Chris Lee & Partners Ltd

TAKING STOCK 25 October 2018

WHEN major sharemarkets fall by 5% or even more in just one week, retail investors (a diminishing but important group) naturally seek to identify the catalyst.

Are markets falling because the spread between dividend yields and bank interest rates, or long bonds, is narrowing?

Is the fear that trading between countries will be dampened, by Trump’s activism?

Are the prospects of Ireland and Britain far worse than imaginable – or far better?

Are we fearing global disruption because of Saudi Arabia’s power in oil production, and thus prices?

Do we fear a collapse of emerging markets, whose debt is in US Dollars, a currency rising in strength? The Shanghai A Share Composite Index is down by more than 20% this year. 

Or is there a simple fear of falling corporate earnings in the major economies.

Whatever the cause, the global volatility index (VIX) has had several sharp moves this year, indicating more fear in the minds of investors (six sharp falls) than greed (one sharp rise).

Is there any single catalyst that drives rapid price changes? Or have we now discovered we have no ability to have a conversation with market dominators, because so much of share pricing results from robotic behaviour!

High frequency traders account for nearly half of turnover in the USA. These are people driven by the misguided belief that they are performing a useful service by intercepting natural buyers and sellers, and slicing off margins because of the superior speed of the electronics. They drill a tiny hole through a mountain so their cables are shorter than others, enabling their messages to out-speed their competitors by nanoseconds.

Sigh! What on earth has this to do with adding value?

These people are not even remotely linked to investors. They make money by buying nanoseconds earlier than real buyers and selling to the real buyers nanoseconds before real sellers. They are simply leeches.

Their reported purchases and sales exaggerate real trading volume and add a cost to real investors.

In the US their “volume” is nearly half of all the many exchanges that participate in the distorted US markets.

But none of this behaviour is as threatening, in my view, as the Exchange Traded Funds, which now own more than a third of all US listed shares, though their market share in New Zealand, thankfully, is more modest.

ETFs are simply computer programme-driven, the software instructed to replicate an index, or a segment of an index, perhaps with some exclusions of particular markets, perhaps tobacco, munitions or pornography-enablers being obvious examples.

As an aside there is a degree of hypocrisy in all of this, as tobacco is sold through retailers, including supermarkets, and pornography is facilitated through Google, yet one rarely hears of funds that exclude the major supermarket chains or Google.

Last week a friend, client and former Auditor-General for NZ corresponded, pointing out that ETFs could simply lose value in line with the market without spooking investors.

The exception might be when one stock fell out of favour, causing its weighting in the index to fall, leading to computer selling at a time when there were no buyers.

As you would expect of such a fine mind, his logic was right. But there are other factors.

Obviously the rules of an ETF are known, so if such a one-stock fall from grace was building, the informed market buyer, expecting the ETFs to sell, would reduce to an artificially low price, his buying offer.

The ETF is bound to sell at any price. The informed buyer knows this. The seller cannot avoid being gamed.

The other major factor is the confidence of investors.

IF an investor is worried about a stock or a market, he will talk to a sharebroker or an adviser or a fund manager. He cannot talk to a computer or an “adviser” who simply refers his client money to a computer-driven fund.

IF the worried ETF investor reacts to fear, simply requesting his cash out, ETFs are now powerful enough to change the pricing of the market.

As an obvious example, one could discuss the excessive pricing of A2 Milk and Synlait Milk shares, in recent months. Both shares more than doubled in price, driving up their weighting in the NZX indices.

ETFs had to keep buying, driving the price up, leading to an even higher price, leading to a higher share of the index.

Those who had knowledge of the source of the buying gamed the ETFs, knowing the index funds were forced to buy at any price.

If I was buying fruit for a fruit salad I would hand pick each item, checking for the condition of each piece. Some would respond by saying dinosaurs exist and I am the proof.

 _ _ _ _ _ _ _ _ _ _ _ _

WE saw a version of this nonsensical price-ratcheting in 1998 when AMP debuted on the NZX, having demutualised and issued shares to their policy holders.

Those shares reached absurd heights - $36 – on the morning of the issue, finished the day at $28 - and within weeks were a still absurd $20. They are now a quarter of that price.

Even a leanly-resourced company like mine was able to calculate their real sustainable earnings, the odds of AMP maintaining its market share and margins, and from that deduce that the shares could not be worth $10, if priced on earnings, dividend yields and long-term market share.

We urged every client to sell and most did, at prices between $20 and $32. Even that was not good enough for one seller, who wanted to sue me for not finding buyers at his target price of $28 on the second week of trading.

The cause of AMP’s absurd day one pricing of its shares was a computer programmer in an Australasian sharebroking firm. He wrote a programme that instructed his machine to buy, say, 100,000 AMP shares at $32. His programme went on to say that if turnover of 100,000 occurred at $32, the machine should buy another 100,000 shares at $33. His error continued on until his company realised the mistake.

From memory, it cost the company tens of millions and cost the programmer his job, a reaction that seemed harsh if compared to the response to the errors of AMP’s CEO, George Trumbull.

AMP’s CEO convinced the company to spend more than a billion on a reinsurance giant, which was later seen to have been on the verge of collapse. When the reinsurance company, then owned by AMP, actually became worthless Trumbull was released from his task and for the one-year he sat at the biggest desk he was rewarded with a farewell bonus of $10 million.

Presumably if his stint as CEO had cost AMP $100 billion, he would have been granted a reward of a billion, not a mere $10 million.

