Chris Lee & Partners Ltd

Market News 19 December 2022

2022 is rapidly approaching its conclusion, as investors bid farewell to a year in which many losers, and few winners, were to be found.

The NZ50G declined 12% as at time of writing, marking a very rare negative year for our local exchange. The NZ50G has increased almost every year since inception, although some of this must be attributed to the fact that New Zealand uses a gross index as its national equity market benchmark.

A gross index differs from a capital index as it includes dividends. New Zealand is one of the few countries that quotes on such a basis for its national exchange, which can sometimes make direct comparisons challenging.

Despite this, it was a poor year for the New Zealand market. After decades of falling interest rates, the rapid increase in the cost of capital caught many investors off guard, including many of our publicly listed companies.

Outlining the winners will not take long.

The best performer among the majors on our exchange this year, perhaps surprising to some, was Channel Infrastructure (formerly New Zealand Refining).

After almost a decade of share price decline, the company has transformed from a refiner to an importer of fuel. After a 71% increase last year, the share price is up almost another 50% again this year, reflecting both the reward from a successful turnaround, and perhaps overzealous selling in the 2020 year.

In this environment, announcements headed ''Guidance Update'' are normally read with trepidation. Channel’s most recent guidance update was a revenue and dividend upgrade, as the company cites the increasing value of its long-term contracts.

A2 Milk is also ending the year on a high note, up 25%, despite spending most of the year flat.

One driver of this, of course, is the buy-back programme currently underway. A2 Milk, a company often criticised for maintaining unnecessarily large cash balances in favour of paying dividends, decided to deploy some of this excess capital this year in order to buy its own shares.

The buyback could not be described as timid. The company has been aggressively buying shares, with 12 million already purchased on market.

This will likely be temporary, as the $150 million buyback concludes and normal supply and demand resumes, albeit with fewer shares available.

Other outperformers this year have been the telecommunication companies Spark and Chorus.

Both have enjoyed near 15% gains this year, whilst paying strong dividends and planning to increase long-term dividends further.

Spark had an eventful year, selling its ''TowerCo'' passive mobile tower assets. The sale of these assets has been a global trend, with both Vodafone and 2 Degrees announcing their own sales of such assets. Spark also announced plans to exit the sport broadcasting business, citing increases in the cost of broadcasting rights as one reason for the decision.

For Chorus, the year has been one of looking to the future. The company has largely completed the national broadband rollout and is now pondering where to distribute this unused capital expenditure. So far, the plan seems to be a very large increase to dividends, underpinning its share price performance.

Infratil saw a modest increase in share price over the year, despite the dreadful performance of Manawa, which fell 30% over the year. Infratil’s focus on data storage, renewable energy and diagnostic imaging gives it a solid platform for growth, underpinned by the cash earnings from the likes of Vodafone.

Vodafone’s rebrand to One will be interesting to observe. Long-term Infratil shareholders will recall the purchase of Shell in 2010, which was eventually rebranded as Z Energy before publicly listing on our exchange.

One listed entity yet to experience a year-on-year decline is the Carbon Fund, which invests directly into carbon credits to give investors exposure to the price of carbon. The fund enjoyed another gain this year, as the cost of carbon continues to rise.

Other winners include Synlait, Westpac Bank, Tourism Holdings, Meridian Energy and EBOS Group.

The number of companies closing the year lower than the beginning of the year is a lot longer.

The biggest decliner was New Zealand King Salmon, which fell almost 90% this year. Much of this decline can be attributed to the very heavily discounted capital raising, itself the consequence of a period of ''elevated mortality'' rates amongst its fish population. The deaths of the juvenile fish were blamed on relatively high water temperatures, and the $60 million dollar capital raising was required to shore up its balance sheet following the loss.

E-Road was another to experience a sharp decline in value, and has halved over the past three months alone. E-Road’s most recent update outlined a number of cost reduction initiatives, including a reduction in Research and Development expenditure. The company’s internal target of reaching $250 million in revenue was also delayed.

Customer retention rates remain high and revenue is still growing. Costs are also growing, and the cash balance shrank over the year. An environment of rising costs and rising interest rates will put strain on even the most established of companies – E-Road will be facing new challenges and will need to respond accordingly.

