Chris Lee & Partners Ltd

Market News 26 March 2018

James Shaw plays his Trump card and offers Green’s rights at question time to the National Party.

Sounds like fun.

Investment Opinion

Test Tube Market? - We, meaning the NZX and investment bankers, may need to recognise that the NZ market may be becoming a business development market more than it is a market for mature companies.

This is no bad thing as long as our investment community quickly get their heads around a modest shift in their focus toward very small companies and away from only the largest (where the best fees have been).

As I read the various stories about companies that have arrived on the NZX and then after a few short years have been taken over by some of the world’s very large investors my initial reaction is frustration for the market and our savers/investors.

However, frustration won’t change the reality.

So, let’s capitalise on the fact that large investors are watching NZ as a successful incubation space for business.

Some of the takeover targets haven’t been recently incubated, witness Opus International Consultants and Fliway Transport, whereas Trilogy is a reasonably young business.

Xero left the NZX market for different reasons but the departure was still related to the maturity and expansion of a business that was initiated in (Wellington) New Zealand.

CITIC’s purchase of Trilogy may well be further evidence of Chinese investment in businesses that are recognised as benefiting from sales to the Chinese population, and the probability of expanded consumerism from there.

If that is even close to the truth it might explain some of the excitement and elevation for the share price of A2 Milk.

We don’t want to lose these exciting investment opportunities from NZ, but the risk is only a strong takeover offer away and may only mean weeks.

If you own a takeover target company, once revealed, do not give up on your investment lightly. You immediately learn that what you have is desirable.

Before we lose too many of these good businesses, I’d like to see more of the venture capital clubs of NZ push some of their start-up businesses a little harder for progress. Introduce them to large investment banks and the NZX sooner. Show them that once their business is established the deeper public markets will consider supporting them into the next stage.

There will undoubtedly be people considering reinvestment of a portion of their Trilogy gains, or A2 Milk gains, into new promising businesses but those investors need active legal teams and investment banking teams to deliver them to public markets.

It would mean that NZ share market investors would need to be a little more familiar with active change within their portfolio and reinforce why they shouldn’t give up on some of their most robust long-term investments, but it should also spell dynamic progress for some of our youngest and most enthusiastic entrepreneurs.

UDC Sale – The latest iteration of a potential sale of UDC Finance is that ANZ is now considering an Initial Public Offering (IPO), presumably listed on the NZX.

This announcement may simply be to maintain price tension as ANZ listens to other suitors but the NZX will be pleased that the IPO option is on the table.

Coming up with a listing code will not occupy much time.

The fact that an IPO is possible implies that the next best bid from a trade buyer, such as Heartland Bank, is (with all due respect) significantly lower than the $660 million offered by the Chinese HNA Group in their failed offer to purchase the business.

What might a ‘significantly lower price’ mean?

I’ll guess that it may mean a bid of $100-150 million lower as potential buyers address the likelihood of higher ongoing costs for UDC once outside the ANZ umbrella (credit strength, funding access and pricing, administrative support, management time etc).

ANZ Bank’s Price / Earnings ratio, for the current share price is about 13.2x. This is below the market average, probably reflecting the downward tension being felt by the banks, from the regulators. I would expect the P/E pricing of UDC to be even lower than that of the wider market for bank shares.

Investors would welcome UDC onto the NZX both for its known business model and for its ‘imputation credit complete’ exposure to the NZ finance sector, something that the Australasian banks do not offer (most profits are sourced to Australia).

Indeed, this may become the logical demand source for funding UDC shares; the sale of a few shares in the Australian banks.

HNA’s departure from the buyers list partly explains the recent weakness in the share price of Heartland Bank, a potential buyer for UDC. Both the additional capital that HBL would require in support of such a purchase and the additional local competition (investor attention if listed on the NZX) has weighed on the HBL share price.

At present, HBL is a more dynamic lender, in terms of risk types, than UDC and thus should be viewed as presenting a higher risk and higher return scenario to investors.

If HBL was to purchase UDC it would reduce the net risk profile of the expanded HBL, but subject to purchase price it may also reduce the overall return on capital for HBL.

The potential for lower return and lower risk is undoubtedly a challenging thought for the HBL board.

In contrast, the lower offer prices presented to UDC, to justify achievement of higher returns is undoubtedly resulting in challenging thoughts for the board of ANZ bank.

Today’s headline discloses the alternative; offer the business for sale more widely (many shareholders instead of one) and test whether a higher sale price is possible.

I don’t want to tell the investment bankers of NZ how to suck eggs, but a quick call to Jeff Greenslade to ask HBL to become the underwriter of the proposed UDC IPO would surely yield a successful agreement for all concerned.

Until more details are known, we shall start a list for those investors who would like to hear more if a UDC IPO is indeed brought to market.

Investment News

Trade – It was refreshing, and more than a little settling, to read Chinese Premier Li Keqiang saying, ‘There’s no winner in a trade war, and war is going against the rules of trade, which are based on negotiation, consultation and dialogue’.

However, one week later President Trump poked the Chinese Tiger just a little too hard.

I doubt that Trump has any chess players on his team. If he once did, they have been fired.

In response to China’s new tariffs on US product, NZ needs to fly up to Beijing and offer to increase our export volumes of fruit, wine and pork.

OCR – Last Thursday was the last Official Cash Rate review for the outgoing governor Grant Spencer (after a long and distinguished career at the central bank).

Unsurprisingly the OCR was left unchanged at 1.75% because economic conditions support this, and the ground should be left neutral for the new governor and the current debate about the government’s Policy Targets Agreement for the central bank.

I like the increasing use of macro prudential tools to manipulate desirable outcomes (financial stability etc) and interestingly their success may be confirmed by the anecdotal evidence that banks are again more enthusiastic about lending 90% of a property value (LVR).

If true, and if the government supported the central bank’s logical preference for ‘Debt to Income’ ratios, it could confirm the lengthy period of the OCR set at 1.75% which the market expects.

OCR pricing shifts were always used to alter public behaviour with respect to the potential impact on inflation. The fact the other tools appear to now be assisting with this objective implies reduced volatility for the OCR in the years ahead.

