Chris Lee & Partners Ltd

Market News – 25 March 2019

Global political leadership is not inspiring me with confidence, with respect to a wider investment focus beyond NZ shores.

We knew ‘self-proclaimed’ President Erdogan had fallen off the rails based on his behaviour over the past couple of years (taking control of the central bank etc), but last week’s use of our shooting tragedy for political gain scrapes the bottom of the barrel.

If the UK had installed John Cleese as Prime Minister to negotiate BREXIT at least we all would have had more fun.

Europe’s leadership has failed by equal portions with Theresa May in their combined failure to reach a workable conclusion based on the majority preference of the UK public. (Democracy is sought but not respected – Ed)

A wide range of countries govern with overt intolerance, including the highly influential Chinese and Russians.

Even for nations who would prefer to ignore parts of Abraham Lincolns ‘of the people, by the people, for the people’ surely ‘for the people’ is the only strategy with any hope of long-term success.

Excessive restriction of public progress cannot be good for outcomes in economics or health, and such repression ultimately leads to wide public reaction, which results in short term damage even if long term gains are achieved (Bastille Day etc).

‘We know best’ is not a good foundation for governance.

My point for investors is to be careful with assumptions about broad global asset allocation decisions and not to expect stronger economic performance and thus not to expect higher inflation or interest rate risks (outside of Venezuela – Ed).

INVESTMENT OPINION

Tax data help please – Have any readers with a reasonably deep knowledge of influential data read the Tax Working Group and lamented the poor quality of data used to reach the recommendations made?

It is unsurprising that Michael Cullen’s TWG recommended a Capital Gains Tax because that is exactly what the politicians asked them to do, making it a political manifesto, not a fact-based strategic review of tax collection in New Zealand (the approach taken by the 2010 TWG).

Given that this is a politically motivated tax recommendation you can be very sure that the politicians are sensitive to public opinion about the changes they would like to make, however, in the opinion of several that I have read the data presented in the TWG to support its recommendations is a ‘dog’s breakfast’ making it near impossible for the public to form a reasoned opinion.

Tax change based on shallow opinion, or weak supporting data, will inevitably lead to poor tax law.

One example of weak data was the chart describing how much tax was paid by each income percentile; the chart presented (TWG page 31) six years old!

It does not say the source of the data, beyond the TWG, but interestingly it differs significantly from similar data described in the 2010 TWG report (Figure 5, page 24). Cullen’s TWG says the top decile of personal income earners pay about 22% of tax, including transfers (Working For Families etc) yet the 2010 TWG says the top decile pay more like 40% prior to transfers and 75% after transfers.

Do any of you happen to know where I can find more accurate current data (old economist workmates perhaps)?

Getting up to date percentages and dollar values would be useful, as would knowing how they compare to other countries, especially if the public are to develop a clear understanding of where taxes are actually gathered from rather than what political headlines they would like the public to believe.

The government told us they expect to be back in April with a list of planned actions. In fairness, they have lost at least a week in that process so perhaps May is now more likely.

Duration – The recent issues of long term bonds, 10 – 11 years, with interest rate resets mid-life encouraged me to write to you about the difference between ‘maturity’ and ‘duration’ risks and to touch on how interest rates are set for these bonds.

Fixed interest investors gain higher nominal returns when they invest in longer terms.

The additional return comes from higher interest rates for longer periods of time (when a normally shaped yield curve prevails) and higher marginal returns for committing a loan to a borrower for a longer period of time (credit margin).

A nominal interest rate is a construct of inflation (perceived), plus a real return for a risk-free borrower (NZ government) and thereafter an additional credit margin for higher risk borrowers.

The moving parts, that one loses confidence in a little, are inflation and the financial future of the borrower. So, we investors add in modest premiums (additional interest rate demands) for longer periods of time.

If I was to lend to Wellington Airport for a 3 year term I might accept an interest rate of 3.00% today (credit margin +0.90%), and for five years I might accept 3.25% (credit margin +1.25%) but for my 11 year commitment to them I need an even higher credit margin to cover the entire 11 years of the loan.

Wellington Airport is paying a credit margin of +1.95% for its new 11-year bond.

The 11-year ‘maturity’ of the bond has driven a credit margin applicable to an 11-year loan.

The ‘maturity’ date of the loan is absolutely the repayment date of this loan, for this simple senior bond with no complex terms and conditions (side bar – WIAL has limited options for early repayment).

However, investors also need to consider the ‘duration’ of the bond, which addresses the interest rate risk of the investment.

What is my exposure if interest rates rise or fall during the 11 year period of this loan.

WIAL had two choices here:

Ask you to lend money at one interest rate for 11 years; or

Ask you to lend money at interest rates that will change during the period of the loan.

By offering you an 11-year bond with an interest rate change mid-cycle WIAL has reduced your interest rate risks. Without getting into detailed market maths with you the ‘duration’ of your bond is approximately 6 years, declining as it progresses toward 2025.

You will receive a known interest rate for the next six years (4.00%) and then you will receive a new ‘market calculated’ interest rate for the period between 2025 – 2030.

If interest rates rise, you will capture that change; something that would not have happened if you had agreed to a fixed interest rate for 11 years.

The opposite is also true, a market decline will result in a lower interest rate for the second period.

Once the interest rate is reset the ‘duration’ of the bond will become approximately 5 years, declining as it progresses to repayment in 2030.

As it happens, based on my view today, I would prefer to have loaned WIAL money for 11 years at a fixed rate, which looks like it would have been about 4.35%, but I don’t hold much sway in such matters.

To be fair to WIAL and its lead managers the market has spoken lately and loves these long-term bonds with an interest rate change at the half way point.

A reasonable number of callers have been anxious about the 11-year period, many make bold predictions about their timeline. We have explained that given the borrower’s potential to meet future financial obligations, the ability to sell the bonds if necessary and the interest rate reset mid-life, there is little to be concerned about and the additional credit margin is worth pursuing.

There you have it – Maturity and Duration are two different, but related, things.

INVESTMENT NEWS

Electricity Industry – Is the reported lower customer churn reflective of consumer fear from higher wholesale market pricing?

Perversely the recent increases to wholesale electricity pricing may be reducing competition for consumers because there is less room for smaller operators who ‘buy from the wholesale market’ to serve the public with lower prices (slimmer profit margins).

