Chris Lee & Partners Ltd

Market News 26 June 2017

The Auckland Council is on the right track with its decision to sell $130 million of liquid bonds and shares (not strategic assets like Auckland Airport and the Port) to use the funds elsewhere on its balance sheet.

By owning this particular portfolio, the council was treating its ratepayers as leveraged investors, with 100% leverage; a hedge fund if you will.

Does this sound prudent to you?

Councils are not in the business of maintaining investment portfolios in non-core assets funded by debt, which by definition these were given the large debt load at the council.

$130 million is only a drop in the bucket for Auckland Council but at least that drop has now made its way into the correct bucket.

 

Investment Opinion

 

French – I haven’t been to France yet, but those who have been often describe how intentionally different the French are in the way they behave socially (fiercely independent) and in their interactions with each other (passionate and colourful).

But the most recent French election result indicates that they aren’t all that different from the populations of many other nations.

French voters have swept both the previously dominant Socialist party and Republican party aside and invited Emanuel Macron’s ‘new’ party through the middle and astonishingly Macron has come from a standing start to now control 60.6% of the new parliament (350 of 577 seats).

This disruptive demand for change in governance is not the preserve of the Gallic, as Hilary Clinton and Theresa May can attest. Even the Russians’ who don’t really get an influential vote are presenting the same message to Vladimir Putin, although this movement ‘mysteriously’ declines by about 10% after each protest.

The second remarkable statistic, which is perhaps a more serious concern, is the ongoing decline in voter turnout.

Do they not turn up because they don’t care?

More likely they don’t feel influential, and if this is the case the new majority (those who didn’t vote) might turn up next time with pitch forks and tractors (14 July is just around the corner).

The French electorate reached ‘peak participation’ at 84.7% in 1978 but participation has declined at each election since, save for two. The 2017 election stood at an appallingly low turnout of 42.60%.

Why are the other 57.40% so uninterested that they would not vote?

More importantly why has voter turnout from what is the same generation dropped by 17% in less than 10 years?

I read the articles that guess that the young want to vote via mobile phone or computer and I think ‘convenience’ is an important part of increasing participation but I also observe that Theresa May’s stupidity, in calling an unnecessary election, spurred a huge proportion of young voters to turn out and vote against her.

Mind you, we don’t want to encourage extreme behaviour from the politicians just to ensure the young get involved in voting for their futures.

I’ll bet that many politicians think they understand the data and made themselves comfortable with a view that it was easier to win if turnout declined and the marketing could be focussed on a smaller group, but this is incredibly naïve thinking and is not a behaviour that any democracy should tolerate.

I have an idea (as usual – Ed); mature democratic countries should add a new amendment to their constitution that dictates a general election result is void and must be re-run if voter turnout is less than a majority of those enrolled to vote.

France would have been forced to re-run their election under my new rule.

Government strategists would no longer hide in the shadows assessing probable behaviour from the minority and switch to grand marketing campaigns to urge voter participation.

If India combines its new finger-print and eye scanning technology with Distributed Ledger Technology (aka BlockChain) they may embarrass the rest of the developed, democratic, world with its voter turnout in future.

Low voter turnout is a disruptive problem that ‘we’ need to solve as an important piece in the puzzle of achieving more satisfied societies.

Investment News

 

 

RBNZ OCR – I thought the previous statement reviewing the Official Cash Rate was about as boring as possible but last Thursday’s found a few options for taming the statement down even further.

The only real news was that the OCR stayed at 1.75% and will stay at 1.75% for the foreseeable future (at least 12 months in my view).

Investors’ should always have cash in an emergency fund, plus coverage for imminent spending, but thereafter short-term bank deposits penalise your average portfolio return.

The following is a relevant exercise for all investors – ‘Call account versus long term bond whilst waiting for interest rates to rise’.

I know the banks only pay 0.10% for pure call accounts now, but for this exercise I’ll use 2.75% paid by Heartland Bank on its call account.

Because it is current I’ll use the Summerset bond (SUM010), six years (to 2023) at 4.78%.

Using approximate results, the following are the returns required over the residual years if an investor rejects the Summerset bond and waits in a call account for a better deal at a later date.

A Tortoise (SUM010 bond) and Hare (2.75% Short term investor) race.

2018 – 2023 the Hare now needs to earn 5.19%;

2019 – 2023 the Hare now needs to earn 5.80%;

2020 – 2023 the Hare now needs to earn 6.81%;

2021 – 2023 the Hare now needs to earn 8.84%;

2022 – 2023 the Hare now needs to earn 14.93%;

I know things change along the way but the Hare must make some heroic assumptions to win the race against the Tortoise.

Heroic assumptions don’t usually play out well for investors and financial advisers.

KPG Rights– Kiwi Property Group (KPG) has announced a Rights issue and intends to raise NZ$161 million by way of a fully underwritten, pro-rata, accelerated Entitlement Offer involving an Institutional Entitlement Offer and a Retail Entitlement Offer.

The Retail Entitlement Offer, which relates to our clients, allows eligible shareholders who held shares prior to the ex-entitlement date (Monday, 19 June) the opportunity to apply for 1 new share for every 11 KPG shares held.

The new shares have been priced at $1.36 and will rank equally with existing shares.

The funds raised via the offer are intended to be used to pay down bank debt (gearing ratio to be reduced to 29.2% from 34.5%) before ultimately being used to fund potential expansion and improvements at Sylvia Park (Auckland), Northlands (Christchurch), The Base (Hamilton), and in the longer term a new site in Drury.

Typically, the cost of debt is lower than the free cash flow dividends paid out by the listed property entities but we congratulate the relatively conservative stance adopted by most of the businesses in this sector; reduce the debt first, then invest in the new strategy.

A Retail Bookbuild will be conducted for Institutions to bid for the remaining shares not taken up by rights holders. Eligible shareholders who choose not to participate in the Offer may receive a payment from the sale of these surplus shares, if a premium is achieved (ie greater than $1.36 per share).

Full details for the entitlement offer will be provided in an Offer document, delivered by Computershare, which will be sent to shareholders on 22 June. Shareholders should consider this document carefully.

Applications for the Retail Entitlement Offer must be received by the registry by 5pm on Monday 10 July.

KPG will pay brokerage on rights applications bearing a broker name (hand writing the broker name is acceptable).

KPG is New Zealand’s largest listed property entity with $3 billion in assets and they are displaying a robust belief in their role of providing some of our largest property spaces for retailing.

Where many would have you believe that the online giants like Amazon will kill off retailing as we knew it, and currently know it, KPG are declaring otherwise, and frankly I think that KPG knows more about my shopping habits than I do.

It is true that most of us have engaged in some online shopping but it is not the majority of our shopping and I don’t think it ever will be for me.

Supermarket shopper behaviour statistics would be useful to see.

Supermarkets introduced home delivery years ago where for a modest delivery fee you can book your shopping needs online. Typically, you can save the delivery fee by not being drawn into unnecessary purchases.

However, consumers still fill supermarkets whenever I am there and my wife refuses to shop online for groceries preferring to assess the shopping on site and to enjoy the social interaction with the community.

If you are a KPG shareholder look out for the offer documents and respond to them promptly once received.

