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Taking Stock 26 May 2022

Johnny Lee writes:

THE Reserve Bank, as expected, has decided to lift interest rates by another 0.50%. The Official Cash Rate is now 2.00%. For context, the OCR was 0.25% last October.

The Reserve Bank now expects the OCR to peak at around 4.00% next year, before gradually declining in 2025. Naturally, predictions three years into the future face a huge degree of uncertainty. The Reserve Bank cannot predict war and disease. Analysis can only be done with the information you have to hand.

The policy assessment was broadly in line with expectations. The war in Ukraine, in particular, is having a significant impact. Commodity prices – food and energy – are rising sharply. Business and consumer confidence is low. Asset prices are declining. Continuing supply chain constraints are continuing to make it more difficult – and expensive – to trade. Labour shortages continue to plague our ambitions for growth.

Perhaps the most optimistic part of the Reserve Bank statement (depending on your point of view) came at the very end – that ''once aggregate supply and demand are more in balance, the OCR can then return to a lower, more neutral level''. The 4% figure is still being regarded as a rate higher than the neutral point.

One of the more interesting charts published by the Reserve Bank in its publication, as part of its ''Special Topics'' research, looked at the rates at which banks ''stress tested'' their borrowers over the past five years. During the low point – 2020 to 2021 – borrowers at 2-3% were being assessed based on rates around 6%. A year later, 6% isn't far from reality.

Part of the reason why these stress tests work is because wages should, in theory, gradually rise. As interest rates move up and down alongside the economic cycle, growing incomes should result in mortgages gradually diminishing in value.

As the Reserve Bank points out, this theory is challenged when interest rate rises outpace wage growth, or when borrowers stop paying mortgages altogether and move to ''interest only'' repayments, an alarmingly increasing trend. Rate rises also disproportionately impact recent borrowers.

None of what the Reserve Bank is saying will be surprising to regular readers. The economic data both here and around the world is grim – life is becoming more expensive, and many of us will need to moderate our spending. Some borrowers, especially those with little employment certainty, will need to make serious adjustments.

But the statement is useful to confirm what we are all seeing – and the plan in place to address it.

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PROPERTY For Industry (PFI) has moved first, announcing a buyback programme that may be surprisingly relevant to its share price.

Property For Industry, like many of the Listed Property Trusts, faces an economic environment that has changed from the previous decade. Inflation has achieved a foothold, interest rates are rising and companies with limited ability to lift distributions – as rental income is not yet increasing at the same pace – are seeing their share prices diminish.

Some of the property trusts – PFI included - have found themselves in a position where the underlying value of their assets now greatly exceeds the value implied by the share price. Investors pricing the shares on dividend yield have naturally demanded lower share prices to account for these rising interest rates.

PFI has responded by announcing it will be selling two properties and purchasing approximately 25 million shares over the next twelve-month period, marking the 5% maximum that the company is allowed to buy every such period. This equates to approximately 120,000 shares a day, accounting for the two blackout months (July and January) and non-trading days.

PFI stated that the buyback ''will deliver a return to the Company in excess or equal to those other opportunities immediately available''. In other words, buying back and cancelling its own shares is apparently the best use of shareholder funds.

PFI is one of the less liquid stocks in the NZX50, with one or two hundred thousand shares changing hands each day. The buyback scheme will dramatically increase this, either fishing out off-screen sellers or forcing the price higher. There simply isn't the liquidity currently available to buy such a number of shares without influencing the share price.

Cancelling 5% of the shares on issue will have a significant effect on the register. Current shareholders who have no intention to sell will find themselves holding a greater proportion of the company - effectively a reverse-dilution – while those considering selling will now have a reason to pause, knowing a relatively significant buyer, operating on a fixed timeframe, has emerged.

This particular buyer also has full access to the company's books and strategy.

There are a number of other Listed Property Trusts trading at a large discount to their Net Tangible Assets – Kiwi Property Group, Goodman Property Trust and Argosy Property Limited, for example – and those without significant short-term expenditure requirements will no doubt be running the rule over their portfolio and ensuring that their asset base is fit for purpose.

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IT has been a busy week for financial results, as the last of our NZX companies report for the quarter.

My Food Bag's result was broadly in line with expectations, with headline profit up significantly.

This headline result is less important than the underlying result, as shareholders will recall that last year's results were negatively impacted by a large deduction to account for one-off transaction costs. The underlying profit improvement was more modest, but still in line with the initial forecasts.

The forecast dividend of four cents was delivered, taking the gross dividend yield well over 10%. The share price responded positively.

Ryman's result was also undoubtedly strong, with an enormous lift in valuations seeing the share price soar.

After a glut of updates from the company, Ryman revealed another land purchase in Melbourne, another planned village in Christchurch, a retiring director and a financial result that broke several records at the company.

Reported profit, which broke $400 million for the first time last year, almost broke $700 million this year. Ryman also confirmed that these unrealised valuation gains are being seen at the cash end too, with underlying profit up strongly. The decline in underlying profit, seen last year, has been reversed and the upward trend re-established.

