Chris Lee & Partners Ltd

Taking Stock Thursday 27 May 2021

Johnny Lee writes:

THE maiden result from newly-listed My Food Bag, announced last week, beat pre-IPO forecasts, and reaffirmed the company's intention to pay a dividend in December this year.

The forecast dividend of 7 cents per share would represent a 6.5% gross yield. The dividend is intended to be subject to a 40/60 split – 40% being paid in December, 60% in June next year.

My Food Bag's share price has fallen since listing, a disappointing outcome for early investors, particularly the large number of small investors invited directly by My Food Bag to participate.  Many of these investors will be unaccustomed to the volatility and long-term nature of investing in growth companies.

The company's forecasts for growth have – so far – been met, but the reality is that the sector is in its infancy and operating within a country of five million people and a small number of potential customers.

Experienced investors seeking a sustainable, enduring model will need confidence that the recent surge in demand in this sector is not simply a flash-in-the-pan fuelled by COVID-related restrictions on movement, but part of a broader societal change.

These growth ambitions do not just include selling more ''meal kits'' to more people.  My Food Bag has well-known ambitions to continue disrupting our existing models, seeking to become a ''One Stop Shop'' for increasingly time-poor customers.  Supermarkets, which largely rely on foot-traffic to promote sales, will already be preparing for such disruption.

Earlier in the year, the New Zealand Government revealed that it continues to be one of the largest customers of My Food Bag, spending hundreds of thousands on meal kits as a way of sourcing a non-cash solution to efficiently feed those in need.  These kits come with detailed and specific instructions on how to cook the food, helpful to those less experienced with the art of cooking.

Although the share price fell on the back of the profit announcement, public disclosures suggest the directors and larger shareholders continue to increase their holdings at these lower prices.

Meanwhile, the company's main competitor – HelloFresh – has been particularly aggressive in its search for market share.  A sustained advertising blitz in our largest media outlets offers hefty discounts to new subscribers, hoping to pry customers from My Food Bag's grasp.  While a premium will exist for New Zealanders wanting to ''support local'', there still remains a large proportion of people who are more price-sensitive to food costs, even in the meal kit business.  Both companies will know that once a customer has signed up to receive their product, consumer inertia will allow them to retain many of these customers.  The difficulty is persuading the customer to make the initial switch.

HelloFresh is the world's largest operator in this space and known around the world for its competitiveness.  Having enormous cash reserves and supportive shareholders allows the company to run razor-thin margins (if a margin exists at all) to capture market share, frustrating their competitors who must either price match, surrender market share, or compete on a basis other than price.

For My Food Bag, the intense focus on sustainability, coupled with the New Zealand-centric ownership structure, will carry some appeal to consumers and investors alike.

My Food Bag's announcement included its intention to advance plans for a soft plastics recycling programme – aiming to reduce its impact on the environment.  This will look to be in place as early as next year.

Another winner from My Food Bag's success looks to be the middle-men – the likes of New Zealand Post – which will be pleased to see increasing demand for home-delivered food in the wake of a decline in posted documents.  Trends towards online shopping have also contributed to this resurgence.

Overall, My Food Bag will be pleased to have exceeded its pre-float forecasts – but it now faces the task of communicating a clear and credible vision moving forward and delivering results for shareholders somewhat disappointed in the early share price movements.

The company next reports in November.

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RYMAN Healthcare has also delivered its full-year result, with dividend growth restored and property revaluations sending its reported profit to a new record high.

The record dividend, of 13.6 cents per share, will be paid on 18 June.

Its underlying profit, a more relevant metric, declined.  Lockdowns and various restrictions on movement, both here and in Victoria, have hampered construction activity for the company.  It is the first year Ryman has seen a decline in underlying profit, albeit a decline only to 2019 levels.

The result was almost the reverse of last years – which saw a decline in reported profit, following negative property revaluations, but an increase in underlying profits.

Debt has grown, albeit at a similar rate to the growth seen in total assets.

The share price fell sharply, although many of the concerns raised by sellers are transitory.  The model is clearly an enduring one, and management have been cautious in evaluating demand before committing to expansion.

Discussions from unhappy non-residents, displeased with actual residents making the willing choice to forego some capital gains on their property in exchange for excellence in care, appear to have turned their outrage towards other non-issues.  One imagines that relevant voices in this discussion would have noted the enormous number of houses built by Ryman, in a country where house construction is to be encouraged.

Ryman has now developed a meaningful footprint in Australia and will soon have fourteen villages under construction across Australasia, with another nine in place shortly afterwards, with a further two opening shortly.

The company also reported it was buying more land, adding to its already significant landbank, in Karaka, Cambridge and Victoria.  The process from land to opening day is a long one – requiring long-term planning and patient shareholders – but so far, this patience has paid off.

The company also announced that CEO Gordon MacLeod is departing to spend more time with his family.  Any new CEO would be unlikely to materially change what has been a formula for long-term success.

Unhappy Ryman shareholders are rare creatures, as the Ryman story has grown to become one of the great successes of our capital markets.

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MAINFREIGHT, another company supported by many a happy shareholder, can celebrate yet another record-breaking result after yesterday's profit announcement.

Every metric in every division was positive.

Revenue and profit grew across all five regions – New Zealand, Australia, Europe, Asia and The Americas.  Unsurprisingly, The United States continues to be the trickiest market, with ongoing lockdowns during the previous twelve months impacting the business.  The diversified nature of its operations, however, more than made up for these struggles – while the transport division struggled, other areas within the US business delivered impressive gains, leading the overall performance in the Americas to report a profit increase over almost 30%.

