Chris Lee & Partners Ltd

TAKING STOCK 29 SEPTEMBER 2016

 

NEW Zealand investors needed to have access to a wide range of choices, they needed to have transparency about risk and return, they needed access to a variety of opinion (advice) and they needed the assurance that the laws would be relevant, workable and competently regulated.

This was the basis of our submission years ago to the advisory committee set up by the Crown, and common sense prevailed, after some false starts.

The changes were delayed when it was found some of the original volunteers to work on a Code for advisers and investors were found to be incompetent, or at least careless, by a Consumer magazine investigation.

But eventually investors were provided with a suitable framework to accommodate their needs.  The eventual designers of the code were competent.

One immediate result was the exit from the industry of a few hundred advisers, a few fully sated by past successes, some unwilling or unable to reach certification standards, some very pleased to escape from prosecution for their previous misdeeds, thanks to a hopeless Commerce Minister and a powder puff Securities Commission.

We now have a fair set of rules, a fully-manned regulator, improving accountability, and a much clearer definition of which advisers are competent to do which tasks.

A very small number, usually capital market participants (brokers etc.), have knowledge of securities and are able to provide guidance on which particular securities match which objectives.

A very large number predominantly sell insurance products, and their employer’s brand of investment funds (unit trusts etc.).  They are the salesmen for investment managers.

A number sell for the various fund managers/KiwiSaver managers and a further small number seek to sell their knowledge of which fund managers are best, though I am not sure how they judge.

At adviser conferences, the vast majority of attendants sell insurance, mortgage broking services, or brands of managed funds.

Capital market participants at such conferences are a tiny minority, I am told.

I recall one capital markets operator, a friend in the industry, telling me how he was described as being an intruder when in a panel discussion he revealed his knowledge of particular securities.

But we do now have diversity and that has been demonstrable in recent weeks, with various high-profile participants coming out with offers from left field.  Some investors will always look to left field.

Former National Mutual salesman, later general manager, Ralph Stewart is seeking to sell a new form of annuity from his company which is new, has no deep-pocketed shareholders, and a most concerning poor credit rating.

I note he is now also seeking to sell less difficult products, such as a system for transferring British pensions.  That may be a better idea.

Like the Rawleighs man, his basket might end up with a colourful array of products, but ultimately access to capital will determine the fate of his ideas.

Former Goldman Sachs (Hong Kong), Hanover and Tower Investments manager, Sam Stubbs, has created a not-for-profit KiwiSaver fund, based on the extremely low cost of funds management supplied by the US not-for-profit manager, Vanguard.

Stubbs will sell to those who regard low fees as being more important than nett returns and will probably find a receptive audience with those whose returns have been sabotaged by fees.  His target will be the least engaged KiwiSavers, who are likely to benefit from low fees.

As an aside, let no one be fooled into thinking this service is a charity.

Not-for-profit organisations might not pay dividends to shareholders but they usually pay very large salaries to ensure the nett margin goes to the key executives, leaving very little residue to flow elsewhere, as is evident by the Vanguard model.  The idea of charity is not necessarily implicit.

Stewart and Stubbs have been joined by the South Island authorised financial adviser Martin Hawes and has decided to help Forsyth Barr re-boot its tiny, under-performing KiwiSaver fund.

Hawes has no funds management or capital market background so may be following the principle that the American Donald Trump is espousing, that there is potential value in getting newcomers to provide fresh eyes.  He may be right.

According to Forsyth Barr (FB), Hawes will chair its KiwiSaver investment committee and will be rewarded by the growth that fund achieves.

As an occasional gentle critic of FB’s investment banking incompetence I am pleased to applaud a new focus on its retail client performance.

FB has some good investment advisers, it has an improving research department, and the re-booting of its KiwiSaver, with a new fresh set of eyes, augers well for its clients, though for Hawes this will be a challenge, as funds management is a demanding art, usually requiring in-depth capital market knowledge and ample time to visit the capital market participants, including the listed companies offering their wares.

It is no fluke that the likes of Milford, Salt, Devon, Mint, Aspiring and Harbour, all have people with capital market/sharebroking histories and regularly produce the best returns for investors.

Whether Hawes can convert his past successes to funds management will be interesting, given his previous published philosophies, on matters like the Crown Asset sales, and, more recently his declarations about the excessive value of sharemarkets.

If he could demonstrate timing skills, and insightful asset selection, he would provide exactly the sort of diversity that Kiwi savers might want.  We will all wish him luck.

Forsyth Barr’s fresh review of its role in the market is likely to have come from the return to the FB environment of Eoin Edgar’s sons, Jonty, Hamish and Adam, now at the right stage of their careers to take over from Eoin, FB’s largest shareholder, semi-retired at 71, in the Queenstown area.

FB has failed to make progress in investment banking, where its errors are widely discussed, but it has built a $4 billion book of client money, delivering to it around $50 million a year in fees.

The book has been stable for many years.  By contrast Craigs, FB’s competitor, has trebled its book to $10 billion in less than a decade.

FB, largely Dunedin based but with sharebroking branches throughout the country, may find traction if the Edgar sons, all now trained in capital markets, take over the helm.

They are unlikely to be able to match the hunger exhibited for decades by their father Eoin but they will have skills in technology, international experience and an awareness of the culture that has led to the successes of their competitors.

New Zealand investors need a wide range of choices of good operators, and if FB can make progress in areas like its KiwiSaver and investment banking, it might become the sort of option that modern investors need.

Hamish Edgar has been appointed to run the $50m Edgar family private empire.  Jonty is apparently focussed on property in the central North Island while Adam may be groomed to be the person to recalibrate FB.

The broking firm has had a huge boost from the insurance settlement of a disputed claim for the tens of millions of costs it incurred over the Credit SaILS settlement it had paid to avoid what would have been an unseemly court case.

The insurer of FB disputed but now has accepted the claim and paid it in full, refilling some fairly depleted bank vaults after contributing to the settlement fund.

So now we have ample evidence that high profile market participants, like Stewart, Stubbs and Hawes are stepping up to broaden the range of offerings that investors can consider.

This is exactly what the market needs: niche providers for those not provided for, by mainstream operators.

In FB’s case many will be cheering on their campaign of what looks like incremental improvements, with invigorated and refreshed leadership.

New Zealand is big enough to accommodate offers from both sides of the divide.

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PERHAPS another example of a new option might come from the decision of Warren Couillault to resume his career with Macquaries in New Zealand.

He has bought a stake from Macquarie Australia in its NZ private wealth business and will attempt to reignite the NZ business into a new phase of investment successes and client growth.

According to market chatter, Macquarie had failed to reach agreement, probably over price, to buy out Forsyth Barr, which now seems to be off the market. (Post Script - Following the publishing of Taking Stock, Forsyth Barr has issued a statement that it is not and never has been in discussion with Macquarie or any other entitiy over a buy in).

