

There’s a reason why Dropbox is only being valued at 16x PE — its growth heydays are widely perceived to be behind it. However, a keener look reveals that there's much more to it than meets the eye.

In contrast to the early 2010’s, Dropbox’s bread-and-butter FSS (File Sync & Share) service has since matured to incumbent status — with both the no. of paying users and ARPU flattening in recent years. Being in a commoditized industry, part of this is inevitably down to the cyclical trough that the tech sector is currently digesting through as a result of the massive pull-forward activity in 2021. The silver lining here is that this also implies that Dropbox’s growth will one day have its day in the sun again, since cycles always recycle.

Invisible to the tech zeitgeist, there is a silent wind slowly filling Dropbox’s sails. In recognizing the maturity of FSS, “Outsider” CEO Drew Houston has since declared war against commoditization by throwing his weight behind a business model shift, in the form of the AI-powered Dropbox Dash.

While Dropbox has long since taken strides into the Enterprise space with its many acquisitions (e.g. HelloSign, DocSend, Reclaim, Nira), it has fundamentally remained a cloud service provider with branching services. However, the insertion of an underlying AI layer supercharges what Drew calls the “application layer” of AI — in contrast to the underlying foundational layer (i.e. models) — and is where some of the major AI players are currently making huge strides in differentiating themselves (e.g. Perplexity, Claude MCP1).

With over a decade of personalized user data within its walls, Dropbox is well-positioned to provide a differentiated USP to its SMB clients (who make up 80% of its userbase) without having to own its own AI model. To share a quick example, think of how much lost insight the business development team of an SMB could reclaim in terms of pricing strategy, or how a wedding photographer could refine their output by analyzing the terabytes of video that they’ve accumulated in Dropbox over the years. These are real-world applications which represent incremental value for the consumer, which translates into incremental ARPU for Dropbox — a strong rebuttal to lamentations about Dropbox’s future growth.

Management claims that this sector is an $8B TAM opportunity today — one which is expected to grow by 27% CAGR to over $20B by 2027. Fact checking their claims reveals that IDC has a slightly less rosy TAM of $6.5B today, but shares similar future TAM growth expectations (FY23: 20% CAGR):

While commoditization will always be a fact in the sector, it hasn't really seemed to impact Dropbox in the past — as evidenced by its consistently climbing ARPU and paying user count, which we shall dive deeper into below. There's an inherent stickiness with the SMBs that make up 80% of its userbase, and as long as Dropbox remains competitively priced, I don't see why that has to change.

This is not to take away from the short-term headwinds that Dropbox is facing; however, to say that their future growth is 0% into perpetuity is patently false. For one, much of the recent ARPU flattening has been due to the prevailing tech sector recession (i.e. macro rather than Dropbox’s fundamentals), which has been weighing heavily on SMBs. With a growth-friendly Trump administration incoming and the Wilshire 5000 off its troughs, there is ample optimism that this too shall pass. And if Buffett is right about a recession… well it’s a 16x multiple.

One place where I never really expected to find an “Outsider” management style was in the “growth at all costs” Tech sector. It was thus a pleasant surprise to find that Drew Houston, the founder and CEO of Dropbox, had managed his company in a fiscally disciplined manner befitting of the moniker “Outsider” CEO.

For the uninitiated, value investors commonly reference William Thorndike’s book of the same name to describe CEOs which shared “outsider” management styles — legends the likes of Henry Singleton and Warren Buffett, who despite their ROIC focus managed to outperform Jack Welch during his legendary growth tenure at GE. Drew Houston embraces a similar mathematical drill-down management style in running Dropbox, which leans into the company’s diversified SMB client base and FCF-generative business model.

In this Dropbox deep-dive, we’ll look at Dropbox from a fresh perspective to uncover the risk:reward asymmetry lying dormant in this misunderstood “Outsider”:

DROPBOX DEEP-DIVE:

1. Maturing FSS and How Things Got This Way

2. Breaking Down the $20B AI Opportunity (Dash)

3. Risks & KPIs to Monitor Going Forward

4. Asymmetric Risk:Reward & The Outsider CEO

Maturing FSS and How Things Got This Way

After nearly 2 decades, Dropbox’s File Sync and Share (FSS) business has claimed the No. 2 market share and has begun showing signs of maturity. While the aggregate business is reliably churning out over $700M of FCF on just $2.5B in LTM revenues, at first glance it appears to have a wall to scale where growth is concerned:

Read more

JPM initiates CELH with Overweight rating (update): The analyst suggests that Celsius’ current 10% share of the U.S. market could see a 10-29% increase in equity value, assuming Monster’s U.S. market share drives 60-70% of its valuation. This estimate, however, doesn’t account for further market share growth, international expansion, entry into new categories, or margin improvements, Teixeira adds.

The resemblance between CELH today and KO when Buffett first bought it in 1989 is uncanny. It’s like someone bottled KO into a time machine and sent it into the future:

• Both are/were suffering from clearly temporary growth setbacks;

• Both occupy top positions in their respective branded retail sectors (i.e. pricing power);

• Both are/were gushing FCF despite prevailing sentiment about future growth;

• Both are/were mainly US businesses with clearly untapped International potential — which markets were severely underestimating;

• Both had plenty of room to increase financial leverage, with ridiculous ROICs;

• (Note: I made a slight error here earlier about KO’s valuation in 1989, which has since been edited out. Fortunately it doesn't really change anything, the point that I was trying to make was that the trailing PE reflects trough demand conditions.)

Not Investment Advice. Read Disclaimers.

Margin Accretion via Solving Supply Chain Incentives

Celsius’s extremely successful strategic partnership with Pepsi in 2022 has since become a model for the rest of the beverage industry to follow. This mutually beneficial partnership came after Bang Energy’s catastrophic implosion, which released Pepsi from its exclusive relationship with them and allowed it to court Celsius. Hence there exists a beaten path for Celsius to maintain its current No. 3 position in the energy drink market — simply follow what came before, and avoid Bang’s mistakes of overleverage and hypergrowth.

Achieving success in the beverage industry is fundamentally a matter of resolving incentives across the value chain. Each stage of the supply chain has various parties with their own incentives — from the manufacturer to the end-customer — where solving them amounts to incremental margins for the brand owner. From this perspective, possesses an entrenched position by virtue of its ability to provide lasting solutions to each stakeholder within the beverage industry’s value chain.

There are a few key bottlenecks within the beverage industry’s supply chain which represent its fulcrums for incremental margins. Pepsi’s $550M investment in 2022 almost certainly involved Celsius switching distribution modes from DTR1 (direct-to-retail) to in-house DSD2 (direct store delivery) using Pepsi’s blue trucks (ala Gatorade). This not only reduces outbound freight costs but also increase sales velocity — simply by reducing out-of-stock situations at end-retailers. DTR relies too heavily on reliable restocking by minimum-wage store employees with little incentive to do so — as compared to Pepsi’s distributors, who are penalized on underperformance. This matters when >50% of Celsius’s sales occur through the convenience store channel, which has the highest margins vs. grocery or e-commerce.

Pepsi’s incredible distribution reach also no doubt helped Celsius in getting placement alongside Red Bull and Monster in checkout coolers and within cool doors at mass retailers like Walmart, which significantly increases the incidence of impulse purchases. This is a huge improvement over Celsius being stocked at the soda aisle when Anheuser-Busch was still their distributor (prior to Pepsi) — much less when they were still placed at the health foods aisle next to vitamins before that. Celsius rapid +100% sequential sales growth to the No. 3 spot until early this year was also no doubt partly due to Pepsi treating Celsius as a priority— ABInBev would prioritize trucking beer to stores first, whereas soda is a priority for Pepsi’s trucks.

This premium placement spins the sales flywheel as convenience stores and mass retailers alike are incentivized to prioritize shelf space for brands with the highest turnover and restocking capacity3. Celsius’s nationwide reach of 98% ACV4 puts them in the same ranks as Red Bull and Monster in the energy drink space — all but placing a distribution moat between them and smaller brands like Alani Nu or Ghost.

Celsius’s being in the ‘better-for-you’ category (i.e. sugar-free) also solves highly differentiated consumer incentives as compared to Red Bull and Monster. The typical energy drink consumer is a blue-collar male, and would be hard-pressed to find similarities between the harsh chemical flavors of Red Bull vs. the green tea and ginger base of Celsius’s drinks. The latter’s sugar-free options appeal to an entirely different target audience consisting largely of women and professionals.

Such bifurcation of consumer segments creates new markets for the energy drink sector, as Celsius’s growth comes from growing the pie rather than stealing market share from existing players. This is not unlike how Uber introduced ‘ride-sharing’ rather than fighting for scarce medallions; or how LCCs opened new routes at airports located in the outskirts rather than compete with incumbent FSCs at main hubs. Management commentary in their Q3 earnings call also alluded to this being one of their main growth drivers:

John Fieldly President, CEO & Chairman

The sell-through data we are seeing continues to be supportive of us being the largest driver of the energy category. I want to reiterate our 3 key growth drivers that we are focused on for the rest of the year and beyond: attracting new consumers into the energy category; expanding the product availability; and increasing consumption frequency.

