Chris Lee & Partners Ltd

Market News 28 August 2023

Johnny Lee writes:

A string of results has hit the market, with most landing in line with expectations, but a handful standing out as particularly market-moving.

EBOS Group’s result has been one such standout, causing the share price to rebound sharply after the large fall experienced over the last few months. This large fall followed the loss of the Chemist Warehouse supply contract, which was handed to EBOS’s Australian competitor Sigma.

The result saw profit lift 23%, earnings per share rise 14%, and the dividend increase 15% on an annualised basis. Its dividend increased to 57 cents per share, making an annual dividend of $1.10 a share. Five years ago, the annual dividend was 68.5 cents per share.

EBOS continues to grow through acquisition, buying New Zealand dog roll manufacturer Superior Pet Food Company. Superior was founded in the 1970s, and sells products marketed under several brands, including Chunky and Possyum. The acquisition is expected to add to underlying earnings per share in its first year.

Two major topics were raised during the investor briefing to shareholders.

The first was an upcoming Australian law change, allowing pharmacies to dispense 60 days worth medicine for patients with chronic conditions, doubling the current limit of 30 days supply. While some Australian doctors have supported the change, some Australian pharmacies have opposed it, stating that it will worsen drug shortages and hurt pharmacy revenues.

In theory, this change reduces foot traffic at pharmacies and decreases margins. However, the Australian Government has also proposed to increase the funding pool to support pharmacies. Ultimately, EBOS is confident that the challenges proposed by the changes can be overcome.

Another topic raised during the briefing was the loss of the Chemist Warehouse contract, and what strategy the company would execute to compensate for this loss.

While details from EBOS were sparse, the company was confident that there would be avenues for growth it would pursue. If conversations are ongoing with other potential acquisition targets, this may explain the lack of specificity surrounding these growth plans. 

Outlook for the year ahead remains positive and the company is confident that it will continue its history of growth, both organically and through acquisition.

Its next update will be made in October, when the company intends to issue a trading update. The 57 cent dividend will be paid on the 29th of September.

A2 Milk

A2 Milk, by contrast, saw its share price drop after issuing a relatively weak forward outlook, suggesting 2024 would see a slowdown of the growth achieved this year. While the company still forecasted growth, it would be in the ‘’low single digits’’.

The results themselves – revenue growth of 10%, profit up 26%, earnings per share growth up 28% - were impressive in isolation. While the infant milk formula market is shrinking, A2 Milk is capturing enough market share to post an increase in total sales in this space. 

Superstitious investors may find themselves in luck next year, which is the Year of the Dragon in the Chinese zodiac. Historically, the Year of the Dragon is associated with increases in birth rates across a number of Asian countries, a helpful boon for infant milk formula companies. 

The Daigou channel continues to shrink, down 39%, as the company pivots towards more formal channels for distribution. The company is also investing further into its United States business, although this remains a slow burn for the company. Frankly, it may be some time before this makes a meaningful contribution to the overall business.

Questions remain over its enormous cash hoard. After ending the last financial year with $887 million, the company committed to buying $150 million of its own shares for cancellation, which it has now completed. 

A2 Milk now ends the year with a slightly smaller cash hoard of $802 million, net to $757 million when excluding borrowings. This includes term deposits of $450 million. At this point, one must assume that a major acquisition or expansion is to be expected over the medium term. 

The company maintains its medium goal of achieving revenue of $2 billion by 2026 ($1.6 billion this year) but warns that it foresees a further deteriorating in the infant formula market, driven by the rolling effect of lower birth rates, meaning that fewer births in recent years will result in fewer (older) children moving to later stage products. A2 also warns that competition is intense, as excess supply meets this diminishing demand.

The share price has suffered a dramatic decline this year, and the announcement last week did nothing to reverse that trajectory. Optimism seems in short supply, and the recent economic turmoil from China will not be instilling confidence in investors. 

Nevertheless, the company has an impressive cash hoard – more than 10% of its market capitalisation - that will shield it from harm, as these challenging conditions persist. 

Chorus

Chorus reported a modest increase in revenue, as it saw both an increase in users and an increase in average revenue per user. The dividend uplift continues, but landed at 47.5 cents per share, after previously suggesting a ‘’minimum’’ of 47.5.

