Chris Lee & Partners Ltd

Market News 24 September 2018

Fonterra took 200 senior staff to California for a business meeting!

This speaks volumes.

Clearly the improvement and expansion of communication technology has not enhanced their ability to communicate without being by each other’s side.

Fonterra’s self-entitlement (shared by many others – Ed) is staggering; until you are reminded they are using Other People's Money.

INVESTMENT OPINION

US Federal Reserve – The Chairman of the US Fed, Jerome Powell, has been speaking kindly of late about previous Fed Chairman Alan Greenspan and I wonder whether he is hinting at an imminent end to the current cycle of interest rate increases.

Greenspan became known as the great dove of US monetary policy, criticised during one reflective period as having left monetary policy too loose, contributing to the problems that arose in 2008 (GFC related to excess use of debt).

However, some are now reflecting on the economic successes that occurred during Greenspan’s time, with low interest rates supporting growth without the return of uncontrolled inflation.

Notes connected to a recent speech from Jerome Powell:

Alan Greenspan suspected that the economy’s productive capacity was rising rapidly, and so he resisted calls from his colleagues to raise interest rates to prevent overheating and inflation.

‘Under Chairman Greenspan’s leadership,’ Mr Powell said, the Fed ‘converged on a risk-management strategy that can be distilled into a simple request: Let’s wait one more meeting; if there are clearer signs of inflation, we will commence tightening’.

(Essentially applying a process of test the theory, monitor, and test it again, to identify the appropriate dose.)

Inflation fell rather than rose, and the Fed’s caution enabled a boom that drove wages up and unemployment down.

US interest rates will tell us soon enough if they think Powell is about to pause with interest rate increases (probably prior to Christmas 2018) and their consolidated view about such an action.

The share market harbours a mild concern about the damaging potential of a meaningful increase in interest rates, so if this threat was not imminent the share market would respond positively and may already be doing so.

Trade War – The US led trade war continues, and in my opinion, it will not resolve itself during this term of the US Presidency (until 2020), which will impact economic activity and thus company valuations.

In fact, it seems more likely that the scale of trade impacted by tariffs is more likely to increase between now and the 2020 election.

Presidents Trump and Xi won’t be able to pass by their own egos in this negotiation so it will last a long while; longer than most expect or want.

Observers believe that Xi will use his claimed ‘President forever’ time frame to try and outlast Donald Trump with this negotiation. He will therefore presumably personalise his actions and comments against Trump to say to the wider US population that ‘in time this too shall pass’.

Xi would be correct with the statement that the problem will pass, given time, but I suspect the US population will agree with Trump that the regional and political targeting of tariffs by the Chinese is in fact an attempt at electoral manipulation and it has the potential to increase support for Trump.

It makes the Chinese little different to the Russians who delivered their messages via technology.

It is this behaviour by President Xi, and the zero chance of President Trump backing down that leads to my opening opinion for investors that this influential trade war will not be resolved soon.

If the world’s largest economies are intentionally try to be disruptive, they will succeed and this will impact the values of businesses that we own, because economies are made up of ‘our’ collective businesses.

After President Trump’s tax cuts were factored in, the US share market began to fall, including a sharp decline in February 2018, testing the confidence of views held by investors. However, during the period of tariff installation the US share market has done little but rise (approx 10%).

Meanwhile the Chinese stock market is 20% lower for the year.

Trump will view this as the equity shift he seeks for his economy. He will be emboldened by this and the very low unemployment conditions in the US. He will not back down.

If Trump can secure improved trading conditions from negotiations with Canada (Mexico is done), and then Europe, his next tactic would be to step up the pressure on China, not back it off.

Imagine if the US then expanded trade agreements with Korea (North and South), and Japan, Malaysia and Indonesia?

Do you think Trump could encourage Apple to do more manufacturing in, say, Indonesia in return for a little financial relief? (or Pyongyang – Ed).

President Xi needs to encourage his people to increase their consumption to improve his negotiating power, but until that time the US holds a hand full of Aces.

Until this ‘Game of Trade’ is settled (Trump wants the Iron Throne – Ed) we investors will be forced to ride out some unpredictable volatility (risk), so once again, make sure your own investment settings (cash, weightings to fixed interest, property and shares) suit your circumstances, under all financial market scenarios.

Apple – a brief note about Apple. I read that they may be trying to launch phones that will not require a physical SIM card, using an ‘eSIM’ method instead.

The ambition is to further disrupt pricing from phone service providers by removing the need to change a physical SIM to change providers, thus enabling users to change provider by the day, subject to price of service.

If Apple can convince regulators to support such a change (why wouldn’t they?) then Apple would gain from this display of delivering value to its customers (in return for its expensive phones! – Ed)

Infratil – The takeover offer for Tilt Renewables (TLT) presents you with a good example of the difference between consultants' theory and real investment decisions.

Infratil and Mercury Energy offered to purchase the balance of the shares in TLT at a price of $2.30.

The valuing consultant (Northington Partners) issued its report for the directors of TLT declaring a valuation range of $2.56 - $3.01, yet in the most bullish share market that many of you will have ever known the market declares that it is satisfied with a share price of $2.33 (at the time of writing).

As a backup assessment of money at work, you might look at Infratil’s own share (IFT).

Its share price, performing nicely of late, sits dead still at $3.50 immediately after being told that ‘we’ are not displaying enough respect for the value of IFT’s fourth largest asset (TLT is approx 12% of assets).

A 15% valuation error of TLT by IFT shareholders, according to Northington Partners, is worth about $70 million (51% ownership of TLT at 45 cents per share between market trading and the valuer’s opinion), which in turn is worth about 12 cents per IFT share.

Side Bar – IFT’s directors think the market discounts its share price by far more than just this 12 cents (assets relative to share price), but in Northington Partners we also have an independent opinion.

However, my point for investors is that where the rubber meets the road investors making decisions with real money are logically factoring in more risks than the theoretical valuer (One’s Amygdala is more useful than another’s spreadsheet).