As the highest-growth niche in what is already the highest growth beverage category (energy drinks), sugar-free represents a vastly trending segment of the beverage sector. Celsius’s 9% market share stands heads-and-shoulders above Alani Nu’s 2.4%, Ghost’s 2.6% and Reign’s 2.6%. This is before considering their nearly 12% dollar share in MULO+ Convenience5, the highest margin category. KDP’s 60% acquisition of Ghost for $1B last month and Monster’s recent investments in sugar-free innovation represents seismic shifts in the sugar-free segment — the following commentary is from Celsius’s Q3 earnings call:

John Fieldly President, CEO & Chairman

All right, Eric. Excellent, Eric. That's the first question in regards around the execution and really as you further identified the sugar-free movement that's taking place in the energy category with Red Bull now further leaning in as well as Monster leaning in with some innovation in sugar-free.

This just reinforces the opportunity that we have at Celsius as a strong, solid #3 player in the energy category. This shows the opportunities we have to further work with our retailers and bring more consumers in as this category not only grow, it gets back in a growth mode, but further seize the sugarfree energy movement and percentage of business continue to grow at an increasing rate.

Celsius’s growth is also a function of solving incentives with market incumbents, namely Pepsi. Building a new brand from scratch is an expensive affair fraught with uncertainties, even for incumbents — with market leaders in various consumer sectors preferring to acquire existing successful brands and take them to the next level instead. KO’s 16.7% stake in Monster and KDP’s recent 60% acquisition of Ghost belies such incentives, with the exclusivity arrangements effectively serving as a moat between them and smaller brands outside the walled garden. Alani Nu’s inability to find an acquirer since mid-2023 demonstrates the difficult of crossing this moat; Celsius has found itself on the other side before too, prior to Bang’s implosion in 2021 which disallowed Pepsi from courting them.

In their recent 3Q earnings call, Celsius management guided that much of 2025’s expected sales tailwinds would come from a recent update to its incentive program with Pepsi, which includes an additional focus on priority periods — e.g. holiday seasons, back-to-school, end-of-year clearance sales, etc:

Kaumil S. Gajrawala Jefferies LLC, Research Division:

I guess, a couple of things. The first is you're specific to mention in your prepared remarks that the new incentive structure with Pepsi and that you're positive about it. Can you give us maybe some more details on what's behind that and why that should drive category acceleration from where we are now?

John Fieldly President, CEO & Chairman:

Yes. When you look at it, the program -- the further alignment and incentive program we implemented in 2004 is really further getting implemented into 2025 with additional focus on priority periods. We just finished NACS last month and coming off their annual operating plan meeting that was in Las Vegas that our group -- our leadership team as well as a variety of other team members attended.

Just -- we're getting great cross-functional collaboration, further alignment on our 2025 plans. And it's -- we feel like we're going to have more of a cohesive approach as we're further aligned to truly drive this category, getting additional availability, expanding placements and getting Celsius in the hands of more consumers and disrupting that path to purchase, which is so critical on building a brand and getting more trial.

This follows an earlier amendment to their incentive alignment program with Pepsi in March, the details of which can be found in their notes:

On March 23, 2024, the Company entered into Amendment No. 1 to the Distribution Agreement with Pepsi, pursuant to which the Company will provide Pepsi with an incentive program designed to incentivize and compensate Pepsi for its continued focus on and actions to support the Company. These incentives are accounted for as promotional allowances and recorded as a reduction to revenue.

The sum of all this is to say that solving incentives across the value chain is a reliable lever for margin accretion that buffers Celsius’s moats against competition, both big and small. Their sugar-free branding differentiation solves different consumer incentives vs. incumbents Red Bull and Monster — which as we saw in last week’s article about Brands, is fundamentally a matter of self-expression. This means that Celsius’s further success is a beaten path with formulaic levers that benefits from defensive moats against incumbents, which calls into question the peak-to-trough 75% crash in their share price, that just inflected last week.

Not Investment Advice. Read Disclaimers.

Why CELH crashed 75%

After several successive periods of +100% sequential revenue growth, CELH came crashing down to earth when it guided slower sales growth in Q1, owing to the temporary Pepsi overstocking situation which management expects to be resolved by year-end. This impacted YTD earnings and resulted in CELH’s artificially high trailing PE of 40x.

Read more

Not Investment Advice. Read Disclaimers.

In this follow-up to last week’s Part 1, we shall be doing a proper financial deep-dive into BABA’s fundamentals + segment analysis of the past 10 years (FY15-24) — in order to identify its recent sources of underperformance, as well as how they relates to their valuation. Here’s what we’ll be covering:

A FINANCIAL MAP OF BABA (Part 2)

1. Weird Capital Structure

2. A Tale of Related Party Transactions, JVs & Land Use Rights

3. Identifying BABA’s Sources of Underperformance through P&L Analysis

4. Detailed Segment Analysis (Deep-Dive!)

5. Amazon:Demystified

6. 📊 Download BABA 3-statement model (FY15-24)


Don't forget to check out Part 1... if you're on desktop, click the left bar for Table of Contents! ⬅️

Weird Capital Structure

As noted in Part 1, BABA does regularly issues shares as part of recurring SBC expense; however it also immediately amortizes the related employee compensation cost. Hence, actual share count growth has historically been negligible. There was a 1:8 share split on July 2019, but its dilution impact has been immaterial (<1% CAGR). One notable recent change was that their ADRs issued dividends for the first time in FY24 — amounting to a dividend yield of roughly 1%.

As one might imagine, there isn’t a lot to discuss about the health of BABA’s balance sheet or cash flows — given that they’re one of the largest companies in the world. They’ve been consistently in a Net Cash position as well as a negative CCC position for most of the past decade, thus going concern risk is negligible. Their leverage ratios are demonstrated in the chart above.

However, one thing that does stand out amidst BABA’s balance sheet is their unusual capital structure. As the chart above shows, their Invested Capital has averaged at around 70% of Total Equity in recent years — implying high levels of Net Cash.

The chart below demonstrates how this becomes even more distorted if we add their Investments + Net Cash (grey). Net Cash + Investments has reached 75% of Total Equity in FY24. This implies that they might not be “investments” in the typical sense of the word, and perhaps more akin to recurring business CAPEX:

The last piece of the puzzle before we move on to the actual analysis is their Fixed Assets. As we can see above, Intangible Fixed Assets (orange) actually make up a far larger proportion of their capital investments than Tangible Fixed Assets (blue). This implies that BABA has mostly been relying on acquisitions to grow its capital base. It also jives with most of their investments being Joint Venture business arrangements in nature, as we saw in Part 1.

Putting all of this together, what are the biggest sources of BABA’s invested capital structure?

What’s startling in basically the Eastern equivalent of Amazon is how little in tangible assets they actually invest in. It’d be perfectly natural to assume that their PPE balance would be high — given how capital-intensive e-commerce logistics actually is.

However, as we can see above, PPE (orange) actually has the smallest balance amongst BABA’s fixed assets — it’s even smaller than their Intangible Assets (grey).

Perhaps even more surprising, Equity Securities and other Investments balance (blue) is almost as high as their Intangible Assets (grey)! As you can imagine, these reflect the high frequency of Joint Venture arrangements which forms part of BABA’s business model.

A Tale of Related Party Transactions, JVs & Land Use Rights

This observation of BABA’s reliance on JV arrangements has led some quarters to allege that BABA abuses Related Party Transactions (RPT) to generate abnormal profits. But is this really the case? In this section, we’re going to explore just how notorious they really are — and identify who the likely culprits involved might be.

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Not Investment Advice. Read Disclaimers.

Michael Burry, rockstar fund manager of Big Short and Gamestop fame, is well-known for his super detailed deep-dives into stocks. He also recently invested heavily into Chinese stocks, including making BABA his top position. The title of this BABA report alludes to both matters.

This two-part BABA report aims to recreate the accounting deep-dive that Michael Burry would’ve done — and by extention, see what he sees in it. In light of China’s recent “policy bazooka”, I was actually looking around for a good financial analysis of BABA — but was unable to find one, to my great surprise. There are plenty of articles analyzing BABA’s businesses, but few that actually tore apart their accounting by taking a magnifying glass to their financial statements. This BABA “Michael Burry Special” aims to fill that gap.

My initial thought process was that if BABA’s earnings could potentially normalize back to FY20-21 levels (current: FY18-19 levels), that 29x trailing PE could look a lot closer to 15x. However, a closer look reveals that there’s actually much more to the story — its PE ratio is not even the correct multiple to use when valuing BABA.

Long-time value investors will also be intimately familiar with Howard Marks’ (paraphrased) rule: “Cycles Always Recycle.” While much uncertainty remains over the trajectory over China’s domestic economy, BABA itself is actually seeing quite a bit of optimism ahead. Their latest earnings call revealed that China retail GMV (Taobao, Tmall) was showing signs of recovery, while their International segment (Lazada) turned EBITA positive for the first time in July 2024. And while any mention of AI will always sound like a soundbite, there’s plenty of CAPEX activity in that segment belying much more demand than they can keep up with.

The long and short of it is that I think Burry might be right — BABA is actually much healthier from a normalized earnings perspective than most people give it credit for. Granted the bar for its expectations has been set pretty low, but that doesn’t take anything away from its still-growing fundamentals.