Chorus has been in the news recently regarding its increase in pricing, which has largely been passed through to consumers through our national broadband providers. This aspect will likely be more visible in its 2024 results, which are expected to represent a modest increase from this year’s result.

Chorus notes that a growing number of users are opting for faster connections, as data usage increases worldwide.

As expected, labour costs soared, as both employee numbers and wage inflation took effect. Neither of these should surprise – wage costs are rising nationally, while activity (and therefore staffing) was expected to rebound post-COVID.

Capital expenditure fell dramatically, as the UFB rollout has largely ended. Declining expenditure remains a driver of the forecasted increase in dividends over the decade, which is in turn driving much of the movement in share price. 

This year’s total dividend of 42.5 cents – made up of 17 cents at the half year and 25.5 cents paid in October – is expected to see further uplift next year to 47.5. While the company did not publish guidance beyond next year, this uplift is expected to continue further over time. However, Chorus may yet decide to invest further into its network, which may alter the timing of this increase.

Competition remains a factor. Wireless Broadband continues to be pushed by the likes of Spark and One, although Wired Broadband (Chorus) is clearly the more popular choice at the moment and connections remains relatively stable. Advancements in technology may influence this, but it is worth noting this factor could move the needle in both directions.

Chorus shareholders will receive their 25.5 cent dividend on the 10th of October.  

Summerset

Aged care provider Summerset saw no major share price movement following its announcement, which came in slightly above market expectations.

Summerset reports that conditions remain challenging throughout the sector, with the weakness of the housing market impacting the timing of sales. While staff shortages remain an issue, Summerset believes it is better positioned than its peers in this environment.

Logically, debt was the major focus for shareholders, following on from the debt troubles its competitor Ryman was forced to address earlier this year. Debt increased to around $1.27 billion, from $860 million a year prior. Summerset notes that its land, developments and unsold stock comfortably exceed its net debt.

Gearing (debt) increased from 29% to 36% over the same timeframe. Its target remains a gearing level with a 30% – 40% range, and Summerset notes that it has enough bank headroom to fund its objectives for now. Shareholders will be hoping this means that the increases in debt moderate, even if the cost of this debt does not.

Summerset now has seven Australian projects in its pipeline, totalling 2,100 units, with two already under construction, and more to begin construction as early as next year. Completion of the projects may start as early as next year, but should make a meaningful contribution to unit delivery in the 2025 year. This geographical diversification will also give the company some flexibility in the event of changes in regulatory conditions.

Summerset warned that its dividend policy is under review, as it anticipates sharply higher underlying profit growth over the medium term. The current dividend policy is to pay 30% - 50% of underlying profit over a full year. Summerset will be trying to find the right balance between rewarding shareholders and ensuring it retains enough cash to fund its ambitions, while reining in any debt concerns that may develop.

Summerset provided little in the way of forward guidance, although it notes there remains significant unmet demand that will support its current projects, and believes it will see significant returns in the medium term, as many of its planned villages open for sales. 

Shareholders will be paid the dividend of 11.3 cents per share will be paid on the 19th of September.

Infratil 7.5 Year Senior Bonds

Infratil has announced it plans to issue a new 7.5-year senior bond.

The bonds have a minimum interest rate of 7.05%.

This bond offer closes on Friday, 1 September at 9am.

Infratil has confirmed that it will pay the transaction costs for this offer. Accordingly, clients will not be charged brokerage.

We have uploaded the investment documents to our website below:

www.chrislee.co.nz/uploads//currentinvestments/IFT340.pdf

If you would like a FIRM allocation for these bonds, please contact us no later than Friday, 1 September at 9am with an amount and the CSN you wish to use. 

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SBS Bank (SBS) has announced a new 5.5-year senior bond.

The bonds have a minimum interest rate of 6.10%.

These bonds have an investment grade credit rating of BBB+.

SBS willbe paying the transaction costs for this offer. Accordingly, clients willnot be charged brokerage.

We have uploaded the investment documents and a presentation to our website below:

www.chrislee.co.nz/uploads//currentinvestments/SBS020.pdf

If you would like a FIRM allocation for these bonds, please contact us promptly, with an amount and the CSN you wish to use. 

The offer is open now and closes onThursday, 31 August at 9am.

Payment would be due no later than Tuesday, 5 September.

If you would like a FIRM allocation for these bonds, please contact us no later than Thursday, 31 August at 9am with an amount and the CSN you wish to use. 