Fisher and Paykel's result, predictably, showed a reduction in both revenue and profit. It will take some years of growth to re-attain the tremendous heights observed during the Covid pandemic, when the company achieved 10 years of sales over a two-year period.

Fisher and Paykel committed $154 million to research and development over the past 12 months – 9% of revenue – resulting in two new products being brought to market. Fisher and Paykel also announced a very modest half cent increase to the full year dividend.

Fisher and Paykel's share price sank further, although I would venture that anyone expecting Covid-level profits to be maintained were not reading the tea leaves that the company was clearly putting on display.

Mainfreight's result was nothing short of terrific, with an enormous lift in revenue, profit, dividend and staff bonuses. Net profit grew 88%.

Very few shareholders will be expecting profit growth of this magnitude to continue indefinitely. The board itself is specific in highlighting that these conditions are anomalous, telling shareholders ''do not expect the same quantum of improvement this year to roll into next year's results''.

Nevertheless, the start of its next financial year has been very strong. The lockdown in Shanghai and the war in Ukraine – presumably both temporary measures - are playing havoc with supply chains.

One of the more pleasing aspects of the result is that all countries and all divisions are experiencing very strong growth. Furthermore, the company is spending more than $500 million over the next two years to increase capacity for growth, laying the foundation to better take advantage of such anomalous conditions.

Mainfreight shareholders and staff should be pleased with this result.

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ANOTHER warning sign from across the Pacific arrived last week, as the major American retailers reported disappointing results to market.

Both Walmart and Target, two of the largest retailers in the US, reported a decline in quarterly profit. Both reported similar messages – the American consumer is becoming increasingly conscious of inflation and is re-prioritising its expenditure.

Without the benefit of Government-issued stimulus payments, consumer behaviour is shifting. The ''must haves'' – food, rent, electricity but particularly petrol – are becoming a greater proportion of the budget, leaving less room for new clothes, household appliances and furniture.

This trend will not have escaped the notice of our own listed retailers. The Warehouse Group, Briscoes and Hallenstein Glasson will be keenly aware of the situation at the ''coal face'' as well as developing trends overseas.

All three of these companies are already adapting their approach.

Briscoes took the risk of ordering a significant stockpile of goods early, avoiding the worst of the fallout from the supply chain crisis. This soon became remarkably prescient, as the benefit of certainty of supply quickly outweighed the increased cost of storage.

The Warehouse is trying to capitalise on the inflation crisis by competing with the supermarket giants, releasing a somewhat limited product range of discounted grocery staples. Not only does this encourage people through the door, but it reinforces the image – an increasingly important image – that The Warehouse is where consumers can go to tighten their belt, not a place to avoid when trying to tighten said belt.

Hallenstein's has also made significant strides towards lowering its cost base, focusing heavily on moving its customers online. The growth in this channel has been nothing short of remarkable – and the Hallenstein's digital team should be applauded for their execution in this space. The Covid-induced lockdowns presented the team with an opportunity to redefine the company's business model, and consumers, surprisingly, have accepted this new way of engagement so far.

Long-term investors in the retail stocks have enjoyed strong profits and dividends for many years now. The retail sector trades at higher dividend yields than the market average precisely because they tend to be at greater risk to changes in the economic cycle.

Hallenstein's and The Warehouse have both begun to reduce dividends. Briscoes has not, and as recently as early May was forecasting modest profit growth this year.

This is exactly when good management is most evident, and if the sharp declines seen overseas begin to replicate on our own shores, good management will most certainly be needed.

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Travel

Chris will be in Taupo on Monday June 6, available to meet with clients.

Edward will be in Auckland over three days in early June. He will be in the boardroom at the Ellerslie International Hotel on Wednesday 8 June (FULL), at Aristotles in Wairau Park on Thursday 9 June, and in Jarden House, Auckland CBD on Friday 10 June.

Edward will be in Wellington on Friday, June 17.

Johnny will be in Tauranga on Wednesday, June 15 and Christchurch on Wednesday, June 22.

If you would like a free appointment, please contact our office.

Seminar Dates ahead:

Monday 30 May, Palmerston North - Distinction Coachman Hotel, 11am

Tuesday 31 May, Napier - Crown Hotel, 11am

Please contact us if you wish to join out guest list.

Chris Lee & Partners Ltd

Taking Stock 19 May, 2022

Johnny Lee writes:

RYMAN Healthcare's share price has been oscillating wildly over the past week, as the market anticipates the release of its annual results (tomorrow, Friday 20 May).

Most New Zealand companies report on the February and August cycle, with only a handful reporting outside these months. Ryman, Infratil, Mainfreight and My Food Bag are among those who report on the May and November cycle. Infratil reported its results to market today.

These four in particular will be an interesting opportunity to take the pulse of our market, due to the diverse nature of the sectors they cover. In a free-falling market, all four have fallen this year, although Infratil has outperformed the average (again).