The dividend soared.  While many companies are fighting to maintain dividends or posting modest gains, Mainfreight has lifted its full-year dividend from 34 cents to 45 cents, payable in July.  The company now pays more in annual dividends than the entire company was worth when it first listed.  A buyer of Mainfreight shares, just ten years ago, would now be enjoying a 10% dividend yield from their purchase price.  The speed of growth has been impressive to observe.

Debt levels, which were already very low, have almost halved.  Modern business theory might lead businesses (and governments!) to accumulate huge levels of debt while interest rates hover at historic lows, but Mainfreight's drawn debt facilities are extremely low and headed lower this year, as the company largely self-funds its growth.

And the growth on display is significant – triple-digit growth in some areas – as the company rode the rebound in global economic output.  The COVID outbreak, and the struggles in supply chains that followed, have highlighted the importance of logistics management.  Mainfreight's considerable scale is allowing the company to take advantage of these global struggles, and the repricing that accompanies them.

This growth is still at the top of the company's priority list.  The company is looking to spend more than half a billion dollars on capital expenditure over the next three years.  This will be made up of land, new facilities and upgrades of existing facilities.  The list is impressive – and spans multiple parts of the world, from Nelson to Dandenong.

The company also bolstered its pool for staff bonuses to reward those at the coalface.  It also made a point of publicly stating the company was ''bloody proud of our people'' – an unusual declaration to be found in a company's financial statements, but a good illustration of the culture Mainfreight works hard to foster.

The share price has been on an astonishing journey over the past twelve months, almost doubling from a position many already considered to be very high.  Nevertheless, the share price reaction to its results was positive – driving the share price up even further.

The outlook for the next year is also positive.  The first few months of the next result – this result was for the year ended 31 March – show the company is still seeing significant improvements and is confident the next result, in November, will be equally positive.

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FLETCHER Building's decision to return a further $300 million to shareholders, by way of an on-market share buyback, may have some observers scratching their heads.  The buy-back will begin almost immediately and follows Fletcher's buyback of 2019, which was suspended in 2020 to preserve liquidity in the wake of COVID.

A buy-back occurs when a company chooses to use its cash reserves to purchase its own shares and cancel them.  This reduces the amount of cash the company holds, but also reduces the number of shares on issue, leaving those who choose not to sell with a greater proportion of the overall company.  It typically increases a share price both in the short-term and long-term.  In the case of Fletcher Building, it purchased about three percent of its own shares in the 2019 buyback, at about $5 a share.

For companies which focus heavily on return on equity, a buyback can have positive long-term effects on these metrics.  While many shareholders do not particularly care about minor changes in these figures, senior management can view these as important means of tracking capital efficiency of a company.

By way of comparison, dividend payments represent an immediate return of shareholder funds and are made to all shareholders equally – regardless of whether that shareholder would have preferred the funds to remain within the company.  The dividend is immediately subject to the prevailing tax rate of the shareholder's jurisdiction.

Buy-backs can also confer taxation advantages in some circumstances – especially when you consider factors such as imputation credits and fluctuating policies concerning capital gains.  In the US, where taxation policy seems to change every election cycle, it can be preferable to retain an unrealised capital gain than receive a foreign dividend.

Buy-backs stirred controversy in the US last year when government stimulus, intended to promote investment and jobs growth, led to record levels of stock buy-backs from listed companies.  Proponents argued that the seller in these buybacks would provide the same stimulus with their subsequent investment.

Ultimately, the buy-back illustrates that Fletcher Building believes the most effective use of shareholder funds is to buy shares in Fletcher Building.  Other options, such as reducing debt levels or investing in future revenue growth, were considered inferior, and holding such a large sum of cash would be inefficient.

In times of uncertainty, listed companies may be more inclined to view a buyback as a safer option.  Fletcher Building will know, with some degree of certainty, what its short-term outlook holds. Investing further into new areas of growth poses a risk of failure, especially when dealing with almost half a billion dollars.

Nevertheless, Fletcher Building shareholders, at least those focusing on growth, will be hoping that the future holds a more strategic pathway to share price growth than annual share buy-backs.   At a time when house building and general construction is experiencing a boom, and with the Government pleading for an increase in housing supply, Fletcher Building has elected to buy $300 million worth of shares - in itself.

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CHRIS has returned home after a successful operation, and now embarks on the road to recovery.  Thank you to all readers who sent messages of support, and the wonderful team at Wakefield Hospital who provided an excellent standard of care.

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TRAVEL

Edward will be in Auckland on June 10 and June 11, Napier on June 24 and June 25 and Nelson on 8 July and 9 July.

Johnny will be in Christchurch on 17 June. 

Kevin will be in Timaru on 14 June.

If you would like to make an appointment, please contact our office.

Chris Lee & Partners Ltd

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Taking Stock Thursday 20 May, 2021

Johnny Lee writes:

POSITIVE results reported from the Listed Property Trust (LPT) sector should give investors confidence in a market in rude health.

The listed property sector has reported growing asset valuations, increasing dividends and strong balance sheets.

COVID marked a period of uncertainty for the LPT sector, as concerns about the future of work, and the impact of this on property prices, rose to the forefront.  These concerns are still being debated, but the short-term story, at least in New Zealand, is one of a country where norms have largely been restored in this sector – for now.  Office space is being occupied by workers, and the likes of shopping malls and supermarkets remain active.  While a return to tourism would no doubt be welcomed, the worst possible outcomes have been avoided.

