Chris Lee & Partners Ltd

Market News 30 October 2023

Johnny Lee writes:

One of New Zealand’s smallest listed companies is making a swing for the fences, as specialist wind farm operator New Zealand Windfarms seeks to transform its business.

NZ Windfarms has – or rather had - a market capitalisation of about $33 million, placing it alongside the likes of My Food Bag in terms of market value. This figure is already significantly higher following the announcement, which saw the share price climb over 30%.

NZ Windfarms has a long history on our exchange, dating back several decades. It operates the Te Rere Hau wind farm, a relatively small but profitable windfarm near Palmerston North, opened by former Prime Minister The Right Honourable Helen Clark in 2006. 

This lack of diversification has put off investors over the years, with some highlighting the risk of investing into a single asset versus investing into a larger company with a portfolio of different generation types and locations around the country. NZ Windfarms also has no retail network, instead selling its generation on the wholesale market. Its cash profits are therefore dependent on the value of electricity and the volume it produces from its windfarm.

The company has been making modest profits - most years - and paying proportionately sized quarterly dividends to shareholders. The company elected earlier this year to suspend dividends, citing its strategic growth aspirations. These aspirations are now reaching the next stage of development.

NZ Windfarms plans to ‘’repower’’ the existing wind assets in its Te Rere Hau wind farm, moving from a windfarm of 91 small, lower output turbines, into 39 large scale, modern turbines. The annual generation is expected to be almost seven times its existing output, and ultimately provide approximately 1.7% of our national electricity.

With a Final Investment Decision not expected until April 2025, and a construction timeframe of at least a further two years, this project will not pay dividends, literal or otherwise, for many years. Indeed, it is more likely to ask shareholders for money, than pay money to shareholders, in the short term.

The company also mentions that this project will mark the starting point of its transition into a larger scale renewable energy developer, with several other projects forming a pipeline of work, perhaps going some way to addressing any concerns about diversification.

Another important point regarding this project is the signing of a long-term PPA – or Power Purchase Agreement – an agreement whereby Meridian Energy agrees to purchase 100% of the electricity generated by the farm for 15 years. The actual price Meridian pays for this electricity will be variable, but does include a minimum (and maximum) to de-risk NZ Windfarms.

PPA’s are becoming more common for developers. They have been previously used by large electricity users – data centres, for example – as a way of fixing costs and ensuring the economics of new electricity generation stack up, at least during the early stage immediately after the project is operational. 

NZ Windfarms decision to tackle a project of this size is bold and will be a huge challenge, with new shareholders, new staff and frankly a new scale of business needed. It may also serve as a proof of concept, as the company begins to build a pipeline of projects going forward. 

During a time of market slowdown, when businesses are more likely to shutter projects than initiate new ones, the electricity sector is powering ahead with new investments.

_ _ _ _ _ _ _ _ _ _

Of course, such a business transformation will be extremely expensive. 

Alongside the announcement, NZ Windfarms also announced it would be raising capital from existing shareholders, as well as a bringing Meridian Energy onboard as a 13.04% shareholder through a separate placement. Between the placement and the subsequent capital raising, the company would be raising $13.7 million, about a third of its market capitalisation, a tall task for any company.

The full breakdown of this arrangement is a placement of 43.2 million new shares for Meridian at 15.5 cents, and approximately 39 million new shares for existing shareholders at the same price in a retail offer, which is to follow shortly, pending shareholder approval.

Meridian has also offered to underwrite some of this retail offer at no charge. If retail investors do not commit enough to the offer, Meridian’s holding will rise from 13.04% up to 19.99%.

This 19.99% percentage is usually chosen as it is the maximum allowed before triggering the threshold under the takeovers code. Presumably, Meridian does not yet have any interest in buying out the company.

Importantly, Meridian’s placement means it is acquiring its stake at a significant premium to the price at the time of the announcement. The 15.5 cents share price had not been seen since January this year. 

While this premium did exist, the share price reaction immediately following the announcement quickly marked it as a discount, although it remains volatile.

Ultimately, a $13.7 million capital injection is of little relevance to Meridian Energy, a company worth over ten billion dollars. Indeed, the announcement from Meridian regarding the deal was brief and of perhaps limited relevance for its own shareholders. Meridian has a number of large-scale projects underway already, and the success or failure of this particular project will not make or break the company.

But for NZ Windfarms, this raise marks the next chapter for the company. Once complete, NZ Windfarms expects earnings (EBITDAF) to rise from around $5 million to nearer $30 million.

NZ Windfarms’ existing shareholders will face something of a dilemma. Many purchased these shares to secure a dividend income in a small, somewhat niche operator of a green asset. Now, they are being asked to inject capital into the company and forego dividends for a period that may endure for some years. 

Indeed, millions have changed hands since the announcement, partly driven by profit taking, but also driven by the reality of what NZ Windfarms is hoping to achieve over the next five years.

NZ Windfarms also warns that a very large capital raising will be required at the aforementioned Final Investment Decision date (April 2025) to see the construction through to conclusion. The company estimates such a raise could be as high as $75 million, although construction costs are notoriously difficult to predict. $75 million would nearly triple the size of the company.

Such a capital raising will be an enormous challenge for the company. The initial raise next month may serve as a useful litmus test in this respect, and signal whether new, outside capital is required to see the project through while maintaining its proportional ownership in the project. Green energy investments remain popular globally, and Meridian Energy’s involvement adds some credibility to the project.

Should it fail to raise the requisite capital, Meridian would no doubt make up the difference, increasing its stake in the project while decreasing NZ Windfarms proportion.

Shareholders will be aware of this upcoming capital raise and will be pricing the company accordingly. One notes that the company is also separately seeking approval from shareholders to allow the company to issue up to 15% of the company by way of placement, giving them some flexibility to invite new capital into the company should it be needed.