Mainfreight's most recent update, only three months ago, highlighted revenue growth of 45% and profit before tax gains of 85%. Since that update, the share price has declined 20%. My Food Bag also confirmed it is on track to meet its prior guidance but suffered a similar decline in share price.

It would be unfair not to note that there has been a distinct change in investor sentiment over the past three months. Consumer confidence has slipped, Covid concerns have receded and concerns around lockdowns have been replaced by concerns around inflation.

Some volatility is normal, but it would be optimistic to regard global conditions now as normal. While the New Zealand index has been seeing 1-2% swings, Ryman's price has been moving nearer 10%, sometimes over a few days.

This is unlikely to be nefarious. Listed companies, especially major listed companies like Ryman, will have strong controls over information flows to prevent one from trading with information outside the public domain. More likely, a number of traders are firming up their expectations for the result tomorrow, de-risking or punting depending on their mood.

Ryman, like every listed company on our exchange, will be keenly aware of the class action suit underway with respect to A2 Milk. Expectations surrounding disclosure are high, as investors rightly demand that companies inform them of pertinent changes to outlook and strategy.

The aged care sector has endured a year of tumult, with mandated lockdowns slowing construction activity, labour shortages causing ongoing problems and forecast house price declines adding uncertainty to projections. The sector has also endured additional costs in areas like security, as it fights to keep out the Covid-infected.

Tomorrow's update should ease some of the share price volatility and provide shareholders with certainty, either positive or negative.

My Food Bag and Mainfreight's updates will also be helpful in gauging the true state of some of our biggest sectors.

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INFRATIL has reported further growth, driven primarily by the outstanding performance of its data centre division.

Infratil's update answered a number of long-standing questions for investors. It has been a period of significant change for Infratil.

Its subsidiary Manawa Energy – formerly Trustpower – has concluded the sale of its retail arm and is now pivoting to become a specialty generator of renewable energy. Manawa is seeking to become a market leader of small-scale solar and wind developments.

Another division, Vodafone, is actively shopping its TowerCo business, effectively competing with Spark which is attempting to sell the same assets. Infratil advises that an update will be provided to market within a month.

The sale of Infratil's RetireAustralia business is progressing, and likely to conclude this year.

The star of Infratil, undoubtedly, is the data centre division. Infratil's valuation of this investment grew 31% to almost $3 billion AUD. Four new data centres are under construction, and Infratil is eagerly acquiring more land to continue expanding this division. Lease terms have extended from an average of 14 years to 21 years.

Infratil also took the opportunity to provide more details of its upcoming bond offer. Infratil is considering making an offer of an 8-year (2030 maturity) bond, with a rate fixed for four years then resetting.

Resetting in this way protects investors from the possibility of further rising rates, while protecting Infratil in the event of falling rates. More details about the bond will be made shortly.

Overall, reading the report, the biggest question remaining to me is how the value of Infratil – its market capitalisation is currently around $5.7 billion and its debt totals $1.4 billion – is not higher. The value of its cash balance, its data centres, its holding in Manawa and its holding in Vodafone almost exceed this figure alone. RetireAustralia, Qscan, Pacific Radiology, Wellington Airport and its overseas renewable businesses (Galileo and Gurin) presumably carry some value.

Further details regarding the upcoming Infratil bond offer can be found below.

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THE Listed Property Trust market deserves an update, following a poor showing this month, with several stocks seeing large declines in share price, despite many seeing positive, but perhaps temporary, property revaluations.

Property for Industry provided a report to market, highlighting a 37% uplift in Net Tangible Assets to $3.03 a share. Meanwhile, the share price responded by dropping 15% to $2.35. Precinct has also recorded a steep drop in share price.

The Listed Property Trust sector is one that is likely to be under the most pressure from rising interest rates. There has been a notable increase in sellers looking to reduce their exposure to this sector since interest rates began climbing, with many citing an uncompetitive dividend yield as the principal driver for their decision.

This is logical and, indeed, was evident during the other side of the cycle when share prices soared as interest rates fell. Short-term forecast dividend growth is fairly low. The challenge for these companies will be to meaningfully lift distributions to remain competitive with other financial products. Term deposit rates are rising. Bond rates are rising. Property trusts promising a long-term return of 3.5% gross will struggle to muster interest. Vital Healthcare's recent capital raising saw acceptance of just 34% of entitlements. Most unitholders simply accepted the dilution, leading underwriters to seek to reduce their exposure.

Some of these companies are turning to property development, aspiring to add value to existing assets or acquire new buildings. Some, like Kiwi Property Group, are actively changing strategy. Most companies are now trading well below their Net Tangible Assets. Could we see asset sales, to capitalise on these gains?

Many of these property trusts will have long-term leases with their tenants that include provisions to adjust rental income by rates related to general inflation. These CPI adjustments may take time to fully integrate and lift rental incomes, but they exist for the very scenario we find ourselves in. One hopes the tenants will be able to absorb such cost increases in difficult times.

