Chris Lee & Partners Ltd

Market News – 25 November 2019

How far do we move regulations to help, or save, people and where should the border with self-responsibility be?

Huge amounts of time and money go into good regulation.

Yet, in Australia residents have left AUD$20.8 billion of superannuation money unclaimed.

This is an enormous sum and proportionately is about 30% of the total sum in our Kiwisaver environment.

The latest legislation sees the Australian Tax Office trying to find these people and reconnect them with their money.

I hope the last action sees the government gain the use of the unclaimed proceeds, removing them from private pension managers collecting fees.

If the investors don't miss the funds, or for some inexplicable reason don't want the funds any longer then it's better that they benefit the nation rather than a single corporate.

INVESTMENT OPINION

Property – A buying tone is returning to the residential property market in our most populated areas and buyers are also circling around the residential properties occupied by the retired.

Last week the private equity funded Heritage Lifecare has been buying NZ based villages, with Golden Healthcare Group the latest.

Immediately after this announcement Metlifecare disclosed to the NZX that it had been approached with a (new acronym) Non-Binding Indicative Offer (NBOI), also known as an FE (Fishing Expedition).

I’m not surprised the unidentified fisherman has targeted MET given the significant share price discount relative to asset values.

The only remaining question is who is under the Swandri, carrying the rod?

The shortlist surely includes the Heritage Lifecare again but might also include the likes of Summerset who have always had ambitions to expand to the scale of their 'big brother' Ryman.

MET directors have already explained the non-binding amount of money is insufficient (the bait has been cast too far away from the fish's nose) so it is now an unbound conversation, but it's a useful reminder to investors of the robust underlying demand for these property assets.

Corporate Carbon Pressure – I am beginning to read more, and more, stories about changes within business to align themselves with better environmental strategies.

This is a good development.

This time, because they have tried before, businesses have moved on from 'green washing' and 'carbon capture imagery' and they are trying to display beneficial and auditable change.

I had always thought the greatest change would occur once the mix of legislation and consumer behaviour created an effective pincer movement that directors were forced to react to.

I'm not yet sure that we have the best legislative framework for ideal behaviours, but the intent is clear and sufficient to encourage change.

The balance of effectiveness between legislators and consumers will move around, like tethered roller blades, probably never in balance but generally moving in the preferred direction.

The legislators in Australia are not displaying sufficient progress, very conscious of how valuable the coal resource is to Australian economics, but consumers are demanding progress, so businesses are responding.

National Australia Bank has announced it will not take on any new thermal coal mining customers and will wind down lending to existing customers by 2035.

Before you pounce on this 16-year time frame as half a generation, remind yourselves that our current NZ government tried to promise an exaggerated volume of houses over an impossibly short time frame and failed badly.

Egotistical and unachievable plans are a waste of the paper and ink used to create them (and thus a failure to the environment – Ed).

NAB's pledge will have been calculated based on commitments in place to current customers, the economic length of those projects and the banks obligations to business solvency and to its shareholders. It will unquestionably have some padding in it for flexibility in the governance of NAB.

In my regularly adopted position of President for a Day, the action I would now take would to pass a succinct new law, title Coal Lending Law 2019, which would take NAB's defined strategy and make its achievement legally binding.

As a reward to NAB for leading good behaviour, Section II of my new law would require all other lenders to submit by November 2021 their schedules toward zero lending to coal related activity, but their termination point would be 2034 (remove the NAB buffer, which they deserve as first mover).

Section III would define the declining high tide mark for coal lending. Coal loans in, say, 2023 cannot exceed the lower value reached during 2022, 2025 lending cannot exceed 2024 etc. NAB expects to be halfway to its new targets by 2028, roughly halfway into the time claimed.

The trend to zero by 2036 (and 2034) must be displayed to confirm success will occur. Failure will be so expensive that it would likely compromise the lenders solvency, which directors are duty bound to avoid.

The financial reaction will see miners reduce their investment in coal. They may continue with some coal mining but will limit it to that which is profitable when financed by 100% equity from their shareholders funds.

These miners will accept lower returns on their equity whilst consumers continue to use coal, but this is where regulators need to help by making alternative easier to progress and thus cheaper than coal as an energy source.

Central bankers have begun pondering how they might contribute to the wider environmental debate, and the possible risks to financial stability, so this NAB proposal plus my new law should show them the way.

RBNZ governor Adrian Orr says there will be new announcements on the future of macro-prudential regulatory tools; I expect one of them to be a new table of differing equity commitments for different business risks and different environmental risks within our economy.

The RBNZ has made it clear that banks will be expected to carry higher levels of equity, which is already impacting the way bank will lend in future, so the next move is for the central bank to define how they would prefer banks to apply their equity.

If the central bank introduces a carbon content measure, they will make it more attractive for banks to lend on wind, hydro or solar generated energy (nuclear? – Ed) relative to coal.

Coinciding with this subject, and directly related to Australia, Sweden's central bank (Riksbank) has decided that it will immediately sell bonds from provincial/state governments where it concludes that greenhouse gas emissions are too high and insufficient action is being taken to change the situation.

Riksbank has sold bonds that it once held from Alberta (Canada) and West Australia and Queensland (Australia).

In theory, we should begin to see higher interest rates being charged for bonds being issued by those with poor environmental performance.

Financial tension, alongside legislation, reinforced by consumer behaviour will deliver changes to business behaviour, but it won't happen overnight.

Will this new environmental pressure be sufficient to deliver diamonds?

This is a useful exercise for NAB to see if they can help the economy to evolve and thus not reduce the bank's role in the wider economy as new energy solutions are found.

NAB has said it will not change its approach with agriculture at this stage. They are aware of animal emissions but I think they have quite sensibly concluded that coal doesn't feed people, but agriculture and it's animals do.

Post Script – The European Investment Bank, governed by the EU, has confirmed that it will no longer lend to oil, gas and coal projects from the end of 2021.

Under the new policy, energy projects applying for EIB funding will need to show they can produce one kilowatt hour of energy while emitting less than 250 grams of carbon dioxide, a move which excludes traditional gas-burning power plants.