If you have any questions in relation to these offers, please contact our office and we will be happy to help.

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Travel Dates - August & September

Our advisors will be in the following locations, on the following dates:

30 August - Blenheim – Edward

1 September – Nelson – Edward

6 September - Auckland (Ellerslie) – Edward

7 September - Auckland (North Shore) – Edward

8 September – Auckland (CBD) – Edward

13 September - New Plymouth – David

14 September - Wellington – Edward

Clients and non-clients are welcome to contact us to arrange an appointment.

Chris Lee and Partners Ltd

Market News 21 August, 2023

Johnny Lee writes:

THE month of August is shaping up as one to forget, as negative data continues to outweigh the positive. Most global share market indices are down, with the major Chinese index amongst the most negative so far this month.

Both Synlait and Fonterra dropped their farmgate prices to farmers, responding to falling demand from China and declining dairy prices. Days later, another dairy auction was held which saw a further 7% average decline. Confidence from the agriculture sector is falling in line with these deteriorating conditions.

Declining demand from China seems to be a common theme at the moment, and a number of concerning developments are emerging from the world’s second largest economy.

China’s National Bureau of Statistics has been criticised over its decision to suspend release of its youth unemployment data, with the Bureau announcing the release of the data would be suspended until it ‘’improved’’. Youth unemployment had reached record highs recently, leading to growing unrest.

At the same time, China’s economy has endured another blow as financial services provider Zhongrong International Trust missed several debt repayments, causing further panic a week after property developer Country Garden failed to repay its own debt last week. The Chinese stock exchange responded by moving sharply lower, prompting the Chinese Government to reportedly ask investment funds to refrain from selling shares. 

A day later, major Chinese property developer Evergrande filed for bankruptcy in the United States. Evergrande reportedly owes hundreds of billions to bondholders as it looks to restructure its debts and sell assets.

New Zealand companies that are highly exposed to the Chinese economy – including those exposed to the export sector – will be hoping that any downturn is brief and that the Chinese Government takes actions beyond simply hiding data releases and asking investors not to sell assets. 

These developments are unlikely to influence our reporting season – August’s full year and half year reports precede these events – but risks from the Chinese economy seem elevated at the moment, and investors should monitor these risks as they continue to develop.

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 LOCALLY, Fletcher Building’s result received a negative reception and its share price fell sharply as both dividend and outlook disappointed the market.

The dividend of 16 cents per share compares to 22 cents last year and reflects the sharp decline in earnings per share, which fell 44%. The company also highlighted that it did not expect to impute its dividend next year.

The major disappointment was in the residential space, which saw a sharp decline in earnings. At the risk of oversimplifying, the costs to build are rising and the sale prices achieved are falling, with further contraction of margins expected next year.

While the share price declined after the announcement, the market remains very optimistic towards Fletcher Buildings longer-term prospects, with analysts anticipating the company will survive this period of difficulty and flourish on the other side. 

Ultimately, it may become a question of how long these conditions last and how long companies can endure them, relative to their competitors. Fletchers has access to funding and capital that is difficult for its competitors to match, which is a powerful advantage in these conditions.

On a more positive note, Contact Energy’s result announcement caused a modest share price climb as the company’s result exceeded expectations.

Importantly for income investors, Contact has suggested the long-awaited dividend uplift may commence next year, with confirmation of this expected in February. This will hinge largely on the fate of the Tiwai smelter, but there is optimism this situation will be resolved satisfactorily and a commitment to higher dividends will be made.

February will also mark the company’s decision on whether to invest $200 million into the battery storage sector, supporting its new wind and solar projects that are expected to complete over the decade. 

Part of its strategy includes increasing demand by signing long-term supply agreements with new, large electricity users, as a way to de-risk new generation.

Curiously, Contact is now also looking to expand its telecommunications (broadband) offering to include Contact Mobile, a service providing cell phone coverage via the One NZ network. Contact seems to be pursuing a similar strategy to Trustpower (now Manawa) of bundling and capturing long-term customers by tying them into multiple products. Contact may have the scale to execute such a strategy.

Contact also hinted that it may look to issue another bond to market as part of its efforts to maintain debt levels within the metric required to retain an investment grade credit rating. Recent bond issuance from Contact has been comfortably oversubscribed, and currently trade at levels that suggest a high degree of comfort in the company’s ability to repay.