Vital – Whilst we are touching on the property sector, clients who seek a financial advice service from us are encouraged to read Kevin Gloag’s latest piece about Vital Healthcare Properties (VHP).

The item can be found on the Private Client login page of our website and is useful to investors holding VHP shares in their portfolio.

VHP also raised additional capital from its unitholders recently but its external management structure provides a different mix of incentives to those managing Kiwi Property Group.

Oil – One of the big economic indicators is moving again.

The price of oil is in decline mode again, trading at US$43 last week, down 22% since January 2017 and back at a price not seen since April 2016 when the price was lifting from the US$29 low point of 2015.

OPEC tried hard to reduce global supply to create additional price tension, preferring a price of US$65 or higher, but they have failed and for the immediate future over-supply is the current concern.

Motorists will not be saddened by this news and it will increase the discretionary spending ratio in the wallets of most consumers.

You know I am a fan of electric cars for the benefits they will bring to our current account balance but until most electric cars are priced competitively with fossil fuel cars they will not sell in large numbers.

Maybe this dip in the oil price will place some additional heat on car manufacturers to boost sales of electric cars though lower pricing to try and initiate the virtuous cycle of more volume equals lower production pricing.

They cannot sit back and wait for regulators and consumers to come to them.

The geographical, social and economic beauty of New Zealand sees us in centre stage for the global pageant and this is reflected in our stronger currency; this too helps lower our purchase price of oil based products.

Enjoy it while it lasts and, if you can, increase your savings rate with the spare money that you find left in your wallet.

Aussie Electricity – It’s important to stay ahead of the demand curve and have a diverse mix of fuels in the electricity sector and it looks like Australia is falling into a point of imbalance (supply shortage) for electricity.

South Australia recently discovered the single fuel risk with its dependence on ‘green’ wind power when a storm arrived. Now most of the Eastern states (but not Victoria) are being presented with electricity price increases of between 7%-20% with the blame being linked to tension in the gas supply market.

Coal may be the cheapest energy source now but it is an unwanted child for electricity generation and coal plant generation is now gradually being mothballed.

The ability for Origin Energy, AGL and Energy Australia to achieve such large power price increases, after a near doubling of prices over the past five years, discloses a situation where electricity supply barely exceeds demand.

The recent disruptions within Australia government (frequent leadership changes) pushed back the development of new generation and this is now playing into the hands of the current generators and disclosing the importance of making strong decisions when in government and avoiding the distraction of beauty contests (one weakness of democracy).

The Paris agreement on climate change (the one that President Trump lost interest in) and the Finkel report in Australia that encourages renewable generation claims they can deliver an over-supply of renewable generation and thus achieve lower electricity prices by, wait for it, 2030.

2030!

I’ll bet consumer and small businesses are pleased to hear they’ll only have to wait 13 years for lower pricing and assume that politics won’t delay the plan any further.

Alan Finkel logically recommends a push for more solar and wind generation but recommends that this be backed up by batteries, hydro and gas sourced electricity.

Hydro makes a lot of sense but I’ll bet the Australians have little stomach for this politically (unlike the Chinese and South-East Asia). Gas, as above, is inconveniently rising in price and batteries, well they require other earth elements to manufacture and have a limited shelf life.

Despite his renewable focus even Alan Finkel sees a need for coal generation as far out as 2050 (17% of the market).

See the mess that politics can create for a nation, when good governance is what is really required.

This price threat is another sea anchor that the current Australian economy could do without.

I suppose it has one silver lining; it might encourage homeowners to consider more solar panels on the roof because wholesale businesses like AGL are also increasing the price they will pay to buy surplus generation from this source.

Astute NZ Investors might be feeling a little better about their shares in Tilt Renewables (with its Australian renewable projects) and in Trustpower (with its Australian dams) right now, as will Infratil as an investor in both businesses.

Actually, this mention of Trustpower, and hydro, returns my mind to the potential Ruataniwha dam in Hawke’s Bay where potential still exists to make progress with both irrigation and electricity generation but for now it is running up against our own version of political impasse.

It would be nice if we could … sorry… trump the Australian political ineptness and push ahead with the Ruataniwha project in NZ.

Start-up businesses – regular readers may recall that I joined the Wellington region’s venture capital investment club (AngelHQ) to develop a better understanding of where new start-up businesses come from (as opposed to divisions spun out of large successful businesses).

Investing in these start-up businesses is high risk stuff and is really only for people with more money (assets and income) than they require but it is exciting to witness the many start up attempts.

The aspect that I find energising is meeting the passionate people who are starting up businesses to try and solve problems they have discovered and the ‘scientists’ who develop solutions and real knowledge about the situation.

It is refreshing that there is no room for politics at this stage of the business cycle.

There are so many stories that I could tell you about. Some are confidential for now, others I have mentioned before (such as Flick Electric) but here’s a new one with a public profile that is involved in trying to solve the headline grabbing subject of farm discharge.

REGEN - http://www.nzregen.co.nz/

Take a look. Be pleased.

We always knew that clever scientists would be involved in helping to reduce the impact that farming has on our ecosystem and this is evidence that it is happening.

You cannot invest in REGEN, yet. Maybe it will happen one day, if the business is not snapped up by a global giant watching the developing science closely from the corner of the room.

Start-up businesses can only raise money from habitual investors (the costs and risks are too high to approach retail investors) but it is very exciting to see these businesses being launched by Kiwis, in NZ.

Xero was this small once, only 10 years ago, and bless them they have stayed headquartered in Wellington.

I’d like to compliment the NZX who regularly allow AngelHQ to use their premises for meetings and presentations. Contrary to what you may read about the NZX not having a focus on growth they are very aware of those who are trying to build new businesses where some will have the potential to list on the NZX for all investors to access.

Ever The Optimist – The log industry is looking very good it seems.

Pricing for unpruned logs has lifted from $111 in 2016 to $124 now and commentary expects this to rise further as domestic demand (our housing push) is competing with continued good demand from China (72% of our exports), India, Japan and South Korea.

Exports were NZ$2.22 billion in 2016 but are forecast to reach $2.66 billion in 2017 and hopefully $3.14 billion by 2021.

The rising price does nothing to temper house building costs in NZ, but desirably it does plenty to help real investment, real produce and real trade outcomes.

ETO II - ANZ-Roy Morgan consumer confidence index rose to 127.8 in June from 123.9 a month earlier, the highest reading since January.

It makes sense that consumers would feel better when employment is up, unemployment is down and net incomes are forecast to rise in 2018.

Investment Opportunities

Summerset (SUM010) – new senior, secured, bond offer (6-year term) with an interest rate of 4.78% p.a. (paid quarterly) is open for investment.

Usefully the interest payments on this new bond are in January, April, July and October, which are months that most investors do not receive much income from portfolios.

Investors are invited to contact us to request an allocation and then to promptly deliver their application form to our offices. There is no public pool.

The offer document and application form is available on the Current Investments page of our website: http://www.chrislee.co.nz/current-investments

Interest starts accruing from the date an application is processed so there is an incentive to act early (4.78% beats the returns paid by all call accounts with the banks).

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

Travel

Kevin will be in Christchurch on 13 July.

