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Market News 21 May 2018

Poor economists, they are so often challenged on their progressively variable conclusions, which to be fair reflect the constantly changing inputs.

Nonetheless, I enjoyed an economist’s sense of humour recently when he offered to estimate his telephone number if the audience wanted to follow up with questions at a later date.

Investment Opinion

Energy – The cobalt supply chain is just one reason to be gradual about ‘our’ switch away from fossil fuels across to more reliance on other energy sources, such as electricity.

Just like investment decisions, rapid change is typically unnecessarily disruptive.

I have just finished reading one of many articles about the political difficulties with the cobalt supply chain to the world, a world with a growing hunger for batteries, which currently require cobalt.

The battery industry is reported as currently using 42 percent of global cobalt production, a critical metal for Lithium-ion cells. The balance is used in diverse industrial and military applications (super alloys, catalysts, magnets, pigments) that rely exclusively on the material.

Approximately 97 percent of the world’s supply of cobalt comes as a by-product of nickel or copper (mostly out of Africa) and related to the start of my story, the poor treatment of the population of the Democratic Republic of Congo (DRC).

Apparently in the DRC child labour is rife in the mining industry.

If ‘we’ are to worry about the environment, maybe we should apply one portion of worry to the future of it, and two portions of worry to the current inhabitants.

While investment analysts are focused on the excitement (and despair? – Ed) surrounding Elon Musk and his Tesla company, what we really need is Nikola Tesla himself and his electricity skills to help develop more options for electricity storage if we are to ensure that electric transport has a robust future, without abuse of people in mining territories.

I have also been reading the summary of NZ Refining Ltd’s (NZR) plans for a month-long $85 million maintenance shut down. This is part of the fossil fuel industry’s huge commitment to the supply of energy.

Ironically this certainty of supply isn’t something that our desired electricity industry can promise without fossil fuels (coal in this case) as a back-up.

With the NZ government’s recent action over the oil and gas industry NZR must now be pondering its forward-looking financial calculations.

NZR is reported (by Stuff.co.nz) as employing about 300 people and supplying 85 per cent of New Zealand's jet fuel, 67 per cent of diesel, 58 per cent of petrol, all fuel oil for ships, sulphur for farm fertiliser, and CO2 for carbonated drinks.

I can see progressive success with a push toward electric vehicles for commuting, and some trucking, but changes to aircraft and shipping are surely more problematic to me and I am a fan of ‘sparkling’ water when asked.

Those with reasonable memories (2017) will recall Kiwirail’s recent decision to expand its diesel fleet by 8 units at the expense of 16 electric units for moving freight. Given that Kiwirail has political masters this decision would not have been taken lightly and thus it was certain that the merits of the decision were compelling.

As is necessary for all business and consumer products, we need to ensure competitive price tension exists. If fossil fuels were removed and electricity was the only energy source you can be sure that pricing of electricity and cobalt would change and the treatment of miners in the likes of the DRC would become even worse.

NZ now has a Minister for Climate Change, James Shaw (Green), a chap who I enjoy listening to, but I doubt even he has addressed the tricky question of ‘are we prepared to push aggressively for changes to energy sources and storage at the expense of people in Africa (specifically, the abuse of children)?

What is more important; climate theory, or real people’s lives?

We don’t need Al Gore to speculate for us about how these children might be treated based on extrapolation variables.

Trying to manage climate change is centred on the long-term comfort (survival) of the human species. Cobalt mining for electricity storage (batteries) never offered comfort and it abuses the most vulnerable of the species today.

The problem of child abuse in Africa cannot be solved by James Shaw but my point is that NZ should be careful with its rate of change for any strategic policy to change its energy sources.

Regular readers will know of my concern for anything that changes too fast for people to keep up. Rapid change is a disruptive influence that it is preferable to avoid, regardless of the topic.

My underlying point, for NZ, is that it is better not to kill off fossil energy sources, that are very well managed at present, until the alternatives are equally well managed, reliable and not more damaging to the planet and its population.

If ‘we’ can achieve such a position then regulation can indeed be used to advance the preferred option and penalise the twilight option.

Frankly New Zealand’s current government ambitions for influencing fossil fuel use may be less influential than a pebble in a pond.

The US is using its newly achieved position of being almost self-sufficient with oil to play a far more aggressive hand with some of its political will. In conjunction with this new energy based strength the US dollar remains the global currency of choice and it is the second powerful prong on President Trump’s trident. (whisper – the nuclear arsenal is the third).

If the US no longer needs to import oil from the Middle East and can block USD payments used by anyone, anywhere (except cash), they command a very powerful position.

