Taking Stock 22 October, 2020

Johnny Lee writes:

THE NEW ZEALAND sharemarket continues to move from strength to strength, shrugging off the drama of 2020 to reach a new record high.

Many shares, including the likes of Summerset, Oceania Healthcare, EBOS Group and Mainfreight, have reached record highs this month. This ascent in share price has been rapid, some of these stocks seeing a 10% increase over the space of only 48 hours.

Investor confidence is returning and, perhaps more importantly, global stimulus is continuing to pour into financial markets. Global markets are now on track to end the year higher than they began.

US stimulus has remained topical over the past fortnight, as messages from US President Donald Trump's Twitter account fluctuated between suggestions of an imminent dose of stimulus, and a refusal to provide further stimulus unless re-elected. Hours later, he was stating he would agree to more stimulus, but the ''other side'' was refusing.

Underpinning these shifts in stance, of course, is the imminent election in the United States (November 4th New Zealand time), a far more turbulent affair than our own election. Both sides are attempting to manoeuvre themselves to be viewed as positively as possible by the relevant voters in the small handful of swing states, which leads to some volatility as these stances change. Another cheque for $1,200 to every American adult could be enough to sway many voters.

Sharemarket volatility is not unusual in these circumstances. US markets rallied 10% in the month following the previous US election and saw a similar movement in 2012. Markets like certainty. Investors like certainty. However, elections do not always produce results that achieve certainty.

Broadly speaking, New Zealand has been a beneficiary of this global stimulus. The hunt for yield has led to a general repricing of shares in the past month, with some stocks that may have been historically viewed as a growth asset, now being re-considered from a future income perspective. Companies like Ryman, EBOS and Mainfreight have consistently grown dividends for many years now. New investors are happy to wait for them to grow if the alternative is almost nil. Well managed companies with a competitive advantage will always see demand.

For long-term shareholders there is a different dilemma to face. Those shareholders now have the opportunity to consider selling to take profits and de-risk. Some may do so. Some may choose to hold on, believing the shares will move higher. Others may also choose not to sell after considering the relatively bare cupboard of alternative options.

The decision to sell is not an easy one, especially from those with an investor mindset who broadly choose only to add to their portfolios and collect dividends.

Selling shares to buy back at a later date is a trading decision and carries the risk that markets continue to climb. Conversely, trimming shareholdings to diversify into other shares can make sense when share prices rise quickly, as we have seen this month.

These share price movements are unusual in a New Zealand context. The New Zealand market, historically dominated by electricity and telecommunications companies, was long considered ''boring'' compared to international markets, in an era where mining and technology flourished. With the decline in interest rates over the past decade, ''boring'' has provided a safe haven with reliable income, pushing share prices higher as interest rates decline. During this time, we have also seen success from the likes of Xero, Fisher and Paykel Healthcare and A2 Milk. Risk has been rewarded.

The New Zealand sharemarket rebound from the struggles of March has been surprisingly swift – and unequal in distribution. Some shares are now well beyond where they began at the start of the year, with some at or close to record highs.

We encourage people to monitor their portfolios and seek advice when needed.

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THE recent flurry of bond issuance, taking advantage of long-dated low interest rates, undoubtedly proves that the investment world sees little path to rising interest rates. Investors are falling over themselves to lend to mid-sized corporates at 2.30% for seven years.

The Reserve Banks ''Funding for Lending Programme'', effectively a way to shore up banks with liquidity as the OCR declines and retail appetite for term deposits wane, may reduce the need for banks to fund their lending domestically. Term deposits rates, now largely returning around the 1% mark, will have little reason to increase.

With improved access to funding, lending rates should respond and provide New Zealanders with lower-cost funding. If properly structured, this can have positive effects on consumer spending, asset prices and economic growth. As we have observed previously, asset owners seem to be the greatest beneficiary of this low interest rate environment.

Further declines in interest rates will create an interesting dynamic for borrowers. As long-term interest rates trend to zero, what happens to the incentive to repay?

Conventional wisdom, and indeed the New Zealand mindset, suggests that any debt be repaid as quickly as possible. Being debt-free is, rightly, viewed as a huge accomplishment for homeowners. The repayment marks the shift towards being a lender to the world, owning assets, and building a nest egg.

For companies, this logic is generally not applied. Businesses tend to hold significant amounts of debt, as the cost of debt funding is generally lower than the cost of equity. Electricity companies paying dividends at 5% are borrowing at much lower levels from the bond market.

But will the mindset of homeowners shift as mortgage rates trend towards zero? Will borrowers be as enthusiastic about aggressively paying off debt which costs virtually nothing, if the value of investments grows at a much faster rate?

From a risk perspective, the argument to repay remains compelling. Interest rates will, surely, one day trend upwards. This may occur during the lifetime of such a loan.

And, of course, investments can also decrease in value. Even the safest, blue-chip company can have a bad year and be forced to cancel dividends. This year has proven that sometimes such risk is unknowable. Sometimes, something entirely unexpected can occur, sending share prices into a tailspin.

Ultimately, I suspect that as interest rates begin to trend towards nil, a shift in the nature of the borrower and lender relationship will need to occur. Negative interest rates will upend it completely. The Reserve Bank, and indeed the retail banks, will be keenly aware of this.

The response of consumers and borrowers in this period of time is still not yet known. If the OCR is to be sent into the negatives next year, as is expected, it will present a unique challenge for our banks and policy makers – maintaining incentives for ''good'' behaviour and rewarding long-term thinking.

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David Colman writes:

THE country has voted to keep New Zealand moving which I hope will be in a productive direction.

I am at least optimistic that an injection of ​new energy into Parliament, in the form of 40 new MPs, will partially make up for the evident lack of experience.