Further abroad, these discussions are continuing in earnest and will certainly help shape our own in due course.  In the United States, where lockdowns continue in some areas, businesses have simply resigned themselves to the stay-at-home model.  Some sectors – technology in particular – have found this transition less painful than others.

The LPT sector, being so closely tied to the vagaries of the interest rate market, has been something of an underperformer this year.  Most share prices have been steady at best, trading at levels far in excess of underlying asset valuations, perhaps in the expectation of these positive revaluations.  This ''catch-up'' appears to be underway.

Goodman Property Trust reported a 128% increase in profit, driven by these property valuations. Argosy also saw a large lift to its Net Tangible Assets, while Property For Industry has upgraded guidance for dividends.  Companies are now seeking opportunities to grow shareholder value, either through improving existing assets or acquiring new assets to broaden their portfolios.

Risks remain.  Rising interest rates would be particularly harmful to the property stocks, both in terms of the future cost of debt, and the relativity between a company's dividend payments and underlying interest rates.

And interest rates have risen.  While rates are still well below the point where investors may consider them viable as an alternative, conversations around inflation and the Reserve Bank's response to inflation will help guide these movements.

For now, the Listed Property Trust sector continues to recover from the lows of March 2020, with the latest developments showing a sector that is resilient and ready to grow.

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IMAGINE reading this three years ago:

''Russian billionaire donates $1 billion worth of shiba inu coin to an Indian Covid-Crypto Relief Fund. Shiba inu coin is a parody of the popular Dogecoin, itself a parody of Bitcoin.''

Cryptocurrencies, for all their faults, are worth large sums of money.  Bitcoin maintains a market cap, at time of writing, of a trillion New Zealand dollars, four times larger than our nation's entire GDP.  The total value of all cryptocurrencies, a value that is constantly in flux, is believed to be almost double this figure.

Cryptocurrencies have become topical in recent weeks, following the actions of the world's second wealthiest man, Elon Musk.  Musk is best known as the Chief Executive Officer of Tesla, the world's largest carmaker (by some metrics).

Musk sparked a huge rally in Bitcoin after announcing plans to add Bitcoin as a payment option for Tesla's products.  At the same time, he announced Tesla had made an investment in Bitcoin itself.

The price of Bitcoin rose, predominantly driven by this newfound legitimacy.  One of the criticisms of cryptocurrencies has been the lack of a practical application – if a coin is solely used as a store of value, why would one type of coin have value over another?  Hype took over and spread across other cryptocurrencies.  Tesla then began selling its Bitcoin, before announcing that it was no longer planning to offer Bitcoin as a payment option, citing environmental concerns.

These environmental concerns centre around the way Bitcoin is ''mined'' – and the electricity usage associated with mining a single coin.  Most of this mining takes place in China, where the bulk of electricity generation comes from coal.

None of this is new information to Bitcoin holders.  Coins have always been made this way, and the huge environmental costs have always been a concern.  The amount of electricity used to run the Bitcoin system is immense – greater than entire countries.

Regardless, the withdrawal from Tesla sent the price stumbling back.  Whether the entire scenario – from the purchase, announcement, sale and cancellation – was planned from the start is unknown, but it does highlight the fickleness of the market, when an asset can lose hundreds of billions in value from a single tweet.

It also highlights the disadvantage of trading in such an unregulated market.  The New Zealand sharemarket is heavily regulated, and surveyed by both man and machine to prevent unwanted behaviour and conduct.  If a large investor misleads the market to temporarily boost a share price prior to sale, the legal repercussions would be severe.

The price has also seen a decline as China considers tightening regulations on the market.  National bans on cryptocurrencies have seen mixed success globally, as speculators attempt to skirt such rules.

This year's sudden spike in value across digital assets – including cryptocurrencies and Non-Fungible Tokens – has led many to spend small fortunes in the hope of one day selling these assets for a slightly larger fortune.

This week's developments have been a setback, but with literally trillions of dollars tied up in such speculation, one imagines the bumpy ride is far from over.

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David Colman writes:

FOR many years it has felt like a decline in interest rates has become expected, with bond yields available to investors falling like a lead weight time and time again.

Three recent bond issues by the Local Government Funding Authority, SkyCity Entertainment and Precinct Properties show bond yields have bounced slightly which should be welcome news for fixed-interest investors.

The bounce is less like a rubber ball after hitting polished concrete and more like the aforementioned lead weight after hitting sand, at least based on current observation.

The three bonds have been, or will be, issued at coupon rates exceeding rates for most comparable bonds listed in the past nine months.

Term deposits, particularly for longer terms, are also offered at better rates than seen earlier in the year.

Five-year term deposits from the major banks are still at low levels between 1.40% p.a. and 1.75% p.a. but are better than the 0.90% p.a. offered by the same banks less than a month ago.

The last significant move up for a number of bond yields was due to Covid-19 concerns in March last year when several bond yields moved well beyond current levels very briefly.

This was likely a rush for cash due to extreme uncertainty and then, as had been the trend before covid became a household name, bond yields fell and continued to slide.

Commentary last year from economists included worst-case scenarios which I am very thankful did not come to pass.  The RBNZ cautiously cut the OCR to an all-time low of 0.25% and promised to keep it the same for a year. Many commentators at the time started to see negative rates as a distinct and very real possibility if, for whatever reason, they didn't see that as possible before then.

Now bank economists are starting to forecast Official Cash Rate (OCR) increases next year, with the ANZ estimating by 2023 the OCR will increase to 1.25% by the end of 2023.

I see some of the commentary reflected in the local bond market with yields for much longer-dated bonds having climbed sharply this year.