My Food Bag is another which has seen its share price disintegrate.

My Food Bag has been hit by a number of negative forces, including rising labour costs, falling discretionary spending and, of course, rising interest rates. Its extremely high dividend yield is underpinning much of the current demand, as investors try to determine where the dividend falls to next year.

At the same time as these economic forces impact the company, there are also questions being raised around whether the trend towards meal kit services is changing direction. The company saw huge growth during the Covid-induced lockdowns. Will this be maintained long term, or will we begin to see people move back to restaurants, or cheaper home-cooking options?

There is also the matter of its primary competitor, HelloFresh. A number of negative media articles regarding the quality of its product have surfaced of late, and the company’s share price has followed a similar trajectory to My Food Bag over the year. Its willingness to aggressively compete for market share will no doubt act as a constraint over My Food Bag’s own offerings.

Pacific Edge also suffered one of its worst years on record.

There are few stocks as divisive amongst the investing community as Pacific Edge. Its share price has swung wildly over its lifetime, with two major runs in 2013 and 2020 seeing its value range from the tens of millions to over a billion.

Shareholders in the company range from the hopeful to the absolute ardent believers. After years of losses and capital raisings, including a capital raising in September 2021, the company now sits atop a large cash balance and a firm belief that it will turn the corner towards profitability soon.

Another sector that saw huge declines was the aged care sector.

Ryman, Summerset, Oceania, Arvida and Radius all saw large share price falls this year, as asset prices like land and housing fell sharply. At the same time, labour shortages were putting existing villages, let alone future villages, in jeopardy.

In the midst of these conditions, Ryman announced the purchase of a 10 hectare site in Taupo, with plans to construct a new $220 million retirement village. Clearly, the short-term concerns are not influencing the long-term strategy.

Ongoing concerns around Ryman’s debt levels have also failed to deter its growth plans.

The retail sector fell sharply.

Briscoes, Kathmandu, The Warehouse and Hallenstein Glasson all experienced 20-30% share price declines, despite relatively robust financial performance. Warning signs from overseas are flashing bright red lights but, so far, the management teams at the head of our largest retailers seem to be up for the challenge.

Next year will be an important period for this sector. Optimism from investors looks to be in short supply, and with Central Banks around the world seemingly determined to continue lifting interest rates, one imagines the trends seen overseas will eventually make their way to our shores.

The property trust sector also underperformed the overall market.

Rising term deposit rates now exceed the dividend return of some of the listed property trust sector, making it a difficult sell for investors chasing an income. Most property trusts are hoping to see modest dividend growth next year, but the rising cost of debt will no doubt also act as an impediment to these ambitions. It remains undeniably true that these companies perform best when interest rates are lower, and less volatile.

The listed medicinal cannabis sector – Cannasouth, Rua Biosciences and Greenfern – all struggled this year. Across all stages of the business spectrum – from start up to listed company – there are new medicinal cannabis companies emerging, hoping to find success in what is a relatively new sector for New Zealand. Many of these firms approach the broking community for assistance in raising capital, and the sheer volume of them indicate a sector that will not lack competition.

One gets the sense that the next two years will be crucial for this sector. Capital will become more expensive, and those with undisciplined spending will likely find the well of investible capital begins to run dry.

Several of our major growth companies also saw share price declines.

Fisher and Paykel Healthcare’s poor share price performance can be forgiven, given the enormous growth witnessed last year. The company was careful not to extend itself too aggressively while enjoying unusual revenue growth during the Covid period. This cautiousness is paying off, as the company looks longer term and continues to look towards new research and development projects.

Mainfreight is another instance of moderating margins. The supply chain constraints experienced over the past few years have begun to ease, but the underlying results remain strong as the bulk of its profits were reinvested into the company.

Other declines include ANZ, Sky TV, Air New Zealand, Vulcan Steel, Fletcher Building, Scales and Seeka.

2022 was a year to forget for most of our listed companies. Common themes existed throughout the year, including the rising cost of labour and freight, as well as the rising cost of debt.