If the market is correct about trading Infratil shares at a discount to asset values (ascribing no value to future opportunity) then Infratil is also correct to discount Northington Partners' optimistic views about TLT’s possible future values.

A patient approach to buying the balance of TLT would be consistent with the behaviour of IFT’s own shareholders' opinions about value.

INVESTMENT NEWS

Confidence – We’ve all read about business confidence slipping but now consumer confidence is moving lower too.

It would be too easy to connect this all to government politics.

I suspect it has more to do with local politics (incessant, excessive, increases to rates), to oil pricing and taxes (a sharp lift in expense to everyone’s wallet) and insurance (another sharp lift in cost for most).

In a Wellington context, increased parking charges complemented by incompetent management of public transport, making our movement harder or more expensive.

Just little things, but they add up to a retreat in confidence, even in the face of robust employment statistics.

No inflation to see here.

Post Script: The well debated GDP story turned out to be a strong +1.00% for the June quarter (+2.80% year on year) confirming that business activity was good and that the risk of interest rate cuts has diminished for now.

Pay– An ANZ chart last week displayed New Zealand’s savings rates and the simplistic conclusion that I reached was ‘the average NZ household is not being paid enough’.

I don’t say this to bolster unionists’ energy or lobbyist headlines, but I am pleased the minimum wage is on the rise.

The savings rates for government and business sectors were rising and have been since 2008 (good behaviour, especially if debt reduction is the focus) but the Household savings rate is negative again and has been since 2011 (spending more than they are earning).

It’s a concern to think that during the life of Kiwisaver net household savings have been moving backward.

As I understand it we can’t achieve savings in all sectors unless NZ becomes a more successful exporter, making our nation a net earner, but it would be nice to see a better balance between savings achieved across business and households (more pay for households, which I hope they’ll save some of).

The current high savings rate by business might explain some of the various special dividends being paid out from businesses who appear to have reached a point of having too much equity on their balance sheets, which helps to support their share price.

(Strange thing for an investor to say, get pay up and dividends down -Ed)

Individually, that would be true, but holistically I wonder if higher pay will be better for the wider economy and not (yet) inflationary as I doubt pay increases will provide sufficient discretionary spending capacity to push inflation.

Maybe the better paid employees will be marginally more productive in response to a pay increase?

How do you think the 21,200 (less important) Fonterra employees not invited to the California junket feel right now, and how might they have felt if they were offered an unexpected pay increase instead of money being wasted by the ‘special 200 employees’?

Cash – Many readers will be pleased to read that the demise of cash is a long way away, and that online payments and cryptocurrencies will not be the reason for its demise.

The European Central Bank, like others before it, have stated that they have no plans to introduce a cryptocurrency but, in the same breath, they do intend to continue to upgrade their cash (notes) to further improve security features against counterfeit.

Not only that, but they are currently upgrading the 100 and 200 Euro notes.

I had always thought that governments would instruct central banks to begin removing large notes (100 and larger) to minimise the potential for money laundering through cash transmission, but there is no evidence of this happening.

I hope this doesn’t mean that too many ‘people in government’ are benefitting from the illicit transmission of value via cash.

From memory, even New Zealand’s volume of $100 notes on issue is increasing. The village-like scale of our economy would make us an excellent jurisdiction to test the merits of removing large notes to try and herd more economic activity to be recorded across the regulated bank environment.

Heartland Bank – users will likely be pleased to learn that HBL has (finally) launched an App so banking instructions can more easily be issued by you, from anywhere.

It works well (personal test).

Voting – We are in the midst of voting season again.

I hope you are all submitting your online votes, or at the very least are passing ‘Open’ or ‘Proxy Discretion’ votes to the NZ Shareholders Association to represent your interests.

EVER THE OPTIMIST– If you measure success by cranes…

Apparently, we are experiencing a new high for the number of cranes on our skyline at 140, up 15 over the past six months (with less having the Fletcher logo painted on them – Ed).

INVESTMENT OPPORTUNITIES

Turners Auctions – subordinated bond offer closed today.

Thank you to all who participated in the offer with us.

Property For Industry – issued its senior bond (7 year) last week at an interest rate of 4.25% p.a.

Thank you to all who participated in this bond offer with Chris Lee & Partners.

Auckland Airport – AIAL has announced its intention to offer a new 6-year bond (2024) with bidding for allocations on Wednesday 26 September.

We currently estimate a yield of 3.40% - 3.50% for this bond.

We have a list for investors wishing to participate in this offer and need to hear from investors by no later than 5pm tomorrow (25 September).

What’s next?

Infratil has a bond maturing in November (IFT180), so they may be preparing to approach the markets;

Investore Property (IPL) stated in their financial update earlier in 2018 that they may wish to issue a new bond for funding. They may be inspired by the bond issue success experienced by Summerset and Property For Industry;

Sky City Entertainment (SKC) stated late in 2017 that they also were considering bond funding for their mix;

I remain surprised that Fletcher Building has not sold its surplus capital notes (held on balance sheet). The market yields are relatively low when compared to their bank funding options and as a biased shareholder I think there are far better places to apply this money (expand for constructions of more prefab homes?);

The cost of debt is relatively low, as you know, so businesses accumulating too much equity will be considering additional debt to increase investment (e.g. Auckland Airport) or to release retained earnings via special dividends (e.g. energy companies, NZX, Port of Tauranga etc).

***After writing this paragraph Auckland Airport announced its new bond, above)***

The Financial Markets Conduct Act (FMCA) has enabled rapid issuance of bonds, once the first tranche is listed on the public market (NZX), so they can arrive at quite short notice (and can be increased in size at short notice too, witness SUM020 last week).

This rapid issuance capacity under the FMCA is good for the depth of our debt capital market (bonds).

Vodafone must be forecasting a better profit in the year ahead because the incoming CEO made a statement that a share market listing is being considered again for 2019.

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

TRAVEL

Edward is in Nelson on 2 October.

Mike will be in Tauranga on 5 October.

