Chris Lee & Partners Ltd

Taking Stock 30 May, 2019

STEEL and Tube investors will have plenty to stew over in the coming weeks, as the share price takes a dive below a dollar, following its release to the market of updated earnings guidance.

Steel and Tube announced its full year result would be substantially lower than previously forecast, and that an inventory write-down would negatively impact its end of year figures.

It still intends to pay a dividend, which is unlikely to be more than a cent or two per share.

Petone-based Steel and Tube is one of New Zealand’s longest listed companies, having listed originally back in 1967. Only a handful of companies, including Hallenstein Glasson, Sanford and EBOS Group, have been listed for longer.

Its share price performance over the past 10 years has been less than stellar, with capital raises at various levels that will have disappointed long-term shareholders.

To make matters worse, it has rejected takeover offers from various groups, most recently Fletcher Building, at prices that looked attractive, justifying its stance by complaining that the offers significantly undervalued the business. With the benefit of hindsight, this stance was not to the advantage of shareholders. The takeover from Fletchers, priced at what was effectively $1.95 a share, is now almost double the current price. Fletchers is likely grateful that the offer was so soundly rejected by Steel and Tube’s board.

Steel and Tube has experienced increased volumes, but is finding margins squeezed as competitors force it to reduce pricing. It is selling more – but for less.

Internationally, major producer British Steel has fallen into receivership, as Brexit uncertainty and international competition reduces the competitiveness of its products. Most of its competition is reported to come from China, which is are flooding the international market with low-margin product. China has taken natural resources, including from Australia, added value via production, and is redistributing to the world, arbitraging lower labour costs and safety standards.

Here in New Zealand, Steel and Tube is also dealing with an industry under huge stress, with many firms reporting similar conditions and trying to control costs as tightly as possible. Shareholders of Steel and Tube are, rightly, questioning its long-term strategy, as it appears its competitors are more than willing to force them to maintain its razor-thin margins. Shareholder goodwill is diminishing, as they watch the value of their investment struggle in an environment in which many other stocks are reaching new heights.

Construction remains a sector that seems troubled, and one that is clearly suffering structural issues. Economic data is suggesting the economy is cooling, and construction is expected to bear the brunt of this slowdown, both in terms of output and employment.

Normally in these circumstances, you would see consolidation as larger players absorb smaller firms to increase scale and diversify risk. In Steel and Tube’s case, its reluctance to entertain offers – an issue raised by Fletchers management – has contributed to a material fall in value.

Today, with the share price trading below $1, Steel and Tube investors will be questioning their board’s wisdom in rejecting the offer. The chairperson will no doubt be very carefully considering their next strategic decision, to ensure it aligns with the shareholders’ best interests.

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AS cautionary tales go, Martin Aircraft’s decision to hammer the final nail in its coffin should act as a lesson to investors.

Formerly known as Martin Jetpack, it listed on the Australian Stock Exchange in 2015 at a price of 40 Australian cents, with many in the industry (including myself) sceptical that the company had any chance of success. Some were reminded of Skycabs, the urban monorail project that explored a public listing in the early 2000s.

Martin Aircraft proceeded to confound the critics, with its share price exceeding $3 shortly after listing, valuing the company at a level comparable to Sky TV or Kathmandu today. Shareholders became hugely wealthy, with many cashing out, scarcely believing their eyes as people became enamoured with the possibilities of personal flight.

Shortly after listing, its founder Glenn Martin abruptly resigned, citing differences in opinion with management and frustration at the corporate approach they were attempting to take the business. After several years of anaemic share price performance, the company delisted from the ASX before being scooped up by the Unlisted Market, home to more than a few penny dreadfuls, and listing there. During its stay on the Unlisted, it traded only a handful of times, with virtually no trades of value occurring.

Today, Martin Aircraft appears to have finally closed its doors, leaving behind piling debts and a litany of broken promises. The Unlisted market chose to lift its trading halt, but it seems improbable that Martin Aircraft will trade again.

 _ _ _ _ _ _ _ _ _ _

ONE group of shareholders that can be pleased will be those patient owners of E-Road, which continues to report growing revenues. Its North American operations are now EBITDA positive, and it sees avenues of growth in all three markets in which it operates.

It appears to have enough cash to fund its current level of growth, and can see a clear path to profitability. E-Road remains focussed on growth, as opposed to shareholder return, but the product is proven and E-Road has shown it can continue to increase in scale without reducing its margins.

It will be nice to see another New Zealand business succeed internationally, given the volume of those that fail with such ambitions.

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THE Reserve Bank’s semi-annual Financial Stability Report has prompted some discussion in markets surrounding the future of currency and how it is used.

Readers will be aware that KiwiBank intends to discontinue the use of cheques, citing falling usage. While some have suggested that users simply change banks to preserve their preferred method of money management, there do not appear to be many substitutes lining up to commit long-term to issuing cheques.

The very readable Financial Stability Report highlights many concerns, among them the concern that physical cash is suffering from the same symptoms and could be headed for a similar destination without some form of Government intervention.

To me, this is very much a generational divide, with my own generation (the oft-maligned Millennials) rarely carrying substantial sums in the form of cash. Most prefer to hold a single card, sometimes loaded directly onto their Smartphone, eliminating the need for a wallet altogether. To some (read: my Dad) this seems a baffling concept.

Many of the services that once needed cash (such as taxis and parking meters) are now controlled by Smartphone. Even door-knocking charities are now requesting direct debit details rather than accepting physical cash donations.

The Reserve Bank, which is currently undertaking analysis on this issue, expresses the concern that if there were a decline in businesses accepting cash, instead demanding electronic payment, that some vulnerable groups could be excluded from areas of the economy. The same concerns were applied with the falling acceptance of cheques – that as they fell out of favour among merchants, predominantly older groups would be forced to adapt to newer technology in order to conduct business.

One concern the RBNZ did not point out is that such a move could effectively force all New Zealanders to establish bank accounts and, likely, to buy smartphones. While this is not a concern for most, it does put significant power into the hands of retail banks, who would effectively have control of an individual’s right to participate in the economy.

There are multiple benefits around the eventual disestablishment of cash as a means of legal tender, particularly around the costs and risks of handling large sums of physical cash.  It would also force certain transactions that may currently be escaping the notice of Government agencies (think tax and money laundering) to become transparent.