So, as far as my eyes can see (a sense with diminishing accuracy – Ed), investors will witness a yield curve with a positive slope (earn more interest from longer periods of time invested), which over long periods means that remaining in shorter term fixed interest investments will generate lower returns.

There will be occasional exceptions to this state of play when longer term interest rates leap up, as they have just done in the US (up 0.50% over 3 months for 10-year bonds), but trading to try and catch these changes will probably result in people earning less in short terms and not knowing when to ‘jump’ longer.

The easier decision is to maintain a smoother sequence of fixed interest maturities across the portfolio, through all time.

As a general rule, you should earn more by accepting more risk, but in my view, you should not introduce bond trading as one of those additional risks.

Talk to your financial adviser about the options.

I look forward to seeing the impact of Adrian Orr on the future attitude for the Reserve Bank of NZ.

FOMC – The US Federal Reserve board announced the anticipated +0.25% change to the Fed Funds rate, now targeting 1.50% - 1.75%.

This is nearly in alignment with the NZ Official Cash Rate. As it happens NZ government bond yields are also now very similar to those of US Treasuries.

There were only two other meaningful points of conversation:

An even split between board members about whether there should be three or four, interest rate hikes during 2018; and

A higher path for longer term forecasts of the Fed Funds rate (now well above 3% by 2020).

The content that takes new thinking to reconcile was all the robust economic expectations (activity, growth, employment etc) and the continuance of benign inflation (the real driver of interest rates).

US long term interest rates inched up a little in response to the governor’s statement, probably surprised by the robust 2020 forecasts for rate hikes, but otherwise the market reaction was muted, suggesting that the market doesn’t entirely share the Fed’s view about how good the economy may become.

Trumped – Donald Trump is quickly usurping the Jack of Hearts as the rightful owner of this verb.

Dictator Trump has signed another executive order blocking anyone in the US from arranging transactions in Venezuelan sourced crypto currencies.

As it happens I think this is an appropriate stance, even if I remain amazed that the President wants to make all decisions on all matters such as this.

 

Good Administration- I am often disappointed, but no longer surprised, by the proportion of investors who do not respond to offers that are in their best interests to take action on, such as attractively priced access to additional shares offered through rights issues.

It’s common to witness acceptance of such deals between 85% - 95%, but never 100%.

However, a news item from NIB in Australia reveals a greater expense relating to poor administration; they are sitting on A$2.5 million of unclaimed dividends!

This must be for people who have failed to supply a bank account to the registry, as cheques are understandably seldom used.

NIB is rattling the cage in public to try and discover the shareholders concerned, including one who doesn’t seem to worry about not collecting A$14,600!

If NIB’s registrar does not find these people, the money will be gifted to charity, as allowed by the law.

The message; keep good records, ensure registrars have accurate bank accounts and communication methods to reach you and take action when invited.

 

Retire Broke? – ‘Good News’ was the headline; the number of people in the US who expected to retire broke was now only 42%!

Broke is defined as having $10,000 saved or less.

I hope they have paid off a house.

The reason for the headline was because this ratio has fallen from 55% last year!

Given the high, and rising, proportion of debt around the developed world it isn’t credible that the majority of the people surveyed will actually be able to retire.

Keep telling your children and grandchildren of their need to contribute to Kiwisaver, alongside other wealth accumulation efforts. I understand any resistance that you meet with, because one of my boys summarises his Kiwisaver as ‘faceless people who are stealing his money’.

Financial thought is clearly not part of the 46 chromosomes.

Japan – Bloomberg reported last week that on one day not a single 10-year government bond was traded.

This collapse in market liquidity will be considered an unintended consequence of the Japanese central bank’s (BOJ) willingness to buy everything!

If you own everything, and you have artificially pressed the pricing of assets up, then you may find that you have nobody else left to trade with and this is confirmation of a failed market state. (or State with a failed market – Ed)

Ever The Optimist – In the face of Fonterra’s woes in China, Synlait marches on strongly in the same market, reporting higher volumes and wider margins.

Rewarding shareholders with a truly impressive rise in the share price.

ETO II - Why isn’t more of this happening; central government support for genuinely commercial employment schemes in the regions where employment is at its weakest?

The government, via its cheerful salesman Shane Jones, has presented $5.8 million (initially for 3 years) to Ngati Whare to support the expansion of Minginui Nursery to one million trees per year.

Minginui sits within the Whirinaki Forest Park, surely an ideal spot to contribute to the bold NZ ambitions of planting 1 billion trees over the next 10 years.

I’ll speculate that Work & Income NZ is one of the most populated gathering points for the town. If this expanded horticulture venture is successful WINZ should become an online access only option for the town.

You couldn’t want for better guardians of this newly expanded business scheme, in the same way that community loans of hundreds of dollars for agriculture in various third world countries become the best performing loans (nil default) because of the commitment of the community to success.

I understand it is most common for women to manage such community loans; I hope it is the women of Minginui who oversee the nursery expansion and encourage the involvement of the young unemployed generation.

As an extension, if this nursery expansion is a success, I’d like to see a tertiary institute offer further training (horticulture and forestry business focus) to the most committed youngsters within the community.

I hope there are other examples of this potential elsewhere in NZ.

ETO III – Ministry for Primary Industries reports that despite trying weather, export returns from farms, orchards, forests and fishing should hit a new record of $42.2 billion by the end of June.

Most sector are enjoying robust sales growth.

We know that tourism is firing too, so it should be no wonder that GST and corporate profit taxes are higher, for Her Majesty’s pleasure.

Investment Opportunities

Investore Property Ltd (IPL010) – offer of senior, secured, 6-year bonds is now open, paying 4.40% p.a.

The bond offer closes on 12 April.

Our allocation is now full.

If you have a firm allocation from us please ensure that you deliver your application form to us no later than Monday 9 April.

Fletcher Notes – FBI rolled their Capital Note on Election Date (15 March 2018 – FBI110), into a new 5-year replacement (15 March 2023 – FBI170) at 5.00% (now trading on market at a yield of 5.25%).

If FBI follows a consistent pattern they are likely to sell their holding (millions) of these notes to the market after 15 March.

Accordingly, we have started a list that investors are welcome to join if they’d like to purchase some of these new Capital Notes, should they be offered to the market.