If the company succeeds in raising the money – and if the company succeeds in its ambition to develop what will be the second largest wind farm in the country – the benefits to shareholders are obvious. Dividends will no doubt flow once more, and future growth will be unlocked as the company explores other asset development opportunities with the confidence of knowing it has the expertise and shareholder strength to take on bigger projects.

The next step is the shareholder vote. A special meeting has been called for December, with a date to be confirmed in due course. Either adopting this new strategy - or maintaining the existing approach - involves risks, and shareholders are encouraged to read last week’s presentation to familiarise themselves with these prior to the vote.

_ _ _ _ _ _ _ _ _ _

November is almost upon us, which means our market is about to deliver its final set of financial results for the calendar year.

Several of our largest companies are due to report, including Westpac (6th of November) Mainfreight (9th) ANZ (13th) and Infratil (16th) while both Ryman and Fisher and Paykel Healthcare are slated for the 29th. If dividends are announced, they are usually paid the following month.

Many of these companies have seen some volatility in the lead up to their respective announcements, with Mainfreight notably weaker over the last month. Ryman also had a poor showing in October.

October was a difficult period globally for shares, with giants Alphabet, Meta, Apple, NVIDIA and Tesla all seeing declines. Poor financial results, coupled with yet another international conflict escalating, has led to October being a ‘’risk off’’ month.

Outside of equities, the general trend of investors moving from shares to bonds continues. This has the secondary effect of reducing liquidity, as most of these investors then hold bonds to maturity. Most of our listed bonds now see a surplus of buyers, each competing for this diminishing pool of liquidity.

New bond offerings continue to see strong demand, with swap rates remaining near decade-highs. Investors seem happy to lock in long-term bonds at these levels, as both borrowers and lenders observe the fluctuations in interest rates.

Next month's results will provide the next clue as to the current state of New Zealand businesses. Judging by the recent movements on our sharemarket, expectations are low.

_ _ _ _ _ _ _ _ _ _

New bond issue

Channel Infrastructure New Zealand (CHI) has announced that it plans to issue a new 6-year senior bond.

Channel Infrastructure is responsible for importing, storing, and distributing 40% of New Zealand's total liquid fuel demand and 80% of its jet fuel demand. The company also owns the 170-kilometre pipeline connecting Marsden Point to Auckland.

It has long-term revenue contracts with BP, Mobil and Z Energy and is forecasting demand to remain at approximately 3,500 million litres of fuel for the next decade, dropping to approximately 3,000 million litres by 2050.

As at the end of September 2023, there were 63,000 fully electric light vehicles in New Zealand, up from 47,000 in 2022. There are currently over 4m petrol and diesel vehicles in New Zealand.

The bonds have a minimum interest rate of 6.75% which will be fixed for the 6-year duration.

CHI willbe paying the transaction costs for this offer. Accordingly, clients willnot be charged brokerage.

We have uploaded the investment documents and a presentation to our website below:

https://www.chrislee.co.nz/uploads//currentinvestments/chi030.pdf

If you would like a FIRM allocation for these bonds, please contact us promptly, with an amount and the CSN you wish to use. 

The offer is open now and closes at9am on Friday, 3 November.

Payment would be due no later than Friday, 10 November.

If you have any questions in relation to this offer, please contact our office and we will assist you.

_ _ _ _ _ _ _ _ _ _

Travel Dates

Our advisors will be in the following locations, on the dates below:

1 November – Palmerston North – David

2 November – Lower Hutt – David

9 November – Auckland (Albany) – Edward

10 November – Auckland (CBD) – Edward

17 November – Arrowtown – Chris

Clients and non-clients are welcome to contact us to arrange an appointment.

Chris Lee and Partners Ltd

Market News 24 October 2023

CHANNEL Infrastructure’s upcoming bond offer, expected to be for a six-year term, opens next week for fixed interest investors to consider as an addition to their portfolios.

The offer is effectively a refinancing of its existing bond, CHI010, which is subject to a possible redemption come March 2024. Assuming this offer is successful, the redemption is all but assured.

Those bondholders who currently own CHI010 directly in their own name – usually through a Common Shareholder Number or CSN – will not be able to simply roll over their existing bonds. In order to retain their bondholding, they will need to apply for this offer – settling November – and hope for repayment in March. Bondholders without such liquidity available will have the option of purchasing the new bonds on the secondary market in March.

The urgency of this raising may be the culprit behind this process. Many listed companies are closely monitoring the volatility in swap rates, which are once again approaching decade-high levels. For companies making barely $10m in net profit, the increase in interest expense over the past month has been significant.

The offer opens next week. Clients seeking an allocation are welcome to contact us.

_ _ _ _ _ _ _ _ _ _ _ _

THOSE unfamiliar with the recent developments of Channel Infrastructure may find a brief summary of the company helpful.

Channel has a long history dating back to the privatisation era of the 1980s and was previously known as New Zealand Refining. The company operated the Marsden Point Refinery, the only oil refinery in New Zealand.

Largely owned by the petrol distributors, this shareholder relationship was designed to incentivise both sides of the arrangement, with the refinery supplying its owners with end-use product, while the refinery had a customer base with no reason to source alternatives.

Over the years, New Zealand Refining shareholders dealt with an array of different market dynamics, but the undeniable trend saw refining margins – the price difference between the input and output of the refinery – retract. As the refinery was the primary source of revenue for the company, any closures for repairs would see revenue fall sharply, adding to the volatility of returns.

Other countries – particularly South Korea – began operating new refineries on a significantly larger scale. With New Zealand moving down a path of banning future oil exploration, the arguments of strategic importance and resilience became redundant.

The company underwent a dramatic change in November 2021. Following a shareholder vote, the company disestablished the refinery, changed its name (from NZ Refining to Channel Infrastructure) and became a fuel import terminal.  

