Taking Stock 15 August, 2019
Johnny Lee writes:
The Reserve Bank’s decision last week to cut the Official Cash Rate by 0.5% has raised eyebrows, especially following the muted response to fixed mortgage rates by our major retail banks.
Seventeen economists were polled for their expectations of the Reserve Bank prior to the announcement. Sixteen predicted a 0.25% cut. One guessed it would stay the same. Zero expected a double cut. For many years it has been a strategic preference of the central bank not to surprise the market. Orderly markets are good for financial stability.
The announcement was followed by a rather impassioned plea from Governor Adrian Orr, who expressed his hope that New Zealanders would ‘wake up and go and spend’. He would rather deal with reining in inflation than trying to stoke it.
Orr, who is quickly proving himself to be a straightforward and honest communicator, has made it clear that he wants the banks to pass on the cuts, to aid in his efforts to stimulate the economy and prevent the committee from failing to meet its medium-term inflation targets. He recognised the role of financial advisers, warning people that they need to put their money to work, investing productively, as opposed to over-investing in low-yielding products.
One need only glance at the nation’s Kiwisaver asset allocations to see his point. New Zealanders tend to invest with a defensive mindset, with large allocations in cash (returning close to nil) and fixed interest (where returns are falling), some of which is invested abroad, for returns lower than local rates, and carrying foreign exchange risk.
Orr has also made it plain that monetary policy ‘needs friends’. The Government 10-year bond rate, at 1.75% only two months ago, now hovers a fraction above 1%. The cost of borrowing will not be a factor in the Government’s thinking. Perhaps next year’s election will spur a more aggressive approach.
The retail banks’ decision to largely leave fixed term deposit and mortgage rates alone, indicates that the OCR may be nearing the end of its useful life. The Reserve Bank intends to publish research disputing this, believing instead that OCR cuts maintain usefulness even as the rate approaches zero.
Zero should not be considered a limit, as Orr has publicly stated that sub-zero rates are within his scope and under serious consideration.
Negative interest rates hit the headlines again this week, with Danish bank Jyske Bank introducing a negative interest rate mortgage product, effectively paying people to borrow money from the bank on a ten-year term. How this works in practice is that the bank reduces the principal owing by a greater amount than paid by the customer.
On the other side of the coin, Swiss bank UBS was reported to be charging savers for deposits, charging up to 0.6% for deposits above a certain size. Readers would have spent most of their lives with these dynamics reversed, with savers rewarded for depositing funds, and borrowers charged for the privilege of borrowing money.
Negative interest rates may seem paradoxical but are ultimately designed to change consumer behaviour. Savers will face a stronger incentive to spend, and borrowers will be more willing to take on debt to buy assets.
Savers may view the security of a low-risk, negative return as preferable to the alternatives. Lenders may see value in capturing the business of a borrower, as well as stimulating an asset class to which they are overexposed. The alternative to lending at a negative rate may be an even lower rate of return.
In New Zealand, we still enjoy some room to manoeuvre before reaching these levels. Mortgages and bank deposits, for now, are mostly (just) north of 3%. However, signs are continuing to emerge that interest rates could continue to be driven lower.
ASB Bank recently completed a $600 million capital raising of five-year money at only 1.83%. Westpac’s $900 million haul last month at only 2.22% shows that markets are moving, and not to the benefit of savers.
New Zealand Refining raised $75 million in December last year at 5.10%. Today, people buy those same bonds at 3.30%. Most senior bonds trading on the market are now yielding well below 3%. Some are below 2%.
Globally, we are seeing changes designed to affect behaviour, largely to stoke inflation both generally and in the housing market.
Investors who have maintained long-term, liquid portfolios will be largely inoculated against these impacts, but should remain vigilant as bonds approach maturity to ensure their investments are still fit for purpose.
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The Napier Port offer has closed, and will list on the stock exchange next Tuesday (20August). Demand for stock will likely be strong.