The return on assets improves for the big five generators through higher wholesale electricity pricing, without any increase to the price they pass to retail consumers.

Between the restrictive Resource Management Act and the higher returns from higher wholesale electricity pricing our major generators have little incentive to push for large increases to generation in NZ.

Last week as I stopped to look down on Roxburgh and admire the benefits of electricity generation and irrigation from a single dam, I lamented again the failure to get Hawke’s Bays project over the start line and our reluctance to consider more elsewhere.

One set of lobbyists focus on the big picture of the global environment (climate) whilst others focus on the protection of plants and animal species within a micro environment (forcing Genesis Energy to import coal for generation – Ed).

One of our riders was even patting Muldoon on the back for the foresight of Think Big.

The returns on your electricity shares will be just fine, but don’t expect your power bill to come down.

US Federal Reserve – You’ll likely find this paragraph a bit boring, and repetitive.

The US Fed has left its Fed Funds Rate (like our OCR) unchanged at 2.25% - 2.50% and stated that they do not expect further changes during 2019.

The market was not surprised by this announcement, having berated the central bank since early 2018 about its blinkered desire to continue increasing the rate until near 3.00%.

The Fed has reacted.

However, whilst the markets are comforted in the short term they remain anxious about a likely recession for the US, as measured by the US yield curve.

Long term bond yields declined after the Fed announcement.

The US 10-year Treasuries (government debt) now sit at 2.52%, being smack on top of the overnight rate (maximum) set by the Fed. All shorter-term bonds sit within the 2.25% - 2.50% range.

There’s a strong statement in those numbers. The market is comfortable with no marginal return for the 10-year period relative to today’s overnight interest rate.

Current US inflation is reported at about +1.90%, so the market is accepting a real return of 0.25% - 0.50% for the coming decade.

I guess that’s better than a negative return, but it tells you that the deepest market in the world does not expect interest rate increases for the remainder of my career, something I reconciled with a year or so ago.

Extrapolation – it helps to partially explain why share markets seem unable to retreat in price, even when earnings are unchanged on the previous year, because the returns from many businesses still comfortably exceed the returns, and anticipated returns, available from interest rate investing.

Levi Strauss – What goes around, sometimes comes around.

Jeans are coming back in to fashion; something I pre-empted years ago, much to my children’s upset.

Don’t give up on an investment simply because others lose interest, it may have a better future than first appears.

e invoicing - Small business minister Stuart Nash is encouraging business toward greater use of e-invoicing within and between New Zealand and Australia for the obvious productivity gains.

It’s unsurprising to me that this call should come so soon after the Mainzeal convictions where they ran their business on creditors funds.

What I hope is happening here is that on top of the obvious productivity gains from moving away from paper invoices, mail and reasonable requests that payment occur, say, one month later, the government is moving to a point where they could set legislation for maximum acceptable payment delays for businesses.

If requests for business were issued in electronic format, then linked to electronic invoicing as jobs were progressed/completed, from electronic accounting systems (such as Xero), linked to business bank accounts then there would be very little reason why the velocity of money wouldn’t increase.

If businesses receive their money sooner, they can progress on with other business tasks sooner; increasing productivity.

The government can help accelerate this move by legislating expectations for payment cycles and punishments for failure to meet them, to the extent of alleging ‘reckless trading’ by company directors who breach such setting and thus would appear to be governing an insolvent company.

After Pike River’s disaster NZ linked directors to safety of staff, so it is entirely appropriate that we link company directors to appropriate financial behaviour with financial obligations to others. Those who lend money, like banks, can set their own financial obligations and ramifications for failure to meet them, which is something small sub-contractors have been unable to do based on current law.

If you can, you should already be paying invoices in 30 days or less in my view.

Italy and China - Italy is patting China’s back with admiration and accepting loan support from them in return.

Should this upset the European Union as much as the UK trying to leave the Union?

Financial markets make it easy for most nations and businesses to borrow from any other location on the planet, so the loan is not surprising, but the future political connotations might be.

EVER THE OPTIMIST – As one group worries about the potential for less Chinese travellers the Auckland Airport data discloses increased arrivals from Indonesia and Taiwan.

NZ has plenty of competitive advantages on the tourism front.

INVESTMENT OPPORTUNITIES

Wellington International Airport – completed its new bond offer on Friday issuing its 11-year (2030) bond with a yield of 4.00% for the period through to 2025 (reset thereafter for 2025 – 2030).

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

Heartland Bank – has announced that it is considering offering a new 5-year bond.

As is the case with other bank bonds, currently, we expect the bond yield to be lower than the interest rates offered on a term deposit from Heartland Bank.

We have a list for investors wishing to consider participation in this deal, once offered.

Metlifecare – has included reference to a potential bond within its funding mix.

We will keep an eye on its public announcements to the NZX.

Given the directors hints that they may also buyback some of their own shares at current market pricing this new bond offer seems inevitable to me.

Napier Port – The regional council has approved the sale of some shares in the port and now appointed its lead managers to bring the offer to market (in the months ahead).

This is an exciting development for investors, and the NZX, and we look forward to this Initial Public Offer reaching the market.

We have a contact list for investors wishing to hear more about participation in the float of Napier Port.

TRAVEL

 

Edward will be in Wellington on 28 March, Wairarapa 9 April, Auckland (Albany) 11 April and in Tauranga 29 April.

Michael will be in Auckland (4 April, city).

Kevin will be in Christchurch on 17 April and Ashburton on 9 May.

Mike Warrington

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Market News – 18 March 2019

May I suggest that you Google ‘Michael Bloomberg rules himself out of 2020 Presidential bid’ and then read his press release; it shows impressive clarity, selfless commitment and echoes of a John F Kennedy moment.

In early February I noted that Bloomberg would make a very good candidate for President.

Initially the headline is disappointing, but once you read the article, you’ll see the calibre and effectiveness of the man.

Rather than running for President he plans to continue putting his time and deep financial resources into effecting desirable changes for communities, changes that politicians no longer have the intent or ability to make.

He is extremely frustrated by the current governance in the US but says I’ve come to realize that I’m less interested in talking than doing. And I have concluded that, for now, the best way for me to help our country is by rolling up my sleeves and continuing to get work done.

He cites his involvement in ‘Beyond Coal’ with its strategies to remove coal from the energy mix, having now reduced coal-fired plants from 530 to 245, so far.