In my view, the unknown risks for share investors do include the possibility of fast changes in exchange rates, trade practices, environmental changes, and debt defaults. I do not see interest rates changing dramatically.

I would fear that these issues might in turn be exaggerated by the mindless power of high frequency traders and exchange traded funds. The high frequency traders might destroy retail investor confidence. The exchange traded funds might be so easily gamed that share prices falls lead to collapses in confidence.

What should drive our share prices are sustainable and reasonably predictable revenue volumes, sustainable margins, dividends and reinvestment successes.

Rising employment opportunities, satisfactory debt servicing patterns, improving social matters and progress in environmental matters would follow, leading to confidence and investment success.

New Zealand has some hope of following these patterns.

I am not so confident about the prospects of some of the world’s biggest countries, where money is extracted by a diminishing number of people, where value is often mistakenly assumed to equate with wealth aggregation, and where sustainability is simply a concept, not the driver of decisions.

John Clarke was right! We do not know how lucky we are.

 _ _ _ _ _ _ _ _ _ _ _ _

THE chief executive of one of our country’s most progressive companies rarely talks to the media, his company much preferring to be silent rather than risk serious thought and long-term strategies to be misrepresented by a media that naturally focusses on headlines and sound bites.

That response reminds me of a lesson in “wisdom” that I observed 47 years ago, when I was with a group of Lions, All Blacks and rugby writers.

A visiting British writer, John Reason, was among the grouping. A more uncouth, unknowledgeable, ungracious and more boring fellow would be hard to imagine. As a visitor to NZ, he was simply a slob.

HE was imposing his lack of rugby nous on one of New Zealand’s smartest and most informed sportswriters, Alex Veysey.

Veysey, beside me at a bar leaner, had heard enough. He bought the bore a drink, smiled graciously, and went home.

The bore had lost his audience without a word of rebuke.

The NZ CEO’s response to media is not disrespectful but does not offer much hope that media content might ever become increasingly helpful.

He does release one strong view.

“Markets are not efficiently priced.”

Readers of the first section of Taking Stock can make their own decisions on why markets are not efficiently priced.

 _ _ _ _ _ _ _ _ _ _ _ _

WHAT is environmentally sustainable; what practices are simply destructive; how does one compromise between today’s quality of life for 7.5 billion people, and the prospects for the next 1.5 billion (nett) people who will enter the world over the next 26 years?

Those who see that technology will replace the fuels provided from fossils, also see technology based on the likes of lithium, a toxic element extracted from ancient rocks, of which there are none, in New Zealand.

They see a food supply not involving ruminants, or indeed animals, perhaps grown in soils not requiring phosphates, least of all phosphates shipped across the world, with leachates that damage water quality.

We face an era of so-called “green” minerals.

Yet there may be hypocrisy in this concept.

Certainly there is ignorance about the wealth generated by minerals generally.

I thought of this recently when one of New Zealand’s most experienced and successful geologists was discussing the changing attitude towards gold-mining.

It is worth pointing out that since 1991, the Macraes Mine in Central Otago has identified what in today’s terms is $9 billion of gold, with so far 5 million ounces exported, largely to Australia.

Gold and oil are our two biggest exports to Australia. New Zealand’s oil is best used for aeroplane fuel, not for land transport, because of its low viscosity.

If Macraes Mine is easily the South Island’s largest miner of gold, with millions of ounces extracted, the next biggest is remarkably small, perhaps the 150,000 ounces extracted from Bendigo, in Central Otago, making it the second biggest mine in the South Island.

Will the future of gold mining in New Zealand be determined by the colour of the party that wins elections?

Will all new mining cease, as some advocate?

Will we be able to approve of the toxic processes by which we extract the minerals needed for batteries that enable electricity to be stored? Or do we sidestep this debate on the basis that most of these toxic mines are in Africa and South America, not in our backyard.

My sense is that these are the sort of issues on which backroom executives should be debating with any strategic thinkers in political parties, if indeed such people exist.

Personally I would much rather be involved in that process than in discussions on what some guy secretly taped some other guy, unwisely and childishly, blurting out, with or without fuelling from a bottle.

TRAVEL

I will be in Albany next Tuesday (October 30) afternoon, with one available time at 3:35pm, at the Aroma Café in Albany Village.

I will be in Christchurch on November 13and 14, at the Airport Gateway boardroom, and in Nelson on Monday November 19, enjoying the café at the new terminal, and briefly available there again on November 21. I will be in Blenheim on Tuesday November 20th, venue to be advised.

Edward will be in Remuera, Auckland on 26 October.

David will be in Lower Hutt on 7 November.

Kevin will be in Ashburton on 31 October and Christchurch on 8 November.

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

 

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

 

 

 

Chris Lee

Managing Director

Chris Lee & Partners Limited

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Taking Stock 18 October 2018

WHEN global sharemarkets had several days of selling pressure last week, it was entirely logical that investors would wonder whether this was the result of its excessive previous rises, or a signal that an apocalypse was on its way.

One commentator summarised this by pondering whether it was a squall or a building hurricane.

The truth is that the pricing of listed assets reflects supply and demand, both driven by maths, but also by emotion, especially panic or by an overwhelming instinct to achieve miraculous gains.

Often these emotions are characterised as fear and greed.

Experienced investors and capital market participants are pretty good at performing the maths, when science is driving sentiment and prices.

Very few, in fact I would say none, are very good at understanding and forecasting the depth and urgency of the emotions that derive from panic or from hunger.