We still await final numbers, and the results for the End of Life Choice and Legalisation of Cannabis referendums will not be known officially until 6 November.

The latter referendum may be of interest to Rua Biosciences (RUA) - formerly Hikurangi Cannabis Company - which lists on the NZX today.

RUA is the first Initial Public Offering (IPO) for the NZX this year. A recent announcement from Allied Farmers suggests there may be one more before the end of 2020.

RUA raised $20 million, made up of the issue of $5 million worth of new shares to business associates and residents close to its operations in Ruatoria (also known as Ruatorea), and $15 million worth of new shares to a small number of retail and institutional investors.

Capital previously raised includes $2 million in August 2018, $7 million in November 2018, $4 million in December 2019 and $3 million in February this year.

RUA shares were issued via the IPO at 50 cents per share, implying a market capitalisation of $70 million with a little over 140 million shares on issue.

The fledgling company is a subsidiary of Hikurangi Group, and was the first company in New Zealand to secure a licence to cultivate cannabis plants for medicinal purposes.

RUA has recently built a certified indoor cultivation facility in Ruatoria and extraction and manufacturing plant in Gisborne and will use the funds raised for marketing, expanding cultivation capacity, broadening product research and development, operational costs and funding the offer itself.

RUA's plan is similar to industry peer Cannasouth (CBD) which listed in June last year.

If the referendum is successful, it may open up other business opportunities in this sector. Neither company has indicated if the recreational market would be an option they would explore.

The NZX will be glad to have a new company join the market, with two companies expected to depart before the end of the year.

Metlifecare and Abano Healthcare shares are due to delist and both companies have had very similar experiences over the past 12 months, with bidders offering to buy shares in the companies only to pull the bids when Covid-19 cases appeared in March.

Bids have since returned in the form of new schemes of arrangement, at lower prices per share than initially offered.

Metlifecare (MET) is scheduled to be delisted following the finalisation of a scheme of arrangement that has spanned much of the year.

MET shareholders were originally offered a scheme at $7.00 per share, which was controversially retracted due to a condition of the scheme requiring the absence of material adverse conditions.

Asia Pacific Village Group (APVG) considered the Covid-19 virus outbreak a material adverse event and eventually returned with a $6.00 bid after facing a legal challenge from MET.

After receiving final court approval on Tuesday, MET provided a timetable for the scheme which indicates MET shares will be suspended tomorrow before being delisted and money paid to eligible MET shareholders on 3 November.

Abano Healthcare (ABA) shareholders will vote on a scheme, on 18 November, to sell their shares at $4.75.

ABA shareholders were originally offered $5.70 per share by Adams NZ Bidco in November 2019, which was later withdrawn. A new bid later emerged from BGH Capital and Ontario Teachers'Pension Plan.

The most recent bid was increased on 12 October from $4.45 to $4.75 following the release of Treasury data, ABA results, and an updated ABA full year 2021 forecast which all indicated the company was in a better position than expected.

The ABA scheme implementation relies on 75% or more of the votes cast, and more than 50% of the total number of shares issued to vote in favour of the scheme.

High Court approval will also be required.

The ABA scheme, very much like the revised MET scheme, is now not conditional on the absence of material adverse changes, giving participants in the scheme greater certainty.

I may be as disappointed as the NZX to see the companies go, as I prefer our exchange to have more companies rather than fewer to provide investors with as large a range of options as possible, and I prefer New Zealand companies to be mostly, if not entirely, owned by New Zealanders.

Let us hope we see IPOs become more frequent next year, as it would be great to see more companies and industries represented on the New Zealand sharemarket, and in turn provide greater diversity to a wider range of investors.

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Investment Opportunities

TWC Quantum is proposing to issue shares in a recently renovated building in Wellington, which is currently being converted into residential apartments. A long-term lease will be put in place to give investors certainty of income.

The projected income, after expenses, will allow for quarterly dividends at a rate of 7.50% per annum.

It is proposed that the building will be funded by 50% equity and 50% debt with a proposed minimum investment size of $10,000.

This will all be detailed in the offer document once completed (likely mid-November).

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TRAVEL

Kevin will be in Timaru on 3 and 4 November to meet with clients (and to reminisce).

David Colman will be in New Plymouth on 3 November and in Whanganui on 4 November to meet clients.

Johnny Lee will be in Christchurch on 25 November.

Edward will be in Auckland on 20 November and will see clients in the CBD.

Please let us know now if you would like an appointment in your town or if you would like us to visit your area.

Chris Lee & Partners Ltd


Taking Stock 15 October, 2020

 

THERE are many explanations for why what one learns from the media is often so at odds with the whole truth.

Not the least explanation is the unwillingness of most of those in power to be open with the media.

Another blockage is the natural and logical aversion of anyone to threaten the success of their business strategy before the plan has been executed.

In the 1970s and 80s the likes of Ron Brierley would have had much less success if he had signalled his asset-stripping plans when he made his leveraged takeovers.  Brierley was a master at managing the obsequious business media of the era when his stardust was visible.

Each of these explanations would be apparent to most people.

But one of the less understood explanations for our being fed misleading or contrived versions of the truth brings little credit to both the media and to those who seek to promote themselves.

I refer to the now well-established method of resolving disagreements with the media by negotiating ''favourable'' media comment on the offended person or company. This practice is insidious and uses media consumers as pawns. It is, at its worst, dishonest and dangerous.

It first surfaced earlier in my career when I learned of a threat from a serial, vexatious litigator who sought an image to benefit his business dealings and his self-esteem, as Donald Trump might have done.

The New Zealand egotist had been insulted by some media criticism. He threatened to serve defamation proceedings on the media outlet and used the threat of that costly process to negotiate a full year of access to the offending media outlet to sate his ego by obtaining attention and being constantly flattered by any media comment. He was allowed to present his views, uncontested and unaltered by editorial standards.