On the matter of our environment he states: Mother Nature does not wait on our political calendar, and neither can we.

The JFK link in his notes:

I hope those who have urged me to run, and to stand up for the values and principles that they hold dear, will understand that my decision was guided by one question: How can I best serve the country?

While there would be no higher honor than serving as President, my highest obligation as a citizen is to help the country the best way I can, right now.

If the public and US businesses share Michael Bloomberg’s objectives, which seems likely for the majority, then he should have no trouble effecting change on the ground whilst politicians perpetuate their ineffectiveness up in the clouds.

INVESTMENT OPINION

Waypoint – It occurred to me that the retirement of legendary investor (with a bond focus) Bill Gross may well be an important waypoint for investors, reminding us that opportunities to discover inefficient marginal reward for risk may be so few that they aren’t worth pursuing for most investors.

To be accurate marginal reward for risk is always changing but the margins are becoming so small they are hard to spot.

From the 1970’s until about 2012, during his time at PIMCO, Bill Gross outperformed 96% of his industry peers via an excellent mind for spotting investment opportunities where the marginal rewards exceeded his assessment of the real risks.

If NZ hadn’t been so small, we would have explained to Gross that the same rewarding opportunities existed in our Tier 1 subordinated bank bond market, a market that has now essentially run its course.

The fund that Gross has retired from (Janus) was not doing so well. The easy to spot margins were no longer clear so he decided to speculate more and to apply a lot more leverage, but this simply compounded the failures when they inevitably occurred.

With the luxury of being able to look down on the timeline of Gross success and ultimate failure I see two significant changes in the playing field and one perpetual reminder (warning):

1: Over time computing power replaced skill of the mind with mathematics;

2: Interest rates at zero, or close to it, have enabled investors to extract all interest rate risk rewards from an equation; and

The warning: the moment you add leverage to a risk you amplify the outcome, which often only has a 50% chance of success (the rest is failure risk). The more you speculate, moving away from known inputs, the higher the failure ratio becomes, as Bill Gross found out.

This reminds me of something I once asked myself in Market News, ‘what do I need to unlearn’ for helping people with investment decisions. Well, the waypoint that is Bill Gross’ retirement is the disclosure that the meaningful discount factor (an inflation adjusting safety buffer provided by interest rates) that was present in calculating future values (risk assessments) is gone, or very close to it.

In the past, we could look at a $100 potential future reward, five years ahead, then discount it at an opportunity cost driven by interest rates, plus perhaps an additional discount for risks around the $100 not being delivered.

When interest rates were 8% the approximate value as at today was $68, but with interest rates at say 2% the value becomes $91. At 0% interest rates the value would be $100 today, and in five years.

The change in value becomes heavily dependent on the possible or probable performance of the entity using the investment provided, with ever decreasing importance on the opportunity cost of the money.

The Bill Gross factor for extracting value is almost gone from markets, as is the man himself.

Kevin Writes:

 

A recent newspaper article claimed that there are 290,000 children in NZ struggling for the basics in food, clothing, hygiene and warmth, a statistic which, if accurate, is an appalling statistic for a developed country like NZ.

While feeding and clothing these children is obviously an immediate priority it doesn’t fix or address the underlying problem of people having children they can’t afford or responsibly care for, a problem the Government seems reluctant to talk about publicly, perhaps for reasons of political sensitivity.

Hard working, law abiding Kiwi families who are trying hard deserve support, but more effort needs to be made to thin out those gaming the welfare system and refusing to work, before the next round of taxpayer funded hand-outs begins. Fat chance I’d say.

The government is currently directing a lot of energy to how they collect taxes, but it is just as important to address how taxes are spent, always looking for waste, and new more effective use for the funds.

At the same time as some politicians are playing lolly scramble with taxpayer money organisations like The Hospice, St John Ambulance and the Rescue Helicopter must fund raise in order to maintain their services. It doesn’t seem right to me.

On a more positive note it was pleasing to learn that St John has recently installed EROAD fleet management technology in its ambulances, continuing EROAD’s impressive growth story in NZ.

EROAD has recently been in the news, announcing a major supply agreement with one of the largest privately-owned trucking fleets in North America.

While still early days for EROAD its North American business will grow by over 30% this year and is now cash flow positive on a monthly basis.

North America hasn’t been a happy hunting ground for all NZ businesses, although recent successes include early stage tech companies Powerby Proxi (bought by Apple), Lanza Tech, Green Button (formed alliance with Microsoft) and of course Rocket Lab.

Others have gone there with seemingly good products but have been unable to grow their sales and make their US operations commercially viable, Pacific Edge being an obvious example.

Unlike Pacific Edge however EROAD seems to have people with good commercial nous including founder Brian Michie and CEO Steven Newman, former CEO and co-founder of Navman, one of NZ’s most successful tech start-ups which grew its annual revenues to $100m and was eventually sold to overseas interests.

EROAD telematics technology has attracted glowing endorsements from users and it now has the highest rated in-cab Electronic Logging Device (ELD) in the US, and the only independently rated ELD device in that market.

EROAD has also recently launched in Australia and although this business arm is likely to be a money-eater in the short term the longer-term prospects look very promising.

If EROAD can emulate in Australia what it has achieved in NZ, and is starting to achieve in the US, it may very well be Newman’s next big success story, and if this should play out I for one (shareholder) would be pleased if they started discounting the price of service to St John Ambulance.

 

Global share markets have quickly recovered the ground lost during the November/December sell-off although a number of global uncertainties still hang over the market.

Markets seem to have already priced in a resolution to the US/China trade dispute with businesses in both China and the US now really hurting and changes to political settings in the US meaning Trump urgently needs to find a deal.

Trump measures his success by the direction of the share market, so he won’t want to risk another meltdown from a failed negotiation.

As an aside a US/China trade deal won’t necessarily benefit all economies, in fact any agreement could require China to buy more agricultural products and energy from the US which could be negative for both NZ and Australia.

Share market investors also seem to be taking positives from recent disappointing global data including weak job numbers out of the US, a big drop in Chinese exports, failure to nail down a Brexit deal, a recession in Italy, and Germany and France both on the brink, slowing global growth and sharply lower growth outlooks and protectionist trade policies everywhere you look.

As John Cleese might say – ‘Otherwise OK?’

