Market News 23 November 2020

Pfizer and Moderna now make it 'two birds in hand' in the battle against Covid19.

Hopefully, the world will soon require an aviary to coordinate the attack on the virus.

INVESTMENT OPINION

Investor Injustice – Some new investors in Synlait Milk (SML) have been mistreated by the company.

People buying and selling SML shares on the 6th and morning of 9 November did so without the knowledge of the new capital raise by discounted share placement. The timing and terms in the announcement impacted upon these people, negatively.

Trading on the NZX settles two business days later.

SML trades on Friday 6 November settled on Tuesday 10 November.

SML trades on Monday 9 November settled on Wednesday 11 November.

Inappropriately SML placed their shares in trading halt on the afternoon of Monday 9 November, and then on Tuesday 10 November SML announced the new share placement would involve retail SML investors on the register as at 5pm on Monday 9 November!

The announcement made it impossible for SML investors to have made an informed decision on 6 November or the morning of 9 November and that group is unable to participate in the offer.

SML appears to have recognised its error because the words carefully used in the announcement on 10 November included the following: almost all eligible existing shareholders have the opportunity to receive at least their pro-rata portion of new shares being offered (highlight is mine)

Companies raising new capital still cop criticism for placements and not simply offering pro-rata Rights issues, and there are two sides to that debate, but there aren't two sides to debate when a company makes it impossible for an investor to participate due to the timing and terms of their announcement.

Post Script: clients receiving a financial advice service from us can find a research piece for SML shareholders considering the offer.

Subordinated Bonds – The reminders about the sharp end of the ''fishhooks'' (concessions made) in subordinated bonds continues to be seen in the latest announcement from the BNZ relating to one of its subordinated bonds (BNZ090).

In response to demands made by our central bank restricting repayment of subordinated bonds, as one mechanism to assist with managing post Covid19 risks, the BNZ has announced that it will not repay its BNZ090 bonds on 17 December 2020 (the first optional repayment date).

The legal maturity of the bonds is 17 December 2025.

17 December 2020 was an optional repayment date, when the market had on balance expected repayment to occur. If the bank was allowed to state such things publicly, they too would have explained that repayment on this date was the original intention.

The new interest rate for the period between 2020 and 2025 will be set at the 5-year benchmark interest rate plus a credit margin of 2.25% resulting in a new interest rate near 2.50%.

The BNZ now has the option to repay these bonds on any quarterly interest payment date, subject to central bank approval.

I don't see a lot of point in guessing when the BNZ might repay. They have a price incentive to repay early, so I don't expect the bond to remain on issue until 2025 but in the meantime, you should just enjoy the interest rate being paid (enjoy 2.50%? – Ed)

The coming to pass of these less likely outcomes from subordinated bonds do not make them bad products for a portfolio but they remind investors that if you make a concession (additional risk in the terms and conditions) you have an exposure to that scenario playing out and not being a breach of the agreement.

Accordingly, subordinated bonds must pay investors a higher return than senior bonds which have much simpler terms and conditions.

The marginal rewards between senior and subordinated bonds evolves.

It has, at times, been very attractive during the past 11 years, such as immediately after the Global Financial Crisis when rewards were up a lot but the default risk of banks was declining.

Today, the marginal rewards offered on subordinated bonds could be described as slender. Are the risks lower now than then?

BNZ090 bond holders have no action to take.

Vital Healthcare (VHP) – You may recall us expressing our unimpressed view about the third-party management of VHP, essentially based on the selfish behaviour displayed by its Canadian based manager.

We were entitled to this independent opinion.

Last week ANZ bank expressed is dissatisfaction about the management of VHP.

Those with long memories will understand why the ANZ has almost no right to express such an opinion, because they were the ones who sold the management contract to them!

Bad decisions are usually found out as time passes.

Council Finances – I think the consequences of our councils thinking they need to be bigger, and exert more influence in our communities, rather than less, is coming home to roost.

The egos of our elected folk make it impossible for them to think less is best.

In Wellington the headlines are now disclosing the risk of rates increases that could, if unchecked, exceed 20%.

Christchurch endures the heat of the financial spotlight often, as does Auckland where its debt position is becoming so large that they have the scale to hire an investment bank all year to help with debt management obligations!

Auckland Council's (AKC) last attendance in the headlines related to their debt management when the media, without specialist knowledge, joined public criticism of AKC for its loss of $1.4 billion. The $1.4 billion number came from the accounting standards methods for revaluing assets and liabilities, not because money evaporated.

The critics, David Cunliffe (re-appearing on the political landscape) and the journalist are naïve on the subject they were being critical of, namely, interest rate swaps.

Interest rate swaps allow two parties to 'swap' interest rate obligations; one accepts a fixed rate whilst the other accepts a floating rate. Each party has a reason for accepting the chosen risk, which relates to debt obligations and the impact changing interest rates would have on them.

AKC elected to fix the interest rates on some debt (all it seems – Ed), adding certainty to its cost and thus probability to budgeting for project decisions, which makes complete sense for many of a council's long-term projects.

No borrower has the luxury of looking backward when making financial decisions so most of the criticism levelled at AKC is inappropriate.

If it's true that AKC converted all of its debt to fixed rate then it discloses an aggressive debt management policy (this assumes they have a policy) because most entities would have some floating rate debt to expose a portion of the liabilities to the potential for interest rates to fall.

You'd certainly do so if you had the potential to increase revenue during periods of higher interest rates (inflation) to offset the risk of higher interest rates, or the ability to repay such debt faster than scheduled.