The Macquarie business seemed to stagnate, losing about a quarter of its advisory staff, but has now resumed growth, perhaps boosted by Couillault, who had sold out of the Fisher/Tower empire some years ago.

The private wealth sector has many providers in New Zealand with the BNZ-owned JBWere, First NZ Capital, Macquarie and the major banks, all prominent participants.

Craigs and FB tend to be retail wealth advisers, and on a smaller scale that also describes our business, though unlike Craigs and FB, we do not offer to manage money.

Macquaries, in my opinion, is the dormant giant, a significant player in Australia that has never achieved scale in New Zealand and should either buy scale (e.g. FB) or exit.

The arrival of Couillault might be the signal that investors should celebrate.  Genuine, properly-priced service backed by great research, and moral leadership, supported by holistic, hard-working advisers is a model that works wonderfully but has rarely appeared in New Zealand.

Investors with wealth have never wanted the robot-like service offered fearfully by those who operate by rote.  Their dislike has grown as returns have shrunk, but fees have not.

Macquarie may find, under Couillault, a niche which focuses more on reward than risk, and which can be offered cost-effectively.

One man operations, charging one or more percent fees, no longer could be cost-effective if they simply sold managed funds, without knowledge of the underlying securities.  They would find nett returns to clients would be difficult to explain.

From all the recent announcements, investors can take encouragement.

Market leader First NZ Capital is growing its offers in wealth management and right across the spectrum others are following suit, ensuring even quirky investors will have a choice.    _ _ _ _ _ _ _ _ _ _ _ _

INVESTORS in the technology stocks ERoad, Wynyard and Orion Healthcare may all be perplexed by the substantial price movements in their listed shares, all heading south.

Wynyard has made inadequate announcements explaining the 80% fall in share price in the last nine months, ERoad has made positive announcements but seen its price move around and Orion’s share price has fallen by 15% in the last month, without explanation.

Obviously investor confidence in these ambitious companies is variable.  Patience may be the key for some investors.

ERoad’s annual meeting presentation is available on its website and is worth viewing.

It has far exceeded its objectives in New Zealand, where it is now a profitable business, but its ambition to capture US market share, as the trucking market adapts to the intended 2017 law changes, has yet to convert to enough sales to break even.

ERoad needs to reach just break-even status in the US, with its black box that calculates road tax and feeds information on the truck’s performance.

At that point ERoad would overall be profitable and able to consider dividends, or fund rapid growth.

Clearly the next 12 months will be critical.

Wynyard must have made errors in gearing up for two Middle East contracts it believed it had won.

It seemed to gear up staffing levels for those contracts and must have imagined the contracts would rain cash on the company.  No cash at all seems to have arrived.  No rain.  Not even a gentle mist.

It seems for reasons that may be geo-political, or may even be determined by the globe’s masters, that the impressive contracts have at least stalled and certainly are not deluging Wynyard with cash.

The company has reacted by refining its board and executive, perhaps hinting at human errors.

It has accepted it will endure losses for longer and must have been grateful to have a supportive shareholder to provide $10 million cash, to keep its bankers quiet.

I have no special knowledge but I read the signals hinting at a need for contracts to start paying, with ugly consequences if they do not.

National security in the Middle East may not take much heed of investor needs, when terrorism is included in the agenda.

Has Wynyard stuck its foot into a very dangerous pool?

Orion Healthcare believes it is on track to recording surpluses by 2018, and has made impressive progress in America.

Perhaps the falling value of the US dollar, and the threat by the Republican buffoon Trump, to undo Obama’s health programme, are seen as inhibitors.

There are ample forecasters who will pronounce the imminent demise of the US dollar.

I am not one of them.  I have only a small hope that the American people will take up the challenge of rebalancing the definition of ‘’the American dream’’ but I do not expect the US dollar to become a junk fiat currency, so Orion’s US earnings, I hope, will be worth having, even after conversion to the strong NZ dollar.

All of these rapidly changing stories remind me that investing in ambitious disruptive technology companies requires a high tolerance for possible failure, a great deal of patience, and a decent dollop of optimism.

Diligent, which fell from a dollar to ten cents in less than a year, hit the jackpot and eventually returned to a sale price of more than $5 per share.

It would be a miracle if all such ambition achieved similar reward.

Intueri, which hoped to use technology to provide inexpensive and accessible education, was suspended this week, my inference being that some of the fees it claimed from the Australian State and Federal budgets may have been for students who did not bother to use the facility provided for by tax-payer money.

Those who seek to gain from disruptive technology must have capacity to absorb losses.

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INFORMATION sharing is a cornerstone of our business model so I always appreciate suggestions from clients to read internet articles they have found.

Several clients referred me to the video of a congressional hearing in the US, where a fiery woman, Elizabeth Warren, was in full flight, discussing the account frauds in America’s giant bank, Wells Fargo, with its CEO, a Mr Stumpf, a fellow with emotional intelligence as low as any property mogul you might want to name, and definitely lower than that of a blowfly.

Wells Fargo publicly trumpeted its success in forcing its retail bank staff to cross-sell new accounts with the bank, under the guidance of a woman in charge of the strategy.

Credit cards, personal loans, overdrafts, savings accounts, managed funds, insurance and very possibly back street vasectomies would be on the compulsory sales list for bank tellers.

Wells Fargo boasted it had more than five accounts per client and was reaping the benefit of cross-selling.

The staff hated the campaign, but the woman, who reported to Mr Stumpf, loved it, her bonuses and entitlements soaring, and Stumpf loved it, his 6.7 million personal shareholding rising by US $30 per share, enhancing his credibility with other yacht-owners for 210 million reasons.

A couple of problems arose.

These reported sales of accounts were created by staff desperately clinging to their jobs by meeting these targets but more than one million of the new accounts were eventually uncovered to have been opened without reference to the client.

In other words they were bogus accounts, ghost accounts, worth nothing, created to protect the jobs of the junior staff.

So the woman in charge retired.  She was granted 90 million reasons for her fellow yacht-owners to regard her as a good person.

No executives were fired but several thousand frontline staff had their US $10 per hour jobs cancelled, presumably for not meeting targets, or meeting them fictitiously.

The Congressional hearing allowed Ms Warren to ask Stumpf about this.

He is chairman and CEO.

He did not really have much to say.  It was a board matter.  He was just chairman and CEO.  He had no opinion.

The Board, who granted $90 million to the female executive in charge, would determine whether any other action was needed.

The poor fellow could not and did not say the following:

‘’This was a programme with good intentions that has not worked satisfactorily, and as chairman I apologise for this.’’

‘’Staff and clients have not been treated respectfully.  I apologise for this.’’