As expected, allocations were extremely modest, with levels of scaling that were described as ‘extreme’. Residents of Hawke’s Bay have largely reported that allotments were filled, with scaling only being applied to larger investors.
Coupled with a higher-than-normal minimum for the broker offer (2,500 shares, or $6,500 worth) most investors outside Hawke’s Bay will be disappointed with the crumbs left behind, perhaps contemplating the secondary market to acquire a reasonable holding. Investors would be wise to closely monitor the listing price on Tuesday, as the market will likely be excited and, possibly, irrational, in respect to an asset that is largely an unexciting and rational one.
Barring any chaos in financial markets, it will likely enjoy a reasonable bump upon listing, perhaps more a reflection of supply and demand, rather than any particular increase in the value of the assets themselves.
Scaling of this magnitude inevitably leads to questions around the pricing of the issue.
Considering the duration of the listing process, the pricing of the shares should delight Hawke’s Bay Regional Council. Similarly, the lead managers will be pleased to see this outcome, with the result being a bumper return for their client (the Regional Council) and still maintaining enough public interest to induce strong demand. Staff will own an asset likely to be worth well in excess of what they paid. Ratepayers will be able to choose whether they want to continue ownership of the port, or to de-risk by selling.
The process was a political one, favouring locals and staff, a courtesy deemed necessary for the listing to achieve public approval.
The listing will be the conclusion to a process years in the making, and the NZX’s first major listing in years. One hopes that its success will help illustrate the key role capital markets can play in bringing together businesses in need of capital, and investors willing to invest.
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One sector that has seen phenomenal performance this calendar year has been the Listed Property Trusts (LPTs).
LPTs are often used as the first step fixed-interest investors take when migrating away from fixed-interest portfolios towards direct ownership through the purchase of shares. LPTs tend to pay stable dividends, reflecting the predictable nature of their revenues, being long-term leases. LPTs often carry the advantage of being a Portfolio Investment Entity, reducing the tax due on distributions for some investors.
Another characteristic of property trusts is that they often perform best when interest rates are falling, similar to bonds. LPTs deliver leverage to this through lower cost of debt and a higher relative reward.
The LPT sector is comprised of four major players, being Goodman Property Trust (GMT), Precinct Properties (PCT), Kiwi Property Group (KPG), and Argosy Property (ARG). All pay quarterly dividends, except KPG, which pays semi-annually.
All four have seen record share price performance this year, benefitting from both the long-term nature of their leases and falling interest rates. The best performer, GMT, has seen terrific returns for investors this year.
All four companies invest in different sectors and markets, giving investors a range of different investments to choose from.
Goodman’s focus remains on Auckland industrial sites, both developing new land and leasing existing space. Goodman previously had exposure to the Christchurch market, but has since divested itself of this. Goodman has very low debt levels, modest dividends and a development pipeline expected to drive improving returns over time.
Precinct is mostly invested in Auckland office space (about 70%) with the remainder of its assets in Wellington. Most of its leases are for very long terms, with a weighted average lease term of more than eight years. This gives it certainty of revenue, which in turn can give greater certainty to unit holder distributions. Precinct also has an investment in the co-working (‘shared office’) sector, a growing movement among mostly young entrepreneurs, where permanent office space is unnecessary. Like Goodman, PCT has very low debt levels, but does expect to take on more low-cost debt as it expands its development portfolio.
Kiwi Property Group specialises in the retail sector, with a third of its $3 billion property portfolio value tied to the Sylvia Park development in Auckland. Leases tend to be shorter, reflecting perhaps the volatility of the retail sector. However, KPG continues to enjoy very high occupancy rates as it consolidates its portfolio towards the higher returning assets and builds towards a ‘mixed use’ model, where commercial, retail and entertainment facilities exist in the same space.