David will be in Palmerston North and Whanganui on 27 June and in New Plymouth on 28 June.

Edward is in our Wellington office (Level 15, ANZ Tower, 171 Featherston St) on Tuesdays, available to meet new and existing clients who prefer to meet in Wellington.

Anyone wanting to make an appointment should contact us.

If you wish to be alerted about the next time we visit your region please drop us an email and we will retain it and get back to you once dates are booked.

Michael Warrington

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Market News 19 June 2017

The Japanese emperor, Akihito, will be allowed by the Japanese parliament a one-time opportunity to abdicate.

This sequence of authority creates a syntax error for me.

 

Investment Opinion

 

Asset Allocation– Almost every day one can read a commentary from a respected person within the financial sector explaining their firmly held views on the future for financial market pricing and investment followed by the obvious conclusions that it wants readers to understand.

Over the past two days I read persuasive items about why I should fear a decline in asset values, both bonds and shares (Bill Gross) and why I should be very bullish about the likelihood of rising asset values, again both bonds and shares (Ron Baron).

Each of these people, among hundreds of financial analysts, deserve some attention as very successful managers and wealthy people (fruits of ongoing success); they are not front-running the market urging us to drive up prices of investments that they have recently purchased so that they may profit by selling. They are expressing genuinely held views.

Baron Capital oversees US$23 billion of invested capital and Janus Capital where Bill Gross works manages US$190 billion. Gross regularly donates tens of millions to various charities.

Both Baron and Gross have undoubtedly earned fees from convincing a large volume of people to invest within funds that they manage but they have no need to boost personal wealth via their statements, they just wish to continue to market their businesses by publicly expressing their views.

So, who will be correct?

In a binary sense only one of them will be, but in truth the answer is more complex and involves time. One day both gentlemen may claim to have been right.

I suspect that Bill Gross’s time frame is 12-24 months but Ron Baron adopts a longer time frame for his beliefs.

Bill Gross is rightly concerned that today’s unreasonably low interest rate environment in many economies (negative real interest rates – i.e. lower than inflation) is stretching the valuation of assets (long term bonds, property, companies) too far.

I suspect that he will also believe that low cost of debt has encouraged excessive debt use and that one day there must be a day of reckoning for the over-leveraged. I agree with that opinion, but knowing the date is near to impossible in my view; we will know once it happens.

By contrast Ron Baron sees inflation, interest rates and oil prices (major expense influences) staying very low and sees the value of blue chip companies (think Dow Jones index in America) doubling to 40,000 over the next 15 years.

Is Baron sticking his neck out?

Maybe not.

Mathematically speaking Baron may not be pushing the boat out as far as it seems because a 5.50% per annum return, compounded, doubles the start amount over 15 years. US companies only pay out modest dividends on average so he may only need a combined return of about 7-8% per annum for his prophecy to come true.

Remember Baron is describing the performance of the index, where the performance of the best businesses is captured (the weakest drop out of the index whilst the new strong performers are added). Performance of businesses and market pricing will undoubtedly be volatile but his assumptions are not radical.

I agree with Baron about two important drivers, interest rates and oil pricing to remain low. That being the case the US, the world’s largest economy, has a lot to gloat about (and they’ve got the leader for gloating – Ed). Not only can they finance their position cheaply but they are now self-sufficient with respect to energy and the value of this should not be underestimated.

Baron is probably uninterested in President Trump’s influence (like or dislike) because Trump won’t be around long enough; eight years maximum, four years probable, one year possible.

Anyhow, I was leading to your, and our, recurring question; what’s an investor to do?

The answer is to always start the decision-making process from the basis of your core strategy.

If your investment strategy for what you should own is good, then there’s a very good chance that the performance of your investing will meet your objectives.

This is why regular portfolio review is so important. Does the mix of investments held, at current values and income levels, meet the limitations defined in your investment strategy?

If not, then you should look very closely at making changes to your portfolio to return to a position within your defined investment strategy.

I can give you one specific, recent, example of what I mean.

Air NZ share price has recently moved from a low point of about $1.75 to $3.20 (six-month time frame).

If an investor with $500,000 had allocated 25% of their portfolio to shares, and say a 5% maximum to a single company (which for this example included AIR) they may have been lucky enough to purchase $6,250 AIR shares at, say $2.00 (being 3,125 shares).

With an assumption that the remaining $493,750 did not move in value – now that AIR shares are trading at $10,000 or 7.7% of your holding of shares, which is a breach of your 5% maximum amount rule for each company.

The reason for the breach is a profit, which is a perfectly satisfactory reason for the breach! However, it is the rules that trump any need for speculation about whether AIR’s share price might move any higher.

In my view, this investor would need a very robust value argument if they decided not to take $3,750 profit off the table (sale of 1,171 AIR shares from the initial balance of 3,125) and remain within the boundary of the already defined investment strategy.

I have seen plenty of people change their investment strategy to suit the current portfolio, which isn’t the best approach because you can see they elected to speculate on one of the likes of Bill Gross or Ron Baron being correct, yet on day one they will typically have described themselves as being conservative investors (ie not speculators).

The original investment strategy was defined to try and achieved intended consequences but speculation invariably delivers unintended consequences.

At least the circumstances I describe would have forced a portfolio review, which is better than no review at all.

If you have an investment strategy (or policy), that’s a great start. If you use it when making each new investment decision, involving competent financial advice, you are more likely than not to achieve intended consequences and avoid too much need to speculate or being buffeted (excuse the pun) by the ongoing stream of variable opinions about the future for your investments.

Raising Equity

Sometimes you raise equity to invest new capital in productive opportunities (example Synlait Milk), another reason might be due to negative cash flow whilst trying to build a relatively new business (example Orion Health) but last week offered up another less common example, to ensure sufficient cash was held to pay for a large loss incurred from a prior business agreement.

Bellamy’s Australia plans to raise A$60.4 million with A$27.5 million of this paid to Fonterra in acknowledgement that Bellamy’s will not be able to take delivery of a previously agreed amount of Fonterra supplied milk powder. Bellamy’s exports to China have reduced significantly under the new Chinese Food and Drug Administration regulations.

The acknowledgement of the ‘take or pay’ agreement failure by Bellamy’s was valued and results in the $27.5 million payment and subsequent need to raise new capital from shareholders. This is a clear example of a strategic error by management in accepting too much risk on the supply side with unclear delivery realities on the demand side of their business.

Actually, I can roll this into two lessons by suggesting that you look at the share price chart for Bellamy’s in Australia.

Market prices move on new information, not the arrival of anticipated action.

Regardless of this recent capital raise announcement the price of Bellamy’s shares has gone up. This tells you that the market is unsurprised by the news and in fact is probably satisfied by the clarity of the financial plan instead of the mystery of how Bellamy’s might deal with the problem.

Late in 2016 the Bellamy’s share price slumped from about A$12 to A$4, which is clearly the moment when the corporate error of judgment was disclosed to the market.

Media readers will, I hope, recognise my appropriate use of the emotional verb ‘slumped’ with the share price move from $12 to $4 (-66%), unlike today’s endless use of emotional extremes where a market move is described as a ‘slump’ (or similar) for a price change of 1%.