The price declines observed across the Listed Property Trust sector are logical in this environment and present a challenge to the sector. Rising interest rates will cause an increase in debt servicing costs and promote a move away from low-yielding equities.

If returns cannot be meaningfully increased, continued declines seem inevitable.

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THE ''cryptocrash'' seen over the past week raises an interesting view into the mentality of investors and fund managers in this space.

For most veteran investors, cryptocurrency remains merely a curiosity, existing in a sphere well outside their risk tolerance, perhaps sharing that sphere with the likes of non-fungible tokens.

Fund managers that leapt into this space with various cryptocurrency offerings, hoping to capitalise on significant public interest, now find themselves rushing to reassure investors who will naturally be panicking over the enormous and sudden losses. Over the past 30 days, Bitcoin has fallen 25%. A number of articles, both here and abroad, are claiming that such declines are expected volatility and an accepted part of investing in cryptocurrencies.

The same people argue that ''Apple and Amazon went through the same thing'' and this is highlighting “the value of long-term investing”.

Bitcoin is no Apple. People speculating on the price of Bitcoin rising, for whatever reason, need to accept that there is always a risk the price simply continues to slide. There will be no receivers and no underlying assets to be sold to recover anything lost. If Bitcoin, or any of the other estimated 20,000 cryptocurrencies for that matter, continues to slide, there would be no recourse, except perhaps on any salesmen who mis-described risk.

Fund managers suggesting that Kiwisaver investors “ought to allocate 10% of their money into Bitcoin” will no doubt be working hard to ensure their investors fully understand the risk of following such a strategy.

A number of prominent cryptocurrencies have faded into obscurity and worthlessness. A number of cryptocurrency trading platforms, including some New Zealand firms, have revealed themselves to be either dishonest or outright fraudulent.

The cryptocurrency market is being tested. I suspect those remaining on the sidelines will continue to do so, and hope that those in the game, so to speak, never have to endure another month like this.

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Z ENERGY shareholders have received an email, advising them of Ampol's recent dual listing on our stock exchange and inviting them to contact their broker if they have interest in acquiring a shareholding in the Australian company. The email does not require a response.

Ampol is the company that acquired Z Energy in the recent takeover. I suspect the email will be a one off.

Ampol dividends do not (yet) carry imputation credits, and the company trades at higher multiples than Z Energy did. It may not appeal to the same investors.

However, investors wanting exposure to this sector now have a new option to consider on our local exchange.

Ampol's stock code is ALD.

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Chris Lee writes:

MOURNED by family, friends and professional associates, the founder of Milford Asset Management, Brian Gaynor, will also be missed greatly by the many retail investors, for whom he was a lighthouse.

In the past decades, Gaynor has been almost the only meaningful source of accessible financial market analysis, almost the only media commentator with both the knowledge and the skill to provide media financial comment insightfully.

From a herd of commentators who in essence have never worked in financial market engine rooms, and largely produce dross, Gaynor stood out because he exhibited knowledge and independence.

In the world of financial markets there are many skillsets, varying from investment banking, mathematical analysis, asset trading, research and funds management.

Gaynor pursued the research path, leading to funds management.

He learned his craft from one of New Zealand's financial market kings, Bryan Johnson, who in his mid-20s had bought 50% of Jarden about fifty years ago, and is credited with having advanced Jarden towards its current elite, and unique, status.

Gaynor, an immigrant from Ireland, learnt the various aspects of research, made himself relatively wealthy at an early age, and eventually became an eminent fund manager, a pragmatist with social instincts who never preached elitism.

He had moved in circles which intersected with financial market kings, but also with the charlatans and crooks who soiled the market in the 1980s, leading to the failure of hundreds of public-listed companies and immense destruction of investor wealth.

He had seen the insider traders (who were inexplicably not prosecuted), the liars and lotharios who seduced the media, the incompetent regulators, the dreadful law-makers and the inept auditors, receivers and lawyers who greedily built their private wealth while creating mayhem.

During a stint as an advisor to Prime Minister David Lange, he had watched the corruption that led to knighthoods being negotiated in exchange for political donations. He told me he was in the room on an occasion when a cheque was swapped for the promise of a knighthood.

Gaynor's social instincts loathed these practices and led to his wish to form and then list on the stock exchange a funds management company with no tolerance of rogues.

Brian Gaynor was clearly not unflawed. Like everyone else, his judgement and some of his theories failed the test of time.

He erred when he was drawn into the toxic world of the likes of Doug (Somers) Edgar, Kelvin Syms and Roger Moses, nearly 20 years ago, when they were cynically recruiting utterly naïve and inept people to flog off empty promises.

He joined the board of Vestar, a Syms creation. Syms, a former partner of Edgar was seeking to exploit Gaynor's admired reputation to build an empire based on selling stuff like Radius, Bridgecorp and virtually any product provider which would pay triple brokerage.