The maths would tell you that genuine investors wanting income enhancement are gaining that advantage by buying NZ shares in companies which seem likely to sustain their revenues, margins, nett profits and dividends.

The property trusts are a good example; so too might be the power generators, perhaps even the banks, though the latter are yet to face a probable round of tougher regulations.

Providing a property trust delivers a worthwhile yield enhancement over bank rates, the trust is doing its job.

Today most income-producing shares offer yields after tax of at least one percent more than bank rates.

The sharemarket in NZ generally offers opportunities for dividend yields of around four percent after tax. Bank deposits might yield nearly three percent after tax. The additional risk of holding shares, with their future pricing unknown, is thus rewarded by yield.

Conversely in 1987, the bank deposit rates, then around 13%, far exceeded the sharemarket’s dividend yield, offering an obvious disincentive to take the risk of share price falls. The only rationale for buying shares in 1986 was that everyone was buying.

The same equations could be made globally in 1987, just as today, when the interest rates are often negative or barely visible so sharemarket yields are rewarding risk.

Of course, many companies have a future that is difficult to assess. Disruptive technology and the speed of change can produce massive challenges for forecasters.

However, it is reasonably easy, to cite an example, to assess that commuters will still commute, buildings will collect from long-term leases, the aged will still need care, and we will still be communicating with each other.

Was the downpour last week a squall or a sign of an approaching hurricane?

While the world continues to use zero interest rates to avoid sovereign banking, corporate and household defaults, my view is that equity markets will be priced most of the time by maths, not by emotion. When markets at headline level are high, squalls arrive more often.

Currently emotion might have the upper hand. Volatility is inevitable. An apocalypse is not inevitable.

Furthermore, there is logic in pricing shares that do not pay dividends with much less certainty than in pricing those with consistent dividends.

Synlait Milk and A2Milk are in this category, as is Xero, even Eroad.

If someone wants to discount the high-yielding stocks, there will be a KiwiSaver fund, or an active fund manager, or the odd sniper who will say ‘’thanks’’. People live off dividend income.

In my view the great unknown in the equation is the investor in Exchange Traded Funds, where no judgement is exercised, where buy/sell decisions are completely unrelated to value, and where no informed, rational person can intervene.

If the public wants to exit ETFs, in fear of a market fall, the market will quickly be priced without logic, playing into the hands of real fund managers and sage income investors.

One hopes, for the benefit of these investors, that the ETFs are not subject to a flow of exiting investors!

 _ _ _ _ _ _ _ _ _ _ _ _

THE NZX Board and CEO has my full support for disclosing the pretentious, headline-seeking childish nonsense put to it by Elevation Capital, a small and barely relevant fund manager.

Elevation Capital describes itself as an early stage private investment company.

Its founder is Christopher Swasbrook.

He clearly fancies himself as a market activist and for this I am grateful. The market needs people who will offer a contrary view.

Years ago Swasbrook challenged the lazy fee structure and poor performance of the Fisher Fund, in its captive role as manager of the Marlin Global Fund.

Like Barramundi, Marlin has been a poor performer.

In challenging Fisher Funds, now owned by the TSB and its Community Fund, Elevation had the support of the NZ Shareholders Association, then in its fledgling years.

In challenging the NZX now, Elevation has the support of perhaps one other fund manager. Elevation has a roughly 2% shareholding in the NZX.

In my view its offer to lead the NZX into Swasbrook’ s preferred paddocks is frivolous, based on evidence of a skill and relevance that I cannot see.

I can see that Swasbrook was chairman of the awful Bethunes Investments, which owned Mowbray Collectibles, arguably one of New Zealand’s most inappropriate NZX listings in the thirty years after the 1987 sharemarket crash.

In 2016 Bethunes fell from a 10c penny dreadful to a 1.7 farthing dreadful.

I am unaware of how or why Swasbrook agreed to attach himself to the dreadful Mowbray Collectibles deal, but that decision is hardly likely to have led to a rich experience between Swasbrook and the NZX.

Mowbrays began as a NZAX entrant, a junior listing, allowing any tiny company to grow into a real NZX company, if it had the grunt.

It never had a show, in my view. There was no grunt, no burgeoning market, no credible strategy, no hint of a dividend flow.

Mowbrays was a hobby shop, a bit like the 1950s Lambton Quay business Don Francis, where as a lad I bought models of aircraft and sailing ships and glued them up, not always successfully.

That shop also sold devices to allow fun-loving youngsters to play tricks. For example, it sold tiny one centimetre sticks, which when poked inside your mother’s menthol cigarettes for guests and lit, caused the cigarette to explode. In the 1950s that brought hilarity to at least one youngster, who politely handed out the cigarettes to the guests, trying to hide his excitement.

Mowbrays was a version of this; a business that traded stamps for collectors and other collectibles for those sharing those hobbies. Valuing the stock must have been a nightmare for auditors.

Its turnover, its ability to achieve scale and its relevance to younger people were all similar to a Meerschaum pipe selling shop. As a listed company it incurred expenses way beyond a sensible ratio of its revenues.

Swasbrook clearly did not see this. Mowbrays was Bethune’s sole asset.

He now wants, from his lofty perch of a 2% shareholding, to impose new directors on the NZX, control the NZX expansion plans, and dictate its strategy.

Now I accept that the NZX has historically been home to some pretty average people, failed the country badly during the finance company collapse, and went down several badly chosen routes, including an attempt to control some foreign commodity exchanges. It has often been poorly chaired and governed.