Venice – Following the story above I have a short observation that was pure irony, with a dash of disappointment, in the images of Venice's recent very high tide flooding where tourists were paddling around the famous city in shoe and leg covers made of single use plastic bags!

Westpac Offer – Westpac shareholders have been approached by the bank explaining a new capital raise and offering access to new shares via a placement.

At face value it looks like a plain event where a company asks its owners to inject a little additional capital to meet new obligations and objectives, but some secondary thought is required on this one.

All banks have increased equity obligations, which is the main driver of this capital raise (tick);

Settlement in Australian Dollars was compulsory, which is inconvenient for most NZ investors and introduces unnecessary foreign exchange expenses converting NZD to AUD as a retail customer (cross);

The document was silent on which register the new shares would appear on, forcing me to guess ASX, which is not the preference of most NZ based investors with other shares held on the NZX register. It adds another cost to migrate ASX holding across to the NZX environment. (cross);

The offer was at a reasonable price discount to market (tick that has become a cross). The offer price was approximately NZD$27.25, subject to wholesale FX rates on the day. Today (Thursday 21 November) the price on the market is NZD$27.25 without foreign exchange fees and being registered on the NZ registry. (cross);

The offer incurred no brokerage costs, whereas market transactions do. (cross) On a flat earth society where foreign exchange fees do not exist, the implied brokerage costs in NZ might range from $0.125 – 0.275 so buying WBC on market near, say, $27.00 is a win relative to the WBC share offer (based on prices on 21 November).

Why have I written this paragraph?

It’s newsworthy for investors.

It highlights how inefficient our capital markets are with respect to borderless settlement of obligations, even though our EFTPOS cards, online banking, pay by smart phone and cryptocurrencies would have you believe otherwise. Remembering that this offer is being made by a bank!

With considerable bias it also highlights the value of engaging with a financial adviser.

KPG evolves – Kiwi Property Group is to expand the variety of property types within its portfolio.

Kiwi Property Chair, Mark Ford, said: Our goal is to create modern mixed-use communities, where Kiwis want to shop, work, play and stay. Our refreshed strategy will help position the company for future growth by aligning the organisation to key opportunities in the market. We see significant scope to create additional value for our shareholders by integrating a range of complementary uses at our significant landholdings. (bold emphasis mine)

The housing shortage and rising residential rent payments seems to have KPG considering developing residential accommodation on its land holdings (hotel, apartments etc). Sylvia Park is the logical place to start and test this market.

They have been adding high rise commercial buildings at Sylvia Park and attracted ANZ to move some of its business there so attracting more residents makes sense too, if they can price it well.

If you were an ANZ employee based at Sylvia Park wouldn't it appeal to you to live in an apartment within walking distance?

Leasehold ownership (like much of Auckland's Eastern Suburbs) or rental within a professionally managed apartment block would appeal to many.

Car rental options like MEVO or Avis located on the ground floor, motorway on ramp 500 metres away plus the option of train and bus networks either side of the building.

Sounding good?

If it works in Sylvia Park you can bet KPG will roll out the same model in Drury.

This is the thinking that will help resolve housing shortages (I dislike overuse of the term crisis), not politicians with half-baked changeable strategies.

242 words later I have painted a 20-year investment strategy for KPG shareholders to enjoy. Well, I borrowed theirs and converted it into my image, but I like what I have to say. (something that’s hard to miss – Ed).

Napier Port – Now that is how to arrange a successful float.

Good processes were followed by the council as it considered the potential sale of shares, staff and Hawke's Bay locals were given priority access and a little upside potential for the share price was offered to investors.

The final icing on the success was learning that Napier Port had under promised with the current year's financial forecasts and last week announced they exceeded forecast profit by +3.2%.

Well handled, all around.

Tax? – You surely must pay some, to receive some.

Amazon is disappointed that the US government (for the Pentagon) chose Microsoft as a cloud computing service provider over them, but they then made the mistake of accusing the government of 'unmistakable bias'.

Amazon is in the midst of its early position of global dominance, along with a few others. They are yet to truly feel the wrath of regulators in the same way that Microsoft did in the past with various anti-trust lawsuits.

Perhaps Microsoft pays more tax in the US than Amazon does, structuring its business to the benefit of its homeland?

Amazon may be thinking that the President doesn't like Amazon owner Jeff Bezos involvement with The Washington Post, a constant critic of Trump?

Maybe Microsoft offered a better service at a better price?

Whichever; it is done now.

I love the sense of fun from the Pentagon when they named the initiative the Joint Enterprise Defense Infrastructure programme (spot the acronym). Presumably the purpose of the appointment is to confirm to Microsoft that You Organise Defense Asset data.

Proxy Voting – In a small win for the emergence of consolidating proxy votes Gerry Harvey, the Chairman of Harvey Norman, has been complaining about the power held by proxy voters and their advisers.

This is an excellent development.

Gerry may feel the collective voting power consolidated in the hands of the few, who haven't put any skin in the game, is unfair.

I beg to differ.

The small shareholders who are now gathering themselves together have tolerated unfair treatment across all time in reaching this new position of mushrooming influence.

If Gerry Harvey wants control, he needs 50.1% of the vote. Without it he should govern the company in a way that is beneficial to all shareholders.

Last year 50.6% of shareholders voted against the board's remuneration proposals. Many were part of an advised proxy group.

I again remind you of the merit of appointing the NZ Shareholders Association as a Standing Proxy for your voting rights on your share investments.

We have the forms and can email them to you if you wish.

Politics – In a display of knowing how to be successful with business in China, by staying aligned with the right politicians, Alibaba is making moves to establish a new listing for its business in Hong Kong.

Alibaba is currently listed in New York and Europe, but not in China.

Agreeing to list in Hong Kong during the current political storm has nothing to do with commerce.

EVER THE OPTIMIST

Countdown employees who have spent 12 months or more working at the company get an increase from the current pay rate ($17.70 an hour) to a 'living wage' of $21.15 an hour.

It's good to see business getting ahead of the legislation with its defined increases to the Minimum Wage.