In this Part 1 report, we’ll cut through the fat in BABA’s financial statements (FY15-24) and attempt to uncover its future earnings trajectory, as well as discern its fair value. Some of the things we’ll cover include:

• Why the PE ratio is the wrong valuation multiple for BABA;

• How to properly understand BABA’s normalized earnings performance (hint: it’s not Net Profit!)

• How BABA’s management use of the unconventional pro-forma metric Adjusted EBITA can be justified;

• What adjustments are needed to Adjusted EBITA to arrive at BABA’s normalized earnings;

• …and much more! You’ll be able to download my Excel model with BABA f/s data (FY15-24).

In next week’s Part 2 follow-up, we’ll take a surgeon’s knife to BABA’s accounting and cut to the bone analyzing their fundamentals. There we’ll discover what BABA’s true growth drivers are, and how it’s actually a lot easier to analyze than most people think. Once you cut through the noise in their accounting, what really moves BABA’s needle becomes blindingly obvious.

This BABA report assumes that readers already have some basic knowledge of BABA’s businesses. It will not rehash what can be easily found elsewhere — e.g. a business analysis of BABA’s various segments, or the merits & weaknesses of the VIE system. Rather, it seeks to reproduce the research that Michael Burry would’ve likely have performed — a full-fledged accounting deep-dive into BABA’s financial statements over the past 10 years.

I guarantee that by the end of next week’s Part 2, you’ll be able to speak much more confidently concerning BABA’s business segments and their future earnings trajectory than most people can. Remember, narratives lie, but numbers don’t.

BABA: Accounting Deep-Dive (Part 1):

1. Why P/E Ratio is the wrong multiple 

2. Making sense of Adjusted EBITA

3. So what then IS the best valuation multiple?

4. Valuing BABA -- Correctly

5. 📊 Download BABA 3-statement model (FY15-24)



Next Week: BABA (Part 2):

1. Identifying Sources of Underperformance

2. ...🔓

⬅️ If you're on desktop, click the left bar for Table of Contents!

Check out two of my earlier articles linked in this report!

Not Investment Advice. Read Disclaimers.

Why P/E ratio is the wrong multiple

At first glance, it might seem as though BABA’s valuation isn’t cheap. From a low of just 19x PE in April, its shares have since reverted to around its post-pandemic mean of 29x PE. That may not seem expensive, but it sure does seem fairly valued.

However, there’s much more than meets the eye to BABA’s P&L.

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2024 seems to be the year of Big Retail mishaps, with the likes of Dollar General, Starbucks and Nike all seemingly facing the same problems. To rather unfairly stereotype the issue, one could describe all of them as “Suffering from McKinsey”.

What do I mean by this? McKinsey and the wider management consulting industry is notorious for recommending strategies to CEOs which may seem good on paper, but turn out to be disastrously detached from “on-the-ground” reality. While it may not be entirely fair to blame McKinsey for this, all three of the aforementioned Big Retail companies appear to share the same problem of “chasing numbers at the expense of reality”:

• This excellent article explains how Nike’s former CEO had a tech background — and in the search for margins, pivoted Nike’s strategic direction entirely towards Digital during the pandemic years, even at the expense of longtime B&M partners. Once the post-pandemic retail environment made it clear that B&M was here to stay, those partners had already moved on to competitors. Nike just announced his replacement a few days ago.

• Starbucks’ former CEO appears to have faced a similar issue as well. He had intended to pivot the company towards a more Digital trajectory amidst the pandemic boom — which while intended to drive more in-app traffic and takeouts with higher margins, had the unintended effect of eating into Starbucks’ ‘3rd Home’ in-store experience. While Starbucks’ problems are more endemic than this, this strategic misstep ultimately hurt domestic performance and Schulz’s handpicked ex-CEO has since resigned.

• A few weeks ago, Dollar General’s share price suffered a steep -30% drop owing to poor forward guidance. As we shall see later, a lot of it was due to a similar “chasing numbers from ivory towers” phenomenon in search of promised margins.

The silver lining here is that both Nike’s and Starbucks’ CEOs have since been replaced, and investors appear to be liking it if both of their share prices are any indication. Nike’s share price has popped +5% on last week’s news, while Starbucks’ share price has surged by +25% on similar developments.

Would it thus be wise to write off Dollar General’s business trajectory as completely irredeemable? To understand this, let’s do a deep-dive into their present-day issues — and why a changing of guard could provide an easy fix to all of their present-day malaise, similar to Nike and Starbucks.

Check out my earlier research articles about Dollar General:

Not Investment Advice. Read Disclaimers.

Problem: Bean counters in ivory towers

Easy fix: Hire more people

A few days ago, TSOH’s Alex Morris published an excellent expert interview hosted by Tegus with a couple former DG store managers. In light of Dollar General’s recent -30% stock price crash, I felt compelled to give it a listen and found the entire interview enthralling.

To describe it briefly, Dollar General’s (DG) recent woes can be boiled down to being a “classic MBA-ify/McKinsey problem”. That is to say, management has been overly focused on achieving numerical growth targets while eschewing business/operational realities. This is a very common issue that has plagued businesses for eons — and fortunately, there’s a clear roadmap towards fixing it.

In DG’s specific case, management is often held accountable to achieving 6% Net Margins as an ideal operational target. The reason behind this is simple: DG has a very simple Retail business model — and with 20,345 stores nationwide (as of 24Q2), there is little going concern risk in the way of excess competition, including from the likes of Walmart or Family Dollar. I’ve covered this previously in my earlier DG articles, so head over there if you’d like to find out more.

With DG’s revenue growth being pretty much capped simply by virtue of their larger-than-life nationwide scale, what really moves their needle is improving margins. Unfortunately, this reaching for incremental margins has resulted in an all-too-common easy fix: cutting costs independent of wisdom in the haphazard pursuit of earnings growth.

In DG’s specific case, the problem is cutting labor hours at the expense of operational sustainability. TSOH’s interview above is particularly enlightening on this matter, with the former store managers being interviewed shedding light on how DG’s top management has been cutting labor hours to the bone in service of reducing unit costs.

Unfortunately, top management’s insularity from the field while dishing out orders from their ivory tower has blinded them to the highly undesirable knock-on effects of doing so:

1. For instance, the store managers mention how DG stores actually receive enough inventory — but they’re not being properly stocked on shelves as a result of lack of manpower. This lack of proper shelf stocking drives customers away to competitors, and once they’ve formed an opinion about your lack of inventory, they’re usually gone for good.

2. Another example provided was the execution of self-checkout. Self-checkout works at places like Walmart because there are adjacent human cashiers having enough eyes on the self-checkout counter to prevent theft — on top of loss prevention staff located at the exit serving as a deterrent. In DG’s case however, they often have only 1 or 2 people manning the register and do not have sufficient manpower to deter shrink. Adding more labor hours would immediately solve this problem.

3. A third related example provided was on the matter of middle managers — i.e. store managers (oversees 1 store) and District Managers (oversees 20-25 stores). While DG’s rank-and-file employees are relatively replaceable, middle managers are not. It usually takes time to get them up to speed on their responsibilities, and having high turnover in this space is a huge suck on resources, both in terms of time and costs. This is again something that can be fixed simply by hiring more qualified talent, since by far the biggest reason for the high turnover of middle managers is being overburdened by the significantly overallocation of stores.

The sense that one gets while listening to the entire interview is that 90% of DG’s problems can be solved simply by adding more labor hours. At one point in the interview, Alex even asks point blank how many incremental labor hours a typical DG store would need to be in a better place. The store manager provides a bit of context before concluding that the solution to DG’s current woes lies in People: 1) regaining Consumer trust & loyalty and 2) becoming the Employer of choice.

On regaining Consumer trust & loyalty, the lack of labor hours has somewhat tarnished DG’s brand image in the eyes of its usual customers — due to reasons ranging from haphazard store upkeep to lack of inventory. Adding sufficient labor hours will provide an immediate fix to this, simply by making stores nicer to walk in again. And given the commoditized nature of DG’s retail business, there should be no problem attracting customers back into their stores as long as the price is right.

The slightly bigger issue is the 2nd one, becoming the Employer of choice. As a result of this race to the bottom in search of margins over the past few years, DG has garnered a reputation amongst potential workers for significantly overworking its employees — and in general being a bad place to find work. Management needs to recognize the “political” component of attracting part-time workers and becoming a place that people want to work at again. Once again, the simple fix here is to add more labor hours so as not to overburden store employees and store managers.

Moats: UnTouched

The good news here is that all these are relatively easy fixes, since adding more labor hours isn’t exactly rocket science. While the business will likely continue sucking air for awhile as DG transitions to a more sustainable work culture, it actually takes nothing away from all of their structural business moats. With 22,000 stores nationwide, DG remains the largest dollar store chain in the nation with the closest proximity towards rural communities.

As one of the store managers interviewed puts it, the customer’s choice on whether to shop at Walmart vs. Dollar General largely hinges on whether the shopping trip is worth spending gas on a 30-minute drive into town to visit a Walmart. Such trips are worth the effort for bigger monthly grocery trips, as obviously Walmart carries a much larger assortment of inventory. But for those weekly in-between “fill-in” grocery stops, where one parent is only looking to pick up toilet paper or some canned peas, DG’s neighborhood store remains the superior choice simply due to their closer proximity.