This change meant that instead of importing crude oil and refining it into consumer products, the company simply imported and stored petrol and jet fuel on site, refined internationally. 

Since the new strategy was adopted, shareholder returns have begun to flow back to equity holders.

Its most recent result, released in August, saw a first-half profit of $14.5 million and a dividend of 4.2 cents per share declared. A second, larger dividend is expected in March.

Covid had a devastating impact on the facility’s throughput, as lockdowns caused planes to stay grounded and drivers to remain indoors. While volumes have not yet fully recovered, jet fuel demand in particular has rebounded, and now sits at about 75% of pre-pandemic levels. This recovery in jet fuel demand is expected to continue, as a number of airlines plan new routes and increased schedules.

The company trumpets its improvements in emission reduction, which sees it now claim only a tiny fraction of our listed companies’ total emissions. While some may scoff at such a statement, it is important to note that the company is focused on Scope 1 emissions and Scope 2 emissions – meaning the emissions involved in importing and distributing fuel, rather than the emissions released by consumer vehicles and planes.

The next step for the company will be to finalise the sale of its now-decommissioned refinery assets, which is in advanced stages. 

Moving forward, the company has ambitions to explore the hydrogen and biofuel space, leveraging its extensive storage facilities to offer scale in these spaces.

Electro-Sustainable Aviation Fuel, or eSAF, represents another opportunity for the company to push its green credentials. Air New Zealand, being Government controlled, has been vocal about its desires to reduce emissions. ESAF may provide a mutually beneficial solution, although the pace of change may not satisfy those seeking urgent reforms.

Amongst the concerns often expressed by investors, the most frequent is perhaps the fear of technological advancement – meaning cars and planes using fewer or perhaps no fossil fuels – making the company obsolete. Shareholders can take comfort from the fact that the company is well aware of developments in this space and is investing into areas - like biofuels - where it can play a role in leading the change.

Channel Infrastructure’s transformation over the past few years has left it profitable, dividend paying and forward thinking. Investing into oil importation and distribution will not suit every investor, but the company has eliminated many of the frustrations - from refining margins to refinery shutdowns - that plagued investors for decades. Its challenge going forward will be to ‘’read the tea leaves’’ as technology evolves and position itself as best it can for tomorrow’s world.

 _ _ _ _ _ _ _ _ _ _ _ _

ONE item of news that may have escaped readers’ notice was an announcement by Swiss food giant Nestle that it was to close one of its infant milk formula plants, located in Ireland.

Nestle is the world’s largest food company and dominates the infant formula market globally. It operates hundreds of factories worldwide. The closure of one particular plant, laying off 500 staff, may not necessarily be newsworthy to New Zealand investors.

What was interesting was the rationale given for the closure.

Nestle is closing the plant due to the steep drop-off in Chinese birth rates, which have fallen from 18 million births in 2016 to fewer than 9 million this year. The factory's supply was largely introduced to address the expected rise in demand from the Chinese market.

At the same time, Nestle notes that consumer preferences in the Chinese market have changed and it is now seeing sharp growth in locally-produced products. Companies with Chinese-labelled products and Chinese ownership may be navigating these preferences more successfully.

This aligns with A2 Milk’s recent statements regarding the shifting consumer preferences.

Similar dynamics are playing out across other products at the same time, as geopolitical tensions begin to cross over into economic preferences. The smartphone sector in particular is seeing shifts in consumer preferences, with buyers often citing loyalty to their home country as the driver of their decision.

This is not unique to China, of course. New Zealand has its own ‘’Buy NZ-made’’ campaign, aimed at persuading consumers to choose locally produced products.

Attempts by Nestle to sell the factory failed, perhaps unsurprising given the global economic climate.

Declining birth rates is a global issue, including in New Zealand. But sharp drop off from China in particular has caught many international firms off guard, after decades of ramping up demand to meet anticipated Chinese demand. 

Nestle’s announcement last week might be just one more data point highlighting the problem, as the infant milk formula market tries to find a balance between future supply and future demand.

_ _ _ _ _ _ _ _ _ _ _ _

NEW Zealand mid-cap Scott Technology has produced a strong result, with significant growth in revenue, profit and margins. The dividend of 4 cents was maintained.

Scott Technology is an automation technology company, creating and selling industry specific solutions including the BladeStop saw and its Rocklabs product for the mining sector. 

The BladeStop saw targets large users in the meat preparation space, marketed as one of the safest ways to operate such technology. It claims to have the fastest stopping time on the market, tested by braver people than me.

Product innovation continues as the company explores a newer, smaller version of the BladeStop saw, intended for supermarkets and butcheries.

Indeed the company has an impressive forward book, with almost $200 million in new orders for next year.

The company notes that its service business - the recurring revenue side of the business - is experiencing significant growth alongside its new customer wins. This includes its higher-margin consumable products.

Scott Technology has been a rare bright light in our market this year, with its share price up 35% against the backdrop of a market that has struggled with high interest rates. These struggles have been particularly evident with growth stocks.

Scott Technology may not yet be a staple of investor portfolios, but its continued growth has been impressive so far, and its order book will give management confidence in the short term. Factors such as labour shortages and rising labour costs will provide tailwinds for the automation sector. Indeed, the bigger challenge may be meeting demand, rather than finding it.

The share price rallied strongly after the announcement, as it now approaches record highs.

_ _ _ _ _ _ _ _ __ _ _

New Investment Opportunities

Auckland Airport Senior Bond Offer

Auckland Airport (AIA) has announced that it plans to issue a new 6-year Senior Bond.

The interest rate has not been set but will likely be in the vicinity of 6.20%.

AIA has a strong credit rating of A-

AIA will not be paying the transaction costs for this offer. Accordingly, clients will be charged brokerage.

More details regarding the bonds, including a presentation, have been uploaded to our website below:

https://www.chrislee.co.nz/uploads//currentinvestments/AIA270.pdf

If you are interested in an allocation, please contact us no later than 9am, Thursday 26 October with the desired amount and the CSN you wish to use.