Local Government Funding Bonds (LGF130) with a coupon rate of 2.00% until 15/04/2037 last traded at a yield of 2.87%, (being a price of about $89 per 100) up from a yield of 1.96% at the start of the year.

The very long-term Auckland Council Bond (AKC130), at a coupon rate of 2.95% until 28/09/2050, last traded at a yield of 3.52% (a price close to $90 per 100) up from 2.71% at the start of the year. Like the local government funding bond above, the price has gone from a premium to a discount.

Higher yields have reduced the value of the bonds above mainly due to the lengthy terms involved.

At the shorter-term end is IFTHC, a floating-rate bond issued by Infratil that is reset annually. It would provide higher returns if underlying short-term interest rates were to rise and has also fallen in price this year albeit very slightly.  Currently the IFTHC interest rate is 2.75% until next reset on 15 December and is priced slightly below par at about $98.50 per 100.

IFTHC are reset based on a margin of 2.50% plus the 1-year swap rate which, as of yesterday, was 0.38%, showing that short-term interest rates have moved up but only slightly, reflected by the price of the floating-rate notes being just below par.

It is important to keep in mind that even if the OCR is raised and interest rates increase further it will still be close to a historically low level. I see less likelihood that rates will climb anywhere near where they were before the Global Financial Crisis (GFC) which still haunts markets today.

Tinkering with interest rates and quantitative easing will continue to be the tools used by central banks to help meet financial stability goals.

Commercial banks have lent house buyers huge sums that will be very hard for many to repay unless wage growth accelerates to accommodate increased borrowing costs if higher interest rates are introduced as a reaction to inflation.

Most central banks, including the hugely influential Federal Reserve, have zero tolerance for failure.  They do not want to see businesses fold, high unemployment and mass foreclosures.

They are still likely to have to keep interest rates at historically lower levels for longer unless some failure can be tolerated and/or inflation takes off more broadly.

Sadly, this tends to suggest for fixed-interest investors that, although bond interest rates have improved slightly of late, they may not improve by much more even in the next few years and perhaps longer.

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TRAVEL

Edward will be in Auckland on June 10 (Remuera) and June 11 (Albany), in Napier on June 24 and June 25 and in Nelson on 8 and 9 July.

Johnny will be in Christchurch on Thursday 17 June.

Kevin will be in Timaru on June 14.

If you would like to make an appointment, please contact our office.

Chris Lee & Partners Ltd

 

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Taking Stock 13 May 2021

 

THE Labour Government's budget this month may offer some comfort that the ravages of Covid-19 have been accommodated by either clever management or good luck.

But the truth is that the many insidious outcomes have yet to surface in New Zealand, if you define ''surfacing'' as being a presence in our mainstream media, where goofiness prevails, front pages more interested in random car accidents than events that affect us all, profoundly.

The imminent budget should be mindful of the following:-

1. Our supply chain (of crucial imports) is imperilled. Motor vehicles, auto parts, household brown goods and whiteware, pharmaceuticals, recreational boats, cycles, building materials and countless other items are both slower to reach our markets and much more expensive, because of short supply. Inflation figures will soon reflect this.

2. Both tiers of our labour market are suffering from shortages. Skilled workers in areas like health, education, policing, technology, and in regulation enforcement, are scarcely available. Manual workers and skilled people who work in agriculture, horticulture, aquaculture, viticulture and silviculture are all in great demand.

The logical outcome is higher wages. Inflation figures . . .?

Meanwhile the creation of money has led to an inevitable rise in wealth of the haves, leaving a growing gap between those people, and those who own neither a house, nor a portfolio of assets, like shareholdings in companies. In the USA, the average money supply over 20 years was a few trillion. It is now nearer $20 trillion, an astonishing phenomenon.

Civil division cannot increase indefinitely, without consequence.

There is unlikely to be any more certain outcome than real consumer price inflation, followed by understandable social grumpiness, as the trickle-up process accelerates.

Anecdotally, though it escapes the notice of the daily newspapers and our television reporters, inflation has already soared in many sectors.

Obviously housing price rises and rents have had increases loudly described in the media, but not so obvious has been the rising cost of luxury vehicles, recreational boats, seaside holiday baches and staples such as food, petrol, electricity, rates and insurance.

If a Consumer Price Index (CPI) was modelled on the spending of people of mature years I guarantee that the index would display today double-figure increases, at a time when for most of the work force, remuneration increases are modest or even frozen.

More than a decade ago, the Reserve Bank mooted the compilation of two consumer indexes, one for senior citizens, and one for the average consumer, who is said to be mid-30s, has a large mortgage, and spends heavily on goods that have become cheaper through improved technology and through importing from countries with low wages and minimal worker protection standards.

So if the ''average'' person paid more for petrol, electricity, rates etc but enjoyed lower interest rates and cheaper television sets, the savings would offset the increases, resulting in a CPI figure of next-to-nothing.

Any time soon the components of the CPI will have to be recalibrated if we aspire to hide the curse of high inflation.

High inflation accompanied by minimal borrowing costs seems oxymoronic. Obviously many wealthy people would simply borrow even more to invest in assets that soar, boosted by high inflation, demand being higher than supply.

Such an outcome feeds inequality.

One unexpected cause of the problem of lack of supply (of imported goods) is now said to be changes in the weather, caused by global warming.

The link between supply problems and climate change is said to be the increasing height of angry wave patterns, and the shortage of ships to deliver containers.

The pressure to speed up delivery of goods, ranging from cars, to cellphones, to building materials, has led to dangerous overloading of container ships, and to a gung-ho seafaring attitude towards ever-bigger waves.