‘’The Board will appoint an independent party to make recommendations as to how we can avoid such future errors, and will publish those findings and the subsequent board response.’’

‘’If I am found to have failed in my duties, I would resign.’’

Anyone wanting to watch a pompous prat be pilloried can google Elizabeth Warren and Stumpf.

(Despite this, as far as I know, the name Stumpf retains its preferred rating to the name Drumpf, sometimes presented as Trump.  But emotional intelligence ratings for all three names seem to be identical!)

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THE international investment banks UBS and Macquarie will be reviewing their due diligence processes after the destruction of the education provider, Intueri.

The two investment banks helped list Intueri in 2014, for a listing price of $2.40.

The company in Australia and New Zealand has from day one been under a cloud, many in education believing its real role in genuine education was shrouding cynical recruitment of students to put backsides into student seats for token education aimed at accessing government grants.

The formal enquiries in Australia seem to raise these issues and one would be amazed if the NZ operation was less exploitative.

Intueri, this week fell to five cents after announcing that no one should acquire the shares.

That there were buyers at five cents reminds one that even when companies are distressed, there always seems to be a market with optimistic punters prepared to take up unwanted shares.

Intueri’s survival for two years as a listed company may now seem to be a miracle.

UBS and Macquarie will not enjoy their association with the Intueri business behaviour.

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I will be in Auckland on October 10 (Aroma Café, Albany) and 11 (Waipuna Lodge, Mt Wellington).

I will be in Blenheim and Nelson on October 25 and 26.

Our city meetings to discuss investment strategies cannot be scheduled until after October 21, and now seem certain to be held in November.

Edward is in our Wellington office (Level 15, ANZ Tower, 171 Featherston St) on Tuesdays, available to meet new and existing clients who prefer to meet in Wellington - by appointment please.

Footnote

 

We have an allocation of the new Trustpower six-year bond, yielding 4.01%, and will soon have details of Z Energy bonds for five and seven years.  Those wanting to see the offer, or arrange allocations, should contact us urgently.

Chris Lee

Managing Director

Chris Lee & Partners Limited

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TAKING STOCK 22 SEPTEMBER 2016

TAKING Stock is not a travel column, nor a geography teaching programme, but investors must adopt a global mentality.  Asia is our biggest trading continent and Japan is the third biggest economy in the world.

For those who have forgotten, it was not two decades ago that New Zealand’s education providers wanted us to learn Japanese, not Mandarin.  Our trade successes were linked to getting the Japanese to eat our food.

Japan is a highly important trading partner (comprising 6.0% of NZ exports).

One of our five authorised financial advisers is David Colman, who joined us four years ago, after a long stint at ANZ Securities, where his integrity and client first approach attracted our attention, and led to an unsolicited job offer from us.

David looks after our clients who seek personalised advice, he manages and visits many of our Central North Island clients, and assists with research and daily trading.

He has travelled widely but last month had his first visit to Japan.

His observations follow.

Japan Deliberation

Written by David Colman

Recently I was fortunate enough to have the funds saved and the leave available to embark on a trip to Japan - A country I wanted to visit for as long as I can remember.

Japan interests me in many ways (even more now that I have been there) including culturally, historically, artistically and economically.

As an investment adviser I have long held the theory that Japan is experiencing economic conditions that we may face, in New Zealand, in the future. It seems imminent that many other countries around the world may face many of the challenges that Japan face now.

In regards to its economy, Japan has been in the midst of two ‘lost decades’ where low demand for goods and services in favour of high savings rates of companies and individuals has stymied growth. Companies are estimated to have cash equivalent to almost 50% of Japan’s economic output.

Deflation, demographics, a strong currency, lower productivity and competition from emerging countries such as China have contributed to the country having a GDP today approximately two thirds off its 2012 peak valued in USD.

Government debt (approximately US$11 trillion) has been climbing faster than the economy has grown for many years. The Government debt to GDP ratio is the highest in the world and is close to 240% of GDP. Investors use the ratio to determine a country’s abilities to make debt repayments which can increase the country’s costs to borrow and yields on government bonds. Debt financing, which is already a major problem, will be worse if conditions continue to deteriorate.

Japan is however a rare creditor nation (less than 20 countries are in such a position) where it has invested more in the rest of the world than the rest of the world has invested in it. It has the largest Net International Investment Public Position of any nation of up to 3 trillion USD (almost twice as high as second place Germany). A depreciating Yen may mean their investments are growing faster in value than their debt.

In Japan, deflation (the fear of central banks globally) is occurring, wages have fallen, the currency has swung higher and there is next to no growth despite massive QE (Quantitative Easing) efforts instigated by the Prime Minister of Japan, Shinzo Abe.

Economic Archery

The Prime Minister’s economic strategy, known as ‘Abenomics’, is described as utilising three arrows. The ‘First Arrow’ (Monetary Policy) is a Bank of Japan inflation target of 2.0%, the ‘Second Arrow’ (Fiscal Policy) is an economic growth target of 2.0%, and the ‘Third Arrow’ (legislative reforms to stimulate growth) involves government lead initiatives to allow for or encourage growth.

The Arrows’ targets are difficult to hit due largely to demographic conditions which include an aging population with low immigration inevitably resulting in population decline.

I sat on a gondola on Miyajima (an island near Hiroshima) and couldn’t help but notice the little boy next to me slurping on his grape soda in a Bartman T-shirt outnumbered by his elders by 4:1.

The young boy will be living in a country which will be required to spend increasing sums on pensions and healthcare for the retired and elderly. The retirement age is 61 years, up from 60 in 2012, and up from 55 in 1998, but most people don’t retire until they are older.

Unfortunately, I was admitted to hospital twice in Ginza (a luxury suburb of Tokyo) where I witnessed a significant number of elderly patients being wheeled into the emergency waiting room. I did not see a single sick child or teenager in comparison.

Strangely, on an irrelevant side note, I recall that at the hospital I didn’t see a single male staff member (doctor, pharmacist, nurse or administrator) out of scores of staff who were visible.

The country will struggle to achieve the same output with a falling number of people of working age. The unemployment rate is approximately 3.0% and there is a strong resistance to hiring outside of the country (foreign residents account for less than 1.5% of the population).

Many Japanese people are working well past retirement age, a behaviour that seems more likely in New Zealand’s future. I noticed at a supermarket in Hiroshima that it employs a high number of elderly shelf stackers, checkout operators and janitors. I estimated at this supermarket that half the workers are easily over 60 years of age and none below 20 or maybe even 25 years of age, in stark contrast to supermarkets in New Zealand where visible staff appear to be often in their late teens and early 20s.

Jobs may remain vacant in Japan if qualified staff become hard to find. To meet staff requirements, the aged care sector is controversially employing staff from outside Japan with many coming from Indonesia and the Philippines. Legislation was passed in 2015 to allow more foreign workers.