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

 

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

Michael Warrington

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Market News 17 September 2018

President Erdogan is at it again in, naming himself as the new Chairman of Turkey’s sovereign wealth fund.

That’d be like Winston Peters naming himself Prime Minister of New Zealand.

Wait…. has that happened already?

INVESTMENT OPINION

Unlearn – What do we need to unlearn as investors to be successful in future?

I have spent various moments over the past couple of weeks asking myself ‘what do I need to unlearn?’

‘Am I letting any old thought processes, or firmly held beliefs, distort the clarity of the current situation?’

It is too easy to become complacent about how the dominoes (measurable risks) are stacked (old developed thesis on likely outcomes) and thus how they will likely fall once we spot the instigating force (breached pressure point)?

Over 33 years of involvement forecasting outcomes has never been as simple as my metaphorical dominoes present so it won’t be easy next time we experience dramatic change either.

One may as well spread the dominoes in random places around the room and still carry the view that they are all likely to topple at some point for reasons that are as yet unknown.

I listened (online, as you do) to an interesting interview of Ben Bernanke (US Federal Reserve), Tim Geithner (Federal Reserve Bank of NY) and Hank Paulson (US Treasury) reflecting on how they tackled the Global Financial Crisis; how it felt at the time given their skills and beliefs at the time and what they might change based on 10 years retrospective knowledge.

They all conceded that whilst they thought they knew which dominoes to remove from the sequence (my words not theirs), and removed them (by injecting massive sums of money), the confidence they presented in public was many times greater than their unspoken fear about the frightening possible outcome(s).

This disconnect reconciles well for me, as it should for all investors.

Nigel Latta would describe it as a tussle between each human’s reptilian fear (survival instinct) and the wider brain’s ability to assess facts.

I haven’t defined any old investment rules that I’d like you to unlearn, but as I write I have been thinking of a few threads, so I’ll phrase them as questions, that perhaps require new learning:

If a period of uncomfortable inflation returns to our economy will the Official Cash Rate (OCR) simply be lifted high enough to create a negative yield curve (short term interest rates above long-term interest rates) to pressure debt repayment or will macro-prudential tools be used more forcefully to ensure price stability?

Conventional thinkers will invest in expectation of higher interest rates.

I suspect we may need to unlearn this one and focus more on the use and impact of other regulatory tools used to control financial behaviour.

Do ultra-low interest rates (negative real yields) always deliver inflation?

It’s reasonably clear that very low interest rates result in higher relative use of debt and higher relative valuation of assets, but I think it is beginning to look as if the link between cheap money and inflation is weakening.

High debt levels, no matter how cheap, may be suppressing the wider population’s confidence with discretionary spending capacity (as it should when you’ve run out of your own and other peoples money! – Ed).

It’s only discretionary spending that can choose to continuously pay higher prices (inflation).

Does relatively high unemployment mean that an economy has capacity to expand further, without being inflationary?

NZ has expanded well without inflation during one of our fastest declines in unemployment that coincided with one of our highest levels of immigration.

What if that NZ unemployment ratio of about 4.00%+ of the economy is the equivalent of full employment as a consequence of our generous social support settings?

US unemployment is continuing to fall below that of NZ without the same level of social support.  

Maybe the current situation provides good reasons for NZ to push minimum wages up well beyond the level of our social benefits to either encourage more attempts to gain employment.

Businesses would like you to believe that higher wages (widely shared) will be damaging to the wider economy, to their business and thus to your share price, but what if higher minimum wages resulted in higher productivity?

What if Donald Trump isn’t a Goose, what if he really is a US Eagle?

No, that one’s a bridge too far in my quest to unlearn.

Financial markets, across all assets, continue to price in a fear of rises, or sharp rises, to interest rates. Believe it or not it holds back some of the bullish fervour that would otherwise be displayed in higher share and property prices.

What if their underlying thesis about interest rate behaviours over the next 10 years is wrong?

Stay on your toes. Keep iterating the possible outcomes. Keep getting financial advice for a different perspective.

I am happy to debate other firmly held beliefs that you base your investment decisions on.

Demographics – A couple of weeks ago I read a headline that unintentionally drew a smile; ‘Too many of us are aging at the same time’.

Clearly, we all fit into that cohort!

The article went on to discuss the importance of demographics on wider economic performance and used Japan as the canary in the mine that all other nations are watching.

Rather than just a rising average age within a rising population base Japan has already arrived at the point of a declining population.

The fear is that the population decline will undermine Japan’s economic performance, but maybe this is another belief that we need to unlearn. Maybe Japan’s equity will be passed down to a more financially active younger generation and maybe the country’s excellent export focus will expand further to sell more products abroad that are not required locally?

David Colman, from our office, has visited Japan several times and he really likes the country. I sense a personal need for a research trip there some time soon.

Fortunately, for this item, we have a client in Japan (ex-pat Kiwi) so I was able to enquire of him:

Will Japan need to invite more foreigners to settle in Japan to offset their population decline?

What is happening on the ground with Japanese demographics?

The response was remarkable, to me at least.

The declining birth rates have two drivers, fertility (a problem felt widely outside Japan also) and a younger generation that is widely disinterested in marriage and having children.

Actually, he said surveys are reporting that many are disinterested in sexual relationships with remarkable proportions not entering such relationships by their mid 30’s.

‘Official Japanese government statistics show that 42 per cent of single men aged 18–34 have never had sex, and 44 per cent of women in the same age group haven’t either.’

‘National Institute of Population and Social Security Research said that people aren’t getting married, they’re not having sex, they’re not having babies.’

His work role saw him involved with large groups of tertiary aged students and he witnessed a rising tide of discontent with a society that rewarded people based on age and not skill.

‘Being told what to think constantly instils either obedience or rebellion and the youth are making their protests heard not by talking but by simply not getting married and women seeking men's jobs so this paradigm shift which was once a ripple is becoming a tidal wave.’

How might they encourage more foreigners to participate in their economy?