Next year will begin much the same. Central banks are staking much of their credibility on the notion that interest rates must remain at higher levels until inflation wanes. A rapid unwind of these hikes seems unlikely.

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THE handling of an apparently imminent Auckland Airport capital raising was thrown into disarray last week when new Auckland mayor Wayne Brown made an absolutely terrible error.

To be clear, there appears to be no equity raising on the short-term horizon. Either such a plan never existed, or the plan was shelved in favour of other options.

Brown, in a public meeting, was seemingly outlining a case for the council to reduce its 18% holding in Auckland Airport. The listed company was apparently about to raise capital from its shareholders – which had never been disclosed to the public – to fund the construction of a new domestic terminal. The council's holding would apparently reduce from 18% to 11%, an enormous reduction implying an enormous capital raise. Capital raisings such as this are normally associated with share price declines.

The comment made was that ''they are about to go to a major raising to fund a new domestic airport and we will not be contributing to that''. This was stated as fact and taken as such.

Whether he was suggesting the council sell its holding prior to the publication of this information is not clear.

Brown himself later clarified that this was not publicly disclosed information and was intended as mere ''speculation'' on his part. Auckland Airport corroborated this with a carefully worded announcement, saying it had ''made no such announcement'' and had no plans to carry out an equity raise, and would instead be increasing borrowings from its lenders to fund an extension of the existing international terminal to form a new domestic terminal. This careful wording was wise, avoiding boxing the company into a corner unnecessarily by dismissing the possibility outright.

The truth may lie somewhere in the middle. It would make sense for Auckland Airport to have discussed – confidentially – funding options with its largest shareholders for the terminal extension. If the council indicated an unwillingness to fund such a project, Auckland Airport would then need to find an underwriter to fund the 18% stake. If this was difficult, other funding options could be explored.

Regardless, the comments from Brown were completely unacceptable. There is simply no believable scenario in which such information could be conveyed without a strict agreement of confidentiality.

Whether the council should own shares in the airport is another matter for discussion entirely. Some will argue that the 18% stake is important as it allows the council a minority vote on matters such as board representation. Others might argue that the council should be borrowing money to invest in the sharemarket, as the investment returns may outweigh the cost of borrowings long term.

Such a debate should be conducted properly. Judging by Brown’s subsequent comments, that debate is almost at hand. 18% of Auckland Airport would have a value of approximately $2 billion dollars.

I accept that not every mayoral candidate will have a background in financial markets and may not understand the consequences of making such statements. It is important that our elected officials come from varied backgrounds, providing perspectives that would otherwise be missed. Indeed, our own former Prime Minister Helen Clark made a similar remark decades ago, providing financial advice to Air New Zealand shareholders on live television.

One hopes that elected officials around the country are taking note and reminding themselves of the impact their words may have. Traders and investors alike pay attention to such commentary, and idle speculation like this, if that is indeed what it was, is best kept outside the public domain.

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This edition of Market News marks the final one of the year. 

The team at Chris Lee and Partners wishes readers a wonderful holiday period.

We close tomorrow, Wednesday 21 December at 5pm and re-open at 9am on Wednesday 11 January.

If you would like to buy or sell investments, please email us and we will place the order as soon as we can. Clients wishing to urgently speak with an adviser are asked to email the office to arrange a time for us to call.

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Travel

 

Edward Lee will be in Auckland on Wednesday 18 January (Wairau Park), Thursday 19 January (Ellerslie) and Friday 20 January (Auckland CBD).

Chris will be in Christchurch on Tuesday 24 and Wednesday 25 January (am), in Ashburton on 25 January (pm), and in Timaru on Thursday 26 January.

David Colman will be in Palmerston North on Wednesday 25 January and in Lower Hutt on Thursday 26 January.

Anyone wanting an appointment is welcome to contact us.

Johnny Lee

Chris Lee & Partners Ltd

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Market News 12 December 2022

Johnny Lee writes:

Beleaguered Air New Zealand shareholders received some positive news last week, as our national airline continues to beat - admittedly low - expectations. The share price saw a very modest increase in price.