With higher dividends on the way, and a credible strategy to execute, Contact remains one of the better performing shares this year and seems to have a pathway to continued outperformance.

Spark, our largest telecommunications provider, also saw its share price rise following its profit announcement. Free cash flow rose 12.9%, with the mobile sector being the standout. This may be difficult to sustain, as some of this gain was driven by an increase in data roaming following the significant drop-off during Covid.

The dividend is forecast to continue climbing from 27 to 27.5 next year. 

Gearing fell, a relief to shareholders who had been watching debt rise prior to the TowerCo sales. Spark did warn that this trend would reverse and debt would rise once again, as the sale proceeds are slowly invested towards its growth strategy.

Data centres remain a core part of Spark’s growth plans, with many of its under-construction projects already committed to customers and revenue expected to grow over the next few years. Indeed, a significant proportion of the TowerCo sale proceeds will be shifted into data centre construction and operation.

This is a sector that is seeing significant optimism across the investment world. While some have questioned whether this is leading to an oversupply of capacity – with the likes of Amazon and Microsoft building facilities across the country – it is worth reiterating that customer commitments are already in place for these builds, and if an oversupply does seem be taking place, Spark can of course reassess its capital expenditure programme. 

After the struggles with Spark Sport, Spark will be focused on ensuring return on investment remains in line with shareholder expectations. While some of the growth rates seen in this result may be difficult to maintain, Spark is looking towards what it hopes will be growing revenue from its data centre investments to support a stronger dividend payout in the years ahead.

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THE Reserve Bank left the OCR at 5.50%, in line with market expectations, but it has explicitly stated that it will keep interest rates high ‘’for some time’’, dousing any hopes of a rate cut in the near future.

Broadly speaking, the economy is moving in the desired direction – immigration is returning, easing wage pressures for businesses. Business activity is slowing. The hope remains that GDP growth will slow, rather than turn sharply negative.

House prices have stabilised, and expectations are rising that we could see a rebound following the declines of the past few years. However, the Reserve Bank is less concerned that the ‘’wealth effect’’ – people increasing spending based on an increase in their paper wealth from increased asset values – would occur at this point in the economic cycle. 

Historically, when house prices have risen, homeowners have been more willing to extend their finances into consumer spending or investment, rather than reduce debt. The Reserve Bank comments suggest that this may not be the case if we see a rebound over the next few years. If its prediction around house prices eventuates, this will be a key behavioural change to observe.

The base case scenario at this point - and the scenario investors may wish to prepare for - is that interest rates are at or near their peak, and will remain at this peak for some time.

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BNZ 5 Year Fixed-Rate Note Offer Open

Bank of New Zealand (BNZ) has announced a 5-year senior note, which opens today and closes on Thursday, 24 August.

The interest rate has not been announced, but based on comparable market rates, it may be in the vicinity of 5.90%.  BNZ Notes have a strong credit rating of AA-.

BNZ will not be paying the transactions costs for this offer.  Accordingly, clients will be charged brokerage.

More details about the bonds, including an investment statement, are expected soon.  If you would like more details about these notes, please contact us promptly with an indicative amount and CSN you wish to use and we will pencil you onto our list.

We will send a follow-up email to anyone who has been added to this list once the interest rate and terms have been confirmed.

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Infratil 7.5 Year Senior Bonds

Infratil has announced it plans to issue a new 7.5 year senior bond.

Full details are expected on Monday 28 August 2023.

The interest rate has not been sent but based on current market conditions may be in the vicinity of 7.00%p.a.

The issue involves two offers:

A Firm Offer expected to open on 28 August for new investors expected to close 1 September.

An Exchange Offer expected to open on 4 September (following the Firm Offer) for New Zealand resident holders of IFT210 bonds which mature on 15 September 2023. IFT210 bond holders through the Exchange Offer can exchange some or all of their maturing IFT210 bonds  for new bonds.

Please contact us if you would like to be added to the list for these bonds with an amount and  the CSN you wish to use and we will pencil you in on our list.

If you are an existing IFT210 bond holder and would like to exchange your bonds please inform us at the time of your request.

We will send a follow-up email to anyone added to our list once the terms of the new issue have been released.

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SBS Bank 5.5 Year Senior Bonds

SBS Bank is considering an offer of up to $125million (with the ability to accept oversubscriptions up to an additional $50million) of 5.5 year, unsecured, senior, fixed rate bonds.