‘They are trying to attract more international students but the demographics of who can come, want to come and actually come is not always revealed. The Japanese government is now offering money for students to come and study. Ironically in 2017 it included 122,000 Chinese and 4,000 American so the programs are mostly attracting Asian countries.’

Getting work visas is difficult and time restrictions are common (3-6 years).

So, what are the visible impacts on investment?

‘25% of houses are empty’.

‘I only pay $300.00 US a month for my house (not in Tokyo) and this is far cheaper than owning a property’. (Especially if values continue to fall)

In New Zealand, maybe this means our smartest property supply strategy should be to invest in more retirement villages to free up suburban housing supply for younger people to use.

Many people raise an eyebrow at retirement villages either through displeasure at the high fees or the implication that it confirms one as being ‘over the hill’.

However, in my experience through one family member and your varied input it is clear to me that these villages provide a high level of service, opportunities for activity and access to plenty of community interaction for very healthy outcomes. This is good news for our wider communities.

So, property investors, when we notice that not even Ryman Healthcare, and its peers, wants to build more accommodation it may well be too late to trim your overweight property portfolio!

I like that the Japanese young are expressing themselves strongly, disrupting what sounds like generations of obedience that became too extreme. I suspect that this greater freedom of expression will be quite vibrant for Japan’s economy, even if they must sell more of what they produce internationally.

In fact this vibrancy may already be well under way.

The Nikkei 225 (Japanese share market index) has enjoyed a robust 10-year period of rising prices (from 8,000 to 22,000), like the rest of us, but this followed 20 years of a declining trend from 25,000 to 8,000.

Demographers would declare Japan a basket case, but it would appear that their young disagree.

Insider Trading – confidence in the operation of financial markets will take a knock if the Financial Markets Authority is unable to secure a conviction for insider trading in its current case against Mr Sansom.

In simplified terms, the case is about a person inside a business passing non-public information to a person outside the business who then arranged a transaction in the shares of that NZX listed company.

The first case ended with a hung jury, surprisingly. This may disclose a lack of depth in the public knowledge of financial markets and abuse of non-public information, or it may disclose a weakness in the FMA’s approach to the case.

Maybe in cases such as this one the regulator should be able to insist on a judge alone hearing, or be able to do so if it is a follow up to a hung jury?

A not guilty result from this case would make no sense to anyone other than a clever legal defence team, who would also be the only financial winners from the situation, being paid far more in fees than Mr Sansom ever stood to make from his share trading.

INVESTMENT NEWS

Reading – For those of you who are enthusiastic readers of useful material with an investment perspective, I’d encourage you to read the recent speech from the governor of the Reserve Bank.

It’s greatest take away point for me was a reminder to lift one’s horizon to longer term thinking when investing and avoid a disruptive short-term focus.

Follow this link if curious: https://www.rbnz.govt.nz/research-and-publications/speeches/2018/speech2018-09-07

Crypto Currency– Have you noticed how quiet the subject of crypto-currency has become?

The business media do not like reporting how ‘bad’ something is becoming. (unless it’s an opposing public policy view – Ed)

The ‘get excited’ headlines around Bitcoin and its peers crowded out many stories during 2016 and 2017 as their market price soared, whilst intrinsic value sat unchanged.

In 2018 though the market price has been falling, and graphically speaking looks rather unimpressive.

Electricity Review – The initial review is out from the Electricity Advisory Panel (EAP) and it has provided reminders to the government about the various stress points or inequities within the electricity market, but it has not presented a ‘bad guy’ if the government wanted to place one in the stockades and punish them for over-charging retail consumers.

In fact, the government might find themselves in the stockade because GST and Transpower were the clearest drivers of price increases that I spotted, but GST won’t go away (neither should it) and we learnt a lot about poorly maintained transmission during the Auckland failure.

Price competition is available, and the retail consumer must accept a large portion of the remaining responsibility for not making sufficient effort to ensure their household is receiving the most competitive price on offer.

The EAP estimated that ‘on average’ NZ households could save $200 per annum via switches to the cheapest provider, and whilst none of us are ‘the average’ the point was that consumers are leaving a lot of value on the table for the generators.

The big five generators/retailers still control 90% of the consumer accounts.

It was remarkable to learn that something between 30-40% of consumers have never addressed the potential to change their electricity supplier; this lethargy plays in to the hands of the generator/retailer businesses.

The annual rate of change is reported as being about 20% of the industry, meaning that 80% are not actively watching their pricing options. This is a disappointing result given the ease with which one can change suppliers.

By reference, the EAP reports that Australian consumer behaviour (lethargy) is very similar to that of New Zealanders.

The higher profit margins gained by generators from the inactive are used to present competitive prices and free televisions to those who actively seek better service and pricing.

And, herein lies the investment point from this ramble; consumer lethargy leaves comfortable profits on the table for energy companies – Genesis, Mercury, Meridian, Contact and Trustpower. Investors know this, and their share prices lifted following the initial report when it didn’t deliver any apparent new regulatory threats.

To some extent these companies will be pleased with the government’s wider energy programme because of their increasing focus on use of renewable energy, which will require them to increase their generation capacity to sell more electricity (think electric vehicles, bans on mining, rejection of coal etc).

With more than a little bias, Z Energy should be pleased about the reminders in this EAP report for consumers to seek competitive electricity pricing, something their new subsidiary Flick Electric does very well.

Nasdaq – It was nice to read about the NZX forming a stronger relationship with the Nasdaq exchange in the US (signed a memorandum of understanding with US tech-heavy bourse, which will let top-tier American companies apply for a secondary listing locally).

In the immediate future I hope this enables the NZX to quickly add a ‘Nasdaq’ fund to its Smart Shares suite of Exchange Traded Funds, because technology focus is one obvious risk that is absent from the offering, yet this sector has been the fastest growing in the past 15 years.

Growth in the use of Smart Shares (+32% over the past 12 months) has quietly been one of the NZX’s success stories while headlines focused on the lack of new listings.