Such a move would not be unprecedented.  In Sweden, there are expectations that society will become fully cashless by 2023.  In a 2018 survey, only 13% of Swedes could recall using cash for a recent purchase.  This movement towards electronic transfers causes some headaches for tourists, some of whom are far more accustomed to using physical cash than credit and debit cards, which carry associated fees.  Similarly, there are concerns around privacy and system outages.

We look forward to reading the Reserve Bank’s analysis on this topic in the months to come, but don’t want to see reduced rates of consumption from the senior members of our community, who typically have the largest capacity for spending.

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WITH more than half a billion dollars returning from the debt market to investors over the next few months from four issues alone, equity markets seem likely to be a beneficiary of this, as new bond issuance struggles to keep pace.

ASB, Mercury, KiwiBank and Rabobank (RCSHA) are all repaying their security holders, with only Mercury likely to offer another bond to market, albeit at a substantially lower interest rate.  The days of 6.9% from such a company seem highly unlikely to return for a long time.

Depending on how the new bond is priced, some will consider whether their investment is better placed in the shares, conferring ownership of the company, as opposed to lending them money as bondholders.  While the risk profile is different, and the market value more volatile, the difference in return and the potential for growth provides some argument for a shift from lending to ownership.

More details on the Mercury bond offer will emerge in June, and those interested should contact us to express an interest.

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Further details on the Port of Napier IPO have emerged.

The timing of the IPO is earlier than some expected, with the council now expecting it to occur in July. This may coincide with the return of capital mentioned above.

We anticipate this offer to be very popular, especially among retail investors.  Ports and other utility assets tend to garner significant interest from the public when priced fairly.  Note that no details are publicly available regarding pricing.

The council has confirmed that Hawke’s Bay residents will be ‘offered a guaranteed minimum allocation of shares‘.  This may be an avenue worth exploring for those interested who are based in that area, or know someone who is.

Johnny Lee 

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David Colman writes:

NEXT Thursday (6 June) the NZX will list eight more ETFs (Exchange Traded Funds) on the New Zealand Stock Exchange under its Smartshares brand.

The total number of NZX-listed Smartshares ETFs including the new listings will be 31 and follows the global trend of ever more ETFs available.

The new ETFs include markets that might otherwise be costly, or difficult for individual retail investors to have broad exposure to.

The new ETFs include equity funds based in the USA, Europe, Japan, emerging markets and globally.

There are also two new funds described as ‘megatrend’ funds which focus on ‘Automation and Robotics’, and ‘Healthcare and Innovation’.

A Passive Global Bond Fund will also be listed.

After somewhat of an IPO drought, the NZX will have a new listing on 19 June for Cannasouth (code: CBD), a medicinal cannabis developer.

Cannasouth, based in the Waikato, intends to use the funds raised for research for the development of cannabinoid health products.

There have been waves of companies started in the research and development of cannabinoid products worldwide, and it is a sector that has been highly volatile, with many companies falling greatly in value.

It is difficult to see how a New Zealand company will differentiate itself against existing local and international companies that have also been researching and developing products for many years.

The company is looking to raise between $5 million and $10 million by selling between 10 and 20 per cent of the company at 50 cents per share, which is a considerably higher price than the company has sold shares for in the recent past.

The company raised $1.2 million at effectively 8.6 cents (adjusted for share-split) per share in August 2018, and raised a further $2.5 million at 25 cents per share in October 2018.

If fully subscribed at 50 cents per share, the company would be given a market cap of approximately $50 million, and would have raised capital at 41.4 cents per share higher (580% more) than the adjusted price paid per share less than 9 months ago.

Just as you would, during a drought, think twice before switching on the sprinklers at the first sight of rain, so should investors be cautious with an IPO from a fledgling business in a potentially hit or miss industry.

Be sure to understand the business case, realistic potential value, and importantly the risks of a new company before handing over any hard-earned savings.

Dominant, established companies generally constitute larger proportions of portfolios, while investments of a speculative nature tend to be a very low percentage, and be funds one can afford to lose.

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TRAVEL

 

Chris will be in Napier on 4 June at the Napier Sailing Club presenting an Investment Seminar (12:30pm) followed by discussion about his new book The Billion Dollar Bonfire (2:00pm).

Ed will be in Napier on 4 and 5 June and in Nelson on 18 June.

David will be in Lower Hutt on 11 June.

Chris and Johnny will be in Christchurch on 19 June.

Chris Lee & Partners Ltd

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Taking Stock - 23 May 2019

AS THE country seeks to digest Grant Roberson’s wellbeing budget format, a much more scary challenge is looming.

The outcome of the Reserve Bank’s challenge to our biggest bank, ANZ, is likely to have far more effect on New Zealanders than Robertson’s interesting budgeting changes.

The battle between our Central bank and our biggest bank brings into the ring our talented Reserve Bank governor, Adrian Orr, with his desire to improve life in New Zealand, and our nation’s most skilled public relations smoocher and cheerleader, John Key, with his desire for banking status quo.

Orr was an inspired choice as RB governor. He has had a stellar career generating wealth for the country and is intelligent, strategic and unafraid of change.

Key, of course, was an FX trader who hitched his wagon to the right horses at the American bank Merrill Lynch, was extravagantly rewarded for the role he played there and returned to NZ from New York to captivate first the National Party, then the country.

His presentation skills were outstanding, his media relations were not far short of exemplary, and he had, and has, a real skill in mixing gravitas and larrikinism, enabling him to attract a following from diverse groups of people.

The ANZ saw his wide network as being valuable to our biggest bank and made him its figurehead in New Zealand, chairing its NZ branch and giving him a seat on the Australian parent board.

As a cheerleader, able to access doors, able to draw media favour, Key was a nice fit for the ANZ.

He will need to be briefed by experts and then exercise all of his gravitas to succeed in his mission to turn around Orr’s determination to bring the ANZ to heel.

The central issue is the arrogant attitude of the ANZ to New Zealand’s financial regulations.

Our Reserve Bank has for many years allowed all of the Australian banks, of which ANZ is the biggest here, to assess the risks of its lending portfolio and thus provide adequate shareholders’ money to offset risk.

The ANZ was expected to use a risk assessment model that met our Reserve Bank’s approval.