Bitcoin, or no Bitcoin, I’ll predict that US paper money on issue will increase in volume during the balance of the Trump administration. It is likely that smuggling US dollars across the border with Mexico will become more popular than smuggling humans.

China and Europe will see a chance to elevate the relevance of the Yuan and Euro as global settlement currencies, which will slowly be useful, but even combined they don’t have the capacity to block the current US influence.

Another energy observation is that Japan, once committed to cutting its coal use by 10% has now increased its use of coal as an energy source and intends that it will be 26% of the nation’s energy in 2030.

They weren’t helped by the Fukushima nuclear plant’s destruction, but the move to coal is instructive as the cheapest, most reliable, near term option for energy.

Australian electricity generation is dominated by coal use. It is pushing toward more renewable energy but it received a rude warning when its ‘renewable energy state’ South Australia, had its power knocked out by a robust weather event.

The CEO of Trustpower recently touched on these points when he spoke about his understanding of the political push toward 100% renewable energy but observing that a mound of coal beside Genesis Energy’s Huntly generation plant remained the most efficient back up energy source in NZ for certainty of supply.

Interview a few Aucklanders who lost power recently to ask about the importance of certainty of energy supply relative to occasional failure to deliver from renewable energy sources.

None of this ramble, including the global irrelevance of our government’s changes, means we shouldn’t set high standards, and I don’t have ‘the answer’, but I like to listen to experts and I absolutely know that to rush is to err.

Proxy Votes – I have often urged readers to exercise their voting rights, when invited, for the constituents of their investment portfolio.

Or, if you are not going to exercise that vote please pass it to a proxy holder, such as the NZ Shareholders Association (NZSA).

The NZSA are demonstrably on ‘our’ side with their voting assessments and intentions.

Assigning your proxy can usually be done online, with great ease.

Until now I thought it needed to be done one vote at a time but Link Market Services tells me that an investor can assign an ongoing proxy by presenting them with a signed letter, listing each security to assign votes on and to whom.

New Zealand’s very low voter participation is disappointing, and this behaviour dilutes the influence of small shareholders, strengthening the relative position of the larger shareholders.

I would like to propose that individual investors strongly consider offering an ‘open’ proxy vote assignment to the NZSA for their securities, especially shares.

Imagine the influence that you can help provide, to a genuine advocate for small investors, by collectively assigning the leverage of a very large voting position. The collective will garner a far greater level of respect (the sum of the parts).

Note also that an ongoing proxy assignment, such as I describe, means that NZ companies will need to expand their relationships with the NZSA and not consider each vote as a single negotiation with them. It should become a long-term relationship and not a ‘battle per meeting’ scenario.

Such an assignment can be removed at any time, by further instruction to the registry.

I have a draft example of the letter I propose, and all readers are welcome to the draft. Clients of Chris Lee & Partners are welcome to ask us to populate the letter and email out to you for printing, signing and returning.

Let’s see if we can use our ‘sum of the parts’ to help the NZSA increase its influence for us all.

I shall be assigning my votes.

On a separate matter, the NZSA welcomes your membership too, so they can afford to represent you, and provide you access to the deepening pool of investor information and events.

Buffettology – Having directed you, last week, to the Berkshire Hathaway annual report video, I’ll save the rest of you by offering a few notes from my observation.

Warren Buffett and Charlie Munger (W+C) answer questions with a charming frankness that strips away 90% of the nonsense communicated in the investment sector.

W+C about their late investing in the technology sector (they are buying Apple now) – ‘we missed the bus, but if you’d offered us Coca-Cola the year after it was developed we would have turned that down too’.

Whilst they do make many informed assumptions when investing they are evidence-based investors more than speculators.

Speaking of Apple, it makes more money than NZ’s reported GDP so we can be sure that Berkshire Hathaway is not looking in NZ for investments. We are too small for them, just as Christchurch projects were too small for the NZ Super Fund; especially once the council refused to raise much needed finance by selling shares in the likes of the airport or the port. (I wonder if the new local government funding review will describe not selling assets as a failure).

W+C are experts at investing in business that require a lot of capital, and how to seek efficiency, but they found it hard to initially understand the capital-lite technology businesses, believing they would be easy to compete with (until brand took over, like Apple).

Waiting for a brand to gain strength requires a lot of patience or investment risk tolerance.

If you want to be a long-term investor, invest in productive things for this is what benefits a population. (W+C compared poor returns on gold over long periods, then concluded crypto currencies would be worse than gold).

A 6.00% after tax profit is a good, long-term, return target.

W+C are not disciples of Efficient Market Theory declaring its Priesthood as having strayed, regularly, from the principles of good investment. They encouraged EMT disciples to re-read Ben Graham’s ‘Intelligent Investor’, to keep learning and to acknowledge that conclusions change over time.