Global markets of course do continue to be underpinned by historically low interest rates (and still falling) and Central Bank stimulus.

The Fed has dropped anchor on its tightening bias promising ‘a more patient approach to rate hikes and prepared to adjust its balance sheet unwind’ and the European Central Bank is already gearing up for a new round of quantitative easing (QE) to support the European banking sector, less than 2 months after ending its €2.5 trillion eurozone QE stimulus programme.

The ECB has also signalled significantly weaker growth and inflation outlooks and a delay to interest rate hikes which it had expected to commence later this year (no-one else had, just them).

What they didn’t mention was that their attempt to stimulate growth by channelling hundreds of billions of euros in low cost loans through the euro banks at almost zero margin has weakened the euro banking sector to the point of distress. Effectively they are back to where they started.

China is also trying to stimulate its slowing economy with more monetary stimulus and has even relaxed restrictions on the shadow banking sector, a sector it has been desperately trying to rein in.

On the local interest rate scene, a rate cut by August is already priced in across the ditch, and one is almost priced in here.

Borrowing costs continue to fall with the NZ 10-year government bond yield trading at historic lows around 2.05%, and its Aussie counterpart nearing historical lows at 1.96%.

The NZ Bank 5 year wholesale rate (swap rate), the benchmark rate for corporate bonds of that term, is now back below 2.00% which, when combined with very thin credit or risk margins, is resulting in interest rates on new bond offers struggling to make 4%.

With interest rate forecast to decline further it is unsurprising to see the surge in demand for reliable dividend payers like utilities and listed property trusts.

The toxic combination of high debt and declining growth will continue to rule future monetary policy decision with low interest rates now the new norm.

An example of the high debt/low growth (as in wage growth) conundrum is currently on display in Australia. 

Australians have the second highest level of household debt in the world, mostly invested in property, and they are now seeing house prices fall as a result of a combination of events including tighter credit conditions, particularly for investors, less foreign investment and proposed tax changes.

Lending to investors has fallen by nearly 50% in less than 3 years and even though APRA has now abolished the restrictions on investor credit sentiment in the Australian housing market has changed on the outlook for prices and this lack of confidence has seen the value of new mortgages decline 25% from its peak.

Falling house prices and high levels of household indebtedness not only elevate credit risk for the Australian banks they introduce the opposite of the ‘housing wealth effect’, which drives consumer spending and household consumption.

Household consumption makes up about 60% of Australian GDP so any changes in spending behaviour are felt across the broader economy.

As a result, the Australian government really has no choice but to cut interest rates, and perhaps loosen credit criteria, in order to revive or at least stabilise the housing market. If the housing boom hadn’t elevated the level of consumer indebtedness to such an extent the potential problem could probably have been managed outside of monetary policy.

Once again savers will subsidise borrowers.

NZ also has high levels of household indebtedness, although the supply/demand fundamentals of our housing market differ slightly from Australia and we are less concentrated in the apartment market, the source of the biggest falls (so far).

House prices in NZ have held up quite well to date, although they are on the radar of most economists, and most certainly the Reserve Bank.

Australia’s household debt problem is an example of the debt hurdle which faces much of the world, be it household, corporate or government debt.

INVESTMENT NEWS

Blank – This section left blank intentionally.

EVER THE OPTMIST – Temporarily, we are not feeling quite so optimistic as we think of those impacted by the violence in Christchurch.

I hope our government reactions include an overt move to increase and assist refugee immigration thus confirming the true values of this country.

https://givealittle.co.nz/cause/christchurch-shooting-victims-fund

INVESTMENT OPPORTUNITIES

Argosy Bond – The ARG010 bond offer has been successful, our allocation is almost full ($100k left to allocate). Thank you to those who have invested in this offer through us, and for the prompt delivery of the application forms.

Wellington International Airport – has announced its intention to offer a new 11 year (2030) senior bond to the market.

The 11 years will be made up of two periods; 6 years then 5 years.

WIAL has defined a minimum rate of 4.00% for the period to 2025. The interest rate between 2025 – 2030 will be set in 2025 based on the benchmark conditions of the time plus the credit margin (once defined this Friday).

WIAL is paying the brokerage costs.

We have a list for investors wishing to invest. Please contact us to define firm interest by 5pm Thursday this week (21 March). We bid for our allocation on Friday and will confirm allocations late that day.

Metlifecare – has included reference to a potential bond within its funding mix.

We will keep an eye on its public announcements to the NZX.

Napier Port – The regional council has approved the sale of some shares in the port and now appointed its lead managers to bring the offer to market (in the months ahead).

This is an exciting development for investors, and the NZX, and we look forward to this Initial Public Offer reaching the market.

We have a contact list for investors wishing to hear more about participation in the float of Napier Port.

TRAVEL

 

Edward will be in Wellington on 28 March, Wairarapa 9 April, Auckland (Albany) 11 April and in Tauranga 29 April.

David will be in Lower Hutt on 20 March.

Michael will be in Auckland (4 April, city) and Hamilton (28 March).

Kevin will be in Christchurch on 17 April and Ashburton on 9 May.

Mike Warrington

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Market News – 11 March 2019

Air NZ reports that tourist numbers are down a little and farmers report that rabbit numbers are rising again.

I’ll just pop down to Central Otago and do a quick validation audit.

INVESTMENT OPINION

Start Ups – I have written previously about my involvement with AngelHQ in Wellington, one of several venture capital investment vehicles around New Zealand, but this note has two purposes; to reinforce that good ideas for new businesses are always being worked on and to touch on tax implications from the recent government proposals.

I originally joined AngelHQ out of curiosity for how people progressed from sitting at a desk with a clever idea, to building a commercial enterprise and then hopefully developing it into a sustainable business.

It cannot happen without money, and assistance.

All of the ideas at their inception are too raw for wide investment participation because the ideas represent very high financial risks and they also require skilled people to shepherd them along the path toward possible success, to avoid getting lost in the dark as most would otherwise.

Indeed, my main opinion of the sector after being pleased that there are plenty of people with clever business ideas is that there are even more people who are wealthy through personal success who generously offer some money plus, more importantly, their time to assist these new start-up businesses.

Sometimes the clever ideas businesses are sold to larger sustainable businesses long before the wider public has a chance to invest, but this is a business success all the same; for example Z Energy bought Flick Electric last year and many of the ideas that I have seen fit nicely into the large businesses who would be threatened by the new upstarts.