However, it improved when Tim Bennett took over from the unseasoned and unimpressive Mark Weldon and continued to be in the hands of a thoroughly decent man, when Mark Peterson became CEO. Bennett and Peterson are mature adults who work cooperatively.

One must accept that the NZX is not a high growth financial services provider. It provides a basic service to sharebrokers, offers various services, and funds to investors, and is a market regulator.

It would be possible to argue that it should still be a cooperative owned by the sharebroking industry, effectively a cost centre, perhaps a uniting factor for what used to be the fraternity of sharebrokers.

That argument becomes a plaintive bleat, once we acknowledge that NZ no longer has 50 sharebroking firms, many in rural areas.

Today there are in effect three sharebroking firms, Craigs being a large retail broker, performing more than 10% of all NZX trades, Forsyth Barr being a smaller retail broker, with a little lower market share, and FNZC being the giant, with a mix of retail and institutional businesses that perform nearly half of all trades.

UBS has an institutional base and a division once belonging to Macquaries, now renamed Hobsons, has a small retail share. Macquaries operates in the wholesale market only and is not a major player.

Hamilton Hindin Greene, now chaired by the former Grant Thornton accountant, Graeme McGlinn, is present in the South Island, and ASB has a small share of transactions from those who day trade or prefer the internet. ANZ Securities any day soon will simply be a renamed division of FNZC.

In the 1980s there were literally dozens of companies, few with any research capacity, none with anything like the market share or general dominance of FNZC, which is able to use its grunt to have the best available talent.

So it is not anything other than sentiment to pine for those days which, anyway, were characterised by clunky technology, daily incidents of insider trading, miserably poor administration and very low levels of quality control, in terms of the regulating of listed companies.

In the late 1980s Brian Kreft led a team that rewrote the rules, bringing order to what was in effect a boozy, rowdy bunch of people, many mediocre. Even the best of the broking people had found themselves serving companies that were simply dishonest. Kreft began the recovery.

There were around 450 listed companies in 1987, if you are respectful enough to call companies like Como Holdings or Holdcorp genuine corporate enterprises.

The NZX today is small, relatively efficient, well managed and probably better governed than it has ever been, though that is not a tribute, except in relative terms.

It does not need a headline-seeking tiny fund manager to be its think-tank, any more than Steve Hansen needs a Carterton children’s soccer coach to advise him on how to coach the All Blacks.

 _ _ _ _ _ _ _ _ _ _ _ _

I NOTE that the former Finance Manager Bill English is to address a grouping of financial analysts on the subject of how to restore confidence in the private sector.

English has recently accepted a consultancy role with FNZC where his value may include his international networks and his knowledge of the big issues facing NZ, like climate change, monetizing our water resources, or the problems of excess tourism.

English is an excellent speaker, a raconteur with knowledge, humour and a relatively modest ego.

What he is not is a private sector commentator, able to speak for the changes needed to retain confidence in the private sector.

As he and his previous boss, John Key, demonstrated in spades, politicians are very rarely of much use in representing the retail sector of financial markets.

They proved they were commercially inept during the fiasco they oversaw when the Crown guaranteed the finance company sector. They produced the worst possible outcome for South Canterbury finance, as one day soon will be displayed in detail.

Their inability to instil good practices while trying to bridge the public sector aspirations with private sector assets was as visible as the Southern Alps on a clear day in Christchurch.

Their performance was abysmal.

If I wanted to hear a view on improving confidence in the private sector of financial markets I cannot readily think of any public sector participant who would be a drawcard.

This is a big complex subject. It would require a speedy acquisition of new knowledge for Bill English if he is able to demonstrate mastery of a subject that has so bamboozled the public sector in recent years.

 _ _ _ _ _ _ _ _ _ _ _ _

THE previous Taking Stock item highlighting the absurd costs of administering and executing a will, or managing a family trust, brought an unexpected level of evidence of dissatisfaction.

I had noted that Perpetual Guardian Trust’s pricing model based on a percentage of assets, led to around 10 times a fair charge. I urged readers to exit any such arrangement, with any over-charging trust company, and to exit it now, all done and dusted by lunchtime tomorrow.

I estimate a fair and full charge to administer and conclude an average estate might be $2,500, including the writing of a will, and executing an estate.

I omitted to warn people always to pay the additional, perhaps $250 cost, of having a drafted will, and any appointment of a trust company, read by a trusted independent person (lawyer, accountant, sharebroker, family, friend), before being accepted.

One of the many who wrote in with their horror stories advised the following:

‘’At the end of last year I attended a Public Trust family trust meeting which usually takes about 20 minutes. During the year the meeting fee had increased in one hit from $220 to $500’’.

‘’I wrote a complaint to PT’s senior management and received an unsatisfactory response – no surprises there. When I informed PT that as trust protectors my husband and I were seriously considering sacking them, we were informed it would cost $1000-$1500 to do so’’.

‘’Our wills, POAs and family trust were all created by PT. After reading your comments and considering our experiences last year we are looking seriously at taking the whole lot away from them’’.

As the previous item of three weeks ago noted, the Public Trust is the best of the trust companies, as far as fee structures are concerned. None are competitive at the task of managing other people’s money.

Clearly Perpetual Guardian Trust is charging at a rate I consider to be gouging. I cannot imagine a circumstance that justifies the acceptance of such charges.

How long before we have an enquiry into these practices?

My advice remains: if you have signed up to an agreement to administer a will or a family trust, review the charges.