INVESTMENT OPPORTUNITIES

Synlait Bond – Synlait Milk Ltd (SML) has announced its intention to offer up to $200 million of a subordinated bond with a five-year term, with details to follow this week and a formal offer expected in the first week of December.

We have a list that all investors are welcome to join if they would like to learn more once the offer is made.

Infratil Bond – continues with its offer of new bonds, but now only with a single maturity date offer:

A fixed rate bond maturing on 15 March 2026 paying 3.35% fixed for the whole term.

The offer documents are available on the Current Investments page of our website.

Please contact us if you wish to secure an allocation.

TRAVEL

Edward will be in Wellington 12 December.

Mike Warrington

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Market News – 18 November 2019

Sometimes I think people are just so keen to be heard they run the biggest flag they can find up the pole.

Last week I couldn’t understand why the television interviewer didn’t challenge the person asserting that a problem exists with people in the 55-90 years age group having more wealth than those in the 25-40 years age group.

No kidding.

Older generation citizens have been good savers, for longer periods of time and understand compounded returns.

They have also benefited financially from the sharp increases in the value of their properties, which I think was the focus of the gripe, but to the property owners this is just a roof that they still require whether it is valued at $100,000 or $1 million.

I don’t think my 25 year old was in the room to support the critic but I wish he had been so I could have started a lecture on simple things like second jobs, saving money, spending less, time value of money, compounding, cutting one’s cloth to suit etc.

Within our house the difference between the generations is seen based on which side of the bar they stood/stand at a young age.

The silly use of the phrase ‘OK Boomer’ to reject the older generation’s views is disrespectful of the effort the latter has made.

The silent, knowing, smile in response isn’t lacking thought.

The older generation are respectful enough to know ‘if you don’t have anything nice to say, don’t say anything at all’. They also know that they already have the resources to make decisions that suit their circumstances and that they represent the largest group of voters in the country.

Yelling at parliamentarians and television interviewers on this subject won’t gain traction.

INVESTMENT OPINION

Peak leverage? – Will we ever look back and be able to identify the period of time when the world reached peak leverage?

The point when the combined productivity of the world was insufficient to stand any show of repaying outstanding debts and was struggling to even service those debts on an annual basis.

I don’t know the answer to this question, but it is linked to a story I read during the week, which compared the previous biggest leveraged company takeover from 2007 to another new record being worked on today.

In 2007, one or two months prior to the disclosure of the US housing loan crisis and 12 months prior to the Global Financial Crisis that followed, private equity firms KKR (Kohlberg Kravis Roberts of Barbarians at the Gate fame - 1989) and TPG borrowed US$45 billion to buy Texas energy group TXU.

TXU eventually filed for bankruptcy.

In KKR’s defence they continue to be one of the most successful leveraged investors in the US over the past 30 years.

Today, the attempt at a new record for a leveraged takeover is a US$70 billion offer to buy drugstore company Walgreens.

The truth of the cliché is that records are made to be broken, but as TXU showed, so are foolish decisions.

Apparently, the gross volume of leveraged loans (odd use of the terms – meaning loans for corporate takeover activity) is now US$3.4 trillion, or twice the value of the ‘biggest share IPO ever’ market listing of Saudi Aramco’s oil business.

The UK central bank reports that the proportion of leveraged loans with no ‘maintenance covenants’ (rules and limits that must be achieved) has tripled since the time of the TXU deal (2007).

I know we’re not all that keen on oil anymore but I’d rather own Aramco than half the now riskier bonds issued to finance corporate takeovers around the world.

I wouldn’t expect to find such bonds in your Kiwisaver fund, but there’s no harm in checking.

Will the proposed leveraged takeover of Walgreens for US$70 billion look like peak leverage in the rear vision mirror?

The assumptions about gas sales for TXU were profoundly inaccurate. Will the assumptions about future drug sales in the US misunderstand the US government determination to reduce drug use in America?

Peak oil? – As many say they would like oil consumption reduced, and some would like the wells capped, Iran announces the potential for an additional 53 billion barrels from a new discovery in the south-west of its country.

This increases Iran’s reserves by 25% to 210 billion barrels.

Given the pressure being applied over Iran by the US, it’s not hard to imagine Iran using this oil resource to establish new global relationships elsewhere, without serious thoughts for the wider environment.

Shortly after reading this item I read another which was trying to debate when the point of peak demand for oil might be.

Many of you will be deflated to read that the current focus is 10-20 years from now and none of the content was willing to predict a rate of decline or whether there was a stopping point for oil use in the transport fleet thereafter.

Accelerating the decline will need governments of the world to regulate for greater electrical energy supply at pricing that comes in under the equivalent energy content supplied by oil.

I prefer not to enter the battery debate in this paragraph!

RBNZ OCR – The central bank surprised a few by not cutting the Official Cash Rate (OCR) last Wednesday, leaving it at 1.00%.

The market had factored in a 60% chance of a cut to 0.75%, so the majority were disappointed by the outcome.

The market was correct to hold its debate between 1.00% and 0.75% outcomes because this was exactly the debate held within the central bank’s committee. Increases were not on the agenda.

A variety of shares fell in price shortly after the announcement, which is surprising to me given the one-day term for the OCR relative to the multi-year time horizon when investing in company shares.

Further, it isn’t credible to think of 1.00% as a cost of funds and be disappointed if you are a borrower and contemplating the costs of being in business, or the opportunity costs of an investor in shares (or getting out of shares).

Some may view it as the equivalent of counting sheep, but I think the statements are useful reading for investors; they can be found on the central bank website here:

https://www.rbnz.govt.nz/news/2019/11/official-cash-rate-unchanged-at-1-percent

 

Quick Attitude Change – The US Federal Reserve cut interest rates by 0.25% at their recent meeting but they then tried to make it very clear to the market this was the last cut based on the foreseeable data.

The Fed will have been feeling railroaded by both President Trump’s rhetoric and the weight of financial markets where vast sums had been invested promoting the expectation of recessions and the need for interest rates to be cut further.

The Fed has effectively stopped the bus.

Trump’s reaction was to yell even more loudly.

