Taking Stock 17 January 2018

Johnny Lee writes:

THE announcement of the closure of several Kiwibank branches in the Wellington region will come as no surprise to readers, who will have seen the concept of banking evolve over their lifetime.

The closures, which inevitably hit the older generation the hardest, are both a consequence and an impetus of a societal move towards a different way of banking.

Increasingly, younger people and new businesses are abandoning their use of physical branches and are choosing to conduct their affairs electronically, relegating branches to those tasks where an efficient electronic solution has not yet been found, such as the sighting of identification.

The idea of withdrawing and depositing, or even using, physical bank notes, is becoming increasingly rare in favour of electronic transfers. Cheques are viewed as almost quaint relics of the past. My eight month old son is unlikely to ever see, let alone own, a cheque book.

The rationale for the latest bank closures, being that the branches are seeing reduced patronage, doesn’t seem to be supported anecdotally, with our local branches seeing queues out the door during busy times. Perhaps this becomes self-fulfilling, as customers choose instead to seek alternatives rather than wait for service.

However, there is still real demand for personal banking services. An opportunity exists for other banks to become involved in this space.

The reduction of ‘customer service’ is, of course, not limited to the banking sector. Supermarkets, petrol stations and even hardware stores are increasingly adopting technology towards a more ‘DIY’ approach to facilitating transactions.

The rollout of the Amazon Go supermarket earlier this year, where customers are billed based on cameras recognising their face and features no human interaction at all, represents an extreme example that seems completely foreign to most of my generation.

Thankfully, by the time this technology reaches our shores, my son will be able to explain to his father how to purchase groceries in the modern age.

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NEWS of the potential takeover of TradeMe in November is both a blessing and a curse for both investors and the New Zealand equity markets.

While shareholders will be pleased with the increased share price, and the NZX will be happy for another success story, its departure from the exchange represents a continuation of recent trends.

Should the takeover proceed and the company be delisted, investors will have lost another investment opportunity and the NZX50 will have seen yet another issuer depart, a mere seven years after it first listed.

Long regarded as a highly cash-generative business, TradeMe has pursued a strategy in more recent times of growing by acquisition, purchasing stakes in established or fast-growing businesses to give them a strategic advantage.

TradeMe is one of New Zealand’s most popular websites, behind only the likes of Google, YouTube and Facebook. This position is unlikely to be challenged for the foreseeable future. Apax Partners, the Group launching the takeover bid, is unlikely to adopt wholesale changes to a model that has seen such widespread dominance.

The bad news for the exchange is the dearth of new listings, an issue of which the NZX and its management team are acutely aware. With interest rates at record low levels, the risk premium between equity and debt is not, and has not been for some time, reflective of actual differences in risk. With the growth of KiwiSaver, the issue is likely to continue until risk premia return to normality (if ever!). Equity markets, appropriately priced, are important for maintaining tension in pricing.

The NZX’s challenge is to foster an environment where entrepreneurship and inspiration can, when combined with capital and oversight, lead to real businesses, real jobs, and real economic growth.

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ANOTHER challenge facing capital markets is the possibility of regulatory change around capital gains.

With the Tax Working Group due to report early this year with their conclusions, the Government will have almost two years to decide whether to make adjustments to New Zealand’s taxation regime.

Two particular areas of concern for our clients will be the treatment of capital gains (either realised or unrealised) and, to a lesser extent, any revision to the GST exemption applied to financial services.

The TWG seem likely to discuss some change on the first point. Although the shape of such change hasn’t yet been defined, if it took the form of a tax applied to unrealised gains, at a deemed risk-free rate of return, it will be important to ensure that this does not produce perverse outcomes, such as incentivising investment in different markets, say Australia.

We look forward to reviewing the findings of the TWG and hope any changes implemented by the Government build on the strengths of New Zealand’s tax system - namely simplicity, predictability and fairness.

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THE one factor necessary to see a change in interest rates will be inflation.

A common perception is that reported inflation often doesn’t correspond with what people see in the real world. That is, that prices seem to be increasing at a faster pace than the 1-2% suggested by official figures.

There are several reasons for this. One is a human tendency to remember price increases more readily than price stability or price falls. The other is that not all inflation is equal, nor visible. This is particularly relevant when applied to expensive items bought less frequently.

