Chris Lee & Partners Ltd

Market News 11 December 2023

David Colman writes:

2023, for many companies, has been a very challenging year but one particular company looks set to end the year on a high.

Turners Automotive Group, listed under the code TRA in both New Zealand and Australia, has been among the best performers in 2023. The group is spread across three divisions including:

- Automotive retail

- Finance and insurance

- Debt management and credit collection

Turners automotive retail division is New Zealand’s largest secondhand vehicle retailer, involved in the buying and selling of used cars, trucks, and machinery.

The finance and insurance division, fed by many motor vehicle loans and insurance policies from the retail division, also provides personal loans and other types of insurance.

Debt management and credit collection is a growing part of the TRA business. It assists businesses across New Zealand and Australia in collecting debts from non-paying customers, including its own.

Full year 2023 profit reported earlier in the year was a new record (Net Profit After Tax of $32.6 million) which was then followed by another record result in the current half year (NPAT of $18.5 million over 6 months).

The half year results included a forecast for another record for the full year 2024 as well, showing Turners is enjoying a period of extraordinary success.

Somewhat sadly, these back-to-back record results for Turners show how dependent on cars New Zealanders have become and perhaps how woeful, or underused, public transportation options are.

New Zealand has over 4.5 million vehicles or 889 vehicles per 1,000 people according to the Ministry of Transport’s 2021 Annual fleet statistics, and I expect the ratio has grown based on the clogged narrow streets of Wellington’s hilly suburbs.

There appears to be a growing number of car purchases financed even at higher interest rates, which have risen rapidly in recent years. This is evidence supporting the fact that many New Zealanders live beyond their means with increasing amounts of debt.

Turners continues to focus on growing market share and has been aided by the number of dealers in New Zealand dwindling (down by 18% since 2017). This is possibly a sign of consolidation, which has also been seen in other sectors as small businesses might close or be acquired by competitors.

Turners shares opened for the year at $3.31 and traded recently as high as $4.80 (up an impressive 45%). TRA shareholders also received gross dividends of 33c over the past year.

The recent strong performance and subsequent increase in the group’s market cap (now over $400 million) has resulted in the company’s inclusion in both the S&P NZX 50 and MidCap Index, which chairman Grant Baker described as a major milestone for the company.

The company is not without headwinds and is cognizant of the impact of rising unemployment rates on car sales and loan repayments. I note that cars, being depreciating assets, can lead to the value of outstanding loans exceeding the value of the underlying asset.

Cars are sadly often seen as a necessity for Kiwis, but squeezed household budgets due to inflation and higher interest rates may dictate slower and lower vehicle sales.

I worry the fantastic year that Turners has had is a sign of an overreliance on cars and that many households may have taken on perhaps crushing debt to obtain a vehicle.

In the US, there are reports of 'doom-spending,' where consumers spend more and save less despite economic concerns, seemingly to cope with them. It is possible Turners has benefitted from car purchases in some cases used to provide a distraction to deteriorating financial conditions.

'Doom spending,' which can be likened to a child-like misalignment of priorities, involves people spending today to feel good in the moment, rather than saving for an uncertain future.

Unfortunately, a significant number of New Zealanders have been in the habit of spending more than they earn for a long time, and savings rates have plummeted more sharply in the inflationary environment following the easing of COVID restrictions.

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In stark contrast to Turners, Synlait Milk (SML) has had a tough year and its shares have been pushed out of the S&P NZX 50 by Turners above.

Earlier in the year, the company was granted SAMR (State Administration for Market Regulation of China) re-registration, which allows access to the Chinese market on which the company and its customers, such as a2 Milk, largely rely. However, this was one of the only bright spots for the company this year.

SML shares are trading close to $1.00 per share, well below $3.56 at the start of the year.

A simple timeline of the company’s year included the below events:

In March, a planned two-year recovery was extended to three years.

In April, a guidance update indicated that no meaningful profit, or a loss, was expected.

The balance sheet update, as part of the guidance, noted that amendments to banking covenants had been required and were approved by its banking syndicate, and that the company was not considering an equity capital raise.

Looking back, a share purchase plan or rights issue might have been a viable option to raise capital.

In June, Synlait announced its intention to sell Dairyworks and Talbot Forest Cheese as “non-core” assets. Both businesses were acquired less than 5 years ago, with Talbot Forest Cheese acquired in August 2019 and Dairyworks in October 2019.

A buyer for these assets has yet to be identified, but New Zealand's reputation for quality milk products, including infant formula, butter, and cheese, is widely regarded. New Zealand is the world's leading milk exporter by a considerable amount, with exports of US$7.8 billion in 2022, well ahead of second-placed Germany, which exported US$3.5 billion in the same year. These factors may mean large food manufacturers see value in acquiring the Dairyworks and Talbot Cheese assets from Synlait.

July marked 10 years since Synlait listed on the NZX in 2013 at $2.20.