Lastly, Argosy maintains a diverse portfolio of retail, commercial and industrial properties, with most of its assets focussed in Auckland and Wellington. Argosy has also been gradually reducing the size of its large portfolio, as it focuses on higher value tenancies. With 60 properties currently in its portfolio, Argosy’s diversity gives investors a broad spectrum of assets under ownership, both in terms of geographic spread and the sector the property is exposed to.
Outside of these four, Property for Industry (PFI), Vital Healthcare (VHP), Stride Property (SPG) and Investore Property (IPL) make up the balance of the listed property sector.
Listed Property Trusts form a key part of income portfolios, combining regular, predictable dividends with high liquidity, while investing in physical assets with an easily understood business model. Property will always feature in an investor’s portfolio allocation, and the LPTs are an easy option to review and consider.
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Kevin will be in Christchurch on 5 September.
Edward will be in Auckland on 4 September, in Wellington on 12 September, in Napier on 16 September and in Blenheim on 18 September.
Anyone who wishes to make an appointment is welcome to contact us.
Taking Stock 8 August 2019
It is now three months since the book The Billion Dollar Bonfire was published.
It was written with two overriding objectives.
1. To prove the case for compensating the South Canterbury Finance Preference Share investors, who were undeniably cheated.
2. To add momentum to the case for reform of our financial market practices and culture.
It seems polite to report on progress but for the benefit of those who have not read the book it might be sensible to outline what the book unveils.
Fairly intense research and my own knowledge, I having been close to Allan Hubbard and SCF, combined to prove that SCF fell into disrepair because of woeful governance, inept leadership, margin-chasing property development lending, mismatched lending and funding cash flows, and uncontrolled, excessive growth.
When the company began to suffer severe indigestion it self-medicated to cover up errors, it concealed problems, it broke the law repeatedly and it left its future at the mercy of Hubbard’s other assets and in the hands of selfish, incompetent politicians and greenhorn public sector staff who had no clue how to minimise the damage of the scheme that guaranteed SCF’s depositors.
SCF could and should have been revived by a combination of time, Hubbard’s long-term assets, and some public sector and political skill.
To achieve this the National government’s political leaders needed to accept that the poorly designed guarantee had put the Crown on course to lose the thick end of a billion dollars. Treasury told them of that likely outcome a year before SCF was put into receivership.
If the politicians had prioritised their fiduciary duty to protect taxpayers’ money they would have done “whatever it might take” to avoid extreme destruction of Crown money.
The way out was not without risk but the path to success was well lit and was being designed by better minds than were available from those left in charge, the SCF board, its advisers, public sector mandarins and, as the book displays, politicians much better at talking than at solving problems.
So the Key government and the Crown allowed SCF to apply band-aids to broken limbs and deep cuts, solutions administered by those who were they rugby players, were not likely ever to have attracted the attention of provincial selectors, let alone the All Black panel.
Yet even then a credible solution arrived, involving a subsidised sale with potential upside, a stop-loss guarantee and a recovery plan for the deceived preference share investors.
Excruciatingly, that plan was sabotaged by a concealed, egregious error by an investigative team appointed by the Companies Office.
After the most skittish investigation the team wrongly reported that Hubbard had illegally purloined tens of millions from one of his publicly funded companies. Further the investigators reported (inexplicably) that Hubbard did not dispute that utterly incorrect allegation. Worse, when the error was discovered fifteen days later the public were not told.
All of this information was accepted in a peripheral court case in 2018.
It is not disputable.
The errors led to a series of consequential blunders by Key’s government, beginning when the then Commerce Minister Simon Power, without confirming the allegations, labelled Hubbard a fraudster, ending any hope of a successful rescue of SCF.
The ultimate result was that Key’s government and the public sector made sequential commercially inept decisions, eventually allowing an appalling receivership process that swapped taxpayers’ dollar notes for fob pocket coins from random passers-by.
The preference shareholders, deceived initially by all the disclosure failures, were ultimately unrepresented by anyone and were separated from any hope of recovery.
The errors and the seemingly indifferent, indeed carefree, behaviour of the politicians cost the preference shareholders the rights that were there in law.
