Chris Lee & Partners Ltd

Market News – 30 September 2019

I haven’t yet read anything that explains to me why the UK government, and its taxpayers, should be footing the bill for the ‘Thomas Cook Airlift’ flying people home after the chosen travel agent failed.

Isn’t this a private problem that the traveller needs to resolve themselves, possibly with assistance from their travel insurer?

Maybe these travellers purchased insurance from Thomas Cook (TC), and maybe TC didn’t reinsure?

This is a reminder about importance of risk assessment – don’t buy a service and insurance for failure from the same business.

UK taxpayers will surely feel even worse about this government underwrite when they read more about just how much money senior executives at Thomas Cook were paid in recent years (millions) as they ‘led’ the company toward failure.

Why do governments and central banks feel it is their duty to rescue the public from everything?

INVESTMENT OPINION

 

Jetstar – Following Jetstar’s withdrawal from providing flights to New Zealand’s regions I can see a wise retired person sitting on The Terrace in Wellington, outside the Commerce Commission office, quietly saying ‘be careful what you wish for’.

Privacy – The European Union took a legal case against Google demanding the ‘right to be forgotten’ be an ongoing expectation of technology businesses.

Google won the case.

Surely Google wouldn’t have found it difficult to defend their position given the behaviour of the population at large and peoples’ constant efforts to be ‘discovered’ via various online services?

 

OCR – The Reserve Bank has left the Official Cash Rate unchanged at 1.00% and stated that it does not ‘currently’ see a need to cut the rate further.

Currently is a conditional word, where changes occur from tomorrow, but for now the central bank quite likes the round number of 1.00% and gives them room to cut to 0% should the next dilemma require such a response.

Many of the economists offering commentary have said the central bank can say what it likes (and it does – Ed) but the economists expect another 0.25% interest rate cut in November. Importantly though, people who manage money aren’t quite as confident about the next rate cut evidenced by interest rates for terms between 90 days and 12 months being very close to 1.00%.

Generally, one finds more truth when they follow the money so for now I’ll work from an expectation of no further OCR cut this calendar year.

Lower Interest Rates – It’s a constant theme, sadly.

The central bank may have paused on its interest rate cuts but there are other forces at play that are removing some of the ‘better’ interest rate options you once had.

Well run non-bank finance businesses are finding it relatively straight forward to build, or maintain, good lending portfolios, typically large enough that diversity makes the loss statistics from the portfolio more accurate (risk assessment tool).

Those large, diverse, portfolios of lending then find it increasingly easy to borrow money against. Their attractiveness to lenders is resulting in lower pricing to borrow money.

Those of you who have been investing for many years will remember the ability you once had to invest in the likes of Fisher & Paykel Finance (FPF), and UDC. Some of you may also have been investing in the Peer to Peer lender Harmoney seeking higher returns.

Well, FPF was taken over by private equity interests and they quickly decided to repay depositors early. UDC progressively brought its deposit interest rates down in line with the ANZ bank and is now in the midst of early repayment to depositors who elect not to transfer into the ANZ environment.

The next to change will be Harmoney who is indicating that it too plans to move away from its retail funding channel, preferring the ease and lower pricing of wholesale funding. They cite the current regulatory framework in NZ and Australia as making true peer-to-peer lending unviable.

Harmoney recently lost a High Court case with respect to what is a platform fee and what is a credit fee. The distinction may seem subtle but the outcome looks likely to be a change in their business model and the gradual rejection of retail investors as a method of finance to this business.

I gave Harmoney a go from an investment perspective but frankly I found it too ‘noisy’, demanding too much time and effort for the marginal rewards and I was too busy to justify that time commitment. I was unhappy when they increased the risks and lowered the returns, which happened right when I was questioning participation based on workload.

Harmoney doesn’t mind my departure. They would now prefer that other retail lenders departed too because the profit margin isn’t good enough to compete with the wholesale funding sources and the ease of access to them.

Harmoney will no longer be a peer-to-peer financier, matching up borrowers and lenders. They will become a typical non-bank lender that is using technology to make the process more efficient, faster, and hopefully lower in cost and like FPF and UDC before them will move to cheaper, easier, wholesale funding sources.

FPF and UDC might argue that the regulatory obligations placed on them to offer investment opportunities to the public became too time consuming and thus too expensive relative to simpler wholesale funding options.

Historically, for a period of time, wholesale financiers demanded higher interest rates to lend money than retail investors would accept, hence the use of the retail market to try and keep debt costs down. Now the opposite situation is in play and opportunities for retail investors are evaporating quickly.

With wholesale lenders now aggressively undercutting retail investors it has created another downward pressure influence for interest rates that can be reached by retail investors. Note the condition here reached by retail investors.

As various alternatives are removed from the menu of options retail investors will be forced to accept whatever they can find; borrowers know this so they will not be offering to pay premium interest rates to borrow such money.

You may have been directing the ‘gun of criticism’ at central banks and private equity investors buying up the various businesses for reducing your investment options but it may also be true that we are reaching a point of over-regulation for how we deliver investment products to retail investors.

Given the very poor behaviour from the finance sector up until 2008 I’d expect investors to prefer tighter regulation at present so it will last for a long while yet, but it may also mean there is a reinforced need to seek financial advice to identify other ways of taking additional risk for additional return (heavy dose of bias here – Ed).

The frustration of this paragraph is that it reinforces the view that investors should still be budgeting on low returns from the fixed interest portion of their portfolios.

 

Repo – Those of you who are avid readers of the international media will likely have stumbled onto ‘loud’ headlines last week about the tension within the US ‘repo’ market.

All headlines seem to be loud these days, so you can and should immediately apply some discount to the implied importance.

The situation in the US resulted in an increase on short term interest rates from 2% to 10% for a very brief period (days). It was a nice outcome for those with spare cash who were net lenders of money for those particular days; some earned a week’s expected income in a day for their fixed interest fund.

The tension was no different to any other market when supply and demand become temporarily very hard to manage (think petrol pricing, avocado pricing etc).

In this case it seems that the greatest withdrawal of cash from the system related to tax payment timing. Even though the grand circle of cash within the US system remains whole, access to tax payment cash may become hard to ‘see’ if a large sum is removed early in the day and then the Tax Department (IRS) doesn’t release those funds via the governments banking services until later in the same day.

That intraday imbalance may cause some operators to worry about supply of funding, which they did in this case, so those folk agreed to pay a premium to be certain they could meet their financial obligations that night.

The wiser people managing cash would have refused to lend cash overnight at 10% by making a loan from them conditional on say 5% for seven days.

The US Federal Reserve was never going to leave the system short of cash. All financial obligations were going to settle, however, for this to be assured the central bankers stepped into the repo market to provide some of the funding required.

‘What is a repo?’ you ask.

As it happens, one of my old day jobs was a ‘repo trader’.

In short it is a secured lending market. One party (A) wishes to borrow money secured against an investment item that it holds (say a government bond) whilst the other party (B) has cash it wishes to lend and is happy to receive the government bond as collateral.

A and B agree on an interest rate for the loan and the term of the loan. They likely also agree on how much cash they will lend against the collateral offered (maybe 98 cents in the dollar).

The term ‘repo’ relates to typical market (or school yard) behaviour of shortening long names – ‘Repurchase Agreement’.

In the loan transaction that I described party A ‘Sells’ and simultaneously agrees to ‘Repurchase’ the government bond with party B. The pricing between the sell and the buy equals the interest rate agreed over the term agreed.

There are plenty of complexities that I could weave into this situation, but I won’t because my point is that the simplicity of the situation means that the funding tension was always going to be resolved by the actions of the banks and the central bank.

Hence my view that the media must have been struggling for content last week or had side competitions over who could wind their headlines up the most.

Nothing to see here, other than a short-term flare.

