Summitry Select

Summitry Select Portfolio Update – Q2 2024

7/9/24

The Summitry Select Composite appreciated +3.3% (+3.1%, net) during the second quarter, capping off a very strong first half of the year.

While our portfolio delivered attractive absolute returns during the quarter, we could not keep pace with the broader market. The S&P 500 total return index appreciated +4.3%, largely driven by companies that are perceived beneficiaries of demand for artificial intelligence solutions, including certain semiconductor stocks and the so-called “Magnificent Seven” (Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia, and Tesla). In fact, during the first six months of this year, the Magnificent Seven appreciated by an average of +33% and accounted for nearly two thirds of the S&P 500’s total return.

Source: 3Q 2024 J.P. Morgan Guide to the Markets

Strong returns from TSM, and the four companies out of the Magnificent Seven that we own (AMZN, GOOGL, META, and MSFT), could not offset the relative underperformance in the rest of our portfolio, primarily driven by declines in some of our consumer names and drag from our sizeable cash position.

Our best performers during Q2 were TSM (+28%), GOOGL (+21%), and NFLX (+11%).

• In January, TSMC issued guidance for 20%+ revenue growth during 2024, and it appears that conditions have improved since, with sales through June tracking +28% higher in New Taiwan Dollars compared to last year. TSMC customers like Nvidia, Google, Amazon, and AMD are seeing greater demand for GPU, TPU, and other chips powering AI applications in datacenters and at the edge. While AI has captured much investor attention, TSMC is also poised to benefit from an upturn in demand for chips that power mobile phones and PCs, as replacement demand for those devices is set to improve, following several years of OEMs digesting demand pulled forward by the COVID-19 pandemic. While meeting this demand continues to require significant capital investment by TSMC, the company’s dominant position provides pricing power that we expect will protect the company’s attractive margins and returns on invested capital.
• Alphabet’s first quarter results and commentary about the remainder of 2024 were very encouraging. During the quarter, growth accelerated across each of Google’s key business lines and margins expanded for the second consecutive quarter. Search revenue grew +14%, YouTube revenue grew +21%, and Google Cloud revenue grew +28%, all compared to the prior year. Operating margin expanded to 32%, even after including $716mm of severance charges. There is still no sign that ChatGPT, Microsoft, or other LLMs are making much of a dent in Google’s Search business. Management continues to show cost discipline, and headcount ended the quarter -5% lower compared to the same quarter last year. Cost savings are being reinvested in the business to fuel growth, as Google will spend roughly $48bn on capex this year, mostly for servers to power AI innovations across the company’s business lines. These investments are expected to drive revenue growth by improving search results, providing advertisers with more effective ad units, and bringing new capabilities to developers building on top of the company’s Google Cloud Platform.
• Netflix reported another strong quarter in April, as a compelling slate of content and the company’s paid sharing initiatives led to over 9mm net subscriber additions, resulting in a total subscriber base of nearly 270mm at quarter end. Subscriber growth was broad-based across all regions, and management expects further subscriber additions and higher revenue per member will lead to wider operating margins in 2024. After their recent run, Netflix shares are not priced as attractively as when we initiated our position, so we are less excited about their future return potential. However, Netflix’ advertising business is gathering steam, with the number of ad-supported plans growing +65% sequentially, after growing +70% in each of the prior two quarters. As management phases out the basic ad-free tier in major markets and introduces more live content like the just-announced WWE deal, ad revenue is likely to become a bigger driver of results and could provide additional upside.

Our worst performers during Q2 were ULTA (-26%), KMX (-16%), and A (-11%).

• As we highlighted last quarter, competition in beauty retail has intensified over the past two years. Beauty is an attractive category for retailers because beauty customers make frequent recurring purchases at attractive margins, and the category is less sensitive to changing economic conditions. As a result, retailers like Target, Walmart, and Kohl’s are increasing square footage dedicated to beauty products in their stores. However, we expect competitive intensity will improve, as these retailers approach the upper limits of their expansion opportunities. For example, Kohl’s has added over 900 Sephora boutiques within their stores over the past 2.5 years, but only plans to add 140 locations this year and a similar number in 2025, after which they will have saturated the Kohl’s store base. Despite increased competition, Ulta’s business continues to generate positive comparable store sales and attractive margins by offering customers access to relevant brands across price points in every category, a unique offering that competitors have struggled to match.
• Carmax is currently battling a perfect storm of high interest rates and elevated used vehicle prices that have combined to reduce affordability and pressure unit sales. While the business has likely lost some market share to competitors offering older vehicles at lower price points, we prefer the company’s strategic direction that focuses on selling newer vehicles, which can be turned faster, and generate higher gross profit dollars. The Carmax model continues to operate profitably, generating over $2,300 of gross profit for every vehicle sold in the most recent quarter, despite -3% lower unit sales compared to the prior year. We believe the business is poised to rebound when interest rates and used car prices normalize, but the timing is difficult to predict.
• While Agilent was one of our weakest performers in the quarter, operating results continue to be consistent with our expectations, as we await an inflection in the company’s capital equipment business that has been pressured by high interest rates and a tough funding environment for smaller biotech customers.

Please note that our portfolio returns last year and through the first half of 2024 have been exceptionally strong, and we do not expect this pace of gains to persist. Regardless, we believe Summitry Select is well positioned to deliver attractive returns over the coming years because we are confident that our portfolio companies offer essential products and services to their customers, generate high profitability, and possess strong balance sheets to weather almost any economic environment. In addition, we currently maintain a sizeable cash balance that we can deploy to take advantage of opportunities without selling existing holdings.

While we do not know what the rest of 2024 has in store, we are confident the market will create opportunities. As always, thank you for placing your trust in us to search for those opportunities on your behalf, and please do not hesitate to reach out with any questions.

Sincerely,

The Summitry Select Team

Note: Nothing herein constitutes investment advice or any recommendation that any particular strategy or security is suitable for any specific person. Past performance does not guarantee future returns. Investing involves risk and possible loss of principal capital. An index is a hypothetical portfolio of securities representing a particular market or market segment used as an indicator of the change in the securities market. Indexes are unmanaged, do not incur fees and expenses and cannot be invested in directly. The securities identified and described do not represent all of the securities purchased, sold or recommended for client accounts. The reader should not assume that an investment in the securities identified was or will be profitable.