You might surmise that the theft of these rights to make informed sell or hold decisions would make an obvious case for compensation.
Most certainly I reached that conclusion, as did a QC investigation.
So the book makes it difficult to imagine that a current government could ignore the facts produced in the 2018 court case. The crass errors and the crass political behaviour need correcting, even all these years later. Maori land claims can be sorted out a century later.
The investors claim, by comparison, seems like a claim from last week.
I hope the current government will see the injustice. Certainly, Winston Peters provided hope when he proclaimed on radio that the media should read The Billion Dollar Bonfire to the very last page.
The second objective, of course, was to highlight the poor law, poor practices and poor culture that allowed all of this to happen, virtually without accountability. The only exception was that one director, lawyer Ed Sullivan, was constrained to the comforts of his Timaru house for his role in shrouding the realities of SCF’s behaviour.
The book uncovers poor law and ridiculous practices, demonstrating in detail how poor operators could enrich themselves without accountability.
So compensation is still a live issue.
I expect to meet with the Minister of Finance Grant Robertson when I return from Europe.
Compensation might cost ten or twenty million but would be a cleansing act, especially if accompanied by an official acknowledgement of the errors of the Crown and of Key’s government.
It is fair to assume that the book has been widely read by politicians and public sector officials as well as by the protagonists, including bankers, advisers, lawyers and business leaders.
The feedback has been encouraging. There can be no hiding from the facts.
At the outset experienced publishers recommended that 5000 books be printed. A few hundred remain unsold in book shops and my office has a box of 24 books still unsold. There is no plan to reprint. The book was not written with best-seller ambitions, a “best seller” in NZ in non-fiction being a book that sells 4000.
It was written to achieve the two objectives outlined earlier.
Obviously it had to have colour to be readable. Because it tackled dreadful and sometimes illegal behaviour from a wide range of people and organisations it had to be carefully researched and documented.
It has faced only the feeblest of challenges, one from a nouveau lawyer whose histrionics must have led to someone paying to tidy up the wet tissues thrown about, the other from a lawyer who struggled to understand that the compensation obligation was not related to the legal guarantee of the Crown but to repair other illegal behaviour.
Reform is underway.
The Financial Markets Authority and the NZX are addressing some of the issues. They may well have been on to the need for this before the book appeared.
I have come to admire the implied vigour of both these organisations, having met with their senior people. It is clear that the SCF saga has not passed unnoticed.
It is likely that neither the FMA nor the NZX would have known about the extraordinary errors of the Companies Office investigative team and thus could not have linked the errors of the Key government to those errors.
The Reserve Bank now supervises the banks and the non-bank deposit-takers. That is progress.
Its vigour has been most impressive in recent months.
It invited submissions during a consultative process. Mine has been acknowledged.
There is no merit in my publishing the submission until it has been considered, discussed and either included, or not included in new regulations.
Of prime importance will be the strident use of the “fit and proper” person process which requires the Reserve Bank to decline to accept into leadership positions any unfit or improper people. Many such people appeared in the SCF saga. The Reserve Bank will need a wider market network to be effective in this role.
Of equal importance will be the need for much more prescriptive trust deeds. They should be approved by the regulators and overseen by much more skilled people than ever emerged from the SCF era, when Perpetual, NZ Guardian Trust, Covenant and Trustees Executors were so culpably ineffective.
Personally, I would bar these operators from corporate trust work until satisfied that they had acquired the resources to operate at a much higher level than I observed a decade ago.
The Reserve Bank will be considering a wide range of submissions within the next few weeks.
Its Governor Adrian Orr and deputy governor Christian Hawkesby are not disposed to accept the status quo and are not the sort of people who would be frightened off by those whose media skills far exceed their business acumen.
There is one major issue that must be rectified.
Recently passed by Parliament, the Insolvency Practitioners Act must be repealed and rewritten.