Ethical – I think it is going to take a while for businesses to improve corporate behaviour away from the singular ‘shareholder only’ focus, but it is beginning to happen, and the trend is settling in.

The most successful will be those who change effectively, and not rapidly.

I have previously touched on the NZX’s introduction of a new group of Smartshare Exchange Traded Funds with desirable ESG behaviours (Environmental, Social, Governance). These funds will only invest in businesses that adopt agreed ESG standards.

As this pool of money grows it will increase the tension on businesses to adjust their behaviour if they wish to attract additional capital and maintain access to debt funding at competitive pricing.

The latter of these two may be the most influential.

Once you have equity capital, if you are profitable enough you may never need to ask investors for additional capital so your ESG behaviour is difficult to influence. However, debt capital is renewed regularly and if it’s provided by a bank it can often be recalled mid-term.

As a result of this ‘leverage’ over debt markets regulators will do well if they begin to insert measurable standards into the marketplace. In NZ our government can do this via the Financial Markets Conduct Act and the Reserve Bank of NZ can establish influence via conditions placed over lenders.

‘Coincidentally’ you may recall that the RBNZ is seeking to widen its regulatory influence over all lenders.

Where the central bank can, and has, placed limitations on bank lending with respect to Loan to Value Ratios (LVR) and they would like to introduce Debt to Income (DTI) ratios there is nothing stopping them from introducing parameters for what good ESG outcomes are required.

If you wish to read about the early connections between banking and the environment you can read them here in the central bank’s report on financial stability: https://www.rbnz.govt.nz/financial-stability/financial-stability-report/fsr-november-2018/the-impact-of-climate-change-on-new-zealands-financial-system

Once limitations are established the banks would immediately pass these through to customers of the bank.

These could be split into different targets for different sub-sectors and would be far more effective if NZ (and the world – Ed) was to put an effective price on carbon emissions.

With this thinking in mind I must applaud ANZ bank, and Synlait Milk (SML), for ‘sponsoring’ this paragraph because it is their latest loan agreement that got me thinking. Their new loan agreement with ESG conditions appears to be the first ever such agreement in NZ.

A new $50 million loan between ANZ and SML defines price changes (interest rate changes), up and down, based on SML delivery against the agreed ESG measures. The measurements are being kept secret for commercial reasons but as a publicly listed company we may get a sense of what SML is measuring within their future annual reports.

We actually don’t need to know the interest rate range SML will pay; what matters is that banks and companies have started along the track of putting a price on good ESG behaviour and they’ve done so without the need for government to meddle in the detail.

We can easily speculate on what the ESG measurements will be for SML. It will surely cover targeted improvements within the following sequence: Land management, animal management, transport use, energy use, staff safety, product quality and I would hope a financial volatility measure (where less is best).

Most of these changes will be controlled by humans, who can be taught about the need for higher performance standards, but in SML’s case how do we teach the cow to hold their Number 1’s and 2’s until the reach the milking shed where the effluent can be better managed?

Congratulations to ANZ and SML for setting better standards early.

EVER THE OPTIMIST

Summer is back.

INVESTMENT OPPORTUNITIES

Infratil Bond – The offer of the 10-year bond (IFTHC) remains open, with its annual reset interest rate, and will close this offer on 13 November. This bond pays an initial interest rate of 3.50% until December 2020 (then reset each year after that).

The extension to this tranche’s closing date is to provide a rollover opportunity to people holding the Infratil bond maturing 15 November 2019 (IFT200). Rollover applications would need to be submitted to us prior to 13 November.

The public can still invest new cash into this bond (IFTHC).

NZ Post – Has announced to the market that it will not reset or repay its NZP010 subordinated bonds this November.

The annoucenment was a surprise to us, but it was always one of the options available to NZ Post.

This means holders have the luxury of doing nothing and keeping the NZP010 bonds.

In electing to keep the bonds on issue and retaining the funding NZ Post must now pay the penalty credit margin at 3.00% which implies an interest rate beyond 15 November of about 4.00% p.a.

4.00% is a better outcome than ‘you’ would have been offered if the bonds had been reset (repaid and reissued), which would have been more likely set at around 3.00%.

Holders of NZP010 bonds are left with a residual risk; NZ Post has the right to repay on any interest payment date, so you cannot rely on the bond lasting for five years.

To some extent I think the decision not to reset or repay these bonds provides a clue that NZ Post will repay these bonds but they are not yet ready to do so.

This is fine, nothing else is paying you a 3.90 - 4.00% p.a. interest rate (at the time of writing this) regardless of the term until repayment!

The bonds continue to trade on the NZX should a bond holder ever wish to take control of the situation and sell the bonds to extract cash for a different purpose.

TRAVEL

Edward will be in Wellington on October 10 & Auckland (Remuera) on 16 October

Chris will be in Christchurch Tuesday 15 and 16 October.

Kevin will be in Christchurch on 17 October.

 

Mike Warrington

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Market News – 23 September 2019

Your emails last week made it clear that you share our ‘veiled tolerance’ of the Anti-Money Laundering legislation.

100% of the responses view it as a huge resistor to efforts by the well-behaved wishing to arrange business, before sitting down with a beverage to listen to the media describing the field day being led by real criminals.

The funniest (saddest – Ed) response described the community–minded lady who was accosted by the bank for trying to deposit her church’s cash takings every Monday.

Aha, thought the bank, there’s a pattern of dodgy financial behaviour here and it involves cash in ‘clean, tidy, well ordered piles’; ‘just like laundry’ they declared.

After six months of interviews and evidence gathering the bank finally concluded that there was an alternative theory and they would give the lady permission to deposit cash for the church.

Presumably they asked her to leave the guns and drugs in her car and not bring them into the branch.

Sometimes you’ve got to laugh to remain sane.

INVESTMENT OPINION

Spark – The Spark Sport situation is another reminder of the risks relating to investment, and from Spark’s perspective managing business risks (expect the unexpected).

I admire Geoff Latch (Head of Spark Sport) for choosing to take on a difficult project. His efforts, and those around him, sit squarely in the ‘show me’ camp. They are giving things a go for the benefit of their customers and their business.

As it happens, my use of Spark Sport has been seamless (for the most part). Streaming, from any source, is adding value to my video content experience both through breadth and depth of content but also through the ability to manage its timing.

I am less impressed by those who prefer to use social media to ‘tell me’ what should happen.

Passionate? – Last year when NZ Refining toured NZ with the road show to promote its new bond issue (NZR010) the Chief Executive (Mike Fuge) responded to our many questions about the business and assured us he was passionate about the potential for NZR in future after the many upgrades and the repairs to the damaged pipeline to Auckland.

Given the passion displayed by the CEO toward his business in the fossil fuels industry I assumed he drove a V8 and worshipped Greg Murphy and Scott McLaughlin.

Today (17 September) he advises the NZX that he has resigned as the CEO of NZ Refining to take up the role of CEO at Contact Energy.

12 months isn’t what I’d call evidence of passion for the business, it looks more like a ticket home from Australia, now replaced by a job closer to his heart (electricity) and in a location he prefers (Wellington).

If anyone is looking for a young, low mileage V8, I’d suggest that you give Mike a call because surely he’ll be rolling up The Terrace to work in a Nissan Leaf?

I’d rather he didn’t place a drag on my dividends by purchasing a Tesla until he’s added more than 12 months with Contact Energy to his Curriculum Vitae.

Time line aside, Mike Fuge isn’t alone in losing the connection; Theo Spierings was passionate about Fonterra, until he wasn’t. At least he stayed around to confront the good and the bad for a while longer. David Hisco probably isn’t all that passionate about the ANZ now either.

If you want to see genuine passion for leadership, introduce yourself to Jim Delegat of Delegat Wine Estate. Just try and lever him out of his executive role, or his shares in the business.