Investment News

 

US Federal Reserve – The Fed is showing some impressive spine with today’s decision to both increase the Fed Funds rate by 0.25%, to a new range of 1.00%-1.25%, and explained how it will begin to reduce the scale of the central bank’s balance sheet.

Quantitative Easing, namely buying bonds with money that wasn’t in circulation prior to the purchase, has added liquidity to financial markets and bloated the central bank’s balance sheet, helping to reduce interest costs during times of duress.

The financial duress began in 2008 and recovery has been far slower than any central banker expected at nine years and counting.

The US Fed’s balance sheet reached US$4.5 trillion (approximately the same as 25 years of GDP in NZ!) and now they have set a course toward US$2.5 trillion without specific dates.

Later in 2017 they will begin the reduction by allowing about US$10 billion of bonds to be repaid, per month, with this number slowly rising to about US$50 billion per month until the balance sheet declines to US$2.5 trillion

It is a long journey but at least the strategy is in place. We really do need to begin moving away from the excessive financial accommodation provided by central banks around the world even though it will not be ‘neutral’ (removal of all QE delivered balance sheet) during my working life.

The market has, this time, taken the tightening news in its stride.

One way to reduce excessive debt use is to increase its price. It’s good to see that we are finally on this path.

Interest Rate Changes – The majority of investors, and global commentators, have been concluding that interest rates were rising, both long and short terms.

In a handful of jurisdictions short term interest rates are rising, importantly this includes the US.

However, long term interest rates have been falling again for several weeks.

After the US Federal Reserve Board increased cash again last week (see above) long term US interest rates fell. This implies that the market is a little concerned about the potential for a US recession if monetary conditions are tightened too much.

NZ long term interest rates followed the US trend lower and then moved even further when our first quarter GDP was reported as being weaker than all forecasters expected.

GDP measurement is notoriously difficult and some say inaccurate so I am not too concerned about this single data point, but the overall trend lower is one that investors need to be careful of.

Rather than guessing too much, perhaps re-read my opening piece about Asset Allocation and personal strategies. (Then take a close look at the current bond offered by Summerset Group).

Oil – The price of oil is declining again and with the ongoing increases in US production it is becoming very hard to believe in the stories from those who forecast prices ‘above US$50 per barrel’ being correct on average.

The US has moved to a position of being more than self-sufficient for domestic energy needs and with the relatively high inventory levels the US has returned to being an exporter of oil (they stopped in 1973 during the oil crisis).

This is a significant moment in global economics and politics.

Before you worry too much about the level of debt in the US ($20 trillion for government and $12.7 trillion household debt) The US Federal Reserve has reported that US household wealth has lifted to a new high of $94.8 trillion, 70% higher than post the 2009 recession. Most of this change is due to the lift in asset prices rather than higher GDP and wages, but for the time being it will offer additional economic and political confidence to the mix from the US population.

If oil producers with negative cash flow, such as Russia, cannot restrain the global supply of oil then logically the general pricing of oil will be stable or weak and this means it will not typically present uncomfortable upward pressure to the inflation mix.

Venezuela is an example of the opposite to the current US situation with its unpopular political philosophy, oil dependency and incompetent (or perhaps corrupt) financial management.

The upward trend for use of solar and wind to generate energy, motivated by tax incentives and climate preferences, will add to the overall supply of energy and this further tempers the risk of higher energy pricing within the inflation mix.

I don’t wish to get into the political ramifications of the changing supply and demand profile of oil but I do wish to highlight that for the time being (2018-2020 window) the price of energy seems unlikely to deliver additional inflation to today’s low levels and thus would not be a driver of higher long-term interest rates.

As ever, we do wish that higher long-term interest rates were visible for investors but we are just not seeing it happening at this stage.

Tech – Investing in early stage tech companies remains difficult for investors without large capital and cash-flow surpluses.

Tesla, a company that I once said I wouldn’t be keen to own (muggins - Ed), has seen its share price surge +75% during 2017 to its current level of US$465 placing its capitalisation of US$62 billion above competitors General Motors, Ford, Honda and BMW.

The excited analysts, which include Ron Baron from above, predict share prices as high as US$1,000 per share.

As you now realise, I have no idea on this one, but I find it too challenging to invest in businesses that are assured of losing vast amounts of money, for years to come, before hopefully reaching a tipping point of profit from scale; assuming that GM, Ford, Honda, BMW, Toyota, VW, Fiat and Daimler will make it easy for Tesla to do so.

‘New’ is often very exciting but a $200 bungy jump may prove to be cheaper excitement than a speculative investment.

GOLD – Bitcoins may be more interesting but central banks are sticking to the tried and true assets still.

Gold still matters - The German central bank has moved 300 tons of stored gold from the US back to Germany; and

Renminbi matters – The European Central Bank has widened its basket of international currencies and purchased its first tranche of Renminbi (EUR 500 million equivalent).

No sign of crypto currencies on central bank balance sheets yet.

Ever The Optimist – After nearly choking themselves by agreeing to buy Hanover’s assets (albeit using shares of ALF) the directors and senior management of Allied Farmers have knuckled down and followed a slow but well defined path back to financial success.

After significant (multi-million dollar) write offs (losses) and sailing very close to the wind on net cash flows the business has gradually been rebuilding its sales and profits in increments of hundreds of thousands.

Last week it announced a ‘better than expected’ 40% (estimated) increase in profit relative to that of 2016.

Good on them for getting back to good old fashioned hard, patient, work following logical business strategies to return to a point of being optimistic about their future as a rural sector service provider.

Investment Opportunities

Summerset (SUM010) – new senior, secured, bond offer (6-year term) with an interest rate of 4.78% p.a. (paid quarterly) is open for investment.

Usefully the interest payments on this new bond are in January, April, July and October, which are months that most investors do not receive much income from portfolios.

Investors are invited to contact us to request an allocation and then to promptly deliver their application form to our offices. There is no public pool.

The offer document and application form is available on the Current Investments page of our website: http://www.chrislee.co.nz/current-investments

Interest starts accruing from the date an application is processed so there is an incentive to act early (4.78% beats the returns paid by all call accounts with the banks).

The retirement sector operators have long used a mix of retained earnings and bank debt to build each new village but we are pleased to see that they too are diversifying their funding sources and issuing bonds to the public.

It is fair to say that this sector has a robust future with respect to its assets and cash flows.

Infratil – bond offer closes this week. If you are still planning to invest you must act immediately.

The bonds being offered are: 5.5 years – 5.65%; and 8 years – 6.15%.

The offer document can be downloaded from the Current Investments page of our website and application forms must be delivered to our offices.

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

Travel

Kevin will be in Christchurch on 13 July.

Michael will be in Auckland on 26 June (Mt Wellington area).

David will be in Palmerston North and Whanganui on 27 June and New Plymouth on 28 June.

Edward is in our Wellington office (Level 15, ANZ Tower, 171 Featherston St) on Tuesdays, available to meet new and existing clients who prefer to meet in Wellington.

Anyone wanting to make an appointment should contact us.

If you wish to be alerted about the next time we visit your region please drop us an email and we will retain it and get back to you once dates are booked.

