Chris Lee & Partners Ltd

Market News – 15 April 2019

General warning.

This note started after hearing the updates about how much money New Zealanders are scammed out of.

If you are ‘approached’ (phone, email, in person), meaning you did not initiate a request for service, and the communication is trying to draw you into an action that you did not intend, then you should back away.

At the very least, think it through with a very cynical eye and ask someone else for an opinion on the matter.

Some of you may have experienced the many businesses that try to convince you to open online trading accounts in financial markets. Often these businesses are based outside NZ and thus do not need to meet as many of our local regulatory consumer protections.

On a recent online advertisement for such online trading businesses I saw in a footnote, demanded by Australia’s regulator ASIC, the following words: ‘84% of accounts trading in derivatives lose money’.

If I remove the professional traders who hold accounts from this data then I speculate (pun intended) that it is nearly 100% of retail investors losing money when trying to trade derivatives through these online accounts.

Don’t be drawn into this either.

INVESTMENT OPINION

Selling Future Cash Flows – Businesses, and people, are discovering different future cash flows to sell to investors and extract large sums of money today, for use on different spending/investment purposes.

Actually, I hope it is a different investment purpose because selling one’s future cash flows implies introducing a cost to that money (just like debt).

Last week Sky City Casino advised the market that it had sold 29 years worth of revenue from its Auckland car parking for $220 million. (we knew we were paying too much for commercial car parking – Ed).

This SKC transaction discloses various things but one is how the recognition of low interest rates has sunk in with investors and how investment managers (Macquarie in this case) are hunting for assets with cash flow certainty to discount at a yield a little above current interest rates and then present it to investors as an opportunity, which it is.

The reality is that Macquarie will probably place this new asset immediately into client portfolios (pass the car park risks to the investor) and begin earning their annual fee so don’t expect it to be re-offered to retail investors via public offer.

I say this as if Macquarie has done something bad; they have not. They, and SKC management, have discovered another reliable cash flow that can be sold to investors who crave regular cash flow with a reasonable return.

Armed with data about the probable cash flow from the car park SKC has agreed a yield to offer to investors who wish to buy that cash flow, thus determining the purchase price today.

I originally thought that yield might be 5% or 6%, but subsequent information implies they gained a yield closer to 8.00%, which seems a little high to me (a loss of opportunity for SKC).

I think you can be sure that the yield offered will be lower than SKC’s cost of capital (the money they use to own their car park) so passing the car movement and cash flow risks to someone else, at a yield below their cost of capital (money to run the business) is a good way to raise $220 million and reduce debts or invest in more rewarding business activities.

I ponder why SKC and other business do not begin to offer such investments to the public directly; annuities with yields dependent on the revenues collected in the car park.

Macquarie is a wholesale buyer, which means the return sought would be higher than a business might achieve if they sell the asset directly to retail investors.

If SKC had offered this investment to retail investors, some of whom might be attracted to an annuity, they might have been able to temporarily sell the asset at, say, a 5.00% implied return.

The cash flows from a car park for 20 years would provide a nice annuity product to investors without the need for an investment manager, and thus avoid the impost of annual management fees which damage returns so deeply in today’s low return market.

If other businesses aren’t so keen on this idea maybe council or government controlled operations could sell off some of their most reliable cash flows to retired investors?

I’m thinking city council parking buildings where they can isolate the actual performance, as opposed to street parking with its vagueries (and desire to push lower with bike use – Ed), or parking fines, which might be a novel one.

In an even more interesting twist on this theme I read an article in the US that described how some students are selling a proportion of their future earnings to raise capital to finance their way through college!

The subtle difference between borrowing money and repaying, or selling future cash flows, is who carries the risk.

If you borrow money, you carry the risk and you must repay the debt obilgation (capital and interest).

If you sell a future cash flow, without guaranteeing the scale of that cash flow, the person who buys it from you carries the risk relating to interest and capital return.

You can see why the simple loan (fixed interest investment) should have the lower interest rate, and why the sale of a future cash flow should at least offer a higher potential return against the additional risk accepted.

I hope some other businesses follow Sky City’s lead and offer amortised cash flows to investors, especially those who are comfortable spending some of their capital in retirement because as a generalisation I would view this as a better option than paying rather hefty fees to the likes of the Lifetime Income Fund to manage capital spending.

I ponder now whether I could sell my National Superannuation payments to my kids, based on an assumption that I’ll live to be 100 years of age?

Business is hard – I saw a headline on Bloomberg last week that was exactly what I had been thinking as I read about the Boeing 737 MAX problems.

The headline was: ‘Anyone who tells you running a business is easy has clearly never tried’.

I don’t want to drift too far in to politics, but politicians would do well to avoid assumptions that private business is a pathway to riches for it places those regulators on their own pathway to the dangers of envy.

Boeing did not set out to have the problems they encountered recently. They are an example of the constant risks faced by businesses and for the most part resolved by those businesses, as they must be, otherwise the business fails.

Of interest to me is the software aspect of the 737 MAX failures.

Boeing make excellent aeroplanes, but as an increased reliance on software is added the business risks have been amplified, not reduced.