Consumers who purchase televisions, for example, buy these items so infrequently that it is more difficult to notice that they have fallen 17% in the past year. However, a 19% rise in your weekly petrol bill will lead to changes in behaviour.

Visibility is also a factor when you consider the CPI is a particular basket of goods, aggregated for the population at large.

A non-smoking person is unlikely to take note of changes to the prices of cigarettes. Vegetarians don’t tend to see changes in poultry prices, and people who own their own home may not necessarily be aware of movements in rents. However, cigarettes and tobacco maintain almost the same weighting as fruit and vegetables.

The Consumer Price Index is an important measure that influences several key inputs for our economy, notably interest rates. The next CPI Data release is scheduled for late January, and is expected to be lower following the recent pullback in oil prices.

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THE recent share price fall in New Zealand banks (and banks that operate within New Zealand) was preceded by the release of a discussion paper from the Reserve Bank, and should serve as a reminder of the relationship between risk and reward.

The proposed requirement for increased capital ratios led to a response from Heartland outlining various methods it could adopt to meet such requirements. This included the suggestion it could raise money through a debt issue. This seems an oxymoron.

The Reserve Bank proposals are designed to create a greater buffer in the event of a banking failure, by forcing the ‘’owners’’ of the bank to have more money at risk before affecting “creditors”.

This could lead to a side effect where banks are less inclined to lend, or to lend at greater margins. This in turn has an impact on economic growth.

The Reserve Bank is currently inviting feedback from relevant parties.

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THIS is my first Taking Stock. In coming weeks Chris and I will write alternate weeks.

He is heavily involved in the process of transitioning his script (The Billion Dollar Bonfire) into an available book. His publishers (BWB Publications) plan to have the book in the shops by April 7.

Clients, users of our firm and readers of this newsletter are welcome to order a copy for mail-out in April. The book will be sold at a 25% discount to clients while stocks last. Orders can be sent to Penelope@chrislee.co.nz


Kevin will be in Christchurch on 31 January.

Edward will be in Napier on 4 February, in Nelson on 19 February and in Remuera on 8 March.

David will be in Palmerston North and Whanganui on 18 February.

Chris and Johnny will be in Christchurch in February, based at the Airport Gateway Motor Lodge, in Roydvale Avenue - dates to be advised.

Chris will be in Auckland in February - dates to be advised.

Michael may be in Auckland in the early part of February.

Johnny Lee

Chris Lee & Partners Limited

Taking Stock 10 January 2019


THE chaos in the US government, with hundreds of thousands of civil servants unpaid, might imply that 2019 will start poorly for NZ investors.

Certainly it will be a poor year if the foreign investors who own around 40% of our sharemarket listings should be spooked and quit our markets.

Happily there is no evidence of large withdrawals. Indeed the reverse is the case.  Foreign investors are taking over companies like SLI Systems, Trade Me, and Restaurant Brands, hardly a sign of foreign flight.

In addition the Ardern government plans to restore its billion-dollar contribution to the Cullen Fund, a display of confidence that is likely to add at least a hundred million of demand for our leading stocks.

KiwiSaver funds allocate hundreds of millions to debt and equity assets listed on the NZX so it would require a Hitchcock-like injection of fear to undermine prices.

Yet there are many New Zealanders examining personal portfolios, fearful of a reversal of the gains that most have enjoyed, each year, for many years.

One canny client who has the time to manage his portfolio on an hourly basis wrote to me over the holiday period, highlighting the attractiveness of Exchange Traded Funds (ETFs) that short the Australian Index, a reverse of the more common ETFs, that buy the index at any price.

The ETF that shorts the index loses if markets rise, but obviously makes profits if the market falls.

For retail investors who want to bet on a falling market, this ETF is an excellent means of making the bet.

Generally retail investors do not have the power to borrow shares from institutions to sell now and to repay by returning shares in subsequent months.

Whereas the likes of Milford or Fisher Funds, and most ETFs, will lend shares to credible market players, their appetite for lending small numbers of shares to retail investors is low.

The inverted ETF is a sane answer.

Indeed such a concept might be the product to drive an ETF in New Zealand.