In effect, he called off his claim for damages in return for free access to self-promotion.

In my language, the media that was party to this agreement was cynical, dishonest and even traitorous, allowing the ugly fellow to be air-brushed and presented as a virtuous leader.

The recent collapse of the faux empire of the former office equipment salesman, Eric Watson, made me ponder the extraordinary presentation of Watson by the NZ Herald, just a few years ago.

Watson was bluntly condemned last week by a High Court judge, who criticised Watson and described his testimony in court as untrustworthy and designed to foil an award to a creditor. Once self-acclaimed as a ''rich lister'', Watson had told the court his spending money came from his mother's generosity, so deeply was he down on his luck.

The court wondered whether Watson had transferred money into his mother's account from which Watson was then able to spend. There seemed to be other dealings that left the judge suspicious about the willingness of Watson to be transparent and to face up to his enormous debts. He owes the IRD tens of millions and an even greater sum to his one-time friend, Owen Glenn.

For the record, my assessment of the business empire Watson had created was that it was always highly leveraged, always intricately structured, rarely involved any business in which he had any obvious experience, and often was based on hopeless business models needing skills he did not have.

The British electrical goods chain Powerhouse was one example, but no one will forget his Hanover empire from which he and his partner Mark Hotchin captured so-called dividends of tens of millions of dollars, perhaps hundreds of millions, ultimately at the expense of the Hanover investors.  (In those times, the accounting standards allowed shareholders to pay ''dividends'' from paper profits, later shown to be imaginary.)

In my language, Watson never was anything like a business leader, his wealth could never be accurately assessed by any pretentious Rich List journal and he had no accomplishment that made his views either interesting or insightful.

He was simply someone who had borrowed money and who was living on borrowings, as many ''entrepreneurs'' were doing in the pre-GFC era.

Yet a few years ago, after he had threatened to sue the NZ Herald over a columnist's criticisms, he suddenly became the object of almost weekly favourable articles and was even granted columns to dispense his views, as though he was a thought leader or a visionary.

It may be ironic that the media is never too transparent about this sort of subterfuge, and it may be my suspicion is unkind, but my guess is that Watson had been granted a period of kind media treatment as some sort of agreement to avoid the legal costs of defending the criticism.

There was nothing illegal about this. A financially weak media company may compromise standards to avoid expense (legal bills) if it wishes, even if this results in the misleading of its readership.

Indeed, the only victim of this sort of ''commercial settlement'' is the readership of the newspaper, duped into believing that the ''news'' presented is balanced and selected for its relevance. Capital market participants were not fooled.

Perhaps such treatment is no worse that the journalist who is granted free travel at the expense of the Crown, or given a sinecure on an obscure board, in return for describing a distinctly ordinary politician as a ''genius''.

We expect the judiciary to tell it to us ''straight''. The judge met this expectation last week when describing Watson's behaviour.  He excoriated the former media glamour boy.

Yet it is reasonable to expect the media to be transparent, given that without such integrity, its role becomes meaningless, just another ''Fox'', without commitment to journalistic principles.

So one must guess. No one investigates the media (apart from the Media Council)!

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TO BALANCE that criticism one can applaud the attempt of the Herald to publish recently the views of an eclectic assortment of business people, with a focus on the government's role in the economy.

They sought ''sponsoring'' companies, who bought the opportunity to air the view of a largely uninsightful bunch of hopefuls and also presented the mundane and equally uninsightful views of such luminaries as bankers and spokespeople for the largely irrelevant groups employed to represent the views of an industry.

Missing from the Herald lineup were our most interesting leaders like Nick Mowbray, our most socially-aware like Stephen Tindall, and our sharpest and best-informed, who clearly declined to participate in this charade.

Yet the ambition of the newspaper to present ''The Mood of the Boardroom'' is admirable, even if pretentious, given that ''the boardroom'' usually talks in platitudes to the daily papers and, anyway, is generally ill-equipped to offer useful ''ratings'' of Cabinet Ministers as the supplement sought to display. Very few board directors have meaningful contact with more than a tiny handful of politicians and thus are ''rating'' them without useful knowledge.  Busy business leaders rarely hang around those who come and go from Parliament.

Asking such people to ''rate'' the politicians produces a result as insightful as asking an Alaskan to rate the performance of each All Black after a test match.

There might also be some real doubt as to the value of elevating the status of bankers by deferring to them as though they hold the key to accurate social, political and economic analysis.

As the Australian Commission of enquiry showed us, there has been an unbreakable law governing banks, institutions and fund managers – their senior people will behave in the most anti-social manner, pursuing unnecessary profits and gluttonous personal salaries and bonuses, unless there is effective law and fierce application of the law.

Worse, the Australian commission showed us that the framing and the enforcement of the law can be swayed by allowing the regulated parties to be involved in creating the laws, responding` with blatant self-interest, again with an emphasis on personal greed.

Nor is New Zealand exempt from these poisons.

The Insolvency Practitioners Act was an excellent example of badly-framed law, largely influenced by the self-interest of our banks, liquidators, trust companies and our lawyers. The law completely subjugates the rights of unsecured creditors and shareholders, to the great and unfair advantage of bankers, fee-collectors and cash buyers at private auction sales.

So in my view, any meaningful survey to discuss economics and politics must be with people who do not have self-interest at the front of their minds when asked to interact with the media. The views of the mediocre are rarely representative of the best in the sector.

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INVESTORS receive precious little help in accessing useful information or analysis from our daily newspapers, especially those papers who confuse home economics with business news.

More likely, those who seek timely and interesting comment will enjoy the output of the growing team of reporters assembled by Pattrick Smellie, who runs Business Desk, an electronic provider of financial news.