Opening new doorways to international investment risk at lower price margins will be good for NZ capital markets (and its retail investors).

EVER THE OPTIMIST– NZ’s June quarter GDP growth was at the better end of the expected range (+0.80%, bring the past year to +2.50%).

This was well above the central bank’s forecast of +0.50% so may remove some of the fear of an interest rate cut ahead of us.

INVESTMENT OPPORTUNITIES

Turners Auctions – has announced its offer of a small subordinated bond with a three-year term and a 5.50% interest rate.

This offer closes at midday on Monday 24 September, so if you are planning to invest, now is the time to act (by delivering an application form to us).

The Public Disclose Statement with its application form is available on the Current Investments page of our website.

Summerset Group – new 7-year senior bond was issued last Friday, and the interest rate was set at 4.20% per annum, which is a good result for investors.

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

If any investors missed this issue and would like to purchase these bonds they should contact us urgently.

Property For Industry – is the next senior bond of the rank with its 7 year bond and a 4.15% minimum interest rate set.

We have a list for all investors wishing to participate in this bond offer.

If you wish to participate in this bond offer, please advise us of your firm request by 5pm this Thursday (20 September). Allocations will occur on Friday with payment due later next week.

PFI is meeting the brokerage costs of the issue, clients do not pay brokerage.

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

TRAVEL

Chris will be in Christchurch on 18 and 19 September.

Mike will be in Tauranga on 5 October.

Kevin will be in Christchurch on 27 September and Ashburton on 31 October.

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

 

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

Michael Warrington

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Market News 10 September 2018

With respect to our newsletters, a wise client recently told me (pleasantly), ‘if you have nothing more to say, then don’t’.

This week’s Market News is thus succinct.

INVESTMENT OPINION

Rental Property Investment – is progressively being defined by our regulators as a commercial activity and as a result it will be impacted more heavily by future costs.

In due course I suspect that both short and long-term rentals will be caught in the definition of being a commercial activity.

Councils’ are eagerly trying to discover which properties are being regularly let out via AirBNB or Book-a-Bach type portals, so they can apply higher commercial rates or bed taxes to boost their revenue.

At face value this money grab may seem greedy or harsh, but in reality, the increased levels of tourism, which drives the additional income to property owners, is also delivering more wear and tear on regional services and they need expansion and maintenance.

I would rather see an element of user pays exist to gain revenue from increased tourist activity than an increase to my residential rates, for no change in service level.

I’ve strayed off my point; residential property investors are sitting in the ever-increasing glare of the regulatory spotlight and I don’t think it’s going to let up, so rental returns will decline, especially the cash element.

Beyond the council reaching in to the pockets of investment property owners, Minister Phil Twyford has announced an intention to increase the minimum health standards that must exist if a property is rented out (he reports that 600,000 properties in the rental pool don’t meet a satisfactory standard).

For the record, I don’t understand why the National Party would speak out against Warrant of Fitness standards for rental properties. Judith Collins flippant response predicted that a WOF for rental property would lead to more people sleeping in cars, without recognising the unintended humour in her statement (at least cars are required to have a WOF).

Landlords will, as they always do, call out that they will simply increase rents to cope with the additional imposts put upon them; Phil Twyford must respond by actually delivering a greater number of affordable homes, or excesses to Housing NZ stocks and suppress any unreasonable rental increases.

Lastly, if the government seeks even more influence they could press the Reserve Bank harder than they did previously and insist that central bank regulations instruct all banks to define property owners for purpose - resident, holiday house, or commercial investment (rental)- and then demand greater bank equity when lending against such rental properties.

Greater equity demands over the banking framework will result in higher interest costs to borrowers for rental properties.

We can’t be far from the point where a property investor must achieve capital gains to make progress because cash returns in the examples that I see are modest to poor (after expenses).

Ultimately, I am highlighting that regulatory risk will always exist for all investment types, it’s just that today it is rental properties that sit in the spotlight.

Light Rail – Guardians of NZ Superannuation, together with a Canadian partner, put in an expression of interest to finance a light rail project desired by past and present Mayors of Auckland. This wasn’t done on a whim; it was a response to a project of rising probability.

Shortly thereafter the NZ Transport Authority stated that they would like to begin in 2020 and called an engagement meeting for the potential project and apparently the turnout was 450 people!

Good grief, do we have that many transport and council bureaucrats with a genuine reason for attachment to this potential project? That’ll slow the project to a crawl.

I guess some dozens of the people will have been representatives of willing investors, which is where my point comes in; I would like an Auckland Light Rail investment partnership to be offered to the NZ public, alongside Guardians of NZ Super, ACC and Kiwisaver funds.

NZ’s retail investors do not have the political lobbying capacity of the large-scale investors, but they definitely have the savings available and the need for investment opportunities with the risk and reward profile of major public utilities, such as Auckland Light Rail.

An NZX listing of units in an Auckland Light Rail Fund would enhance many things, including:

Wide access to capital for the project;

Competitive risk/reward pricing for the project;

Liquidity for the institutions with their subtly changing holding requirements and for retail investors with more common needs for change;

Market pricing for other such public projects;

Reduction of public financial risk by shifting the funding well clear of the government entities launching such projects; and at a pinch,

Happiness to the board and CEO of the NZX who are looking for greater depth and breadth for NZ capital markets!

The NZ investors whom we see do have a good breadth of investment risk but they would benefit from even more.

INVESTMENT NEWS

Trump – We all know President Trump takes an unusual approach, but the Whitehouse insider who decided to write an expose for the New York Times is yet another of the self-entitled people I referred to in recent weeks who think they should usurp democracy because their opinions deserve more influence.

The writer should disclose himself or herself and, frankly, either respect the public’s choice, or stand for the Presidency and stop sniping from behind the curtain.

TILT – Tilt Renewables independent directors have announced that in their view the takeover offer from Infratil (IFT) and Mercury (MCY) at a price of $2.30 per share is too low.