Since 2014, a year when Key was Prime Minister and Orr was the chief executive of the NZ Superannuation Fund, ANZ’s model of risk assessment has flouted the Reserve Bank’s requirements.

Accordingly, the ANZ has had far less capital than the Reserve Bank regards as appropriate, enabling the ANZ to have a significant advantage in matters like the pricing of its lending.

Banks measure their return on capital with a fanaticism that I regard as short-term and unintelligent. Personally I regard survival and nett profit after tax as being more intelligent measurements.

Because the ANZ needed less capital, through its own unapproved self-assessment of risk, it has been able to achieve its desired return on capital with slightly lower margins, thus locking out competitors when pricing its lending.

NZ banks, not allowed to self-regulate their capital needs, operated at a disadvantage.

Orr has observed this and will change it.

Furthermore he wants all banks to reduce the risk of failure by increasing their capital, virtually doubling the requirement and slashing return on equity for shareholders.

He calculates this would enable banks to survive events that someone guesses, using meaningless historical figures, might occur once every 200 years.

He will allow the Australian-owned banks to assess their own risks, using an approved model.

But he has barred ANZ from this privilege, requiring the ANZ to use the same model as NZ banks.

It is said that this will add close to $1 billion of input from the ANZ shareholders, to add to the several billion needed to achieve the new, higher minimum capital levels expected of all banks.

The ANZ is hoping its champion cheerleader Key will succeed in having the central bank back off.

Not helping its chances, the ANZ, behind closed doors, has been loud in its demands, most recently urging a fall in the overnight cash rate.

It has had the biceps to threaten to withdraw from vital NZ sectors, disrupting the economy. Whether it has used that threat is not public information.

Many in capital markets are watching for the signals of a dog fight. Some see this as a looming battle that will have an effect on the rural sector.

Behind the scenes the ANZ will be debating how to arm Key for the battle.

Key is not a strategist, a visionary, or a fellow with a career in NZ banking. He was an FX trader. Foreign Exchange is to banking what stockyard auctioneering is to farm management.

Orr has the backing of the Coalition Government. We face a fascinating few weeks, the battle outcome certain to be revealed.

_ _ _ _ _ _ _ _ _ __

ADRIAN Orr’s role as governor is likely to be defined by how much control of our banking and moneylending services can be returned to New Zealand.

Our NZ banks include Kiwibank, Heartland, TSB, The Cooperative Bank and SBS.

Collectively, they represent nearly 15% of our banking market.

His argument is not as simple as the anti-Ocker chants we used to hear from uncommercial politicians, like the late Jim Anderton, Robert Muldoon or Helen Clark.

The truth is that our recovery from the 2008 global financial crisis had its foundation in the Australian banks.

One such bank, National Australia Bank, wrote a billion-dollar cheque to enable its subsidiary, BNZ, to honour its lending commitments in 2008.

Orr will know this but he is sufficiently independent and confident that he will not be browbeaten, certainly not by Key.

I expect that among his motives will be the redevelopment of the non-bank lending sector, which was decimated in 2007 and 2008. It was a victim of incompetent governance, miserably weak law, inappropriate company management, feeble enforcement by the old Securities Commission, further undermined by an extraordinarily high number of finance company owners and lenders with neither a spine, a brain or moral fibre.

The areas Orr must address are outlined in the last pages of my book, The Billion Dollar Bonfire.

They include a new rigid application of the fit and proper person examination, a switch to regulatory approval of trust deeds, rotation of auditors, new accountability for the trust deed supervisor, an overhaul of absurd accounting rules and new supervision of the work of receivers.

There ought to be recognition of the need for capital market participants to earn their considerable privileges by demonstrating genuine value-add and a commitment to legal and moral behaviour, with binary outcomes. The fit and proper person tests must be applied intelligently.

Access to the courts must be rapid and affordable, enabling true accountability for failure, be the failure caused by directors, executives, deed supervisors, auditors or receivers.

Orr has exactly the right credentials to force through these reforms but will want the task shared by the Financial Markets Authority, which has a new chairman (Mark Todd) to support its chief executive, Rob Everett.

One might surmise that Orr will have a full diary dealing to the Australian banks, resisting their bullying, while overseeing reform for the non-banking sector.

He is just the man to achieve this, without losing his grin.

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

THE Infinz awards for the financial sector may need to be reconstructed, or at least to be revised, after nearly two decades of relevance.

It seems the awards no longer are seen as evidence of the recognition sought by financial market leaders.

Perhaps the awards are not moving from the criteria of the past.

The evidence of dissatisfaction is provided by the most often honoured of all recipients, First NZ Capital, which has been named Sharebroker of the Year in 12 of the past 15 years.

FNZC, now reverting to the name of its founder (Jarden - Ron Jarden), has withdrawn from consideration for the awards, politely acknowledging its gratitude for all past accolades, but firmly stating that its business focus is based on servicing a client base whose needs are not included in the criteria on which voting is made. Its withdrawal is brave and a clear signal it puts clients ahead of ego-stroking awards.

Jarden has branched into several new activities and now has a focus on wealth enhancement for its clients in areas outside traditional sharebroking.

It conducts nearly 50% of all NZX transactions in listed equities but its product range also includes hedge-fund activity, property development funding and angel investing, none of which come into the criteria of the Infinz awards.

The Infinz organisers might be best to remove from its awards the category of Sharebroker of the Year, given the withdrawal of the business that dominates the sector.

To make the award to a much lesser party might be seen as patronising, akin to a Miss Friendship award at a talent contest.

If the Rugby Championship had an award for the best team and the perennial winner stepped aside, there would be little jubilation at the elevation of the runners up.

Awards themselves are a fickle business, none more dubious than those which, unlike Infinz, are granted by a panel of random people, often of no obvious relevance.

The Infinz awards are determined by the users of the services being judged, a basis for realistic decisions. They are asked to vote on specific aspects of each contender.

Pontificating panellists chosen by the sponsors have a flawed history, witnessed by the decisions to award gold ribbons to chairmen or entrepreneurs whose time in the sun would have hardly needed an application of sun lotion.

Some fairly unlikely choices have made a mockery of some such awards.

Infinz, which charges its winners to advertise their successes, may itself have exceeded its quota of hours in the sun.