It was prepared without submissions from the victims of poor work by insolvency practitioners and thus is a somewhat arcane piece of legislation that does not address the real problem, that being the ongoing indifference shown towards unsecured creditors, most easily illustrated by the primary duty to restore money quickly to the secured creditors.
The new Act reads as though lawyers and trustees and bankers and receivers drafted it.
It should be rewritten now to include a provision for the compulsory representation of unsecured creditors in an overseeing committee which should sit over every receivership, liquidation and statutory management.
The insolvency practitioners themselves are facing a crisis, as their senior people now become greyer and have few younger people stepping up. There are insufficient women in the sector, and it has unjustifiable, unbridled power.
The argument that the banks oversee the recovery process is glib. If banks can restore their money immediately, there is no incentive to achieve fuller prices to cater for unsecured creditors and shareholders, who have no advocates and no effective access to mediation.
There is a little used channel by which receivers can be made accountable but generally the access to the courts is expensive and intimidating.
My view is that if the law is not rewritten to provide help to the unsecured creditors there will be many cases being referred to litigation funders.
The SCF receivership, run by McGrathNicol, produced the worst receivership outcome I have ever seen. Details of it are recorded in The Billion Dollar Bonfire. They should be widely published.
There have been many, many other outcomes of receiverships that were unfair on unsecured creditors and shareholders. Suicides have resulted.
The balance of power needs regulatory intervention.
The latest Act requires insolvency practitioners to register with the Companies Office and to pass a “fit and proper” test but the Companies Office has then handed back to the insolvency practitioners the responsibility of regulating themselves.
Throughout the whole of my career I have not observed behaviour in this sector that justifies such a privilege.
Nor should these people be allowed to act unilaterally. The McGrathNicol people, according to Treasury, were not answerable in any way to Treasury yet the assets the receivers were selling were in effect Treasury’s assets.
Treasury urged the National government to install an independent supervisory committee to sit on top of McGrathNicol but inexplicably this request was ignored, another of Key’s government’s crass errors. Did that government have no commercial skills?
A supervisory committee comprising independent professionals and representatives of the unsecured creditors should be imposed every time on receiverships and liquidations.
I will update progress on this site and on other issues raised in the book, before year end.
May I record my profound thanks to the senior journalists, my legal and publishing advisors, bank directors, investment bankers, family and friends, as well as my research assistants, who have created the momentum that has led to The Billion Dollar Bonfire penetrating the offices of regulators and politicians. One bank bought a copy of the book for each of its directors!
There are many who want to see reform, who are disgusted with the culture of entitlement that led to such vulgar behaviour, for example, by certain law firm partners with female staff. They want to see a legal and moral response to the recorded errors that have so demeaned our country. We want to see unfit and improper people removed from a very privileged sector.
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For people like me who have had a long career in capital markets it is natural to focus on the evolution of those markets, even when on leave.
But more pressing issues facing the globe are demanding attention.
I wrote recently about right-sizing, a topic that by definition refers to the preservation of necessary resources.
Poland, a country of 38 million and a huge exporter of fruit, especially apples, is facing a catastrophe because of changes in rainfall. Hundreds of small rivers have literally dried up and major waterways are at unprecedented shallow levels.
Last year Poland received barely two thirds of the rainfall it needs to provide just its people with their required daily quota.
One city, roughly the size of Hastings, is now delivering 10 kg plastic bladders of potable water every day, its water infrastructure unable to achieve the rationed amount required.
European authorities claim that this year, on July 29, the world consumed all of the resources that can be produced sustainably in the calendar year: food, water, clean air etc.
Twenty five years ago the sustainable resources were consumed by October 21, 16 years ago by Sept 22, and two years ago by August 2.
The world now has 7.5 billion people. When I was born in 1950 the world population was two billion.
Britain seems to be acknowledging this with its policy that denies benefits to those who live on benefits if, after 2017, they produce more than two children.
In 2035 the world population is expected to hit nine billion.