I am sure you'll all agree that your council has made it pretty obvious that they have the potential to increase their rates invoices to meet increased costs!

AKC does however deserve some criticism if they locked in fixed interest rates for 100% of their debt profile and , in my view, criticism for following work programmes that allow for such enormous debt positions, which drive the $1.4 billion revaluation loss.

Typically AKC would be able to explain to rate payers that the value of their assets had increased in response to plunging interest rates (the driver of the $1.4 billion debt revaluation loss) but in their case that's scarcely true when you ponder the fact that the share price of Auckland Airport is lower this year than last year and Ports of Auckland is underperforming financially.

You may recall my view about the financial waste with councils owning businesses that they do not need as part of their regulatory or community function, or owning more than a controlling interest (50.1%) where they determine control is vital to the way the service is provided.

Did AKC begin to agree with my view during 2020 when they chose not to participate in the AIA capital raise, diluting their shareholding from about 26% to 20%?

And what is magical or influential about a 20% shareholding in their local airport?

Would they not have served their city better 10 years ago by selling their AIA shareholding and supporting, then investing in, Lloyd Morrison and John Key's proposal to develop a second airport for Auckland at Whenuapai?

I wonder how AKC councillors and finance staff felt in April witnessing the impact on AKC finances as the realities of Covid19 became clear. Losing money on interest rate movements and on the value of assets they thought it was important to own.

It's time to step down from my soap box.

It's also a good time for journalists to improve their knowledge before writing articles in the public domain.

If councils think it is OK to increase our rates by 5-23% per annum to continue with their egotistical approach to local governance, then my views are irrelevant (still – Ed).

Investors in AKC bonds have nothing to worry about from council incompetence; you are secured against the ratepayers' compulsory financial commitments to the council.

ETF – There is an educational irony in the Tesla share price performance that the bi-polar (investment thoughts) Warren Buffett would endorse; you can dislike the idea of investing in Tesla at current pricing, but be wise to retain an exposure to it all the same.

Buffett famously adds value for Berkshire Hathaway investors by selectively investing in opportunities that demonstrably should add value, however, he declares that when he is gone the best thing Mrs Buffett could do with her wealth is to place it in an Exchange Traded Fund focused on the US economy.

Both positions can be correct.

Warren loves to assess micro drivers for investment outperformance.

Mrs 'Buffett' does not.

A majority of investors who prefer to select specific companies to invest in do not like the Tesla story, nor its astronomical (no link to SPACEX) share price performance but there's no doubting Tesla influence within the US economy is rising.

As a reminder, the Tesla share price has moved from US$50 in 2019 to US$450 now and they still do not deliver a profit to owners.

Investors who dislike Tesla have missed an enormous value change for a rising participant in economy, but investors holding an ETF exposure to the broad US economy have enjoyed some benefit.

Warren Buffett's investment performance continues to exceed the market average, but his theory of ETF use for others exceeds the performance of the majority of active fund managers.

It's a recurring conundrum.

Cheques – the reminders keep coming that the cheque book is heading for retirement, fast.

Last week another of the major financial institutions in NZ declared that it would no longer accept cheques as a form of payment, including asking their bank not to process cheques if presented at the bank for deposit to their account.

For many, including us, cash is no longer accepted as a method for payment even if presented at a bank branch (Anti Money Laundering reasons).

From an investment processing perspective cash is out, and cheques are rapidly on their way out.

If you still love your cheque book, I hope you are developing an alternative method for making your payments.

I am certain that the majority of you are still wary of cryptocurrency as an option, but its presence is rising. I read a survey that reported 10% of the US population have participated in ownership of cryptocurrencies, a statistic that seems to be validated by PayPal's introduction of a cryptocurrency payment method to its service offering.

 

EVER THE OPTIMIST

What a strange ETO this one is; the tourism industry wants to employ more people but is having trouble finding them!

Given the staff requirements of our horticulture sector surely, we will see a temporary decline in the unemployment numbers over summer.

Investment Opportunities

Chorus Bond – Thank you to those who participated in this bond offer through Chris Lee & Partners.

CNU should be very pleased to have issued $400 million bonds in the end ($200m of each maturity), responding to very high demand for the bond offer from investors.

The 7-year bond interest rate was set at 1.98%;

The 10-year bond interest rate was set at 2.51%.

It's a shame the person with the magic wand didn't resolve slightly different interest rates; 2.00% would have been a nicely rounded outcome for the 7-year term and we would have tolerated 2.50% for the 10 year.

The bonds begin trading on the NZX from late next week.

Infratil Bond – IFT is offering investors the chance to buy more (up to $100 million) of its IFT300 bonds at a market yield of 3.00%, with IFT paying the brokerage costs.

The IFT300 bond pays 3.35% interest and matures on 15 March 2026.

The initial period for participation ends on 15 December 2020 and the purchase price is $101.619 per $100 bonds (this reflects the difference between the 3.35% interest rate paid out and the market yield of 3.00% for this offer).

Early Bird interest is being paid at 3.00% for applications that arrive prior to 15 December.

Participation involves the use of an Application Form (available on the Current Investments page of our website).

Investors must contact us to gain a firm allocation prior to submitting an application to our offices (or to us by email).

Ryman Healthcare – has announced that it proposes to issue a new bond over the next couple of weeks (more details to follow), possibly a 6 or 8 year term.

TRAVEL

Johnny Lee will be in Christchurch on 25 November.

Michael will be in Hamilton on 7 December and Tauranga on 9 December.

Please let us know now if you would like an appointment in your town.

Thank you.

Mike Warrington