Possible deals for 2018:

Sky City Casino – bond;

Vodafone – IPO of ordinary shares;

UDC Finance – IPO of ordinary shares.

All investors are welcome to join these lists by contacting us.

The fastest way to hear about new investment offers is to join our ‘Investment Opportunities’ (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 Christchurch on March 27 (pm) and 28 (am) in the Boardroom, Airport Gateway Lodge, 45 Roydvale Road.

Chris will be addressing the NZSA meeting at St Christopher’s Hall, Avonhead, at 7pm on March 27. All clients are welcome.

Chris will be in Auckland April 17 (pm) at Albany Motor Lodge and April 18 (am) at Waipuna Lodge, Mt Wellington.

Kevin will be in Ashburton on 12 April.

Edward will be in Remuera on 10 April and Albany 11 April.

David Colman will be Palmerston North and Whanganui on 27 March, and New Plymouth on 28 March.

Our future travel dates can also be found on this page of our website: https://www.chrislee.co.nz/request-an-appointment

Any person is welcome to contact our office to arrange a meeting.

Michael Warrington

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Market News 19 March 2018

President Putin, for life;

President Xi, for life;

President Mugabe, almost for life.

What is it about such people that they think the population will not succeed without them.

Clearly none of them are serious students of history.

I wonder if Jacinda’s kids will allow us to keep her as Prime Minister for life?

Investment Opinion

Cryptocurrency – There is always an ocean of stories about cryptocurrencies when you open the media, regardless of the channel.

It is still difficult to forecast what the future for this commodity will be.

Without central bank endorsement cryptocurrency will remain a commodity, available for use to settle trade by those willing to accept valuations (i.e. is Bitcoin acceptable at US$9,000? or Ethereum US$700 etc).

I remain sceptical about investment in cryptocurrency as a commodity but continue to see merit in the underlying technology (Blockchain) and the potential for expanding technology-based payment methods.

On the point of central bank involvement, I wonder whether central banks will begin endorsing cryptocurrencies as they confirm the merits of efficiency, cost reduction and stability for a financial system.

Further, given various nations’ willingness to engage in trade wars, and technology disruption, I expect they’ll look very closely at the benefit of financial war too.

The European Central Bank (ECB) has been working hard to avoid having the future of the Euro undermined, post the BREXIT decision by the UK. They now have an Italian electorate that shall be as unpredictable as ever before. They might be keen on an idea to help push back, in their favour.

Maybe if they could draw other nations into their currency (Euro) without them needing to be members of the European Union.

My proposal to the EU and ECB, which comes cheaply if they happen to be reading, is to launch a cryptocurrency that is linked to the Euro and monitored and regulated by the ECB.

The regulated and monitored status may invite a few critical headlines but importantly it will exclude the criminal element and will increase the long-term stability of the new electronically based payment method, and thus legitimately be described as a currency.

Imagine the uptake by UK businesses, and those in Sweden, Norway and Iceland etc (not Euro use countries), all of whom have an absolute desire to trade with members of the European Union.

Many of these businesses will indeed have Euro bank accounts and financing arrangements already, but if the ECB offers them a settlement process that excludes a banking organisation and reduces transaction costs without increasing financial risks, surely these businesses will engage?

I am not encouraging readers to invest in cryptocurrencies, but in a world with increasingly disruptive political positioning we should expect more of the same and need to address the impact it may have on current investments (financial intermediaries, such as banks?).

The changes in the regulated cryptocurrency space will not happen quickly, so we’ll have plenty of time to consider them and their impact.

Banking – Speaking of banking, two other stories highlight reasons for caution on the weightings of investment in this sector, especially for we ‘down-under’ investors;

The Royal Commission of Inquiry into the Australian banks has begun, and it is logical to conclude that launching the investigation required a starting point of believing that the public were not being well served by the banks.

‘Excessive profits’ is a frequent allegation made against banks (rightly, or not).

The head of the inquiry has already invited the banks to confess their sins (my headline), so the tone of the investigation is clear.

Most of the banks initially replied that they could not supply that much detail in such a short time frame. This drew a critical response.

If the banks were stalling the behaviour is consistent with the criticisms of the sector.

If the banks were truly unable to respond it becomes unsurprising that CBA bank didn’t realise criminals were money laundering via their ATM network.

Neither response is impressive.

I’d be very surprised if the inquiry didn’t result in recommendations for increased service levels, without tolerating increase costs reaching the customer, which may mean a regulatory note about return on capital references.

The second word of caution for investors in bank shares came from the Bank for International Settlements (BIS), which recently released a report (available on their website) highlighting the uncomfortable (my word) level of financial risk in Australia and Canada (amongst others).

The BIS points out the currently high risks within debt-service ratios and cross-border claims (the volume of funding required from offshore lenders).

Lenders need to hold a view that housing prices will be stable at current levels, a view which I think is sound, but the BIS independent view is not to be ignored because it highlights that there isn’t a lot of room to move in the wrong direction.

PPP– Minister of Finance, Hon. Grant Robertson, says he will seek help from the investment community to fund infrastructure deemed necessary by the current government.

He’s an intelligent man, so I hope we can take him at his word, because he is describing Public Private Partnerships (PPP).

If I sound uncertain it’s because this would be a stark change in policy from the Labour party and frankly, from the underwhelming use of PPP by the National led government.

Further, the ‘show me’ scenarios like the changes to public transport (Public Transport Operating Model) validate the government’s (both colours) move away from encouraging private capital to invest in services that the government feels are needed.

The Labour government has ruled out using PPP to re-build the entire new Dunedin hospital.

However, let’s give this minister a chance to ‘show’ us his plans.

We know that the government, and councils can borrow the cheapest money in NZ (last week, demand for their 3.00% 10 year bond was 2.5x the amount required) and thus the theoretical approach to each new infrastructure project should be for the government to borrow 100% of the money and build it.

But it’s not that simple.

Bureaucrats and politicians with no ‘skin in the game’ are perpetually shown to make poor decisions about long term investment of other peoples’ money. They can bet on black, or red, (and do) without really feeling any pressure to spend time considering the consequences (other than vote capture – Ed).

When investing, as opposed to providing essential services (opinions vary on what is essential), the decision makers in government should also be considering who will pay for the use of the product or service; tax payers or users?