Last year a record 3000 containers were lost overboard, and this year's figures suggest the problem is worsening.

More, and heavier, containers are being loaded onto vessels. And captains are being incentivised, indeed instructed, not to be deterred by dangerous seas.

According to the World Shipping Council, the worst-ever figure for lost containers was around 5000 lost boxes, in 2013, but of that figure 4293 were lost in one awful incident when a ship broke in two in the Indian Ocean.

This year 750 containers were lost from a Maersk vessel en route to Los Angeles from China in January, and in February 260 containers fell off another Maersk vessel when it was buffeted by high seas.

In recent months the shipping industry says it has encountered the worst seas for 70 years.

More than 220 million containers are shipped across the ocean each year, suggesting that losses are relatively tiny, but there is no argument that the losses are increasing and that the average value of the goods in a container is increasing.

We surely do not want a container full of microchips and semiconductors to feed the bottom of the ocean.

Few of us will have forgotten the impact of the grounded vessel in the Suez Canal in March.

It might be stretching the point to blame container losses for the fracture of our supply chain – factory closures for Covid are the real issue – but it is not irrelevant that the sea patterns are demonstrably an increasing threat.

Fractured supply chains, genuine labour shortages, and the printing of funny money are still the major issues for investors, consumers, and those who make such decisions as the freezing of wages for whole sectors of the public, even if none of these subjects are used to sell newspapers or attract advertising.

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THE fifteen years of legal bills that arose from the forlorn fight over Feltex's failure have come to an end, mercifully.

The fight for compensation from directors and promoters of the Feltex share listing has been led by a former employee of the Fay Richwhite company, now a sad shadow of its former alpha-like presence.

That employee was Tony Gavigan whose partner at home is a lawyer of no special distinction, practising just down the road from their home in St Mary's Bay. The two of them have been the prime legal team.

Much of the money raised from the public has been paid to meet legal bills.

Had the claim succeeded, Gavigan and his partner would have been well rewarded.

The claim failed and kept failing in the courts, the very last case being a plea to the Supreme Court to reverse a Court of Appeal finding, which in effect said that the case had gone on for far too long and was wasting time and the various defendants' money.

My view always was that had the case had a fair chance of succeeding, the team leading the attack would have had bazookas rather than Colt 45s.

I am certain Gavigan was sincere in his hopes, but I believe he was raising millions for an attempt that had little show of success after the court first decided that the potential defendants had behaved lawfully.

Class actions are now more fruitful than they were in previous years, largely because the litigation funders have had many successes, and gradually are obtaining more clarity about the likely responses of the court.

Litigation funders employ the sharpest in the profession, usually.

The action against the goofy Mainzeal directors is fairly convincing evidence of their effectiveness.

I also observe that highly skilled solicitors are more often happy to be involved. They want to see the law better defined, and they want miscreants to be accountable. They do not just reach for the low-hanging fruit.

Only a few years ago one often observed full-blooded legal bills for half-hearted efforts, so things are getting better in 2021.

The Feltex saga was a disgrace.

Anecdotes of gross over-selling by at least one party in the initial listing process in today's more vigorous environment would probably have ended the careers of some of the distinctly mediocre people involved.

I doubt that the best of the capital markets people today would offer to sell Feltex.

The directors of Feltex would be unlikely to record on their CVs any role they played in Feltex.

It is said that one of the ''modern'' manufacturing plants extolled by the prospectus as being ''efficient'' had broken skylights and windows, pigeons nesting in the ceilings, and plant long beyond its use-by date.

The Feltex initial public offer deserved to be challenged. Within two years, it was shown to be a lousy offer.

But after the court decided its directors and the promoters had met the standards of the day when the prospectus appeared, the Feltex case had to fizzle out, unless the best legal minds were engaged to push for different interpretations of the law.

A great deal of investor money has reached a bonfire.

Thankfully there will be no more investors lamenting the thrusting of money to meet the costs of the litigation effort.

All investors should look for names in the Feltex process that have regularly appeared in other corporate disasters.

Never-again lists should be updated.

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From next week, Johnny will be writing and editing Taking Stock, for an unknown but lengthy time.

I undertake surgery on Monday and will be under instruction from bossy people for a few months but hope to defy all predictions and be contributing to Taking Stock in a month or two.

In the unlikely event that this week’s Taking Stock is my swansong, may I record my belief that it has been a privilege to have an audience in newspapers and with our newsletters, for 36 years. Thank you most sincerely.

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Johnny Lee writes:

A2 Milk's update to market this week did not make pleasant reading, but broadly confirmed what many investors had already suspected – the recovery to previous levels is taking longer than expected and the ''Daigou'' channel has not yet returned as anticipated.

Daigou, or Surrogate Shopping, forms a significant part of A2's distribution network into China. Agents within Australia, often Chinese students, agree to purchase and either courier or physically carry supplies into China for resale at a significant profit.

This practice became commonplace for infant formula after 2008, when 54,000 Chinese babies were hospitalised after consuming tainted formula. The high level of trust in New Zealand safety standards led to a boom in demand for our products.

Daigou carries some advantages over traditional retailing – including access to immediate scale and a functional distribution network with virtually no capital expense. As A2 Milk has grown, it is now considering ''evolving its channels to market''.

One major disadvantage is the obvious lack of control. For premium brands demanding premium pricing, A2 lacks the ability to set pricing to its eventual consumer, relying on market forces to set prices. The Daigou market is also vulnerable to counterfeiting.

Daigou is not universally popular among consumers, especially in the infant formula space. Many criticise the practice of foreign nationals buying huge volumes of an essential product to send abroad for a profit. A2 Milk, of course, is simply trying to sell its product.