Another area that was mentioned as low-hanging fruit was DG Fresh, their recently botched attempt at improving fresh food selection via the introduction of bigger coolers. The store manager interviewed mentioned how the failure of Fresh was actually an issue with execution rather than the legitimacy of Fresh — which as you guessed, once again boiled down to a problem of insufficient labor hours. There were teething issues with restocking which contributed towards shrink, and fresh inventory was not properly stocked on shelves which resulted in spoilage. Once again, these are fixable problems over the long-term simply by hiring to a sustainable level — and Fresh remains a legitimate concept which can help DG push on growth.

Furthermore, the store manager goes on to say that DG actually still has the branding advantage over Family Dollar in these rural communities. Perhaps because the community has grown up with Dollar General as the neighborhood grocery store, there is still a strong brand presence in the hearts and minds of these rural communities. The sense I got from listening to the way he was describing things was that as long as DG could get their s*** together, those old customers would come flooding back, if for no other reasons than good prices and nostalgia.

There are other areas of improvement that were discussed in the interview, such as pivoting away from higher-margin clothing in favor of consolidating the sales focus around what customers actually want — in contrast to what looks good as numbers. If you’ve ever wanted to understand Dollar General’s business, I’d invite you to listen to the full thing yourself.

Suffering from MBA-fitis

In conclusion, not only does Dollar General’s woes not appear insurmountable, they don’t even seem to be particularly problematic over the long-term. This is a classic case of MBA-fitis, where management has gotten their heads stuck so far up their ivory tower that they’ve missed the forest for the trees. This is a tale as old as time in Corporate America, and DG will neither be the first nor the last large business to befall to this sin.

However, it also implies that their problems are quite simple to fix. All they really need to do is to stop doing the wrong thing, and things should resolve themselves quite quickly. As the interview implied, the comprehensive fix really does seem to be as simple as making the necessary investments in labor hours, and also rehabilitating the DG culture and brand in the minds of both customers and employees. While this might be a bigger issue for smaller businesses, it’s something the largest dollar store chain in the country can take their time to fix.

To address the elephant in the room, yes Walmart has recently taken share from DG. Yes, they’ve made investment in areas in which they are “uniquely positioned” to capture, in areas where DG cannot hope to compete (e.g. self-checkout, online pickup). However, that takes nothing away from DG’s main business moat — their close proximity to the target demographic (rural communities). I don’t see how having online pickup is going to convince someone living in rural Arizona to drive an extra 30 minutes just to buy some toilet paper. None of the structural reasons why people choose DG over Walmart have changed.

Also, it’s worth pointing out two other pertinent matters — 1) this is a self-inflicted rut rather than one imposed on them by external circumstances; and 2) the present-day is a terrible macro environment for DG’s target demographic of lower income consumers.

On the former, we’ve already demonstrated how this is something fixable over time. I think it’s worth restraining ourselves from extrapolating current margin performance into perpetuity, and really taking a hard look at what truly moves their needle.

On the latter, it’s worth pointing out that cycles always recycle eventually, and with enough time things will start looking up again for them and their customers again. Economists will tell you that a recession is far from the only possible outcome for 2025, with the recent interest rate cut lending credence to a possible smooth landing. Central banks have a tendency to overextend their hand by playing God with monetary policy — and while such flagrant abuse simply amounts to kicking the can down the road, it also implies that a recession in 2025 is far from the only possible outcome.

If this comes to pass, it would be excellent news for DG’s customers — and by extension, Dollar General as well. If you’d like to learn more about this, check out my recent article below:

All in all, there appears to be a clear path towards the fix, which is also something that DG can simply coast towards. It doesn’t even seem particularly challenging to achieve, especially for the largest dollar store chain with 20,000 stores nationwide.

In the remainder of this article, I’ll be performing a scenario analysis which examines the earnings impact of reinstalling sufficient manpower into DG’s labor base. Given how the majority of DG’s current woes appear to be fixable simply by adding more labor hours, I’ll be examining earnings scenarios in which DG adds incremental employees to their labor pool. We’ll also look at non-worst-case scenarios, where some of the growth opportunities discussed earlier are successfully executed.

Finally, I’ll wrap up this report by taking a stab at their valuation — where we’ll discover how the previously implied 6% Net Margin holy grail is no longer necessary to justify their fair value. Of course, we’ll also be working out what the new Net Margin baseline should be.

Without further ado, let’s start with a review of Dollar General’s recent Q2 results — and understand why the recent -30% crash in their share price was an overreaction.

DG Q2 Results and the -30% Share Price Overreaction

In late August, Dollar General’s share price crashed by -30% on two things: slight misses in Q2 analyst expectations, and a weakening consumer outlook for the remainder of the financial year:

• The valuation of its biggest competitor, Dollar Tree, has also fallen by a similar -30% since then. Hence, this is an industry-wide issue (i.e. macro), not a Dollar General specific problem.

• Q2 EPS miss of $1.70 vs. $1.79 expected, Q2 revenue miss of $10.21B vs. $10.36B.

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TABLE OF CONTENTS:

1. Q2 Segment Results: Where It Hurts (P&L Analysis)

2. Solvency Issues Overblown — Here’s The Proof (B/S + CFS Analysis)

3. INTC: Worst-Case Valuation

4. INTC: Best-Case Valuation

5. 📊 INTC 3-Statement Model (download)

Not Investment Advice. Read Disclaimers.

Watching the trashing that Intel is taking in markets invoked a sense of déjà vu within me. This led me to seek answers in Yefei Lu’s excellent book Inside the Investments of Warren Buffett: Twenty Cases, which gives a blow-by-blow account of what Wells Fargo went through in 1989-1990 when Buffett first acquired his legendary stake in it.

The entire Chapter 16 on Wells Fargo is worthy of a re-read — but in the interest of brevity here’s how Buffett might have perceived Wells Fargo at the time:

• The bank was rocked by two concurrent industry crises — the Savings & Loans banking crisis which had been ongoing for most of the late-1980’s; and a real estate recession which started around 1986 and was still happening. The recent Loma Prieta earthquake in 1989 also massively affected Californian property values.

• Wells Fargo’s loan portfolio was not only concentrated in construction and mortgages, it was also significantly exposed to California. There had also been a huge property bubble brewing in the state around the same time as the aforementioned events, priming both industries for a huge meltdown.

• However, Wells Fargo’s balance sheet was incredibly robust. At end-1989, it reported a Tier-1 Capital ratio of 4.95%, delinquency ratio of 0.32%, and loan loss allowances of 1.77% of total loans. By all accounts, it was simply not going to fail and would weather the storm just fine.

• In stark contrast, markets infamously punished Wells Fargo’s stock price, driving it down to just 5x trailing PE at one point. It’s no surprise then that Buffett gobbled it up, whereupon it earned a spot as one of his legendary anchor investments.

Now, let’s try and compare Wells Fargo in 1990 to what Intel looks like today:

• The semiconductor company is having its reputation trashed by successive execution failures — including the inability to replicate TSMC on US shores by yesterday, as well as a broader industry downcycle owing to excess sector inventory resulting from massive pandemic pull-forward demand. Notably, neither of these were within management’s control, and there are already clear signs of recovery in both.

• There is a clear light at the end of the tunnel for INTC — becoming the only reliable leading-edge foundry in the Western Hemisphere before 2040. On two continents, and for both militaries. Imagine what the chip demand for a rejuvenated pan-European military force would look like — this is before anything the biggest military, Navy and Air Force would require. This is Lockheed Martin’s resurrection in all but name.

• Both Uncle Sam and Queen Europa have every incentive to see Intel IFS succeed, and will likely even backstop them if necessary. Not only is the risk of bankruptcy negligible, there’s already precedent for equity partners (Brookfields and Apollo) co-investing in foundry shells at the joint venture level, rather than requiring equity dilution at the Group-level.

• As we saw in last week’s Part 1, Intel faces no cash flow risk whatsoever. In stark contrast, it would seem that the broader sector might finally be turning around, as evident by the 1H24 inflection of CCG operating income. While turning performant overnight remains an unlikely prospect, bankruptcy appears to be an even less likely one.

There is simply overwhelming evidence that INTC is going to emerge from this entire debacle just fine, as Wells Fargo did. Maybe not unscathed as evident by the recent headcount and dividend restructuring — and maybe Pat could afford to recognize the optics of praying online — but we’re talking about bankruptcy being the alternative here. That’s just not going to happen, and if so it’s worth asking what else could happen.

In last week’s INTC Part 1 article, we explored how Intel’s business is far from being written off as dead. In this Part 2 follow-up, we’ll unpack their historical earnings performance by segment to drill-down deeper into the various factors of recent underperformance, and obtain clarity on which parts of the business require rehabilitating (or not).

As we shall see, there’s a lot of misunderstanding floating around about the future trajectory of their businesses (e.g. CCG). This should be enough to inform us where INTC’s fair value stands, including taking account of the many uncertainties at play. As we shall see later, it’s not a very high bar to clear.