The answer to this question will help the minister to determine which items are in fact investments and which are essential services.

If the government borrows 100% of the money required for a project, the cost will massively exceed the low interest rate if the project is not required by tax payers and not used by those who would pay for the service.

It shouldn’t take you long to think of many government led ‘investments’ where the cost of debt may have been very low but ultimately cost much more than the 10-15% that a commercial business would be satisfied with from successful investment.

The ‘Bridge to Nowhere’ is a good actual and metaphorical thought.

I read an NBR article sourced to a lawyer at Simpson Grierson aimed at the NZX with ideas for expanding our capital markets. Coincidentally it connected NZ’s need for more infrastructure spending (see Grant Robertson assessment) with the need for private money and thus a confluence on the NZX.

The article discussed the potential for PPP that ultimately expired and returned 100% ownership to the Crown, after providing the opportunity for higher returns on private investment over a long-time window, such as 20-30 years. The expiry of the PPP could be timed to match any demographic declines that might indicate reducing liabilities elsewhere for the government.

This concept of ‘return the essential asset to the Crown’ would likely sit better with the Labour party, and perhaps most New Zealanders, than having their asset privately controlled, but logically the structure would allow providers of private capital access to the returns they deserve for the risk they accepted.

This aligns with Grant Robertson’s question from the markets; can you help me access additional capital and what is the price?

The premium price of the private capital could then be boxed in to the agreed time frame, of say 20-30 years.

The premium price could be lowered if the government agreed to a repurchase price for the asset of $1.00 at the future date; effectively reducing the capital risk to nil and placing only operational risk and returns with the investors.

Providing such a capital guarantee shouldn’t be too big a stretch for the government, especially if the comparison they are making is with the 100% funding and ownership model.

This PPP opportunity shouldn’t be hard to establish.

New Zealanders are allocating money to an ever-increasing pool via Kiwisaver and these fund managers will soon struggle to find sufficient good domestic assets to invest in. Given the NZ dollar liabilities of their customers (the savers) Kiwisaver fund managers have an absolute need to hold a significant proportion of assets in the NZ economy.

Given the ability for investors to change Kiwisaver managers, those managers require liquidity for most of their investing. This is where the Simpson Grierson point matters; encouraging the government and the NZX to reach agreement on establishing a variety of PPP investment vehicles and allowing those vehicles to be NZX listed (transferable, tradeable) will add to the demand profile for investment in such opportunities.

I know that the CEO of the NZX would be happy to see additional products listed on the exchange.

I know that our clients would benefit from additional investment products and risk types.

I know that Kiwisaver fund managers would be pleased to consider low risk, equity investment opportunities which also offer liquidity.

Other than government agreeing to get on with accepting this method of accessing the additional investment capital that they seek, I do not see any insurmountable restrictions.

So, in the form of an open letter to the minister:

Dear Grant,

If you approach us, with the following NZX listed Public Private Partnerships (PPP) we will be very keen to present the opportunities to the investing public seeking financial advice from us:

National Cancer Centre (Wellington) Fund;

Housing NZ managed, Kiwibuild funds (various);

Te Apiti highway (Manawatu) fund;

SH3 Taranaki to Hamilton Highway improvement fund;

Horowhenua Kapiti Expressway Fund;

Rail Corridor from Auckland City to Airport fund;

Golden Triangle Rail Fund (AKL, HAM, TGA);

Auckland Harbour Bridge Skypath Fund;

I only made one of these up, the rest are linked to your party manifesto.

I encourage you to make contact with James Hawes (Simpson Grierson, NBR commentary) and Mark Peterson (CEO of the NZX) and invite them to establish a pathway of PPP cash to your door.

In turn, they will make contact with the investment community who will be waiting for the opportunity to invest.

Sincerely;

Etc, etc.

NZ Council’s should join in on any planning for increased use of PPP for funding. Funding tension exists in Christchurch, and now in Auckland (who have reached their borrowing limit via the Local Government Funding Agency); they too need to contemplate inviting other equity risk investors into their funding plans.

To our clients; do not accumulate too much cash earning 0.1% with the major banks (2.75% if in Heartland Bank) waiting for us to offer these new PPP investments to you.

Sadly, like all things in politics, this investment idea will be very slow to progress, if the current government progresses it at all as they fret over sharing value with the well behaved New Zealanders who are actually saving money!

GDP measure OK? - Our strong currency, on a gradual rising trend again without as many beneficial interest rate differentials, implies that NZ may be earning more from tourism than is being captured in GDP data.

Maybe our GDP measurement process is losing integrity?

The latest quarter for GDP measured at +0.60% disappointed economists who had been expecting +0.80%, citing a weak period for agriculture, but my anecdotal observation of ‘people busy spending money’ is of a high rate of activity.

Yet, in response the NZ dollar has not fallen. There has been sufficient trade, or optimism for future trade, to hold the price of the currency up.

Just a thought, not a deep thesis on the matter.

AML Wars – Above I referred to the potential for financial wars between trading blocs based on methods of payment.

Another battle line has been drawn by the US via Anti Money Laundering legislation; the US has instructed the Industrial and Commercial Bank of China to improve its AML capture and monitoring.

The less than veiled threat is the loss of banking licence or privilege with the US, and perhaps with US dollars.

Investment News

Trumped – There seems to be no end to the range of things Donald Trump wishes to control.

Maybe his behaviour isn’t so different to that of Presidents Xi and Putin with the only difference being Trump cannot stay on past 2024.

Last week President Trump used an executive order to block a takeover offer in the markets. (Broadcom’s hostile offer to buy Qualcomm).

We sometimes debate the merit, or lack of merit, in decisions made by our Overseas Investment Office (and Commerce Commission) but imagine how we’d feel if Jacinda had a simple YES / NO flow chart for corporate takeover decisions in NZ?

We, collectively, often question the value of committees but aren’t they, and disseminated authority, a safer long-term strategy for decision making than leaving it all to one person?

Maybe if I spoke for Donald Trump his response would be; ‘you have seen how the Senate and Congress fail to make progress, right?’.

This Broadcom decision is a long way from what I consider to be national governance responsibilities.