COVID saw a significant increase in stockpiling, as many feared a breakdown in supply chains. This stockpiling, coupled with a sharp decline in birth rates, has led to A2 paring back its short-term expectations, and put in place a plan to take ''more aggressive actions to address excess inventory''. Birth rates are relevant as infant nutrition makes up a majority of A2 Milk's revenue.

Declining birth rates are a worldwide phenomenon. Virtually every country outside the African continent is now below replacement value. While this does lead to broader issues around the shape of the workforce and societal planning around infrastructure, it also leads to specific problems for companies like A2 Milk.

A2 Milk also announced it was considering a buy-back. By using its considerable cash reserves to buy back shares, the company is effectively saying it believes that buying shares in A2 Milk is the best use of shareholder funds. Share buybacks are becoming increasingly common. With fewer shares on issue, the value of the remaining shares should, theoretically, increase.

ATM's share price fell sharply after the announcement, having fallen over 60% from the lofty heights of August last year. Investors, or potential investors, will be cautiously awaiting its full-year results, due in August, for another update.

TRAVEL

Edward will be in Auckland on June 10 & June 11, Napier on June 24 & June 25 and in Nelson in July 8 & July 9.

Johnny will be in Christchurch on June 17 and returning in July.

Kevin will be in Timaru on June 14.

If you would like to make an appointment, please contact our office.

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Taking Stock 6 May, 2021

WHEN the Covid virus disrupted New Zealand’s investment markets last year, investor focus switched to two sectors which would benefit from the political response to the virus.

We toured the country, perhaps stating the obvious at seminars when we directed investor attention to those sectors – health and technology.

Inevitably, the money created worldwide had to wash up in those sectors as the specialists sought to combat the virus.

On the local scene, Ebos and Fisher & Paykel Healthcare were advantaged, both companies now enjoying share prices that are at least a third higher than was the case when the virus arrived.

The already cash-rich technology shares, seeking solutions in many areas, have had astonishing increases in revenues and profits (listed below in percentages), as the chart shows.

Microsoft          

2020 1st quarter revenue - $35b

2021 1st quarter revenue - $41b

2020 1st quarter Profit - $11b

2021 1st quarter Profit - $15b

Amazon            

2020 1st quarter revenue - $76b

2021 1st quarter revenue - $109b                          

2020 1st quarter Profit - $2b       

2021 1st quarter Profit $8b

Apple                 

2020 1st quarter revenue - $58b

2021 1st quarter revenue - $90b              

2020 1st quarter Profit - $11b    

2021 1st quarter Profit $24b

Alphabet           

2020 1st quarter revenue - $41b

2021 1st quarter revenue - $55b              

2020 1st quarter Profit - $7b       

2021 1st quarter Profit $18b

Facebook          

2020 1st quarter revenue - $18b

2021 1st quarter revenue - $26b              

2020 1st quarter Profit - $5b       

2021 1st quarter Profit $10b

Tesla                  

2020 1st quarter revenue - $6b  

2021 1st quarter revenue - $10b              

2020 1st quarter Profit - $0b       

2021 1st quarter Profit $0.04b

The increases in revenue and profit are astonishing and explain the share price increases over 12 months.

Microsoft - 45%

Amazon - 45%

Apple - 80%

Alphabet - 80%

Facebook - 55%

Tesla - 350%

The weak US Dollar may have reduced the gains for NZ investors but clearly the sector leaders have had extraordinary gains.

Most savers in NZ would have has some exposure to these windfall gains through their KiwiSaver accounts. Many others will have exposure through the ASX-listed ETF (NDQ) and at least some of these shares are in listed funds on the NZX, which naturally have also risen.

The only health stock to have had such a rise in fortune in NZ in the last year has no relevance to Covid, Pacific Edge Ltd (PEB) being a bladder cancer testing company. Its share price has risen by more than 500% in the 12 months.

However, global investors who follow the sector in detail will know that there have been many others labelled under the health sector whose revenues and profits have risen dramatically.

Technology stocks have also soared, an obvious recent example being stocks able to benefit from the global shortage of the electronic chips that now form the basis of so many devices, not the least being the automobile computers that enable us to be transported.

One stock I watch is relevant to the health sector in New Zealand. This relevance results from our government as it prepares to remedy the cost-cutting in health that characterised previous governments, which had dealt in headlines without disclosing the cynical under-funding. (The easiest way to acclaim budgeting wizardry is to slash costs, and hide the damage, a Key trademark in that era, a strategy taught in every American bank.)

The US drug research and manufacturing company, Vertex, has now met with NZ government organisations Medsafe, and Pharmac. Its US chief executive boldly allocated cash surpluses in the past decade, not to pay cash dividends, but to develop research. He eventually produced a truly miraculous drug which restores vitality and an improved life to more than 90% of people born with the genetic defect that leads to cystic fibrosis.

The Vertex drug was rapidly approved by the Federal Drug Agency in the USA, where the health insurers now fund it. Many other countries, such as Malta, the UK, Scotland, Ireland and Switzerland also fund the wonderful drug, known as Trikafta.  Canada and Australia are currently going through the approval process.

The drug retails for around US$311,000 per annum, meaning that very few people without government funding can benefit from the remarkable efficacy of the drug. Its restorative powers would be the most spectacular of any drug with which have I ever been familiar.

Cystic fibrosis sufferers endure lung damage, akin to the damage a set of bellows would face if every week someone drove a four-inch nail into the bellows.

Eventually the bellows would not work.