Robots are being deployed to meet staffing shortages including rubbish retrieval, customer service and food preparation. Tokyo hosts the 2020 Olympics and Paralympics and there are plans to deploy robots with the ability to communicate in many different languages to help foreign athletes and sports fans negotiate airports, train stations and the events themselves.

I was encouraged to see that there is still low-skilled work available for non-robots as evidenced by the confused teenager at the Subway sandwich chain in Tokyo being taught how to cut and stuff a bread roll for the first time. He is likely to be earning perhaps 900 yen (a little over NZ$12.00) an hour (Tokyo has one of the highest minimum wages in Japan).

Negative Interest Rate Evaluation

 

Yesterday (21 September) the Bank of Japan publically considered their ‘comprehensive assessment’ of the effectiveness of the Bank’s negative interest rate policy which has been in place since the end of July 2016.

The central bank governor Hurahiko Kuroda previously stated ‘there is still ample space for further cuts in the negative interest rate’ indicating that they will continue at least shooting the ‘first arrow’ although they have scrapped a previous deadline to hit their 2 % inflation target within a specific time frame resorting to a soon as possible approach.

If QE is decided to not be working will the Bank of Japan slow down or halt its buying of Japanese government bonds, local funds and Japanese companies’ shares? What measures will it take as preferable to the status quo?

How will these changes coalesce for the Japanese people young and old?

Perhaps the Japanese government and the central bank might reconsider their approach and reduce the supply of money that it seems no one in Japan is willing to spend anyway. It might encourage companies to find other sources of funding rather than depending on government support and create an ultimately leaner and more efficient and productive economy. The companies may be forced to spend some of their capital and charge higher prices to afford to increase wages to keep staff that are in short supply. I believe this might let the government put some arrows back in their quiver.

A further increase to the Consumption Tax which is a similar concept to G.S.T. in New Zealand may help to refill government coffers and repay debt. The rate was increased from 5.0% to 8.0% in 2014 but an increase in the Consumption Tax rate from 8% to 10% was postponed in 2015 and has not been implemented due to the previous increase having a negative impact on spending. It has been re-scheduled to be increased in April 2017.

Retirement age increases may be necessary to reduce the burden on the shrinking workforce. Increasing use of technology including robotics may continue to help alleviate a short supply of workers and help maintain or improve the quality of life for Japanese citizens.

The Olympic Games in 2020 may boost tourist interest in this fascinating and unique country and Tokyo seems like a city well poised to gain from such an event. There are an overwhelming multitude of places to visit and activities available. As a tourist, I experienced fantastic customer service and paid no consumption tax at an electronics store and, as I handed over cash for the purchase, I was told that a 5% discount applied if I paid by credit card instead. This is a strange phenomenon to me and I am still scratching my head why a credit card payment would be incentivised by the retailer in preference to cash. Perhaps I am witnessing why deflation expectations are so entrenched. I was left wondering whether l would get a greater discount if I went back later.

Meditation

 

As I sit at a restaurant and ponder the massive Debt to GDP ratio that confronts the Japanese and is likely to lower living standards in the country in some way I observe that life goes on, restaurants still serve up steaming bowls of noodles to waiting customers, trains are jammed full of tired workers, streets are full of vehicles of all kinds and the abundant array of LEDs and neon still brightly illuminate the landscape.

Japan and New Zealand are vastly different (see the comparison below) but I still believe how the Land of the Rising Sun deal with their challenges, may well teach us in the Land of the Long White Cloud, and other countries how to manage a similar demographic trend which is likely to be faced to a lesser degree in future (although New Zealand has a rising population).

For Japan, the tightening of monetary policy would likely lead to a major correction in the stock market and risk recession but ultimately it seems natural that the days of easy credit have to end at some point. This applies to most of the global economy where markets have been artificially supported by unprecedented levels of money provided by central banks. Debt has been used to avoid failure now, in the quest for financial stability, but is very likely creating a greater risk of financial, political and social instability in the future.

Sadly, as Market News and Taking Stock readers will be aware, we do not expect a global tightening of monetary policy and expect low interest rates and extremely slow repayment of debt to be a global trend for the foreseeable future.

Borrowing now to support under-performing markets, desperately hoping for a miracle to occur to allow repayment in future isn’t much different to using a loan to fund gambling at a casino. Sovereign debts have been poorly managed exposing a downside of democracy where often the bigger spending candidates win. They are elected on the basis of the promises they make to voters regardless of the debt they take on to provide the promises once elected. This is a subject I will have to explore another time. My ramen noodles are served.

Japan and New Zealand comparison 2016

Population

Japan 126.3m (11th highest globally)

N. Z. 4.5m (127th highest globally)

Land Area

Japan 364,500km² (Pop. Density 350 per sq. km)

N. Z. 263,800km² (Pop. Density 17 per sq. km)

Urban Population

Japan 93.7%

N. Z. 87.6%

Median Age

Japan 46.9 years (Retirement Age of 61 years)

N. Z. 38.1 years (Retirement Age of 65 years)

2050 Forecast Population

Japan 107.4m (-15%)   (Pop. Density 295 per sq. km)

N. Z. 5.6m (+24%)   (Pop. Density 21 per sq. km)

2050 Forecast Median age

Japan 53years

N.Z. 43years

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CHRIS LEE writes:

Japan’s extreme reliance on its people to fund its huge debt levels, and its rapidly growing average age, is high on the list of the world’s worries.

But it is NOT the reason for US commentator David Stockman’s worry beads, which now threaten to suffocate him.

Stockman is a long-time economic commentator, once a senior adviser to President Ronald Reagan, and a member of the US Congress Budget Office.

He is not just a media reporter or a headline-writer though I suspect he could be a headline-chaser, also keen to promote his latest gloomy views, about to be published again in a book.

His gloom is more to do with China, than Japan, he sees Europe as a continent ruled by political rather than financial gurus, and he sees the USA as a morass.

His answer is gold.  He forecasts a 40% fall in US equities within a year, and bases that on the claim that corporate US is announcing falling profits while share prices are rising.

As an aside, these two conditions need not be mutually exclusive in logic.

If earnings produce dividends, while interest rates keep falling, then logically share prices will reflect relative yield, not absolute profits, so prices rise because interest rates are so dreadful.

Indeed, in New Zealand corporate profits are rising, interest rates are falling, foreign capital is arriving faster than ever, so our share price rises are logical.

On historical measurement, our share prices are very high but rarely before have dividend yields had such a positive margin over interest rates (because rates are so low!).

The likes of Stockman, in discussing share price multiples of dividends, needs to programme into his thinking the zero or near-zero yields available from bank rates or Treasury bonds.