Business Desk charges a subscription that enables anyone to buy a daily business reporting service. It has attracted a large number of subscribers, enabling Smellie to employ a range of mostly talented and energetic people.

Previously, this space was controlled by the National Business Review, whose primacy in this field probably ended when the advertising mogul Barry Coleman bought the business, ran it with little empathy for business readers and then sold it, vendor financed, to an advertising sales manager, Todd Scott.

Coleman made himself a pile of money but his business paper held too few of the standards that had created a special status for the NBR in its first 20 years.

With one or two exceptions, the experienced journalist Tim Hunter being one, the NBR today rarely is of much use to investors, and has not been since it lost its investigative focus in favour of an advertising forum. Put simply, its output is linked to its impecunious ownership.

What might be of some relevance to investors is the new energy of Australia's business reporting sector, the journalists seemingly energised by the findings of the enquiry into banks, fund managers, and institutions. The best newspapers are beefing up their business sections.

Corruption has dominated Australian politics and business for decades, even invading its police, and certainly challenging its financial regulators.

After the commissioner fingered banks and institutions for clearly toxic, greedy practices, Australian business journalists were emboldened and are now regarded by some business leaders in New Zealand as being genuine contributors to a Fourth Estate.

The surging level of inquisitiveness has led to a new competence in business journalism there, the media apparently able to pay wages that attract people with genuine knowledge, experience, and daring.

As a result, the better business leaders behave more respectfully to the media, leading to a little more transparency, and a slightly greater degree of trust. These are all hopeful signals, though the new aggression is still in its formative stage.

One business leader told me that it was a novel experience to face a reporter whose questions were meaningful and whose preparation for the interview was impressive.

Maybe there is hope here, though first New Zealand will need a deep enquiry into the practices of our own fund managers, banks, and institutions before any real progress can be made. A public enquiry would enable inspection and media coverage without fear of defamation.

Insider trading laws, designed to ensure symmetry of information, are often used as a reason to decline a response to relevant questions. This is one impediment.

Maybe more timely and respectful disclosure by businesses might reduce this problem. Another major inhibitant in New Zealand would be our defamation laws, which in effect can gag the media, no longer able to afford the cost of fending off writs, often filed to avoid scrutiny of past and present behaviour by our own versions of Trump.

Many an enquiry has been halted by some pretentious lawyer dishonestly feigning to have the power of a judge to adjudicate on the difference between criticism and defamation.

Perhaps the arrival of litigation funders might discourage those business leaders who seek to avoid disclosure, often at the cost of investors.

Just imagine the impact had Mainzeal's awful governance and practices been widely discussed five years before it collapsed. Sub-contractors would have been spared losses, now known to be in the tens of millions of dollars.

Of course a commission of enquiry into corporate behaviour would extract the truth and would enable the media, without fear of defamation writs, to investigate the truth about the sort of practices that have led to billion-dollar fines for banks and institutions in Australia, Britain, Germany and the USA.

Just one small example – the selling by banks of insurances that could never be claimed – ought to be sufficient to prove intent, and the depth of the rot, sanctioned by those at the apex of the bank.

Yet while such open hearings, plus a better and cheaper way of resolving defamation, and a higher standard of journalism, might combine to provide NZ with a cleaner business and investor future, one simple fact remains and should never be ignored.

How much better and cheaper would it be if we had binary definitions about the characteristics of someone classified as ''fit and proper'' for leadership roles in activities involving other people's money? The provision to exclude the unfit and improper should be our most potent weapon to control cowards and bandits. Sadly, the law is almost never applied.

Might we be better if we simply restored into our corporate, political, and social values the two little words ''personal honour''? When did that concept disappear?

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THE continuous issuance of corporate debt instruments – Oceania Healthcare and Argosy Property the latest – raises three obvious thoughts:

Firstly, the success of such issues relates to the public acceptance that our very low rates are heading lower in the immediate future. Confirmation of this was the successful government bond issue in recent weeks, well subscribed by KiwiSaver managers and the like, at NEGATIVE rates. KiwiSavers are now locked into the loss.

Secondly, we now see public companies accessing much longer-term funding at rates that pose no risk to the companies. If the companies can raise money at 2% for seven or so years, their projects will not need high internal rates of return to allow growth of revenues, profits, and dividends. Money that is ''free'' should underwrite the success of even a half-decent business idea.

The third thought is that if such issues are from companies without a credit rating, then, as happened in the early 2000s, credit rating agencies would become less relevant, at least for a while.

The difference in rates paid by strongly-rated companies, like Auckland City Council, and unrated companies, would appear to be irrelevant, if judged by investor responses.  In my view any unrated bond should be regarded favourably only if it has a very long record of success (Infratil is an example), or if the bond is secured by easily-valued assets (like the property of a retirement village).

Enthusiastic support for issues seems certain, at least in the short term, given the commitment of KiwiSaver funds to maintain a strong position in the fixed interest field, however lean the return.

We have already seen the double-intermediating KiwiSaver fund, Simplicity, venture into money lending, to avoid the intermediation cost of buying home mortgage securities.  Simplicity obviously believes that first mortgage lending involves only the lowest types of risk, like borrower failure, housing price falls, interest rate rises, and compliance costs.

When inexperienced non-banks seek to shoulder their way into such lending, one infers that lending margins are high and that the value of bank databases and bankers' knowledge and experience is next-to-nil. Many finance companies, including Watson's Hanover Group, believe money lending was simple, in its shameful era before 2008.

I guess we will one day discover if the assumptions being made by Simplicity will be justified by the ultimate nett returns for its clients.

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New Issue

ARGOSY'S new 7-year bond (maturing 27 October 2027) offers a minimum interest rate of 2.20%p.a.