In September, full-year results included a loss of $4.3 million and addressed a2 Milk’s purported cancellation of an exclusivity agreement. SML disputes that a2 has the right to do so.

In October, the companies entered arbitration after failing to compromise over the exclusivity dispute.

The resignation of Synlait chair Simon Robertson in the same month continued a trend of leadership changes with numerous resignations and appointments of directors and senior executives throughout the year.

Synlait’s Annual report for the year ended 31 July 2023 listed total assets of $1.6 billion and liabilities of $895 million. Debt is a pressing issue for Synlait as net finance costs doubled for the period to $34 million, contributing to a loss of $4.3 million on revenue of $1.32 billion, which was down $70 million from FY2022.

Total loans and borrowings were $423 million in June 2023, with $243 million due for repayment within a year and $180 million retail bonds (SML010) due for repayment in late 2024.

Synlait’s standing is dependent on the sale of its brands, debt management, and the value of its assets. It is possible, due to the deterioration of SML’s market share price (not helped by index funds selling shares robotically due to the company’s exclusion from an index), that a buyer may see shares as attractive for a takeover at current levels. However, this could be a complicated endeavour due to Synlait’s current ownership.

Any prospective buyer would need to contend with existing large shareholders (Bright Dairy owning 39% and a2 Milk owning 20% of the shares on issue) and have plans in place to address debt obligations.

Bright Dairy and a2 Milk, holding Synlait shares that have dropped in value, must be watching their respective investments closely. Bright Dairy is a subsidiary of Chinese State-owned Bright Foods based in Shanghai and has significant influence over Synlait’s affairs.

Four of the eight directors on the Synlait board have been appointed by Bright Dairy, including former New Zealand lawyer turned finance minister Ruth Richardson.

A2 Milk is both a shareholder and customer of Synlait Milk and has approximately $700 million in cash on hand, which easily exceeds Synlait’s market cap of approximately $260 million, noting a2 Milk already owns $52 million worth of the shares. A2 would appear to have ample funds available to address Synlait’s current liabilities if it ends up owning the business.

Synlait shareholders endured an incredibly disappointing 2023 and face an uncertain new year.

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Scales Corporation reiterated market guidance for the 12 months to 31 December of an underlying Net Profit After Tax in the range of $14 million to $19 million.

Managing director Andy Borland noted that the 2023 year had been challenging, particularly in Hawke’s Bay following Cyclone Gabrielle.

Scales is a diversified agribusiness with three distinct divisions including global proteins, horticulture, and logistics.

Scales has benefitted from being a more diversified business, with the global protein business performing well. The company will provide an update on the division in February next year.

Guidance included:

- Horticultural division forecast to return to more normal trading

- Global Proteins expected to deliver a continued strong performance

- Investments within the protein division including Meateor Australia and Esro Food Group in Europe commenced production in 2023 but are not expected to contribute positively in 2024 due to start-up characteristics

- implied underlying NPAT between 47 million and 55 million

- implied EBITDA range between $81 million and $91 million

- fully imputed interim dividend of 4.25cps to be paid on 18 January

- dividends forecast to be higher beyond July 2024 but expected to be only partially imputed

Cyclone Gabriel had an impact on the 2023 season but the company indicates that the impact of the event on the 2024 season is limited with the total planted orchard area being approximately 5% lower than the same time last year before the cyclone.

Favourable tailwinds for 2024 were described as improved foreign exchange rates and lower shipping costs.

Scales will not be the only company hoping the weather events of 2023 are not repeated anytime soon.

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Our offices will close at midday on Wednesday 20 December and re-open on Monday 8 January. We will occasionally check emails over the Christmas period. 

We wish everyone the best over the holiday season.

Market News 4 December 2023

Johnny Lee writes:

Genesis shareholders received an important update last week, regarding a new strategic direction for the company. All shareholders should take the time to read it. 

The company is planning to allocate all profits over the next 6 years generated from the Kupe gas field towards new renewable generation and battery storage. After this 6-year period has elapsed (2030) the Kupe field is expected to gradually wind down production until being decommissioned in 2036, with the company exploring the possibility of installing an offshore wind farm in the area.

This reallocation means that the cash dividend will fall by about 20%. This will impact all shareholders, including the Government. The company’s gross dividend yield will move from approximately 10% to nearer 8% per annum.

As part of this focus on new renewable generation, Genesis intends to increase its annual renewable electricity generation from 3,200 GWh to 8,300 GWh, moving the company from 65% renewable generation to 95%.

The Huntly asset has evolved and will continue to evolve. Coal usage has largely been replaced by gas, and the company intends to replace this further with batteries, hydrogen and biomass. This will not be a short-term change, but Genesis believes that increased renewable generation and battery storage will improve the viability of these newer technologies.