The bonds will rank equally with existing SBS Bonds (SBS010) and are expected to be assigned a BBB+ credit rating by Fitch Australia Pty Limited.

The interest rate has not been sent but based on current market conditions may be in the vicinity of 6.20%p.a.

The offer is expected to open on Monday 28 August 2023.

Please contact us if you would like to be added to the list for these bonds with an amount and the CSN you wish to use and we will pencil you in on our list.

We will send a follow-up email to anyone added to our list once the terms of the new issue have been released.

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Travel Dates - August & September

Our advisors will be in the following locations, on the following dates:

30 August - Blenheim – Edward

1 September – Nelson – Edward

6 September - Auckland – Edward

7 September - Auckland – Edward

8 September - Auckland – Edward

13 September - New Plymouth – David

15 September - Wellington – Edward

Clients and non-clients are welcome to contact us to arrange an appointment.

Chris Lee and Partners Ltd

Market News 14 August 2023

Johnny Lee writes:

Reporting season has officially commenced, with Vital Healthcare being the first of the majors to publish the results of the last twelve months.

While the headline result – a $150 million dollar loss – may alarm unitholders, the cash result was less concerning, seeing a modest 6% decline on a per unit basis. 

Despite this reduction, the forecast increase in distributions was achieved, and is further forecasted to be maintained over the next twelve months. Income investors of Vital Healthcare can expect this income to remain unimpacted.

Debt to assets levels rose to above 36%, caused by both escalating debt and falling asset levels. The company also saw cash in hand decline.

Vital Healthcare remains firmly focused on redevelopments, with over $300 million of redevelopments left to complete, and another $2 billion earmarked over the next decade. 

Asset sales will continue, as part of a drive towards focusing on its core assets and disposing of non-core assets. These asset sales will be critical to rebalancing debt levels, and will require careful management to ensure fair values are achieved for unitholders.

The shares continue to trade at a steep discount to the Net Tangible Assets of the company. This NTA has been steadily declining in line with the property market at large.

Healthcare property remains a strong defensive asset, with long lease agreements guaranteeing income from – largely – entities that are either Government funded or utilised by those wealthy enough to fund themselves. Rental negotiations - most tied to inflation - are creating uplift in rental income while redevelopments create additional value from existing properties.

The dividend will be paid to unitholders on the 21st of September. 

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Last week also saw negative updates from both Briscoes and Restaurant Brands, as consumers continue to tighten wallets and prioritise spending on essentials.

Briscoes managed to eke out an increase in its half-year sales update, with sales increasing 0.35%, compared to last year’s increase of 2.66%. Its share price, which experienced a very strong July, saw a modest decline following the announcement.

More troubling was the confirmation of their sales margins deteriorating. While this has been well telegraphed to the market as a growing concern, declining growth and falling margins are clearly not the direction the company is targeting, and turning these around remains the focus as it seeks to navigate what are undoubtedly difficult conditions to operate a retail brand. 

Crime is becoming an increasing problem, with Briscoes stating that crime has ‘’exploded’’ in the retail space. The company reports dozens of ram raids and break ins impacting their stores, forcing fundamental operational changes in order to keep staff safe. Briscoes is also reporting rising levels of abuse from customers, a rather shameful reflection of the state of mind of some of our compatriots. 

In response, the company is investing in higher levels of security. Another natural conclusion to this trend will include a further incentive to push towards online sales, which reduces the costs of training and employing security staff.

Briscoes formal results will be released September 13, and will include a dividend declaration.

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Restaurant Brands, the operator of Kentucky Fried Chicken, Taco Bell and Pizza Hut, also updated the market, sending the share price into a tailspin as shareholders faced a scenario of rising sales, but faster rising costs.

Net profit after tax for the full year was expected to land between $12 million and $16 million, compared to the previous year's result of $32 million. 

Sales did increase, up 7%, driven by new store openings and a strong US dollar over the period. 

However, rising ingredient costs and rising wage costs were placing huge pressure on margins, with the company struggling to lift pricing in line with these costs. 

Restaurant Brand’s half year results will be reported on August 28. Restaurant Brands does not normally pay interim dividends. 

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Reporting season will continue throughout August, with most major companies providing their half or full year results this month. Dividends, if announced, are typically paid the following month.