Interest will be paid quarterly. The deal closes tomorrow; it is a fast-moving contract note offer with ARG paying the brokerage costs (clients do not pay costs). There is no application form.

If you wish to invest in this bond, please act now and join our list (email or phone) prior to 10am tomorrow at the latest.

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OUR seminar programme is now completed. Those who want the somewhat cryptic presentation notes, and the extensive but eclectic statistics discussed, will be sent them by our office.

A video of the Palmerston North seminar has not yet been finalised but, with luck, will be available to clients upon my return from the South Island, in early November.

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Travel

 

Edward will be in Auckland on 20 November.

Kevin will be in Timaru on 3 and 4 November.

David Colman will be in New Plymouth on 3 November and Wanganui on 4 November.

Johnny will be in Christchurch in November (dates to be advised).

Chris will be in Auckland in December (dates to be advised).

Chris Lee

Managing Director

Chris Lee and Partners Limited

 


Taking Stock 8 October 2020

Johnny Lee writes:

THE New Zealand sharemarket has now returned to record highs, buoyed by recent commentary surrounding the energy sector and an intention to further reduce the costs of foreign giants Rio Tinto and Sumitomo Chemical.

Politics and the sharemarket have an uncomfortable relationship at times, rewarding some sectors and punishing others.

Twelve years ago, Auckland Airport shareholders were subjected to a last-minute decision by the government of the time, which chose to block an offer from the Canada Pension Plan Investment Board.  Telecom was the subject of countless enquiries into its use of market power.  The electricity companies themselves experienced periods of political interference over the years, with some public figures even promising to buy the shares back, at one point even suggesting the shares be ''taken'' back.

Last week's statement promising to extend the lifetime of the Tiwai Point smelter led to a strong rally in the share price of our various electricity companies, with the likes of Contact Energy and Meridian Energy seeing renewed buying interest.  Contact Energy has moved from $6.22 to $7.45. Meridian has moved from $4.67 to $5.36.

Markets respond well to certainty, and the promise of an additional three to five years gives the market ample time to complete the necessary changes to our transmission network, in order to better adapt to a post-smelter world.  Unfortunately, this sentence has been written before.

Simple arithmetic suggests that the Crown's share of Meridian Energy has increased in value by over $500 million during this period.  The proposed discount to transmission costs, a burden ultimately borne by future taxpayers, will be significantly less than this.

Contact Energy released a statement to the market almost immediately, praising the plan and re-affirming its commitment to developing the Tauhara geothermal development.  Contact also noted that the Tauhara investment would necessitate a review of its dividend policy, no doubt looking to its short-term capital needs for such an investment.

Rio Tinto will be satisfied with the (presumably) final outcome.  The company would have known that the decision, to threaten hundreds of jobs unless further cost reductions were made, would be deeply unpopular with the New Zealand public.  It also would have known that any backing down from its position would jeopardise future negotiations, both here and abroad.  In the end, a few more years have been purchased by the taxpayer, and yet another opportunity has been created to restructure our transmission capacity.

Further abroad, the United States heads to the polls in three weeks' time, an event that will almost certainly introduce volatility to world markets.  Regardless of outcome, any hint of uncertainty will create waves of volatility which will almost certainly reach these shores.  Our own election, only nine days away, may end up having a far smaller impact.

Politicians and investors are not always happy bedfellows – but both rely on the other to play their role.  Both groups benefit from certainty and stability in a particularly uncertain and unstable era.  If we are to accept that the Tiwai Point issue has now concluded, a risk to investors has been resolved, and investors can have more confidence in the future of their investment.

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Chris Lee writes:

WHILE most investors lament the continuing collapse of interest rates, one group of income investors might have a ray of optimism to enjoy.

Falling rates have meant that those who would not venture beyond bank deposits or credit-rated bonds would need a nest egg of some millions to provide the level of income that a more normal nest egg would have provided just four years ago.  Eating capital may become a solution for many.

It follows that those who pay a percentage fee to have money in any low-risk income fund will receive virtually nothing, perhaps even literally nothing, if their financial advisers continue to charge 1% per annum for their (value-add?) advice.  One wonders why Kiwisaver robot funds would be buying negative-rate Government stock, but then again one wonders why anyone believes ''free money'' is a global solution for anything.

The prospects for rising rates in the next year or two seem grim.

Yet there is one group of investors who might find that the probability of long-term very low interest rates might help them restore their capital.

Fourteen years ago, Infratil issued a perpetual bond with an annual interest rate reset each year at 1.5% higher than one-year benchmark, bank swap rates.  Infratil raised $220 million.

The margin of 1.5% may have been credible in 2006, but within a year or two, especially after the global financial crisis of 2007-08, the margin was risibly lean, leading to a vulgar fall in the value of the bond, from $1.00 to $0.50 cents, or thereabouts.

Because credit margins always change, it had been quickly identified that Infratil's formula was either a mistake, or exploitative.

The company had been advised when it designed its bond to reset the credit margin every few years but had ignored that advice.

As the bond has no required repayment date, the trading value slumped to around 50 cents in the dollar, and subsequently has vacillated in a range between 50 and 75 cents.

Infratil accounts for its obligation as a debt and has no benefit in holding the captive money, as a credit rating credit for example.  It does not subject itself to the credit rating process.

It has bought back some of its bonds previously and would have had the choice of on-selling them later, at a profit one would hope, cancelling the bonds and booking as a profit the discount amount, or, less probably, it could have held the bonds in its treasury.

Now that interest swap rates are so close to zero, Infratil should be considering how it can use this extraordinary circumstance to put right the error it made 14 years ago, when it failed to establish regular review dates to reset its 1.5% credit margin.