China Construction Bank

China Construction Bank (CCB) has announced that it is making an offer of 3-year floating rate notes.

The interest rate is adjustable every three months. For the initial three months, it will likely be set at around 6.75% and will increase if rates rise or decrease if rates decline.

China Construction Bank is one of the largest banks in the world and has a strong credit rating of A.

This investment suits investors who are concerned about inflation and wants to protect themselves if rates rise further or stay high.

We have uploaded the investment information to our website below:

https://www.chrislee.co.nz/uploads//currentinvestments/CCB1126.pdf

CCB have confirmed that it will not be paying the transactions costs for this offer. Accordingly, clients will be charged brokerage.

If you wish to make a firm allocation, please contact us promptly with the amount and the CSN number

Please note that this investment offer closes tomorrow at 12pm, with payment due on 1 November.

_ _ _ _ _ _ _ _ __ _ _

Travel Dates

Our advisors will be in the following locations, on the dates below:

27 October – Christchurch – Fraser

1 November – Palmerston North – David

2 November – Lower Hutt – David

8 November – Auckland (Ellerslie) – Edward

9 November – Auckland (Albany) – Edward

10 November – Auckland (CBD) – Edward

17 November – Arrowtown - Chris

Clients and non-clients are welcome to contact us to arrange an appointment.

Chris Lee and Partners Ltd

Market News 16 October 2023

Johnny Lee writes:

Are we saying goodbye to another publicly listed company?

Last week, Sky Network Television has confirmed it has received a ‘’preliminary expression of interest’’ from a third party, and has chosen to suspend its share buyback programme while this is evaluated. The announcement did not disclose the identity of the bidder.

The share price responded positively, jumping 10% despite the absence of any information that might inform such a buyer. While such buying is clearly very speculative, the likelihood is high that if a takeover eventuates, it will be priced at a premium to market rates.

Of course, there are no guarantees that this will occur. Sky TV has labelled the takeover as highly conditional, language typically used when downplaying the likelihood of an offer progressing to a full takeover.

Even if a formal offer is made, takeover offers do not always have a successful conclusion for all parties. E-ROAD shareholders will be acutely aware of this, following the attempted takeover from Volaris. E-ROAD now trades at 68 cents, well below the offered price, a poor outcome for everyone except those who sold early to Volaris Group.

In this case, there may be some cause for optimism that board support will be forthcoming. It had been reported last year that Sky TV was actively courting Private Equity bidders to look at the company’s books, hoping to improve shareholder value.

Indeed, there will be more than a few happy shareholders should it proceed. Sky TV raised around $150 million at 12 cents per share in June 2020 as part of a rescue package. A significant amount had to be raised from underwriters, after retail investors wavered during the uncertainty of COVID.

Notably, the New Zealand Rugby Union chose not to participate in this offer, allowing itself to be diluted after acquiring a 5% stake in 2019. This stake was part of a settlement in exchange for broadcasting rights granted to Sky TV.

In September 2021, Sky then consolidated its shareholders, cancelling nine of every ten shares held, and effectively repricing the capital raise from 12 cents to $1.20. Today’s share price is more than double this figure.

Since then, Sky Television has gathered momentum, making profits again and paying dividends to reward those shareholders who held on. After fending off a brief flurry of competition from Spark, Sky Television has re-established itself as our pathway to watching (most) sport.

The offer may also face challenges in the form of the Takeovers Panel. Many a deal have been scuppered by the approval process.

The news last week regarding Sky Network Television will create excitement for shareholders and perhaps proves the value added by the post-COVID strategy.

Should it proceed to a full takeover and delisting, it will mark yet another major company to depart from our shores, barely a year after Z Energy left. To put it bluntly, we need new listings on our exchange.

But it is no sure thing. Hurdles remain and recent history tells us that these hurdles can be challenging to overcome.

Shareholders will receive correspondence directly from the company as more details emerge.

_ _ _ _ _ _ _ _ _ _

David Colman writes:

Fletcher Building investors face uncertainty again.

Pipes have been bursting in many recently built homes in Western Australia with more than 10,000 homes potentially at risk of severe water damage.

The pipes were installed by many builders including construction company BGC Australia PTY Ltd (BGC) and supplied by Fletcher Building subsidiary Iplex Australia. Issues appear to be concentrated in homes built between 2017 and 2022 in Perth.

BGC used the Pro-fit hot and cold water pipes in 11,817 homes and estimate the cost of replacing the pipes (if needed) at $60,000 per home.

Each reinstallation can take up to 6 months.

Homeowners need to find alternative accommodation while they wait for the remedial plumbing which involves:

- protecting the home from dust

- cutting into walls, ceilings, and floors (as applicable)

- removing and replacing pipes 

- repairing walls, ceilings, and floors to their original state

Iplex Australia manufactured the polybutylene Pro-fit water pipes for decades and discontinued the product in 2022.

The Pro-fit product was sold throughout Australia with the rate of failure in other states reported to Iplex Australia as being not materially unusual for the type of product.

In April, Iplex Australia established a A$15 million fund to provide financial support to builders and plumbers to repair leaks, fix damage, and replace pipes, while gathering data to understand causation.

Iplex Australia claims work with builders and its testing regime showed a correlation between basic plumbing failures/mistakes and the location of the plumbing failures which have occurred. The company does not agree that there is a manufacturing defect.

This month, BGC claims that a change made by Iplex in 2017, when it started using the Typlex1050 resin in the manufacture of the pipes, may be a factor that led to what it claims is a product manufacturing failure.

The Department of Mines, Industry Regulation and Safety (DMIRS) inspected 50 houses and concluded that workmanship was not the cause of the pipe failures and have referred the matter to the Australian Competition and Consumer Commission (ACCC).