To date our noisiest ETF provider has simply charged a fee to hand NZ investors’ money to a US ETF, a double intermediation process that draws obvious scepticism.

An NZ-run ETF that shorted various indexes might have a value that was real, though scale might be an issue.

I guess some might also see irony in an ETF provider selling the idea of a long portfolio matching the weighting of the largest NZX-listed companies, then using those stocks to lend to a short fund that would be betting stock prices would fall.

Indeed there is irony to this but if there is a quid in it for the ETF manager, he will no doubt tolerate the criticism.

Meanwhile those who want to short the Australian market can do so, quite simply.

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AN American takeover of SLI Systems will not worry too many of those who read Taking Stock.

Listed at $1.50 and supported by the likes of the NZ Venture Capital Fund, SLI slumped to penny dreadful status.

It must have had the nexus of a credible idea to have attracted an American bid but those who bought at the new issue price will be disheartened by the takeover offer, at barely a half of that issue price.

If 2019 is a year when investor nerves are regularly frayed, the investors most likely to endure portfolio devaluations are those with technology companies that aspire to break even, one day.

Frayed nerves are likely to snap under relentless pressure so we urge clients to reassess their tolerance levels and trim or eliminate the stocks that cannot be priced on dividend yield.

We will be trying to persuade all advised clients to develop an investment strategy and monitor it. All clients are welcome to discuss the very practical way this can be done.

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ONE security that was clearly mis-priced last week was the Precinct Convertible Note.

The security converts in two years and offers a one-off bonus should the Precinct ordinary share be trading above $1.40.

For each cent the lead share exceeds $1.40, the note holder gets another cent of value added to his ‘’repayment’’ (conversion).

The ‘’repayment’’ is in shares so someone with 10,000 Precinct Convertible Notes would get a bonus of around $570 worth of additional Precinct shares, if the Precinct share price were to be $1.48 when the notes convert on 27 September, 2021.

Last week the Precinct shares hit $1.48 yet holders of the note were selling the $1.00 notes for $1.03. You could argue that the notes were worth $1.057.

Two years ago I praised the structure of the Precinct note offer.  I am amazed that others have not copied it.

The note pays 4.8% per annum. If the bonus is eight cents, then after four years the early subscribers would have had a 2% per annum boost to add to the 4.8% return.  Our clients were large users of the note.  They will be hoping that Precinct continues to enjoy a rising share price.

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A FEW days of sun on Waiheke Island helps me to the conclusion that the gulf island is drawing a picture of a problem New Zealand will soon face on a much larger scale.

Waiheke has around 9,000 residents but its success in selling its beaches and its vineyards has led to uncontrolled tourism, with up to 50,000 people on the island in summer.

Waiheke cannot support such numbers.  Its water supply is limited, its infrastructure stretched, its roads unsuited to greater traffic volumes, its car parking gets stretched, and the queues grow longer.

Of course visitor numbers produce dollars, with GST getting back to central government coffers.

Those who live on the island but do not sell to the tourists are understandably unimpressed by double-decker buses running on country lanes probably best suited to a hansom, or perhaps an electric bike.

New Zealand as a whole faces the same problem.

To accommodate the nearly four million tourists we simply must provide better roads, with barriers, with passing lanes, or at least with batons to discourage overtaking.

Yellow paint does not cut the mustard!

The GST bonanza has made fiscal surpluses look great but the offset is the need for better infrastructure.

A Swedish roading expert has observed that the way to look after road traffic is to separate those driving in opposite directions.

Barriers, wire or even batons will reduce collisions.

Waiheke is blessed in that the roads dictate slow speed that are tolerated because the island is so small.

Our impressive fiscal strength, almost entirely created by overseas visitors paying GST, needs to be spent, if we are to encourage yet further tourism growth.

Our roads would be a good place to start.

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MY son Johnny joins our business next week. He has had a 12-year stint with ANZ Securities where he led the equity trading desk.

He will usually work Wednesday, Thursday, Friday, enabling me to roam on those days.

Johnny has excellent knowledge of New Zealand and Australian securities and will be a client-first advocate, as we all are.

His father is delighted with his decision to join us!

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Kevin Gloag will be in Christchurch on 31 January.

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

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

Chris Lee

Managing Director

Chris Lee & Partners Limited

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