To his credit, Gaynor lasted two board meetings and walked out, revolted by what his due diligence was uncovering.

When he sought to list Milford in the 1990s, he ran into vicious criticism from the property enthusiast Jones, who had not enlisted Gaynor into his fan club.

Jones' media columns were a factor in Gaynor's decision to fund Milford privately. At that time, Jones was seen as a market sage, by some investors.

Gaynor's company, over many years, has achieved rare scale with more than $10 billion funds under management, meaning Milford's fees and performance bonuses are each year collected in hundreds of millions, enabling the company to develop a competent, flexible, research-based organisation.

It has served its clients, staff and shareholders well, distancing itself from most of its competitors, and significantly outliving other public-listed companies including the creations of those who criticised him.

Brian Gaynor more or less retired from his Milford daily routine some years ago, but retained access to Milford's research capacity, enabling him to discuss big subjects in everyday language, supported by the quantitative research of Milford.

What separated Gaynor from all the unmoneyed, untrained, academic commentators that the media seeks out was his ability to analyse, to put into perspective, and his refusal to be cowed by the herd protection mentality that defines the mediocre.

Like many, I lament that he never wrote the definitive book on the ratbags who fouled New Zealand's capital markets in the 1980s, setting back the country for at least a decade.

Brian knew who the culprits were, labelled two of them ''the worst New Zealanders I ever met'', (both were knighted) and built his career serving those he preferred, in so doing acquiring wealth few ever achieve.

His career and life are over. He leaves an army of admirers, of whom I am one.

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Investment Opportunities

Infratil Limited (IFT) has announced that it plans to issue a new eight-year senior bond, with an interest rate reset after four years.

IFT will be paying the transactions costs for this offer. Accordingly, clients will not be charged brokerage.

The offer will be listed on the NZX.

Clients interested in participating in this offer are welcome to contact us as soon as possible with their indicative level of interest and the CSN they wish to use.

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Travel

Chris will be in Taupo on Monday June 6, available to meet with clients, before talking to a group on June 7

Edward will be in Auckland over three days in June. He will be in Mount Wellington on Wednesday 8 June, on the North Shore on Thursday 9 June, and in Jarden House, Auckland CBD on Friday 10 June.

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

Seminar Dates ahead – please contact us to book:

Monday 23 May, Mt Wellington - Mt Richmond Hotel, 1.30pm (FULL)

Tuesday 24 May, Takapuna - Milford Cruising Club, 11am

Thursday 26 May, Whangarei - Flame Hotel, 11am

Monday 30 May, Palmerston North - Distinction Coachman Hotel, 11am

Tuesday 31 May, Napier - Crown Hotel, 11am

Chris Lee & Partners Ltd

Taking Stock 12 May 2022

Johnny Lee writes:

KIWI Property Group’s transformation from ''mall owner'' to ''community developer'' continued last week, with the company announcing it had received approval for its application regarding its Drury development.

It is somewhat reassuring to see, in the midst of so much talk about housing, the environment and the future of society, that actual progress it being made to tackle these issues.

Described as a ''pedestrian-centric community'', the idea is to build communities where people live, work and socialise within their communities, with access to a ''transport hub'' – in this case a train station – for external travel. Current shareholders will be aware of Sylvia Park's intention to build out its offering to include residential sites. Shareholders of Winton Land Company will also be familiar with this design.

At some point in the future, New Zealand will need to consider the full long-term impacts of this trend towards this style of community living. Remote working and carless living will appeal to many, and the benefits to the environment are fairly obvious. However, Covid-induced lockdowns revealed that many of our industries – hospitality in particular – struggled to adapt to the immediate shift in consumption caused by an exodus of customers.

For Kiwi Property Group, the strategy is certainly logical and theoretically sound. The company collects rent from the residents and businesses operating in the area. The businesses have a guaranteed customer base, and the residents have all their needs met in their immediate surroundings. In theory, it is a win-win-win.

The risk is in the execution of the strategy. Building an entire community from scratch is an enormous undertaking, especially in the early stages. Kiwi Property Group will be careful to manufacture an image of excellence, particularly in respect to its residential offering.

These are long-term projects that will span many years. The Drury development is intended to cater to 60,000 people. For Kiwi Property Group, this approval is simply the first step of many.

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THE comments from Simon Henry, the Chief Executive Officer of market newcomer DGL Group, have seen considerable media coverage and universal condemnation from virtually all corners of the country, from the Prime Minister to investment leaders and major shareholders.

For some, this was simply a free hit. Some fund managers, who do not hold shares in DGL Group and did not intend to acquire any, immediately announced they would no longer hold shares in DGL Group. Most said nothing, viewing the comments as simply the embarrassing mistake of a media novice holding views that are well out of keeping with the overwhelming majority.

Clearly, the comments were both unacceptable and patently false. The idea that either fund managers or retail investors consider such factors when investing cross the boundary from insulting to laughable. Indeed, those few investors who actually read the 84-page prospectus probably did not even notice the picture in question.