On the questions of equality (women in this case) W+C replied that more women in business and politics will almost double the quality of performance.

On questions about artificial intelligence (AI) W+C acknowledge the various benefits of robotics but question the AI’s ability to make investment decisions (allocating capital). ‘False precision will deliver false outcomes’.

Listening to this AI answer I realised that the scale of Berkshire Hathaway and its oft-described family firm approach means their decision makers have access to vast information about financial risk, information that is unavailable to most analysts and certainly to AI computers.

Listening to W+C was more valuable for me than most of the qualifying ‘Continuing Professional Development’ that satisfies our regulators.

Investment News

Fletchers – Shareholders who elected not to take up their Rights to more FBU shares at $4.80 will be sent a payment for $1.65 per Right because they have now been sold to institutional investors.

The $6.45 price paid for the additional FBU shares, well above the diluted market price of $6.07 at the time of the announcement, displays a robust vote of confidence from professional investors in these financial steps being taken by the company.

Institutional FBU investors took up 98% of the Rights offered to them, whereas retail investors only took up 58%.

The market price on the day the surplus retail Rights were sold was $6.56 so you can see that the market has ‘charged’ a 1.67% ‘underwrite’ fee for accepting these additional shares.

I read a couple of articles that griped about the underwrite fee but this was incredibly short-sighted thinking from the same media who had just finished writing about the person(s) who positioned FBU with the financial problem that this capital raise was solving.

$25 million was part of the price for solving the $1 billion problem.

I could bat around the minutiae of who extracted the most value from the capital raising but from my perspective the Rights offer now looks like a good example of win:win:win to me, which implies good strategy by FBU and good advice from the investment bankers.

$1 billion – Two weeks ago the CEO of Westpac NZ, David McLean, batted away a media suggestion that he was focused on lifting the local bank’s annual profits to $1 billion.

Last year’s after-tax profit was $970 million.

Actually, I’d be disappointed if WBC wasn’t targeting a profit above $1 billion given the continued growth in consumer debt, funds under management and our rising population base.

However, that’s not the thrust of my message here, which is who else is talking in terms of billions?

Last week A2 Milk announced a forecast of ‘almost’ $1 billion revenue ($900-920 million) for the current year; note the difference though between revenue and profit, but for ATM to so quickly be talking in billion(s) is a remarkable achievement by any company.

Further, with ATM’s rapid growth trajectory they have every chance of leaping straight past Westpac NZ’s annual profit result too.

Given ATM’s low capital requirements, relative to that of Westpac, a lonely man could conjure an argument of sympathy for the bank.

Petrol – The price of petrol clearly isn’t high enough.

Over the weekend I saw two Dad’s driving their dogs around, instead of walking, whilst they played digital games on their mobile phones (catching digital characters in different geographic locations).

Tilt – The Tilt Renewables share price is another example of excessive selling by unhappy shareholders, unhappy for reasons other than value, and I might add another example for Warren Buffet of ‘Inefficient Market Theory’.

Having pressed the TLT share price down a little too far, to $1.80, the market witnessed an alternative view about the value of their company when Mercury Energy (MCY) purchased 19.99% of the company from the Tauranga Energy Consumer Trust (TECT) at $2.30 (+27.7%).

MCY would have purchased more shares too if takeover regulations hadn’t stopped them at the 19.99% level. They won’t get any further because Infratil, owner of 50.5% of TLT has already stated that they would block any further moves by MCY.

For the patient investor TLT value = $2.30

Indexing – Shares moving in and out of indices, tracked by various funds, also results in temporary distortions to a share price relative to a company’s value.

Last week’s review of constituents in various MSCI indices (Morgan Stanley Capital International) resulted in some large jumps in share pricing for those most likely to be ‘in’ or ‘out’ of an index.

A2 Milk (in) was a jump, Synlait Milk (in) was a jump, Fletcher Building was a fall (to $6.30) on speculation of ‘out’ until the market discovered it was ‘in’ and became a jump (to $6.65), Mercury was a fall once confirmed as being ‘out’.

The value of each company didn’t change that day, but the interim pricing did.

If you remind yourself that volatility is for traders and value is for investors, you’ll ignore this noise and be fine.

Turkey – as a pronoun.

After Turkish President Erdogan ‘wins’ the upcoming democratic election he plans to take more control of monetary policy.

This spells doom for the Turkish economy, not progress.

Globally, the volatility of inflation has been controlled and stable for decades because governments passed control of monetary policy to central banks, removing it from the vote catching playing field that is politics.

Edogan’s foolish ego will deliver instability to Turkey.

Ever The Optimist – I thought I’d have plenty to say about the NZ Budget, but not so.