It would be nice to see some reach public markets, as Xero did all those years ago.

Last week I saw a promising new business in the alcohol sector. I wouldn’t have been able to spot the opportunity from the middle of a vineyard, brewer, distillery or supermarket aisle, but there they were convincing the room of their business plan and how they would succeed, and I believed them.

Another idea, born directly from the high achieving folk at NZ universities was so very informative, and a joy to listen to, it left me revelling in the fact that a few folk from NZ had solved a time and quality problem within the chemistry field that will see the world’s largest players in that field beating a path to their door for a license to operate.

I have intentionally kept the specific information confidential, as agreed, but wanted to let you know that ‘cool stuff’ continues to emanate from our universities and shrewd people who are always scanning mature sectors trying to spot gaps in service or product.

There is no doubt that the NZX would be very keen to see these businesses reach the point of maturity where they benefited from being listed on the exchange to raise capital and broaden the access of our capital markets (side story in ETO below).

The NZX is one of many who generously offer space (large rooms) for venture capital meetings to occur, as do leading legal and share broking firms.

The second point is the frustrating aspect.

Introducing a capital gains tax in the format proposed will increase the cost of capital quite significantly, which will in turn reduce the amount of capital available to high risk start-up ventures.

Accountants have described how this increase in the cost of capital will be damaging to New Zealand’s already weak productivity; although it’s not great news that we are so unproductive with our currently lower cost of capital.

Peter Beck of Rocket Lab, who has a direct knowledge of the subject, has criticised the proposed tax impost as likely to be very damaging to our already fragile foundations for supporting start-up businesses.

Angel Investment Association Chairman, Marcel ven den Assum, has also added a careful initial reaction, ‘The CGT could be very damaging to early stage investment if implemented poorly’.

One counter opinion offered is that a CGT may enhance productivity by shifting investment away from non-productive property assets, but if it was as simple as this the government would be able to introduce a nice simple land tax as recommended by the 2010 Tax Working Group.

The greatest value of start ups is surely the employment it brings, felt widely (RocketLab is reported to have 350 employees with most in Auckland), and not the investment gains made by a smaller group.

If the government introduces CGT on such investment, they should be expecting rather large volumes of capital loss tax deductions from those who generously provide financial support to the start-up sector because successes are a small minority relative to total investment in the sector.

Those of you with clever business ideas, keep it up, we need you; it’s not tax that will make or break your business.

NZ Inc – I love this country, but some of the big indicators aren’t looking so great.

Corporate tax collected is lower than expected;

Corporate confidence is down again;

Small business owners are finding it very hard to find a skilled next generation willing to buy into their well established businesses;

Air NZ tells us tourism numbers are weaker recently;

We had our worst monthly trade balance in January 2019 (-$791 million), even though we have been surfing one of our strongest growth periods. Maybe we bought too much and produced too little?;

Statistics NZ tells us that less people came to NZ than the initial estimates (50,000 less!);

Average incomes do not afford average shelter close to the majority of employment;

Several employers tell us a proportion of our unemployed simply won’t turn up for available work;

The state of mental health is not robust;

In fact the state of general health is reported as being poor.

(Housing consents are up – Ed)

Yes, there is a constant flow of good information too, which I like to include under ETO, but I received a dose of ‘balance’ this week with some of the data above and thought it wise to bring it up here too.

Mainzeal – was found guilty of reckless trading, which included funding their balance sheet with money owed to others, but not yet paid.

When a business fails those creditors discover the importance of being paid with some immediacy after a job is completed (or before in many instances).

Some of you may remember when Fonterra and Fletcher Building formally announced that they would finance their businesses with creditors money; when they extended the delay for paying them from 60 to 90 days!

We receive questionable treatment within the finance industry too, a sector that is usually flush with liquidity, and provides it to others, so has no excuse for delayed payment.

My hope is that the Mainzeal judgment will place all directors on notice to reassess what is a credible delay between receiving a financial obligation and paying it.

My view is ‘up to 30 days’ as a norm and ‘beyond 60 days’ is intolerable. Where offsetting funds have already been allocated for the task those funds should be deemed to be held in a trust account environment.

Any business not capable of meeting such standards should be looking inside the tent for the problems.

Also, if a director is convicted of reckless trading then I’d expect that they resign from other directorships on the basis of being demonstrably not a ‘fit and proper person’ for such a role.

As we have pointed out in the past, it is rare for a retired politician to be a fit and proper person in directorship roles.

INVESTMENT NEWS

Bond shortage? – The BNZ kindly sent me a report assessing the volume of bonds maturing during 2019, especially the strongest (government, local government, AAA credit rated etc), and highlighted that at present with so many bonds maturing ($9 billion in March alone!) it might be hard for borrowers to present enough new bond offers to keep a reasonable balance between supply and demand.

After several years of borrowing to invest (think Canterbury earthquake) the NZ government is now back on track for a gradual decline in its debt ratios.

Judging by my rising rates costs, councils haven’t stopped hiking their spending, but they won’t be able to issue enough bonds to soak up the available cash. Thankfully the Local Government Funding Agency places some restrictions on how much funding they’ll agree to per council.

Foreign borrowers can, and will, issue bonds in NZ dollars to absorb some of the money (think World Bank etc) but they are very price sensitive, much more so than access to the funds.

Dr Bryce Wilkinson once proved to our clients (in the 1990’s) that bond supply, or lack of, had little long-term influence on bond pricing (returns) which were driven by inflation and marginal returns for risk, but a lack of reinvestment opportunities will nonetheless be frustrating for investors.

The BNZ’s conclusion, tracking those who invest to match market average risk profiles (indexed portfolio risks), that fund managers will reinvest the proceeds in the longer term bonds that are available, which may result in a slightly flatter yield curve via a relative decline in longer term yields.

This is of course not music to your ears, but the BNZ is only the piano player and I happen to agree with the tune.

US Price Pressure – It’s just a small anecdote, but one that would be felt widely; the US has an ‘expanding shortage’ of truck drivers and it’s beginning to show through in consumer pricing.

Coincidentally NZ also has a driver shortage. So, Kiwis won’t plant trees, pick fruit or drive trucks. Is it any wonder we have poor productivity issues as a country?

I like big trucks. They are evidence of an economy at work.