Indeed the concept of such awards might no longer be relevant in this era of clickbait, likes, dislikes and other such gratuitous garbage, so often delivered anonymously, or by marketing contrivances.

I read with utter joy a comment recently that one would never be affected by such detritus if one never resorts to opening up those internet channels.

[This article was written before the awards were announced.]

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Mercury NZ Limited announced its intention to refinance the MCY010 capital bonds on the next reset date on 11 July, which is likely to give investors an avenue to buy capital bonds, not wanted by existing bondholders, on new terms.

We have opened a list for investors interested in participating in the refinancing of MCY010.

More details of the refinancing will be released once available.

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Travel

 

I will be visiting Whangarei in June.

Ed will be in Napier on 5 June and in Nelson on 18 June.

 

Edward and I will be in Nelson tomorrow (Friday, 24 May) at the Beachcomber Hotel Conference room, Tahunanui, at 1pm, discussing The New Norm for Investors, and at 2.30pm discussing the background to the book The Billion Dollar Bonfire.

David will be in Lower Hutt on Tuesday, 11 June.

Johnny and I will be in Ashburton for a function (at 6pm) at Paper Plus on Tuesday, 18 June, and will be in Christchurch available to clients on 19 June at The Airport Gateway Lodge.

Tuesday 4 June, Napier Sailing Club

Investors’ seminar: 12.30pm, Billion Dollar Bonfire: 2pm

I also hope to arrange seminars in Palmerston North and Tauranga in June and will be in Whangarei in June.

Anyone wishing to make an appointment to see any of the advisors, or to register for the seminars, please contact us on info@chrislee.co.nz

 

Chris Lee

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Taking Stock 16 May 2019

With the stroke of a pen, Infratil shareholders are to become shareholders of New Zealand’s largest mobile phone operator, and second largest broadband provider.

The news surrounding the conditional purchase of Vodafone, made jointly by Infratil and Canadian asset management behemoth Brookfields, sent Infratil shares in to trading halt while the discussions concluded.

This is a normal response and should not cause alarm. Implementing a trading halt ensures that, as discussions evolve, parties that have access to information that is not yet public do not have an unfair advantage. The response was entirely appropriate given the situation.

Vodafone marks the most high-profile purchase Infratil has made, and will rival its Trustpower holding in terms of size. The purchase price of $3.4 billion is roughly in-line with the value associated with the failed Sky Television merger attempt three years ago. Infratil’s share of the purchase, which includes their roughly $1 billion cash contribution, will form a substantial part of its portfolio once the August settlement has passed.

Incidentally, Spark’s opposition to the Sky TV merger may have been to the ultimate benefit of Vodafone. Readers may recall that the Vodafone/Sky TV merger involved Vodafone receiving a proportion of the settlement in SKT shares, then valued above $5. Those shares today are valued at around $1.20.

Infratil’s strategy of ‘decluttering’ has seen it divest of assets such as NZ Bus and the Australian National University student accommodation assets, as they seek to hold fewer, but simpler assets.

These assets were both from its ‘core cash generative assets’, which left a space to be filled by the Vodafone purchase, which is being viewed in this light.

Infratil generally define its portfolio of assets along three lines – Core, Core Plus and Development, with each targeting a specific return and each tolerating a particular level of risk. Assets like Wellington Airport and Trustpower fall in to the first group.

The obvious train of thought turns to the funding of the purchase, which is to include a $400 million capital raise. Infratil have stated a ‘significant proportion of the equity raising is expected to be directed towards existing shareholders.’

The broker managing and underwriting the capital raising is UBS, who managed the capital raising in the recent EBOS Group issue. Given Infratil’s track record, it would be unlikely that retail shareholders be treated with the same disdain as the EBOS Group investors faced.

This capital raise will occur over the next few months, giving Infratil time to price the issue fairly and ride out any potential downturn in the market that occurs over the period. I note that Infratil’s share price fell following the announcement, as expectations around the necessary discount to raise such a sum were formed. I would expect that any issue would be well supported by the retail sector, as Infratil shareholders will have confidence in their company’s ability to improve and develop the Vodafone product.

Few would bet against Infratil, who have an impressive track record when it comes to identifying undervalued infrastructural businesses. Although most of its assets are long-term in nature, its purchase of Shell’s assets in 2010 was held only 5 years before being sold for a handsome profit, choosing to list the company on the NZX. Those who invested in Z Energy, as it is now known, have in turn reaped significant gains. Such a path for Vodafone is not outside the realms of possibility, although Infratil have indicated that Vodafone is intended to form a core part of its long-term portfolio.

The comparison to Shell is one worth emphasising, as Infratil was at pains to do in its market releases.

Both businesses (Shell and Vodafone) represent New Zealand assets of a large, international company. Both operate in mature, cash-generative markets, and have endured concerns around competitiveness in the markets they operate (unfairly, in some quarters).

Vodafone is unlikely to be described as New Zealand’s most beloved company. It is often found heading lists such as ‘Most Complained About Traders’, and operate in an industry where public endearment is rare.

However, Infratil’s skill in this space should not be underestimated. Shell (and Caltex) underwent significant change, in a sector that was similarly out of favour, and emerged with a business with a positive brand image and strong market share.

For Vodafone, this may mean a change in the branding of its product. Infratil would be wise to capitalise on the fact that this purchase represents a New Zealand/Canadian consortium, purchasing a New Zealand asset previously held by overseas interests.

Generally speaking, New Zealanders should be pleased with this outcome. The telecommunications sector is one that dominated by two players (Spark and Vodafone). This will not change following the acquisition. However, with Infratil’s energy, capital and expertise, a company that has experienced very little growth over the last few years may find additional avenues to expand. A success for Vodafone will represent a success for New Zealand.

When Z Energy completed its rebranding, it made a point to themselves to ‘shut up and listen’. It approached its customers and researched what the end client wanted from their fuel provider, and how to add value to both sides of the transaction. Such an approach to this business may prove effective.

The next step for Infratil will be ensuring regulatory approvals are met. Firstly, Brookfields will need authority from the Overseas Investment Office to purchase a New Zealand asset. Secondly, the Commerce Commission will need to be satisfied that the purchase meets its requirements to maintain competitive markets. Key to this requirement is Infratil’s existing stake in Trustpower, which has a small presence in the fixed broadband market.