One must wonder what prompted such an outburst from Henry. No one would have thought such talk was in line with today’s norms, or that choosing to have such opinions permanently recorded on the internet would have any outcome other than the one that ultimately occurred.

I suspect that the younger generation, having grown up surrounded by social media and the anonymity it can provide, has the luxury of better understanding this permanence.

My Food Bag’s share price has, of course, fallen since listing. The much-touted dividend yield is now closer to 15% than 5%, and while the company has not failed in its short-term growth targets, the underlying economic environment has changed.

Interest rates are rising, and inflation will cause belt-tightening. I am certain there will be customers who elect to cancel their subscriptions, and I am certain there will be significant efforts made within My Food Bag to shield customers from inflation. This will be a challenging time for the company, which did not even exist when New Zealand last entered a period of high inflation.

DGC (DGL Group) shareholders have seen a significant short-term share price gain since listing. Some companies have done better over this timeframe, and others have done worse. Before this entire affair began, I imagine DGC shareholders were quite pleased with the share price performance of the company thus far.

One aspect this does highlight is the risks of investing in a company majority owned by a single party. While investors value management who retain ''skin in the game'' (or alignment of management and investor incentives, if quoting textbooks) shareholders must also accept that control of the company is effectively ceded by such an arrangement.

A CEO who owns 54% of all listed shares has a strong incentive to increase the value of his company. But when he goes ''off reservation'', the power to effect change is fairly limited.

The distasteful affair is a good reminder for all – the internet never forgets.

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Chris Lee writes:

WHEN Henry spewed his public bar buffoonery into the media, the only insightful published response worth discussing came, predictably, from Jarden, our investment market leader.

Politicians, fund managers, and others seeking ''likes'' from social media sheep offered no newsworthy comment, as far as I could see.

However, Jarden used Henry's idiocy to uncover quite how he had reached his nouveau riche status, illustrating why such ''rich list'' status was no evidence of wisdom, any more than foreign exchange trading successes, or wealth from an empire of brothels might merit a fawning media response.

Jarden explained that Henry had built a chemical-handling company that in 2020 was making a profit roughly similar to a local McDonalds branch, or a very busy fish and chip shop.

DGL, abbreviating the name Dangerous Goods Ltd, had made about $2 million in 2020, but believed its potential was high and persuaded two retail sharebrokers to list the company in Australia and New Zealand, its opening value being around $100 million, a figure that seemed extreme.

Henry owned more than half of the shares and was escrowed for some years, giving him an instant wealth measurement exceeding $50 million.

The share price was a high multiple of EBIT (earnings before interest and tax), which empowered Henry to take DGL on a buying spree of like organisations whose EBIT multiples were much more sober.

In effect, the high EBIT of DGL gave it borrowing power and a high enough share price to buy other companies cheaply, and to then merge them into DGL, cutting costs through synergy.

This is pretty much what another media-focussed character, the British immigrant Andrew Barnes, had done when he bought Perpetual Trust and then borrowed mezzanine finance to buy out other trust companies, seeking to effect synergies, cut costs, and ultimately increase nett profit after tax (NPAT).

The end play for Barnes was to be a sale to the public, but in his case the broking fraternity demurred, his trust sector hardly being a sector in its dawn phase.

Still, the strategy is legitimate and simple, not a sign of business genius, and often not a strategy that builds better products or services, but a legal and credible 101 business play.

It usually just results in labour force savings, perhaps rental savings, and improves share price value by increasing NPAT.

Jarden described this as being from Play book 101.

In Henry's case, the DGL share price rose 400% after listing, making Henry's shares valued at hundreds of millions, leading to his determination to have the media address him as one of our richest and cleverest business creators.

Of course, his shares are escrowed. It would be sensible for him to monetise his gain when the escrow lifts, as Jarden explained. There is no certainty that his exit price would be at its current price.

If in the future he could find a buyer for his shares at the remarkably high current valuation, he would logically sell some and bank the money, at which point he would be demonstrably on the current government's list of people who have too much wealth.

Maybe he would get on to that list that left-wing economist Max Rashbrooke describes as people with ''undeserved'' wealth, a phrase that sounds like an Animal Farm incantation.

What Jarden's helpful response did was to uncover the origin of Henry’s suddenly acquired belief that his views of the world and other successful people were of value to others and would be seen as thought-leading.

Sorry, Mr Henry. You are no thought-leader.

Play book 101 is no more a sign of special talent than FX trading successes, or winning a multi-bet at the TAB.

Thought leaders are trained, experienced, wise, strategic, and think for long periods before spewing out gratuitous detritus.

Perhaps the Jarden response might make others examine carefully those they promote, before that promotion risks turning a cretin into a media-embraced five-minute hero.

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Travel

Kevin will be available in Timaru next week, on Thursday May 19 (FULL) and Friday May 20.