The market’s reaction was more realistic; it has backed off and now prices in the probability of the economy being OK, inflation existing and thus allowed longer term interest rates to rise again above the level of short-term interest rates.

Maybe the Fed governor recognised that he was being led around by the nose when it’s he who is expected to be the leader, so he changed the tune.

Good on him.

 

Infratil – Announced its half year results last Wednesday.

Given the volume of you with investments in their bonds and shares I thought I’d draw your attention to the good result (albeit well forecast) and to encourage you to visit the online presentation to stay informed about the new collection of risks within the portfolio.

https://infratil.com/assets/imported/nzx/Infratil-Interim-Results-Presentation-to-30-September-2019-311735.pdf

I happen to think the result is a little understated, given the way things are accounted for, but that’s better than the opposite.

I look forward to their new investment thesis playing out over the coming five years, especially for the shareholders.

UOC010 – 10 years ago when the University of Canterbury (UOC) issued its first bond to the market, with NZX code UOC010, we hoped it would deliver many more bonds from all of the universities, but this didn’t happen.

Only one year after the depths of the financial crisis, led by a Vice-Chancellor (Dr Rod Carr) with financial market experience (BNZ and RBNZ), UOC asked investors to lend them money so they could accelerate the improvements being pursued by the university.

Using the university’s very strong cash flows to bring forward its capital spending programme made a lot of sense to us then and we were pleased that our clients energetically supported the new concept and invested in the bond offer.

The ten years bonds had two different interest rates (7.25% then 5.77%) over periods of five years (2009 – 2014 – 2019).

Today’s lower interest rates should be making it even easier for universities to bring forward such programmes but it’s just not happening via bond offers, sadly.

UOC010 bonds reach their maturity next month (15 December) and we’ll be sad to see this risk type depart our client portfolios.

The UOC010 bond offer had another novelty; it offered investors the opportunity for philanthropy toward the university. The choices were to reduce the interest cost to 0.00% or to gift the principle sum to the university at maturity, or both.

Around the world many of the world’s wealthiest citizens donate huge sums to the tertiary education institutions that helped them on their way, with competitive egos often defining the scale of donations, but it has not been common in NZ.

UOC was clearly keen to make public its willingness to promote the concept of philanthropy toward universities. The options were spelt out well in the prospectus of the day. Good on them.

However, I think the final letter issued in the lead up to maturity reads more like the messages on torn off pieces of card held by the frustrating beggars lining some of our city streets.

At launch the label used was ‘Fixed Rate Bond with Philanthropic Options’ yet the maturity letter now describes it as the ‘Philanthropic Bond Scheme’. It now encourages bond holders to ‘consider making a philanthropic donation’ just in case they forgot this option from the outset.

It applies more pressure by thanking ‘all who have elected to donate interest or capital’ thus far. The register will know this specific list, so they could have received differently worded letters of thanks without trying to guide the heat of an incandescent spotlight on the other bondholders.

They don’t stop there.

They offer websites, names, phone numbers and email addresses for those wishing to make contact to make their belated donation. The only thing not included is their ApplePay, Splitwise, PayPal or Bitcoin account details.

It would have been appropriate in the letter of thanks to have a single paragraph about the final opportunity for exercising the Philanthropic Option, but not to make the entire letter a plea for donations.

The latest letter was written by the new Vice-Chancellor and she may not have realised the subtlety of the Philanthropic Option in the original offer document.

Dr Carr has been ‘moved’ on by his children to accept the role as the first Chairman to the Climate Change Commission (think Zero Carbon Act), where they want him to deliver his next meaningful impact on society. He has quite the CV now.

If you hold UOC010 bonds there is no action you need to take. The bonds will be repaid on 15 December. There will be no reinvestment offer.

NZ Post Bond – Recent increases to longer term interest rates have been very helpful to holders of NZ Post bonds (NZP010).

The interest rate reset on these bonds (last Friday) was 4.23%, something to be pleased about in the current market conditions.

Less happily, Infratil’s perpetual bond was reset to 2.67% for the year ahead.

EVER THE OPTIMIST

Continuous small gains can add up to a large snowball.

Improved trade agreements with China and a newly developed agreement between 15 nations in the Asia Pacific region (excluding India at this point, sadly).

I have been pleased to see our government continue negotiations with all possible trading partners because we will need this diversity to help insulate ourselves from the worst behaviour of the most powerful political forces around the world.

Politicians and negotiators seem excited about gimmicky names for these trade agreements, but I have intentionally avoided using them.

INVESTMENT OPPORTUNITIES

Infratil Bond – continues with its offer of new bonds, but now only with a single maturity date offer:

A fixed rate bond maturing on 15 March 2026 paying 3.35% fixed for the whole term.

The offer documents are available on the Current Investments page of our website.

Please contact us if you wish to secure an allocation.

TRAVEL

Edward will be in Auckland City this Thursday 21 November, then in Napier on 2 December and Blenheim 4 December.

Mike Warrington

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Market News – 11 November 2019 

Rocket Lab continues to impress as a NZ business success started by a Kiwi with a glass that was always half full (Peter Beck).

However, last week's news of a payload for launch 10 reveals another strand of evidence that some people have far too much money, and a shortage of attention about where spare resources should be used.

The ALE-2 payload delivers man-made shooting stars into the sky, guided back into our atmosphere, to burn up at a time and location of the consumer's choosing.

It sounds like an expensive replacement for a fireworks show.

To be fair, Rocket Lab is also launching micro satellites for businesses testing internet communication services via Radio Frequency (RF) between Low Earth Orbit satellites and with earth.

Once proved, it won't take long for a literal web of LEO satellites to be put in place to provide a constant ‘real time global communications constellation' and have significant benefit to economies globally.

Fibre (light) will be faster than radio waves (see Olaus Roemer), but at least there will be choices on price and service for most internet users.

INVESTMENT OPINION 

Mega Share Float - Saudi Aramco, reported as the world's most valuable business at US$1.6-1.8 trillion, is up for sale.

Will we look back in 10 and 20 years and realise that sale of the Kingdom's oil business was a fork in the road?