Infratil is confident these requirements will be met. If the latter point proves too challenging, Infratil have outlined some scenarios that could be used to alleviate concerns around anti-competitiveness. Among these is the possibility of Trustpower divesting of its broadband, a less than ideal outcome for the smaller shareholders of Trustpower. Hopefully, this scenario can be avoided altogether to bypass any undue pressure.

For investors, they will need to consider whether this direction from Infratil meets their needs. Some will already have exposure to Spark shares. Others may worry about the size of the transaction. It is undoubtedly true that this represents a very large step in to a new business, with thousands of new customers and new headaches to resolve.

Ultimately, Infratil have proven in the past that it is capable of improving mature, low-growth businesses and realising real value for its shareholders. Investing in infrastructural assets is its core business, and the Vodafone business will provide it, once major capital expenditure has been finalised, with such an asset.

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Pity the fools. Subscribers to the recent Uber IPO have found themselves in the red, as the hype passes and reality sets in.

Uber lost $1.8 billion USD last year, and over $2 billion the year prior. Drivers for the company complain about their level of income, while investors plan for a driverless future to reduce costs.

Yet its IPO was immensely oversubscribed, and subsequently listed at a share price of $45, at a ‘valuation’ of almost $80 billion. Its ‘value’ is now billions less, with large swings occurring daily as the market tries to determine its value.

Lyft, a competitor of Uber’s, has seen a similar collapse in value, with billions wiped from investors holdings.

In the US, 2019 had been regarded as the ‘Year of the Unicorn’, a term used, mostly in the US, to denote a start-up company with a valuation of above $1 billion dollars USD. This is, for comparisons sake, roughly today’s value of Synlait Milk.

Lyft and Uber met this threshold. There are also expectations that companies such as AirBNB and Pinterest may look to list on the exchange. One hopes that investors will be more cautious.

There may come a time when Uber’s share price recovers and these optimistic punters will be smiling at their portfolio again. This is what occurred with social media giant Facebook, whose price fell substantially shortly after listing before today being worth many multiples of the original figure.

Investing in this space remains high-risk, with virtually no barriers to entry to prevent competitors eating away at margins.

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Prices of various Listed Property Trusts have seen climbs in recent weeks, with several reaching all-time highs as a combination of factors play out.

Firstly, with low interest rates heading lower – this week has seen interest rate swaps slump even further – the savings from their future interest costs look set to boost returns, as well as make the relative difference in dividend yield look more attractive. On this second point, some of this appears to be eroding, as dividend yields begin to fall to less enticing levels, in some instances below 4%. This has been driven entirely by large gains in share prices, as opposed to falling dividends.

Secondly, large property valuation gains are seeing their portfolios soar to new heights. Goodman Property Trust recorded valuation gains of over $200 million, which saw its share price hit a record high.

Thirdly, we have seen a large return of investor capital this week, as ASB Preference Shareholders find themselves repaid. Those chasing equivalent returns will be disappointed with bond market returns, as the cycle turns away from fixed interest securities.

Vital Healthcare has seen large gains, as the messy affair with its external manager continues to play out, and its management team undergoes further change. This has been a model that has attracted criticism from many market participants, including us, although recent changes by the external manager to its fee structure and other rights have marked a tiny step in the right direction.

The share price gains have seen their prices soar above the value of their Net Tangible Assets, which may lend confidence to their management to pursue further growth opportunities. Clearly, people are willing to buy units at elevated prices, as they chase returns.

Listed Property Trusts represent an important sector in many portfolios, providing reliable, quarterly (in most cases) income while generally exhibiting less volatility than other equities. Many use these Trusts as the first step away from term deposits and bonds in to riskier, higher yielding assets, to form a more balanced portfolio.

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Travel

Ed is in Napier on 5 June & Nelson on 18 June

Chris will be in Dunedin tomorrow and invites clients and the public to a 40 minute seminar entitled ’The New Norm for Investors’ about how to invest whilst interest rates are so low. After a break he will then talk for 30 minutes about what he learned while researching The Billion Dollar Bonfire. He is confounded by what was uncovered.

Chris’s speaking tour dates, venues and times are:

Friday 17 May, Edgar Centre, Andersons Bay, Dunedin

Investors’ seminar: 11am, Billion Dollar Bonfire: 12.30pm

Monday 20 May, Southwards Car Museum, Otaihanga, Paraparaumu

Investors’ seminar: 11.30am, Billion Dollar Bonfire: 1pm

Tuesday 21 May, Petone Workingmen’s Club, Udy Street, Petone

Investors’ seminar: 11.30am, Billion Dollar Bonfire: 1pm

Thursday 23 May, The Chateau Marlborough, cnr High and Henry Street, Blenheim

Investors’ seminar: 2pm, Billion Dollar Bonfire: 3.30pm

Friday, 24 May, Beachcomber Hotel, Tahunanui, Nelson

Investors’ seminar: 1pm, Billion Dollar Bonfire: 2.30pm

Tuesday 4 June, Napier Sailing Club

Investors’ seminar: 12.30pm, Billion Dollar Bonfire: 2pm

Johnny Lee

Chris Lee & Partners

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Taking Stock 9 May 2019

Last week marked the final listing date of TradeMe, which was delisted following the completion of the successful takeover from British private equity firm Apax Partners. Shareholders have now been paid at the takeover price of $6.45 a share.

Opinions will be mixed as to whether this next chapter is a mark of success or not. My own view is that this outcome is indicative of a healthy stock exchange, and one that rewards entrepreneurship and risk-taking, and produces good outcomes for the many shareholders of TradeMe, including the millions of people in KiwiSaver.

TradeMe's exit from the NZX50 allowed retirement operator Oceania Healthcare to enter the index, and keen-eyed observers would have noticed some unusual trading patterns that occurred on the night of Oceania’s entry to the index.

On the close of market on Thursday, several stocks saw sudden shifts in share price, and the index shot to a record high. Very high volumes of stock changed hands late in the day, as index funds found themselves needing to buy large amounts of shares to ensure their portfolios met their adjusted requirements.

Passive index funds have always been at risk of being 'gamed' by this process, as the sharper operators see these spikes as opportunities to sell at elevated prices. Indeed, the days following saw many stocks retreat in share price towards their earlier levels.