These topics seem to be arising daily in conversations and in the European media.
Will there be enough doctors willing to take on more patients, enough carers for geriatrics and enough people willing to serve as teachers or policemen or nurses, enough tradesmen? Or will every young person be practising on his screen, hoping to win millions on screen games?
Capital market people everywhere, including NZ, might be wise to be listening. Investment patterns may change involuntarily. Already we are seeing sin taxes applied to air travellers and tourists. It is said in Europe that the cruise ships entertaining their tourists around Europe, produce more toxic by-products than Europe’s entire car fleet.
The unsustainability of those companies servicing today’s rich may require capital market participants to be wary of seismic change around the next corner.
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Travel (by airship, maybe!)
Kevin will be in Queenstown on 23 August and in Christchurch on 5 September.
Edward will be in Auckland on 4 September, in Wellington on 9 September, in Napier on 16 September.
Chris Lee & Partners Limited
Taking Stock 1 August 2019
Johnny Lee writes:
Napier Port’s product disclosure statement (PDS) is now in the public domain and able to be pored over by the public.
At eighty pages long, the PDS would struggle to meet any conventional definition of ‘light reading’, but those contemplating investing in the port will find it thorough and readable. It provides both a snapshot of New Zealand’s logistical framework, and the Hawke’s Bay local economy, making for good reading.
Assuming a price towards the upper end of the range offered ($2.27 - $2.60), this will place it towards a Price to Earnings multiple north of 25, and a dividend yield of around 4% gross.
Port of Tauranga, by far New Zealand’s best and biggest port, pay a similar dividend yield, albeit one temporarily bolstered by special dividends that may not occur beyond next year. Napier Port’s dividends can, and should, grow over time.
The money being raised will primarily be used to repay debt and return a handsome sum to the council’s new Investment Company (HBRIC). Once this has occurred, it will provide some flexibility for the Port to borrow funds to construct a new wharf, budgeted to cost almost $200 million.
The key risks to the business are outlined in the document. Other than acts of God, the risks can be summarised as cost management of the new wharf, economic risks, and biosecurity risks for the products it exports. There is also some detail around the specific risks of majority shareholder interference, but owners of New Zealand’s major electricity companies will be familiar with the Mixed Ownership Model and the risks this imposes on the minority shareholder.
The new wharf, named 6 Wharf in the document, is estimated to cost almost $200 million and take two years to construct. While under construction, other areas of the business will be impacted, as the wharf is located at the end of the container terminal, reducing the usable space of the area. The construction is being managed by HEB Construction, which is one of the major subcontractors for Transmission Gully.
The Port derives the majority of its revenue from Container Services and Bulk Cargo – with the remaining amount (about 5% of total revenue) sourced mostly from the Cruise Ship industry.
Container Services, primarily marshalling, crane operating and stevedoring, makes up the bulk of its revenue. The Port has invested heavily in to refrigerated containers, allowing them to properly service perishable goods such as pipfruit (apples and pears) and meat.
New Zealand anticipates the planting of approximately a million apple trees this year, with two thirds of those being planted in the Hawke’s Bay. Napier Port will be the closest port to these growers.
The Port has recently implemented a strategy to connect further with importers, to try to increase the number of full containers arriving. At present, a significant proportion of containers that arrive are empty, to allow exporters to use them for their products. By bringing in containers full of imported goods, they increase the overall value of the goods handled at its port.
Bulk Cargo refers almost exclusively to logs – trees felled in the Hawke’s Bay region, then exported, primarily to China. The Port handles the transport on to the boats, as well as offering fumigation services.
Log prices were experiencing bumper prices for most of the last few years, but have slumped in the last month following ongoing concerns around the Chinese-US trade discussions. This has led some forestry firms to halt harvesting, which impacts the Port.
Log throughput is not easily predicted – as harvesters will ultimately respond to market pricing – but analysis of forestry planting can hint towards export numbers. The Hawke’s Bay saw a boom in the planting of saplings between 1993 and 1997. These trees, mostly Pine, are now coming to maturity for export. This boom is expected to last a few more years before returning to long term averages.