If they are based on fees calculated as a percentage of assets, today, right now, arrange a new will or a new trust and sack the company overcharging.

You cannot do this when you have died!

Ironically an employee of a trust company was recently interviewed in one of those patsie columns that ask piercing questions like: -

‘’Do you care about your customers?’’

The employee of the trust company sternly and presumably sincerely advised people never to use family or friends to administer or execute wills or trusts.

My advice is diametrically the opposite.

I would urge people never to use any trust company unless there simply is no alternative.

If one does use a trust company spell out very specifically the process by which they will be replaced should the settlor, other trustees or beneficiaries be dissatisfied with performance or charges.

I repeat that will or trust administration can be performed satisfactorily by almost anyone who is honest, can read, has access to a lawyer (for advice, if needed) and has no wish to transfer wealth from the estate or trust, by overcharging.

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TRAVEL

I will be in Auckland on Tuesday October 30, based in Albany, and Mt Wellington on Wednesday, October 31.

I will be in Christchurch on Tuesday 13 & Wednesday 14 November, in Nelson November 19 & 20 (am) and in Blenheim November 20 (pm) & 21 (am).

Edward will be in Remuera, Auckland on 26 October.

Kevin will be in Ashburton on 31 October and Christchurch on 8 November.

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

 

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

 

Chris Lee

Managing Director

Chris Lee & Partners Limited

 

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Taking Stock 11 October 2018

SOMEONE at Powerhouse Ventures should check the air conditioning and the water, urgently.

Illness is rampant.

Not only is the investment company’s portfolio almost terminally ill. The directors’ room is infected, its former chairman John Hunter forced to resign, unfortunately due to major health issues.

The executive offices are also infected, its legal secretary, Rachael Triplow is leaving to pursue a healthier career and its chief executive, Paul Viney, is resigning, citing health problems.

Goodness, at this rate the wages bill will soon be appropriate for a company that looks headed for the corporate cemetery, the shareholders’ funds in a race to the sanctity of two brackets, one in front and one behind nett shareholders’ funds.

To recap Powerhouse Ventures listed in Australia two years ago, with a totally misleading prospectus, which sits on my desk to fire me up when I think of corporate ethics. The shares were sold at A$1.07 and are now 14.5 cents.

The company invested in incubated technology start-ups, claiming it would provide needed capital and expertise to nurture great ideas. It had neither wealth to dispense, nor, it seems even the remotest in-house expertise, let alone any respected position in the treasuries of corporate investors.

In 2016 it alleged its total investments were worth $20.7 million.

That was a calculation that relied on an absurd, and obsolete estimate of its largest start-up, HydroWorks, which within months was worth nothing at all, in fact a negative sum.

In 2017 the investments were alleged to be worth 17.5 million. Today in 2018, the alleged value is 11.5 million. You may muse that today’s figure is still at odds with reality.

In 2016, when PVL listed, its utterly misinformed, I would say hopelessly incompetent, Chairman was Kerry McDonald, once a National Australia Bank director, still a vocal economist with a voice on governance matters.

How he has escaped accountability for the PVL prospectus, which he signed and commended to investors, is not a question to be put to me.

Immediately after the listing he resigned and was replaced by John Hunter. Within two months he was replaced by an American Blair Bryant, a personable fellow with energy.

Within weeks Bryant was dismissed for failure to disclose a personal bankruptcy in his earlier years, an offence the equivalent of a parking ticket compared to the appalling behaviour of PVL over many years, as we now know.

Bryant was replaced by an Australian with a skill in oratory, Russell Yardley, a man buoyed by a previous success in building a start-up.

Viney, who was Chief Financial Officer became CEO when the somewhat wet CEO Stephen Hampton quit, after some spectacularly inept decisions, and now we have Viney falling to the disease afflicting PVL, or some sort of illness, and Triplow heading off to a task hopefully more suited to her talent.

My sense is that I will not be writing about PVL as a listed ASX company for much longer.

I still await a response from the apparently toothless Australian Securities & Investment Commission to the complaint I filed 18 months ago, pointing out the misleading prospectus was as bad as any of Bridgecorp’s rubbish, pre the 2008 non-bank lending sectoral collapse. Is it time for ASIC to purchase some dentures?

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ONE option in Infratil’s new bond issues introduces a new dilemma for investors.

Infratil has set a high standard, meeting its bond commitments for two decades offering what were often innovative products, such as the 14-year bond it offered at 8.5% set rate, twelve years ago.

It also introduced a genuine perpetual bond to New Zealand in 2007, setting a permanent credit margin when margins were at an all-time low.

Those who bought the long bond at a fixed rate have been winners, the 8.5% coupon now a luxurious rate at a time when swap rates are near to an all-time low.

Conversely, the perpetuals, set at a 1.5% credit margin that was improbably low, have caused investors severe indigestion, doomed to what may be centuries of appallingly low returns.

Infratil’s new product seeks to create a 10-year bond with a rate review after five years, ostensibly addressing the fear that after five years one or the other parties (Infratil or the investors) might need rescuing from the results of a significant change in swap rates, the base on which a credit margin is added, to create the interest rate (also known as the coupon).  

Infratil will reset the rate in 2023, using the formula of the 2023 5-year swap rate, plus today’s credit margin.

Credit margins do not correlate to swap rates. They reflect the strength of the company AND the willingness of banks to lend.

In 2007 the banks would have lent to Infratil at a base rate plus a credit margin of 1.5%, or so Infratil professed.