A falling oil price and an unexpectedly strong surge in both international and domestic travel demand has led to the upgrade to earnings guidance.

The oil price, of course, is beyond the control of Air New Zealand and linked more to geopolitical and supply/demand factors. Air New Zealand has historically operated a hedging programme, allowing them to mitigate some exposure to rising oil prices. 

The surge in demand will be a welcome relief for a number of associated sectors as well as the airlines. Support industries like accommodation and hospitality will be pleased to see that both New Zealanders and foreigners are moving around the country with increased confidence.

Continued inflationary pressures remain a concern. New Zealand will need to be careful not to price itself out of the global tourism market, and rising domestic ticket prices will no doubt lead some to weigh up alternatives to air travel when travelling the country. Ultimately, if the planes are full, there will be little incentive to lower prices.

The increasing confidence has led to Air New Zealand hiring an additional 2,200 staff, as it gears up its workforce to deal with the surge in demand. One imagines this will be of great relief to those former workers that may have struggled since the pandemic.

At the same time this is occurring, the shifting stance in China is also creating optimism among travellers. A loosening of movement restrictions is likely to see economic benefits, and China – prior to the pandemic – was a major source of tourism numbers for the country. Expectations are high.

The company is not out of the woods yet. A global economic downturn, which many now predict to occur next year, will no doubt lead to turbulence for global airlines.

Air New Zealand began its post-COVID journey by outlining goals and various scenarios that could occur. By and large, it has met those goals and the current scenario was among the more optimistic outlined. It remains a long journey towards profitability - and dividends - but these updates should comfort those who decided to embark on the journey with it.

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Any market observers seeking examples of shifting market sentiments need look no further than that of imitation meat (pea, rice, and bean protein) producer Beyond Meat.

Beyond, worth almost $15 billion in July 2019, has fallen almost 95% from this peak. While this initial valuation was partly due to overexuberance, the stunning decline in value also provides an insight into how much the world has evolved around it.

Having established itself as one of the market leaders – alongside competitor ‘’Impossible’’ – it set out to establish relationships with major retailers, including fast food outlets McDonald’s and Kentucky Fried Chicken.

Competition emerged. Some of the world’s wealthiest investors, including Microsoft co-founder Bill Gates and Amazon Chairman Jeff Bezos, began investing heavily into early-stage competitors of Beyond. Even in New Zealand, competition was observed in the form of Sunfed Meats. The argument was that by making a product that was supposedly more environmentally friendly, healthier, and eventually cheaper, while being indistinguishable by taste, would see the industry flourish.

Instead, rising inflation has seen reduced patronage at restaurants. At the supermarket, American consumers have begun their belt-tightening much faster than New Zealand consumers. While the demand for meat-free chicken remains a steady growth market, the other products - where Beyond operates - has declined sharply.

The rising cost of capital has also applied the brakes. Investors may be willing to invest in loss making ventures long term when rates are close to nil, but as rates rise, this well begins to run dry. This style of company relies on this period of loss making to grow revenues and achieve scale, eventually using this scale to achieve profitability. 

When access to capital evaporates, the focus shifts to cost savings, which are now beginning to occur. Staff are being laid off, growth ambitions are being shelved and weaker companies begin to discount product to secure revenue, driving down the value of the whole sector.

In the end, you are left with a company losing hundreds of millions of dollars, needing to raise capital at depressed levels and competing against companies with no regard beyond their own survival. 

I expect to see these dynamics continue to play out across more than a few sectors, as interest rates find their peak.

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Reverse listing vehicle Goodwood Capital has found another home, after many decades of underperformance and failed ventures.

Goodwood Capital was previously known as Claridge Capital, Certified Organics, Seadragon Limited and Snakk Media, amongst other identities. It will be hoping the change from Goodwood Capital to WasteCo will be the last.

These reverse listing vehicles serve to simplify the listing process. A reverse listing occurs when a listed company elects to buy a private company, settling the transaction in shares and therefore surrendering control to the private entity, who then – typically – renames the company and begins operating as a listed company.

In this instance, Goodwood Capital purchased WasteCo, but the transaction was settled in the form of 584 million new Goodwood Capital shares, giving WasteCo control over Goodwood Capital. Goodwood Capital was then renamed WasteCo.