It is also becoming disturbing just how fast Trump hires and fires senior staff for the Whitehouse. The departed can’t all have been bad choices at the start point or provided appropriate reasons for dismissal during the past 18 months.

There is only one constant in the mass hiring and firing; Donald Trump.

Maybe he is videoing the activity for a future television show of ‘You’re Fired’?

There is something disturbing about the new ‘central dictator’ approach to government that has arrived in Russia, China and the US where in the past it was the domain of Zimbabwe and Cuba, but I am not yet clear on its impact on our investment decisions.

Sky TV – There is a ‘changing of the register’ occurring for Sky TV.

Turnover on Friday 16 March was 34.25 million shares. Prior to March, turnover ranged between 200-500 thousand shares per day.

I’ll speculate that the longer-term holders over the past decade are being convinced to exit a business that needs to remove its spots and apply some stripes.

[someone is buying… who believes in a new strategy]

Eroad – Actually, with a great deal of bias (as a shareholder) even I could be convinced to vote for President Trump if he delivers policy change consistent with the latest ‘Economic Report of the President’, in which, he describes a probable need to switch from fuel-based taxes to distance-based taxes in the transport sector.

Previously Trump had favoured a fuel-based tax. The change of opinion (normal for this President – Ed) in a formal report implies that someone has pointed out to him that this implies declining tax collection (engine efficiency and electric vehicles).

Eroad is rather nicely placed to provide service to the US transport industry with respect to measurement, regulatory obligations and tax collection.

 

Ever The Optimist – NZ guest nights rose to another record (4.97 million) up 1.4% from a year earlier.

This partly explains why I was asked to pay so much, for so little, during a recent trip to Auckland!

ETO II – Italian design business (Successori Reda) tells us wool, especially fine wool, is having one of its best ever moments.

I guess they were bound to be polite whilst visiting NZ, but actually making the visit speaks as loudly as the headline about why the sector should be upbeat at present.

Investment Opportunities

Investore Property Ltd – has formally announced its offer of a new senior, secured, 6-year bond.

The yield will be set on 20 March (minimum set at 4.40% p.a.) with quarterly interest payments. The interest payments are on the unusual, but helpful, months of January, April, July and October.

Kevin Gloag has published a research piece on the Private Client page of our website (accessible by all clients receiving financial advice services from us) which investors will find useful.

We are gathering interest from investors now (please contact us to join the list) and will bid for a firm allocation on 20 March (tomorrow).

The bond offer opens on 21 March and closes on 12 April.

Investments will be processed on application forms and investors do not pay the brokerage costs.

Fletcher Notes – FBI rolled their Capital Note on Election Date (15 March 2018 – FBI110), into a new 5-year replacement (15 March 2023 – FBI170) at 5.00%.

If FBI follows a consistent pattern they are likely to sell their holding (millions) of these notes to the market after 15 March.

Accordingly, we have started a list that investors are welcome to join if they’d like to purchase some of these new Capital Notes, should they be offered to the market.

Having said that, clients can now instruct us to buy FBI170 securities on market because trading has begun.

Possible deals for 2018:

Sky City Casino – bond;

Vodafone – IPO of ordinary shares.

All investors are welcome to join these lists by contacting us.

The fastest way to hear about new investment offers is to join our ‘Investment Opportunities’ (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 Christchurch on March 27 (pm) and 28 (am) in the Boardroom, Airport Gateway Lodge, 45 Roydvale Road.

Chris will be in Auckland April 17 (pm) at Albany Motor Lodge and April 18 (am) at Waipuna Lodge, Mt Wellington.

Kevin will be in Christchurch on 22 March and Ashburton on 12 April.

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

Our future travel dates can also be found on this page of our website: https://www.chrislee.co.nz/request-an-appointment

Any person is welcome to contact our office to arrange a meeting.

Michael Warrington

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Market News 12 March 2018

I read a very good study about why wages aren’t rising as fast as productivity (profits) and robots aren’t the major influence.

The lack of competition for employment following many years of merger and acquisition seem to be a greater problem.

The article describes the impact of monopsony where in many small towns the largest employer, say Walmart, does not need to compete all that hard to attract employees.

I’ll guess that the rising use of debt by consumer, as a proportion of assets and income, further reduces the negotiating power of such employees.

I have no doubt that unionists will leap up and explain the need for their involvement, but I also see merit in New Zealand’s efforts to walk minimum adult wages up at a similar rate to the expansion of the economy.

Perhaps this subject also speaks to the rising involvement of the Commerce Commission, and its international peers, in the market place?

It is another thread that investors should be aware of; it’s possible that average profit margins are as high as they’ll be, right now, with reductions more likely in the decade ahead?

Investment Opinion

NZ Shareholders Association – We like to give the NZSA a plug from time to time for their good work, and to encourage the public to join the association and both support them and benefit from them.

Amongst the many Fletcher Building stories about who knew what and what should have happened, and when, the NZSA can hold their heads high for representing the interests of small shareholders because they began to share their concerns about the company nearly four years ago.

Followers will recall that Mark Adamson was appointed as CEO of FBU five years ago.

The NZSA shared its concerns directly with the FBU board and with members of the NZSA. Both sides had the opportunity to consider and adjust their positions, if necessary.

The record shows that FBU did not adjust its position and the subsequent losses have been widely reported and analysed, after the event.

I expect that NZSA members will, for the most part, have at least reduced their exposures to FBU shares based on the escalating concerns of the association.

I feel certain that the NZSA saved a good deal more than its membership costs for those investors who reacted to the rising tide of bad news at FBU.

Even though the NZSA did not have sufficient proxy votes to effect change at board level during FBU’s Annual Meetings the corporate respect they are gaining is rising fast and hopefully this will deliver more leverage when they ask to meet with other company board members in future.

Any rejection of approaches from the NZSA, requesting a meeting with the Chairperson, should now be the first flag of concern regarding the company in question.

The NZ public, who like to invest in shares directly, should help to reinforce this rising NZSA influence by becoming members of the association (www.nzshareholders.co.nz) and by always passing ‘Open’ proxy votes to the NZSA so they can represent them effectively with the company.

This assumes said investor doesn’t wish to attend meetings themselves to exercise their own votes, but this is a tiny minority of investors.