In 2018 that margin is 2.5%, perhaps less, but in 2009,10,11,12,13,14,15, that margin might have varied between 2.5% and 5%, given the violent swings in bank liquidity and bank sentiment post the 2008 crisis.

There is a case to say that banks today are on the cusp of enforced changes to their business model.

Banks in recent years have priced risk leanly because they were able to make such easy profits from selling their managed funds, dopey insurance products, FX and wealth management advice. The high margin stuff subsidised corporate lending.

They performed all these underlying tasks of high margin business with little skill and at excessive prices, and coerced staff into unsubtle selling roles, to bring in the luxurious profit margins priced into these services. Bank staff are neither good at, or comfortable with, naked selling.

Today, in Australia and possibly New Zealand, the authorities are looking at how many billions they will fine the banks, and how much micro management there will be of bank products, to avoid such gluttony in the future.

Infratil might have asked itself how the banks would react if they were denied such soft margins in the future.

My guess is that banks will refocus on their core business, collecting deposits, lending that money, and regarding money lending as the core of its nett revenue. Risk might be repriced.

Would banks seek to have the swap rate move? Banks know that very low base interest rates would be the only solution for grossly over-indebted countries, corporates and households. So base rates may remain close to zero, pretty much forever, supported by accommodative central bank monetary policies.

Ah, but credit margins reflect the risk of non-repayment, so every bank has the right to set credit margins and decline to lend to those who want to argue.

It is easy to imagine credit margins that are far less compressed than today, when the difference between a BBB minus credit-rated borrower and an AA rated borrower might barely be measurable.

Infratil may well be confronted, by 2023, with a credit margin for a five-year bond, issued by an un-rated company that, could reach 5%.

There is the conundrum for today’s investors.

 

If in five years credit margins have doubled, in this instance from 2.5% to 5%, then Infratil’s investors will not enjoy being locked into a five-year security from 2023 that might pay, say 5%, but should be paying 7.5%.

I see no hope of credit margins falling, though no crystal ball is ever without some murk.

Of course those who still regard Infratil as exploitative, for failing to reset the awful perpetuals at a modern credit margin, do not accept Infratil’s position, which is that most of the perpetuals have been sold and repurchased at much less than par.

If Infratil paid a new margin on the perpetual bond of 2.5%, the additional 1% added to the coupon would reward those who bought them after 2008, when credit margins rose and the bonds were at discounted prices.

My view is that Infratil should announce that in 2020, the perpetuals will be reissued or withdrawn. This would still over-reward those who bought at discounts but would get rid of a product that for those who bought at $1.00, and still hold them, cause the investor to regard Infratil in a highly unfavourable way. That cost is not worth the bitterness, in my opinion.

Will the new five plus five bond result in similar disharmony?

My own response will be to buy the six-year bond and avoid the risk of a feud with a company that in most other respects has been admired as an investment company cleverly managed by smart people, for decades.

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IF the NZ Herald was planning to attract subscribers to its planned pay wall business section by producing a supplement on the so-called ‘’Mood of the Boardroom’’ it needs to be told this.

No one will pay for boring waffle, with business people who carefully orchestrate messages that keep all their options open.

If the NZ Herald really does plan to challenge the National Business Review it will do so only if its content is compelling, vital, relevant and fresh.

That sort of content will not come either from business owners talking their book or business owners using coded ways of capturing political attention (politely) or for that, business owners answering patsie questions.

The NZ Herald has not assembled a team of brave, inquisitive, informed writers, so it was hardly a surprise that they did not get to hear the views of our boardroom leaders with energy and permission to address the real issues.

The issues we hear relate to: -

Peak tourism – and inadequate roads, signage and airports.

Environmental destruction – abuse of waterways, general pollution.

Dysfunctional health and educational services – inadequate funding, hopeless governance, unfit for purpose.

Inadequate business laws – poorly supervised and enforced

Shortage of labour skills – not lined to immigration or educational curriculum.

Income inequality – excessively overpaying executives or underpaying everyone else.

Housing prices – building materials, land prices and consent processes, and skill shortage.

Mediocrity in local Government – no evidence of leadership and commercial skills.

Mediocrity in central Government – failure to encourage public/private sector crossovers, the short comings of three-year cycles.

Most of all we are told of a total lack of long term planning with Governments operating on short-termism (Key was the guiltiest of all) and business transfixed with quarterly results.

If the NZ Herald would ask the right people for their solutions to these issues they might have produced content that demanded an audience.

To be fair, the important thinkers might not talk to newspaper reporters, believing that the media is just a circus, there for entertainment, used by those without access to the corridors of power.

The truth is that our so-called business pages are filled with trivia, platitudes and uninformed analysis. Most columnists seem to believe their audience are school children needing to be lectured about personal budgeting. Children cannot afford to buy newspapers. Adults can.

I asked a senior, skilled business journalist last week which media organ actually wanted an audience of the 200,000 people who buy shares or bonds, and want penetrative information on company plans and their progress, with regular updates.

The answer was ‘’not the National Business Review’’. Its target market is best described as junior or middle management business people, lawyers, accountants and juniors in the funds management sector.

It has no desire to sell a weekly newspaper to retired investors.

The second answer was ‘’not the daily newspapers’’. It employs poorly paid career reporters with little ability to penetrate the defences of organised businesses.

Perhaps the nearest to this market that does have discretionary spending budgets is Warren Head’s ‘’Headliner’’, a magazine-style news sheet which is unpretentious.