Chris will be in Taupo on Monday June 6, available to meet with clients, before talking to a group on June 7

Edward will be in Auckland over three days in June. He will be in Mount Wellington (exact location TBD) on Wednesday 8 June, on the North Shore (exact location TBD) on Thursday 9 June, and in Jarden House, Auckland CBD on Friday 10 June.

If you would like a free appointment, please contact our office.

Seminar Dates ahead:

Please note that guests have NOT been transferred from the March lists. Please notify our office if you wish to book a seminar seat. Several venues have limited numbers.

Monday 16 May, Tauranga -Tauranga Cruising Club, 11am

Tuesday 17 May, Hamilton – St Andrews, Hamilton Golf Club, 1.30pm

Monday 23 May, Mt Wellington - Mt Richmond Hotel, 1.30pm (FULL)

Tuesday 24 May, Takapuna - Milford Yacht Club, 11am

Thursday 26 May, Whangarei - Flame Hotel, 11am

Monday 30 May, Palmerston North - Distinction Coachman Hotel, 11am

Tuesday 31 May, Napier - Crown Hotel, 11am

Chris Lee & Partners Ltd

Taking Stock 5 May 2022

Johnny Lee writes:

THE flurry of capital raisings and debt issues continue, with Channel Infrastructure (formerly New Zealand Refining) joining both Mercury Energy and Vector Limited in the pursuit of long-term debt.

Both Mercury and Vector, by happy coincidence, have indicated minimum interest rates of 5.50%, which seems to be the current benchmark. If set today, both would in fact come closer to 5.80%, as swap rates climb further.

The Mercury bond issue has a formal maturity date of 13 May 2052, making it a 30-year bond, but the wording around this should be considered carefully before making any decision regarding the offer. Mercury has the right – but not the obligation – to re-purchase these Bonds in 2027 and 2032.

Mercury states that the Bonds will initially comprise 50% equity, expected to fall to 0% equity in May 2032. Mercury then goes on to state: ''Mercury believes that hybrid securities such as the Capital Bonds that are ascribed equity content are an effective capital management tool and intends to maintain such instruments…'' (my emphasis).

To further quote Mercury when it last issued such a structured bond in 2019, a reduction in equity ascription would lead to ''high-cost debt with limited benefits'' that is ''not consistent with the rationale of the issue''. Choosing not to redeem the bonds at the five-year mark would introduce ''refinancing risk at year ten''.

The Vector offer is far more straightforward.

Vector's bond is technically a rollover of an existing bond, the VCT080. As with any given rollover, some investors will elect repayment instead of continuing their investment, creating an opportunity for existing bondholders to purchase more, with any remaining unpurchased amount given to brokers to allocate.

Channel Infrastructure's five-year bond has yet to declare a minimum interest rate. If it chooses to do so, this will occur tomorrow (May 6), along with the indicative margin.

Channel Infrastructure is a different company from New Zealand Refining. Ostensibly an importer and distributor of refined fuel, the company is now progressing the long and arduous process of cleaning, dismantling and demolishing the refinery as it works to retrain its workforce towards its new corporate direction.

Ultimately, the company emerging from this should have more predictable cashflows, more stability and major shareholders who are aligned with this direction.

Several other companies have indicated, either formally or informally, their intention to raise additional capital via the bond market. Investors missing out on the existing offers will have other opportunities.

Advised clients can find an article regarding the Channel Infrastructure bond offer on the Client Log-in area of our website.

Clients with an interest in the forthcoming bond issues are welcome to contact us and add themselves to our New Issues email list.

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SUMMERSET'S Chairman's address, made last week, paints a company in rude health, but an industry in dire need of a short-term and long-term solutions to systemic problems.

Profitability remains high and demand for its services remains strong. The growth strategy – both in New Zealand and Australia – remains on track, albeit hampered by lockdowns and restrictions.

The immense land bank, sufficient to almost double the size of its business, gives the company a visible path to greater success.

The Retirement Commissioner will also be delighted to read that resident satisfaction levels are nearing 100%, a clear indication that the current structure is working effectively for shareholders as well as residents.

The issue Summerset faces - and indeed the entire industry faces – is a shortage of nursing staff.

The numbers are startling. There are more than 1,000 vacant positions in aged care alone. Almost half of all Registered Nurses left their jobs last year. There is also a $20,000 per annum funding gap between aged care nurses and public hospital nurses.

There is only one obvious long-term solution: Greater incentives need to be installed to encourage young people – men and women – to consider nursing as a profession. Pay, of course, will be an essential part of this equation.

However, training takes time. The short-term solution will likely need to rely on immigration. Unfortunately, health care providers are also battling with overseas employers actively recruiting our nursing staff, worsening the shortfall.

These issues are occurring on both sides of the Tasman Sea, and indeed globally. It is also an awful truth that nurses were among the hardest hit by Covid, with hundreds of thousands of health and care workers dying from the disease, and a much greater number leaving the sector altogether in the aftermath of the virus.