But his comments and his book will resonate with investors and may prove to be prophetic, just as they may prove to be mistimed or inaccurate.

He is absolutely right to observe the extremes of who has benefited in America from the unprecedented flood of money and credit.

Those who see him as a visionary may sell assets now, and capture profits, while waiting for the ‘’bargain of the century’’ that he forecasts, when panic selling follows.

He is certainly correct when he talks of the unsustainable siphoning of the free money to the richest people.

Stockman says that 90 percent of the population have had no increase in nett wealth since 1987, while the top 1% have had 300% increases, and the top 0.1% have had 1,000% increases.

He offers no solution but simply observes that what others have named the ‘’pitchfork’’ reaction, is inevitable and will be most uncomfortable to the beneficiaries of this absurd inequality.

In my view the first real signals of capital market collapse would be growing unemployment, followed by much higher cost of credit (higher margins, higher interest rates).

Those signals are not visible now but we should all remain alert.

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SYNLAIT Milk’s continued rise in sales and nett revenue highlight the difference of its model from Fonterra’s model.

Synlait simply processes milk and wholesales the processed product, often dried milk.

Others then brand the milk and retail it.

Synlait’s model is to earn its profits from its processing margin, rather than from benefiting (or suffering) from milk price changes.

Its growth has led to its rights issue announced recently, an offer of two new shares for every nine held, at a price of $3.00, at least 10% lower than recent Synlait share prices.

Investors should note that the issue is not renounceable and that there will be no trading of rights.

The issue is underwritten by First NZ Capital, Synlait’s preferred investment bank.  No doubt FNZC will invite sub-underwriters to spread the liability.

I suspect all Synlait shareholders would want the discounted shares, even if only to sell at a later time.

Disclosure:  I own Synlait shares.

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TRUSTPOWER bond-holders must also be alert.

All bond-holders are being asked to approve an exchange, on identical terms, of Trustpower bonds into the new-look Trustpower, trimmed of its windfarm assets.

Existing bonds have attractive rates so bond-holders would be wise to sign the exchange document and forward it to their broker, probably our business, for most readers of this newsletter.

If bond-holders forget, or are away, they will be repaid at a fair market price, but will then have brought forward tax liabilities.

We urge all Trustpower bond-holders to act immediately and will offer assistance to any who are out of the country or otherwise unable to act themselves.

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TRAVEL

I will be in Auckland on October 10 and 11 at Albany, Mt Wellington and have available times at both venues.

Edward is in our Wellington office (Level 15, ANZ Tower, 171 Featherston St) on Tuesdays, available to meet new and existing clients who prefer to meet in Wellington - by appointment please.

Kevin will be available in Christchurch on Friday 30 September.

Chris Lee

Managing Director

Chris Lee & Partners Limited

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TAKING STOCK 15 SEPTEMBER 2016

ABOUT 100 years ago my mother’s grandfather, a Dane, moved with his wife into a ‘’workers cottage’’, a state-built house on the corner of Seddon Terrace and Coromandel Street, Newtown, Wellington ,the former named after the Prime Minister of that era.  Their cottage was either the first, or one of the first, of its type.

My great grandparents moved in after most of their 19 children had grown up, only the younger, including my grandmother, Nellie Christensen, still living with their parents.

The house remains there today under some sort of heritage protection and will still be a functional house, albeit with an inside bathroom, I would hope.

It was a semi-detached smallish home, three bedrooms up a very tight, OSH-unacceptable staircase and downstairs it comprised a kitchen/laundry, a family dining room, and a tiny lounge, reserved for occasional visits from the clergy.

The toilet was outside.  There was a tiny backyard, but no useable garden.

Around 10 years after they moved in, the Crown offered to sell it to my great grandparents.  They had expended their cash on raising 19 kids and lived week-to-week, so Jimmy Wilton, a world class 200 and 400 metre runner who had married my grandmother when he returned from the war, raised the money and lived in it with my great grandparents until they expired, hopefully not by falling down the staircase.

My grandparents then owned it until the early 1960s when they settled permanently in to a cottage Jimmy and my father had built at Paraparaumu Beach in the late 1940s, and sold the workers cottage for 4,000 pounds.

Sorry about all this family history but here is the point.

The state built the house, it was fit for purpose, and as soon as the tenants and family could arrange to buy it the house was sold to them, and the money recycled to build another house, for someone else who needed help.

The mission had been accomplished, the money was recycled.

Newtown was not then a particularly fashionable area, and was some distance from where Jimmy worked, for one of New Zealand’s engineering companies, until he was nearly 70.

I think there might be some symmetry in this story of logical housing policy as next week Jimmy Wilton’s great grandson, Andrew McKenzie, takes over as the new chief executive of Housing NZ Corporation.

His mission will be to guide the politicians into a sensible, commercial but kind, social solution to today’s housing conundrums.

Andrew McKenzie has previously had senior roles (as Chief Financial Officer) at both the Wellington and Auckland city councils, was a few years ago named as New Zealand’s best CFO, and has worked as a senior executive in Fletcher Building.

He has five excellent adult children, has played a wide range of sports at premier level, and he has a good balance of intellect, humour, compassion and experience.

He faces a job which is constantly challenged by would-be tenants, unhappy tenants, criminal tenants (P Kitchens, etc.), historical building errors (asbestos etc.), hypocritical and hypercritical politicians, braindead media commentators, and a lack of financial resources.

He may come to wonder why he is accepting a role that he did not seek, but was asked to accept.

My view is that the housing issues, that so dominate media focus, must be addressed practically, rather than optimally, as I see no hope that an optimal solution is deliverable.  It will help to have a CEO with a compassionate demeanour.

There are three main problems in housing.

Thanks to our British heritage, our nation happily regards housing as a social matter so problem one is ensuring that those who cannot yet help themselves, should have a satisfactory shelter to enable them to function.

This means we must build, maintain and rent out housing that is functional for those seeking to get established.

The second problem are the dysfunctional, also known as the homeless.

We need a safe lock-up bed/kitchen/toilet dwelling for the homeless, who vary between victims of misfortune to brain-damaged drug addicts.  We must be kind to those unfortunates.

Our third issue, which hopefully Andrew McKenzie will not have to solve, is the cost of housing in the best parts of a country, which itself is one of the most desirable places our planet offers to its inhabitants.

Seddon, an early believer in social housing, determined that to meet demand you build workers cottages and sell them to the tenant as soon as they could pay, helping with a low-cost state advance, if need be.

Funnily enough the interest rate of the 1950s was 3%, roughly the commercial rate today.

Build, rent and then sell, when the tenant can buy.

I cannot imagine a more logical sequence to enable the Crown to address the problem.

Housing for the dysfunctional is less straightforward.

Gibbing out containers is a European solution; building shoe boxes in areas where land is cheap is a possible solution for New Zealand.  Dormitories seems an untenable solution.