Sadly, a huge majority of retail investors do not exercise their rights to vote at company meetings. I wish to call from the highest roof to all such shareholders to share their proxy votes with the NZSA; even if you do not wish to vote, you will add value to your retail investment holding by passing the leverage of your votes to the NZSA.

Beyond proxy voting the NZSA holds regular meetings around its regions and are successful in attracting some very senior business executives, including Chief Executives, to speak at those meetings.

Often, when I have attended some of the regional sessions and interacted with such executives, I have considered the annual membership fee to be a bargain, and that was before I was offered a drink and a snack.

I met recently with the NZSA CEO and Chairman and was pleased to discuss their success and to hear that they also plan to expand the already deep volume of information on their website by building an educational resource.

The association’s intention is clearly to continue expanding the value that it presents to its membership; this is the sort of focus on its clientele that members should be pleased to see (and all businesses would do well to copy).

There are too many situations to count on all my fingers and toes where small investors have been poorly treated by corporate governance and in my opinion the NZSA is the best entity for helping to ensure this risk is reduced for smaller investors.

If you are not a member of the NZSA please spend a moment considering becoming one and then every time you are invited to vote, and don’t wish to attend the meeting, appoint the NZSA as your proxy.

Trade Wars – The escalation of trade tension may make for good media content but I share the view of those who are becoming increasingly concerned about the damage it will do to global trade, and in turn to investment returns and employment opportunity.

President Trump, he of the ‘Make America Great Again’ campaign, will not achieve his slogan by increasing the use of artificiality.

One doesn’t become great by being given a head start, or a longer pole for vaulting.

We have just lived through an era of excessively low interest rates, especially once they became negative in real terms (below inflation), and this has delivered many unintended and undesirable consequences but just as we are seeing signs of exiting that adrenalin booster we appear to be arriving at the door of another unwarranted subsidy.

Shortly after reading the initial headlines about the new US steel tariffs I read about the ‘resignation’ of Gary Cohn from the Whitehouse. Cohn is (was – Ed) one of Trump’s most senior economic advisers (from Goldman Sachs history) and was credited with much of the work behind the recent tax review.

Cohn was firmly against the escalation of increasing trade tariffs and was seen to be gathering a lobby against the strategy.

Trump’s reaction to this was, it seems, to accelerate the introduction of the new tariffs before opposition could develop and to ‘accept’ Gary Cohn’s resignation.

I doubt there will be any shortage of willing sycophants offering to claim Cohn’s vacant chair and agreeing to stroke Trump’s ego.

It is possible for a person to be a good natural leader, but the difference between being a great leader and being drowned by political nonsense is the quality of the team around you.

Surely Trump’s executive wing is reducing in quality as he burns off people at a rate of one per month. It isn’t logical that the net quality and effectiveness of his team is improving as time passes; the best will have approached him on day one for consideration.

16 months in, Trump has dispatched the equivalent of an entire major league first-string team from his employ.

Unsurprisingly other nations are now addressing how to respond to the new US tariffs. Europe and China have declared they will make changes.

South Korea was one of the larger exporters of steel to the US. The US decision may drive South Korea closer to North Korea, although this may well have good stability implications for our time zone.

If any nations take a legal challenge against the US government to the World Trade Organisation this organisation will be placed under serious stress to confirm its effectiveness or to be seen as a cousin of the less than effective United Nations.

If nations increase the incidence with which they will say ‘no’ to trade it cannot be good for the overall economic activity around the world and this extrapolates to some disappointing scenarios.

 

Investment News

CBL – The failure of the CBL Insurance business leaves another awful stain on NZ financial markets, with this one squarely inside the boundaries of the ‘new, improved’ regulatory environment.

If you search Brian Gaynor’s related article on the NZ Herald you’ll benefit from his views on the multiple failures by almost all concerned with the CBL business, its arrival on the public markets and the various disclosure failures.

I won’t dwell on the disclosures other than to say that I was astonished to learn that the regulatory enforcers of good disclosure, including the Reserve Bank of NZ and the Financial Markets Authority, do not come out of this story well with respect to their commitment to financial disclosure and stability.

After learning about the extensive delays with disclosure to public markets the most astonishing news item for me was that CBL made a very large payment after being explicitly instructed by the Reserve Bank not to do so.

I had to read this information three times.

Explicitly instructed by the regulator not to do something, but the company went ahead and did so anyway.

Wow. I find this a breath-taking lack of respect for the rules and financial stability.

The Reserve Bank’s reaction can be seen in a quote from the subsequent court documents:

In a High Court affidavit, the Reserve Bank’s head of prudential supervision wrote: "The directors' decision to pay away such a significant amount of CBL Insurance's cash ($55m to offshore parties) in contravention of directions from the Reserve Bank means that CBL Insurance's assets are and remain in serious risk of further dissipation if the directors remain in control of those assets."

I shudder at this action by CBL when I think of our banking framework, also regulated by the Reserve Bank, if directors are willing to make such decisions regardless of explicit instructions from the regulator.

I know the banks are not the same as insurance businesses, and that bank directors will be less than pleased with my alignment of the situation, but the conscious decision by any director to ignore an instruction from the central bank has me startled to the point of wondering what the limits of poor behaviour are?

 

 

Ever The Optimist – NZ log sales continue to soar both in volume and price, with China driving the majority of the change (not NZ house building! – Ed)

Upcoming changes to government regulations which will allow for Chinese buildings to be designed using New Zealand wood grades and sizing (radiata pine specifications will be included in the Chinese Code of Design) are likely to further stoke demand in the future, AgriHQ said

I have now met a few investors in private forestry syndicates and after 20 patient years watching growth data and some very low points for wood pricing these people are very excited to be in the harvesting mode as demand improves.

There are clear incentives to replant relating both to environmental costs (carbon tax) and to try and reinforce NZ as a go to supplier of wood for construction.

Maybe, as the world trends further toward better environmental credentials, wood use will rise and concrete and steel will decline?

As always, NZ must focus on its natural advantages of plentiful rain fall and under-populated land for agricultural use.

Investment Opportunities

Investore Property Ltd – has formally announced its offer of a new senior, secured, 6-year bond.