Fletcher Building shares were placed in halt on Wednesday 11 October after it obtained a copy of the presentation given to media and analysts by BGC with the building company estimating costs of A$1.8 billion to fix issues associated with the pipes.

FBU provided a detailed presentation, regarding the situation, on Friday which strongly disputes the BGC presentation.

FBU described the BGC estimate of a A$1.8billion dollar cost to remedy the problem as “designed to be inflammatory” and instead suggested an industry cost could be between $50m to $100m which is not quite as headline grabbing.

FBU’s presentation showed that 10.9% of homes built, using Pro-fit between mid 2017 - 2022 in Perth, leaked in the last 2 years which was in stark contrast to 0.19% of homes built using the same product over the same timeframe in the rest of Australia.

FBU’s presentation noted that only 1 of the 28 homes (the 0.19% outside of Perth) that reported a plumbing failure was determined to have been caused by a manufacturing defect with 8 more yet to be determined/tested.

FBU argues the high rate of plumbing failures are unique to Perth where 65% of the applicable homes in the state were built by BGC.

Iplex’s investigations indicate many pipes in Perth were found to have been installed improperly with some bent beyond installation guide limits. Perth builders uniquely purchased the lowest ratio of elbows that allow for pipes to be connected on sharp angles.

Admittedly FBU’s presentation provided a compelling counter to BGC’s many hypothesises but so far it is still unclear which party will ultimately be held responsible for the faults and on the hook for the unknown costs associated with repairs.

Longstanding Fletcher Building shareholders and those involved with the building industry will be familiar with the kind of uncertainty that this issue raises and the potential material impact it could have for parties found liable.

While BGC and Iplex Australia both vigorously defend their positions it is expected that many more houses will report water damage associated with the leaking plumbing with new homeowners being the plumbing failure victims.

Auckland Airport Senior Bond Offer

Auckland Airport (AIA) has announced that it plans to issue a new 6-year Senior Bond.

The interest rate has not been set but will likely be in the vicinity of 6.20%.

AIA has a strong credit rating of A-

AIA will not be paying the transaction costs for this offer. Accordingly, clients will be charged brokerage.

More details regarding the bonds, including a presentation, have been uploaded to our website below:

https://www.chrislee.co.nz/uploads//currentinvestments/AIA270.pdf

If you are interested in being pencilled in for an allocation, pending further information, please contact us promptly with the desired amount and the CSN you wish to use.

When the offer opens next week, we will contact those who have been added to our list to seek confirmation before purchasing.

Travel Dates

Our advisors will be in the following locations, on the dates below:

17 October (tomorrow) – Wairarapa – Fraser

24 October – Takapuna, Auckland – Chris

25 October – Ellerslie, Auckland – Chris

27 October – Christchurch – Fraser

1 November – Palmerston North – David

2 November – Lower Hutt – David

8 November – Auckland (Ellerslie) – Edward

9 November – Auckland (Albany) – Edward

10 November – Auckland (CBD) – Edward

17 November – Arrowtown - Chris

Clients and non-clients are welcome to contact us to arrange an appointment.

Chris Lee and Partners Ltd

Market News 9 October 2023

Johnny Lee writes:

The Reserve Bank decision to maintain the Official Cash Rate at 5.50% was in line with market expectations, with little to suggest a change in course is likely in the near-term.

Inflation remains high, but is expected to soften and re-enter the target range (1-3%) by late next year. Barring any surprises in the short-term data, the path seems to have been well and truly set.

The Reserve Bank noted that import prices are easing, and while oil prices were elevated during the period, this too has reversed since the meeting was conducted. All signs seem to suggest that higher interest rates are having the desired effect on dampening consumer demand.

Concerns remain regarding the slowdown from China. China is, by far, our largest trading partner and the destination for most of our exports. A further slowdown in China will have wide-ranging effects, although one could argue that many of the factors driving the decline were predictable and have been anticipated for some time.

Falling birth rates, rising geopolitical tensions, and increasing credit concerns in the property sector are all contributing to declining sentiment. Youth unemployment is rising, although this data is no longer published after reaching a record high earlier in the year. 

As much of our international trade is now tied to China, those businesses positioned to address growing demand, among increasingly wealthy consumers, will be watching these developments carefully.

Our major bank economists now anticipate interest rates to completely plateau in 2024, in line with the Reserve Bank, with most anticipating 2025 as the earliest timeframe in which we may see a moderation towards a more ‘’neutral’’ rate.

Most of the ‘’risk’’ is seen on the upside – meaning that data may surprise by being stronger than expected, prompting higher rates. Inflation data is expected on the 17th of October, while labour market data is expected on the 1st of November. 

The next and last statement of the year is scheduled for the 29th of November. 

 Those watching markets over the last week or two will have noticed a shift in market pricing, as swap rates and investment yields climb higher, leading to a repricing of assets.

This increase in interest rates is occurring globally, with the US 10 year nearing 20 year highs and our own swap rates nearing 15 year highs. The US labour market continues to outperform expectations, causing headaches for the Federal Reserve, fearing the flow-on effects on inflation.

In the secondary market for listed bonds, several low-interest rate bonds are available at substantial discounts. This discount elevates the bonds effective yield, and many are now trading at yields of between 7.00% and 8.00%. The enhanced yield is a result of the capital gain that investors will realise upon the bond's maturity as in addition to the annual interest payments, investors will receive the full face value ($1.00) at maturity. For instance, if a bond is bought at 85 cents, it will mature to a full dollar, providing a 15-cent capital gain and thereby increasing the effective yield.

Even the now-infamous AKC130 – the Auckland Council Bond maturing in 2050 – is trading with a yield to maturity of around 6.65% per annum. This is equivalent to approximately 54 cents in the dollar, to those willing to consider such a long investment horizon.

Investors who may be interested in a list of low interest rate, high yielding bonds are welcome to contact us.