Regular readers will know that it’s situations like these, false passion and real passion, that cause me to rely as much on my instincts for investment considerations as I do the grandly presented corporate speak.

Business people are all experts at slide show presentations now, but this skill doesn’t help with revenue, margin, profit, or risk management.

ComCom – We do like that the Commerce Commission exists to stress test for the presence of competitive tension and good form across NZ business.

However, the ComCom does themselves and ‘us’ a disservice when they make basic errors such as completing calculations based on the wrong number of shares on issue for the company being assessed and by using accounting methods that differ from those that must be applied by the target company.

These errors add unnecessary volatility (risk contributor) to the marketplace.

FMA – Immediately after reading about the ComCom errors I read the story about the Financial Markets Authority asking the government for increased powers, specifically, ‘the power to go in and poke around inside banks and insurers so it can stop potential problems for consumers before they happen’ (FMA CEO).

Again, we like that the FMA exists, but they seem to have failed to proofread this new request which could also be re-worded as ‘the power to declare one as guilty until proven otherwise’.

This request discloses an overt mistrust by the FMA over those that it regulates, which is a disappointing flag for them to fly.

Hong Kong – Credit rating Agency, Moody’s Investor Service has joined the ranks of those concerned about Hong Kong’s short to medium future and announced a downgrade of its credit rating from ‘Stable’ to ‘Negative’.

Moving away from ‘stable’ would seem obvious given the less than stable response from the public to changes being made by the Hong Kong government, in favour of greater influence from China.

Fitch Ratings had already downgraded Hong Kong.

Having said this, HK credit ratings remain in the very robust AA category.

This development has been 22 years in the making but those brought up under a regulatory regime of law and order operated as it occurs in the United Kingdom are not enjoying the move toward governance in accordance with China’s preferences.

The Chinese political process is not going to change, so in my view the folk of Hong Kong should not hold on to hopes that all will settle back to the ways of old. The changes will not be like Mugabe’s Zimbabwe, but I think the changes will be as significant in scale for HK over the decade ahead.

This makes the prospect of investment in Hong Kong a very difficult risk to address because the justice system supporting these decisions seems very likely to change significantly from this point.

I read one article that referred to some Hong Kong businesses ‘moving out’. Jacinda must have missed my recommendation that she invite them to set up in New Zealand because they are now visiting Singapore to consider this as an option.

Boris Johnson could do well to contact them too; decrying the errors of his predecessors in not offering all Hong Kong citizens a UK passport in 1997 and inviting them to apply now if they bring their businesses with them (to Northern Ireland? - Ed).

Last week’s explosions in Saudi Arabia are a problem, both for politics and commerce, but Hong Kong’s situation is a much larger development.

HKSE - LSE – In related news, the Hong Kong Stock Exchange has been trying to buy the London Stock Exchange and most recently offered to pay 37 billion pounds.

The LSE board of directors unanimously rejected the offer within days.

They were unimpressed that the unsolicited offer seemed to have been presented to the media almost as quickly as it was presented to the LSE but in truth this gave the LSE a polite reason to reject the approach.

It no longer matters what price HKSE offers for the LSE as the answer must be no because of the huge increase in political risks relating to Hong Kong.

If the UK doesn’t like Europe’s influence over UK domestic matters there is no way the LSE will countenance handing control to the dominant nation on the Asian continent.

Japan and Korea – So many more nations are expressing their discontent with each other at present.

Is this new freedom to speak one’s mind inspired by President Trump?

The irony with this new spat between Japan and Korea is that it was the US that tried to inspire a greater ‘settlement’ of their differences after the second world war (1965 treaty) but now Trump is giving them, and others, the freedom to swing their arms based on various previously suppressed opinions or truths about past agreements.

In the case of Japan and Korea’s latest cooling of relations the grain of salt that appears to have started the slide is a judgment by the Korean courts that its citizens can lay claims against Japanese organisations that played a role in the latter nation’s oppressive past.

Rather than halting such a political development the current Korean leadership seems to be allowing it to proceed, confirming that this generation, 54 years on, wishes to relitigate whatever was agreed in 1965 but is now to be disputed.

Japan who no doubt feel they have made apologies and tried to move on under a very different political style, have responded by distancing themselves from the new Korean demands but also showed that they cannot ignore this new threat.

When I first read of this dispute I was surprised by the disruption between two mature and successful trading nations and the headlines which didn’t ring true. The new theory of a deep-seated historical dislike makes more sense as the driver.

Sadly, it confirms that nations find it very difficult to focus on moving on from past failures.

It is very hard to move forward if we keep looking back.

I find it hard enough to form robust investment views about successfully addressing the decade ahead, without allocating any more mental energy to matters from the recent past (10 years), let alone a past that is 50 and 100 years ago with respect to Japan and Korea’s history.

This situation reminds us how quickly unexpected investment risks can emerge and then escalate, making the returns we accepted yesterday look quite inadequate today.

I’d guess that major Japanese businesses operating in Korea are now discussing their concerns rather frequently.

Many New Zealand businesses have decided that they must expand their operations into mainland China. I think these decision makers are consistently underestimating the risks. Fonterra executives could boost the company’s revenue by holding regular seminars on how not to expand into China.

As I touched on above, businesses in Hong Kong, especially those controlled by owners outside Hong Kong, will also be addressing sharp increases in the risk of operating that business there based on the new strategic intent displayed from Beijing.

This pressure will be most intense for businesses controlled by American owners, given President Trump’s efforts to run Huawei out of town.

Throughout my career the world has been changing, but right now I don’t like the path we are on with respect to tolerance.

Spending – Monitoring spending will be more important in a low yield investment environment.

We worry for you about the track that has seen returns quickly decline from 8%, to 6%, then 4% and now 2% for many bonds and deposits.

We don’t want you to cut spending in your retirement years, but to maintain the discretionary spend in a low yield investment environment you should take a close look at your list of expenses to try and spot those they may be avoidable.

High ratio fees charged by most portfolio managers and investment advisers in our industry always warrant close scrutiny. Given the declining state of nominal returns paying high annual fees measured against your wealth is something that needs to change.

You can do the math; If you earn 2.50% on the fixed interest portion of a portfolio, then pay 33% tax you are left with 1.675%, less an annual fee of 0.67% (1.00% fee prior to tax deduction) leaving you with 1.005% net for the year.

Note of course that inflation is targeted at 2.00% and that our councils and insurance companies make no effort to stay within such inflation targets.

The same portfolio managers and investment advisers do deserve higher fees on investment in property and shares, but still not as high as many of you are paying.

When you discuss investment with the younger generation remind them that savings will always be the greatest driver of future wealth, but this fact will be even clearer in the decade ahead with its very low returns.

The ‘eighth wonder of the world’ being compound interest (or dividend reinvestment programmes) is rapidly losing its magic so keep replacing it with acute awareness and cost control.

ECB – Mario Draghi has retired from his role as the President of the European Central Bank playing the same symphony until the end – ‘cutting interest rates and buying bonds’ with the volume and elevation set by Tchaikovsky.

New ECB President Christine Lagarde may well have asked Super Mario to play the Jack of Hearts as his last hand so as to provide her with a little more time to review her cards, or maybe he played it while she wasn’t watching to ensure she didn’t meddle with his strategy.

It’s always hard to know and nobody is saying.

Or maybe the ECB Chief Economist is, because he hasn’t wasted any time by pronouncing that the ECB will need to cut interest rates again.

Nothing has changed for you, or me.

What we know is that Europe’s economy is not strong and that negative real interest rates will remain the order of the day for many years to come.

Oil– The attack on Saudi oil fields throws up several thoughts for me.

It confirms that Iran and Yemen don’t expect the US to come to Saudi Arabia’s rescue, especially now that the US is self-sufficient in oil from its own sources.