CF also denies the body the enzymes produced usually by the pancreas, meaning food digestion is possible only with artificial additives. So CF people cough a lot, lack energy, usually are perilously thin, and irrespective of their amazing courage, they usually find a full involvement in society is imperiled; not to mention that the median age of survival is only 18.

Trikafta clears the lungs of the bacteria that creates the holes. Recovery to a virtually full life occurs within days. I have seen this, so can promise that the drug works.

In NZ roughly 530 people have CF.

Less than a handful can afford the cost of the non-funded, indeed non Medsafe approved drug.

Vertex meanwhile has a soaring share price, richly rewarding the shareholders who funded the life-changing research, even though the dividends have yet to flood in to the investors.

This is just a single example of the extreme rewards that follow successful research in health.

In NZ, our government has promised to fix our shaky health services. So it should. The sector has been short-changed by governments for decades. New Zealand cannot be proud of such under-funding.

Presumably fixing it will first require recruiting hundreds of GPs from overseas, dozens of specialists in all areas of health, like surgery, ENT, and midwifery, far more money spent on modern scanning equipment (avoiding a trip to Melbourne to have access to some new technology) and purpose-built hospitals, including premises built for pandemic viruses.

Health is the last sector that politicians should under-fund.

Our finance minister Grant Robertson would need to allocate more billions, not hundreds of millions, to match his promise of a once-in-a-lifetime restoration of our health system to best practice standards. If he did nothing else in this role that so ill-matches his background, he would attract the affection and admiration he seeks.

If we could find billions for sometimes spurious provincial growth dreams, he surely might find billions to restore NZ to first-world standards in healthcare.

I have signed the petition calling on the Crown to fund Trikafta and greatly admire the people who are fighting to have this amazing restorative drug funded. The irony is that the retail cost of the drug could easily, at wholesale level, be reduced to a level far lower than the cost of treating CF patients, most of whom every year need weeks of intensive hospital care and eventually need a lung transplant, at a cost the health authorities report, is far greater than would be the cost of the drug.

(This raises the question: who oversees Pharmac’s decisions by relating those decisions to cost savings elsewhere in the government’s enterprises?)

Robertson’s next budget will be scrutinised with optimism. Investors should not overlook the certainty that technology and health are two sectors that no government can overlook, when it budgets its spending.

A portfolio of investments without health and technology exposure would be missing obvious components.

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NEW Zealanders who still can see ‘’gold in them thar hills’’ will know that OceanaGold, once Macraes Gold, has become a large company, with its major mines in Central Otago and Waihi now producing hundreds of millions of revenue each year.

Those with a fascination for gold may not know that an Australian junior miner last year bought out a fairly interesting exploration licence at Bendigo, near Cromwell, in an area not far from the original Macraes mine.

The connecting dots between Macraes and Bendigo were supplied by Warren Batt, a long-term geologist whose work led to the discovery and establishment of Macraes Mining. He now works with another reputable and experienced geologist, Kim Bunting, who has a mission to prove that Macraes is not an orphan.

Bunting has long believed that the area around Bendigo and its little base, Bendigo Village, shared many features with the land Batt had investigated more than 30 years ago. He and Batt are now seeking to establish another major mining find.

The two geologists raised a few million for a company, Matakanui Gold, drilled a few holes, found there were indeed substantial inferred resources, and developed their findings to the point that a small Australian mining company, Santana Minerals, bid to take over the licence.

Santana Minerals raised about $9 million in Australia, pledging to provide Matakanui with enough cash to use diamond drilling to further investigate the mineralisation at Bendigo and nearby Ophir. Each diamond-drilled hole costs at least $100,000. The prospective area is measurable in hundreds of acres, so there will be many holes drilled.

The company has now reported to the ASX that its recent drilling has intersected some fairly rich veins, displaying visible gold in its cores, and will soon have an independent analyst release a new figure of inferred gold.

The previous figure of 255,000 ounces will be replaced by a new figure but will still be only a step towards the million-plus figure that Bunting has long believed would emerge.

(Macraes was built on the premise of a million ounces. In 30 years, it has produced five million ounces!)

Those New Zealanders who funded Matakanui have yet to be rewarded, as Santana Mineral’s share price has been static, for some obvious reasons.

The Australians who provide money to explorers now want to see three signals before they accelerate progress at Bendigo:

1. The inferred resource growing, with exciting grades. (That seems to be happening)

2. The gold price being stable or rising. (That seems to be happening)

3. The NZ government being enthused by the future revenues, of taxes and royalties, and by the prospect for employment, and thus preparing to support the venture.

The third of those signals is not visible, though there is no obvious reason why gold mining on private land should be thwarted by politicians.

Perhaps once the inferred resource reaches a seven figure amount the enthusiasm of our government to licence a mine, and grant it resource consent, might be apparent.

To put a perspective on this, a million-ounce resource, mining 100,000 ounces per year would generate, at today’s prices $250 million in annual sales, would create hundreds of well-paid jobs, and annual royalties and taxes of tens of millions.

One imagines that the half a dozen houses around Bendigo, where vineyards nestle into the hills, might restore property to the levels of a century ago, when amongst others the perpetually self-focused Todd family were plucking large sums out of the area, as landlords of the miners’ huts, and as employers of the shovel and pick miners.

Indeed, one wonders if the Todds were also selling pies and whiskey to the miners.

Santana Minerals remains a committed investor in this project, with its hopes rising, as the assaying process accelerates and yields are analysed independently.

New Zealand’s top five exports to Australia include oil and gold.