Biomass is clearly becoming a serious consideration for the long-term future of Huntly station, although the company stresses that it is not yet practical as an option. Discussions have advanced for sourcing black pellets from within New Zealand, and Genesis believes biomass will be competitive with coal as a fuel source over time – and will be more competitive as the carbon price increases. 

The presentation also provides a very useful snapshot of the current state of the renewables sector. Solar costs have continued to decline, with the company noting that some potential investment decisions have seen further improvements on their metrics with these declines. At the same time, the wind generation sector is experiencing supply chain constraints, pushing generators further towards solar. Wind remains a part of Genesis’s longer-term strategy, while solar takes the front seat.

The downside of these moves is, simply put, the cost. The company is planning to spend over a billion dollars on these developments, and the company believes that, in certain scenarios, its credit rating (BBB+) would be at risk at the current rate of dividend distribution. 

The company does mention a period, between 2025 and 2027, where the company will need to rebuild its balance sheet. The company will no doubt provide guidance closer to the time as to what such a rebuild might look like, but Genesis has seen support from the listed bond market in the past.

As Genesis itself points out, the steep ‘’ESG discount’’ – which Genesis hopes to unwind with this new strategy – may see value restored to the company’s share price. There is no doubt that Genesis’s low level of renewable energy generation (relative to other New Zealand generators) has led the company to be priced differently from the other listed generators. This new strategy may change that investor perception, particularly from international investors.

Shareholders who hold held Genesis shares for its relatively high dividend yield have been given fair warning: the company is changing its strategy, and these dividends will be reduced by 20%. Longer-term, if the strategy is financially successful, the dividends will grow. In the interim, Genesis dividend yield will continue to trade above the industry average, but perhaps at levels nearer its peers.

The move to a greener grid will come with costs, and these costs will be borne by shareholders and consumers alike. This may not be the only instance of such a company re-evaluating its balance sheet in the face of a billion-dollar expenditure.

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Ryman Healthcare has reported its final set of results for the year, with its half year results out last week.

Firstly, and for some most importantly, a clarification on short-term dividends was provided. Dividends have been suspended for at least another 3 years, as it attempts to manage its debt levels.

Readers will recall Ryman raised hundreds of millions in March of this year, reducing its gearing from 45.3% to 33.1%. It has seen a slight increase to 33.6% since then, with net debt climbing from $2.3 billion to $2.47 billion over the six-month period. The company remains within its lending covenants for now.

In terms of profit, while its headline result showed a very modest increase in underlying profit, the profit per share dropped sharply following the issuance of the new shares earlier this year.

Several projects have been placed on hold, as well as some recently acquired land now being placed back on the market for sale. Hopefully, the sales price achieved from these sales is not materially lower than the recent acquisition price. 

These sales should give investors a clue as to the slowing demand. Ryman places much of the blame on a weak housing market and is hoping its slowing build rate will soon match demand.

New sales volumes also missed the mark, well below previous results and barely above 2021s COVID result. 144 new sales were booked, down from 216 in last year’s half year result. Resales remained steady.

Formal outlook was weaker than previous guidance, both in terms of build rate and underlying profit. Going forward, the company notes that its outlook will not be based on underlying profit. Ryman hopes to be free cash flow positive from 2025.

The response from markets illustrated continued concern over the company, and indeed the sector at large. The company had adopted a strategy to accommodate a certain level of growth, and these growth rates are now being challenged. It is clear now that there will be a lengthy period of ‘’reset’’ for the company, as it looks to adapt this strategy to a new economic environment.

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David Colman writes:

The investment world lost a role model last week with the death of Charlie Munger aged 99.

Charlie Munger was vice chairman of Berkshire Hathaway and right-hand man to his more famous business partner Warren Buffet.

Warren Buffet in his earlier years often invested in struggling businesses at bargain prices mainly targeting short-term gains before being greatly influenced by Charlie’s old school philosophy (especially by today’s standards) of investing in quality businesses at reasonable prices based on long term fundamentals instead.

Both men proudly from Omaha, Nebraska are widely considered value investing legends and accumulated a US$800 billion conglomerate of companies over many decades.

Berkshire Hathaway has never implemented a stock split since listing its Class A shares (BRK.A) on 29 May 1965 at US$11.75 per share. The shares currently trade close to US$545,000 per share (about NZ$888,000) illustrating how much wealth can be gained through careful and well researched investments held for a long period of time.

The company, that Charlie was a major part of, benefitted immensely from his knowledge, skill, discipline, and patience.

His many telling observations over the course of his illustrious career were often thoughtful and practical lessons for any investor.

He often espoused the value of wisdom in terms of recognising your limits and regarding investment decisions as part of Berkshire was quoted as saying ‘we have three baskets for investing: yes, no, and too tough to understand.’

He described himself as a cheerful pessimist and I encourage investors to look up his many wonderful quotes that provide a window into the mind of one of the most successful investors of all time. 

Chris Lee & Partners Ltd