Of the possible forks in the drawer, which one was it?

Energy consumption change or political influence change?

It will be hugely interesting to learn who become the major investors on the Aramco share register after the float of the company.

Will it be the world's largest oil industry players such as BP, Royal Dutch Shell, Exxon Mobil and Chevron or more ominously will it be sovereign wealth funds from China, Russia, India, Japan and perhaps the European Union?

The recent failed auctions for licences to mine oil deposits in Brazil (China was the only outsider to bid for 10%. The other 90% went to Pretroleo Brasileiro) may mean BP, Shell, Exxon Mobil etc are lining up to buy into the developed Aramco or maybe they feel they have enough oil supply for the foreseeable years?

If it’s the latter, the Aramco deal could evolve from the world's biggest ever IPO to the biggest ever failed IPO.

Will nations playing a tune of environmental sustainability realise that access to energy for their population comes ahead of pure energy use principles?

If it's going to be various governments that participate in ownership, then the more the better to help reduce the potential for excessive influence and misbehaviour over global energy supply.

In theory this move away from US attempts to exert control in the region, so as to ensure access to the energy supply, has resulted in relentless violence so wider ownership might result in less regional violence.

Whatever the remaining oil reserves are, why is Saudi Arabia agreeing to sell them?

They have had decades to accumulate enough capital to then develop new income streams for their nation, so why the focus now on capitalising on the future resource?

Under the label of ego, some of the past wealth will have been wasted on the likes of Mercedes Benz with gold fittings and unique characteristics but this must have been modest and surely some significant business assets have been developed; haven't they?

The sale won't be a simple conclusion about the oil running out. 

The decision will have been influenced by the US achievement of oil self sufficiency and also because interest rates are near 0.00% which makes the future value of the oil roughly the same as the money they'll raise today.

Time value of money (TVM) will remain a powerful force if the kingdom reinvests wisely into other scarce or productive assets. What will these assets be and where will they pursue them?

So many questions, as there are bound to be, as we approach what may be a profound change to the future control of the world's largest single oil resource.

Mind you, to put this pending transaction into a different perspective, the US$1.6 trillion that Saudi Arabia may raise from the share sale would only finance 18 months of the US government's current fiscal deficit.

Does this make Saudi Arabia's influence less than we thought, or the US financial strain greater than we realise?

Energy use – Related to the content above, and the increasing awareness and concern for our environment, it must be frustrating news to many that Iceland will soon be using more energy to mine for Bitcoin than it does for operating its homes!

Environment – The passing of the Zero Carbon Bill into law in NZ is useful in evolving the nation's expectations from businesses and consumers.

However, most of the initial commentary that caught my attention is concerned about the effectiveness of the law that has been passed.

The cross party support is a double-edged sword; they all mean well, but the haste in passing the law is likely to reflect political impetus and not real influence.

Nonetheless, I am a fan of making a start when trying to achieve something and not wasting months or years debating what perfection might look like but achieving nothing.

I look forward to evolving our understanding of how this new law will impact investment behaviour and returns, and I want to see some tangible improvement for the environment. 

US Fed – The US Federal Reserve has continued its new theme of cutting interest rates by bringing the Fed Funds rate down 0.25% to the 1.50%-1.75% range, but it was at pains to declare that there are no more cuts planned.

Yes, you know the spiel, 'the current intention ….'.

Some of the Fed board members have been issuing pre-scripted speech notes, in an orderly sequence, to try and leave financial markets with no expectation of further cuts to the US interest rates.

One should always take this reverse lobbying (The FED receives far more lobbying than it gives!) with a grain of salt but I see that market conditions this week are in agreement with the Federal Reserve; current interest rate settings may be sufficient to assist the economy and employment without prompting new inflation.

Over recent months the US yield curve (plot graph of interest rate returns for terms between 1 day and 30 years) was a crooked line reflecting disagreement about the potential for recessions, inflation and stagflation. The low point moved from the front of the yield curve, into the middle and back again during the debate.

The bold predictions of recession whilst the yield curve was negatively sloped (the front third anyway) have quietly been removed from the headlines barely 6-9 months later.

Today the US yield curve begins at 1.50% for a 1 day term and rises in very small increments up to 1.80% for 10 years and on to 2.30% for 30 years.

It would be useful if they could hold that position for the year ahead and provide financial market pricing with a little more stability and thus predictability, which would assist with better economic progress.

If the Fed keeps its overnight interest rate at 1.50%, ignoring 'Storm Trump', the US dollar will retain reasonable strength and this would reinforce its position as the reserve currency of choice at a time when the Chinese with their Yuan and the many crypto currency proposals are trying to undermine the USD.

New Zealand has not done as well as we hoped for our agriculture sector in its recent trade negotiations so our primary producers could be forgiven for lobbying the Reserve Bank to continue cutting the Official Cash Rate and hope to weaken our currency further and thereby assist the quantum of export revenues. (De facto tariffs? – Ed)

Debt disagreement – Four weeks ago Goodman Property Trust (GMT) raised $175 million new equity to reduce its debt ratio to below 20% of assets.

Two weeks ago Kiwi Property Group (KPG) announced a share placement to raise $250 million new equity and reduce its current debt ratio to approximately 27.5%.

Yet last week the friendless manager of Vital Healthcare Properties (VHP) announced plans to increase the entity's debt ratio to 42% from 35%.

Who is looking North and who is looking South?

They are all on the same playing field. 

They have similar assets.

Someone has lost their compass (and doesn't like Google Maps? – Ed).

VHP appropriately highlights its lease terms at more than double the industry average, but I expect KPG, GMT and the others would offer a rebuttle of continuously high occupancy and increased rental income (dividends) for owners, something that VHP investors have not enjoyed.

I have some sympathy for VHP explaining that the very low cost of debt encourages use of more leverage when compared to assured income above 6.00%, delivering more return per dollar of equity invested. Mind you, I think VHP should show investors it actually can also deliver greater returns without increased debt (risk) before embarking on this next strategy.

For now VHP has only achieved greater revenue for its manager, not its owners.