This prediction is also consistent with the developing view that President Trump prefers not to go to war.

It may reinforce the real reason that vehicle manufacturers are pushing the hybrid and electric energy agenda for a larger proportion of their vehicles, being their concerns about a dramatic shift in who now controls the global supply of oil.

If Iran is willing to attack, or sponsor attacks, on Saudi Arabia, when will they attack Israel, and how would the US respond to such an act?

What should be clear to us is that we are again moving into a period of higher fuel pricing and this will reduce our discretionary spending capacity, right at the time that our central bank governor wants us to spend more.

EVER THE OPTIMIST

The UK Trade Minister has made a visit to NZ.

Increased trade between NZ and the UK should be our focus, and not the political fun dominating the headlines.

INVESTMENT OPPORTUNITIES

Infratil Bond – Infratil has closed the offer of 7-year fixed rate bonds (IFT280), as intended.

However, they have left open the 10-year bond (IFTHC), with its annual reset interest rate, and will close this offer on 13 November. This bond pays an interest rate of 3.50% until December 2020 (then reset).

The extension to this tranche’s closing date is to provide a rollover opportunity to people holding the Infratil bond maturing 15 November 2019 (IFT200). Rollover applications would need to be submitted to us prior to 13 November.

The public can still invest new cash into this bond (IFTHC).

Thank you to those who invested in this offer through Chris Lee & Partners to this point, we appreciate it.

Metlifecare (MET) – MET issued $100 million of their new seven-year senior bond (MET010) at the 3.00% interest rate (underlying rates declined during the last few days so the minimum rate protected investors).

Thank you again to participants.

TRAVEL

Edward will be in Taupo, 24 September (tomorrow), Wellington 10 October & Auckland (Remuera) on 16 October.

Chris will be in Christchurch Tuesday 15 and 16 October.

Kevin will be in Christchurch on 17 October.

 

Mike Warrington

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Market News – 16 September 2019

For those who hoped Donald Trump would just go away, or look forward to the day it happens, you may be disappointed to learn that financial markets expect him to be around for long enough that they must closely monitor the financial impact of his utterances.

JP Morgan has launched an index that monitors market reactions to his ‘Decrees by Twitter’.

JPM has called it the ‘Volfefe Index’ to tease the President’s unusual use of language, which includes some unrecognisable terms. (Vol is from Volatility, but Fefe is from one of the President’s manufactured words).

You wouldn’t bother making this effort (create an index) if you expected the Presidency to end in 2020.

INVESTMENT OPINION

Fun quote – From the Commerce Commission:

Fonterra's 'Velocity' programme doesn't appear to have delivered.

Small News – but of relevance to ongoing change that impacts us all;

Inland Revenue and Accident Compensation Corporation will no longer accept cheques as a method of paying obligations owing to them.

Having the biggest ‘business’ (IRD) in the country adopt this position will inspire others to follow.

Banks will not fight the development, given the costs of processing cheques and Kiwibank has already confirmed its position of no longer offering cheque books to customers.

This behaviour will undoubtedly be replicated by others.

AML and Capital Markets – Anti-Money Laundering legislation, thrust upon us by the G20 in 2012, is well meaning but has been very disruptive to regular business administration and is often anti-competitive given the new inconvenience for trying to arrange normal business elsewhere.

There was an interesting case on Fair Go last week where a bank thought a person was behaving poorly so the bank simply shut down the client’s bank account and refused to explain why (the AML law demands secrecy!).

As it happens the person was an honest law-abiding citizen and the bank had made an error with their assessment, but couldn’t say that either.

I guess the central bank should, at the margin, be a little concerned about the impact of this bank’s behaviour with respect to financial stability in NZ. It certainly destabilised this particular man’s finances and probably had domino effects to payment of his utilities, rates, groceries, etc. each month.

However, in its defence, the new AML law is effective at uncovering criminals too; witness the ‘surprise’ busts of NZ crime (especially the drug trade) every other week in the news, where you might wonder ‘how on earth did they discover that?’.

A huge proportion of the vital information provided to the Police is sourced to the banks based on their improving AML monitoring and deep knowledge of NZ payments.

Our opinion is that the AML law has created a vast workload for all organisations, multiplied by the fact that all businesses are doing the same things for the same shared customer. This must surely be a meaningful drag on the economy (proportion of time allocated to an unproductive activity).

Meeting one’s AML obligations should be done at a central point (a government organisation) and then shared with the person’s permission because the AML evidence obligations are the same for all of us.

I raise this because I was very pleased to see this ‘centralise AML’ message as one of the recommendations to regulators within the recently released Capital Markets 2029 task force report.

I doubt such a development will happen fast, but if a Minister is bold enough to set it as a strategy, where IRD seems the appropriate catchment organisation, (unless your name is Orwell – Ed) then we can tolerate the delayed delivery of the strategy knowing that a new improved AML process would be on its way.

Segue moment -

Switching to the rest of the Capital Markets task force report;

With our immediate focus being you, the investing public, I was pleased to see other good recommendations from the task force to government that they enable more private investment in public sector assets and necessary infrastructure.

This recommendation should also be read as being directed to all territorial councils and the report takes a firm view on this by also recommending that central government reforms local government law to ensure that councils assess all funding options for necessary infrastructure.

Debt funding may seem fine until you are choking on debt as Christchurch and Auckland would seem to be doing, but at some point the sale of shares (equity funding) will be an appropriate solution too.

Councils would do well to reflect on the recent success by Hawke’s Bay Regional Council and the Napier Port in raising capital for economic expansion in their region, or the government’s success with the Mixed Ownership Model where many of their diluted shareholdings are worth more than the original 100% investment holdings (various reasons).

The task force would like to see the new Infrastructure Commission accelerate partial (or full) private funding solutions for infrastructure projects in NZ.

Interestingly that whilst the task force does make recommendations about the need to increase the number of investment listings on the NZX it does not then link this ideal as a recommendation to try and ensure all infrastructure projects that involve private investment (such as Public Private Partnerships) are listed on the NZX.

I spoke of the value of liquidity from an NZX listing recently after Matt Whineray’s article encouraging the government to enable more Public Private Partnerships (investment in necessary infrastructure). NZX listings provide valuable liquidity and should provide valuable disclosure behaviours from directors of such entities.

Whilst we do not participate in Kiwisaver it is covered well in the report and makes recommendations for what it perceives to be the best moves to ensure this very large savings pool is well directed in terms of its use to the NZ economy.

Kiwisaver is a fast growing but poorly led elephant. Investors and managers are too short term in their focus and thus they remain too liquid, which hinders long term investment in growth assets which demand some stability with funding.

The Reserve Bank has made it abundantly clear that investing in short term liquid securities will be the least reward asset to hold, so it shouldn’t be difficult for financial advisers and investors to conclude that longer term commitments will be rewarding.

Proposal – Kiwisaver fund managers offer fee discounts for term commitments to the management contract (a bit like the days of discounted mobile phones).

A longer term commitment has ‘equity’ value to the fund manager.

A commitment of say three, four, or five years enables that fund manager to determine a scale of funds that can be invested into longer term, developing or less liquid investments that seem likely to add long term value to the fund.

The fund manager’s process should then be no different to the way you manage your portfolio as you assess the amount of money that is ‘probably’ required for repayment over a short time frame, ‘possibly required’ over a short to medium time frame and lastly ‘unlikely’ to be required over a medium to long term time frame.

Given the ongoing growth in funds under management it’s hard to believe a fund manager couldn’t define a proportion of funds that could be invested in good quality but long term and illiquid assets (imagine if Transmission Gully had been offered as an investment).

My proposal would see a fund gaining the highest fee for the investor adopting the shortest term commitment and asking for the lowest risk asset.

My 25 year old son should avoid this choice like the plague; Reducing fees should be as important to him as pursuing some more rewarding long term investment options.