It’s why I have liked the ANZ ‘Truckometer’ since inception.

If I hadn’t trained myself to interact with financial markets and ramble about a disparate array of things that might, at a stretch, influence your investments, I’d be willing to drive big shiny well maintained trucks.

Given my views on accumulation I expect that I would ultimately end up with many trucks, but that doesn’t sound like a bad thing. Bruce Plested of Mainfreight was into it before I finished college!

Reading about Mainfreight’s history I was reminded of the propensity for governments to allow stupid regulations; in 1978 Mainfreight needed a licence from NZ Rail to carry goods more than 150 kilometers (Wellington to Palmerston North).

Let’s not go back to a day when our government tried to manage the economy (tax on focus groups? – Ed) rather than govern the country.

I have strayed at a tangent from the topic of inflationary price pressures within the economy’s delivery channels.

With my usual bias I hope that US trucking firms will arm themselves with EROAD units on the dashboard to minimise time commtiment to regulations and increase the pleasure of being a driver and reduce the risk of large price increases to bulk products consumed widely by the public; think McDonalds, supermarkets, Amazon and Walmart.

For the past decade businesses, like trucking, have been able to keep some downward pressure on costs through lower interest rates (a lower cost of capital to business) but when we hit 0.00% we ran out of options on this front, and in the US case interest rates (costs) are drifting up again.

Let me see, what else drives up the cost of capital?

Ah yes, taxes.

There are always evolving risks for investors to watch.

Real Success – It’s the time of year for the annual letter from Warren Buffett as Chairman of Berkshire Hathaway. It’s easy to read for investors and a useful perspective in my view.

http://www.berkshirehathaway.com/letters/2018ltr.pdf

I copied a few quotes (in italics) here that appealed to me and had parallels for you as an investor:

In managing, I will make expensive mistakes of commission and will also miss many opportunities, some of which should have been obvious to me. At times, our stock will tumble as investors flee from equities. But I will never risk getting caught short of cash.

The parallel – always hold cash to cover emergencies, known spending and any desire to position yourself to buy additional investments should pricing fall.

We use debt sparingly. Many managers, it should be noted, will disagree with this policy, arguing that significant debt juices the returns for equity owners. And these more venturesome CEOs will be right most of the time.

 

At rare and unpredictable intervals, however, credit vanishes and debt becomes financially fatal. A Russian roulette equation – usually win, occasionally die – may make financial sense for someone who gets a piece of a company’s upside but does not share in its downside. But that strategy would be madness for Berkshire. Rational people don’t risk what they have and need for what they don’t have and don’t need.

Use of debt increases the volatility of an investment value. Understanding that volatility and being able to control the value change is critical for an investor assessing risk tolerance. Never position yourself so that a third party can dictate terms of your investing (e.g. a bank!)

A major catastrophe that will dwarf hurricanes Katrina and Michael will occur – perhaps tomorrow, perhaps many decades from now. ‘The Big One’ may come from a traditional source, such as a hurricane or earthquake, or it may be a total surprise involving, say, a cyber-attack having disastrous consequences beyond anything insurers now contemplate. When such a mega catastrophe strikes, we will get our share of the losses and they will be big – very big. Unlike many other insurers, however, we will be looking to add business the next day.

If you are positioned with a cash reserve (plus highly liquid bonds) and more discretionary income than you need, you will be well positioned to buy additional investments when pricing falls.

Let me add one additional calculation that I believe will shock you: If that hypothetical institution had paid only 1% of assets annually to various ‘helpers,’ such as investment managers and consultants, its gain would have been cut in half, to $2.65 billion. That’s what happens over 77 years when the 11.8% annual return actually achieved by the S&P 500 is recalculated at a 10.8% rate.

In this section Buffett was reminding us all of two values – the impact of compound earnings and the very real value losses from large recurring fees.

 

EVER THE OPTMIST – We needed the industry to take seriously the Capital Markets Review launched by the FMA and the NZX, and I am pleased to see that they have.

Martin Stearn, as Chair, has attracted very strong participation listed as the following:

Rob Campbell, chair of Sky City and Tourism Holdings;

Rachel Dunne, partner at Chapman Tripp;

Ross George, managing director of private equity firm Direct Capital;

James Lee, chief executive of FNZC;

David McLean, chief executive at Westpac NZ;

Neil Paviour-Smith, managing director of Forsyth Barr;

Rebecca Thomas, chief executive of Mint Asset Management;

Matt Whineray, chief executive officer at New Zealand Superannuation Fund; and

Geoff Zame, head of institutional equities at Craigs Investment Partners.

I only see two sectors missing, early stage (venture capital) and debt markets, although the latter is operating very well already.

ETO II – CentrePort (Wellington) is getting back on its financial feet, reporting a doubling of profit (excluding earthquake and insurance related matters) following increases in logging and cruise ship movements.

INVESTMENT OPPORTUNITIES

Argosy Bond – ARG has announced its first ever bond issue (up to $100 million) to complement its bank supplied financing.

The term is for seven years (2026) and the minimum interest rate is 4.00%.

The offer is open now and closes on 22 March.

Metlifecare – has included reference to a potential bond within its funding mix.

We will keep an eye on its public announcements to the NZX.

Wellington International Airport – have announced an 11 year resetting bond. More information is due out next week.

Clients are welcome to join our list for this bond.

Napier Port – The regional council has approved the sale of some shares in the port and now appointed its lead managers to bring the offer to market (in the months ahead).

This is an exciting development for investors, and the NZX, and we look forward to this Initial Public Offer reaching the market.

We have a contact list for investors wishing to hear more about participation in the float of Napier Port. We would expect the float to occur in the second half of the year.

TRAVEL

David will be in Lower Hutt on 20 March.

Chris and Johnny will be in Christchurch on March 20 and 21

Edward will be in Wellington on 27 March, Auckland (Albany) 11 April & Tauranga 29 April

Michael will be in Auckland (4 April, city), Hamilton (28 March) and Tauranga thereafter.

Mike Warrington

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Market News – 4 March 2019

Fonterra’s move to expand New Zealand’s A2 gene herd is a nod to A2 Milk’s success and to the growing demand from consumers.

Scientists will continue to debate the reality of A1 and A2 milk, as many have debated the merits of Apple’s IOS and Google’s Android, but successful businesses focus on client demand, which reinforces brand value.