If swap rates are virtually nil, Infratil's annual reset process may produce a minimum coupon of 1.5%, which would not budge even if swap rates became negative.  It is unthinkable that the annual coupon would fall below the 1.5% credit margin.

So what would be the effect on Infratil if it offered all perpetual bond-holders a choice now of switching to a 10-year bond with a 1.5% coupon?

Such an offer could not disadvantage any stakeholder in Infratil and would actually advantage shareholders if swap rates were to rise in the next decade.

From a perspective of a bond-holder, the replacement security would perhaps be disadvantageous in that it would lock in the 1.5% rate, but would bring certainty to the date on which Infratil eventually would be repaying, offsetting the cost of locking in the rate.

If Infratil cannot lose by locking in 10-year money at 1.5%, and the perpetual bond holders have the choice of swapping or staying with the bonds, then Infratil would have demonstrated that it was offering to fix a problem. It must know it has alienated many of the retired retail investors with whom Infratil otherwise has an excellent relationship.

Infratil's deserved and well-established status as a reliable and fair bond issuer would have been restored.

Those bond-holders who would like this solution might want to advise Tim Brown at Morrison + Co of their opinion. Tim Brown is a problem-solver. Now might be his time to solve this problem.

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David Colman writes:

LAST week I wrote about the New Zealand seafood industry, focusing on Sanford, which is a company that has had a dramatic and tragic past few years.

Lengthy voyages to retrieve stranded fishermen, a scuffle on a far-flung island, deaths on board one of the company's fishing vessels, Covid-19 impacted results and the resignation of the CEO have all been part of its recent history.

It seems only fair to now write briefly about a much smaller seafood industry player, New Zealand King Salmon, which released its annual report last week.

New Zealand King Salmon (NZK) is a niche aquaculture operator in the greater seafood industry with a focus entirely on farming premium king salmon for the domestic and international market.

It produces and markets king salmon products from fresh whole salmon to premium pet food. Brands associated with NZK are Ora King, Regal Marlborough King Salmon, Southern Ocean, and Omega Plus+ pet food and treats.

Like many companies NZK was disrupted by Covid-19 restrictions. It has had restricted availability of air cargo, sales to restaurants being halted during lockdown level 4, and other restrictions since, but was able to supply supermarkets as an essential service.

Sales over lockdown dropped by 50% and the company was a beneficiary of the Covid-19 wage subsidy, keeping over 500 staff in work.

NZK reported for the full year 2020 a net profit after tax of $18million, up 59% on FY19, due to an increase in biomass and larger average fish sizes.

Revenue fell to $155.3million, down 10% on FY2019 with regional demand in New Zealand and Australia down significantly in slightly esoteric contrast to revenue achieved in other regions including North America, Asia and Europe where revenue was much the same as in 2019.

Pro forma earnings were relatively flat at $25.1million versus $25.2million the year before.

Total assets increased due mainly to increased inventory and biological assets.

Total liabilities also rose mainly due to increased debt and deferred tax liabilities.

The company is very likely to have operated relatively productively following the end of the period reported. But it may have continued to find customer demand still lower than levels experienced before Covid-19, due to limitations on hospitality services including restaurant customers, especially in Auckland, where stricter Covid-19 restrictions returned.

As is not uncommon for New Zealand listed firms, NZK has a high degree of foreign ownership, with large shareholders of NZK including Malaysian-based Oregon Group Limited which holds 40% and Hong Kong based China Resources Ng Fung Limited which holds 9.9%.

The overseas companies likely see growth potential for aquaculture in New Zealand. I note the sea within the New Zealand exclusive economic zone has been measured to be 15 times the size of the land it surrounds.

In September last year Fisheries Minister Stuart Nash launched a national Aquaculture Strategy with ambitions of earning $3billion in revenue by 2035 (up from approximately $650million in 2019) with goals including, but not limited to, development of sustainable open ocean and land-based farming, greater efficiency, building resilience to environmental change, and reducing waste and emissions.

An independent business case was commissioned by New Zealand Trade and Enterprise and the Ministry for Primary Industries and published in February. It concluded that farmed salmon offers a very compelling and human health story by comparison with other farming systems in New Zealand. The business case noted farmed salmon has a very low carbon footprint and provides a healthy animal protein option for consumers.

New environmental standards regulations come into effect in December this year as part of the aquaculture strategy which is evidence that the strategy is continuing to progress.

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VITAL Healthcare Property Trust (VHP) has announced a $150million equity raising by way of an underwritten $125million placement and $25million Unit Purchase Plan (UPP).

As at June 2020 VHP's portfolio amounts to 44 properties worth approximately $2billion, with occupancy rates above 99% and a weighted average lease expiry of over 18 years. 75% of the properties are spread across six Australian states and 25% are located in New Zealand.

Northwest Healthcare Properties Limited (a subsidiary of Canadian listed Northwest Healthcare Properties REIT), which manages VHP, has committed to subscribe for at least $31.9million worth of new units representing its 25.5% holding in VHP.

Funds raised through the offer will allow Northwest to help VHP fund approximately $100million worth of development and a potential $95million premium hospital purchase to add additional tenant and geographic diversity to VHP's Australasian investment property portfolio.

NorthWest is also looking to sell several VHP regional assets worth approximately $100million.

VHP estimates debt to gross assets will be reduced from 38.7% to 33.0% if the acquisition and asset sales are completed.

New units under the placement will be issued at a fixed price of $2.80 and new units under the UPP will be issued at the lower of $2.80 or a 2.5% discount to the volume weighted average price during the five trading days before and including the UPP closing date of 28 October.

The units have traded at a level above $2.80 only during two periods of time including at the start of this year before the Covid-19-led plunge in March and over the last two months.  The units traded as high as $3.04 on 8 September before units traded ex-dividend the next day.