Extrapolate this thought to the many businesses using ever more technology and claiming that artificial intelligence will soon replace humans in many fields.

This is something I doubt very much.

Yes, technology and science are helping us along a path of improvement, as one would hope, but computers are not consumers; we need to keep the labour force employed too, otherwise the economy fails.

Relying solely on technology will be a brave move, perhaps too brave, as Boeing is finding out at present.

Believing that business is an assured pathway to excessive riches would be a foolish conclusion for regulators.

Infratil (IFT) – I had one of those Dr Who time warp moments last week when attending Infratil’s annual Investor Day; has it really been 12 months?

As usual, the event was very well organised and informative. IFT has a proud history of good communication with its stakeholders.

The major message was that the portfolio reset (simplification) is largely complete with a couple of items yet to sell.

Interestingly they use similar terms for their portfolio as I do for mine in trying to describe assets as ‘Core’, ‘Core + / Growth’ (‘Supplementary’ for me) and ‘Development’ (‘Explore’ for me).

Whilst they describe all assets as having the potential to be sold, I’ll bet they hear Lloyd’s ghost loud and clear if they ever offer up Trustpower or Wellington Airport for sale. These two businesses provide the water-tight cash flow that all investors crave and thus provide a good proportion of the underwrite for the risks management likes to take in ‘Core+’ and ‘Development’.

The strongest sub-messages were:

Hugely exciting performance by the Canberra Data Centre business, which has now expanded into New South Wales and is wearing running shoes, not loafers, to keep up with customer demand for the service;.

Marko Bogoievski (IFT CEO) speculates that CDC will become IFT’s single biggest asset, soon; and

Very strong performance by Longroad in the US where all original capital has already been returned and the residual business value is $128 million with plenty of new projects underway.

HRL Morrison & Co (MCo) was challenged on the day about their fees after a stellar year of outperformance for IFT and whilst the nominal numbers are indeed large I don’t buy into this argument.

Fees for managing IFT are described ‘on the tin’.

MCo’s fees for outperformance are attractive for them (at 20% of outperformance), but it is 12% per annum that they must outperform which was reasonable when set, relative to the lofty 15-20% targets set up by Lloyd and is surely more reasonable now in a world of collapsing interest rates and relative returns on equity.

Sure, I’d rather own shares in MCo than IFT, but that’s not what was offered on the tin.

I doubt that the financial advice industry will be too vocal about MCo fees because many in our sector charge fees at ratios that have a familiarity when viewed alongside MCo’s (excluding us of course).

What IFT investors do receive is the demonstrably strong management skills of the MCo staff whose performance is far better aligned with IFT shareholders than those tangled up in the recent fee debate surrounding Vital Healthcare Property Trust.

Today IFT shareholders will be rather happy about the recent 30% increase in their share price. If they’d like to understand some of the reasons how this happened they’ll find more detail on the company’s website: https://infratil.com/

INVESTMENT NEWS

Young Business Successes – There was a good article sourced to Callaghan Innovation last week about the growing number of NZ start up businesses that are succeeding, and often doing so on the global stage.

Callaghan highlights the importance of these businesses being able raise new capital, and for founders to be willing to exit their ‘baby’ to reinvest such funds into new ventures (capital recycling) for the ongoing success of the NZ economy.

The NZX would agree with the economic benefits of raising new capital and expanding the register of owners of a business and would undoubtedly welcome all comers to list their businesses on the local exchange.

Callaghan rattles off various successful names such as Xero, A2 Milk, Lanzatech, Rocket Lab, PushPay, Vista, Gentrack and My Food Bag, whilst carefully not dwelling on failed businesses, observing that successful new businesses have added $34 billion of value over the past 15 years.

I noted one Wellington based business that wasn’t recorded in the article, which I have been following (disclosure – I own a few), by the name of Volpara (VHT.ASX). Volpara operates in the health sector (breast cancer screening) and has developed a software application that is effective enough to have already captured 7.1% of all women screened in the US.

You might notice from the code above that Volpara is listed on the Australian stock exchange, but not NZ, which is a problem that the NZX must resolve for NZ investors.

Another article, on a similar subject, confirmed that Sam Stubbs has been able to repay his personal loan of start up funding to Simplicity Kiwisaver because outside investment is now being attracted to support this business.

It would be nice to learn that Sam is considering recycling his own capital into another new business venture, or that he is supporting the ventures of others.

The thrust of the Callaghan story though is that NZ, and NZ entrepreneurs, are becoming much better at trying to build businesses to serve the world and not just our local village.

Here’s hoping that a few of these businesses remain listed on the NZX to provide ‘us’ with direct access to more investment opportunities.

Maybe the NZX could consider launching a Smart Share ETF that focuses on investment in immature businesses that meet certain early stage success criteria?

Global Growth – It’s not great news, but it needs reporting to investors; the International Monetary Fund has again reduced its global economic growth forecasts (3.6% in 2018, expecting 3.3% in 2019).

This is consistent with the sharp fall in interest rates recently, for short and long terms.

AirBNB tax – AirBNB has agreed with Danish law makers to supply data relating to the 39,000 who list their properties in Denmark via the property sharing platform.