I don’t need to dwell on political philosophy to say that the budget was fiscally careful and to compliment them considering how they’ll budget for the whole next 3 year term in government.

I also like the intention to introduce a new department to cost and assess political promises and to begin measuring government performance in other areas of societal wellness.

I think those who criticised the lack of big strategy from the budget rather missed these two new points.

ETO II - When we hear the European drums, they presently echo the subjects of Brexit, Italy’s lack of a government and the European Central Bank’s monetary settings.

This ETO wants to highlight a European success story; Portugal.

Like Ireland, Portugal has reformed its economy and is enjoying the successes they deserve.

After 14 consecutive quarters of labour force reduction employment is growing again.

Unemployment has fallen from 17.50% to 7.90%, ‘growth’ has improved from receding to be +2.70% for the past year, debt to GDP reached 130% and has begun a decline, now at 126% (initially targeting 80%).

The government is forecasting a fiscal surplus of 0.25% of GDP in 2020 (It was -0.9% last year).

Portugal has exited its special funding from the European Union and IMF.

The credit rating has been lifted back to investment grade (BBB credit rating).

The proportion of low skilled employees is declining; in 1982 only 2% had university degrees but now 20% of the population do.

Portugese banks are again attracting capital investment from international providers.

Do you remember the derogatory acronym PIIGS?

P – Portugal.

Be honest about the facts, set a good strategy, do the hard work, be persistent and be patient.

ETO III – We should be grateful for small bursts of luck.

The climate recently has resulted in a new monthly (April) record of 148.2 million kilograms of milk solids; lucky because it is amid the Mycoplasma bovis threat to the country’s herd.

Investment Opportunities

Fixed Interest investors should be on alert. We understand that the past three bond announcements (Christchurch Airport, NZX and now ANZ bank) are the beginning of a ‘season of issuance’.

NZX Bond – The NZX has announced a new subordinated bond to replace its bank debt, most of which is used to support its clearing house (settlement) risks.

The new bond will have a 15-year (2033) legal maturity date, with Election dates each 5 years (2023 next).

The interest rate will be set on [date] but in our view will need to be 5.00% or close to it. Guidance was given on 17 May at 5.40% minimum rate and the final rate set will be on 25 May.

The issue size is small at $40 million, with $5 million of this held in a priority pool for NZX shareholders.

This offer is being processed via a Product Disclosure Statement (prospectus) and application form and the NZX will be paying the brokerage costs for the issue.

A summary of the key details and investment opinion for the NZX Note Issue will soon be available on our website for advised clients.

We have a mail list for investors who wish to participate in this offer.

CIAL – The Christchurch Airport bond was finalised last week with an interest rate of 4.13%.

Thank you to all who participated in this offer with Chris Lee & Partners Ltd.

ANZ Bank – today announced a new 5-year senior bond (ranks alongside bank term deposits). We estimate a market yield of about 3.60%.

This will be a fast moving, contract note style offer with investors paying brokerage.

Summerset Group – indicated in a recent corporate release that it is considering issuing a new bond (SUM020).

Given the new methods available to the market under FMCA law, it would be remarkable if their new bond weren’t identical to its current bond (SUM010) except for the maturity date and interest rate.

One can certainly get a head start on considering all the key risks of lending to SUM.

Housing NZ – has received permission to increase its funding programme via bond offers.

They are making presentations to the market shortly and may offer new bonds thereafter.

HNZ’s very strong credit rating implies relatively low interest rates.

We will keep you updated here.

ICBC – Industrial and Commercial Bank of China has also indicated that it may issue a new bond in coming weeks, after presenting financial updates to the market.

With their ‘A’ credit rating investors should expect ICBC bond yields to align reasonably closely with returns on bank term deposits.

If a bond offer is announced, we will repeat the details here (Market News) and via our ‘All Issues’ email group.

Fletcher Notes – We continue to keep our FBI170 list open for those wishing to hear more about the possible supply of this fixed interest investment.

All investors are welcome to contact us to join lists if they wish to invest under a new offer.

The fastest way to hear about new investment offers is to join our ‘Investment Opportunities’ (New Issues) email group, which can be done via our website or by emailing a request to us to be added to this list.

Travel

Edward is in Auckland on 28 May, Wairarapa 11 June, Napier 12 June and Taupo 13 June.

Chris is in Auckland 18 June, Whangarei 19 June, Auckland 20 June and Christchurch 26-27 June.

Kevin will be in Christchurch on 7 June and in Queenstown on 15 June.

Our future travel dates can also be found on this page of our website: https://www.chrislee.co.nz/request-an-appointment

Any person is welcome to contact our office to arrange a meeting.

Michael Warrington

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