As a reminder, the list of major companies who report on the other cycle - May/November - includes Mainfreight, Ryman, Infratil, the Australian banks and Fisher and Paykel Healthcare. 

The themes of deteriorating asset values, declining discretionary spending and rising costs were prevalent during both the February and May result season. These themes will likely persist. Optimism remains in short supply.

Companies, generally speaking, work hard to ensure that shareholders are kept informed and are not unduly surprised by financial results. From this perspective, company forward outlooks are often more useful to investors than simply formalising previously stated forecasts.

Beyond a desire to keep shareholders informed, there are other consequences that arise if companies mislead the market, incentivising accurate and timely dissemination of information. 

Contact Energy, Spark Limited and Fletcher Building are among the next companies expected to release results to the market.

While the reporting season captures attention locally, investors globally continue to cast a fearful eye towards the Chinese economy, as more data emerges suggesting the world's second largest economy is beginning to encounter speedbumps.

Deflation is beginning to impact consumer behaviour, as buyers retreat with the hope of prices falling further. Rising youth unemployment is causing headaches, both economically and politically.

The property market in China is also raising alarms, as one of the largest property developers in China struggles with its debt.

Country Garden, chaired by the ‘’richest woman in Asia’’ Yang Huiyan, continues to dominate airwaves as investors ponder whether the company is acting as a canary in the mine, or simply experiencing a liquidity crisis, similar to last year’s Evergrande crisis.

Country Garden has missed a bond repayment date, entering a 30-day grace period within which to either organise repayment, or default. While the level of debt itself is not significant enough to damage the Chinese economy, markets are fearful of contagion, with a collapse likely leading to a sudden loss in investor confidence. Property development remains a huge industry in China, accounting for over a quarter of its GDP.

These alarm bells have rung before, and the Chinese government has previously played an active role in preventing any loss of confidence. Investors now wait to see if any further intervention is required, as the world’s second largest economy encounters further problems emerging in the aftermath of the pandemic.

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Travel Dates - August & September

Our advisors will be in the following locations, on the following dates:

18 August - Christchurch – Fraser (FULL)

30 August - Blenheim – Edward

1 September – Nelson – Edward

6 September - Auckland – Edward

7 September - Auckland – Edward

8 September - Auckland – Edward

13 September - New Plymouth – David

15 September - Wellington – Edward

Clients and non-clients are welcome to contact us to arrange an appointment.

Chris Lee and Partners Ltd

Market News 7 August 2023

David Colman writes:

Borrowers have been getting used to the real cost associated with debt again, after many years of diminishing rates following the Global Financial Crisis in 2007/2008 and emergency interest rates seen during the height of the pandemic.

The Consumer Price Index (CPI), a broad measure of New Zealand’s inflation, fell by 0.5% in the March to June 2020 quarter and the CPI had only been above 2%yoy twice since September 2011 - once in March 2017 and as expanded on below in March 2020.

The March 2020 quarterly increase in the CPI, before the crescendo of covid concerns changed the course of both monetary policy and fiscal policy, was 2.50%yoy with a quarterly increase of 0.8%.

Inflationary pressure in March 2020 on the back of low interest rates, high asset prices, and high government spending, and could have increased further if pandemic related policies hadn’t deflated pricing pressure.

I theorize that in the last two years we have been hit with many years of pending inflation that may have come sooner if the pandemic hadn’t happened. 

The combination of stimulus and lower rates extending into 2020, likely contributed to historically higher inflation we have seen since.

Indebted businesses with low margins that survived in a low interest rate environment have been forced to raise prices for their goods and services, in a higher interest rate environment which is also a key inflationary factor.

These kind of reactionary readjustments keep inflation higher for longer which in turn can keep interest rates higher for longer.

We are likely some way through the current monetary tightening cycle, with the Reserve Bank of New Zealand (RBNZ) seemingly resolute in its stance that inflation is falling - and if it continues to ease - the RBNZ will not increase the OCR (Overnight Cash Rate) from its current level of 5.50%.

For now, any move to lower the OCR will depend on inflation data to over the months ahead, noting that inflation is still relatively high and well above the 1% to 3% year on year target range.

Many central banks, including the hugely influential US Federal Reserve, currently share the same outlook as the RBNZ committee, with views that inflation is high but easing, with a pause on central bank rate hikes widely implemented internationally.