For the first two years the data will be manually supplied but by 2021 information flow will be automatic. This sounds as if Danish tax authorities need time to develop their technology to receive the data live.

Denmark has an efficient tax at source economy and it clearly wanted this new revenue development to be captured in the same efficient way. So should all economies.

AirBNB is doing the right thing. They have no role in each different country’s tax or land use regulations so reaching agreements to transfer data to regulators ensures business longevity and shouldn’t have much impact on the financial performance of the business.

Regulators simply want to collect tax based on revenue (and capital it would seem – Ed).

New Zealand is also moving further down the tax at source efficiency model.

Given the scale of tourism in New Zealand our IRD would do well to get on a plane and ask AirBNB for the same agreement for NZ property use.

EVER THE OPTIMIST – You must admire the likes of Sir Stephen Tindall for the financial commitment he, and others, make by investing in multiple young businesses.

These people are often reinvesting money from their own successes and typically offer time free of charge to help these ‘businesses with real potential’ to push further forward.

I see a lot of this happening in the venture capital clubs around NZ.

The item that caught my eye last week related to Sir Stephen providing financing to ‘Simplicity’ Kiwisaver which is an example of him supporting competition that aims to avoid domination of an industry by ‘the few’.

It is very hard for most investors to invest in these evolving businesses, but you should be pleased that there is a lot happening because it is a sign of a healthy financial market populated by enthusiastic business builders.

ETO II – An oblique extract that I took from the Infratil Investor Day was that within many global democracies there are safety valves to dilute the short term impact of ‘incompetent’ leadership.

Some examples were given displaying that whilst central government can charge ahead with strategies that do not have wide support (think President Trump or the Australian Federal government) individual states can make their own decisions about what they will allow locally.

Longroad (Infratil US company) explained how Trump can be anti the Paris Accord and a cheer leader for the coal industry but California has enacted a 100% Clean Electricity Standard and many others are following the same path.

Tilt Renewables are witnessing similar behaviour in Victoria and NSW Australia.

This doesn’t, of course, help where dictators preside (Russia, China, Turkey etc).

INVESTMENT OPPORTUNITIES

Metlifecare – Possible new bond.

Given the directors hints that they may also buyback some of their own shares at current market pricing this new bond offer seems inevitable to me.

Napier Port – The regional council has approved the sale of some shares in the port and now appointed its lead managers to bring the offer to market (in the months ahead).

A new holding company has been formed.

This is an exciting development for investors, and the NZX, and we look forward to this Initial Public Offer reaching the market.

We have a contact list for investors wishing to hear more about participation in the float of Napier Port.

Mercury Energy – Investors holding Mercury’s subordinated bonds (MCY010), which come up against their next Election date on 11 July 2019, should expect a communication from them by early June.

My mix of grey hair and speculation concludes that these investors will be offered an opportunity to either exit their investment or reinvest in a new similar bond for another term.

If a new replacement bond is offered it seems highly likely that new investors will be invited to participate, which helps ensure that the same total amount of funding is retained by the company.

Rabobank – Whilst I am considering complex subordinated bonds, I DO NOT expect Rabobank to offer a new investment to holders of the RCSHA perpetual bonds.

It is our view, based on repayment of the RBOHA and Rabobank statements about these securities, that RCSHA will be repaid on 18 June 2019.

If we are correct you would expect to see an announcement by mid May.

TRAVEL

 

Edward will be in Tauranga 29 April, Blenheim on 15 May.

Kevin will be in Christchurch on 17 April and Ashburton on 9 May.

Mike Warrington

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Market News – 8 April 2019

The European Union was probably feeling a little smug as it watches the UK parliament tearing itself apart over Brexit.

Theresa May has finally agreed to involve the opposition in negotiations, something that should have happened one day after the binding referendum because surely such a momentous development required a whole of government approach.

The EU should not be smug. Alongside the real risk of Brexit without an agreement the EU is now venting its frustration about China’s involvement in Europe, through Italy.

It’s not hard to imagine China approaching other financially weak EU nations to ‘offer’ them some new business opportunities.

INVESTMENT OPINION

Kiwisaver (plus) – The government is introducing new levels that can be chosen for Kiwisaver contributions (by the saver), which means the options will now be 3%, 4%, 6%, 8% and 10%.

The employer and government contributions do not change.

I hope the government continues to debate making Kiwisaver compulsory (with some exceptions granted for logical reasons) at the lowest setting, and to do so as we try to drive minimum wages up would make the visible impact less for those who have not already decided to join Kiwisaver.

On this matter, I disagree with the National opposition that increases to the minimum wage are happening too fast. If our economy cannot afford these increases after an extended period of strong economic performance then something is wrong with the employment processes.

Further, government and council policies have contributed to a far more stark move in the pricing of property and this is where they should focus their attention with respect to income and expenses for the wider community.

These drivers, of course, remind us of the cost side impact that will be felt by all businesses, so do not expect strongly rising profits from business even though ‘they’ are operating in a relatively strong economy.

Our generation (50+ years) can do two things for our kids, and grandchildren to be effective with their future finances:

1.       Urge them to save money via Kiwisaver throughout their working lives; and

2.       Pass down some equity early, if you have any to genuinely spare.

The low interest rate environment should help with the rest as they clear debts.