Michael Warrington

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Market News 12 June 2017

Anecdote 1:

It is only a small item within an otherwise reasonably good effort as governor of the Reserve Bank, but Graeme Wheeler made an unnecessary error recently by trying to ‘shoot the BNZ piano player’.

Mind you, there is an irony in the fact that ‘we’ out here reserve the right to speak freely, but the governor doesn’t enjoy the same luxury (professional capacity).

Does the fact that I didn’t receive a letter from the governor after criticising their regulatory team mean that I am right, or that Mr Wheeler has wisely become more thick-skinned?

Anecdote 2:

Some people must be slow learners if one is willing to pay $1m for the privilege of lunch with Warren Buffett.

Buffett will be pleased for the nominated charity but surely he’ll lament that the top bidder has clearly not learnt about the concept of value from his many public commentaries.

Perhaps he’ll assume the winning bidder is a well-paid Hedge Fund manager where paying the lunch fee is easily justified against the fees collected on his fund?

Investment Opinion

Inappropriate– I don’t think I’ll ever be able to resolve the great divide that regularly exists between returns paid by banks for bonds issued relative to interest rates paid on term deposits.

The default risk between the two (bank deposit and senior unsecured bond) is the same.

Bonds have the advantage of liquidity which enables investors to easily exit the investment early, if necessary. Other than this subtle difference the returns should be very similar.

But, they are not.

Yields on senior bonds from banks sometimes move above rates offered on term deposits, but it is usually the other way around with term deposits offering the higher returns.

Last week was a good case in point, and two pieces of information prompted this paragraph.

We are frequently being told about clients achieving 4.50% p.a. (and above) on five-year term deposits (with quarterly interest payments), yet in the same week Westpac issued a new senior bond for a five-year term with a yield of 3.775% p.a. (paid semi-annually).

You can do the math but there is little point because you’ll end up in the same position as me on the game board, with a question mark hanging over your head.

Liquidity (saleable), such as that offered by bonds, is unquestionably a valuable position for an investor to hold.

Valuing that liquidity in equivalent interest rate terms is difficult, but I like to describe it as being worth 0.25%, but in this low interest rate environment liquidity is definitely not worth conceding 0.75% p.a. of additional return.

In a risk versus return sense this situation doesn’t make any sense, but it exists all the same.

The lessons are thus;

Always pressure your bank to compete on interest rates for term deposits, especially as the amount offered for deposit increases, and

This is another reason not to slavishly adopt an investment policy centred upon Modern Portfolio Theory and its input driver that an efficient pricing frontier exists for each risk assessed.

PPP – I read an article last week where local government has asked central government for funding contributions to upgrade water networks nationwide.

My immediate reaction was to be critical of poor strategic planning by local government. They know what assets they have, they should have some idea of assets needed and they must have a good idea of expected useful life including ongoing maintenance obligations.

Councils have a good handle on demographic change within their areas so planning around this shouldn’t be too hard either.

If councils have been governed poorly, and or poorly managed, it is unlikely to be a common value problem countrywide (i.e. the scale of each’s financial burden) so it is not the place of central government to prop up the weak with additional funding where part of the tax dollar sought comes from the better managed regions.

Revisiting the Kaipara District failure (Mangawhai water scheme), and massive debt obligations, quickly discloses different council performance across the country.

I also recall that Kawerau District Council had wisely managed itself into a position of nil debt, recognising the low average income of their area. They thus have flexibility to borrow for necessary projects if any were thrust upon the region and avoid crying out to government for assistance (a disclosure of poor local governance).

I wonder if a lot of experienced council finance staff now regret the removal of sinking funds (accumulating money for debt repayment or preparing for upgrades or replacements of major infrastructure).

Councils’ have another funding choice, as we have discussed a few times; Public Private Partnerships (PPP), a funding choice that does have government support (principle).

The subject of PPP is why my thoughts continue with this subject. I’d like to see greater use of PPP in NZ to solve the funding shortages for various projects.

Yes, the equity content within PPP funding packages is more expensive than plain debt, but many of our councils have reached the point of being unable to comfortably borrow more money. (Come in Auckland, Christchurch).

This greater expense (equity) need not land at the foot of the ratepayer. It is more likely that the apparent cost should disclose to the council why they should consider the user pays potential of the project being funded; identify the commercial or private interests that will benefit from the development.

Once those beneficiaries, if any, are identified the council can address tolerable pricing (user pays charges) and gain a good understanding of whether the project is worthwhile starting.

If it is clear the project is necessary, is demanded by the local economy and can pay for itself (directed charges) then make a start, urgently; don’t hold back over political posturing of not liking PPP funding or preferring central government would pay for it to save money for local rate payers.

HRL Morrison & Co (HRLM), Infratil’s managers, set up a PPP fund some five years ago and struggled to fully invest the funds available. They only made meaningful progress when they included Australian projects in the mix. It was madness that NZ didn’t reach out to HRLM with a menu of PPP projects as soon as the fund was launched rather than watch the cash leak across to Australia’s economy instead.

The rising nominal savings amount held in Kiwisaver funds could support PPP investments and with enough thought the NZX could offer to list the largest PPP projects to inject some liquidity for these otherwise untradeable assets.

I saw another news item recently that said the government was again trying to push for greater use of PPP investment into large developments but frankly this chatter sits firmly in the ‘show me don’t tell me’ category after previous weak efforts to make progress.

I think the Hon. Steven Joyce could ponder the benefit to both government debt (down) and private savings rates in NZ (up) if he retreated a little further from funding very large projects and either offered Research & Development grants toward shortlisted PPP funded projects or perhaps cut the tax rate on Kiwisaver funds (prior to withdrawal) to boost their reserves and have them lining up to fund low risk PPP assets.

Some very long-life PPP assets, such as an Auckland Harbour tunnel, or rail connection Auckland city and the airport, would make ideal annuity like assets for retired investors if user pays cash flows were directed to amortised repayment of such a dedicated PPP fund.

Sometimes I wonder if decision makers, such as Hon. Steven Joyce, get too hung up on the thought that PPP funding is a higher cost than government or council debt. This is true, but this higher dollar cost for productive assets is surely a lower economic cost than the tax incentives consumed by decades of investment in unproductive housing.

Yes, we need more houses (homes! – Ed), but we don’t need them being purchased by investors incentivised by tax advantages.

Remove the advantages from investment in unproductive assets and start directing those benefits to capital that is deployed in productive assets.

Rant over. (You were slipping very close to the easily managed ‘world according to Mike’ – Ed).

Europe – Last week one of the world’s largest bond managers (PIMCO) spoke of its concern about Italian bonds if the European Central Bank was to pull out of its current support programme (buying all manner of European bonds to ensure everyone is funded – like the US Quantitative Easing policy).

The explicit statement is – ‘if you do not buy Italian bonds private investors certainly will not’ and this would spell certain failure for Italy (debt default, financial problems).

Why would private investors buy bonds yielding 2.20% for 10 years from a country that appears unable to service its debts even at this low cost?

PIMCO was not predicting the demise of Italy but it was lobbying the ECB to stay the course. It was probably also disclosing to the experienced that PIMCO does indeed hold some Italian government bonds and does not want to be blind-sided by an unexpected change to the ECB support mechanisms.