Folk approaching retirement who might be reducing their risk profile and be contemplating withdrawal from Kiwisaver (again a fee reducing behaviour) should not mind paying the higher fee for short term commitment because that cost of that short term will be modest.

(You’re beginning to sound like a Kiwisaver dictator – Ed)

No, just opinionated.

There’s heaps of good thinking in the Capital Markets 2029 report so it is worthwhile reading for those curious about how our markets operate and where experienced professionals believe the resistance points are currently.

Touching on one other commendable recommendation - adding financial literacy to NCEA for the secondary school curriculum; This should be so easy to install and offer to kids for their obvious long term benefit.

It would also be an easy way to gain extra NCEA credits from extra-curricular learning.

One of our kids gained extra credits from a high quality holiday programme in the art/design field that she enjoys. It would be so easy to develop a short, sharp, two week course on financial literacy that could be presented and tested during school holidays. It would help to fill the kids brains with relevant life training skills plus ‘some’ well received extra NCEA points to boost the score card.

Congratulations to Martin Stearne for chairing a successful capital markets task force and the quality of its recommendations.

Here is a link to the document: https://www.fma.govt.nz/assets/Reports/Growing-New-Zealands-Capital-Markets-2029.pdf

AML for Crypto – Facebook’s proposed payment unit, crypto currency, ‘Libra’ continues to make progress and rather than dropping it on the market to see how it goes they are interacting with regulators as they develop what they surely want to be a long-lasting service.

US Regulators have logically demanded that Libra must meet the most stringent of rules relating to money laundering and terrorism finance and if Facebook wants its payment method to be truly successful they’d be wise to allow regulatory influence into its development.

Mavericks like Bitcoin will not be allowed to succeed as very wide use, or legal tender payment methods given their pursuit of operating in the shadows.

I would like to believe that the preferred country of registration for Libra, Switzerland, will result in some more high-quality standards for participation in the financial settlements arena.

Mind you, before Facebook has even expressed a position with respect to working with regulators the French have come out swinging and declared they will block Libra from Europe if it threatens monetary sovereignty (this relates to my oft used points about legal tender and tax collection).

Facebook might be able to temper regulatory concerns if it offers to pass through to governments a modest tax on Libra transactions, a little like the fees collected by Visa and Mastercard but these fees don’t make it to the government purse.

Lastly, of political interest, at present Libra only intends to include the following major currencies (or government bonds) in its asset pool: US dollars, Euro, Japanese yen, British pound and Singapore dollar.

Spot the missing currency.

Cheap Money – Businesses with very long-term strategies, such as Mainfreight’s 100-year plan, must view today’s interest rates as a gift from the gods.

Observe Apple with its holding of US$200 billion cash yet it also wants to borrow money on today’s terms where interest rates are low on a nominal and real (ex-inflation) basis.

The better the long-term planning, the longer the term such businesses can borrow at today’s apparently low cost.

EVER THE OPTIMIST

Poor old Statistics has had a rough time over the past couple of years, losing their Wellington building to earthquake demolition, then a messy Census and finally the departure of their CEO accepting responsibility (for an earthquake? – Ed).

Well, they suffered two earthquakes; one terrestrial and another managerial.

However, my point is that they remain a very good source of data for investors, with last weeks ETO item being their report about NZ tourism.

Some had feared the drop off in visits from those in Asia would finally slow the sector and our economy, given that tourism is now our largest business, however, increase in visits by Australians and Americans have more than filled the gap (gross numbers +2.00% year on year).

Of granular detail to me was the fact that the fastest growing subset was people staying in NZ longer than 15 days, which seems to reflect the demographics of more people in the retired cohort(s) with more time and more money.

So, if tourism folk and their marketing advisers are at the top of their game they will direct more of their budget to seeking out this group and then treating them really well once they get here.

ETO II

I am scraping the barrel a bit here but RBNZ Governor Adrian Orr will be pleased to read that consumer spending was up for the month of August at +5% relative to 2018 spending.

INVESTMENT OPPORTUNITIES

Infratil Bond – new bond offer remains open, but this is the final week.

If you wish to invest please act now. If you need a slight delay before delivering your application please contact us to discuss the options.

On offer are two different terms:

7 years at a fixed rate at 3.35%; and

10 years at a floating rate, reset annually (3.50% for the first period).

Metlifecare (MET) – offer of $100 million senior, secured, bond (MET010) is available to investors.

The term offered is 7 years (2026) and the interest rate will be set on 20 September.

Helpfully, recent increases to interest rates have resulted in a Minimum rate set at 3.00%.

MET is paying the brokerage costs on this offer; however, it is a fast-moving offer (closing on 20 September) so we will issue contract notes to participating investors (no application form required).

The offer document is available on the Current Investments page of our website and with MET being an NZX listed company one can access a long history of public announcements from them.

Investors seeking a firm allocation in this new bond offer are encouraged to contact us now (and no later than 5pm on Thursday 19 September). Firm allocations will be confirmed by 10am Monday 23 September.

Payment will be required by Thursday 26 September.

Kiwibank – last week replicated the behaviour of the other banks and issued $400 million of senior five-year bonds (maturing 20 Sep 2024) to the market as part of its funding programme.

The yield on the bonds was 2.155%, interest paid semi-annually.

These bonds rank alongside term deposits with Kiwibank, even though yields on the two items do not sit ‘alongside’ each other. A five-year term deposit with Kiwibank currently offers a return of 2.70%.

To confound the theorists the additional yield here does not relate to additional risk.

The only meaningful difference between these two investments is liquidity; one can sell a Kiwibank bond but one cannot sell a Kiwibank term deposit (and banks say no to breaking deposits, or penalise harshly if they happen to agree).

Liquidity has a value, but it is hard to price. The price is cheap when you don’t need to sell an asset, but that same price is rather high when the need for a sale becomes urgent.

I think I’d be willing to give up something between 0.15% - 0.25% in yield to accept the Kiwibank bond relative to the term deposit.

I can reduce my need for lower returns via liquid assets, such as bonds, if I maintain higher levels of cash and very short term bank deposits (always plenty of money around me), but as you all now know returns from short term deposits will deliver the lowest returns.

Dairy Farms NZ – Based on stories fed to the media it seems possible that Dairy Farms NZ (a diary farm consolidator) could consider listing on the NZX to raise capital for expansion.

They had been buying up farms with money from private investors but the government’s additional limitations on foreign investors has reduced the pool of wealth to tap into, which in turn has also placed some downward price pressure on the value of dairy farms.

There’s no point in debating land or share pricing here because there is no offer on the table but being able to invest in the land and cows has been very difficult for New Zealanders even though it is one of our biggest sectors of the economy.

I once urged the government to consider selling 49% of its share in Landcorp to provide wider access to our primary industry. Jacinda didn’t even return my call.

Maybe Dairy Farms NZ will present the next opportunity to invest in the sector?

Maybe they are one of the ‘several other possible IPOs’ that NZX CEO Mark Peterson referred to in their latest results report?

TRAVEL

David Colman will be in New Plymouth on 19 September

Edward will be in Taupo 24 September.

Chris will be in Christchurch Tuesday 24 September and Wednesday, 25 September.

Kevin will be in Christchurch on 17 October.

 

Mike Warrington

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Market News – 9 September 2019

The UK is a political shambles at present, but I’ll bet the residents of Hong Kong would take a democratic shambles over their own scenario.

Mind you, the UK public may well feel that their government is trying extremely hard not to respect the preference of the majority (democracy).

The majority of UK’s members of parliament are now confirming that they represent the European Council more than their own country, which feels unwise to me given the views expressed by their electorate.

INVESTMENT OPINION

Market Leadership – There are plenty of politicians who yell loudly about the failures of letting the market (aka the people) set the standards, and there are plenty of examples to support their calls.