Spark – After the surprising announcement that Simon Moutter had resigned as CEO of Spark ro be replaced by Jolie Hodson my initial reaction was ‘this is a very good look for the company’.

Spark now has ladies leading the board of directors (Chair) and the company (CEO). In fact NZ has returned to a position where we again have women in the roles of Governor General, Prime Minister, Chief Justice, Chair and CEO of our fifth largest NZX listed company.

I apologise to the many I have missed (CEO of Statistics NZ and IRD for example – Ed) but you get my point (one Kevin touches on too); NZ is getting better at recognising the best people for roles based on their skills and we’ll all be better for it.

In a strange digression – NZ would be much better off if we ushered some of our most capable women to the top of our health system based on what I have been hearing from the sector.

However, beyond my anecdotal admiration of the change at Spark, Kevin Gloag had a more detailed opinion for you, which features here:

The resignation of Spark CEO Simon Moutter seemed to surprise most people, although Spark’s board claims to have been carefully planning for his departure after Moutter indicated a five to seven-year tenure at the time of his appointment in 2012.

While seven years at the helm of one of NZ’s largest and most high-profile companies is a very commendable effort his resignation all seemed a bit sudden and unexpected and it seemed odd that his departure, which follows 3 months’ notice, had not been previously signalled to the market.

I think it is generally agreed in business circles that Moutter has done an outstanding job transforming Spark, formerly Telecom, from a state-owned monopoly to a competitive retail service provider.

Moutter was Spark’s chief operating officer during the Theresa Gattung era before leaving to become chief executive at Auckland Airport then returning to Spark to assume the top job soon after the demerger of Chorus in 2011.

Moutter restructured the Spark business by cutting costs and divesting non-performing assets.

He invested in new technology and lead the company on a fresh path into wireless communications, digital technologies, including streaming entertainment and sports content, and rejuvenated Spark’s mobile business by taking market share away from Vodafone who had long dominated this space.

Not only did Moutter turnaround Sparks financial performance, evidenced by strong growth in Spark’s share price and dividend during his leadership, he has gone some way to repairing Spark’s very poor public image, which reached all-time lows during the Theresa Gattung era of 1999 – 2007.

During Gattung’s time as Telecom’s CEO consumers will probably remember the telco for its high prices and poor service and shareholders for a share price that halved during the early 2000s as the rot set in.

Telecom was privatised in 1990 when the government sold it to largely overseas interests and under private ownership it used its monopolistic advantage to rapidly grow its profits and dividends which significantly increased Telecom’s value, most of which ended up in the hands of overseas investors, at the expense of local investors and taxpayers.

Unfortunately for Gattung she took the reins from Rod Deane following a prolonged period of cost cutting, poor customer service, price gouging, and zero investment in new technology as Deane and his board focussed totally on adding value for shareholders not customers.

A large part of the cost cutting was reducing staff numbers which fell from 25,000 in 1987 to under 8,000 by 1997.

This significant reduction in head-count is probably part of the reason Deane earned himself the nickname of Dr Death within Telecom’s ranks.

One of Deane’s final acts at Telecom was to pay A$2.2 billion at the height of the Dot- Com bubble for Australian business telecommunications company AAPT, a business that would later be sold by Moutter for less than a quarter of its purchase price.

Interestingly Deane was also Chairman of Fletcher Building in 2007 when the beleaguered construction company bought the Formica Group, another decision which now seems poorly timed and poorly made.

Many believe that Gattung was thrown a hospital pass and that the business was only headed one way after the Deane era.

History shows that under her watch Telecom was left stuck in the mud as strong competition and new government regulations arrived and punished the complacent telco for poor service, profit gouging and out of date technology.

Shareholder value halved as revenues fell after Telecom lost the confidence of its customers with resulting loss of market share and margin which provided the opportunity for government regulatory intervention and asset value destruction.

The government compounded Telecom’s woes by passing legislation forcing them to open their network to rival companies.

Gattung eventually took the hit and sadly for her she will be remembered for leading NZ’s largest company through a period of very poor financial performance and severe profile damage.

Possibly her large severance payment will also be remembered.

Whether such harsh criticism of Gattung is justified is arguable although you can’t question her honestly after she once commented that ‘Telecom’s marketing strategy was based on creating and exploiting consumer confusion.’

So, when you consider where the Telecom business was a decade ago and where it is today its hats off to Simon Moutter and his team, they’ve done a great job in my opinion.

Perhaps what is disappointing is that Moutter is leaving while his bold move into content, which started with Lightbox and now Spark Sport, is still in its infancy and not yet fully proven and it would have been reassuring to see him there to lead Spark into the new era of 5G technology.

Shareholders will be hoping that Moutter’s replacement, Jolie Hodson, is equally as savvy and successful. Her CV certainly suggests that she is a worthy replacement. Time will tell.

With the recent CEO appointments of Kate McKenzie at Chorus (once part of Telecom), Jane Hrdlicka at A2 Milk and now Jolie Hodson at Spark even Theresa Gattung might be rejoicing as she has been a strong advocate for higher roles for women in business.