This tends to suggest that short term interest rates may remain stable in the immediate future but could fall rapidly if inflation data points to year on year consumer price increases below 3%.

CPI data in New Zealand is released quarterly (monthly in other countries) as a year on year percentage and the last release in June included the extreme September 2022 quarterly increase of 2.20% which will not be included in the CPI data to September 2023.

If the quarterly CPI measure for September 2023 is similar to the previous quarter which was 1.1%q/q then the CPI y/y% may be closer to 5.0%y/y% which is still higher than the Reserve Bank’s target range of between 1% and 3% and would still require much smaller future quarterly price increases to show that the target range is achievable under current settings.

Annual inflation between 1% and 3% would require four quarterly gains of between approximately 0.25% and 0.75% with any quarterly figures above that perhaps indicating the RBNZ still has work to do or much longer to wait.

Good quality bonds issued in 2020 for example offered returns of between 2.00%p.a. and 3.00%p.a. which appeared acceptable rates to many when inflation had been low for almost a decade in addition to new fears related to the pandemic and its potential for financial repercussions.

Many of the benefits of investing in fixed interest investments, whether term deposits, bonds, or notes - have not changed.

They still suit investors seeking income and capital protection, but with the recent recovery in interest rates globally, now reward savers instead of punishing them.

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With the rapid increase in interest rates available a common question has been whether it is worth selling a bond with a lower interest rate to buy another bond with a higher coupon rate.

Unfortunately, it is rare that doing so is favourable as the fact that interest rates have climbed means the value received for the sale of bonds, that have decreased in duration (closer to maturity) and offer lower rates than new issues of comparable bonds, will result in a loss, even before accounting for the cost of brokerage.

An investor contemplating selling a particular bond could consider two scenarios, either hold or sell, that may help them determine if it is an acceptable course of action.

The below simplistic scenarios using Auckland Council Bonds AKC140 as an example may help illustrate the factors involved:

Scenario 1 - Hold AKC140 until maturity

10,000 Bonds

Coupon rate: 2.411%

Maturity date: 20/10/2027

Interest remaining: $1,085 (9 half yearly payments)

Funds received on maturity at par value: $10,000

Total position in 4 years is $11,085 including par value plus remaining interest payments.

Scenario 2 - Sell bonds to invest elsewhere

Sell the same 10,000 Bonds at a yield of 5.30% (based on recent trades)

Sale proceeds: $8,990

Brokerage cost: $90

Funds received: $8,900 after brokerage

Funds required by 20/10/2027 to equal the position above:

$11,085 - $8,900 = $2,185

$2,185/4.25 (where 4.25 is the number of years until maturity) = $514p.a.

$514/$8,900 = 5.77%

Brokerage to buy at 1.0% ($89.00) divided by 4.25 = an extra 0.235% p.a.

Target yield until maturity to equal holding = 6.005%

In scenario 1 the investor would have $10,000 repaid in October 2027 as opposed to possibly only $8,900 in scenario 2 so beyond October 2027 the potential for income may be reduced by a significantly lower principal amount.

AKC140 Bonds are rated AA and comparable AA rated investments are currently offered at rates between 5.0% and 5.30% (similar to the on market yield of 5.30% used in the example above).

In conclusion a sale of the AKC140 bonds, given in the example above, at a yield of 5.30% would require a purchase of the value received, from the sale, at a yield of 6.00%p.a. or better (for at least the same term until October 2027) to be even considered and would require a significant compromise of selling a bond with a very high quality issuer (with a very low risk of default), to buy bonds or subordinated notes with an issuer that would likely not be as such high quality.

There are also practicalities such as investing in lots of 1,000 bonds and minimum holding requirements that can be a factor.

Many bonds were issued during the pandemic period at interest rates that now look unsatisfactory.

A market exists to sell these bonds. However, many of these bonds mature soon, and carry market values well below par. Anyone considering such a sale should ideally seek advice and carefully consider market values first, and ensure that such a sale makes sense at these values.

Travel Dates - August & September

Our advisors will be in the following locations, on the following dates:

18 August - Christchurch – Fraser (FULL)

30 August - Blenheim – Edward

6 September - Auckland (Ellerslie) - Edward

7 September - Auckland (Albany) – Edward

8 September - Auckland (CBD) – Edward

13 September - New Plymouth – David

Clients and non-clients are welcome to contact us to arrange an appointment.

Chris Lee and Partners Ltd