What we hope to find in the data is the presence of a substantial Margin of Safety. Without further ado, let’s dive in. This is your financial primer to Intel: Wells Fargo 2024.

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Q2 Segment Results: Where It Hurts

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FREE-TO-READ:

1. Only Leading-Edge Foundry in the West

2. Equity Raise Unnecessary

3. Headcount Decapitation & Dividend We Fall

4. Review of Q2 results: Not-so-Sad

5. Intel: Not A Loser, Just Less Paranoid (than AMD or TSMC)

6. This Is What Volatility Looks Like, and Why Value Investors Win


PAID SUBSCRIBERS ONLY:

7. Uncovering Intel’s Sources of Recent Underperformance - via Financial Statement Deep-Dive

8. 🔒

9. 🔒

10. 📊 INTC 3-Statement Model (download)

“Coupled with Intel’s organic FCF being in persistently positive territory, these Partner Contributions also demonstrate how Intel will never need to perform an equity raise — they can simply look for more partners to fund further IFS buildout at the joint venture level. I mean, technically it’s an equity raise, but you know what I mean.”

INTC needs no introduction — you either love it or hate it, there’s no middle ground. Let’s cut straight to the chase.

The 1st half of this article is available for all to read, and will basically expound on all the reasons why INTC shouldn’t be written off for dead yet. The 2nd half of this article is reserved only for paid subscribers, and does a deep-dive into their financial statements of the past few years to uncover their recent sources of underperformance. We’ll continue this exercise in next week’s Part 2.

Sophisticated semiconductor industry analysts will appreciate being able to separate the wheat from the chaff with these articles, by directing their energies towards analyzing only the parts of INTC’s financial statements which matter. If you identify as one, you’ll know what I mean — the semiconductor industry is a byzantine minefield of rabbit holes to navigate, and reducing the scope of your analysis by 90% can help you save tons of research time, just by knowing exactly where to look (and where not to).

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Only Leading-Edge Foundry in the West

As I’ve previously explained in my Intel Part 3 article, the Western hemisphere has only one leading-edge foundry that it can rely on, Intel. TSMC and Samsung may currently lead Intel in process nodes, but their geographical proximity to America’s biggest rival makes them unreliable for chip manufacturing in sensitive sectors (e.g. military purposes).

As I’ve covered previously in my Intel Part 2 article, Intel is admittedly slightly behind in process nodes across the board when compared to TSMC and Samsung. However, this is something that it can eventually catch up to over the medium-term; in contrast, it would take far longer for TSMC to replicate its leading-edge manufacturing capacity on US shores.

A recent article by Tom’s Hardware suggests that even if they could, it would take far more than that to replicate its cost structure in Taiwan on US soil. What is considered acceptable working conditions there has faced severe pushback by employees in the US — such conditions would likely be exacerbated in Europe:

One big problem is that TSMC has been trying to do things the Taiwanese way, even in the U.S. In Taiwan, TSMC is known for extremely rigorous working conditions, including 12-hour work days that extend into the weekends and calling employees into work in the middle of the night for emergencies. TSMC managers in Taiwan are also known to use harsh treatment and threaten workers with being fired for relatively minor failures.

TSMC quickly learned that such practices won’t work in the U.S. Recent reports indicated that the company’s labor force in Arizona is leaving the new plant over these perceived abuses, and TSMC is struggling to fill those vacancies. TSMC is already heavily dependent on employees brought over from Taiwan, with almost half of its current 2,200 employees in Phoenix coming over as Taiwanese transplants.

This means that while TSMC might have the edge over Intel in the short-term, over the long-term Intel will gradually become more competitive simply by virtue of its geographical location. Even on process alone, Intel appears to already be leading in backside power delivery1, where they purportedly have a roughly one year’s headstart over both TSMC and Samsung.

The DOD has already contracted Intel Foundry for their chip manufacturing, and it seems unlikely that they won’t shift most of their orders from TSMC in Taiwan to Intel over the long-term. Also, imagine if you are Apple or even AMD. Wouldn’t it make sense to move just some of your orders to the US, purely for risk management purposes? That means Intel IFS, which would have the edge over TSMC on US shores.

As I’ve previously covered in my INTC Part 3 article, the main draw of a mature IFS is to replicate TSMC’s business model — for every $1 of CAPEX invested, a reliable $1 of Net Profit can be generated like clockwork, given the lack of available alternatives. Obviously this may change going forward, but even half of that performance would be more than satisfactory.

For context, the chart above shows how TSMC’s revenues are currently $70B, with average historical NM of 35-40%. If Intel IFS can achieve even half those revenues with similar normalized NM of 35%, that would add an incremental $12B to their bottom-line over the long-term. For reference, Intel’s highest-ever full-year earnings were only $21B in FY18 and FY19 respectively — adding even $10B to that would immediately restore their long-term earnings track record.

Equity Raise Unnecessary

A lot of the recent scare over INTC comes from the notion that they might be forced to do an equity raise in the near-future. The natural interpretation of this, following the massive 15% cut of its 124,000 strong headcount and the suspension of its dividend, is that INTC might be facing a cash crunch owing to deteriorating operating conditions which might necessitate an equity raise.

The reality is a bit more nuanced. INTC is currently on a warpath towards completing the buildout of Intel Foundry Systems (IFS) as a national strategic concern — with both Uncle Sam and Queen Europa breathing down its neck to replicate TSMC’s manufacturing capacity on US shores by yesterday. As one can imagine, such artificially imposed governmental constraints would understandably wreck their near-term performance, independently of actual business cycle concerns.

Having said that, this is not the same as BANKRUPTCY. Keep in mind that there aren’t any business or financial pressures forcing Intel into insolvency here. As we shall see later, their OCF is still in significantly positive territory, albeit half of what they used to be. THERE IS NO GOING CONCERN RISK.

In the absolute worst-case scenario where Intel is unable to keep up with the buildout of IFS, they can simply tell both governments that it has no choice but to delay IFS completion in order to reduce cash burn. It serves nobody’s interest to see Intel go bankrupt — if anything, both governments would bail them out before entertaining such a thought. Simply pushing out IFS completion by a few years would immediately restore Intel’s cash flow & balance sheet trajectory to solvent levels, thus avoiding any potential going concern risk.

This also implies that there is no conceivable scenario where Intel resorts to issuing equity and significantly dilutes shareholders due to going concern risk. The military industrial complex will make sure of that.

Headcount Decapitation & Dividend We Fall

Firstly, I must acknowledge that this is a highly sensitive issue and that the loss of jobs is never something to be taken lightly. My heart goes out to everyone involved.

Having said that, I think many industry observers can agree that this was the right decision for Intel. Something that caught my attention was Noahpinion’s recent take on the issue, which suggests that Intel has yet to see a dime of the CHIPS Acts subsidies — if you recall, these were announced just 5 months ago in the form of an $8.5B non-binding preliminary memorandum of terms (PMT). With the US elections just over the horizon and a possibly hostile President coming in, it makes ample sense to extend cash flow risk headroom in light of their massive remaining commitments to fund the buildout of IFS.

Perhaps Gelsinger & Co. are aware of ongoing developments in the halls of Washington that mere mortals like us are not privy to. But if those CHIPS Acts subsidies are not forthcoming, then Intel might be staring at the prospect of having to fund the IFS CAPEX black hole completely by itself.

The silver lining here is that the aforementioned missing subsidies amount to “just” $8.5B — small potatoes in the grand scheme of things. For context, Intel’s annual FCF throughout FY17-21 regularly hovered around $20B, prior to the recent industry downturn. Cutting both headcount and dividends will go a long way towards shoring up their cash flows — and with a possible recession looming on the horizon, such news would be better announced sooner rather than later.

Review of Q2 results: Not-so-Sad

As I’ve covered in a previous note, Intel’s dumpster fire Q2 miss was actually… not as bad as it seems. The charts below show how the biggest factor by far behind their Q2 earnings miss was in fact GP decline, rather than OPEX increase. While higher depreciation owing to larger Foundry investments might have been the likely first culprit to come to mind, the actual reason behind the GP decline was due to sharply dropping Gross Margins in Q2 (green line):

We now know that the reason for this was due to a very deliberate management decision to ramp-up manufacturing in “AI-PC”, rather than poor execution. To get more technical, earlier anticipated greater demand for Meteor Lake chips based on Intel 4 (7nm) had spurred a management decision to move some manufacturing capacity from their legacy development fabs in Oregon to their high-volume Fab 34 facility in Ireland, which is expected to result in $1B in capital savings over the long-term2.

However, this decision resulted in lower margins in Q2, as the Ireland fab has yet to fully scale. This is actually a good problem to have, as it implies that there was too much Meteor Lake demand for Intel to service at its usual fabs. It had also been announced in advance, rather than simply being unchecked poor execution.

Initially, Intel analyst Patrick Moorhead suggested there could’ve been yield issues on Meteor Lake production, which might’ve necessitated running hot lots3 persistently to meet demand that could have impacted Q2 margins. However, he later retracted his statement, saying that the yield issues were merely his interpretation.