Places like Huntly, Dannevirke, Ekatahuna, Featherston, and Wairoa are all often mentioned as places where sites for shoe box housing might be inexpensive.

I guess many residents in those towns would have a good argument about the suitability of ‘’their backyard’’.

Clearly it would be idiotic to build such shoe boxes in the most expensive areas, like Waiheke Island, or Milford or Remuera.

Someone, presumably Andrew McKenzie, will need to think through the least offensive solution.

He will have to face the biggest single problem looming in the housing market - the ageing, and as a result the cost, of trained builders.

Two years ago I had the opportunity to sit at a Cabinet dinner where I was allowed to bend the ear of relevant ministers on my pet subject.

Mine was the absurd failure to recognise the need for apprenticeships, and the unwise encouragement in our education system to focus on sports physiotherapy, the art of knucklebones, and the sexual preferences of 13th century witches, instead of those areas where we need skilled people.

Accomplishment, career enjoyment and financial independence will always be available to those who solve problems, like electricians, plumbers, glaziers, carpet layers, tilers, painters, decorators, builders (of course), and naturally, nurses, mechanics, aged care providers, teachers and crime preventers.

These people are the true heroes of our society, not the psychopathic property moguls, the billionaire bankers or the self-serving lawyers, accountants, trustees or auditors.

If we were ever again reduced to basics, as Christchurch was after the 2011 earthquake, the heroes would be those who had learned how to fix things properly.

We will always have a dearth of builders if our system indulgently promotes the concept of training rugby players how to talk with a referee, rather than training people to build and fix things properly.

Perhaps the Housing Corp should offer to pay for relevant apprenticeships in return for a three year bonded commitment to build for the Housing Corp.

The housing ‘’crisis’’ in Auckland simply reflects supply and demand.

There is a shortage of supply of land in the most desired areas, there is a shortage of builders, and there is even a shortage of affordable building materials, as Ryman Healthcare noted, when it explained delays caused by slow delivery of concrete panels. (Ryman may buy a supplier).

There is extreme demand for housing in the best areas, caused by newcomers wanting to live in the world’s best areas, and by the return of New Zealanders who have decided that their future is best, overall, in our shaky islands.

For those who must live in the best places, but are average earners, apartments are the obvious solution.

Regional development is badly needed, it being quite ridiculous that great places, like Whangarei, have not been further developed as an alternative to employment in Auckland.

If anyone can compassionately and affordably address our social housing problems in New Zealand, I am guessing it would be Andrew McKenzie.

To solve the housing price problem also needs central and local government leadership, right down to rebooting the high value of apprenticeships.

When will we see action, not useless debate?

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NEVER let anyone tell you that seals have no brains.

They know the danger posed by orcas and they know how to deal with it.

Last week I watched a clip on an international news programme of a seal clambering on to the transom of a small boat, seeking refuge from a pod of orcas that was closing in.

After enjoying the seal’s company, the fizz boat occupants used the oars to push the seal back into the sea.

As the killer whales zeroed in again, the seal went straight back to the boat and climbed to safety.  Oars were less painful than orcas.

Seals are no fools.

And they know where to eat!

Ask any salmon farmer.

When King Salmon’s shares are offered to the public soon, there will naturally be a focus on how King Salmon manage the health of the salmon, how the fish can cope with our warm waters, and how the King Salmon company can keep the sharks and the seals from sampling the stock, every morning, lunch and teatime!

We now export more than a hundred million dollars’ worth of salmon, with King Salmon the king player, after a long difficult history, beginning when it was named Regal Salmon, and listed years ago.

At that time it had some amateurish governance, some bad luck, and exhibited many signs of inexperience but with the long time help of a supportive Asian shareholder, and more recently some support from a private equity company it has survived, and it is optimistic that it can produce sustainable volumes of salmon exports, profits and dividends.

Not everyone will be as optimistic.  They will need convincing.

The ambitious Mt Cook Alpine Salmon Company, privately owned by a range of Dunedin, Wellington and Queenstown investors, has struggled, burning capital and unable to turn a good product (fresh water, small salmon) into profits and dividends.  I am not sure that those investors are all that thrilled.  Everyone seems to have had a feed except the shareholders!

They continue to expand their business and will no doubt be energised if King Salmon successfully lists on the NZX and provides comparable valuation metrics.

King Salmon is confident it has the right recipe.

There is no doubt that the modern dietician extols salmon as a food.

Sadly, seals are no fools.  They know where to go for a free feed.

Survival of stock is a problem.  Disease is also a threat.

The King Salmon investment statement will tell us how far the company has advanced, since the days when its governance left investors with only the morsels.

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IT is now eight years since the collapse of the non-bank lending sector, comprising finance companies and mortgage funds, the latter mostly owned by incompetent insurance and trust companies.

If we need new properties to be built we may need non-bank lenders, willing to accept higher risks for higher returns.

Last time the high risks were evident but the high returns went to the greedy and often dishonest people lending other people’s money, rather than to those who had invested money.

We need a new model, much better governed, better regulated and better structured.

The new model would need more capital (genuine capital), better matching of loans to deposits, much better supervision of the borrowers, and better selection of who was granted loans.

We will need a fairer distribution of the surpluses.

The likes of Strategic, St Laurence and South Canterbury expired because they had hopeless lending standards, grew because they could, were greedy, and careless with other people’s money.

They did not necessarily start out like that.

But it is a fact of life that when some boys suddenly start enjoying their toys, they want bigger and more toys to impress their friends and families.  Other adults were, and are, unimpressed.

Greed and poor standards, combined with unsupervised access to other people’s money, make for poor outcomes.

Property development need not be a high-risk area.

I propose to present some suggestions on this subject in coming weeks.

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IT may be a stretch to connect corporate behaviour in New Zealand with fear of a pitchfork rally in the USA, but there may be a connection.

Here we have seen the likes of Spark, Air New Zealand and Qantas allocating a greater share of profits to staff.

Spark will pay all its staff at least the living wage, as opposed to the minimum wage.  Air New Zealand and Qantas are both awarding four figure bonuses to large numbers of staff.

Clearly this is a signal that the split of surpluses between shareholders and staff is being challenged.

The need to rethink is much greater in the USA where public company executives are routinely over-rewarded while essential staff are paid as little as is legal.

The pitchfork rally will sort this out if the owners of the company do not pre-empt such an unpleasant solution.

What is encouraging some optimism, is the growing trend of active fund managers and sovereign wealth funds to take up the issue with the boards of large companies.

Fund managers have the voting grunt, and access to legal budgets, to be a genuine threat to the status quo.