As it happens the scale of the Italian problem is so large it seems almost certain that the ECB will continue to provide funding support and thus reminds us that survival of the European Union remains probable, even if the Euro loses a few users.

In the same news journal I read a story that covered various statistics where Europe was now performing better than the US who is desperately trying to confirm they are strong enough to begin increasing interest rates.

I know it’s all ‘statistics’ but the reports were of higher economic growth per capita in Europe, lower debt (on average across a disparate bunch) in Europe, higher employment participation in Europe and the prediction was soon Europe will enjoy higher sustainable growth rates.

Ever so slowly Europe seems to be hopping out of the basket. PIMCO just wants to make sure that errant children continue to be supported and are not thrown overboard to the sharks.

Investment News

 

UK Election – The Conservative party made the same error as I did in assuming that Labour's disarray would result in a larger majority in the house of parliament.

In reality, the politicians have again confirmed that they do not understand what their constituents expect.

Theresa May and the Conservatives have been punished for playing political games at a time when their undivided attention should have been on the unenviable task of negotiating BREXIT terms and conditions with the European Union.

Other than that, I think it is best that I don't try to guess what might happen next in the UK.

This outcome has little influence on your near-term investment decisions, but it is likely that it delays and dilutes any new trade ambitions NZ had with the UK.

UDC – I must correct a comment I made about future deposits with UDC.

The ‘funding sources being reviewed’ article I read spoke of repayment, which is true from the ‘old UDC’, however, some UDC folk kindly paid us a visit to walk us through the imminent evolution of this business.

ANZ has sold ‘old UDC’ to HNA Group and expects the transaction to proceed to a point of being unconditional later in 2017.

Investors in ‘old UDC’ are being asked to vote for changes to the current trust deed to enable early repayment or a switch to deposits with the ANZ bank. You are strongly encouraged to exercise your vote, for the following reasons:

You should always exercise a right to vote;

The changes proposed are in your best interest because they add options to you as an investor (early exit, switch to ANZ etc.);

‘Old UDC’ needs 25% of depositors (by monetary value) to vote to achieve a quorum for the proposed meeting (75% of voting needs to be in favour to proceed);

Voters will be paid, money, at 0.1% of the value of their voting amount if a quorum is achieved and the trust deed changes approved. Not a free lunch, but close.

The meeting, where the vote will be held, has three locations (simultaneous attendance), Auckland, Wellington and Christchurch. If one cannot attend they should submit a proxy vote for the Chairperson to place on their behalf.

The trust deed vote does not impact the change of ownership of UDC from ANZ to HNA Group.

Once the sale of UDC is complete ‘new’ UDC will continue to operate.

‘New’ UDC will accept term deposits from retail investors, however, it is very important to note that the risk profile will have changed significantly (weaker) from the ‘AA-‘ credit supported position when owned by the ANZ Bank to a new credit rating of ‘BB+’ (seven steps lower).

As a result of this lower credit rating (higher risk profile) ‘new’ UDC will be required to pay significantly higher interest rates than were offered in the past under ‘old’ UDC.

Another subject worth covering is the change to the loans that will be made with the money supplied by term deposits in ‘new’ UDC.

In the past depositors in the ‘old’ UDC shared in lending across almost all the loans arranged by UDC.

However, under ‘new’ UDC depositors’ money will be used for a more focused type of lending (such as car dealership floor stock financing), the type that cannot easily be bundled up (securitised) and sold to institutional investors.

‘New’ UDC will be using securitisation to provide most of its funding in future. This is likely to help keep ‘new’ UDC’s funding costs down, but they also need this funding strategy because retail investors currently providing a large portion of the $2.5 billion used by ‘old’ UDC are likely to seek repayment until they can assess ‘new’ UDC as an investment.

So, yes, in time ‘new’ UDC (BB+) will seek term deposits from the public and may well be worth considering for modest sums, subject as ever to the higher rate of return offered for this ‘new’ elevated risk.

Let’s see what higher returns means, once offered.

In the meantime, we urge you to exercise your vote and to closely assess your current investment exposures to UDC as it goes through this significant change to its risk profile.

Ever The Optimist – Kiwifruit exports have passed wine exports.

Kiwifruit will need a strong strategic plan to stay ahead of the wine industry and its lofty targets but it’s good to see them both performing so well.

Investment Opportunities

Summerset (SUM) – has announced a new senior, secured, bond offer (6-year term) and set a minimum interest rate of 4.70% p.a. (paid quarterly).

The retirement sector operators have long used a mix of retained earnings and bank debt to build each new village but we are pleased to see that they too are diversifying their funding sources and issuing bonds to the public.

It is fair to say that this sector has a robust future with respect to its assets and cash flows.

We have a list, which all investors are welcome to join, and the offer opens on 15 June and closes on 6 July.

Investors who wish to participate in this offer are welcome to contact us (email, phone) to be added to this list; please advise an indicative amount.

Infratil – new bond offer is still open.

The bonds being offered are:

5.5 years – 5.65%; and

8 years – 6.15%.

The way Infratil is handling allocations sees us handling applications on a first come first served basis, so if you are investing please submit your application form immediately. (If you wish that we process it on a later date please draw this to our attention).

The issue is open now and closes on 23 June. (Exchange applications for those rolling IFT160 bonds must be in prior to 12 June).

The offer document can be downloaded from the Current Investments page of our website and application forms must be delivered to our offices.

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

Travel

Kevin will be in Christchurch on 13 July.

Michael will be in Auckland on 26 June (Mt Wellington area).

David will be in Palmerston North and Wanganui on 27 June and New Plymouth on 28 June.

Edward is in our Wellington office (Level 15, ANZ Tower, 171 Featherston St) on Tuesdays, available to meet new and existing clients who prefer to meet in Wellington.

Anyone wanting to make an appointment should contact us.

If you wish to be alerted about the next time we visit your region please drop us an email and we will retain it and get back to you once dates are booked.

Michael Warrington

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Market News 5 June 2017

Anecdote 1:

Is anyone else more than a little suspicious that British Airways has blamed someone tripping over the ‘power-cord’ for their recent complete shutdown of the business?

What chance a technology failure through budget cuts, or hacking by nefarious folk?

As ever in this world, ‘what aren’t we being told’?

Anecdote 2:

Auckland Hotels are having a laugh pretending to be upset that the Council may change its tax pricing regime.

These are the same businesses that change their room pricing from $350 per night to $700 per night as soon as Ed Sheerin books concert dates.

Investment Opinion

RBNZ– The Reserve Bank has confirmed that it is progressing with plans to add Debt to Income ratio regulations to its macro-prudential tool box.

To temper any fears of imminent use Graeme Wheeler stated ‘We wouldn’t use them if we had them at this point in time’ given the recent easing in house price inflation.

The statement about imminent use may well be true, but why say it?

New Zealanders are still poor savers and frankly I would rather the Reserve Bank made it clear they will introduce debt to income regulations for borrowers if NZ doesn’t display better savings behaviour.