WasteCo may be a familiar name to Christchurch readers, operating from Blenheim Road in Riccarton. The company provides waste management services, including waste collection (such as ‘’wheelie’’ bins and skip bins) road sweeping and waste sorting, as well as a new venture specialising in the collection and treatment of medical waste.

The company employs around 170 employees – triple the number from 2020 - and services several councils around the South Island.

The company’s growth strategy has several, quite distinct ambitions. 

Firstly, it is considering a number of opportunities to acquire smaller businesses in the sector. It has used such acquisitions to grow over the last five years, and a public listing will provide an avenue to raise capital for such a direction.

It also views geographical expansion as a possibility, branching out into other areas of the South Island outside its existing coverage.

It also sees an opportunity as businesses increasingly focus on their ‘’green credentials’’, helping companies process waste and educating them on policies to improve their environmental standing.

The company does not pay dividends and does not intend to pay dividends in the near future.

The usual risks exist – departure of key staff, loss of contracts, low margin competition, poor execution of growth strategies, general economic decline – risks that tend to decline over time.

The benefits of listing will no doubt play out over time, as the company is able to raise capital from new shareholders, and offer transparently valued scrip in place of cash as it continues its acquisition strategy.

Ultimately, the company remains a small cap, with a value around $50 million, putting it in the same tier as New Zealand Windfarms, Radius Residential Care or the recent medicinal cannabis listings. Revenues are soaring, profits are inconsistent, and debt is growing.

2023 promises to be a challenging year for small growth companies. Excellent leadership and management will be critical.

Travel

Travel dates for next year are available on our website here:

https://www.chrislee.co.nz/request-an-appointment

Office news

Our office closes at 5pm on Wednesday 21 December and re-opens at 9am on Wednesday 11 January.

As usual, we will be responding to e-mails during this period. Clients wishing to urgently speak with an adviser are asked to e-mail the office to arrange a time for us to call.

Next week will mark the final edition of Market News for the year, and will cover the highs and lows of 2022.

Chris Lee & Partners Limited

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Market News 5 December 2022

Johnny Lee writes:

World sharemarkets enjoyed a modest rebound last week, after commentary from the US Federal Reserve Chairman Jerome Powell led to a burst of optimism from traders.

Powell's comments indicated that future rate rises may come at a slower pace than recent hikes, opening the door to 0.25% rate rises. To be clear, there was no discussion of rate cuts or even pausing the rate hikes - simply smaller increases.

The enthusiasm following the comments are perhaps more indicative of the prevailing gloom, rather than the economic benefit of further rate rises. Markets fearing (and pricing) a 0.75% hike gladly accepted the news, and repriced equity markets accordingly.

Rhetoric remains an important tool for central banks. They will be hoping that the threat of rising interest rates is sufficient to reign in consumer spending and borrowings, potentially paving the way for the implementation of such rate rises to be unnecessary. It is a tool that works, both in terms of setting a tone and in terms of modifying consumer behaviour.

2023 will likely mark a noticeable shift in consumer behaviour.

There has already been a visible increase, in terms of both data and media coverage, of households beginning to feel the strain of higher rates. The data shows that a rising number of New Zealanders are officially in arrears, as people struggle with debt levels. Mortgage rates are beginning to reset, as borrowers adjust from 3% mortgage rates to 7% rates.

Term deposits are also beginning to creep higher. Most major banks now offer rates exceeding 5% across all one to five year terms. While there is nothing mathematically significant about a rate of 5%, there was a noticeable shift away from term deposits once rates began to slip under this figure. Will we see a return to investors using term deposits?

The impact we have yet to feel, in my opinion, is with regards to corporate profitability. The retail sector, including likes of The Warehouse, is still seeing positive momentum, evidenced from updates as recent as November. New Zealanders are still spending, despite the mounting levels - and increasing cost - of debt.

Logically, as these higher mortgage rates begin to consume a growing proportion of people's income, the available funds for spending on discretionary goods will decline. We saw the opposite impact occur when interest rates were falling, and consumer confidence and spending rose.