Cruise Ships represent the Ports biggest growth opportunity, and perhaps most predictable source of income. Cruise lines determine and book their stops about two years in advance, giving ports transparency around demand. At present, the Port is restricted by the lack of space available, but the construction of the new wharf will help alleviate this.
The Port saw around 70 cruise ship visits last year, and expects this figure to substantially grow over the next few years.
Napier Port employs around 300 staff, most of whom are subject to collective agreements with a union. About half of them will be negotiating a new agreement to come into effect in October this year. Although the Port has not seen industrial action in over a decade, the greyer-haired readers will be keenly aware of New Zealand’s history with port workers and collective bargaining. However, around a third of its staff have worked at the Port for over a decade, and the listing includes generous loan terms to staff to finance the purchase of shares, giving workers an additional incentive to ensure the Port is efficient and productive.
Dividends, initially, will be lean. The Port forecasts a dividend of about 2.5 cents in December 2019, with future dividends being paid in June and December months, with a 40/60 split, meaning December dividends will be marginally higher than the mid-year payments. The Port’s forecasts include an expectation of a 3 cent dividend next June, and an approximately 4.5 cent dividend in December 2020. Full imputation is likely.
The Port are upfront about dividend growth in the short term. The construction of the wharf, expected to complete in 2022, will lead to a build-up of debt that will diminish its ability to grow dividends.
Although access to the float is likely to be scarce, the chief executives recent comments suggesting a desire for a mix of investor types, implies that secondary market trading will be healthy, with opportunities for investors to purchase stock after the float. Surprisingly, the Initial Public Offering is subject to a minimum investment of 2,500 shares – approximately $6000 worth.
Investors could expect to view this as a long-term growth asset, with growth coming from a variety of sources, including increasing cruise visits, increasing apple production and, depending on log prices, the tail-end of a boom in forestry. The Port will also be implementing strategies to make the port more efficient, including the importation of more goods to reduce the number of empty containers brought to the Port. In the short-term, the Port intends to spend substantial sums on the construction of a new wharf, leading to an increase in debt levels. This new wharf should allow it to increase the Ports throughput.
The listing is expected to occur on the 20th of August. Our list for Napier Port is closed, and expectations for allocations (if any) should be modest.
David Colman writes:
The value of New Zealand electricity share prices have increased by an extraordinary amount in the last year with data from Tuesday, 30 July shown below:
CEN - Contact Energy Last traded at $7.83 +38%
(+44% including dividends of 35c)
GNE - Genesis Energy Last traded at $3.48 +39%
(+46% including dividends of 17c)
MCY - Mercury Energy Last traded at $4.68 +40%
(+45% including dividends of 15.3c)
MEL - Meridian Energy Last traded at $4.83 +54%
(+60% including dividends and special dividends of 19.5c)
TPW - Trustpower Last traded at $7.60 +27%
(+40% including dividends and special dividends of 74c)
The NZ50 gross index (which includes capital gains and dividends) increased by approximately 21% in comparison to 10,860 points from 8,920 a year ago.
To help understand a price increase like the above involves an exploration of various aspects of the electricity industry and market forces.
Electricity demand is certainly nowhere near growing at rates comparable to share price performance.
Demand for electricity is growing at about 1.5% per annum. Commercial consumption is increasing by approximately 1.2% per annum and residential consumption is increasing by approximately 1.7% per annum.
Increased power demand from population growth obscures the fact that per household electricity consumption is falling, from an estimated 7500kWh per annum in 2013 to 6997kWh per annum in 2018.
Much of the drop in household power use can be attributed to greater use of LED lighting and more energy efficient appliances. Current trends show dishwashers, refrigerators and clothes washing machines are consuming much less power from year to year with use of clothes dryers and televisions consuming more power.