Disclosure: A small group of our clients years ago funded Matakanui and are now Santana Mineral shareholders. I am amongst that group. Progress can be observed by enrolling on the Santana website for all reports sent to the ASX.

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Johnny Lee writes:

INFRATIL has announced its next foray into the health sector, with an investment in Pacific Radiology Group (PRG).  The purchase is conditional, but assuming these conditions are met, the transaction will complete by the end of this month.

It is important to note that Infratil is buying only a majority stake – 50.1% to 60% - of the company. The existing shareholders, being the doctors who currently own the company, will retain the balance.  While some might prefer complete 100% ownership, the partial ownership structure carries the advantage of effectively ‘’bonding’’ the doctors to the firm.  Partial ownership is a feature of many of Infratil’s investments, including Wellington Airport (Wellington Council), Vodafone (Brookfield) and Trustpower (publicly listed).

Infratil shareholders may recall Infratil’s most recent acquisition, of Australian-based QScan Group, which operates within the same space – diagnostic imaging – as Infratil seeks to harness what it sees as the outperforming trends of the future.

These trends include a greater emphasis on early detection of health issues, as well as improving technology and diagnostic techniques that will enhance the value proposition of this field.

Pacific Radiology is a name most New Zealanders will be familiar with.  The company offers diagnostic services throughout New Zealand, with its coverage concentrated around the South Island and lower North Island.

The company offers services ranging from relatively simple procedures, such as x-rays and ultrasounds, to more specialised processes, such as MRIs and CT scans.  These complex procedures are the main profit drivers for the company and are expected to be the greatest avenue for growth, as it becomes more commonplace to utilise this technology.

Increasing the number of clinics, especially around Auckland, is an opportunity for the company.  Two thirds of its 46 clinics are in the South Island, with only six in the greater Auckland area.

One of the largest constraints for this growth will be high quality staffing.  It is no secret that New Zealand would welcome increased interest from young people in joining the medical field – whether as doctors, nurses or radiologists.  Ultimately, many of these roles, that are critical to the wellbeing of our society, are sourced from overseas.

Infratil may be uniquely positioned to consider a role in this space, as the company can afford to take a long-term stance in incentivising people to train and study in this field.  Young people seeking stable, well-paid employment, career progression across two countries and a role that meaningfully improves the wellbeing of society could do far worse than enter the health specialist sector.

Competition risk is something Infratil is keenly aware of – but where it believes Pacific Radiology has a leading edge.  Whenever a sector enjoys high margins or profitability, it is normal for competitors to seek to capture these for themselves.  However, PRG boasts that it employs the best radiologists in the country, and Infratil’s willingness to share in the success of the company, by offering an equity stake to doctors, should aid in staff retention and recruiting.

Funding is already in place and will require no capital injection from shareholders.

 The takeover of Tilt Renewables, assuming it progresses as expected, will realise well over a billion dollars for Infratil.  Temporary financing will reconcile the difference in settlement dates of the two transactions, but Infratil is hardly strapped for cash at the moment.  Indeed, the better question may be how Infratil chooses to invest the balance of its war chest.  Infratil is unlikely to be tempted by the returns offered in the cash market.

On the topic of funding, PRG is primarily funded by the ACC, with insurers, DHBs and private patients also serving as a significant source of income.  The diversification in funding prevents it from being too vulnerable to unexpected change.

The acquisition of a controlling stake in Pacific Radiology Group builds on Infratil’s recent purchase of QScan and seeks to capitalise on what Infratil sees as a sector likely to outperform.  Infratil’s recent success with Tilt Renewables has led to a very cash-rich position in a company well-versed in the art of effective use of capital.

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WHILE the avalanche of bond maturities occurring over the next two months is likely to dominate investor thinking, there are a number of events occurring this month that deserve more than a passing thought.

Australian financial regulator ASIC has formally accused Westpac Bank of insider trading, alleging the bank used insider information to make illegal profits.  One imagines Westpac, much like AMP Group, will be looking forward to the day when its stock exchange announcements do not revolve around legal action being taken by lawyers and regulators.

The Budget will be announced later this month.  The Budget rarely has direct influence on our stock exchange, but does help provide direction around the macroeconomic picture and Government focus for the year ahead.

On the market, Mainfreight, now our fourth largest listed company by some metrics, is due to report its full year results.  The recent price spike, from $68 to $75 over the past 10 days, has not escaped our notice.

A sudden price rise in the days leading up to a public announcement is not necessarily nefarious in nature.  Analysts updating their forecasts and expectations can sometimes coincide with these timings, and occasionally, a small price rise can precede a larger price rise, as investors ‘’on the fence’’ find themselves prompted into action by the sudden enthusiasm.  Regardless of the cause, Mainfreight is now worth $700 million more than a week ago, and $3.9 billion more than a year ago.

My Food Bag, which listed in March, will announce its maiden result on the 21st of this month.  The share price has settled at a much lower level than its initial listing, although significant shareholders have been increasing their holdings at these lower levels.  As always, someone will be right, and someone will be wrong.

The likes of Infratil and Ryman Healthcare should also be reporting later this month.

May is shaping up as a busy month for the finance sector!

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TRAVEL 

Ed will be in Auckland on June 10 & June 11, Napier on June 24 & June 25 and in Nelson on 8 & 9 July.

Johnny will be in Christchurch on May 20 and again in June. He will also visit Tauranga on 12 May.

Kevin is in Christchurch on 1 June (limited appointments left) and plans to visit Timaru in June as well.

If you would like to make an appointment, please contact our office.

Chris Lee

Managing Director

Chris Lee & Partners Limited

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