Already there are fund managers vowing they will not support companies like the retailer Wal-Mart because of its low-pay policy, enabling it to report US $25 billion profits, while paying staff at $7.50 per hour. (The Norwegian Sovereign Wealth Fund has barred Wal-Mart).

Those fund managers might also want to have a say on the extreme wastage on executive entertainment.

Most will recall the crass US million-dollar budgets for birthday celebrations for the wives of executives, a practice in vogue during those crazy days prior to the global financial crisis (Tyco, Enron etc.).

In an era where inequality will lead to a change in the way capital and labour share profits, there will also be a new focus on stupid excesses, companies effectively abusing company money with ridiculous use of expense accounts, and the propping up of fragile egos by using precious cash for trinkets like company aircraft.

Likewise corporate sponsorship will surely invite more shareholder input.

(How much ‘’Brierley’’ shareholder money was given away?)

Shareholder involvement in determining executive pay, expense policies and sponsorship is surely the optimal way of addressing bad practice.  Clearly the directors as a group often fail in exercising wisdom.

If shareholders cannot address the problem, it will be left to politicians and legislators, urged on by the voting masses.

Failing that, it will be the sharp end of a pitchfork that prompts a solution.

Surely the better process for solving the problem will be obvious.

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TRAVEL

Kevin will be in Christchurch on Friday September 30th at the Russley Golf Club.

Edward is in our Wellington office (Level 15, ANZ Tower, 171 Featherston St) on Tuesdays, available to meet new and existing clients who prefer to meet in Wellington - by appointment please.

I will be in Albany and Mt Wellington on Monday October 10th and Tuesday 11th.

David is now back from Japan, sadly having lost some days due to food poisoning, requiring hospital treatment.  Penelope is in Sri Lanka, last seen as a lightweight elephant jockey, an occupation of her distant past.

Both David and Penelope hope to share their relevant observations in a future Taking Stock.

Chris Lee

 

Managing Director

Chris Lee & Partners Ltd

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TAKING STOCK 8 SEPTEMBER

 

AMONG the many subjects I need to know more about, apiculture has never reached the top, but when I look at the hockey stick trend line of our honey exports, priorities must change.

New Zealand just six years ago exported $98 million of honey.

Since then the export numbers have grown in value, as follows:

2011 - $102 million

2012 - $121 million

2013 - $145 million

2014 - $187 million

2015 - $223 million

Registered beekeeping enterprises have grown from 2957 (2010) to 5551 (2015), beehives 376,673 (2010), 575,872 (2015) and annual production has grown from 12,553 tonnes to 19,710 tonnes.

Honey exports have grown from 7,147 tonnes to 9,046 tonnes over those years, representing total growth of 26.7%, yet the value has risen 127.5%.

Clearly honey prices are higher and far more of the honey exported has been the highly valued Manuka honey, which is now selling for the high UMF (Unique Manuka Factor) band, at prices three times the prices that applied five years ago.

Something is going right.

Much credit belongs to the NZX-listed honey company Comvita, whose share price signals the success Comvita has had in marketing the high-value honey products.

I found interesting the information that honey often increases in UMF bands while in storage.

Effectively the company which buys a barrel of honey (300 kilograms) on the wholesale market at $25 per kilo may start out with honey UMF rated 5, but after a year in storage the chemical change in the honey may move it to a higher UMF band, adding to its value, as happens, for example, with some wines.

Prices are always changing but as an example honey with a UMF factor of 5.0 might sell for $25 a kilogram but each additional band may be worth more.

Indicative values last month were

UMF 5 - $25

UMF 6 - $26

UMF 8 - $36

UMF 10 - $51

UMF 12 - $57

UMF 15 - $91

UMF 18 - $125

The value of honey is not simply a function of UMF rating.

Manuka honey, widely accepted as having antibiotic and other health qualities, is unique honey, exclusively gathered from hives where the bees feed on Manuka flowers.

There is a tiny pocket of Manuka forest in Australia but as a generalisation, Manuka honey is a New Zealand product.  The King Country and Northland areas have been planting Manuka to facilitate growth in the honey sector.

Curiously the world is sold ‘’Manuka’’ honey each year in volumes four times New Zealand’s production.

In effect, wholesalers overseas mix the honey and mis-label it, undermining the exclusive value of the NZ product.

Dozens of countries buy NZ honey, as a food or a medicine.

We exported 9046 tonnes last year.  Hong Kong took 1200 tonnes, China 1600t, UK 2100t, Australia 1000t, USA 500t, Japan 500t, Germany 100t, and the rest of the world 1040 tonnes.

China does not like the mis-labelling and is about to take action which should stop those who mis-label by mixing the largely NZ product.

It will be licensing Chinese honey importers and requiring those who export to China to be registered and to have their product certified by science, as our best honey exporters do.

The industry expects such a system will add value to our unique product and will result in lower supply as the fake labelled honey is removed from the supply chain.

I was intrigued to learn that beekeepers in New Zealand will lease land from landowners, pay a regular rent, and install and manage beehives.  One Auckland hotel roof collects rents from its beehives.

A growing number of New Zealanders now earn rental money by entering such an arrangement.

Comvita has been at the centre of much of this.

It deserves great credit, as does its board, led by sharebroker Neil Craig, who fended off a foreign takeover bidder, seeking to buy the company just three years ago for a price less than half of today’s market price.

Many of our exporters have piggy-backed on Comvita’s international marketing success.

One of these is Oceania Natural (ONL), a small player, which raised capital and listed on the NZX NXT board for growing companies.

It certainly has been welcomed by the honey sector and its enthusiasts, its share price implying great confidence in its ability to execute its plans.

It also has a Noni factory in the Cook Islands, the Noni juice popular as a healthy fruit drink.

ONL has a market value now seven times that of another well-known NXT listing, Snakk Media.

It was ONL’s recent offering of a ‘’Manuka honey ‘’ bond that led to my knowledge-gathering.

The issue was organised by CMP Ltd, a capital market niche company managed by Tim Preston, previously a long time participant in NZ financial markets, most visible for his long role as CEO of ASB Securities.

ONL, with Preston’s help, has an offer for Wholesale (Eligible investors), limited to that group because there is no investment statement authorised by the market regulator.

Eligible investors are offered a 12-18 month term, interest paid quarterly at 8% p.a., with a possible, but not certain, bonus on repayment date, should the honey’s UMF band have improved.

Investors would be paid a bonus equating to 20% of the value of that UMF rating improvement.

Eligible investors would have their investment supervised by the national law firm Duncan Cotterill, which would ensure each investor is allocated as security for his loan, barrels of honey, labelled in the ownership of the investor.

The minimum investment, around $46,500, would attract ownership of five 300kg barrels of certified, insured, properly stored honey.

If for any reason ONL defaulted, the honey would be saleable by the investor (or his agent) to any of the other NZ wholesale buyers of what is a product with limited supply.