VHP, like many of its listed property peers, has a history of equity raising. Longstanding unit holders may recall that the company raised $160million in June 2016 to reduce debt via a fully underwritten 2 for 9 rights issue at $2.08 per share, with Northwest taking up its $39.3million dollars-worth of new shares at the time.

It seems rights issues have fallen out of favour, with companies instead preferring placements and share/unit purchase plans in recent years.

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OUR seminar programme has now ended. The somewhat cryptic notes used are available to clients, as are the 30 pages of statistic quoted during the seminars. These can be emailed out on request.

David Colman is preparing a video of one of the seminars. We hope to make this available on request within the next few weeks.

Chris is now on leave, but may be able respond to emails while enjoying his break.

The seminars' purpose was to underline the need to diversify, the outcomes of our challenging problems requiring polar opposite strategies.

Thank you to the nearly 2,000 people who attended the 13 seminars.

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Oceania Healthcare – new 7-year bond offer closes this week (maturing 19 October 2027) with a minimum interest rate set at 2.30%p.a.

Interest will be paid quarterly.

The deal closes tomorrow; it is a fast-moving contract note offer with OCA paying the brokerage costs (clients do not pay costs). There is no application form.

If you wish to invest in this bond offer, please act now and join our list (email or phone) prior to 10am tomorrow at the latest.

TRAVEL

Kevin Gloag will be visiting his old stamping ground of Timaru on Tuesday 3 and Wednesday 4 November.

Please contact our office for an appointment.

Chris Lee & Partners Ltd


Taking Stock 1 October, 2020

Johnny Lee writes:

IN AN environment with overwhelming demand and a dearth of companies looking to raise capital, the ‘’balance of power’’ currently favours borrowers and has done so for some time.

During the 2008 Global Financial Crisis, the balance of power was firmly shifted in the opposite direction.  Companies, unable to borrow from frightened lenders, were forced to approach their shareholders for capital.  Share purchase plans and rights issues were priced generously, allowing shareholders to pick up additional shares at deeply discounted rates.  Most companies survived this era, and the subsequent rebounding of share prices led to a substantial return for risk.

People lending money today, whether to their bank in the form of a term deposit or on the listed bond market, are subject to low returns, with all indications suggesting rates will continue to descend.  Recent commentary from the Reserve Bank suggests there is little hope of this course reversing, at least in the near future.

This has led to scenarios in which bond issues and capital raisings, whether from the likes of Auckland City Council, Infratil or ERoad, have seen scaling due to the large discrepancy between the amount of money looking for a home, and the amount of money companies are trying to raise.

One could argue that such scaling is a sign of mispricing.  If a company is raising 30-year money at 2.95%, and sees overwhelming demand, stakeholders would be correct to question whether the return offered was too high.  Of course, other factors need to be considered – such as ensuring an issuer is well supported long term – and in fairness, issuers have no way of knowing the exact level of demand.

It is appropriate for issuers and advisers to use this information to help gauge supply and demand for future issues.  Bond issues often include a clause allowing the issuing company to accept oversubscriptions, giving them some flexibility around this.

But what is not appropriate is for brokers and financial advisers to attempt to profit from this, by pre-empting market pricing and re-allocating risk back to investors.  Recent efforts by some market participants to ‘’on-sell’’ bonds, prior to listing, at significantly lower rates should not be supported by investors.  If advisers wish to profit from what they perceive to be mispricing, this should occur on the open market, not sold to clients, thus distorting a client’s risk and return.

The reality is that some brokers and financial advisers lack the capital to take such risk.  Investors, who are instead carrying the risk, are providing this capital.

Ultra-long-dated bonds do create a problem for some traditional broking houses.  One-off brokerage fees can seem modest when considered over a 30-year time frame.  Not all investors will hold their bonds until maturity, viewing the bonds as a form of liquidity.

However, brokerage earned should not be a factor when advising people on investing their savings, and demanding such a steep premium dramatically shifts the proposition.  As an example, a buyer of the bonds at 2.35% would need to hold them for over 4 years simply to break even – which is ignoring opportunity cost.  At current pricing, they would already be going backwards.

Investors should always be wary when faced with offers that seek to impose more risk or less return on them than offered by the market.

Long-dated bonds are likely to become more commonplace, as lenders seek to lock in historically low rates for as long as possible.  Retail investors then have the choice as to whether or not the market rates offered represent a fair return for that risk.

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THE next time you find yourself grinding your teeth after an encounter with strict Anti-Money Laundering requirements, spare a thought for Westpac Bank shareholders.

Most bank shareholders have had a torrid year, as share prices have struggled with the combination of a shrinking economy, rising unemployment, increased capital demands from the regulator, and more than a few self-inflicted wounds.

Scandals around inappropriate conduct, mis-selling of products, overcharging, and even misleading the regulator have weighed heavily on the sector, causing several leadership changes and large fines to be imposed on the Australian banks.

The latest such fine, a whopping $1.3 billion Australian dollars, will wipe out three months of Westpac’s profit with a single stroke.

Its shareholders are furious.  They have a right to be. Ultimately, they are the ones writing the cheques.  The share price, which has been in the doldrums for some time, fell slightly after the announcement, but has since rebounded alongside its peers.

The fine, imposed on Westpac for failing to meet its AML/CTF (Anti-Money Laundering, Counter-Terrorism Financing) obligations, is the largest of its kind in Australasia.  It is also approximately half of the amount raised during the November capital-raising last year, which was memorable in part due to the large number of last-minute withdrawals by retail investors.

The more cynical operators may view corporate fines, paid for by shareholders, to be ‘’the cost of doing business’’.  It is not.  The breaches relate to 14-year-old legislation – and although AML requirements do evolve and change, our major financial institutions should be at the forefront of these evolutions to maintain the highest possible standards.