They then change their terminology to state that the ‘premium’ offered is ‘materially below the average level for successful takeovers of this kind’.

OK, so a premium price has been offered, just not enough they say.

The directors want more for TLT shareholders for the passing of 100% control to IFT and MCY (something which does not increase TLT’s profits) and they’d like IFT and MCY to pay more for the ‘potential’.

We’ve all invested on potential before and sometimes discovered how far it can differ from reality.

The directors say that the offer ‘comes at an opportunistic time and doesn’t factor in a major future project that may deliver significant benefits to the company’.

Well, yes, if someone wishes to buy your company the ‘opportunity’ does appeal to them, but as a listed company TLT shareholders are, and were, aware of those opportunities, their status and their potential.

I hope the directors haven’t been caught in an awkward spot of knowing more than they can disclose to the wider public.

Directors will release their Target Company Statement in the next two weeks, but the draft is clearly aligned with the directors’ view that the takeover offer price is too low.

TLT shareholders have an alternative if they are concerned about the potential for forced exit from the register, use the proceeds to purchase some IFT and MCY shares to gain a new indirect access to the performance of TLT.

It’s a nice position to be in; one with good choices.

Interest Rates – You know how we all believed (hoped – Ed) that interest rates would increase as the next move?

Well, over the past two weeks they have been falling and now 50% of the market believe that the Reserve Bank’s next action for the Official Cash Rate (OCR) will be a cut.

Avoid being in a state of underinvestment.

Neutral OCR – Further to the comment above it is worth noting that when the day comes that interest rates do need to be lifted analyst settings for what a ‘neutral interest rate’ is are being lowered.

The Reserve Bank now estimates that a neutral future OCR is 3.50%.

ASB tells us that they see potential between 2.50% - 3.50% with a likely number just below 3.00% based on current information.

Many variables drive what one might conclude is a neutral interest rate (logical) but ASB concluded with the valuable insight that these drivers support the downward trend for a neutral interest rate since 1980.

At present they argue that the downward trend is not over.

PCTHA– Investors in the Precinct hybrid notes (PCTHA) will be pleased to see that they are ‘in the money’.

They should recall that the Precinct notes will convert into Precinct shares, or if repaid in cash (PCT’s choice) the value will reflect the higher of approximately “$1.02 or any share price premium above $1.40.

At the time of writing PCT shares were $1.45 which implies a current repayment value for PCTHA notes of $1.0355.

You will be able to track this changing value by glancing at the PCTHA pricing on the NZX, which reflects the PCT share price and any accrued interest.

Vodafone – announced a 16% decline in its NZ profits, which goes a long way to explaining why the potential share market float was cancelled.

If you want to sell a business you do so during periods of good financial performance, not the opposite, which is, when you read between the lines reason to be extra vigilant when buying an investment during periods of good financial performance.

Consumers speak – Restaurant Brands sale of Starbucks franchise in NZ should be no surprise to New Zealanders given that countrywide we are served by excellent local coffee options.

RBD took a while to listen to their local consumers, an important requirement of being successful in business.

The new owners have more confidence than I could conjure up.

EVER THE OPTIMIST– you’ve got to love the patriotic approach of Brendan Lindsay (sold out of his Sistema business) as he reinvests in 20% ownership of another strong NZ brand; Methven (MVN).

Nice.

ETO II – Zespri reports an expectation of much higher profits this year ($175m versus $102m).

It was also good to see that growers making the effort to be organic receive 50% more per tray of green kiwifruit, at $8.67 per tray.

Meanwhile Gold tray pricing is even stronger at $10.28.

So, imagine what their pricing might be if they are successful with their ambition of delivering a ‘lucky’ red varietal to the Asian market?

ETO III – I knew we would find economic benefits from blockchain technology, and here’s a real-world example:

HSBC bank and various peers have established a blockchain platform for international trade of commodities, covering product checking, delivery and payment records on a single shared platform.

Historically such trade (exports, imports) involved a lot of paper, many staff hours across all participants in a transaction and is described as taking 5-10 days to complete.

Documents exist to support promised product delivery and promised payments once products arrive (Letters of Credit from banks). HSBC claims those documents number in the hundreds of millions each year.

HSBC’s test transaction for a real delivery of Soybeans from Argentina to Malaysia took 24 hours to complete.

Apparently one great risk for exporters of perishable goods is that a product might arrive at its destination prior to the related formal documentation and thus the product may not be processed (as it rots). This risk will become a thing of the past.

One trade analyst predicted savings of 44% in time and 31% in costs and the potential to boost exports that have otherwise been unable to occur when time delay was a critical failure.

The internet, and its attached applications, is going to be very good for trade and the NZ government deserves a pat on the back for launching the ‘push’ (sponsorship) to install fibre across our country rather than wait for commerce to instigate the change.

INVESTMENT OPPORTUNITIES

Turners Auctions – has announced its small offer of subordinated bonds with a three-year term and a 5.50% interest rate.

The Public Disclose Statement and application form are available on the Current Investments page of our website.

If you wish to invest, please complete an application form and deliver it to us because applications are being handled (at this stage) on a first come, first served basis, without firm allocations.

Summerset Group (SUM) – has confirmed their issue a new 7-year senior bond, being arranged this week.

A minimum yield of 4.15% has been announced and SUM has agreed to pay the brokerage costs of the issue. (clients do not pay brokerage).

The bonds will be listed on the NZX under the code SUM020.

We have a list for this bond offer and investors are welcome to join and need to do so by 5pm this Thursday (13 September). Allocations will be completed late on Friday and payment will be required next week.

Property For Industry – has announced its intention to issue a new 7 year bond with further details to be released next week.

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

ASB Bank – announced a new 5-year bond, but we haven’t made a song and dance about it because the likely yield will be between 3.20% - 3.35% and at 0.75% below a term deposit from the same bank for an equivalent term, this bond has few redeeming features, especially for clients with plenty of liquidity in their portfolios already.

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

TRAVEL

Edward will be in Auckland on 24 September and Nelson on 2 October.