So, in the face of the 'better net returns' argument, which is well understood by the other property investment entities, why are the others reducing debt?

It is counter-intuitive to raise new equity at, say, KPG theoretical 6.00% return reference to then use this money to repay debt costing 3.00% (recall the recent Argosy bond at a cost of 2.90%).

Are most other property entities building a war chest to buy assets from distressed sellers over the next 24-36 months?

At present I think the more likely argument is that they are concerned about good access to bank lending if the Reserve Bank in NZ presses ahead with the proposed increases to equity on bank balance sheets.

If the bank equity increases are too tough banks will respond by rationing lending to the lowest risk and the most profitable opportunities. Lending to property investment entities is relatively low risk but perhaps the returns to the bank are low on such lending?

Given the VHP manager's demonstrated selfishness I think I'll choose to back the management decisions made by GMT and KPG and continue to ponder what else may be causing them concern.

If you know of people who are carrying excessive debt levels then you might draw their attention to the new strategies being employed by some of our most capable property investors.

Interest Rates – Over the past couple of weeks longer term interest rates have lifted from disturbing lows reached during October.

At one point the five year benchmark rate was a little below 0.75%, which implied the interest rate reset on the NZ Post bond (NZP010) might be 3.75%. 

This wasn't a bad outcome given that NZ Post is paying the penalty credit margin as a result of not repaying the bonds at this first possible date but the good news is that as I write the five year benchmark rate is 1.15% and this implies a reset on NZP010 to 4.15%.

Keep your fingers crossed because this would be a good result in an otherwise desert-like interest rate landscape.

The slightly higher interest rates are linked to the lift for long term interest rates in the US, which is partially driven by the hints of optimism around a turn in the trade war on top of continuing good economic perormance data (production, unemployment etc).

We aren't seeing meaningful inflation pressure so don't expect these interest rate moves to continue into a long term rising trend.

Auckland Property – It's a small anecdote, but the recent rise in share price across most of the retirement village operators may be an early sign of confidence that residential property values have settled in Auckland and will rise again.

EVER THE OPTIMIST 

NZ Dairy futures continue to reach new high prices and the current pricing implies payouts near $7.38 for early 2020 delivery.

This will be great news for the well managed dairy farmer, and a relief to the banks who are sweating on a few over-leveraged and marginal operators who feature in their rising bad debt books.

If low interest rates and rising milk prices don't deliver success then a struggling farmer should be looking closely at a different career.

ETO II

I like what I have been reading about the growing reporting of 'Living Wage Employer' accreditation for those paying their staff a minimum of $21.15 per hour.

ANZ gained the accreditation and is now trying to convince its external providers to do the same.

Queenstown Airport has achieved that outcome and confirms that both it, and its contractors, are paying minimum wages of $21.15 per hour.

The next thing that 'we' should strive to do is convince more people to join Kiwisaver and to encourage employers to increase their contributions to 3.00% for employees in the lower wage bands (the well paid can more easily save money).

ETO III

NZ achieved a small tariff gain in an upgrade to the Free Trade Agreement with China.

Paper and Packaging products will see tariffs slowly wound down over a 10 year period.

A small gain, but a gain nonetheless and reason to believe we can continue to negotiate incrementally better trading conditions with other nations through time, and effort.

INVESTMENT OPPORTUNITIES 

Infratil Bond – continues with its offer of new bonds, but one series stops this week:

The 10-year bond (IFTHC) with annual interest rate resets closes this Wednesday. If you were planning to invest in this series, please contact us immediately.

The new fixed rate bond maturing on 15 March 2026 paying 3.35% fixed for the whole term remains open.

The offer documents are available on the Current Investments page of our website. 

Please contact us if you wish to secure an allocation.

TRAVEL 

David is in New Plymouth 14 November.

Edward will be in Auckland City on Thursday 21 November and Albany on Friday 22 November. Then, Napier on 2 December and Blenheim 4 December.

Chris will be in Christchurch on December 10 (p.m.) and December 11 (a.m.), his final visit until February 2020.

Mike Warrington 

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Market News – 4 November 2019

China, and its leadership is progressively becoming a greater problem for us all.

Last weeks (orchestrated) news described 'Xi thought' as if it is a newly developing constitution that Chinese people (and the NBA – Ed) should respect.

I find that it is much wiser, and more widely effective, to abide by 'she thought'.

INVESTMENT OPINION

Tiwai Point – This story will roll on for several months now, being the timeline that Rio Tinto says it is working to for its business review.

I am pleased to see some spine in the early responses from the Crown with respect to the ongoing requests for subsidies.

I don't think the government has been particularly strong on various difficult decisions but this one might play right into their hands under their preference for more use of renewable energy within our economy (as opposed to being used by Australia's).

Ironically after our government's move to ban mining of fossil fuels it forced one of its subsidiaries to buy in coal to generate electricity. That entity was Genesis Energy for the running of the necessary Huntly power station.

I haven't seen it reported but wouldn't it be amusing if we learnt that GNE buys its coal from Rio Tinto!

Meridian offers Tiwai smelter extraordinarily low electricity pricing linked to the Manapouri scheme alone. Maybe it's time for the smelter to pay the same wholesale pricing as all other users and acknowledge the need for New Zealand to retain its more expensive thermal generation for the surety of the whole system?

After all, Meridian (and others) provide payments to Genesis Energy to have them maintain the Huntly power station, which they say they would otherwise mothball.

Take back the local renewable electricity, stop buying the coal, reduce this nation's carbon emissions, all through one decision with wide and deep public support.

Simple yes?

I have learnt from a friend in the high voltage sector of the electricity industry that Meridian could use Manapouri to serve some of Southland via the Tiwai grid exit point. However, the 220kV lines would be required from Roxburgh to Benmore and will require increased capacity.

In my capacity of President for a day, I'd view this upgrade as a desirable investment where the return on investment would come from gaining a market price for electricity to Rio Tinto and leave the free option of spilling unwanted electricity more widely to NZ.

Because a little more disclosure is warranted, my scenario would only serve the South island well and perhaps Wellington, but the HVDC poles across Cook Strait would need improvement, as would the networks in the central North Island, to truly get the Manapouri capacity all the way to our Auckland and Waikato population base.