Data for average annual Auckland household electricity costs going back three years show electricity bills have increased on average in the vicinity of 1.5% per annum (roughly in line with inflation) despite less electricity consumed per household.
Estimates of the average annual rates for a 3 to 4 person household are shown below:
CEN - Contact Energy $2,062 up 0.6% per annum annualised over 3 years
GNE - Genesis Energy $2,433 up 3.6% per annum annualised over 3 years
MCY - Mercury Energy $2,264 up 0.5% per annum annualised over 3 years
MEL - Meridian Energy $2,278 up 0.9% per annum annualised over 3 years
TPW - Trustpower $2,126 up 2.1% per annum annualised over 3 years
Trustpower (provider of both electricity and broadband services) released their annual report in May and included net profit of $93 million (down 18%), operating earnings of $222 million (down 9%), earnings per share of 29c (down 19%), an increase of utility accounts of 1%, $64 million in retail earnings (up 8%). In other words, figures that hardly correlate to the increase in share price.
Further annual results for the industry are due this month and will contain useful data to evaluate the companies once released. Annual results release dates are as follows:
12 August: Contact Energy
20 August: Mercury NZ
26 August: Meridian Energy
28 August: Genesis Energy
Borrowing costs as a result of the continuing downward trend for interest rates have alleviated some costs for electricity providers, which is a somewhat significant factor in recent share price trends.
For example Trustpower issued 7 year senior bonds in 2014 at an interest rate of 5.63% (TPW140) compared to a 7 year bond Trustpower issued in July this year at 3.35% (TPW180, which have already traded, notably on its first day of trading, at a yield of 3.00%).
The reduction in borrowing costs for $125 million worth of bonds is $2.85 million per annum. If reduced interest rates, based on current market rates, were extended to all of Trustpower bonds worth approximately $500 million, the borrowing costs would be potentially lower by over $10 million per year – the equivalent of a 10% increase in company profit.
Lower interest rates for the companies above explain perhaps some of the share price rises but I theorise, as many would, that much of the share price increases have been driven by lower interest rates available to institutional and retail investors which is affecting market sentiment.
Parties involved in the hunt for yield such as Kiwisaver providers, fund managers and retail investors have targeted electricity shares for obvious reasons.
Electricity companies are seen as quality, established essential companies with assets that are expected to produce for decades. Electricity companies are easy to understand, and have proven over the years an ability to provide reliable dividends.
It is a reasonably competitive market but dominated by the companies listed above.
New entrants to the market are unlikely to emerge to challenge the existing companies due to the high cost of entry, including difficulties imposed by the Resource Management Act. It would not be cheap, or easy, as a brand new company to establish electricity generating infrastructure in New Zealand, particularly given only small increases in demand expected.
Evidence strongly indicates that electricity stocks have not risen in price due to the fundamental demand and supply influences for electricity use. Lower costs to borrow have freed up capital and customers consistently paying month after month ensure excellent cash-flow, but on balance I conclude much of the recent share price increases have been and continue to be driven by the exodus of money flowing from fixed interest investments to shares that offer more attractive dividend yields, than ever lower yields achievable with bonds.
A strategic shift to buy shares in quality companies that have long-term prospects (such as electricity generators and others) that benefit from lower borrowing costs has become widespread.
Ever increasing contributions to Kiwisaver, managed funds (including Exchange Traded Funds), and investment of money from maturing bonds, seem likely to continue to support shares in the electricity industry and other industries, with the listed property sector being another sector experiencing very similar share price movements in the last year.
Electricity gentailers (generators and retailers) have performed well, with shares prices increasing dramatically of late, and even though prices may continue to rise it may well be time for investors to evaluate their exposure to particular sectors as should be done from time to time.
If values of specific investments have increased beyond target ranges within an investment policy of your own, we would encourage advised clients to contact us to discuss.
Kevin will be in Queenstown on 23 August.
Mike will be in Tauranga on 7 August.
Chris Lee & Partners
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