A2 Milk, and its shareholders, are to be complimented for their persistence.

Meanwhile, Fonterra’s shareholders will be rather less impressed having just learned that the company has cancelled its interim dividend payment and is questioning its final dividend too.

Fonterra seems to be confirming that they are simply a milk processing utility and not a value adding business; they are leaving that space to others, which is a very sad statement in my view.

INVESTMENT OPINION

‘Green’ Bond – Is something green just because we say so, or does it deserve the definition based on a reflection of the facts (rather than of light - Ed)?

Is it green enough to encourage the Green Party to invest their surplus funds into?

Each time I am presented with an item for sale carrying a ‘warm’ or ‘nice to have’ label, such as green bonds, I immediately raise one eyebrow and try to look through the marketing blurb expecting to find the shareholders as the winner.

Why not describe such branding as ‘Carbon Credit’ for this is what they are purporting to contribute to? Ultimately if would gain credibility if the carbon impact was measurable.

I am trying hard to reduce this cynicism.

I attended the road show presentations for the latest green bond being issued by Argosy to discover more about the credibility of the labelling.

My conclusion was they Argosy is trying to follow a credible, and auditable, process for reducing the carbon footprint of the business, but discovered that the main beneficiaries are indeed the shareholders via higher rents and longer tenancies in ‘green’ properties.

There is no additional yield on green bonds, but fortunately there is no less yield at this stage.

Over time they might hope to borrow money a little more cheaply if they can display ever more ‘green-ness’, but in reality, I think investors will demand more interest rate for non-green borrowers rather than accepting less interest rate from the green ones.

I quite liked the proposal from an industry peer at the road show when he suggested that they offer to pay us a penalty interest rate (say an additional 0.50%) if they did not meet their stated green goals.

Mind you they were careful not to provide us with such goals when we asked what they were.

In their defence ARG explained that data is proving real financial savings for tenants and thus higher rental outcomes, and longer leases for Argosy, so they have a clear incentive to increase the proportion of the portfolio recognised as green.

Argosy describe the method and principles for which they claim ‘green’ status in section five of the offer document. They say it is more than just the major item of reduced energy use; there are features such as enabling staff to reduce car use too such as secure bike parks, showers, etc (but not charging points for the boss’ Tesla? – Ed).

ARG and the lead managers are pretty keen to saturate us with the message; the term ‘green’ features in the prospectus 358 times!

Will this growing movement toward ‘green’ genuinely inspire better environmental behaviours by companies?

I think the answer is probably yes. Certainly, it should be for the property companies where they say they can improve tenancy terms (length and price) as a result because this pressure will be exerted by the shareholders.

If it is harder to achieve improved profits for shareholders then businesses will be reluctant to ‘go green’ unless they feel an increased threat to their sales, or an increased cost of capital to run the business.

I can see how consumers might gradually change their behaviours but I don’t yet see lenders successfully charging higher interest rates on bonds issued by entities with weaker environmental settings.

NZX – The NZX directors have received another round of lobbying from a different subset of shareholders who have concluded that activism is the best way to try and profit from their investment in shares; NZX shares in this case.

These modest scale shareholders seem to again be behaving as if they have control and will dictate change, when they are not in such a position.

In my view they are very welcome to make direct contact with a company Chairman and firmly express their views but frankly I would be embarrassed if my best lobbying technique was to loudly leak my views to the media.

The latest lunge criticises the new strategic focus of the NZX as too slow. ‘We want sugar now’ (read a higher share price).

In Warren Buffett’s words, the critics err in focusing on the share price rather than the long-term financial performance of the company.

The NZX has acknowledged a need to improve the forward-looking strategy, having done so, and whilst it’s business size hasn’t been expanded all that much recently it continues to deliver attractive returns which frankly are hard to find elsewhere in this market.

If fund managers were consistently delivering 6.00% p.a. returns after tax and fees then they might have a more robust pedestal to speak from.

Bank shares – The newly proposed regulations for bank equity capital in NZ could so easily result in more New Zealand domiciled banks being listed on the NZX to deliver a truly local share register.

Brian Gaynor touched on this in a recent article for the NZ Herald about his hopes for a deeper and more effective NZX market.

The major banks must surely be looking, with a little envy, at the ease with which Heartland Bank became Heartland Group, the parent of an Australian financial operation and a New Zealand bank.

If the major Australian banks split their entities to present a truly NZ banking operation, they could simultaneously meet NZ central bank regulations and more efficiently deliver NZ imputation credits to investors with NZ tax residency.

As my mind wandered on this subject, traversing various wishes and what ifs, I again found myself staring at Kiwibank and wanting the government to sell 49% of the bank to the public and to list the bank on the NZX.

There are so many good reasons for this happening.

The Mixed Ownership Model (MOM) has proved through delivery that independent governance and closer public scrutiny delivers better service and better financial performance. Part of the longevity of that governance and scrutiny is that the majority shareholder carries a perpetual political sensitivity, but it is good that this can be separated from good financial management.

The ‘nice to have’ aspect of listing Kiwibank on the NZX is minor relative to the value it would represent to reducing political risk (use of tax payers funds for private financial problems) and to broaden the pool of capital available to the bank for expansion to compete with the other major banks.

The greatest benefit of moving to a MOM model for Kiwibank is to completely remove the political risk; a large proportion of the public using Kiwibank services view the bank as having a government guarantee.

One grouping view the guarantee as explicit.

The other group logically conclude the guarantee is implicit, and I agree.

As a tax payer I do not like the fact that even I see an implied government guarantee for Kiwibank. The reality is that this situation inhibits some of Kiwibank’s potential.

If I was the Chairman of Kiwibank in its current state of ownership I would be reluctant to pursue certain logical risks because the tax payer may become answerable (financially) based on possible outcomes, regardless of how improbable.

Legal ownership of Kiwibank changed in 2016 with the introduction of ACC and Guardians of NZ Super to the register but this is a technical change only and does not reduce the risk to the government balance sheet nor does it remove the implied government guarantee.

However, the moment the share register includes private investment interests (the public directly owning Kiwibank shares) the implied government guarantee vanishes.

The Reserve Bank’s pending demand for additional capital would be an ideal time to list Kiwibank on the NZX and invite new shareholders to provide that capital. Subject to a collective agreement that Cabinet controlled the voting for shares held by NZ Post, ACC and NZ Super (which they do in practice) each of these entities could release a little of their current ownership into such a float on the market.