The New Zealand market is generally small enough to provide these opportunities, as traders are aware of how particular fund managers prefer to trade. In larger markets, these trades would be far less visible. 

Passive funds, which are fairly mechanical in nature, have seen a rise in popularity globally over the past decade. Some of this can be attributed to new, younger investors, who may find passive funds to be a cost-effective way of achieving diversification. Another reason for the increase in their usage is courtesy of financial advisers, who are generally taught to advocate their use in favour of more active management.

Active fund managers, by comparison, target long-term performance, above averages, to justify their fees.

International research does exist that shows that many active managers fail to exceed even the simplest benchmarks, leading the barrel-scraping end of the industry to chase benchmarks which lack credibility, effectively transferring risk to their clients while capturing the reward for themselves. The most egregious of these invest in New Zealand shares, and pay significant performance fees for exceeding the 90-day bank bill rate (not even 2%).

There is no justification I can think of for why a fund manager would design such an imbalance in risk and reward. It is simply greed. I would suggest that it would prove a greater challenge investing in shares that don't outperform this benchmark. 

Fortunately, New Zealand is also home to a group of fund managers with very high standards, who place clients first and utilise scale, research and trading nous to achieve outperformance for their investors, without charging fees that reward non-performance.

Many of these institutional investors use their weight to force better standards of governance, although as the recent EBOS Group capital raise shows us, poor outcomes can still occur.

Fees are obviously not the sole consideration when determining where to invest your funds. Risk and return come first. However, it is important to ensure the balance of risk and return is not tilted too heavily against the investor by exposing investors to all the risk, and rewarding the fund manager for poor performance.

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One organisation that would not find itself a member of such a group of outperforming fund managers is AMP, which has reported huge capital outflows in the fallout of the Australian Banking Royal Commission.

AMP has been one of the worst performers on our exchange over the past five years, with dwindling dividends and a plummeting share price, as the consequences of the Commission's findings continue. This has been against a backdrop of fantastic performance for most of our market, as many companies are enjoying record profits and handsome gains in their share prices.

AMP was found to have charged fees for fictitious services and to have misled an Australian regulator. One hopes this implies incompetence, rather than dishonesty.

Its new CEO, Francesco de Ferrari, warned investors to expect results to deteriorate before they improve. The result was even worse than he anticipated, with almost two billion leaving its management over the quarter.

Many New Zealanders found themselves the owner of AMP shares following its demutualisation 20 years ago, with more created following AMP's merger with AXA Asia Pacific in 2011. Some of these new shareholders chose to sell early, receiving a price many multiples of today’s value. 

Those few who remain as shareholders appear to be close to another revolt, as its leadership team undergo personnel changes to steady the ship.

De Ferrari, who is only a few months into the job, faces a difficult task of restoring trust in AMP, which operates in a sector where trust is easily lost and difficult to recover. Among his first moves was to cut the fees of some of its products, and scrap some executive bonuses. It has also begun selling assets, as its focus returns to its core businesses.

Rebuilding the brand will require time, and has a considerable chance of failure. The falling share price will trigger some to re-examine whether this level of risk is appropriate for them to be taking. 

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One area where passive funds and Exchange Traded Funds can offer real value is in providing access to markets that would otherwise be unavailable.

Trading internationally from New Zealand-based brokers can often be expensive and difficult, as regulation, especially in the area of tax, and intermediation costs can hinder the ability to price these services attractively. 

This can make investing in particular sectors difficult. In New Zealand, we have few options for investing directly in to the technology sector, and those remaining options seem to be dwindling.

As Mike touched on in Market News, it is encouraging to see the Smartshares platform (owned by the NZX) exploring this space, stating they intend to list a "Robotics and Automation" ETF next month, and funds with a strong moral focus on ESG factors – Environmental, Social and Governance. 

Details are scarce at this point, but it is encouraging for me to see the market regulator identifying gaps in the market and proactively solving them - though Mike tells me he is not keen to see a marijuana fund!

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Both New Zealand and Australia's Reserve Banks released statements this week, with Australia opting to maintain their cash rate at 1.5%, while we moved to cut ours, also to 1.5%. Our dollar fell on the back of the RBNZ's release, as the RBNZ’s view was more pessimistic than forecast. Our sharemarket index rose at the same time.

It marked the first time the OCR has changed in two and a half years. It was clear from the accompanying statement that the RBNZ shares the market’s view of a slowing economy, a falling employment rate, and inflation below its targets.

It was also clear in statements following the announcement that the RBNZ would not be opposed to more stimulus from central Government. The annual Budget is due at the end of this month, and it will be hoping for some assistance in this area. Likewise, it will be hoping that the cuts flow through to borrowers.

The new rate of 1.5% is the lowest it has ever been in New Zealand, and retail banks are already moving to cut term deposit rates and some marginal changes to mortgage rates. 

For investors, the message has not changed. Interest rates are extremely low, and likely to head even lower. Those that utilise term deposits for liquidity can anticipate returns to diminish. Some will need to consider shifting along (up) the risk continuum, by allocating a greater proportion to equities.

For borrowers, the message is instead that the incentive to reduce debt is weaker. House prices may recover, and existing borrowers should have slightly more change in their pocket once the rate flows through to their fixed borrowings.

One contrasting view that struck a chord with me was that of National Australia Bank's CEO, Philip Chronican, who believed that a cut in Australia was unnecessary and would do little to stimulate the economy. His argument was that, with rates at such low levels, any economic activity that has not yet occurred is unlikely to be influenced by even lower rates.

Time will tell whether the cut by the RBNZ has the desired impact. 

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If you had been asked in 2010, 'Which major US IPO will have the best opening day over the next decade?" I doubt many would have responded by naming meat-imitation company Beyond Meat.

The company uses pea protein to synthesise a product intended to carry the characteristics of meat, while drastically reducing the environmental impacts of husbandry.

On its first day of listing, the share price almost tripled, as investors rushed to buy into an industry supported by some of the world’s wealthiest people.

In New Zealand, our expectations are somewhat tamer. With Napier Port due to list in the second half of this year, most investors will be looking for reasonable dividend yield, a sustainable business model and fair access to participate. 

On these points, it would be wise to moderate these expectations, as demand is likely to outstrip supply for this modestly sized business.