My own research is that this long-established magazine reaches retail investors who enjoy Head’s focus on business and investment.

Market professionals rely on Bloomberg, receive news directly from the NZX and seek out media content only when a particular journalist has produced insightful material such as when the NBR’s Tim Hunter focussed on CBI or when Jenny Ruth pursued Fletcher Building’s board and executive.

My fear is that New Zealand will end up having no useful business press, no specialist weekly magazine, and no material worthy of a payment per item.

There is a real market of 200,000 people who could pay for a valuable service but will not pay for the sort of patsie handouts displayed in the ‘’Mood of the Boardroom’’, nor for material from people trying to establish a business, or trying to justify mediocrity.

Perhaps the Australian Financial Review could become the Australasian Financial Review.

Perhaps the NZX could revert to its old 1990s style weekly diary.

At least that would be accurate.

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TRAVEL

 

Edward will be in Remuera on 26 October.

Kevin will be in Ashburton on 31 October.

 

 

I will be in Christchurch on Tuesday 13 November & Wednesday 14 November, in Nelson November 19 & 20 (am) and in Blenheim November 20 (pm) & 21 (am).

I will be in Auckland on Tuesday October 30, based in Albany, and Mt Wellington on Wednesday, October 31.

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

 

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

 

Chris Lee

Managing Director

Chris Lee & Partners Limited

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Taking Stock 4 October, 2018

David Colman writes Taking Stock this week.

Goodwill

Sky Network TV (SKT) released its 2018 Annual Report last week in which the board agreed to reduce the carrying value of SKT’s goodwill from $1.43 billion to $1.07 billion.

These are large numbers considering the company has a market capitalisation (the value of all its shares multiplied by its share price) of roughly $850 million and raises the subject of the relevance of goodwill to an investor.

The current market capitalisation displays that investors still believe that SKT goodwill needs to be reduced further.

For comparison: Spark New Zealand Limited which has a market cap of $7.4 billion estimates the value of its goodwill at $213 million.

Goodwill is an intangible asset that in simple terms can be considered as the value of the company’s brand.

In broader terms Sky TV’s goodwill is a dollar value estimating the sum of intangible assets including:

- The quality and experience of the company’s management and marketing teams

- The scale of the business and its market share (competitive advantage)

- The reputation of its products and/or services (Brand value)

- The loyalty of its core subscribers to the Sky brand (mainly Sky sports fans)

The goodwill value is sometimes used to estimate a theoretical premium for the business if it merged with, or is taken over by, another company.

The origin of the goodwill accounted for by SKT has been carried from a 2005 merger with Independent Newspapers (INL) when SKT inherited INL’s old balance sheet. The goodwill accounted for the premium paid by INL for SKT share (13 years ago).

Perhaps the board could have reduced the goodwill figure when assessing the fair value of intangible assets every reporting period and could have reduced this figure much earlier.

Perhaps the board will adopt a strategy of evaluating goodwill more regularly, given that by definition intangibles evolve less obviously than tangible assets, and not in another 13 years.

What has SKT reassessed when it has cut goodwill by $360 million?

It would be a stretch to attribute the entire cut to goodwill as recognising long serving CEO John Fellet’s pending departure, though his contribution was lauded. Mind you, it was Fellet’s era that was also slow to recognise the changing market for consuming video content.

I would argue the cut reflects, more obviously, that the company has been under pressure due to increased competition and reduction in subscribers/market share and that the remaining $1.07 billion dollars in goodwill remains unrealistically high for a company with a market capitalisation of $850 million.

If used as an estimate of a premium that a potential company might pay to take over the company (note the Commerce Commission did not allow a merger of Vodafone and Sky Network TV) the share price (indicatively $2.20) plus the premium (goodwill of greater than $2.70 per share) equates to over $4.90 which is a price not paid for SKT shares since 2016.

An investor could ignore much of SKT’s remaining goodwill and reflect on the more tangible elements of the business.

The total assets of the company outside of goodwill equal $433 million.

Revenue was down to $839.7million (- 6.0%) but so were expenses to $553.9 million (-7.9).

The company made a net profit (ignoring Goodwill) of $165.9 million (-1.0%) and looking back has a dividend yield close to 9.5% at $2.20 per share (share price down 17.9% from a year ago and annual dividends falling from 27.5c per share to 15c per share).

Not many would blame the directors for giving goodwill a low priority as it doesn’t represent a true monetary value like revenues, net profits and real cash in the hand do but as the business has shrunk in size so too should any abstract value dreamed up for goodwill.

John Fellet himself in the report admits that ‘even with an accounting degree the concept of goodwill is not always an easy one to follow’. His description is an accurate observation in my opinion.

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There has been much coverage of New Zealand’s lower levels of business confidence this year. If business confidence remains low for a prolonged period of time it may well affect firms hiring new staff and hamper growth.

Employment is and should be a high priority for any nation and is relevant to investors.

New Zealand business confidence has been spooked by labour law changes which have abolished the 90 day trial period for businesses with more than 20 employees (70% of employees) and have introduced a more accommodative collective bargaining system which caters to union demands.

This could lead to further strikes. Stoppages have been rare in the last decade.

Strike action has disrupted the education, health, justice and transportation systems and has spread to the private sector which fears strike action will continue to twist the arm of larger employers lowering productivity and increasing costs.

Business confidence is understandably low for a number of other reasons including: a not-so-new coalition government made up of parties with differing views in many areas, the mycoplasma bovis outbreak and fears of similar biohazards, international trade tensions, increasing fuel prices, and a housing market squeezing household budgets, not to mention construction industry failures, leading to a high profile court case.