Anecdotally, the rising bond yields across the market are proving popular with investors. Secondary market activity from retail investors is increasing, as the dearth of new bond listings and excess levels of cash lead investors to top up portfolios with existing bonds. 

The risk with this approach, of course, is if interest rates climbed higher. There is also always going to be the risk of bond default, although slim, is a risk that will vary from issuer to issuer.

While the term deposit market has not yet seen a significant repricing, it is inevitable that maturing deposits will not be retained unless rates remain competitive. The term deposit market remains inverted or ‘’downward sloping’’, meaning the highest rates available are for shorter-term investments.

Dividend yields are also rising. While dividend values themselves are only seeing modest increases, yield stocks have been battered as investors continue to sell shares and move into high yielding bonds. The likes of Spark, Chorus and Meridian Energy have all seen their share prices move lower, as the ‘’flight to yield’’ continues. With a reduced share price, the dividend yield is of course higher, presenting an opportunity for long-term investors.

At the same time, companies are paying dividends, which pushes share prices lower as cash leaves the balance sheet. Readers with shareholdings across the NZX would have seen these payments arrive in their bank accounts over the last few weeks, following the conclusion of ‘’dividend season’’.

Complicating all of this is the escalating situation in Israel, the ongoing war in Ukraine and our own imminent election. When geopolitical tensions rise, it is normal to see investors reduce risk, fleeing equities in favour of bonds and Government stock. The oil price may also see volatility.

The last few weeks have seen the market reprice itself, and this market repricing will soon find equilibrium again. Rising dividend yields will entice buyers back into equities, while bond yields will eventually reach points where sellers lose interest. 

Until this equilibrium is found, investors with surplus cash have improved options to consider, both in terms of listed bonds and listed shares.

A brief update from the listed property trust sector.

Stride Property’s update to the market has continued the negative trend across the sector, with another devaluation, this time of -4.7%.

Investore, the separately listed entity managed by Stride’s investment management arm, had an even larger devaluation, with the portfolio falling -6.6% in value. 

Property trust valuations have been under pressure this year, with high interest rates causing borrowing costs to increase, and lowering the value of fixed cash flows.

Net tangible assets have been declining in line with these falls. Despite this, companies continue to trade at steep discounts to these levels, perhaps reflecting a market anticipating further declines in valuations.

Trading at such steep discounts makes it difficult for these companies to raise capital. Only five years ago, it was typical to see these companies trade in excess of NTA, leading many to raise capital and either rebalance their debt levels or resize their portfolios. With discounts now the norm, even steeper discounts would be required to entice investors to part with further cash. This is not impossible, but has been rare since the inflationary cycle began. 

Despite these devaluations this week, distributions have been relatively consistent across the sector and income for shareholders maintained, perhaps the only silver lining during a difficult period for the listed property sector.

New bond issue

Kiwibank (KWB) has announced that it plans to issue a new 5-year senior fixed rate note.

The interest rate has not been set but will be in the vicinity of 6.25%.

KWB has a strong credit rating of AA.

KWB will not be paying the transaction costs for this offer. Accordingly, clients will be charged brokerage.

More details regarding the notes, including a presentation and investment statement, have been uploaded to our website below:

https://www.chrislee.co.nz/uploads//currentinvestments/KWB1028.pdf

If you are interested in being pencilled in for an allocation, pending further information, please contact us promptly with the desired amount and the CSN you wish to use.

When the offer opens later this week, we will contact those who have been added to our list to seek confirmation before purchasing.

Summerset Senior, Secured Bonds

We've secured a limited quantity of Summerset's 6.59%, 5.5-year senior secured bonds. The total price, accounting for accrued interest and brokerage, is below par (meaning 10,000 bonds are priced slightly under $10,000). If interested, please email us and we will send through a contract note.

Travel Dates

Our advisors will be in the following locations, on the dates below:

11 October – Christchurch – Johnny

17 October – Wairarapa – Fraser

24 October – Takapuna, Auckland – Chris

25 October – Ellerslie, Auckland – Chris

27 October – Christchurch – Fraser

1 November – Palmerston North – David

2 November – Lower Hutt – David

8 November – Auckland (Ellerslie) – Edward

9 November – Auckland (Albany) – Edward

10 November – Auckland (CBD) – Edward

17 November – Arrowtown - Chris

Clients and non-clients are welcome to contact us to arrange an appointment.

Chris Lee and Partners Ltd

Market News 2 October 2023

David Colman writes:

Today marks the start of a new quarter.

The first month of the quarter will see an election with voting closing on the 14th, a monetary policy statement and OCR announcement tomorrow, and the next inflation update on the 17th.

The last quarter ended with interest rates sharply up both locally and internationally.

US 10-Year Treasury rates are at a level not seen since the 2007-2008 financial crisis, in line with a growing realisation that interest rates potentially could remain at current levels for a much lengthier period than thought, or perhaps increase.

Technology companies with any inkling of having AI exposure have bucked the overall trend this year with markets for the year performing poorly as they tend to do as interest rates and associated borrowing costs hamper margins, growth prospects, and profitability.

October is a month irrationally feared by many investors due to major market failures such as the Panic of 1907, the 1929 Crash, and Black Monday in 1987, all occurring in the month.

Some might consider October a good month for companies with confectionery exposure, given the insatiable appetite of Halloween trick or treaters on the 31st. Inflation and cost of living increases may mean costumed youngsters will get less brand name candy this year.

Statistically, September has been historically worse for investors on average than October, but really there is no time of year that anyone should fear financially in isolation if they have a reasonably diverse portfolio and a longer-term investment horizon not governed by month-to-month performance.

The most recent crash occurred in March 2020 on global pandemic concerns.

The NZ50G fell to as low as 9,201 points on 20 March 2020 and today sits just above 11,178, the lowest level this year which occurred just two business days ago on Thursday 28 September 2023.