Regular readers may recall how the RBNZ butchered Kiwibank’s capital management two years ago through an unnecessary debate about counting subordinated bonds as capital for the bank. The new RBNZ equity recognition proposals and an NZX float for Kiwibank would remove this nonsense about capital and where it will come from.

NZ Post is finding it very difficult to generate satisfactory returns on capital and whilst they have truly been dependent on Kiwibank’s success they are finally beginning to show signs of getting the mix right with its delivery business; perhaps they’d like some of their ‘NZ Post’ capital back to direct into their real business?

Kiwibank is only part of NZ Post because the politicians who established it remembered the Post Office Savings Bank deposit books and dropping them to the school office with pocket money for processing, not because a bank belongs in the postal business.

The same politicians probably retained a dislike for the original sale of Post Bank to the ANZ in the 1980’s.

I retrospectively complimented the late Jim Anderton on the establishment of Kiwibank (having disagreed with him initially) but it’s time for the state to let go of this business that they have no need to control.

Hawke’s Bay Regional Council is doing with Napier Port precisely what I think the government should do with Kiwibank.

Tax – Whilst the government is using ‘fairness’ as one of their planks for lobbying public acceptance for tax change, I would be more enthusiastic if more effort was made to capture a fair amount of tax from foreign businesses based on NZ generated business (think Amazon, Lime, Apple, Google, major banks etc).

INVESTMENT NEWS

Heartland Bank – HGH shareholders will likely have heard from the bank directly with their half year results, which confirmed the ongoing financial progress being made by the bank (group).

This note is to draw attention to the fact that we have placed Kevin’s latest research item for HGH on the Private Client page of the website. It can be accessed by clients who have chosen a financial advice service from us.

Success – If Elon Musk is so successful with his businesses, why does he need to increase the mortgages on his homes by US$60 million?

Proxies – I hope you are increasing your use of the NZ Shareholders Association as your proxy holder at meetings, when you do not attend the meeting yourself.

The NZSA’s participation as a voter at meetings is rising and it has done so to an extent that they now have the scale to feature near the top of the reported table of ‘Proxies Received’.

The more proxies carried by an independent agent, such as the NZSA, the better.

Green Mining – Does the continued rise in the price of Palladium reflect an unintended consequence from climate-based regulations or a reason for regulators and business to operate together?

Palladium is an important element used in catalytic converters, which in turn are used to manage exhaust emissions from cars.

The increased demand for Palladium leads to increased mining, something that environmental regulators are not all that keen on.

Electric vehicles will slowly counter this situation but therein lies the opportunity for regulators.

Mining demand for battery elements will be the next story within this topic.

Arrow Construction – It’s pretty clear that the recent loss in front of the Builders Disputes Tribunal (reported at $4.2 million) placed Arrow into a position that the directors must have felt would be defined as being insolvent, and after the Mainzeal judgment about risks of operating whilst insolvent who can blame Arrow directors for immediately placing the business into voluntary administration.

The construction industry clearly sails very close to the wind financially, which reminds us of the real value of equity and setting pricing to achieve a realistic return on that equity. Any business run on close to 100% debt (bank debt plus obligations to others providing to the project) isn’t really in business at all.

In the construct industry the head contractor clearly uses sub-contractor sweat and product supply lines as equity for a project and this should ring alarm bells to all such sub-contractors.

EVER THE OPTMIST – A research team at RMIT University of Melbourne has developed a low energy technique to convert carbon dioxide back into a solid carbon (near coal like) state, which can be stored.

Once this can be achieved on a large scale it will contribute both to improving the environment and to setting an ever more credible price for carbon credits and auditable carbon offsetting efforts (recall last week The Warehouse claimed a carbon neutral position as a business).

By the way, putting one’s money where one’s mouth is, Sir Stephen Tindall also offers his time and some money to Project Crimson who are all about adding trees to the NZ environment:

https://projectcrimson.org.nz/

The CEO of Project Crimson would be pleased to hear from you if you have land to help expand their planting, or if you know of teams needing fundraising ideas who can supply labour to plant trees! (I’d be happy to put you in touch with her).

ETO II - The company that own’s the gondola in Queenstown, Skyline Enterprises, sees enough future tourism to justify a $100 million plan to expand the capacity of the attraction.

Locals might prefer that they also build a gondola from the airport (over Queenstown Hill? – Ed) to town to relieve the traffic flow on the roads, but to some extent this is a quality problem for our economy to be resolving.

ETO II – Speaking of successful investment, last week I saw yet another report of recurring growth from Delegats as they march toward being a $1 billion company, continuously increasing its export volumes (wine) every year.

INVESTMENT OPPORTUNITIES

Argosy Bond – ARG has announced its first ever bond issue (up to $100 million) to complement its bank supplied financing. The bond will be listed on the NZX.

The term is for seven years (2026) and the minimum interest rate is 4.00% p.a. (paid quarterly).

The offer opens on 7 March, closes on 22 March, will be processed by application form and ARG is paying the brokerage costs.

They are describing the offer as ‘green bonds’ based on a Green Bond Framework defined in the offer document, involving standards set by the NZ Green Building Council. The NZ standards are linked to Australian standards, which in turn are related to International influences.

Essentially a ‘green’ building sets high (measurable) energy efficiency standards and it’s useful to see such intentions in the governance standards of companies.

We have a list for those wishing to participate in this bond offer. It is now urgent to let us know if you wish to invest, prior to 6 March, the day when we seek a firm allocation for this bond offer.

Metlifecare – has included reference to a potential bond within its funding mix.

We will keep an eye on its public announcements to the NZX.

Napier Port – The regional council has approved the sale of some shares in the port and now appointed its lead managers to bring the offer to market (in the months ahead).

This is an exciting development for investors, and the NZX, and we look forward to this Initial Public Offer reaching the market.

We have a contact list for investors wishing to hear more about participation in the float of Napier Port.

TRAVEL

Edward will be in Auckland (Remuera) on 8 March in Wellington on 27 March & Tauranga 29 April.

David will be in Lower Hutt on 20 March.

Michael will be in Auckland (4 April in the city), Hamilton (28 March, at Airport) and possibly Tauranga thereafter.

Mike Warrington

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