INVESTMENT NEWS

Infratil – Continues to display the merit of active management, by some professional investors.

After investigation whether they could expand their student accommodation investment’s scale, and discovering that genuinely large scale could not be achieved, IFT sold its Canberra student accomodation.

The price achieved by IFT was AUD$162 million, which presents itself well against a recent interim valuation of NZ$107 million and is very close to double the purchase price less than three years ago.

Good investors buy assets well.

Sky City Casino – The sale of their parking revenues is an interesting development, however, I have run out of space within today’s newsletter so I’ll talk more about this transaction next week.

The environment – Plenty of people, governments, corporates and consumers, are trying to nudge regulations and consumer behaviour toward more desirable outcomes with the planet’s resources and the environment.

Progress is being made, but investors should not be factoring in dramatic change to the assets in their portfolio based on reading that global use of coal has increased and that Saudi Arabia’s oil exporting business (Saudi Aramco) is massive, with profits double that of Apple and five times that of the next largest oil companies (Exon Mobil and Royal Dutch Shell).

Change is coming, slowly.

Interest rates – In case you are still unsure about the interest rate thesis Johnny and I established last week, take 10 minutes to run your eye over some global financial commentary on the subject, plus market reactions.

The item that caused me to reach for the keyboard for this paragraph was a few quotes from Mario Draghi on behalf of the European Central Bank. Remember that the ECB has not done what the US Federal Reserve did, European interest rates have not been increased.

Draghi said:

Substantial monetary policy easing remains essential to ensure the continued build up of domestic price pressures over the medium term.

20 years ago we would have missed five heart beats if we read such a statement from a monetary leader; it is code (easily decoded – Ed) for ‘we want more inflation’.

He then wrapped up his declaration in a wide variety of conditions which make analysis of the next change nearly impossible to predict based on normal measures by saying:

In view of the persistence of uncertainties related to geopolitical factors, the threat of protectionism and vulnerabilities in emerging markets, the conduct of monetary policy in the euro area will continue to require patience, prudence and persistence.

The ECB has been debating whether or not to reject the principle of negative interest rate use, although they have delivered a similar effect through ‘money printing’ (buying anyone’s bonds to ensure liquidity exists).

However, even if the ECB rejects negative interest rates it continues to be very clear to investors that returns from lending money will remain extra-ordinarily low for so long that it will no longer be extra-ordinary.

Many jurisidictions do not offer real returns (interest rates higher than inflation rates) and those who do, such as New Zealand (barely – Ed), will be unlikely to do so for long as a result of the world’s renewed commitment to very loose monetary policy and to overt attempts to increase inflation.

What to do?

Re-read last week’s Market News and engage with a financial adviser.

Lyft – The Lyft IPO (US$72 per share) in the US failed to live up to the name and the purpose of this company.

The share price fell (US$68 as I write).

After a brief period moving forward (one day) the investor journey was backward.

I have mis-read investment opportunities in the past because they didn’t have financial characteristics that made sense to me, and I’ll continue to miss out on many, but I just cannot conclude that I want to own a company that continues to burn money (lose enormous sums) even after if appears to have achieved critical mass in the third most populous nation on earth.

Another point of interest is that traders are willing to go short LYFT (sell a share they do not own, believing the price will fall) a mere two days after that share begins trading on the market tells another side of the value story.

If you sell something you do not own you must borrow it from someone else (for a fee) to deliver to the buyer.

These people, selling LYFT short, hold the opposite view to the investment banks who promoted LYFT, and people who buy IPO’s, who believe it is a good investment at a fair price.

Maybe investment banks simply focus on the brokerage and the egotistical league tables?

Do investors in a bullish market simply buy everything?

The LYFT share float may well become a very interesting case study for US college post graduate programmes.

EVER THE OPTIMIST – Stuff reported last week that NZ currently has a record number of cranes at work on constructions sites (148), which is clearly a good sign for intended economic activity.

I hope most of the construction companies are operating with better profit margins and cash management practices than the few failures that have been in the headlines recently.

The detail of who is using cranes and where is a very good study in where progress is required, and being made (housing is using about 40% of the cranes).

INVESTMENT OPPORTUNITIES

Heartland Bank – issued its new 5-year bond last week at 3.55%.

The high level of demand allowed the bank to increase the scale of the transaction to $125 million something that will please management and should please the bank’s shareholders.

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

Metlifecare – Possible new bond.

Given the directors hints that they may also buyback some of their own shares at current market pricing this new bond offer seems inevitable to me.

Napier Port – The regional council has approved the sale of some shares in the port and now appointed its lead managers to bring the offer to market (in the months ahead).

A new holding company has been formed.

This is an exciting development for investors, and the NZX, and we look forward to this Initial Public Offer reaching the market.

We have a contact list for investors wishing to hear more about participation in the float of Napier Port.

TRAVEL

 

Edward will be in Auckland (Albany) 11 April and in Tauranga 29 April.

Kevin will be in Christchurch on 17 April and Ashburton on 9 May.

Michael will be in Wellington on 15 April.

Mike Warrington

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Market News – 1 April 2019

The Financial Markets Authority has produced a guide to investing in shares for the public.