Unfortunately, this level is well below the January 2021 peak of 13,558, with portfolio values of late reflecting the impact of rapid inflation and interest rate increases.

Global economic conditions have deteriorated as a larger portion of government, corporate and household spending is used to service debts that grew larger through the height of the pandemic and have become costlier to service since.

Growth companies have been most affected by the deterioration as funds are harder and more expensive to raise and prospects of rapid success are more difficult. The gold price is also vulnerable to higher funding costs.

Risk appetite has fallen, dampening demand for shares, with savers able to access less risky fixed interest investments for income at levels much higher than when governments and central banks were propping up countries through the height of Covid concerns, offering free money.

For income investors, not seeking growth, interest rate increases are welcome.

Bond yields have improved to levels that in many cases exceed dividend yields for shares with the same company.

Precinct is one recent example - its 3-year convertible notes (PCTHB) issued in September provide a fixed income at 7.56% per annum which is higher than the Precinct (PCT) dividend yield of 5.87%, based on the PCT share price and last year’s dividend payments. This simplistic example ignores the potentially different tax implications involved and that the notes and shares do not have the same growth, risk, and other characteristics.

_ _ _ _ _ _ _ _ _ _ _ _

Newcrest Mining (NCM.ASX) shareholders will have until Friday 13 October to decide whether to vote in favour of a scheme in relation to the proposed acquisition of Newcrest by Newmont, the global gold giant.

If the scheme receives shareholder and court approval, then NCM.ASX shareholders will receive 0.4 Newmont shares (last traded at US$37.28 under the code NEM) for each Newcrest share and a franked special dividend of US$1.10 per Newcrest share.

If the shareholders are on the Australian register, they will receive Newmont shares in the form of Newmont CDIs (CHESS Depository Interests) which will be listed on the Australian exchange.

Some New Zealand tax resident shareholders may be considering selling their NCM.ASX shares if the scheme is approved as they may wish to avoid holding Newmont shares (which are shares on the New York Stock Exchange and Toronto Stock Exchange but will be represented on the ASX as Newmont CDIs and in Papua New Guinea as PDIs).

As part of the scheme, if approved, the special dividend may influence New Zealand tax residents to sell on a cum-dividend basis due to the zero benefit from the franking credits that an Australian resident would receive.

Theoretically, it is possible that on the special dividend ex-date the share price will fall closer to the net benefit for an Australian tax resident (dividend plus franking credits) rather than the net benefit to a NZ tax resident (dividend and no franking credits).

Cum-dividend dates are 16 October and 17 October with the ex-dividend date on 18 October which is also when the court approval decision is due which may affect whether the scheme is implemented or not adding to the complexity of decision making for shareholders.

If any Newcrest shareholders would like to discuss the scheme please contact me.

_ _ _ _ _ _ _ _ _ _

The Warehouse Group (WHS) Full-Year Results released on Thursday showed the retailer’s gross profit margins were squeezed due to rising inflation, increased cost of living and rising interest rates for customers at the same time the group was at a peak year of spending on a transformation programme.

Group sales were up 3.2% on FY22 to $3.4billion.

Gross profit was down 2.4% to $1.13billion.

Net profit after tax was down 56% to $37.5million.

Net debt increased marginally to $48.1million from $41.2million for the year but was down significantly from $83.4million at the FY23 half year.

A final dividend will be welcomed by shareholders after no interim dividend was paid, with a final dividend declared of 8 cents per share, consistent with the group’s dividend policy to pay out up to 70% of NPAT.

All divisions including The Warehouse, Warehouse Stationery, Noel Leeming and Torpedo 7 saw gross profit margins decline.

The Group’s largest brand, The Warehouse, which operates 88 stores across New Zealand, recorded a record $1.9 billion (up 9.6%) in sales during a tough economic environment with sales growth slowing from 4.8% in the first half to 1.4% in the second half. Operating profit was $71.6m (down 5.5% on FY22).

Grocery shopping at The Warehouse has grown significantly but difficulty competing in the grocery space is evident with last week’s media coverage of Sanitarium (ironically for an organisation that operates as a charity) choosing not to supply The Warehouse stores with Weet-Bix, seemingly in favour of other operators in the grocery space compelling The Warehouse Group to write to the Commerce Commission to investigate.

The Warehouse will be hoping that the Grocery Industry Competition Act introduced in July and New Zealand’s first Grocery Commissioner Pierre van Heerden delivers on the goals of increasing competition in the space.

This may allow The Warehouse a greater opportunity to compete and gain market share from the powerful New Zealand grocery duopoly of Foodstuffs (operator of New World, Pak’nSave, Four Square, Gilmours and Liquorland) and Woolworths Group (subsidiary of Australian Woolworths Group and operator of Countdown, Woolworths, SuperValue and FirstChoice).

Warehouse Stationery, which operates 66 stores recorded sales of $248million (down 0.4%), with operating profit of $23million (down 0.2% on FY22).

Noel Leeming (67 stores) dropped in sales to $1.06billion (down 3.3%) with operating profit cut in half to $27.3million (down 49.3%) driven by customers affected by the increased cost of living, reducing demand for higher priced discretionary products.

Torpedo 7 (25 stores) dropped in sales to $162.2million (down 5.4%) and reported an operating loss of $22.2million. This is a substantial decline from a loss of $2.2million in full year 2022. Demand for bikes has cooled dramatically since Covid and the wet summer and late ski season impacted seasonal sales.

The Market, which is the Group’s online platform, did not get much attention in the results.  It made an operating loss of $22million and is described as in its early days with indications of good uptake from customers and suppliers.

Recognising that full-year 2023 was a challenging year, the WHS outlook states that initiatives to improve operational performance will continue.

Unexpectedly, full-year 2024 has started with softer sales and the business remains cautious leading up to the busiest time of the year before and after Christmas.