If the council ends up dedicating a pool of stock to Napier ratepayers, some investors may be better placed than others to participate in the offer (and find themselves with new friends!). 

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Vector’s offer of a 6-year senior bond (VCT090), maturing on 27 May 2025, closes next week. Those interested should contact us and advise their level of interest, no later than close of business Wednesday (15th).

The offer will be booked by contract note, with brokerage paid by Vector.

The interest rate will be set on 16 May 2019. We estimate that the yield will fall within the 3.50% - 3.60% range with a Minimum Interest Rate being set on 10 May.

TRAVEL

Ed will be in Blenheim on 15 May, and in Napier on 5 June.

Kevin will be in Christchurch on 13 June.

Chris will be in Auckland tomorrow and invites clients and the public to a 45-minute seminar entitled ‘’The New Norm for Investors’’. After a break he will then talk for a similar period about what he learned while researching The Billion Dollar Bonfire. He is flabbergasted by what was uncovered.

Chris’s speaking tour dates, venues and times are:

Friday, May 10, Milford Bowling Club, North Shore

Investors’ seminar: 11:00am, Billion Dollar Bonfire: 12:30pm

 

Tuesday 14 May, Edgewater Events Centre, 54 Sargood Drive, Wanaka

Investors’ seminar: 2:00pm, Billion Dollar Bonfire: 3:30pm

 

Friday 17 May, Edgar Centre, Andersons Bay, Dunedin

Investors’ seminar: 11am, Billion Dollar Bonfire: 12.30pm

 

Monday 20 May, Southwards Car Museum, Otaihanga, Paraparaumu

Investors’ seminar: 11.30am, Billion Dollar Bonfire: 1pm

Tuesday 21 May, Petone Workingmen’s Club, Udy Street, Petone

Investors’ seminar: 11.30am, Billion Dollar Bonfire: 1pm

Thursday 23 May, The Chateau Marlborough, cnr High and Henry Street, Blenheim

Investors’ seminar: 2pm, Billion Dollar Bonfire: 3.30pm

 

Friday, 24 May, Beachcomber Hotel, Tahunanui, Nelson

Investors’ seminar: 1pm, Billion Dollar Bonfire: 2.30pm

 

Tuesday 4 June, Napier Sailing Club

Investors’ seminar: 12.30pm, Billion Dollar Bonfire: 2pm

Johnny Lee

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Taking Stock 2 May 2019

 

Of all the factors that can influence the value of your portfolio, one that investors must simply abide is the weather.

Last week’s extensive earnings downgrades from Genesis and Mercury highlighted that best, as both companies suggested that their earlier forecasts could be challenged, and their results would likely be towards the bottom end of those forecast ranges.

Electricity generation in New Zealand is not a zero-sum game, but dry spells tend to lead to high electricity prices, which can lead to strong performance for those generators who are less affected by the lack of rainfall.

In this instance, the drier-than-expected central North Island and a sustained outage at New Zealand’s largest gas field occurred, while our South Island catchments remained largely unaffected.

Mercury Energy, formerly known as Mighty River Power, operates a number of geothermal and hydroelectric stations within the central north island, where some lake levels are well-below historical averages.

Mercury have previously enjoyed periods where lake levels were high while the South Island struggled through drier conditions. Mercury is currently embarking on the long process of constructing a wind farm in Palmerston North, which is already having some impact on the electricity futures market.

Genesis Energy operates several hydro stations in the same region, feeding in to Lake Taupo, as well as the Huntly power station. The Huntly station, powered by either coal or gas, can serve as a backup when generation is poor. With the current outage in the Pohokura gas field, imported coal can be used for generation. This is more expensive, and less friendly to the environment.

Meridian’s hydro generation, conversely, is based in the South Island and have largely benefitted from these events, enjoying the rising wholesale price of electricity as their production remains at strong levels.

The electricity generators and retailers (known as Gentailers) are among the most popular sectors on our exchange, valued for their reliable profits, easily understood business models, Government majority ownership and high liquidity. Their long-term performance has been outstanding, delivering both strong dividends and substantial share price gains since listing a decade ago. Temporary falls in their share prices should not herald a sudden change of strategy.

As investors, diversification and long-term thinking provide the best defence to such fluctuations.

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There would be few industries in New Zealand that could survive when 40% of your customers are unsatisfied with your performance, 53% of people don’t trust you, and 65% don’t think you have their best interests at heart.

The results of Consumer’s annual banking survey probably won’t surprise readers, but it absolutely should. No sector should tolerate such a public image. Conversely, the better performing banks, The Co-Operative Bank and TSB, should be pleased with their result.

Banks, especially in New Zealand, Australia and the US, have long been political punching bags, copping flak for various injustices both perceived and real. Some of these criticisms have led to real change, albeit change that can often be difficult to view from the outside world. Some of these changes, however, are clearly taking too long to flow through to the end customer.

Seventy per cent of customers that were offered either a new credit card or an extension of their credit limit, felt it wasn’t a good choice for them. This number should be virtually zero, and indicates to me that staff are either failing to communicate and understand their customer’s needs, or are feeling incentivised or otherwise pressured to achieve outcomes for customers that do not align with the customers own objectives.

Sixteen percent of customers felt pressured to purchase financial products they did not need, such as insurance. Again, this figure should be close to nil. This is an area the banks are acutely aware of, and they will be disappointed to find the figure so high. While there will always be miscommunications, this figure should not be even remotely close to this level.

During my time twelve years at Direct Broking and the ANZ, there was absolutely an ethos to treat customers fairly and correctly. Complaints, which were rare, were dealt with impartially and mistakes fixed. At times, the complaints were unreasonable and had to be dismissed. This is simply the nature of doing business in a complex industry where misunderstandings can occur.

However, complaints around staff pressuring customers to borrow more should be sounding alarm bells to this industry and it should take a firm stance against such conduct.

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The Herald’s decision to introduce a paywall to some of their online media content was, while well-telegraphed, disappointing to read. One suspects other media outlets will be watching digital viewership statistics carefully.

The $5 weekly fee, to access ‘premium’ content on their website, is borne from falling revenues in the media sector, where advertisers are now flocking to social media providers and the likes of Google. Attempts to amalgamate the various players in the fragmented industry have been rebuffed due to anti-competition concerns, and have fuelled outcomes such as this.