I don’t doubt their intention of being helpful, but I’d have preferred that they encouraged the public to seek financial advice from the many skilful folk available (licensed, experienced, educated, audited within an inch of their lives, and keen to serve).

Share investing tutorials would sit better on the NZX website rather than the FMA’s.

INVESTMENT OPINION

Tax data thanks – Thank you to those who offered input on NZ tax data.

In practice it served to confirm how hard it is to present such data in a cogent way so as to support recommendations, especially those as significant as being made by Michael Cullen’s Tax Working Group.

Interest Rates etc – You missed out on an epic conversation in our office between myself and Johnny Lee where we solved many unknowns of the current financial universe, so I’ll try to share it with you after the fact.

You won’t like our conclusions.

The conversation started after the Reserve Bank’s Official Cash Rate announcement, which put markets on alert by clarifying that the next move for the OCR is probably lower.

Financial markets were becoming aligned with the prospect of lower interest rates but investors preferred to place their fingers in their ears and sing ‘La La La’ loudly pretending not to hear of this potential for lower returns.

The current OCR is 1.75%. Recent movements have been in 0.25% increments, which I think can continue to be used, but if our OCR ultimately falls to 1.00%, as the ANZ forecasts, I would like to see the central bank contemplate reducing future movements to be in a scale of 0.10% or 0.125%.

America likes its eighths. NZ likes decimals, either would be fine.

It’s not just the RBNZ who have directed market attention to looser monetary policy. Central Banks everywhere are back at the lectern explaining that they have plenty of capacity to ease monetary conditions, even though most have not been tightening conditions, with the exception of the US.

The US Fed has ‘paused’ on its interest rate hiking path, trying in vain to explain why they’d like to continue, but as Johnny pointed out in Taking Stock last week the US financial market is questioning the central bank’s sanity and is driving yields (interest rates) on medium and long term bonds much lower, and surprisingly quickly.

Interest rate markets and currency markets are enormous and as ‘deep as the deep blue sea’ with risk managers making decisions, so the sharp declines to US interest rates need to be taken seriously, both by us and by the Federal Reserve.

Financial markets are making it very clear that the US Federal Reserve will not be increasing its overnight interest rates again during this cycle.

I still hold out hope that the Fed will reduce the scale of its balance sheet further, by selling more bonds into this market with an enlarged appetite for buying bonds with lower returns (higher values for the bonds). After all, they started buying bonds to provide finance to the economy when very few others would do so; yet now plenty of investors wish to lend money via the purchase of bonds, and in my view the US Fed should respond to this by selling the bonds that it holds to the market place.

It would be the appropriate outcome by allowing private lenders to take over the reins of long-term lending risks within the economy.

The European Central Bank (ECB) talked a good hand as they explained the need to tighten monetary policy by decreasing from bond purchases and slowly increasing the overnight interest rate in Europe, but unlike the US they achieved little or no progress against their intentions.

In the show me, don’t tell me stakes, the US took action, Europe did not.

Today, the ECB is trying to explain to financial markets that they have plenty of potential to ease monetary policy again.

German yields are already negative. Where does the ECB seriously think they go next?

The men and women at the lectern can say what they like, but money says it most clearly and the interest rate markets have taken a sharp, and concerning, lurch lower for interest rates.

[What happens when 0%.... must save more to survive spending in future… must accept more risk to find real returns]

Johnny and I would still like to believe that 0% isn’t going to feature in the NZ market, other than call accounts with major banks, but what if it does happen for longer terms?

How will savers and investor respond?

I discussed the situation with a friend (not from markets) who lamented that where he felt ‘$300k was good his kids will probably need $3,000k’ to retire.

We think that you got a glimpse of investor reaction last week when there was a mini surge to buy long bonds, to lock in the ‘attractive’ 3.50% - 4.00% interest returns and share prices for businesses with the most probable future revenues and dividends jumped by quite surprising amounts.

In turn these higher share prices imply lower returns from those shares over the years ahead of us but when confronted by the prospect of bank term deposits falling from 3.50% to 2.50% one will find it easier to tolerate dividends at 5.00%, down from 6.00%.

It is becoming the opposite of a virtuous spiral.

Johnny and I pondered, as we should for our clients, what happens next?

This is not a ‘where does it end’ enquiry, because it doesn’t, the continuum of investing is life long, and somehow we must manage our way through it.

It is an absolute truth that our kids will needs a very different plan for managing expenses in retirement than we are using for today’s retired generation. My kids will need either a lot more capital, a willingness to spend capital in retirement, or in all likelihood some of our capital. I hope conditions are ‘better’ 25 years after that for Johnny’s kids (one and counting).

I have some hope that NZ will avoid 0% interest rates because in my opinion the OCR is less influential now for adjusting public behaviours than it was in the past. Macro-prudential tools have proved to be effective so I’d like to see more of them applied so that savers (who become lenders) can access a positive real reward for their good form (having been savers).

Savers deserve to earn positive real returns (interest rates higher than inflation).

Regular readers will recall my preference that the RBNZ Introduce their desired Debt to Income ratio rule.