AML requirements have certainly changed over the years.

In the early 2000s, it was not unheard of to open share trading accounts based on a phone call, with shares being sold later in the day.

Today, certified copies of passports, political exposure declarations and even trading behaviours are expected to be collected before conducting any business.  Trusts have even more stringent requirements.  The benefits of such rigmarole are perhaps too intangible for those subjected to it.

However, the penalties for breaching these rules are severe, and the costs are not always borne by the perpetrators of the breach.

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David Colman writes:

LAST week as I wandered along Waikanae Beach I was strongly reminded of New Zealanders’ love of fish.

Whitebait nets lined each bank of the stream and boats drifted offshore with anglers' lines in the shimmering sea.

Perhaps some day the idea of eating any kind of animal protein will be foreign to a vegetable protein world, but for now seafood is seen as an excellent source of protein, vitamins and minerals, with one of many apparent health benefits being a lower risk of heart disease as opposed to red meats and poultry.

Of course, many of the health benefits are lost when the fish is deep-fried in batter or breadcrumbs, and accompanied with a generous scoop of chips. Tomato sauce doesn’t help either.

Seafood is represented on the New Zealand Exchange by New Zealand King Salmon and New Zealand's largest seafood company, Sanford.  Shares in both companies have fallen by more than 20% in the year to date, but it is Sanford that has caught my attention, unfortunately not for positive reasons.

Sanford is a significant part of New Zealand’s primary industry with commercial fishing and aquaculture operations.  Aquaculture, which is essentially the farming of the sea, is now producing 40% of Sanford's sales revenue and has been a useful source of funds to cover reduced deep-water fishing catches.

Sanford faces a tough immediate future as Covid conditions continue to put food service businesses (locally and globally) under stress, and restrict fresh fish exports due to the cost, or lack, of air freight services.

Sandford’s CEO Volker Kuntzsch resigned on 10 September, the week before my Waikanae Beach walk, after what must have been a tough few months, following a tough few years.

Recent events include a mediocre half-year report, a costly rescue mission, crew members facing violent disorder charges, and the tragic death of a young woman in mysterious circumstances.

In May, Sanford released a half-year report showing falls in sales volume, revenue, earnings and profit that resulted in a cut to the interim dividend from 9 cents to 5 cents per share.  Antarctic toothfish were elusive, with the catch down 39%, and Covid conditions impacted staff operations, supply chains, and forced the temporary closure of non-essential stores.

In June, one of Sanford’s 11 vessels, the San Aotea II, embarked on a mission to retrieve sailors from another Sanford ship, the San Aspiring, as a solution to Covid-related travel restrictions for the crew who had been largely at sea since February.

New crew members aboard the San Aotea II had to be sailed halfway round the globe to replace the rescued crew.  The rescue mission covered a vast distance, requiring 25 days to get to the Falklands at what I imagine was a great cost to the company and crews on board.

The journey on the way back took longer due to weather and currents and the ship arrived back in Timaru on 1 August.

During their wait in the Falkland Islands, three Sanford crew members seriously assaulted five people at a local establishment. The victims received hospital treatment as a result of the crew’s violent opposition to the fact the bar they wished to enter was closed.

In July, a 21-year-old woman died on board the San Granit, with the cause of death still unknown and under investigation.  A 26-year-old man was fatally injured on the factory floor of the same vessel in November 2018.

Fishermen, including Sanford employees, often cite the camaraderie aboard ships as one of the highlights of life on the high seas, but two separate deaths, and the assaults in the Falkland Islands, raise serious questions regarding the culture onboard and ashore.  Sanford can have over 200 crew at sea at any one time. 

In addition to the events above, Sanford has proposed the closure of its Tauranga fish processing plant following processing volumes falling well below pre-Covid levels, and a seismic engineering report showing the site was not viable in the long term.

The company's September update noted international markets remain difficult due to struggling food service channels, with retail and online sales unable to make up the difference.

Total sales revenue was indicated to be significantly lower, and cost cutting measures have been put in place such as adjusting operations, reducing capital expenditure, a hiring freeze, and reviewing remuneration to help maintain balance sheet strength.

Sanford's full-year result is forecast to be significantly impacted by pandemic related issues and I would say the events of the past six months will have also had some influence.

Despite a very challenging environment the company observed pockets of growth and is confident that its strategy and operational excellence will deliver improving results in future.

If the company can find a new high-calibre Chief Executive to face the many challenges ahead, it may be exactly what is needed at this time to set Sanford up for a more productive future.

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OCEANIA Healthcare has announced an offer of new 7-year bonds (maturing 19 October 2027) and we anticipate in interest rate around 2.25% (note the recent bond from Summerset as a guide).

Interest will be paid quarterly.

The deal opens and closes next week; it is a fast-moving contract note offer with OCA paying the brokerage costs (clients do not pay costs). There is no application form.

If you wish to invest in this bond offer, please act now and join our list (email or phone). You will then be asked to confirm your request prior to 5pm on Thursday 8 October.

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TRAVEL 

Kevin will be in Christchurch on Wednesday 21 October.

Michael will be in Auckland briefly during early Monday 19 October (in the city).

Seminars

 

Please note: Due to restrictions on groups over 100 in Auckland, we cannot admit anyone who has not re-registered for our Takapuna or Mt Wellington seminars. Please do not assume that your previous registration has carried over.

Auckland – October 5 – 11am - Mt Richmond Conference Centre – very few spaces left

FULL - North Shore – October 6 – 11am - Fairway Events Centre, Takapuna. Please do not arrive if you have not already let us know you plan to attend this seminar.

Chris Lee and Partners


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