Chris will be in Christchurch on 18 and 19 September.

Kevin will be in Christchurch on 27 September.

Mike will be in Tauranga during early October.

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

 

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

Michael Warrington

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Market News 3 September 2018

Prime Minister Jacinda Ardern has called another group together to think about stuff.

Last week the stuff was the collective opinion of business, a knee jerk reaction to negative press from the business sector.

Jacinda doesn’t want a negative tone from business leadership to settle in the minds of the many that those businesses employ.

That’s political thinking, not economic thinking.

Jacinda did however make one statement at the time that resonated; ‘we want to deliver better productivity, not more debt, more immigration and higher house prices.’

As I sat on the couch I offered Jacinda a better idea for her productivity strategy than her ‘business opinion committee’; approve the ‘Debt To Income (DTI)’ regulatory tool for the Reserve Bank.

The other macro-prudential tools have proved effective in contributing to financial stability, through influence over better financial risk decision-making by the public.

Which, in turn, has allowed the central bank to hold its interest rate lower than otherwise possible (1.75% until 2020);

Which, in turn, has contributed to some weakness in the NZ dollar relative to the major currency of trade, the US dollar;

Which, in turn, is boosting the export revenues of our productive sector (I hope Jacinda spotted this productivity connection when she read Market News this week).

Now, please don’t beat up on Jacinda for not reaching the same conclusion as me, because her time to consider ideas is scarce, every day she has 100 people in her face full of clever ideas and criticisms.

When I sit on my couch I only have three.

 

 

INVESTMENT OPINION

Politicians – Consistent with my view last week about politicians over-calculating their importance in displays of selfishness and a lack of respect for others:

Auckland’s Entrust, holder of the public’s majority share in Vector (VCT), wants to call a special meeting for the removal of VCT’s chairman (Stiassny)…. one month before his already announced retirement date.

Give me a break.

If Entrust’s current trustees have this much time to waste and such fragile egos or lack of commercial capacity then it is their trustees who should be changing.

Headlines or Markets – Media headlines are heavily skewed toward anxiety or doom and gloom for investors, but the US share market is playing to a different tune.

Last week the Dow Jones and S&P 500 index set new all-time highs.

I expect that many journalists have investments and thus consider real financial risks when they write their stories, but the collective wisdom of enormous sums are rejecting their headlines.

We can argue about overly optimistic market pricing (which I believe) until we are blue in the face; if the market wishes to move higher, it will.

Further, the US market is moving higher at the same time that the Chinese share market is moving lower.

You can, and should, read into this situation that the scale of the US economy remains significantly more influential to global economics than China’s.

The NZ market has followed the optimistic moves of the US share market, which is typical, but China is our largest trading partner (directly and via Australia) so we (the Royal we – Ed) need to remain alert to the risk of a decline in trade and its impact on the value of NZ businesses, regardless of US optimism.

US market pricing will impact the NZ cost of capital, the risk and reward that might be tolerated and market confidence, but if a specific business (such as Fonterra) sells less product, and/or at lower prices, then the value of such a business will decline.

In fact, unintentionally, Fonterra is a good example. The US and NZ share markets have both been strong and setting new all-time highs, but Fonterra has made errors specific to their business, some of which relate to trade in China, and their unit price has fallen from a recent high of $6.50 to a low of $4.80.

Over the past five years the Fonterra unit price has traded within a range between $4.80 - $6.80, twice touching the bottom where it is now.

By contrast the US S&P 500 index was at 1,655 five years ago and is at 2,914 today (+76%).

So, what to do?

Who will be correct, the media/analyst or the investor?

In time they will all claim to be correct and cite their victories (in isolation).

More importantly, uncertainty will prevail, hence our encouragement that you invest according to a set of investment rules that suit your circumstances. If you do that well, you shouldn’t lose.

Anecdote – Having just told you to be careful of headlines and thus random anecdotes, I do like to accumulate anecdotes in our distillery as we try to deliver value to you about investment markets.

This anecdote relates to the proposed share market listing of Aston Martin.

I view this as a message that Aston Martin is fully valued and that financial markets are paying relatively high prices for shares, otherwise its current private owners would not sell it.

Just one strand of information, amongst thousands, that make up a rope.

Are you online?– I guess so if you’re reading this.

Are your parents, neighbours and friends online?

Business continues its rapid move to digital (online) service only and this will very soon make it rather difficult for the public to do some business if they are not online.

You can see how fast businesses are moving away from hard documents with the continued steep decline in mail use being experienced by NZ Post, and banks are closing branches again.

The moves to digital service are entirely understandable, and necessary as businesses strive to keep their costs down.

However, I have some sympathy for people who are not online who are likely to begin missing out on useful opportunities or charged higher pricing due to the request for more manual service methods.

I fear that these manual charges could become quite high (online pricing falls a bit due to competition, but manual rises a lot), in the same way that electricity generators use profit margins from consumers who never negotiate their pricing agreement to subsidise the pricing of those who do.

Initially I thought ‘unconnected’ people should ‘get online’ or ask for assistance from a trusted person, but in many cases this will either be undesirable or near impossible.

What chance the banks or local council could become trusted organisations for the public to arrange occasional online assistance?

Regardless, I think there is value in having a think about family or friends who are not online and pondering how you might help them to simplify their various transactional requirements and how to keep them connected with necessary information flows, within a trustworthy process.

INVESTMENT NEWS

Z Energy– I regularly hear from investors expressing uncertainty about the investment future for Z Energy (ZEL).

Some are owners of ZEL shares, others have invested in ZEL bonds and many investors hold both.

Investors with no investment exposure to ZEL are the most strident with their view that fossil fuels will be ‘gone by sunset’. (or they hold this as a policy view – Ed)

I don’t agree with that view, believing instead that fossil fuels will outlast my time on this planet, however, of more interest to investors should be ZEL’s strategy of acknowledging that fuel use for transport is changing and they intend to sit at the forefront of that change.