A still reasonably fresh government on top of labour law changes has had a jarring impact on the domestic oil and gas sector (no new offshore exploration). It has introduced a tax on tourism by way of a tourist levy, and has advocated for a capital gains tax that hangs in the air at least until the next election.

The New Zealand oil and gas industry concentrated in Taranaki employs more than 11,000 people and contributes several billion dollars to the economy producing approximately 35% of the nation’s oil needs. The sector faces an uncertain future and many jobs may go. A reduction in local supply will require greater imports of oil and gas. The government is being sued for its handling of the matter.

Some tourism operators are making comments on peak demand.

Limits are being tested in terms of the amount of planes that can be landed at airports, the amount of campers on roads, and the amount of accommodation required putting perhaps a limit on the amount of revenue that can be garnered from jet boating and bungy jumping.

The dairy sector will take a hit of more than $280 million from the mycoplasma bovis bacterial disease outbreak, whether it is eradicated or not, after help from taxpayers to the tune of $600 million. The scale of the outbreak requires a 10 year plan to try and eliminate it, with costs likely to increase and an outcome less than certain.

Trade tensions particularly between the USA and China are likely to play out until at least Trump is gone with neither leader wanting to lose face and back down.

Fuel prices particularly in New Zealand dollars continue to rise with much of the additional costs associated with higher margins, fuel excise increases, ACC increases, a lower New Zealand dollar and, especially for Auckland, a regional fuel tax.

It is ironic that in June 2008 when oil soared to US$160 a barrel motorists were paying less per litre than today with the price peaking then at about $2.15 a litre. Some of the difference can be explained by NZ$1 buying 76 US cents at the time (today 65c) but a barrel of oil today is just under US$70, less than half the highest price in 2018.

Household budgets continue to be squeezed on the back of major increases in accommodation costs, whether renting or buying, against only minor increases in wages. Less surplus funds after living costs means there is less discretionary spending.

Low business confidence should remind corporate New Zealand that it needs to aspire to be more than a big farm with a beautiful backyard. In a country devoid of a globally significant city, with a scattering of small towns, we continue to be largely at the mercy of international markets and their demand for our food and forestry exports.

The value of our imports continues to exceed the value of our exports.

As a country we simply spend more than we save.

We largely import what we do not manufacture or produce here including necessary machinery (motor vehicles, aircraft, etc.) and less necessary products. Explore K-Mart, Warehouse and other retailer’s shelves to discover what we can do with less of.

It would be great as part of Kiwibuild if there was a covenant to furnish and fit out the homes with predominantly New Zealand made goods.

Even in a business confidence slump New Zealand has natural environmental advantages shared amongst a limited population that should not be ignored.

Investors might expect lower business confidence to affect their portfolios in the sectors above if business operators’ concerns are not addressed adequately. Certain companies in the above sectors have performed well and may represent a significant exposure of investors’ portfolios.

The kiwi workforce is well educated and can generate growth if employed optimally.

Far from optimal, the government is not fostering confidence with the botch-up of the government chief technology officer position leaving a man unengaged and a more than $100,000 hole in government coffers. It seems the role itself was poorly defined from the beginning. Strangely the idea appears to have been dismissed.

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Interest Rates

New Zealand’s Official Cash Rate was kept at 1.75% last week and now sits well below the US Fed Funds target rate of between 2 and 2.25 percent. The US has raised its rate 3 times this year on the back of encouraging growth, employment and inflation measures in the States, which may look rosy due to tax cuts introduced in 2017.

The Fed has signalled a further hike is likely before the New Year and then more in 2019 barring unanticipated deterioration in data.

Perhaps more than $200 billion worth of tariffs on Chinese goods imported to the US and reciprocal tariffs from China may have consequences for inflation that the Fed may have to consider further down the track.

This bodes well for New Zealand exporters or companies with exposure to the US market due to the absence of any tough trade stance taken by either country to New Zealand and the implications of a New Zealand dollar continuing to fall in value against the US dollar (the world’s reserve currency).

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NEW ISSUES

 

Infratil is to raise up to $250 million with a bond issue in two separate series, with the first series maturing on 15 December 2024 and the second series maturing on 15 December 2028.

The interest rate on the 2024 bonds has been fixed at 4.75%

The interest rate on the 2028 bonds has been fixed for the first 5 years at 4.85%, and will then reset in December 2023 for a further 5 years using the same 2.50% margin over the then five year swap rate.. A margin set under current conditions may, or may not, be favourable in future. If credit margins rise, investors will be under-rewarded. Of course the opposite is also true.

IFTHA perpetual bond holders will be well aware of the influence a fixed 1.50% margin has had on their bond value and returns since listing. IFTHA bonds are perpetual (no maturity) and reset annually so are quite different to the 10 year bond above but highlight that the margin requires consideration.

Holders of Infratil's $111 million bonds maturing on 15 November 2018 have the opportunity to exchange all or some of their IFT180 Bonds for new Bonds of either series. There is also a general offer of both series of the new Bonds.

The Infratil offer document and applications forms can be downloaded from the Current Investments page of our website.

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TRAVEL:

Chris will be in Christchurch on October 9 and 10.

Edward will be in Remuera, Auckland on 26 October.

Kevin will be in Ashburton on 31 October.

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

 

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

David Colman

Authorised Financial Adviser

Chris Lee & Partners Ltd

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