Johnny and I came up with another macro-prudential tool, active control of Kiwisaver contribution levels, until we discovered MP David Parker had also proposed it back in 2014!

It must be a good idea then.

Johnny and I concluded that if it is important, as it is, for the RBNZ to use macro prudential tools to manage the liability side of our economy, then surely it stands to reason that NZ should also try to manage (manipulate – Ed) the asset side of our economy, with Kiwisaver being the easiest broad lever to manoeuvre.

Imagine if you will the following governance rules that we drafted:

Compulsory Kiwisaver (with a few limited exceptions);

Increased minimum contributions as financial conditions dictate (lower investment returns result in increases to the minimum contribution);

Reduced contribution rates, or early withdrawal rules, for Kiwisaver funds that exceed defined nominal values (to ensure these well-funded citizens can boost consumption sooner);

RBNZ to control the changes in settings for compulsory Kiwisaver contributions (not Cabinet, or Treasury);

Now check this paragraph from Hon. David Parker dated 2014:

‘the policy targets agreement could delegate to the Reserve Bank the power to vary Kiwisaver contribution rates within a defined range. Increasing the Kiwisaver contribution rate instead of raising the OCR would have the same effect as an interest rate increase in terms of reducing inflationary pressure and increasing savings.’

This new macro-prudential tool will not change the returns available to our savers, and deferred consumers, but it would absolutely make a contribution to financial stability and economic activity in the decades that followed.

Beyond Kiwisaver potential consumption can be found in the enormous amounts of equity held in housing, especially for the current retired generation. This group is already being serviced by home equity release mortgages provided by the likes of Heartland Bank.

Accordingly, in our view, home equity release mortgages have a very long future in an economy following the extra-ordinary increases to property pricing relative to incomes, returns and rates of consumption.

I’d better draw this sermon (ramble – Ed) to a close, one that began with the reality of the latest moves lower for investment returns.

Johnny’s and my broad conclusions were:

Interest rates are falling again, probably to levels that NZ investors will find distressing;

Don’t sell long term bonds;

Don’t sell (good quality) real assets;

Don’t be afraid of home equity release;

Tutor the younger generation on the importance of savings.

 

Media Content – The media landscape continues to change, and it does so quite quickly now.

Disney has always been a dominant provider of content, and now has indigestion to overcome following its purchase of 21st Century Fox, sold to them by the wily Rupert Murdoch, but this confirms Disney knows where the next battle will be fought – content, to send down the wires.

Rupert Murdoch has decided to exit the playing field. He will no doubt have a strategy; perhaps to return to his original focus of the news.

The rapid rise of distribution via the internet, and via a mix of phone companies (Apple, Samsung) and Internet Service Providers (Spark, Vodafone locally), content providers and distributors are in a tussle over who earns what from delivering content to your eyes, and how.

Netflix has shown how online hiring of content has attracted huge demand and caused dramatic change in how we consume video content, but this was only possible as communication networks were upgraded.

Chicken?

Egg?

Farmer!

Apple has decided to become a farmer by controlling content and the channel (device) that consumers use to view the content.

Will Apple now start buying controlling interests in ISP’s like Spark, Verizon, Vodafone to ensure best price practice across the network or simply lobby politicians for intense competition within that sector?

I suspect the latter because as a phone user I don’t wish to be told who I must use as an ISP.

Netflix, Amazon Prime and Disney have burgeoning reservoirs of content, there are plenty of single subject content suppliers too, such as Formula 1, Red Bull TV, the Olympics and FIFA but none have control of end user devices in the way that Apple does.

Will they try to stay broad in their distribution methods, or should they strike up alliances with Samsung, the next largest international supplier of phones and tablets?

All these businesses have learnt the long-term value of having recurring revenues from ‘hiring out content and services’, as have technology companies with their software and hardware (think the cloud), so this trend to control content for hire will continue.

I wonder if Apple’s ego means they think they can control the universe of content, channels and devices so as to capture huge economics, but this isn’t a credible strategy because it doesn’t suit the consumer.

Apple could however, capture more content, such as Formula 1, FIFA World Cup or the Olympics, if it can show better distribution, to a wider audience, with better analysis of that audience, which means capturing deeper revenues to share with the content supplier. (Apple clips the Olympic ticket).

Spark is using this same strategy, in a micro local way, with the video content they are building, to be a preferred ISP by offering access to content that others don’t supply.

However, if Apple TV could supply me with access to Formula 1 racing slightly cheaper than Spark (current provider in NZ) then I’d be very tempted to change supplier. If it meant I could also review the content on an iPhone or iPad I could be convinced to switch hardware, if I was using Samsung at the time.

Netflix, Amazon and Disney may think they are a quartet seeking dominance in desirable content for the globe, but the reality in my view is that Apple already has an advantage with its large scale ‘control’ of how the public consume content. Apple can begin buying in the best content as simultaneously establishing a production unit, as they have.

In reality, I still only have so much time each day to watch video content and only so many discretionary dollars to spend, so I don’t see the cake getting bigger, which means there are going to be some losers here being those with the weakest content and poor distribution/service (common reasons for any business failure).

We have all seen Sky TV suffer under the weight of this rapid change.