Again, I am up for this.

Please get Transpower’s CEO on the line.

Alison?

Yes, hello.

It's Mike (President Mike? – Ed). I have a Public Private Partnership proposal to help you fund the capacity expansion of your grid; let's call it, say, The Manapouri Fund.

It's a 30 year term, principal and interest (capital repayment) preference share with returns being a mix of debt and equity so as not to compromise your robust credit rating.

Yes, I know, it's a very simple idea. I'm sure it would have come to you too.

We have many clients pondering how to manage their cash flows well into retirement. You can help them, and they'll help you, to help the nation.

Returns?

Let's discuss the finer details over a Central Otago Rosé when we sign up the deal.

Let's do this. (contemporary government language that I expect Cabinet Ministers Google when wondering what to do next).

Post Script: which I hope our government ministers have read in the Australian media.

A client in Australia has drawn my attention to the fact that Rio Tinto is playing exactly the same game in Australia with its three smelters there (2600 employees), they are confronting the Australian energy sector and government claiming current pricing is unsustainable.

Environmentalists will be disappointed that Rio doesn't address the problem that goes with excessive use of coal to generate the electricity used. Rio is simply demanding lower prices!

I guess that means Rio has no ESG (Environment Sustainable Governance) ambitions. This may affect their access to capital over time.

All we need our NZ government to do is decline subsidy requests for access to the best power supply (ESG) possible. They should in fact be considering price premiums for such power to reflect the zero-carbon content value of the supply.

Coal – During the week I read another story about the coal industry that displays consumers understand the need for change.

Election placards in 2016 announcing 'Trump Loves Coal' didn't have any impact on the sharp decline in demand for coal from the electricity sector in the US, a decline that appears to have started in 2009 and never turned back upward in direction, no matter how strong the US economic recovery was.

Demand reached a high point of 1 billion 'short tons' between 2007 – 2008 and is now back down to 496 million and showing signs of continued decline. The last time the volume used was below 500 million was 1979.

This sharp change has resulted in the Chapter 11 bankruptcy filing by America's largest private coal miner Murray Energy. As we discuss the 1,000 employees impacted by Tiwai Point negotiations Murray Energy has 7,000 impacted by one of their industry evolutions.

For different reasons both stories remind me of the importance of energy to residential consumers, businesses, and governments and how powerful (excuse the pun) being self-sufficient with energy is in a global context.

I'll share a tutorial with you. I didn't know what a 'short ton' was; it is 2,000 pounds (907.18kg). A 'long ton' from Britain was 2,240 pounds (1,016.05kg). The metric tonne is 1,000kg. If anyone happens to know why the US and British ton were 12% different I'd be pleased to learn this too.

From an oblique angle this is relevant to NZ investors in Infratil, major shareholder in Longroad Energy the specialist renewable energy developer focused on the development and operation of wind and solar energy projects throughout North America.

A decline in fossil fuel energy supply will keep the door wide open to those developing renewable energy supply.

I am pleased to see consumer demand influencing the rapid decline in coal use as a fuel and I look forward to Infratil’s half-year financial performance report next week.

Tired of it? – Yes I am tired of the Brexit story.

I hope the UK election in December enables the population to say something useful to their parliament.

Fitbit – Alphabet (Google) appears to be trying to buy Fitbit in what would be a concession that this is the fastest way for them to get into the smart watch sector and avoid starting from scratch.

They could unquestionably design and produce their own but they must like Fitbit's product thus far, and probably its brand name too, so buying the business became the strategy.

The reason for this paragraph is not to applaud Google, it is to highlight an action I think we will see more of in the immediate years ahead; the world's largest and strongest businesses cherry picking a selection of smaller businesses and products that they wish to add to their already dominant portfolio(s).

These enormous and successful businesses talk of share buybacks and buying other good businesses if the price is right.

This must seem daunting to smaller businesses that are not taken over by the elephants. They'll need a compelling service proposition.

Imagine if you are a smart watch manufacturer and not in the stable of Apple, Samsung or Google. I think your last hope would be to co-develop with someone like Omron and develop a best in class health monitoring smart watch.

Each country, and the world's largest businesses, are going to be hard to stop in the period ahead I think.

Many of you will remember how dominant Microsoft became. For an extended period governments tried to tear them down with antitrust legal threats, and it worked for a while, but look at them now, back again atop the list of the world's largest companies (2nd as I write).

Commentary once addressed the oil companies as the frighteningly large, dominating businesses but today the biggest in their sector, Exxon Mobil, is 12th at $340 million, approximately one third the value of each of Apple, Microsoft, Amazon and Alphabet.

Artificial intelligence is described as one of the next big things, and it is unquestionably important, but it would be naïve to not acknowledge that these biggest technology companies will be at its forefront.

I hope your Kiwisaver provider has a portion of your funds allocated to these global majors.

Metlifecare – Maybe the Metlifecare directors read Market News recently when I voiced an opinion and agreed they had flip-flopped too much by hinting at a share buyback last year then decided to allocate funding from the recently issued bond to building new villages?

Maybe they wanted to make this new buyback decision after the bond issue was complete so that it wasn't a disclosure obligation within the new bond offer documents?

Maybe I think too much like a conspiracy theorist?

Maybe they were simply deafened by criticism from other major shareholders?

Regardless, MET directors announced recently (24 October officially) that they will now spend $30 million buying back some MET shares based on the deep discount in the share price relative to value of assets on their balance sheet.

So, credit when it is due, I should applaud them for finally doing what they said they once would.

I have a new conspiracy theory; who knew about this decision on 14 October and began buying MET shares pushing the share price from $4.45 to $4.65 after a long period at lower levels?

I need to move on. (Agreed – Ed)

Review and Stress Test – A couple of years ago we encouraged investors to run a stress test across their portfolio; reduce the value of property items by about 20% and other shares by 25% or 30%.

Then consider the results measuring the valuation loss relative to the scale of the overall portfolio. Can you cope emotionally with the scale of such a change?