A quick scuttlebutt revealed this excellent Reddit comment, which explains how Intel’s Q2 gross margins weren’t actually impacted by chip yield/throughput issues. Rather, the manufacturing bottleneck was actually in advanced packaging, specifically Foveros4, which is only manufactured at their Fab 9 plant in New Mexico. This was a production issue which had been announced 3 whole months ago during their Q1 earnings call, so it’s not like markets couldn’t have seen it coming.

The interpretation of this is that Q2’s margin deterioration was merely a short-term issue owing to an assembly line bottleneck in advanced packaging; rather than some sort of structural defect in manufacturing process of its new Meteor Lake chips (e.g. “EUV problems”). The latter would put Intel’s manufacturing processes structurally behind TSMC, while the former should easily be solved by this time next year.

Intel: Not A Loser, Just Less Paranoid (than AMD or TSMC)

The bigger drop in sentiment came from concerns about Intel’s longer-term trajectory, rather than simply the Q2 miss. A big part of it was simply Intel’s legacy narrative returning back to haunt them — they’ve failed before, now look at them fail again.

While it should be acknowledged that Intel is indeed facing issues today, this narrative is beyond incorrect, as their current “failures” are completely detached from their previous “failures” from before Gelsinger joined as CEO. In fact, they aren’t even really “failures”, as I shall explain below.

As most Intel observers know by now, Intel had faced some serious efficiency issues in the half-decade before Pat Gelsinger joined as CEO — including running hot lots all the time to meet KPIs and a terri-bad company culture which trounced operational performance. It also missed two cycles of sector innovations to competitors — chiplets on the design side to AMD, and EUV on the manufacturing side to TSMC.

Sector analysts will know that both of these missteps didn’t result from hubris — rather they were simply logical decisions made as a matter of risk management, given what could’ve possibly been known at the time. Prior to Lisa Su’s tenure, AMD’s decision to pursue chiplets was considered risky, as it required:

• a sea change in the conceptual understanding of chip manufacturing,

• the reliable implementation of interconnects on massive scale (which had never been done before),

• overcoming doubts on whether chiplet performance would even beat single die performance after lower interconnect efficiencies, and

• whether product market fit would even exist at scale for the completely new chiplet technology.

The same thing can be said about why Intel missed EUV to TSMC. Anyone who understands lithography tech will understand why Intel decided to persist with multi-patterning while TSMC switched to EUV. According to chip sector folklore, ASML’s engineers basically had a huge stroke of luck in solving an issue which had previously plagued EUV tech — achieving a stable 100 watt of EUV output. ASML’s CTO recounts a story where they had butted right up against a January 2018 deadline to find a solution to this, without which they would’ve called off the industrialization of EUV:

That time window was relevant, because that was the deadline for customers to place orders for High-NA machines. If they didn’t, we’d stop the program.

This incredibly timely discovery allowed ASML to push EUV through according to deadlines, which subsequently allowed TSMC to firmly leapfrog Intel in the foundry business. As you can imagine, this involved tons of uncertainty which could’ve straight up put TSMC out of business, or at least hurt them. But they took the risk, and fortune favors the bold.

As you can also imagine, 90% of MBA suits and McKinsey consultants at the time would not have recommended Intel to pursue either chiplets or EUV — the risks involved were simply immeasurable. AMD’s pursuit of chiplets and TSMC’s switch to EUV were both bet-the-farm decisions — if anything went wrong, that could have been the end for them. A good example of what both of their fates might’ve looked like had the winds blown the wrong way was sapphire glass manufacturer GTAT, which infamously blew up in 2014 following an alleged “bait-and-switch” tactic by Apple. Understandably, Intel might not have wanted to entertain such ungodly levels of risk at the time.

While many words can be spilled over Andy Grove’s precocious quote, “Only The Paranoid Survive”, I wouldn’t be so hasty to crucify Intel over their decision not to bet the farm on entirely non-existent tech the way both AMD and TSMC did, in both of their respective leapfrogging endeavors. On Earth-56, both of them might have gone completely bankrupt. In any case, it sounds like Intel is already wising up to incremental risk-taking, as evidenced by their recent share price trajectory.

This Is What Volatility Looks Like, and Why Value Investors Win

Intel’s recent share price crash is actually a great template for what Buffett & Munger mean by focusing on short-term volatility vs. having a long-term business view. Most readers can probably agree with the points I made above, and that Intel will eventually become the only leading-edge foundry in the Western Hemisphere within any reasonable amount of time.

If so, and we can agree that going concern risk is not present, then Intel’s current share price volatility is also a great example of why most investors aren’t long-term investors. When the entire world is going against you, it’s unassailably hard to swim against the tide without true conviction — even if you believe that your facts are correct. Thus, being a long-term value investor takes real analytical experience to develop such conviction and cover all possible angles, even amidst debilitating levels of volatility.

Now that we’ve established how INTC isn’t about to face bankruptcy anytime soon, what else might be in store for its future? Perhaps more importantly, what does their worst-case valuation look like? That’s what we’ll be exploring in this two-part INTC report for paid subscribers — check out our previous Intel articles below too!

Not Investment Advice. Read Disclaimers.

Uncovering Intel’s Sources of Recent Underperformance — via Financial Statement Deep-Dive

In the remainder of this report, we’ll be doing a deep-dive into INTC’s financial statements, updated to Q2. By doing so, we can zoom in on the parts of their financial statements which are underperforming, thus allowing us to narrow down the scope of our analysis to just the needle-movers.

Sophisticated semiconductor industry analysts will also appreciate being able to separate the wheat from the chaff with these articles, by directing their energies towards analyzing only the parts of INTC’s financial statements which matter. If you identify as one, you’ll know what I mean — the semiconductor industry is a byzantine minefield of rabbit holes to navigate, and reducing the scope of your analysis by 90% can help you save tons of research time, just by knowing exactly where to look (and where not to).

Without further ado, let’s take a hard look at Intel’s biggest source of recent underperformance…

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Part 2: A Data-Driven Approach to Analyzing Shopify's Future

1. Measuring Merchant Satisfaction and Innovation To Estimate Enterprise Conversion Potential

2. The Enterprise Growth Formula

3. SHOP 3-Statement Model (updated)


Disclaimer: The contents of this document are NOT meant to serve as investment advice. Read our full disclaimers below.

Not Investment Advice. Read Disclaimers.

The quote above by Jeff Hoffmeister, Shopify’s CFO, was given at the recent Morgan Stanley TMT Conference 2024. As you can tell, he doesn’t describe Shopify like other marketplace platforms do, which tend to boast about setting terms of engagements at their merchant’s expense (e.g. Amazon’s 50% take rate).

Rather, he describes Shopify as being in servitude to its merchants — by anticipating problems that they face and utilizing the platform’s aggregated economies of scale to create otherwise unattainable solutions for their merchants. In other words, “how do we add value to our merchants, instead of taking advantage of them?”

Reading this really put a smile on my face.

Shopify is one of the more inspiring stories of innovation in modern American capitalism. Typically, you’d only accord such praise to legends like Herb Kelleher of Southwest, John Malone of TCI, Henry Singleton of Teledyne or Steve Jobs of Apple. I have a feeling that Tobias Lütke of Shopify will one day leave a legacy in an adjacent zip code, if not a similar one.

Shopify has come a long way from simply being the digital shopfront of small businesses. Nearly 3/4 of their FY23 revenues came from Shop Pay, which charges a 2.9%++ take rate on all GMV processed on the Shopify platform (orange):

As alluded to above, such a business model ties Shopify’s incentives to that of its merchants, i.e. what’s good for them is good for Shopify. This has resulted in Shopify bringing significant innovation to the small & medium e-commerce space, including:

• Shopify Audiences: Treats the entire Shopify platform as a single giant merchant, and shares customer data between all merchants who opt-in to inform future growth strategy and ad targeting.

• Shopify Plus: Full stack turnkey solution which bundles Shopify’s entire product suite into a single package for larger merchants.

• Hydrogen and Oxygen: “Headless” e-commerce which decouples the front-end shopfront from back-end infrastructure. This allows merchants who have customized back-end needs (e.g. Dollar Shave Club’s paused subscriptions) to access Shopify’s benefits if they don’t want to give up their existing e-commerce setup.

• Commerce Components: Modularizes any component of Shopify’s business integrations, thus allowing merchants to onboard on a piecemeal basis. Particularly attractive to large Enterprise customers who are entertaining joining Shopify, but don’t want to risk transitioning cold turkey away from their existing partners (e.g. Salesforce).

Shopify has since graduated well past its small business roots and is now focusing on attracting Enterprise accounts, which involve lower margins but much larger GMV. While they still remain in the early innings of Enterprise, they’ve already managed to gain some legitimacy by attracting relatively large accounts, including Overstock.com ($600M market cap), Everlane ($500M valuation), Carrier B2B ($50B market cap), and Coach (parent: $9B market cap).

In the recent Morgan Stanley TMT Conference 2024, Shopify’s management explained what their on-ramp formula for the Enterprise market looks like. The reason why Shopify waited until now to pursue Enterprise is because the e-commerce needs of Enterprise are very different from SMBs (small & medium businesses) — e.g. SMBs might be fine with adapting to Shopify’s existing offerings, while Enterprise might need more customized solutions to accommodate their legacy setup.