One or two early headlines have questioned Apple’s move into controlled video content, but I happen to think they are evolving from a position of strength.

INVESTMENT NEWS

Standing Proxy – Excellent news.

The NZ Shareholders Association announced in its recent newsletter that they are very close to gaining approval for investors to grant them a standing proxy for use at Annual meetings.

Until this point investors had to actively instruct the registries for each shareholding, at each Annual meeting, as to who you wish to act as your proxy if you did not attend a meeting in person.

Many investors do not exercise their voting rights, which is a waste of influence.

Some do not wish to spend the time considering the motions being put to a vote, some do not like the technology for delivering their vote (via a proxy), some do not think their small amount of votes will be noticed within the ocean of other votes.

All of these concerns can be addressed by the standing proxy.

We have been strongly encouraging voters to deliver their voter proxies, and the decision made with that vote, to the NZ Shareholders Association both to have your vote count and to increase the influence of that vote by centralising it with the organisation that demonstrably represents ‘our’ perspective.

Proxy votes reaching the NZSA are continuing to increase, which is great, but they need to become far larger yet for the Association to be an ever-present influence at Annual Meetings and around Boardroom tables.

The concept of a Standing Proxy is that you can assign your ongoing voting rights for securities held to the NZSA (or other) and thus not have to take a new assignment action for every investment every year.

If the NZSA is successful in getting this into action it will be excellent news for retail investors and again, we will strongly encourage you all to consider assigning a Standing Proxy to the NZ Shareholders Association.

Here is the NZSA website: https://www.nzshareholders.co.nz/

For this item of action alone, for NZ investors, they should earn your consideration for membership, but you’ll also find much more value is available from this organisation.

I am a member and I frequently pass my proxy votes to them.

Bias – Nikko Asset Management was talking up its value hopes for A2 Milk when it expressed fears that an offshore investor would swoop in and try to take over the company.

L1 Capital, owner of 14.8% of Chorus did the same thing when it expressed a view that CNU was worth a far higher share price.

Both of these public statements were unquestionably biased, but they were also valid given how frequently NZX listed companies are being taken over by others and removed from public listing.

I do not attempt to validate these opinions about share values for ATM and CNU, but concur with the view that maybe our apparently highly priced shares in NZ aren’t as high as they seem when considered on a global relative basis (Einstein’s theory of relativity? – Ed)

Not quite Einstein settings, but yes, a relative measure against a global equilibrium of return for risk.

Electricity Pricing – the rise in wholesale electricity pricing is giving confidence to Mercury to push ahead with its Turitea wind farm in the Manawatu.

Decisions like this should simultaneously give confidence to shareholders in the electricity generation and retail businesses about the very long term value of their investments.

US Federal Reserve – Last week I recorded for you that the Fed had not changed the US Fed Funds rate, which was a surprise to nobody.

However, this week financial markets have moved to price in a 90% chance that they will be forced to cut interest rates by the end of 2019.

Unexpected?

Yes, by most investors down under who have been expecting, then hoping for, rising interest rates, but it is just not happening.

EVER THE OPTIMIST – For all the recent angst around small aspects of our relationship with China, they are a nation that NZ continues to enjoy trade surpluses with.

Trump must be fuming with envy.

ETO II – Clever scientists to the rescue again.

Stanford University scientists have found a way to extract Hydrogen from sea water and by protecting the anodes, previously damaged during electrolysis (it is wasteful to use pure water, which does not damage the anodes), they may have opened a door to a smarter way to extract energy form the sea (smarter than under-water turbines).

Using hydrogen as an energy source is desirable because it doesn’t emit carbon dioxide.

With global warming, and rising sea levels we’ll have plenty of sea water to convert into hydrogen, leaving clean oxygen (and a little salt? – Ed) as a by-product.

That fits the strategy, yes?

I hope they can succeed on an industrial scale.

INVESTMENT OPPORTUNITIES

Heartland Bank – has announced that it is offering a new 5-year bond.

The deal occurs this Friday (5 April). If you wish to invest please contact us with a request for a firm allocation by 5pm this Thursday (4 April).

The transaction will be arranged by contract note and investors will incur brokerage costs on this transaction.

As is the case with other bank bonds, currently, we expect the bond yield to be lower than the interest rates offered on a term deposit from Heartland Bank (The minimum, and estimated, bond yield is 3.50% p.a.).

Interest is payable semi annually (April, October).

We have a list for investors wishing to consider participation in this deal.

Metlifecare – Possible new bond.

Given the directors hints that they may also buyback some of their own shares at current market pricing this new bond offer seems inevitable to me.

Napier Port – The regional council has approved the sale of some shares in the port and now appointed its lead managers to bring the offer to market (in the months ahead).

A new holding company has been formed.

This is an exciting development for investors, and the NZX, and we look forward to this Initial Public Offer reaching the market.

We have a contact list for investors wishing to hear more about participation in the float of Napier Port.

TRAVEL

 

Edward will be in Wairarapa 9 April, Auckland (Albany) 11 April and in Tauranga 29 April.

Michael will be in Auckland (4 April, city).

Kevin will be in Christchurch on 17 April and Ashburton on 9 May.

Mike Warrington

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