Last week ZEL announced the purchase of 70.1% of Flick Electric as part of its strategy to align with their customers evolving use of energy.

Flick Electric provides retail electricity consumers with direct access to wholesale electricity pricing, thus intending to reduce the marginal price paid by consumers to the very large generators. The process is effective, which I can confirm as a disclosed Flick Electric consumer.

Flick also wishes to be a leader in pairing up micro electricity generators (solar panels on rooves etc) with retail electricity consumers; peer-to-peer energy markets.

ZEL already has some electric vehicle charging points on forecourts and the price of oil and addition of new government and council fuel taxes is accelerating the sales rate of electric and hybrid vehicles.

The market for electric vehicles is changing faster than many of us thought as the idea came to market.

Tesla does not have the electric vehicle production market to themselves; the world’s largest manufacturers are spending very serious sums of money developing electric cars.

In fact, I think ZEL’s future will be longer than Tesla’s as it confronts the might of Toyota, Daimler, Fiat, etc.

Large sponsorship deals for the increasing volume of electric vehicle racing series confirms the development willingness of the major car manufacturers.

ZEL sees this rising tide of electric vehicles and wants to provide ‘fuel’ to that fleet.

I suspect that they’ll see merit in charging points within the cities, but not in the suburbs, when a driver is more likely to be very close to home, or within reach of a friend’s residential plug.

Maybe ZEL will try to replace Wilson Parking as manager of city parking zones in return for the right to install charging facilities? (The removal of Wilson Parking will gain a lot of public support – Ed).

Maybe vehicle manufacturers will offer exchangeable batteries in future? (enabling ZEL to be a battery exchange point)

All these ideas, and more, will have been passed around the ZEL board table because they are quite clearly displaying a willingness to change alongside their customers changing transport fleet.

On this governance point, I was most impressed (for ZEL) by the decision of two ZEL directors to stay on the ZEL board and resign their membership of two major electricity generators once ZEL purchased Flick Electric.

This was done to avoid any conflict of interest and is a display of the exciting potential these directors see for ZEL, with Flick Electric in the business, relative to the relatively plain outlook for the major generators.

I am impressed by this level of forward thinking, and current execution, by ZEL and their shareholders and lenders should be pleased about this level of strategic intent from the company.

Disclosure: You may recall that I owned a few shares in Flick Electric from its start up days. It is nice to receive this display of respect from ZEL for Flick, and the profit that came from my investment. However, for the record, I retained some of my shareholding based on continued belief in the combined strategies of Z Energy and Flick Electric.

Infratil – US subsidiary Longroad Energy should be pleased to read of California’s new law mandating that all state electricity come from renewable Sources by 2045.

It’s a theme that is visible state by state even though Trump is trying to play a different tune at times (coal is good? – Ed).

California is the equivalent of the world’s fifth largest economy. It currently only sources 44% of its power from renewables.

Trump’s interference is very short term relative to this good quality long term governance by the state.

MOM – A Treasury review has declared the Mixed Ownership Model a success, from the Crown’s perspective.

The government both funded $4.7 billion of important projects and still receives the same or better dividends from 51% shareholdings in the energy companies as they did with 100% ownership.

Private governance and management has added value for all.

I can certainly vouch for the value added to the public as investors, providing diversity and robust options for ownership (shares) in a portfolio.

Fran O’Sullivan, in the Herald, went one further and suggested the government consider selling the remaining 51% shareholdings of their MOM investments to a stable, local, collarboration of investors in ACC, Guardians of NZ Super, Iwi, and Kiwisaver, to further free up large sums for new important infrastructure developments.

It would be a progressive government that agreed to sell as Fran proposes, to then reinvest in, say, Transmission Gully, making it clear that a toll will be charged from day one.

Having taken the equity risk on developing Transmission Gully, then settled the financial performance down in the subsequent five year period, I have no doubt the government could then easily sell 20 year management contracts to utility investors to manage the road and release important capital to government through economic cycles.

I see Landcorp is back paying dividends, perhaps the government could offer investors a 49% share in this business?

Credit Agricole – CA’s subordinated bonds treated investors in NZ well, with high yields and then repayment as anticipated after 10 years.

However, it wasn’t all plain sailing, as the Global Financial Crisis undermined confidence in European banking strength, and our confidence in CA’s ability and willingness to repay its subordinated securities ‘downunder, out of sight, in NZ’.

But repay they did, and repaid feels good as I read last week about CA being fined by the European Central Bank for mis-reporting its Tier 1 equity ratios recently!

EVER THE OPTIMIST– More primary industry businesses in NZ are enjoying higher revenues, both from volume sales growth and the weakening NZ dollar for their exports.

This is great news; real productivity, value add from NZ competitive advantage with lucky icing from a weakening NZ dollar.

Example – Scales reports earnings up 20%.

INVESTMENT OPPORTUNITIES

 

Summerset - has announced that it is considering an offer of 7 year bonds.

No interest rate has been set but given current market conditions it may be set around 4.20%.

The retirement village operator is expected to release further details on Monday 10 September.

Please contact us if you are interested in this issue.

 

Turners Auctions – has announced its offer of a small subordinated bond with a three-year term and a 5.50% interest rate.

The Public Disclose Statement with its application form is available on the Current Investments page of our website.

Clients receiving a financial advice service can review Kevin Gloag’s research item on the Turners bond offer on the Private Client login page of our website.

The offer is not being arranged by firm allocations. Rather, the company is receiving all application forms and processing on a first come first served basis as able.

If you wish to invest please complete an application form and deliver it to us.

Spark – issued its new 6 year bond last Friday, and confirmed its interest rate at 3.37%. (who said interest rates were increasing?)

The issue was fast moving and processed by contract note.

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

 

More bonds – We continue to scan the near horizon for the next bond offer.

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

TRAVEL

Edward is in Auckland (CBD) on 24 September, then in Nelson on 2 October.

Kevin will be in Christchurch on 27 September.

Mike will be in Tauranga during early October.

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

 

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

Michael Warrington

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