A Torpedo 7 recovery plan is in place for the most difficult brand. Notably Torpedo 7 is a smaller division of the group, representing just 4.8% of sales compared to 55.7% for The Warehouse, 31.2% for Noel Leeming, and 7.3% for Warehouse Stationery.

Spending plans have been slashed to $80million for FY24 compared to $154.4million spent in FY23.

WHS shares traded as low as $1.69 following the announcement and were down about 35% for the year to date and down $1.50 or 47% in the past year, correlating with the difficult retail environment for the company over the same time frame.

_ _ _ _ _ _ _ _ __ 

Hallenstein Glasson Holdings (HLG) released full-year results ended 1 August 2023 with group sales of $409.7million (up 16.7% on the prior year).

Net Profit after Tax increased 24.9% from $25.61million to $31.98million.

The company’s strong balance sheet allows HLG to pay a final dividend of 24 cents which will be 75% imputed (the interim dividend of 24c was not imputed).

Glassons Australian sales increased by 21.8% to $191.23million but NPAT fell by 10.5% to $17.11million with intercompany changes impacting the profit figure.

Glassons New Zealand sales increased by 7.7% to $112.45million and NPAT increased by 167.1% to $10.89million, again intercompany changes impacted the profit figure.

Hallenstein Brothers (New Zealand and Australia) sales increased 17.9% to $106million with net profit up 85.7% to $3.89million.

E-commerce declined by 23.5% which appears to be a trend across the retail industry post Covid restrictions, with customers likely preferring to shop in person with a fashion retailer where physically trying on clothes before purchase is traditionally a prerequisite.

Online sales represent 18.29% of total sales, down from 27.88% in the prior corresponding period.

Covid conditions pushed online sales to very high levels and HLG notes that online sales are 71.4% higher than the 2019 financial year before the pandemic when they represented 15.20% of total sales.

Future outlook noted that group sales for the first eight weeks of the new financial year have declined by 5.86% with economic conditions and cost-of-living pressures impacting consumer spending habits.

A warm winter has made clearing winter products more difficult, but HLG is encouraged by the reaction to new season products.

The company is pleased that, despite a stronger US dollar, gross margins are tracking ahead of the prior year, reflecting excellent supplier relationships and lower freight costs.

HLG is looking for operational efficiencies, cost efficiencies, and agile product management to position it well for the peak trade season ahead.   

_ _ _ _ _ _ _ _ _ _ _

Kiwi Property (KPG) is proposing to amend the Gearing Ratio set out in the Master Trust Deed by increasing it from 45% to 50%.

Holders of three of the KPG Bonds (KPG030, KPG040 and KPG050) have been asked to vote on a special resolution to approve the amendment, with a meeting scheduled at 1pm on Friday, 20 October. The meeting will be held at the Russell McVeagh offices in Auckland but I suspect most bondholders will either appoint a proxy or simply vote online at investorcentre.linkgroup.nz/voting/KPG. 

In November 2022, KPG agreed with its bank lenders to increase the maximum gearing ratio under its bank lending documentation to 50% (from 45%) once it no longer has any Bonds outstanding with a maximum Gearing Ratio of 45%.

A gearing covenant requires a company to keep finance debt below a percentage of the total tangible assets of the company with an unremedied breach of the gearing covenant being an event of default.

KPG has since issued a new series of Bonds (KPG060 issued in March this year) with a maximum Gearing Ratio of 50%.

The Gearing Ratio Amendment, if approved, will ensure KPG’s Gearing Ratio covenant is consistent across its funding arrangements. It will also better align KPG’s financial covenant arrangements with other New Zealand listed property trusts.

To persuade bondholders to vote in favour of the amendment KPG will pay a consent fee to bondholders who vote in favour of the amendment. The consent fee will be 0.50% of the principal value of relevant bonds held. For example: If a relevant bondholder has 10,000 bonds and votes in favour of the amendment they will receive a one off consent fee of $50.00.

KPG notes that the consent fee is not an interest payment and will not be taxed as such, which likely requires the recipient of the funds to include the consent fee as part of their income tax return.  We ask bondholders to consult a tax adviser to confirm their tax obligations.

Controversially, no fee will be paid to those who abstain or vote against the amendment even if the amendment is approved, resulting in those holding the same bonds being treated differently.

I would have expected that all bondholders affected by the amendment, whether they vote for the amendment or not, would be compensated for the change if it occurs.

KPG’s average gearing ratio over the past five financial years (2019 to 2023) is 32.3%, was 35.0% as at 31 March 2023 (the most recent reporting date), and 35.8% at 31 August. Further property valuation declines and any increases in borrowing would drive the gearing ratio higher.

The way the KPG amendment is being conducted gives me the further impression that bondholders do not seem to benefit from the same equal rights expected by shareholders.

Earlier this year Genesis Energy offered an option (the ability to exchange old bonds for new bonds) to those who held bonds in custody that was not available to all bond holders such as those who held bonds directly under a CSN.

In June I wrote to the FMA regarding the Genesis bonds scenario above and received a reply in July that the FMA does not provide legal opinions but that they were not aware of bondholders having the same comparable statutory provisions that shareholders receive under section 174 of the Companies Act 1993.

It seems that if the terms of the applicable bond trust deed allow it, then bond holders can be treated differently depending on the circumstances.

I have written to the FMA regarding the Kiwi Property Group scenario as well and look forward to their response.

_ _ _ _ _ _ _ _ _ _ 

Travel Dates – October

Our advisors will be in the following locations, on the following dates:

11 October – Christchurch – Johnny

17 October – Wairarapa – Fraser

24 October – Takapuna, Auckland – Chris

25 October – Ellerslie, Auckland – Chris

27 October – Christchurch - Fraser

Clients and non-clients are welcome to contact us to arrange an appointment.

Chris Lee and Partners Ltd