The central bank is directly tasked with achieving financial stability in NZ and the rising levels of private debt in NZ should be a concern to them, as it is to the banks that are alert to the widening divide between increased debts relative to declining bank deposits to fund the economy.

At a recent Budget focussed presentation, ANZ’s Chief Economist Cameron Bagrie explained he has lifted our poor savings rate to a priority item of concern for NZ. He observed that our country’s Banking Industry Country Risk Assessment (BICRA from Standard & Poor’s) is weakening.

Last year S&P reduced our country rating from 3 to 4 on a scale of 1-10.

If NZ continues its large current account deficits, does not increase its savings rates and then the unthinkable of lower asset values (think houses) occurs our credit score will weaken further.

If our credit rating weakens further international lenders will be less willing to do business and the price (interest rate cost) of our debts will rise. It is an undesirable cycle to end up in and one that is within our control.

I know our story is different from Venezuela’s but look at how quickly they rode from oil revenue excess (and confidence excess) to a near default position by ignoring good financial management strategies.

If we consume less we will save more. Given the rapid rise in tourist numbers for NZ, now feels like a pretty good time for our domestic population to pull back on its consumption without compromising local business activity too much.

We must drive up the NZ savings rate. I have agreed with Cameron on this for a long time.

Hon. Steven Joyce hints at encouraging more savings via his 2018 budget, assuming he gets to write one. He’ll need to do this if he also wants to reduce government spending to only 27% of the NZ economy, as stated in this year’s budget.

On a micro basis you can make a difference too; tell your children and grandchildren to start, and stick to, a principle of saving a portion of their income throughout their pre-retirement lives.

A person who reaches retirement with a debt-free home and some investment savings (such as Kiwisaver) places themselves ahead of about 65% of our population at present and that is a scary statistic.

Young savers do not need to focus on a horizon 40 years away, just a sensible principle at the end of their nose.

Kiwibank – More from the RBNZ Files;

The Reserve Bank, who I have criticised already on this matter, has decided that it does not recognise the recently issued (2014, 2015) subordinated bonds as equity on Kiwibank’s balance sheet (KCFHA and KCF010 listed on the NZX).

It did when they were issued but it does not now.

That’s a 180 degree change of position in less than 24 months and is a sign of weakness within the RBNZ regulatory division.

This situation is the kind of instability that the Reserve Bank declares it guards against as part of its regulatory function.

Clearly the RBNZ has made an error, either at the date of issue of the securities by Kiwibank or now. Making the change now, prior to the defined 2020 review date for the Tier 1 securities (KCFHA), has compounded the error made by the RBNZ and it makes the central bank look foolish in my opinion.

It discloses a poor grasp on their regulatory function or a poor grasp on market integrity, which contributes to the financial stability that they strive to deliver.

The public did not need to know about this evolving opinion within the RBNZ. The year 2020 (first review date for KCFHA) is very close by and approximately the right time frame for the central bank and Kiwibank to meet and address repayment of the securities on a scheduled date and reissuance of new equity capital that was agreeable to the central bank.

Kiwibank has stated that even though they seem now to gain no equity credit for these subordinated securities they do not currently intend to repay them early (it remains a risk though).

Kiwibank has tried to be at the front line for competitive banking prices but this RBNZ decision saddles them with some very high cost debt that they no longer want. The KCFHA notes cost 7.25% but the money is loaned out on the likes of mortgages between 4.50% - 5.25%, which is hardly a recipe for financial stability at this particular bank.

If you are an investor in the Kiwibank subordinated bonds (KCFHA and KCF010) there appears to be no reason to take any action. The risk profile of the bank is arguably slightly stronger now that its owners have injected $247 million of additional core equity ranking behind you, so your risk/return profile has improved.

A significant part of the problem faced by Kiwibank is the fact that their shares are not listed on the NZX, or ASX, and thus cannot be used for converting bondholders in the event of distress.

This introduces two old thoughts to my mind;

1.    The NZ government should now list a minority share of Kiwibank on the NZX (offer up NZ Post shares in Kiwibank), with government, ACC and Guardians of NZ Super retaining control; and

2.    ASB Bank doesn’t have shares listed on the NZX or ASX either yet the RBNZ has never rejected their subordinated perpetual preference shares as equity on that bank’s balance sheet.

ASB might argue that it can offer a pathway through to shares via its owner CBA bank, but this is little economic difference to the connection with equity performance offered within the Kiwibank structure (save for the ability to decide when to sell that ordinary shares risk).

Mind you, let’s not forget, if ‘we’ reach the point of converting subordinated bank bonds into core equity in any bank, we are in very deep trouble and have likely lost 100% of our money.

The RBNZ is not arguing that the prospectuses for these subordinated securities were misleading, and neither did the Financial Markets Authority. It was very clear that write off and total loss were possible in the event that Kiwibank became ‘Non-Viable’.

So has the RBNZ entered an unnecessary debate in the public spotlight to argue its point over a zero value item?

There are no winners as a result of the RBNZ actions and I include financial stability at the top of that list.

Ironically the recent Financial Stability report from the RBNZ said (paraphrased) ‘all is good, with weak spots improving’, (New Zealand’s financial system remains sound and the risks facing the system have reduced in the past six months) but they have undermined this whole update with their poorly handled publicly disclosed decisions surrounding Kiwibank’s equity.

Apparently the Reserve Bank is having it governance procedures reviewed at present by Ian Rennie. It will be hard for him to miss this weak spot within the bank regulation area.

Investment News

 

Irrigation – Finally some renewed voices of reason have appeared regarding the Hawke’s Bay Ruataniwha Dam irrigation proposal.

The region’s mayors have collectively said they support the project and it is time to get on with it. Apparently $25 million has already been spent relating to the project but nobody has yet touched a shovel to make a start.

Napier’s mayor, Bill Dalton, a semi-retired businessman, acknowledges there are risks but he rightly states ‘If you try to eliminate all of them it will never be built’.

‘That's the job of the management team - to minimise and mitigate those risks - you don't not go ahead with something like this just because there are risks’.

The world has a serious problem with access to clean water for consumption let alone being able to assign it to horticulture as NZ can (huge competitive advantage).

International observers must marvel at our behaviour of going round and round in circles discussing various perspectives whilst our natural advantage makes its way down rivers and out to sea.

The benefits to NZ, and in this case the wider Hawke’s Bay, are obvious so it is time for talk to stop and converting our advantage to start.

Fines – Australia has shown a very robust approach to penalising illegal behaviour by senior people involved in finance businesses.

Directors and senior management of MFS Group have been collectively fined A$651 million for 217 breaches of the Corporations Act, including misappropriation of funds.

They have been banned from acting as directors or managers of corporate businesses for terms ranging from five years to permanent bans.

NZ regulators look a little weak in this light.

LPT – Kevin Gloag writes:

Listed Property Trusts, and companies, (LPTs) have become a popular choice for income investors and recent reporting from some of the sector’s major players suggests that investor confidence is well justified.

The LPTs own property assets spread across the business, office, industrial, retail and medical sectors and arguably own some of NZ’s best commercial property and house many of our leading businesses.

Despite growing uncertainties overseas the fundamentals for the NZ economy remain strong and combined with a high level of business confidence this has created a very favourable operating environment for the LPTs (high occupancy, rising rentals).