As a result, Shopify has been very deliberate about innovating new solutions, in order to better appeal to Enterprise customers. For instance, Hydrogen’s “headless” integration allows Enterprise customers to attach their existing back-end infrastructure to a Shopify shopfront — allowing them to enjoy Shop Pay’s famous 36% higher conversion rates without having to fully transition to Shopify. Similarly, Carrier and Everlane can use Commerce Components to bolt-on Shopify’s integrations on a piecemeal basis, without the risk of adopting a full-fledged turnkey transition. This ultimately reduces cost and risk for potential Enterprise clients, with the goal of eventually encouraging them to fully move their back office e-commerce functions over to Shopify.

The formula is to first use these solutions to on-ramp Enterprise customers, by giving them access to Shopify’s industry-leading “just better than everyone” merchant solutions (e.g. significantly boosted conversion rates, longer sales cycles). Once they’re in the funnel, Shopify can then upsell ancillary offerings like Payments, Logistics or Audiences which adds incremental value to them — some of which are absent at Enterprise competitors. This gradually increases the stickiness with the Enterprise client, which reduces friction to try even more bolt-on solutions with Shopify. Before you know it, they’ve fully made the transition over to Shopify.

While the title of this article was “Disrupting Salesforce”, this narrative isn’t merely confined to Shopify disrupting Saleforce’s Enterprise CRM industry. Shopify can apply the same roadmap to make inroads into every Enterprise Retail-related market — I just used Salesforce since it’s more recognizable.

And while Shopify’s success in such an ambitious Enterprise endeavor has far from guaranteed, it’s worth noting what this narrative implies:

1. Shopify is still a startup relative to the humungous global Enterprise market, their $70B market cap notwithstanding;

2. Shopify’s growth runway is practically unlimited — the implied TAM here is pretty much the entire Enterprise Retail market (e.g. Salesforce, Oracle’s e-commerce segments, etc)

3. Shopify’s future growth isn’t contingent on beating Amazon at e-commerce.

While it’s true that their future margins will likely be compressed, it’s a worthy tradeoff for persistent double-digit revenue growth for the foreseeable future. This is something I’ve already more than accounted for in my Shopify Part 1 report, so click the link if you’d like to see the assumptions I used in their valuation.

Just imagine charging a client the size of Nike 1% of GMV — the growth potential is inconceivable.

But wait, there’s more.

While e-commerce has certainly kicked B&M in the face over the past decade, the future of Retail is undeniably Omnichannel. And while pursuing an Offline market is less exciting than Enterprise, it’s also a gazillion times bigger. 80% of US Retail remains B&M (China: 70%), offering enterprising Tech sector incumbents the opportunity to steal market share from the B&M Retail industry.

What do Shopify’s Offline solutions look like? In management’s own words, their Point-of-Sales (POS) solution has gone from being just an ancillary service (for e-commerce merchants who also want to sell in a physical location), to becoming a standalone product. As the US Retail industry gradually transitions to Omnichannel over time, the worlds of B&M and Retail will inevitably collide. And as one of the incumbents, Shopify will most assuredly be there to pick from the low-hanging fruit — enabling B&M giants to transition to e-commerce in India, China and Southeast Asia.

This brings us to International. While Shopify’s legacy storefront subscription industry (and future GMV potential) can no longer be characterized as being unlimited in the USA, it still looks to be that way in the rest of the world. As we shall observe below, Europe has been growing like gangbusters and key markets like APAC and India have barely gotten started. Once again, this implies that even Shopify’s original shopfront subscription business has plenty of legs underneath it.

There are not a lot of businesses with $70B market caps that one can truly say has practically unlimited growth — but Shopify is certainly one of them. As the famous Buffett quote goes:

Shopify ticks all three boxes, and has a decade-long track record to prove it. It doesn’t get any more hardcore than that.

So now that we’ve established that they’re a wonderful business, is their valuation at a fair price? We’ve already explored this in Part 1, so click the link below if you’d like to figure out where the threshold for their fair value lies:

However, if you’d like to understand Shopify’s business better — as well as what their formula is for tackling the enormous potential in Enterprise — you’re in for a treat, as we'll discuss all this in this Part 2 report!

The objective of this SHOP Part 2 report is twofold:

1. Provide hard evidence using numerical data to support the narrative of Shopify’s immense future growth in Enterprise as described above, using both historical data and forward-looking estimates;

2. Justify the SHOP valuation as discussed in Part 1

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A Data-Driven Approach

Measuring Merchant Satisfaction & Innovation To Estimate Enterprise Conversion Potential

This article describes how the best measure of performance for asset-light Tech companies is Revenue/Employee. Why?

Big Tech is notorious for publishing nebulous performance indicators, which cannot be objectively estimated since they tend to involve subjectiv estimates of long-tail events far in the future. Some of them are well-intentioned like LTV/CAC; but others like WeWork’s Community-adjusted EBITDA are straight up pure fantasy.

In any case, the road to hell is paved with good intentions — which is why it’s always better to observe the wisdom of Edwards Deming: “In God we trust. All others must bring data”.

In contrast, Revenue/Employee is a highly objective performance measure, as it uses historical and straightforward data to measure efficiency. Furthermore, it’s an excellent “no-bullshit” performance screener, since the largest cost base in most Big Tech companies is usually headcount.

Revenue/Employee is also a good proxy for measuring Shopify’s level of innovation, since developing new innovative e-commerce solutions requires incremental headcount; while incremental revenue measures how much merchants value those solutions. And by extension, how much incremental GMV merchants think they can generate, since buying those innovative solutions from Shopify incurs higher costs.

So how has Shopify’s Revenue/Employee performed over time?

Read more

TABLE OF CONTENTS:

1. Point of Maximum Pessimism for Big Saas?

2. How Can 600x P/E Possibly Be Undervalued? 

3. SHOP: 26% Revenue Growth in FY23

4. SHOP's Financial Analysis (FY16-23)

5. Valuation

6. Scenario Analysis

7. 📊 Download SHOP 3-Statement Model


Disclaimer: The contents of this document are NOT meant to serve as investment advice. Read our full disclaimers below.

Not Investment Advice. Read Disclaimers.

Point of Maximum Pessimism for Big SaaS?

I recently came across a super-interesting presentation by Avenir titled “Avenir x Saas: What's Gone Wrong in Software and Why We're Optimistic”. You can download the full deck here — it was originally shared by one of the authors of the deck on Twitter/X.

The basic gist of Avenir’s thesis is that Big SaaS went through a classic industry-wide overcapacity until 2021 (alá O&G) — resulting in sector revenues being pulled forward, which subsequently needed to be churned through before industry conditions could normalize:

Charts like the one above demonstrate how despite the Tech sector’s (and particularly SaaS) asset-light characterization, the broader tech industry still expresses the same boom/bust cycles as other capital-intensive industries, with identical peaks/valleys as say the O&G or airline sectors. At the end of the day, competition remains the great equalizer, moats notwithstanding.

The case that Avenir made for the upcoming “SaaS-sification” of markets is twofold — i) industry valuations exhibit “point of maximum pessimism” characteristics, and ii) the overall industry is getting fitter.

I’ve grabbed some of the more straightforward charts defining this narrative from the decks and placed them below. If this has caught your attention, the full deck will be a joy for you to go through:

Even without typing out Avenir’s full thesis here, any seasoned industry observer should be able to fill in the blanks. It basically describes an overlap of slowing growth from pushing on a string, falling valuations, and improving margins hidden amidst sector cyclicality. Current industry multiples do not necessarily correlate with underlying performance, lending to potential industry-wide mispricings and risk:reward asymmetry resulting from excessive pessimism.

A big narrative which wasn’t mentioned in their deck though was macro. The following article demonstrates how derivative pricing is already imputing interest rate declines, undoubtedly positive for SaaS sector multiples. The (relatively) depressed multiples of non-Mag 7 Tech appears to undermine widespread economic consensus that the Fed is bound to lower interest rates sooner or later:

The Last Bear Standing

The Great Rotation

If you have been waiting for a tell, wait no longer. The great rotation is here. On Thursday morning, the Bureau of Labor Statistics reported deflation. For the first time in nearly two years CPI fell sequentially, the lowest month over month reading dating back to May 2020. The dip in price levels pushed year-over-year inflation ever so slightly below 3%, reaching a two-handle for the first time since March 2021…

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2 years ago · 20 likes · The Last Bear Standing

These findings led me down a rabbit hole of self-discovery. The objective fact is that Tech stocks have inflated multiples for a reason — they tend to be good businesses, independent of current market valuations. With the real economy entering into “Goldilocks” territory, the path of least resistance appears to imply some sort of sector rotation favoring these dead horses being reverse-beaten in some form.

How Can 600x P/E Possibly Be Undervalued?

Ultimately, this exercise of self-discovery led me to Shopify, for reasons which I shall explain in the rest of this report.

Most of us can broadly agree that Shopify is more or less in control of their own destiny — by virtue of being part of a global oligopoly within its sector. There is virtually no blow-up risk, and any serious competition to their stratospheric industry lead is found wanting.