There is no easy solution to these problems. Journalists cannot be expected to work for nothing, and limitless Government funding cannot be the answer to the problem. Unless they are able to prove the value of advertising on their sites, then such restrictions to media seem inevitable.

There is some risk to acting first in this space. There is the risk that viewers simply refuse to accept the value of their journalism and move to an alternative provider, such as the Stuff platform, which was involved in the aforementioned merger attempt. This could snowball the existing issues, and strengthen their competitors.

There are also advantages to acting early. As we have seen in the digital entertainment space, especially in the US, early incumbents have the advantage of proven value, forcing new entrants to the space (such as the new Spark Sport) to fight harder to win the same amount.

New Zealand, of course, already has paywalled journalism. The National Business Review have most of their site locked to the public, at a price virtually the same as the Herald is proposing. The NBR was clever in its approach, attracting major corporates to purchase bulk subscriptions for its staff.

 The NBR found a niche in business news, and has produced excellent content without the need for ‘clickbait’ and the more bottom-dwelling content found in overseas circulations.

One could argue that the sort of content I am referring to, with hard-hitting analysis on reality television shows and live blogs detailing the Prime Ministers family life, exist to serve demand that I simply do not understand. This is undoubtedly true, as media outlets would not produce such material if there was not an audience for it. You could also argue that this content, which costs virtually nothing to produce and requires zero investigative skill, effectively subsidises the remaining content.

However, I would venture that there still exists an appetite for specialised research and analysis. The steps taken by the New Zealand Herald are unlikely to lead to either increased access to media, or to an increase in competition, but may eat in to the NBR’s market share. Optimists might hope this tension may lead to better journalism.

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Vector Limited has announced its intention to raise $200 million (with the option to raise an additional $50 million) in a senior bond issue.

The offer will be in the form of a 6-year, unsubordinated, unsecured fixed-rate bond. This means the rate will not reset at any point during its lifetime. Our expectation is for a rate in the range of 3.5% – 3.7%. Vector has confirmed that it will pay the brokerage costs.

The offer opens on the 13th of May, and closes three days later, booked by contract note. The timing of the offer will coincide with investors of ASB Preference Shares being repaid, as payment is not required until the following week.

Anyone interested in investing in this offer should contact us as early as possible with their level of interest, but no later than the 14th of May.

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Florists in Addington will be enviously viewing the brickbat sellers across the road, as EBOS Group’s decision to limit their capital raising to institutional investors raises questions around their commitment to retail shareholders.

EBOS Group, the largest pharmacy and hospital pharmaceutical wholesaler in New Zealand and Australia, has seen terrific growth since its inception, with its leadership excelling in recent years when acquiring both complementary businesses and new avenues of growth. The recent investment in to the pet care sector has already paid dividends. This capital raising allows EBOS to maintain its debt at levels which will provide flexibility to pursue other initiatives.

However, the offer should have included a retail component, regardless of its size. The resulting dilution (the offer to institutional shareholders was priced at $19.70 a share) sends the wrong message to retail shareholders, especially those who have persisted with their leadership during the smaller capital raisings that have occurred over the last fifteen years.

Perhaps EBOS Group would do well to heed the words of EBOS Group, from 2013, when it wrote to retail shareholders for additional capital and stated “It was a matter of priority for the EBOS Board that all existing Shareholders should have the opportunity to participate in the funding of the … Acquisition”.

Disclosure: I am a shareholder in EBOS Group.

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The Billion Dollar Bonfire, Chris Lee’s book on the demise of South Canterbury Finance, has now been printed and is to reach the shops by next Monday. Those who have purchased a copy have had their copies couriered and should receive them shortly.

Any Taking Stock reader, who is interested in purchasing a copy of the book, can do so by contacting Chris or visiting the publisher’s website at www.prlbooks.co.nz. We will keep a small supply of books in the Paraparaumu office on behalf of PRL Books for those who wish to pick one up.

Travel

 

Kevin will be in Ashburton on 9 May.

Ed will be in Blenheim on 15 May, and Napier 5 June.

Chris will be in Timaru on May 7 and invites clients and the public to a 45 minute seminar entitled ‘’The New Norm for Investors’’. After a break he will then talk for a similar period about what he learned while researching The Billion Dollar Bonfire. He is flabbergasted by what was uncovered.

Chris’s speaking tour dates, venues and times are:

Tuesday 7 May, Sopheze on the Bay, Caroline Bay Tea Rooms, Virtue Ave, Timaru

Investors’ seminar: 2:00pm, Billion Dollar Bonfire: 3:30pm

Wednesday 8 May, Burnside Bowling Club, Christchurch

Investors’ seminar: 1:30pm, Billion Dollar Bonfire: 3:00pm

 

Thursday, May 9, Ellerslie Race Club Remuera Room

Investors’ seminar: 12:30pm, Billion Dollar Bonfire: 2:00pm

Friday, May 10, Milford Bowling Club, North Shore

Investors’ seminar: 11:00am, Billion Dollar Bonfire: 12:30pm

 

Tuesday 14 May, Edgewater Events Centre, 54 Sargood Drive, Wanaka

Investors’ seminar: 2:00pm, Billion Dollar Bonfire: 3:30pm

 

Friday 17 May, Edgar Centre, Andersons Bay, Dunedin

Investors’ seminar: 11am, Billion Dollar Bonfire: 12.30pm

 

Monday 20 May, Southwards Car Museum, Otaihanga, Paraparaumu

Investors’ seminar: 11.30am, Billion Dollar Bonfire: 1pm

Tuesday 21 May, Petone Workingmen’s Club, Udy Street, Petone

Investors’ seminar: 11.30am, Billion Dollar Bonfire: 1pm

Thursday 23 May, The Chateau Marlborough, cnr High and Henry Street, Blenheim

Investors’ seminar: 2pm, Billion Dollar Bonfire: 3.30pm

 

Friday, 24 May, Beachcomber Hotel, Tahunanui, Nelson

Investors’ seminar: 1pm, Billion Dollar Bonfire: 2.30pm

 

Tuesday 4 June, Napier Sailing Club

Investors’ seminar: 12.30pm, Billion Dollar Bonfire: 2pm

Johnny Lee

Chris Lee & Partners

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