The yield will be set on 20 March (not less than the minimum interest rates of 4.40% p.a.) with quarterly interest payments. The interest payments are on the unusual, but helpful, months of January, April, July and October.

We are gathering interest from investors now (please contact us to join the list) and will bid for a firm allocation on 20 March.

The bond offer opens on 21 March and closes on 12 April.

Investments will be processed on application forms and investors do not pay the brokerage costs.

Fletcher Notes – FBI has announced they will rollover their Capital Note on Election Date (15 March 2018 – FBI110), issuing a new 5-year replacement (15 March 2023 – FBI170) at 5.00%.

If FBI follows a consistent pattern they are likely to sell their holding (millions) of these notes to the market after 15 March.

Accordingly, we have started a list that investors are welcome to join if they’d like to purchase some of these new Capital Notes, should they be offered to the market.

Possible deals for 2018:

Sky City Casino – bond;

Vodafone – IPO of ordinary shares.

All investors are welcome to join these lists by contacting us.

The fastest way to hear about new investment offers is to join our ‘Investment Opportunities’ (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 Christchurch on March 27 (pm) and 28 (am). He will be addressing our NZSA meeting, at St Christopher Hall, Avonhead, at 7pm on March 27. All clients and investors are welcome to attend. Please advise us if any plan to attend. Chris will also be in Timaru on 10 April.

Kevin will be in Christchurch on 22 March and Ashburton on 12 April.

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

Our future travel dates can also be found on this page of our website: https://www.chrislee.co.nz/request-an-appointment

Any person is welcome to contact our office to arrange a meeting.

Michael Warrington

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Market News 5 March 2018

I am not a high volume reader of books. My reading time is usually filled with an ever-changing feast of information related to investment decisions. However, I made it through three books this summer.

Two are of little use to you (Jimmy Barnes and Tom Scott), but the third one provided to me by a client, just before my doomed flight to Wellington last week, was by Stephen King.

No, not the horror author (Cujo, Christine, etc.), but a global economist reporting on other non-fiction horrors.

Yes, plenty of people will respond by saying economists are a ‘dime a dozen, for two dozen changing opinions’ but some cut through the cloud quite well in my experience.

If you’re stuck inside with the return of the rain, and are curious, the title of the book is ‘When the money runs out – the end of Western affluence’.

The thrust of the book is that too much debt has built up as we ‘persistently try to consume tomorrow’s income today’.

It also concludes that current regulatory settings are delivering undesirable outcomes and that politicians are not strong enough in will to counter the excessive service demands of the majority.

Poor political leadership means that most countries are not doing what Norway is, and saving now to better afford the future (Their US$1.1 trillion fund, which owns 1.4% of all global shares!).

For the record, the NZ government is trying to lead well on finance, but what we have in long term savings is just a drop in the lake, when we still have an ocean to confront, and our private debts are excessive. (Nice segue to below – Ed)

Investment Opinion

Billions – Following my comments a couple of weeks ago about the Trillions of dollars of debt that the US (government and private borrowers) appear to be drowning in, a client asked about the NZ numbers.

Here are the current numbers from the same source, albeit measured in paltry Billions:

NZ government debt - NZD$61.8 billion (Debt to GDP at 24.6%, although I thought it was closer to 30%);

NZ Population – 4.75 million;

NZ Employed people – 2.605 million

Average Wage – NZD$30.74 per hour

NZ GDP - US$185 billion (NZD$253 billion)

GDP per person – NZD$53,250

NZ Average income – reported at approximately $52,000

NZ Household Debt to Income – 168%, which places us at 10th worst of all world nations where such data is captured. I couldn’t find an easy reference to a value for private household debt, so let’s estimate $87,000 per working person based on the data above.

Now, let’s add on a share of the NZ government debt per working person being NZ$23,000 each.

This results in a grand total of approximately NZ$110,000 debt per working person, or 211% of their income and 206% of GDP per person (all persons).

A $110,000 debt per employed person doesn’t, at first glance, seem all that disturbing at 55% of the US equivalent (observing our better average incomes), however, repayment of this debt still requires about 20-25% of the average income (interest plus some principal over 18 years) and very few people save at this rate.

Our population’s willingness to continuously increase debt and spend tomorrow’s income needs to change.

Even if we haven’t reached the US’s very bad debt ratios we are not in a comfortable position and we need to prove to ourselves that we can reduce debts and gain a better control of our financial circumstances.

Lobby – It’s possible that the US gun lobby will be out-lobbied by the weight of money.

After seeing the blinkered response of the National Rifle Association and legislators, US investors are beginning to make demands of those managing their savings to exit investments in weapons manufacturers.

The absurd proposal to arm teachers confirms that America has lost its way on this subject.

Investor decision-making is beginning to become influential with respect to environmental impact so there is no reason that it shouldn’t become more effective than politicians at making weapons manufacturers change behaviours with respect to their product and its distribution.

I see that public advocacy is also having NZ businesses back away from their previous support for rodeo in NZ.

Businesses are always worried about the expectations of their consumers and the potential for negative changes to sales.

Part of the delay in achieving gains from lobbying over guns in the US will relate to the fact that the NRA is an association, not a business, but that doesn’t mean the cause of pressuring for change is wrong.

The NRA didn’t see the hypocrisy of their claims that they ‘defend the individual freedoms that have always made America the greatest nation in the world’ but then followed this up by criticising the students and investors for the stance being taken by them.

It will be a long road to change but it’s very clear that waiting for politicians to make change is a fool’s game, especially US politicians when it comes to gun regulations.

 

Investment News

Buffett – Warren Buffett’s annual letter to shareholders makes good reading for all investors and is very widely digested and shared by media channels, in much the same way as I am about to do!

It is easy to read and filled with common sense in a financial environment that often displays little ‘sense’ and seldom a ‘common’ thread with respect to value.

The consistency of approach displayed by Warren Buffett and his team over decades of different market drivers is both a credit to their strength of character but also reminds us that value shouldn’t be hard to identify but many people clearly make it hard to extract.

The irony in having me declare that Warren Buffett’s letter (a telling you event) is a must read is that I far prefer the ‘show me’ method of delivering a message.

Warren Buffett cannot be questioned on the ‘show’.