Of course, this is also reflected in Shopify’s sky-high valuation of 11.6x P/S, 10x P/B, and roughly 600x trailing P/E — certainly not in the realms of what most people consider as “value investing”. However, we also know that “growth and value are joined at the hip”, etc etc by now.

For context, their current valuation is “merely” 19% above their pre-pandemic high 4 whole years later; and only 2.5x above their lowest trough in Oct ‘22. In that same time, Shopify’s revenues have quadrupled:

For those unfamiliar with the company, here’s a quick Shopify primer. SHOP is the premier e-commerce platform for small businesses in North America. There are just a handful of global players at such scale, and to this day it’s difficult to see who can even potentially dethrone them. Even Amazon seems to be having difficulty, as evidenced by the recent making-up between the two giants on checkout options.

While Amazon’s Marketplace remains the undisputed leader for all things e-commerce, they don’t allow small businesses to brand themselves, or collect crucial customer data to inform subsequent growth strategy. It’s like the difference between a small business selling through their own store vs. through Walmart — you’d probably sell higher volumes through Walmart, but they decide how your product is presented to customers (i.e. branding) and gatekeep crucial customer data to maintain control over their suppliers.

Shopify does almost the reverse, by allowing small businesses to control their own e-shopfront’s branding and customer data collection, while taking care of all the back-end infrastructure. Their core product is shopfront subscriptions, which on the surface looks pretty similar to other website builders like Wix or Squarespace. However, the actual magic of Shopify happens behind the scenes, with over a decade’s worth of business integrations that enable small e-commerce businesses to set up shop overnight.

However, shopfront subscriptions aren’t even where Shopify generates most of their revenues. Shopify also has an in-house payments service called Shop Pay, which is effectively similar to Visa or Apple Pay. While the latter two do appear as options during checkout, customers enjoy various benefits from using Shop Pay over them when shopping at a Shopify-powered merchant (e.g. autofill customer details) and are greatly incentivized to use them. Merchant Solutions generated nearly 75% of total FY23 revenues, with Shop Pay’s 2.9%++ take rate representing the bulk of that.

Since Shop Pay’s revenues are a function of total merchant GMV, it also significantly aligns the incentives of Shopify with its merchants — in contrast to if Shopify were merely selling them shopfront subscriptions. This symbiotic relationship — where what’s good for merchants is also good for Shopify — elevates the entire merchant ecosystem, which stands in sharp contrast to competitor e-commerce marketplaces like Amazon who are incentivized to engage in “your margin is my opportunity” games with their own merchants.

That’s all you really need to know about Shopify’s competitive advantage. They are so far ahead of everyone else in the space that few industry observers would worry about it at all. The main sticking point with SHOP has been precisely that — since everyone knows about their moat, their shares currently trade at a whopping 11.6x P/S ratio. On the surface, many would consider even their 20% revenue CAGR merely fair value at that price — yet a closer look reveals that maybe things are more (or less?) than they seem.

Since SHOP’s business is something very few will be unfamiliar with, I’ve chosen to begin with what most readers will presumably be more interested in — analyzing their valuation. In this SHOP Part 1 report, we’ll perform a full-fledged scenario analysis behind their valuation and explore all key levers involved. Those who are already familiar with SHOP’s business should get the most mileage out of it.

In the follow-up Shopify Part 2 report, we’ll flesh out the nitty-gritty details behind the valuation model in this week’s Part 1 — by performing a deep-dive into their business operations, recent developments, and forward-looking growth strategy. This should allow readers to fit the business and operational context back to the figures used in the valuation model in this report and test them for appropriateness.

Check out my previous articles about Value Investing:

1. What Did Buffett See in AAPL in 2016? Coca-Cola

2. Is EBITDA Really Bullsh*t?

3. How To Create A Low-Volatility Value Investing Portfolio

4. When To Sell Stocks, According To Warren Buffett

5. Unpopular Opinion: Diversified Portfolio > Concentrated Portfolio

6. Was John Maynard Keynes A Value Investor?

7. RISK: The Definitive Value Investing Definition

8. MUNGER | Warren Buffett's BFF

9. Value Investors = Business Owners. Here's The Irrefutable Proof.

10. How I Became 100% Convinced that Value Investing Was Superior

11. Click HERE For More Value Investing Articles

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SHOP: 26% Revenue Growth in FY23

As the title alludes to, it’s quite hard to reconcile Shopify’s current market cap with the colloquial notion of value investing. So how do we square this circle given SHOP’s 11.6x P/S? It all begins with their sky-high revenue growth, which was 26% in FY23.

Given Shopify’s uncomplicated Tech business model, only a few items in their P&L statements move the needle for their bottom-line. This makes it relatively simple to perform a scenario analysis for these KPIs — and try to square their future earnings with their market cap.

Before we get into the meat of the analysis, let’s get the ancillary stuff out of the way first — their balance sheet & cash flows.

As you might expect from a business with global oligopolistic status, SHOP’s going concern risk is virtually nil. They are in a healthy Net Cash position of $4B, and their Cash Conversion Ratio (OCF/NP) is regularly in the black:

Read more

Not too long ago, I wrote about SEA Ltd, whose e-commerce arm Shopee was the regional No.1 player in a commoditized industry in a fast-growing emerging market economy.

As my earlier article titled “Is Mr Market Stupid?” describes, consensus valuations had over-attributed poor business optics — while completely ignoring its fortress balance sheet, robust cash flows, long-term secular tailwinds, and how its No. 1 industry position gave it the economies of scale to become the Walmart of its industry.

Within a span of 6 months, management recognized the poor market optics in prioritizing growth over profitability and dramatically curtailed S&M spend. This improved visibility of their organic ex-growth profitability, causing analysts covering SEA Ltd to re-rate its valuations and sending its stock price to nearly double within less than a year:

Mexico’s No. 1 LCC, Volaris Airlines (NYSE:VLRS) appears to be in a similar setup today. Let’s do a count of the number of similarities between SEA Ltd in Aug 2023 (when I wrote my first SE article) and VLRS today:

• Like SEA Ltd, its share price has crashed by 70% from its peak achieved in 2021.

• Like SEA Ltd, its the No. 1 player in a commoditized industry of an emerging market — giving it the necessary economies of scale to achieve the lowest unit costs, and thus give customers the best prices.

  • VLRS is the largest LCC of Mexico, sporting a lower RASM than Aeromexico’s CASM.

  • This means that VLRS’s unit revenues are lower than Aeromexico’s unit costs, implying that they have even lower unit costs.

  • Like SEA Ltd, it is also the largest player in a 3-player oligopoly of a consolidated commoditized industry, where economies of scale rule supreme.

• Like SEA Ltd, it has a fortress balance sheet, a Net Cash position (ex-leases) and robust cash flows to defend against any reasonably possible cash flow risk.

• Like SEA Ltd, its industry TAM has very long-term secular tailwinds with a highly visible growth runway. For context, their revenues have grown by 15% CAGR over the past 5 years.

• Like SEA Ltd in Aug 2023, VLRS’s valuation today appears to be significantly discounting longer-term growth due to short-term operational challenges.

Ultimately, this boils down to Margin of Safety — which once again, is similar to how I described SEA Ltd. Recall that at the time of my SE article above in Aug 2023, was trading at a mere 12.5x normalized P/E and had a massive margin of safety built into its valuation, considering everything I’ve discussed above.

On the surface, VLRS today looks like exactly the same setup — except it’s trading at an even lower 6.8x normalized P/E. This VLRS Part 2 report will do the deep-dive for you so that you don’t have to.

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Check out our previous articles:

1. Click Here For More Value Investing Articles

2. Nvidia ($NVDA)

3. SEA Ltd ($SE)

4. Floor and Decor ($FND)

5. Tesla ($TSLA)

6. Disney ($DIS)

7. Intel ($INTC)

8. Paypal ($PYPL)

9. Occidental Petroleum ($OXY)

10. My LinkedIn

11. My Twitter

VLRS: CASM Deep-dive

VLRS Part 2 report: Table of Contents

1. CASM Deep-dive
i. Analyzing Historical Fuel Cost Performance
ii. Fleet age
iii. RASM vs. CASM performance (2017-2023)

2. Estimating Normalized Net Margins

3. Fortress Balance Sheet + Robust Cash Flows
i. Debt serviceability
ii. Historical OCF consistently > historical profits
iii. ROIC performance

4. Valuation

5. 📊 VLRS 3-Statement Model (download here) 

Disclaimer: The contents of this document are NOT meant to serve as investment advice. Read our full disclaimers below.

Not Investment Advice. Read Disclaimers.

Analyzing Historical Fuel Cost Performance

Airlines are famously known for their high operating leverage — which is why fuel expenses usually occupy the attention of most airline industry observers.

The chart below breaks out their Expenses by type, as a % of revenues:

If you compare the annual fluctuations of each cost component to their LT averages (rightmost), you’ll see that most of them are pretty stable over time — with the only exception being fuel expenses (blue line), which sports relatively high volatility.

This implies that outside of fuel costs, most of VLRS costs are more or less “fixed” in nature, and thus can be treated as a fixed normalized % margin in our valuation model.

The chart below demonstrates the correlation between VLRS’s unit fuel costs and Brent oil prices since 2017:

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