There's a better than even chance that your portfolio income won't change under such conditions, or only modestly if it does. Is this more important?

I think it is.

Falling interest rates are delivering real damage to our nominal and real incomes. Swings in share prices may not. Which should concern investors more?

If the positive difference between dividend income and interest income widens, are you receiving sufficient 'insurance premium' to tolerate the potential for 30% swings in the value of your shares?

If average interest rates are, say, 2.00% and your average dividend is 5.50%, then seven years of the marginal run rate will finance the cost of a 25% stress test.

Just doing math.

I observe that a 30% decline in the value of shares (generic US share index) would only take us back to the pricing of 2016. Remember that time (like it was yesterday – Ed). A 50% decline takes us 'way' back to… early 2013.

You can run your own stress tests anytime, and probably should always be considering your risk tolerance against the potential for such moves but I'd encourage you to factor in one other statistic, that your forecasts only stand a 50% chance of being correct.

As one last thought, you might also review investments that have not provided income over the past 10 years nor displayed successful growth during the most optimistic decade for share pricing in my career.

If not now, then when?

Interesting data – At a recent sequence of presentations from enthusiastic new businesses seeking venture capital investment I noted a few interesting 'facts' thrown out by people who stood on the stage.

Item 1:

The food required by the global population over the next 40 years is equal to the food volume used over the past 8,000 years.

I was too tired to consider the historical population and contemplate the math but it puts into perspective all attempts to have people reduce meat consumption.

Will we produce enough meat and plant matter for the hungry mouths of the future?

You may be expecting the new business to be another of the 'plant based protein' businesses storming the fields, but it wasn't, it was another offering very clever solutions to irrigation management.

This same chap also touched on one of New Zealand's natural advantages, given our water resources, NZ has 756,000 Hectares of irrigated land whilst Australia has only 476,000 and much of it is regularly under threat when droughts threaten the water supply.

Item 2:

Relates to the rapid rise of Artificial Intelligence (aka fast moving flow charts run by increasingly powerful computers).

The presenter explained that in recent history a large car rental company would update its pricing 500 times within a 5 hour window using simple drivers, but now the largest firms update pricing 50,000 times in 5 minutes!

What I was hearing was that booking a flight, accommodation, renting a car, or arranging many other similar purchases would soon look the same as my memory of live pricing for foreign currencies where nothing sits still.

Every new piece of information gathered by the business and captured in the super computer would result in a price change to the consumer at the front end.

A storm in the Gulf of Mexico that threatens oil fields results in a lift in the wholesale oil price, which triggers an increase in the cost to return a one way rental car from Westport to Christchurch, adding $11 to the daily rate for hiring the car.

Three minutes later a fatal accident closes Lewis Pass forcing a vehicle return journey to be via Arthur's Pass adding 6km additional fuel costs and 30 minutes additional labour cost to the journey. This bumps up the car rental booking by a further $8.

I could ramble on, but you get the point, live information about business risks will translate into live updates about access to and pricing of services.

The good news is that a NZ business called MarginFuel is near the forefront of winning contracts from global car rental firms to place them in the lead to win business from consumers.

If you are not reading about new, faster, uses of technology and data knowledge in your invested companies annual reports, they may be missing an important trick.

Clever Thinking – Good executives come up with good business developments.

We've always known Z Energy (ZEL) benefited from good management but they displayed it again recently with their newest method of buying fuel from them.

If the price of fuel at a ZEL station reaches a point that appeals to you buy as much as you wish into a personal reserve holding. If you want to buy 1,000 litres then you can do so.

You can then drive to any ZEL station and begin collecting that prepaid fuel into your vehicle. You can also share the fuel with friends or family in other parts of the country, until your reserve empties.

This service will be fun for those who love to follow the pricing statistics of fuel. It will be a joy to offer free fills to your kids, your Mum or your favourite Aunty when you think the time is right.

It could be awesome for businesses, buying in bulk and then having drivers in the fleet, anywhere in NZ, draw down on the prepaid resource as they move around serving customers.

ZEL benefits both from the potential to achieve an incremental gain in market share and an effective reduction in the storage costs of its wholesale fuel stores (because some is paid for before it leaves the property).

If the service is successful it could help reduce the scale of ZEL's balance sheet by proportion with the amount of prepaid fuel.

In turn, this would reduce ZEL's exposure to movements in the wholesale price of oil and refined fuels because instead of stores equaling 100% unsold exposed to the current price they may be able to reduce this to a lower number, such as 90% unsold but they have collected a profit margin on 100% of the flow.

You can bet there will be some artificial intelligence behind the pricing in the fuel industry too. If a special offer at $2.11 results in a huge draw down of fuel into prepaid reserves the pricing for casual drive up consumers may jump elsewhere in that area to say $2.41.

It will be fun to see where technology and good business management end up taking us in future. It may well be increasingly frustrating for non technology users but it will, as it should, reward the best-prepared consumers.

Well done ZEL, from the perspective of a biased shareholder.

EVER THE OPTIMIST

Minister Kris Faafoi has trebled the Financial Market Authority's litigation funding, which is 'a start' toward making it clear that the regulated will not be able to outspend the regulator when allegations emerge.

As long as the FMA doesn't call me, this is great news.

INVESTMENT OPPORTUNITIES

Infratil Bond – offers the following new bonds:

10-year bond (IFTHC) with annual interest rate resets, starting at 3.50% until December 2020 and cannot fall below 2.50% during its life;

A new fixed rate bond maturing on 15 March 2026 paying 3.35% fixed for the whole term.

Both tranches are open to new investors.

Both tranches can be used for reinvestment by holders of the IFT200 bond maturing on 15 November 2019. This Exchange offer closes on 8 November so please act urgently if using this facility.

The offer documents are available on the Current Investments page of our website.

Please contact us if you wish to secure an allocation.

TRAVEL

Edward will be in Nelson on 12 November and in Auckland City on Thursday 21 November and Albany on Friday 22 November.

David Colman will be in New Plymouth on 14 November.

Edward and Johnny will be in Christchurch on Wednesday 27 November.

Mike Warrington

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