However, at present I am beginning to read more examples of where the market is setting better standards, and better long-term strategies, than local and central government.

The prompt for this brief thought was Walmart’s ongoing evolution to reduce its distribution (sales) of guns and ancillary products in contrast to President Trump and Congress’s inability to see the obvious.

In NZ, major energy users are discussing grouping their demand to encourage new investment in additional renewable electricity generation to encourage the industry in that direction. This will be far more effective than having our government decide overnight to block new oil and gas mining licenses.

Negative Interest Rates – Are negative interest rates a trap that ‘we’ are unwittingly walking into based on today’s financial strategy of ‘nobody is to be left behind’ and ‘nothing should be allowed to fail’?

Spending less than you earn is to accumulate acorns because ‘winter is coming’ (you couldn’t help yourself could you – Ed).

Saving is a good behaviour. Accumulated net equity (wealth) is to personal financial stability what insurance is to your car.

In my wide observation, once people have a surplus of savings their confidence for spending rises and once a person has a significant level of savings the passive income potential supports more spending, and to some extent charity.

So, saving is unquestionably a wise strategy.

There must be a price, and by price I mean a cost, to a borrower if they are to use the money accumulated by the wise.

When that cost falls to below 0.00% and begins to penalise the wise and reward the unwise (debt for consumption) something is amiss.

I think John Mauldin used an appropriate description recently in one of his articles when he said ‘negative interest rates are a symptom of an underlying disease’.

It is not healthy to explain to savers that they must pay a ‘fee’ for storing their savings and then celebrate with the borrower in the next aisle that they will be paid a fee if they agree to borrow some money.

When a borrower uses money for investment, often the productivity from that investment will serve its purpose of servicing the debt and hopefully repaying that debt (or a good portion of the debt, depending on investment preferences).

When a borrower uses the money for consumption the repayment of this debt is entirely dependent on the income of that borrower, and given that the person’s income didn’t support their desired level of consumption it’s hard to imagine that income repaying the debt and keeping the person in the lifestyle to which they have become accustomed.

After all, this person is borrowing more money to support a lifestyle they cannot afford on their regular income.

You may insert a real person that you know into my paragraph above, or you could insert the Argentina, US, Italy or Greece, the description is the same.

Short to medium term interest rates in Europe are almost entirely negative across the union. We discussed a couple of weeks ago some very long term interest rates are too (Germany, Switzerland).

Last week I read about the first loan to a private company at negative interest rates; Siemens AG borrowed $1.6 billion at -0.315% for a 2 year term (German government bonds are -0.91% at present). Siemens is one of the world’s largest energy and health sector businesses and is clearly respected for its potential to repay this debt.

Siemens has an A+ credit rating from Standard & Poor’s at present and according to the S&P table of default statistics only 0.09% of A+ entities will default on the financial obligations within a two year period.

The fact that investors are willing to pay Siemens 0.315% to hold their money for two years means they are more confident about the company’s finances than S&P’s average failure rate for such a credit rating. (In theory you break even if you receive +0.09% from a vast pool of A+ credit rated entities over a two year term).

In fact, it’s pretty clear that the market thinks there is zero chance of Siemens defaulting on its debt between now and 2021 and for some reason (strange underlying market) are willing to pay for the privilege of having Siemens temporarily use their money.

You don’t find a 0.31% loan repayment failure rate (the same ‘loss’ value as lending to Siemens) until you come down to the scale to the BBB+ credit rating category.

If investors agree to accept negative returns they are free to do so (as in freedom), but with many central banks using tax payers funds to buy bonds, adding unnatural demand to this negative return market place, they are sponsoring a vicious cycle, which cannot be what they intend long term?

Who would pursue a strategy of a vicious cycle?

The Proverbs and Shakespeare state ‘neither a borrower nor a lender be’ describing the differing folly that effects both sides of the equation.

Would they rewrite their scripts if they were around today?

USD – Central bankers, who gathered recently, are again discussing their concern about the dominance of the US dollar in global finance.

Interestingly they are finding reasons to support the concept of digital currency, partly for efficiency, but more so through concern about single currency domination which the US currently enjoys.

They weren’t keen on the private currencies, such as Facebook’s Libra, holding centre court but they are beginning to see more potential to connect technology with legal tender payments, subject to these being controlled by central banks (aka government).

Therein lies a major problem. It’s all nice for central bankers to sit around singing the same theoretical tunes but the music stops when political power struggles to enter the room.

The central bankers meeting quoted these statistics:

The US accounts for only 10 per cent of world trade and 15 per cent of global GDP but a third of countries peg their currency to the dollar, 50 per cent of global trade is invoiced in dollars, two-thirds of global foreign exchange reserves are denominated in dollars and two-thirds of global securities issuance is in dollars.

China may well be enthusiastic about reducing the value of the Yuan to assist with the value of its trade but the stronger USD has other consequences, including strengthening the financial ties between the US and countries that have borrowed money in US dollar terms, where the ‘strength’ rests with the US.

Argentina is a current example.

Argentina has now imposed currency controls, which means they are restricting (US$10,000 limit) the ability of locals to sell Pesos to buy other currencies, where the US dollar will be the favourite.

This reminds me of the eagerness of retailers to ask for USD from us when we were over there last year, in preference to having us pay in local currency. In fact USD settlement of transactions (payment and receiving any change) was as easy as doing so in Argentinian Pesos.

It is also a reminder of the financial trouble that Argentina is in, again, and how they will re-open negotiations with the likes of the IMF to ask for financial support and try to negotiate with other lenders for deferral of payment or new lower interest rates (please).

Argentina’s large volume of US dollar debt makes it impossible for them to escape a financial relationship with the US and the US banking system. You may recall the last time they tried to avoid payment on old USD bonds the US court blocked them from making different payments to different lenders within the same pool of bonds (some agreed to discounted terms, others did not).

The ‘block’ was created when the US court stopped any US bank from settling the proposed USD transactions for Argentina. Agreements made in USD are subject to US law.

Losing access to US banking wasn’t a tolerable outcome for Argentina.

Is Facebook wealthy enough yet to buy up a nation’s US dollar denominated debt, releasing them from the USD stranglehold, on the condition that they make ‘Libra’ legal tender in that nation?

Here’s looking at you Argentina.

The US will not give up its position of financial strength lightly, and given the current trade tensions they are likely to increase their belligerence with respect to threats, not fill in the moat and make it easy for competitors.

The point of this brief ramble is that the trade war and its global trade ramifications are far from over, and are probably just past quarter time. Last week Donald Trump declared that he will be tougher on China in his second term!

Bond Bubble? – Last week I read an article that described bond prices as being in a bubble and I thought, ‘how can that be for an asset that has a finite life?’.

Investopedia defines a bubble as existing when ‘It is created by a surge in asset prices unwarranted by the fundamentals of the asset and driven by exuberant market behaviour.’

A bubble of price excess is prone to burst when the majority opinion changes from one of bullishness about rising price to one of bearishness that expects a retreat in price, the ‘burst’ being the point when such a change in opinion occurs, typically over a very short time frame (think Bitcoin at US$20,000).

I don’t think the use of the term ‘burst’ is appropriate for bond risk really, especially not for bonds from borrowers of low risk (having a high probability of repayment).

Please discount bonds from those who fail to repay from this story. Their failure to repay (collapse in price of the bond) had nothing to do with the movement of market yields, which influence the price of bonds. Failure to repay is a function of a failure in business.

A bond (fixed interest investment) with a fixed term until maturity offers a clearly defined set of rewards over that fixed period. In simple terms it has a $100 cost at the start, defined interest payments during the period and $100 repaid at the end. It all fits nicely in to a clearly defined ‘box’.