The sector’s capable and very well-paid managers have built-up quality property portfolios with strong tenants and near 100% occupancy whilst maintaining relatively low and manageable debt levels.

The LPTs main objective is to provide shareholders with reliable and sustainable income and the consistency of their performances and predictability of their dividends is finding favour with many income investors.

A small bonus for investors is that the share prices for most of the LPTs have come down over the past 6 to 9 months as interest rates have tried to push higher. Pricing now rests much closer to the Net Tangible Asset values which is a reasonable setting in our view.

The share prices of LPTs are very susceptible to changes in interest rates and the increase in longer term bond yields in the US, following Donald Trump’s election, saw some investors reduce their exposure to yield based stocks.

The US 10 year Treasury rate is the main driver of longer term interest rates in NZ and Trump’s ambitious growth plans lifted rates in the US on the expectation of higher inflation and therefore higher rates.

And while the lift in US Treasuries interest rates initially dragged our longer term wholesale rates higher by about 1% both markets have since given back about a third of this increase on doubts that Trump’s reform and growth agenda will gain traction.

As interest rates have slowly retreated from their post-Trump highs the share prices for dividend stocks have gradually recovered, although many are still well short of their previous highs. This reflects the additional international political risk at present, which is an appropriate assessment by the market.

All but one of the LPTs that reported recently for the year ended 31 March 2017 recorded impressive profit growth mainly due to property revaluation gains, but more importantly for their shareholders they all recorded growth in net distributable income, or cash earnings, per share. The one exception was National Property Trust, which has a number of issues to overcome.

While valuation gains are important for shareholders, in terms of net asset backing and security, it is the cash flow and dividend yields offered by the LPTs that drives their share prices and is the tangible appeal for investors.

LPT dividends are calculated as a percentage of their net distributable income, or cash earnings, and it is the level and perceived sustainability of these cash dividends that largely determines the market values for the shares/units.

It was pleasing to note in the recent round of announcements that Argosy, Kiwi Property Group, and Investore all increased their dividend guidance for the next 12 months, signalling growth in net property income and rental income, which is a healthy sign for the sector and a signal of directors’ confidence in performance.

While fundamentals for the LPT sector remain strong it is likely that the large property revaluation gains of recent years will flatten off in the near future as interest rates rise slowly and more supply becomes available but it is far more important to experience rising rents, as many are.

Rising property values have been pushing returns (capitalisation rates) lower, or vice versa, but the property managers believe that we are now at a high point for the current commercial property cycle which should put a cap on property prices for a while and ease the current downward pressure on yield.

And although quite a lot of new property supply is forecast to come on-stream by 2020 higher borrowing costs and tougher lending conditions will continue to limit the number of new developers, and development projects, ensuring continued demand for quality buildings in premium locations.

Those LPT’s with buildings in Wellington are handling the obligations admirably and if anything the risk is to the upside based on a new scarcity of good quality buildings. These are the things that we are happy to leave to management to resolve for us, relative to investors who own single buildings themselves.

So overall we believe that the listed property trust sector is in very good shape and well positioned to continue capitalising on NZ’s growing economy and stable business outlook.

Clients wanting more information on listed property trusts are welcome to contact us.

Ever The Optimist – Dame Nemat Shafik, one time deputy governor at the Bank of England and now Director at the London School of Economics, recently disclosed that the BoE had used Dr Seuss books to help staff to write reports more clearly.

What a clever idea, adding The Cat in the Hat to management.

It is not very pleasing to need Quantitative Easing;

I do not like rigging LIBOR on a plane, I shan’t rig CURRENCY from a train, I won’t rig the GOLD price from Pall Mall, I will not rig our financial markets at all;

I am the Lorax, I speak for the public, for the public are not heard.

Every now and again people try too hard to write Magnum Opus reports when all they really needed was to deliver a children’s book.

ETO II – The economy must be going well, judging by the fact that two people didn’t take the time to respond to my offering them business last week (real estate, electrician).

Or maybe a little success breeds contempt?

Investment Opportunities

Administration – The large majority of you handle investment applications really well (thank you) but to clarify a few issues around investing in new issues (and rollovers) to all readers;

DELIVERY - Please always deliver application forms to our office for processing, unless we expressly ask that they go directly to the registry.

It is now typical for issues NOT to have public pools, so, application forms sent directly to the registry are not processed. They then add some workload to the registry who try to identify which broker’s allocation they might belong to, and then try to return the applications to that broker for scheduling under firm allocations.

These delays are likely to have an impact on when an investor starts earning income from the investment, or even whether securities will be allotted to them.

Emailing scanned application forms to us is acceptable in the modern era (completed and using the Direct Debit method of payment). We encourage this delivery method given the poor service provided by NZ POST with respect to mail timing.

TIMING – Once you have made a decision to invest we encourage you to deliver your application form to us immediately.

Having your application form within our office confirms your acceptance of the allocation we may be holding for you.

Without your application form, or knowledge from you about its pending arrival, we start to assume you may have changed your mind and thus we would ultimately re-allocate the securities to ensure we meet our obligations to the company offering the investment prior to the closing date.

Typically Early Bird interest is paid on investments and this exceeds what you would be receiving on money held in a call account (i.e. you have a financial incentive to act early).

If your application is dependent on the timing of other funds being returned to you please draw to our attention the ‘Post Dated’ nature of the application form. We will hold it until that date.

Summerset (SUM) – has announced a new senior, secured, bond offer (6 year term) and we expect the interest rate to exceed 4.50% p.a.

The retirement sector operators have long used a mix of retained earnings and bank debt to build each new village but we are pleased to see that they too are diversifying their funding sources and issuing bonds to the public.

We have started a list, which all investors are welcome to join.

The offer opens on 15 June and closes on 6 July.

Investors who wish to participate in this offer are welcome to contact us (email, phone) to be added to this list; please advise an indicative amount.

Genesis Energy (GNE) – the offer of $225 million subordinated Capital Bonds with an interest rate at 5.70% for the initial five years to 2022 closes this week.

All application forms should now be in.

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

Infratil – new bond offer is still open.

The bonds being offered are:

5.5 years – 5.65%; and

8 years – 6.15%.

The way Infratil is handling allocations sees us handling applications on a first come first served basis, so if you are investing please submit your application form immediately. (If you wish that we process it on a later date please draw this to our attention).

The issue is open now and closes on 23 June. (Exchange applications for those rolling IFT160 bonds must be in prior to 12 June).

The offer document can be downloaded from the Current Investments page of our website and application forms must be delivered to our offices.

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

Travel

Chris will be in Whangarei on June 12, Auckland on June 13 and Christchurch on June 20 and 21.

Michael plans to be in Auckland in late June.

Kevin will be in Christchurch on 22 June.

Edward will be in Hamilton on June 7.

Edward is in our Wellington office (Level 15, ANZ Tower, 171 Featherston St) on Tuesdays, available to meet new and existing clients who prefer to meet in Wellington.

Anyone wanting to make an appointment should contact us.

If you wish to be alerted about the next time we visit your region please drop us an email and we will retain it and get back to you once dates are booked.

Michael Warrington

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