We are seeing these dynamics play out overseas. Major US retailers are reporting falling sales, and surpluses of inventories. Indeed, while the S&P 500 index has declined 15% this year, the Consumer Discretionary index has fallen nearly twice that amount.

Another sector beginning to turn is the rental market. Recent data from the United States is showing that an increasing number of young people are choosing to live with family, forcing rental property owners to lower rates to compete, as it were.

The United States rental market is different from ours, with a much larger percentage of homes owned by institutional investors. This percentage grows each year, as large investment funds continue to invest across the residential property sector. Some of these funds have reported huge declines in 2022, as rising interest rates bite into asset valuations.

The modest bounce in equity prices last week may seem paltry compared to the much larger declines seen over the year. Indeed, other data points still paint a picture of a consumer under pressure. The Federal Reserve's statement next week will provide further clues as to the scope and duration of the current hiking cycle.

Our own Reserve Bank has no scheduled statements until late February. 

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The new listing of ''technology and investment company'' Black Pearl Group will likely mark the end of a quiet year for the NZX, in terms of new equity listings. Indeed, the last few years have been generally quiet on this front, with major listings like My Food Bag and Vulcan Steel representing the largest raises.

Black Pearl did not raise capital, instead using the public listing to act as a means of transparently valuing acquisitions it makes, by allowing the company to offer shares in itself when purchasing other companies.

Many unlisted technology companies have seen valuations fall in the last year, as the cost of capital rises, and loss-making start-ups struggle under the pressure of shareholders losing money and unwilling to part with more. Investment companies like Black Pearl will be hoping to find value in amongst such firms.

It has been a difficult period for investors in new listings, with many experiencing share price declines and some declining even further than the market average. While success breeds success, failures do not, with investor confidence in new listings low and entrepreneurs finding capital increasingly expensive to raise.

A listing of this nature tends to see low levels of liquidity, for several reasons. Long-term investors tend to wait on the sidelines, wanting to see concrete progress towards executing its strategy. Shorter-term investors will be wary of dilution, as the company potentially issues stock to fund its growth strategy.

Early trading suggests that very small investors are making up the bulk of trading. 

New listings such as this appeal to a particular type of investor, typically one with specific knowledge of the company and sector, and an appetite for short-term volatility. Those seeking predictable profits and reliable dividends will look elsewhere, for now.

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Fisher and Paykel Healthcare's strong result saw the company's share price sharply rebound, as investors look through the post-COVID return to normality. Its long-term growth ambitions remain on track, as the company exceeded guidance.

Fisher and Paykel Healthcare – which designs and manufactures respiratory care products – has seen revenue fall sharply compared to last year's result, following the COVID-induced surge in demand. As always, the context of this decline in revenue is important. The huge number of sales during the initial COVID outbreak is unlikely to be matched for many years.

The biggest negative to take away from the announcement was the declining gross margin, which was blamed on elevated freight levels. We have seen these moderate over the period, and further moderation is expected as the global supply chain is restored.

Manufacturing has also been impacted by staffing constraints, a common theme across many industries. Both a shortage of workers and increased absenteeism - due to illness - is becoming an increasing challenge for businesses.

The general shift away from sales of hardware, towards sales of consumables, was to be expected. COVID saw a large number of new customers for Fisher and Paykel - customers who will require support and maintenance long term, converting to reliable, recurring revenue. Fisher and Paykel also makes the point that many of these customers oversupplied themselves during COVID, suggesting sales will improve in the second half of the financial year as these supplies are exhausted.

With the northern hemisphere flu season about to erupt - it usually peaks during the December to March months - Fisher and Paykel anticipates a busy close out for the year.

The company is investing heavily in research and development, it is ramping up its production capacity, it is focusing on improving margins and it is maintaining very modest gearing levels as it gradually lifts its profits and dividends. Shareholders will be pleased that their company is capitalising on the opportunity provided by the COVID outbreak, and recalling that despite the sharp falls in year to year revenue, the long-term growth ambitions remain very much on track.

TRAVEL

Travel dates for next year are available on our website using the link below:

https://www.chrislee.co.nz/request-an-appointment

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