After reading the letter I concluded that I’d like to share a few of Buffett’s pieces of wisdom that resonate well with us (quotes in italics, followed by comments from me):

That last requirement (a sensible price) proved a barrier to virtually all deals we reviewed in 2017, as prices for decent, but far from spectacular, businesses hit an all-time high. Indeed, price seemed almost irrelevant to an army of optimistic purchasers.

This upper quartile pricing (as I call it) statement is unsurprising to most people, but it doesn’t stop those managing Other Peoples Money from making very short-term decisions that ignore this reality.

Even a high-priced deal will usually boost per-share earnings if it is debt financed. At Berkshire, in contrast, we evaluate acquisitions on an all-equity basis.

It is extra-ordinary that the greatest investor of our time with compound annual returns of 19.1% per annum over 53 years describes an aversion to debt even though it has ‘dampened our returns over the years’.

Leverage accelerates change in both directions. Understand that finding value is the win, not the leverage.

The less the prudence with which others conduct their affairs, the greater the prudence with which we must conduct our own.

I almost feel prophetic with this quote. Those of you who read Market News on 19 February would remember my reference to controlling the reduction of ones own risk is appropriate when the market around you does the opposite (let’s chalk that up to luck shall we – Ed).

At yearend Berkshire held $116.0 billion in cash and U.S. Treasury Bills (whose average maturity was 88 days) … This extraordinary liquidity earns only a pittance and is far beyond the level Charlie and I wish Berkshire to have. Our smiles will broaden when we have redeployed Berkshire’s excess funds into more productive assets.

Don’t be afraid to hold cash while you wait for a suitable price on the next investment sought under your investment strategy.

Charlie and I view the marketable common stocks that Berkshire owns as interests in businesses, not as ticker symbols to be bought or sold based on their “chart” patterns, the “target” prices of analysts or the opinions of media pundits.

Investing is not trading, nor a function of analysing commentary (which begs the obvious question… – Ed)

This table (displaying huge falls in share pricing through the years) offers the strongest argument I can muster against ever using borrowed money to own stocks. There is simply no telling how far stocks can fall in a short period. Even if your borrowings are small and your positions aren’t immediately threatened by the plunging market, your mind may well become rattled by scary headlines and breathless commentary. And an unsettled mind will not make good decisions.

I would expand on this by saying that an investment portfolio that holds a low proportion of fixed interest investments will feel very similar to that of a person who has borrowed to buy shares when a pricing crisis emerges. There will be little if any room to move.

Performance comes, performance goes. Fees never falter.

A quote from a summary of his winning ten-year bet between low fee index performance relative to high fee professional managers. This is a global, borderless fact; keep your fees down to keep your wealth up.

What investors need is an ability to both disregard mob fears or enthusiasms and to focus on a few simple fundamentals. A willingness to look unimaginative for a sustained period – or even to look foolish – is also essential.

Keep it simple. Keep it real.

http://www.berkshirehathaway.com/letters/2017ltr.pdf

For those curious about accessing more detail, this is the website link to the whole letter.

Synlait’s – expansion North with processing is underway with its conditional purchase of a site in Pokeno.

Much like its site near Dunsandel, just south of Christchurch, I think the selection of a site in Pokeno is strategically intelligent.

The list of benefits as I see them are:

It is close to the Waikato milk producers;

It is a short hop to the Port of Tauranga and Auckland Airport for distribution;

It sits beneath the national electricity grid for energy supply with minimal line loss to an energy hungry business;

It is adjacent to the country’s largest population of consumers; and

If employees are living in the newly exploded Pokeno housing area they could walk to work. Others from Auckland can travel against the traffic flows (when it flows – Ed) from Southern districts of Auckland.

The purchase also appears to confirm a continuation of applying profits to the ambitious growth intentions, and not to dividend payments.

Mind you, investors would be hard pressed to conclude any dissatisfaction with the performance of this business as an investment.

Ever The Optimist – Oslo-listed Tomra Food has purchased 100 percent of the shares in Hamilton-based fruit packing and sorting company BBC Technologies.

At face value this is a compliment to the quality of BBC Technologies but more deeply I see it as further recognition of the quality of the NZ primary sector for its food produce and international businesses see value in being invested in the future of that sector in NZ.

It is a lower risk strategy to invest in the processing side, relative to producing, but it is our competitive advantage with food production that will both deliver better returns and better export receipts for the country.

Investment Opportunities

Transpower –offered a new senior bond to the market, with a 7-year term and an interest rate set at 3.823%.

The offer closed, fully subscribed last week.

Investore Property Limited - offering a 6 year senior secured fixed rate bond maturing 18 April 2024.

The Product Disclosure Statement is available as a PDF from the Current Investments page on our website.

We have started a list for investors to join if they would like to purchase these new Senior Bonds.

Fletcher Notes – FBI has announced they will rollover their Capital Note on Election Date (15 March 2018 – FBI110), issuing a new 5-year replacement (15 March 2023 – FBI170) at 5.00%.

If FBI follows a consistent pattern they are likely to sell their holding (millions) of these notes to the market after 15 March.

Accordingly, we have started a list that investors are welcome to join if they’d like to purchase some of these new Capital Notes, should they be offered to the market.

Possible deals for 2018:

Sky City Casino – bond;

Vodafone – IPO of ordinary shares.

I see that Vodafone has sold out of its Qatar subsidiary and the new owners will continue to operate the business under the Vodafone brand. Presumably Vodafone has a similar intention for its NZ business, if the once proposed IPO goes ahead this year.

All investors are welcome to join these lists by contacting us.

The fastest way to hear about new investment offers is to join our ‘Investment Opportunities’ (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 Christchurch on March 27 (pm) and 28 (am). He is addressing an audience of NZSA and interested clients and investors at St Christopher Hall Avonhead at 7pm on Tuesday, March 27. Please advise us if you are planning to attend.

Edward will be in Auckland on April 10 (Remuera) and 11 (Albany).

Kevin will be in Christchurch on 22 March and Ashburton on 12 April.

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

Our future travel dates can also be found on this page of our website: https://www.chrislee.co.nz/request-an-appointment

Any person is welcome to contact our office to arrange a meeting.

Michael Warrington

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