The market cannot inflate this price outside the defined ‘box’ (start and finish dates, surrounded by widely shared interest rate pricing influences) so a balloon-like price isn’t possible in my view.

Strange implied returns for the residual period of a bond are possible (for example, negative returns for a 30 year period) and the markets view of returns evolves every day, but it does not ‘burst’.

Today’s negative yields are indeed strange and have temporarily forced the value of some bonds higher than most of us anticipated, but those very low returns are being accepted widely around the globe so they are not a local or isolated pressure point creating a bubble. The market pricing of all good bonds is influenced by these sharp declines in market yields, but those bonds will assuredly repay $100 on maturity date, which is unavoidably moving toward us.

The profile of a bond value over time may look like Mt Taranaki, beginning at $100, rising to $125 (if yields falls) before declining to be repaid at $100.

It may look like the Remarkables with a jagged sequence of price changes, or a glacial valley (if yields rise) such as the one to the South side of Mitre Peak, but the value of such a bond always returns to $100 upon repayment.

The current arrival of negative yields may add a little more altitude to the summit of the Mt Taranaki bond price midterm, but again the repayment value will still be $100.

Please don’t read ‘Bond Bubble’ headlines and react to them by changing your bond portfolio, which I hope was established on the basis of a well-defined investment policy.

Oil – Our Prime Ministers may get lucky on the oil price debate without being drawn too deeply into the fact that most of what we pay locally is tax.

That luck is linked to the international price for oil, which is slipping at present given the concerns about weaker economic activity, alongside robust mining volumes in the US. Under this scenario it would be typical for the price of oil to trend lower.

The weaker NZ dollar is the only problem to this lower price outcome, but a weaker currency is far better for our exporters than debating marginal cents on the price of our fuel.

Standing Proxy – This reminder to investors to offer Standing Proxy (for shareholder voting rights) to the NZ Shareholders Association was prompted by their views about Rubicon (RBC).

Leading into the RBC shareholder meeting, where RBC has asked for high reward for a new director, the NZSA has responded with their assessment:

‘it won’t be supporting Adams’ proposed $137,127 a year pay package, saying it is excessive for a company with a market capitalisation of only $89 million, is not profitable, does not pay dividends and has been a serial destroyer of shareholder value.’

This is a great example of the depth of thought that the NZSA applies to representing shareholders at Annual Meetings (or special meetings, when called).

If you do not exercise your own votes as a shareholder in companies then I strongly encourage you to put a Standing Proxy in place to appoint the NZSA to act for you.

The more of us that do this, the more powerful ‘our’ advocate becomes.

If you’d like copies of the blank forms, and explanations for processing, please email us to request them.

EVER THE OPTIMIST

I hope we can continue to stay beneath the radar of the global trade squabbles.

Lamb pricing reached new highest prices since 1982 (the days of subsidies) enjoying strong overseas demand, and all of this is happening as the NZD dollar is falling to further increase the local currency value of our exports (double ETO – Ed).

INVESTMENT OPPORTUNITIES

Infratil Bond – new bond offer remains open with applications being processed on a first come, first served, basis.

If you wish to invest please act now. If you need a slight delay before delivering your application please contact us to discuss the options.

On offer are two different terms:

7 years at a fixed rate at 3.35%; and

10 years at a floating rate, reset annually (3.50% for the first period).

The offer closes on 20 September so we are now inside the last 11 days of the offer. If you wish to invest and haven’t yet done so now is the time to act.

Metlifecare (MET) – Has finally announced the launch of its $100 million senior, secured, bond (MET010). The term offered is 7 years (2026) and the interest rate will be set on 20 September (Minimum rate defined on 16 Sep); we estimate the interest rate will fall between 2.75% - 3.00%.

MET is paying the brokerage costs on this offer; however, it is a fast-moving offer (closing on 20 September) so we will issue contract notes to participating investors (no application form required).

The offer document is available on the Current Investments page of our website and with MET being an NZX listed company one can access a long history of public announcements from them.

Investors seeking a firm allocation in this new bond offer are encouraged to contact us now (and no later than 5pm on Thursday 19 September). Firm allocations will be confirmed by 10am Monday 23 September.

Payment will be required by Thursday 26 September.

TRAVEL

Edward will be in Napier on 16 September, in Taupo, 24 September and Wellington on 10 October.

David will be in Lower Hutt on 11 September and New Plymouth on 19 September.

Mike Warrington

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Market News – 2 September 2019

September already, really?

At least that means it’s a big month for income from dividends and interest payments.

INVESTMENT OPINION

Hydro Climate (not rain) – The decision by Hon. David Parker to decline the proposed small hydro scheme on the West Coast has released a huge flow of previously ‘dammed’ energy on the subject; supporters are offended in the extreme and those opposed are over-joyed.

Society’s propensity to issue opinions with extreme tones dilutes the views of those with genuine concerns. Online portals have made it easy to be a ‘keyboard warrior’ and there’s no putting this cat back in the bag. Facts will be as important as ever for debate to reach good conclusions.

What I see is a nation that is still struggling with its overall strategy with respect to balancing the needs of the population with our impact on the environment and failing resource management regulations.

David Parker would appropriately respond to me that he has taken on the review of the Resource Management Act with a view to making it more ‘fit for purpose’, which indeed he has, but this work won’t be completed during his time in parliament and probably not before I have grandchildren.

‘Don’t hold your breath’, because your reduced oxygen use will not save the planet, or the Minister.

In this case the West Coasters had gained the support of the Department of Conservation, presumably no mean feat, and gained confidence that spending millions in preparation of a proposal was, on balance, appropriate.

It’s hard to tell whether these people have real reasons to be concerned about NZ leadership because everyone on both sides are shouting so loudly.

I am tempted to side with the West Coasters because they have spent a lot of time and real money to put their case. The opposition has not.

However, with insufficient facts I can only repeat that the clearest conclusion for me is one of governing from a position of uncertainty about strategy.

What I heard here was ‘please stop using fossil fuels, ban the issuance of future mining licenses, subsidise electric vehicles, try to establish a high price for carbon to penalise emission and reward extraction, but block credible energy generation from renewable resources’.

Maybe David Parker could replace some of the resistance points within the current Resource Management Act with a clause that demands ‘if not, then what?’; meaning, if this proposal displayed that it was capable of meeting a society need, what concepts will do so after if reject this particular proposal.

We cannot continuously say no to all credible proposals for progress without compromising societal outcomes.

Do I have a point here for investors?

I was trying hard not to stray too far into politics. Yes, if ‘we’ reject good proposals, and do not have better alternative proposals to solve problems, we will slow economic activity, which is not good for society or investors.

I think I find myself siding with West Coasters on this one, as I did when I was disappointed about the cancellation of the water catchment proposal in Hawke’s Bay in recent years.

Misleading – I was unimpressed by the announcement from Metlifecare directors last week when they announced they will not pursue a share buyback but will allocate their spare capital to developing more villages.

I’m not questioning the business strategy of building more villages, it may be the best capital allocation decision, but in my view the market was misled by them when they elected to comment on their share price last year.

In a classic error of voicing an opinion about one’s share price MET stated publicly in October 2018 that it was considering the potential of buying back some of its shares.

‘The share price is too low so we might buy some back’, which is always the cry, unless someone can remind me of an occasion when a company’s Chair lectured the market on its share price being too high?

The directors’ discontent in October 2018 was when the MET share price was $5.98.

Today the MET share price is $4.30, now a 35% discount to the Net Asset Value described for the business.

As I understand it development margins from building new villages come in between 22-27%, so under present conditions the company would extract better value by purchasing some of its own shares than by taking on a new development with the usual risks of such projects.

Accordingly, the share buyback thinking made reasonable sense to me.

Maybe the clue to the changing opinion from directors was observed when they did not update the market in February 2019, as they suggested they would?

Today, the directors believe they can add more value by expanding MET’s property portfolio.