The consequences of inaction are clearly spelled out in the address. The aged sector currently meets the needs of triple our public hospital capacity. If a decline in service levels were to occur, the Government would be expected to remedy that shortfall, something I suspect it has neither the willingness nor the ability to achieve.

It is worth highlighting that both Summerset and Ryman have made significant pushes into Australia, diversifying away from New Zealand-specific risk.

Across the sector, Ryman will be next to report to market, with an announcement expected in the next fortnight. Ryman has yet to make a single announcement to the New Zealand Stock Exchange this year, an extraordinarily unusual fact for a major New Zealand company.

The aged care sector is an absolutely essential one for New Zealand, with public services being unable to accommodate the demand for their services. The CEO of one of our sector leaders is highlighting a coming crisis – hopefully, we can begin to address it.

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ONE of the key considerations investors need to make in an inflationary environment is the concept of demand elasticity – that is, how demand for a product changes as the price of the good or service changes.

We know price increases are occurring, and at a faster rate than wage growth. Households are already making decisions to prioritise essentials or finding ways to change their behaviour to account for these increasing costs.

Economic theory dictates that as the price of something increases, the demand for it gradually diminishes. Some goods – like televisions, automobiles – are typically regarded as highly elastic, meaning that people will simply not purchase such goods if the price is too high. Conversely, goods like medicines, food and electricity are regarded as inelastic - we buy these almost regardless of cost, cutting back consumption in other areas to account for their higher price.

Some products, such as alcohol, are subject to considerable debate as to their elasticity.

For investors, this factor is important as company revenues, profits and dividends are of course tied to this demand. The likes of Meridian Energy will feel less pressure on this front than, say, a company selling jewellery.

There are a number of companies on our exchange that have historically paid very high dividends and trade at yields well in excess of the market average. Indeed, investors have done extremely well investing in such companies, accepting risk and volatility in exchange for an outsized return.

Investors considering these companies should first consider – how sustainable are its revenues, and therefore dividends, if inflation was to rise and discretionary spending to decline? If rising costs cannot be passed on, is the company flexible enough to adjust to such an environment?

Of course, all of this is factored into the market price, and used to justify the high yields on offer for these companies.

But it is undoubtedly true that most market signals are pointing towards a period of high inflation and subsequent rising interest rates. For now, the world is moving on from the past decade of low and falling rates.

This will have an impact on every listed company – but those with products that are either replaceable or inessential will likely find themselves in need of a new strategy, as consumers tighten their belts.

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THE electricity sector is poised for a decade of change, with a number of major projects announced as companies seek to improve shareholder returns.

Contact Energy's well known geothermal development, Tauhara, is underway and expected to begin generation as early as next year. Contact has also recently announced plans to partner with BP's solar division with the goal of building several large-scale solar plants. Discussions are also underway to progress the Green Hydrogen project in the South Island together with Meridian Energy.

Other generators have also announced plans to expand new and existing generation, including a major solar installation in Christchurch and a large-scale wind farm in Hawke's Bay. Battery projects are also being discussed.

There are some common themes with these projects. The focus is clearly pivoting towards green, renewable energy, with high upfront costs but low marginal costs going forward.

These trends are even being reflected at a household level, with solar uptake across the country slowly accelerating. One wonders if a market leader will emerge in this space.

Some of these major projects may never see the light of day – economics change, markets change, and better opportunities arise. The electricity generators will also be careful in ensuring that increasing generation does not lead to an oversupplied market. A significant proportion of future demand is expected to be tied to an increase in electric vehicle uptake.

However, it is encouraging to hear the change in tune for these projects. For a long time, investment was deferred due to both uncertainty and the belief that tomorrow's technology would be cheaper and better. Now, it appears that leadership within this sector has decided to commit themselves to getting things done.

These projects also have flow-on effects to other sectors, including engineering, construction and logistics.

This will be an exciting period of change for the sector. Technological improvements continue to offer new investment ideas both for large scale companies and individuals, and with the likes of Amazon, Microsoft and even Canberra Data Centres (part-owned by Infratil) building large-scale data centres in Auckland, our listed generators are growing in confidence that the time is right to respond to this demand.

Travel Dates

If you would like a free appointment, please contact our office.

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Seminar Dates ahead

Monday 9 May, Christchurch - Burnside Bowling Club, now 2pm

Tuesday 10 May, Timaru - Sopheze on the Bay, 1.30pm

Monday 16 May, Tauranga -Tauranga Cruising Club, 11am

Tuesday 17 May, Hamilton – St Andrews, Hamilton Golf Club, 1.30pm

Monday 23 May, Mt Wellington - Mt Richmond Hotel, 1.30pm (FULL)

Tuesday 24 May, Takapuna - Milford Yacht Club, 11am

Thursday 26 May, Whangarei - Flame Hotel, 11am

Monday 30 May, Palmerston North - Distinction Coachman Hotel, 11am

Tuesday 31 May, Napier - Crown Hotel, 11am

Chris Lee & Partners Limited

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