Time will tell.

They have a demographic tail wind. (rescuing them from mistakes? – Ed)

However, my main criticism here is to directors that feel they can influence a share price by expressing their own minority view about that pricing. To then ‘threaten’ a share buyback hoping to add demand to the marketplace is unnecessary, unwise and as I say more than a little misleading if they don’t follow through and show conviction with respect to value.

It is a case of ‘telling’ the market, when ‘we’ are more interested in what the company ‘shows’ us.

Auckland Light Rail – Matt Whineray, CEO of NZ Super Fund will be pleased; Hon. Phil Twyford has nominated ‘NZ Infra’ on a short list of two, alongside NZ Transport Agency, to develop finance and build the proposed Auckland Light Rail service.

NZ Infra is a partnership between NZ Super and Canada’s CDPQ Infra Group. The initials CDPQ stand for Caisse de dépôt et placement du Québec and you can read a little more about them here: https://www.cdpqinfra.com/en

Matt’s schoolboy French language skills must have been dusted off for this negotiation.

Phil Twyford described the two entities as differently funded; no kidding, NZTA is a government agency.

I tried to read more about the NZTA proposal on its website but it shows there have been no new funding decisions (published) since June 2017. Am I unfair to align this with the current period of government and cancellation of various new roading proposals?

Maybe this is what freed up time for NZTA to consider if they should compete to design, fund and build train sets?

Perhaps they could also compete for the supply of electric scooters around NZ too?

Too far. Sorry.

Last week one or two readers weren’t happy with the proposed light rail in Auckland and thus were not happy that the NZ Super Fund would be ‘promoting’ it.

NZ Super is not promoting the light rail concept, this is the job of planners, councillors and government ministers. NZ Super and CDPQ is saying they would like to be the business that participates in design, financing and ongoing management of delivering the project.

Assuming the light rail project proceeds, which I think is a huge assumption, I would like it if NZ Infra wins the mandate. Once the project is completed, and the financial risk reduced, I’d then be pleased if ‘AKL Light Rail’ was listed on the NZX with NZ Infra offering 49% for sale to retail investors.

NZ Infra would then, I hope, be invited by government or councils to recycle their initial capital into a new long-life community asset that required external funding and management.

If we ‘rinse and repeat’ this cycle investors might enjoy new depth to the investment opportunities listed on the NZX, adding visibility and liquidity as benefits.

Postscript: The directors of the NZ Social Infrastructure Fund think I am unlikely to see Public Private Partnerships listed on the NZX. Their recent review of assets for potential sale (or listing) has discovered that private investors are willing to pay far higher prices for assets than comparable market listing proposals.

This removes private asset sales, but it doesn’t block the more publicly oriented sellers that are our government entities (central and local) from NZX listings to share ownership publicly. Perhaps ‘they’ could limit the ownership register to NZ resident investors (or funds acting for the same group).

Kiwibank – Whilst I am on the investment activities of NZ Super, they (alongside NZ Post and ACC) have confirmed they are willing to increase their equity investment in Kiwibank to support immediate growth followed by the new capital demands being proposed by the Reserve Bank.

Last year Kiwibank expanded faster than planned, a good thing, which led to the bank checking with its owners that they agreed to suport ongoing expansion and the higher capital demands this implied. They agreed.

This of course confirms that Jacinda has rejected my proposal to float 49% of the bank on the NZX, without writing to tell me of her decision, but the opportunity is not lost for her.

My strategy remains available. Prior to the ‘expiry’ of the next tranche of Kiwibank subordinated bonds in mid 2020 Kiwibank could, with Jacinda’s permission, offer about $500 million of new shares to the public, representing approximately a 25% ownership.

The government would retain control via NZ Post, NZ Super and ACC channels.

Shall I start a list and invite investors to join?

It could become my passive protest without needing to sit on Parliament lawns for 100 days to deliver the message. I could provide Jacinda with remote access to the list so she could monitor it for ‘political popularity’.

And Jacinda, remember that one of the greatest values of publicly floating a little of Kiwibank is once and for all removing the assumption that Kiwibank has an unwritten government guarantee, something that is reinforced by Hon. Grant Robertson’s plans to install government guarantees across a proportion of bank deposits.

Selling some shares would not only remove the implied ‘100% government guaranteed’ opinion of Kiwibank but it would simultaneously raise new equity, and quite likely do so at a ‘nice price’.

Chat with the Chair of Hawke’s Bay Regional Council and of Napier Port if you are at all unsure how the experience might go.

Just saying. (don’t seem to be able to stop you – Ed)

EVER THE OPTIMIST

Plenty of economic experts are predicting a sharp decline in economic activity for NZ, which makes sense in the currently disruptive global trade and political climate, but it has been nice to read about many good performances from our economy over the past year, such as:

Wine Industry – international demand at an all-time high, which was seen in Delegats’ strong recent results;

New trade records across the Port of Tauranga (and feeder ports such as Timaru) and their credit rating agency S&P liking them enough to increase their credit rating to ‘A-‘;

Scales reports continued strength from the horticulture sector matching its 2018 record crop and expanding sales in Asia and the Middle East have replaced some weakness in European demand.

Especially given that these three particular businesses are all involved with exporting our primary industry products to the world.

ETO II – Actually, what follows should have been the lead ETO item because it is excellent all around.

Some Dunedin based young entrepreneurs from a Venture Up business programme, under the label Spout Alternatives, are trialling delivery of milk to major users in tall kegs (as in very similar to beer kegs).

The initial intention was to reduce plastic use in the milk sector. They quickly passed by the beloved glass bottles from history and realised that the biggest users were throwing out the most plastic and realised a bigger vessel was the answer (the keg).

Simple; but brilliant ideas often are.

If pricing is comparable they will surely take Dunedin cafes and major milk users by storm. I hope they are already planning for sales and service across New Zealand.

If Fonterra was clever (changes its spots? – Ed) they would call these youngsters, buy the rights to their idea for a modest sum, offer to finance expansion and provide assured nationwide milk supply and delivery services to achieve a countrywide service inside 12 months.

ETO III – Usually currency wars result in the NZ dollar being knocked around and often rising in value to the detriment of our export sector, however, at present the NZ dollar is falling in value against the US dollar, Australian dollar and Japanese Yen. We are stable against Chinese Yuan.

These are the major trading currencies for our export products so the weakness is great news for New Zeland’s most valuable businesses (selling to the world).

Share investors can observe the benefit by looking at the share price chart for Fisher & Paykel Healthcare (FPH) last week.

I am reluctant to encourage Donald Trump, but I’m pleased with the current weakness in the NZD. To be fair to our central bank, its surprise 0.50% interest rate cut was the most influential recent driver, and it may well have been the FX market that the Governor was trying to shock.

INVESTMENT OPPORTUNITIES

Infratil Bond – new bond offer remains open and is progressing well with applications being processed on a first come, first served, basis.

If you wish to invest please act now. If you need a slight delay before delivering your application please contact us to discuss the options.

On offer are two different terms:

7 years at a fixed rate at 3.35%; and

10 years at a floating rate, reset annually (3.50% for the first period).

The offer document can be downloaded from the Current Investments page of our website.

Transpower – issued its new 6 year bond last week at a yield of 1.735%.

Thank you to all who participated through Chris Lee & Partners in this very strong (credit) bond offer.

TRAVEL

Edward will be in Auckland (Takapuna) on 4 September, in Wellington on 12 September, in Napier on 16 September and Taupo, 24 September.

David will be in Lower Hutt on Wednesday 11 September and in New Plymouth on Thursday 19 September.

Kevin and Johnny will be in Christchurch on 5 September.

Chris will be in Blenheim 13 September and in Christchurch Tuesday 24 September and Wednesday, 25 September.

 

Mike Warrington

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