ONL is using this unusual offer to acquire stock when it is available, enabling it to meet the demand created by its sales team and by its Hong Kong partners.

It wants to raise around $8 million to build up its stock.

Wholesale or Eligible investors (defined in the Financial Markets Conduct Act) interested in the details of this unusual and higher-risk type of investment are welcome to contact us.

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THE country’s most experienced financial market journalist is probably Fran O’Sullivan, now with a senior role at the NZ Herald.

She has particular interests in Fonterra and China, and clearly has a focus on politics, but to her credit since her move to its business section, the NZH has had occasional forays into real business journalism, with results that will help those of its readers who invest.

One such group would be the KiwiSaver investors, where combined funds now exceed $30 billion.

It is probably child-like to claim that half of the contributions come from subsidies by employers, as it is very likely that most of the employer contributions are really just transfers from potential wage increases.

But the $30 billion plus is real, the savings one day will help the savers, and KiwiSaver contributors ought to take a greater interest in their savings than is implied by their behaviour.  The tiny tax benefit is also a ’’free’’ component of the returns.

The NZ Herald performed a useful public service recently when it conducted an analysis, superficial but still useful, of the costs of fund managers.

The analysis was superficial because fund managers have the right to deduct certain expenses as well as the management fee, and these deductions are not visible.

Unsurprisingly the NZH summary observed that the most extravagant fees were charged by NZ Funds Management, which has a history connected to Doug (Somers) Edgar and Money Managers, Gerald Siddall and Russell Tills, all founders and shareholders in the appalling First Step product that cost investors more than a hundred million, but provided its owners and salespeople with income close to that figure.

NZFM also had a ‘’Super Yield’’ call fund, filled with synthetic floss, which cost its investors dearly and in one unpublished case led to a substantial total compensation repayment for an angry client.

It bought the rump of Money Managers when the MM brand had arrived in the same trash can as Bridgecorp, Lombard, and Strategic Finance etc.

NZFM now operates as a KiwiSaver manager.

My view is that there are far too many KiwiSaver funds, very few with the scale and intellectual resources to merit their use.

The same applies in general to those selling investments via unit trusts.

We need a handful, or at most two, to offer diversity but I have no idea why we need the likes of NZFM, especially if, despite its history, it somehow today has the highest fees of all such managers.

The NZ Herald’s team has done the public a favour by highlighting this.

I accept that sometimes the best performers spend the most on research, and acquire the most expensive ‘’talent’’ but I would be struggling to keep a straight face if I used that explanation for NZFM’s fee status.

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INVESTORS observing the continued rise in value of the shares of Ryman, Summerset and Metlife will probably be unsurprised.

Often we have written about the inevitable progress of these three companies which enjoy the twin benefits of a rising demand for their product (demographics), and a rising value of property generally (supply and demand).

Many of our clients probably have a full weighting to these three companies.

In Auckland last week I talked to a much admired client who is planning to move into a two bedroom retirement village apartment, from a one-village provider.

Her new apartment will cost more than a million dollars and she will then pay around $11,000 p.a. for her running costs and contributions to the villa.

Meals are not included.

When her occupancy ends, the village operator will repay to her 70% of her $1.1 million ($770,000) unless her occupancy ends inside three years.

Much of her $11,000 annual charges are fixed for life, but not all of that sum.

Approximately 40% of the charge is reviewable at the operator’s discretion.

Our client, perhaps more a friend than a client, will enjoy a quality life, with access to care should it be needed, and will have nice surrounding facilities.

The capital gain upon termination, of $330,000, is certain. If the apartment rises in value, that rise is also for the operator, not the resident.

Does this explain why we observe that the shares of the big three listed operators are over-represented in client portfolios?

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RECENTLY I referred to Karori’s suburban population as being 30,000.  That figure was from an old Karori electorate number which included other suburbs.

Karori’s actual 2013 population was said to be nearer 13,000.

Thanks to the reader who brought this to my attention.

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TRAVEL

 

David is back from Japan next Monday.

I am in Christchurch on September 20th (pm) and 21st, at the Chateau on the Park.

Edward is in our Wellington office (Level 15, ANZ Tower, 171 Featherston St) on Tuesdays, available to meet new and existing clients who prefer to meet in Wellington - by appointment please.

Kevin will be in Christchurch on September 30th.

Please contact us if you wish to meet us in these cities.

Chris Lee

Managing Director

Chris Lee & Partners Ltd

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TAKING STOCK 1 SEPTEMBER 2016

 

PATIENT investing is not a common description of investment behaviour in New Zealand.

By Swiss standards we would almost all be regarded as day traders, so impatient are our investors for visible progress.

But when Powerhouse Group many years ago began to form its relationship with the University of Canterbury, later extended to other New Zealand universities, it invested knowing that an idea beginning with university research might take a decade to achieve commercial success.

Powerhouse provided seed finance and board leadership to assist ideas that might be commercialised and so today, here we are learning that three of the 27 different companies it will have in its portfolio shortly, are about to achieve commercial scale.

Powerhouse says it is not an angel investor, it is not a venture capital fund, where finite terms are in place, but is a patient investor fund, with no time limits placed on those whose ideas it is trying to commercialise.

All of Powerhouse’s investments are described in the prospectus it has produced as it seeks A$20 million, and moves to a listing on the Australian exchange, as the next step in its own development.  The money it will raise will be used entirely for its projects.  Its offer is open to all New Zealand investors.

Its ultimate step will be to raise more money, perhaps next year, enabling a dual-listing in Australia and here.

Powerhouse so far has had to measure the progress of its incubated companies by obtaining fair value reports, usually issued by accounting firms, but not validated by the ‘’market’’.

Using its ’’fair value’’ assessments, Powerhouse has averaged a 35% growth rate for many years, and expects this growth rate to be at least maintained in the future.

It has been supported publicly, notably by the Christchurch City Council, which has a chunky ownership of Powerhouse, and some of its incubated companies have received helpful grants from Callaghan Innovation, a fund maintained by the Crown.

Its current fundraising is being done at asset backing, A$1.07, a lower rate than the price set last year when it raised capital.  To atone for the higher price set last year, Powerhouse is to top up with ‘’free’’ shares, the earlier investors, so they are not disadvantaged.

Powerhouse believes it has three companies whose ‘’fair value’’ will soon be validated by sharemarket listings

Those companies are;

Hydroworks, whose turbine designs achieve efficiency gains for hydro plants.  Output increases of even just three percent translate to huge dollars for power plant operators.

The Christchurch based company has won significant contracts in Australia to refurbish old hydro plants, and does so because it can prove its turbines produce more output.

The company also produces mini-turbines used in irrigation canals to provide tiny hydro plants with power, at very low capital cost.

Hydroworks three years ago raised capital at $17 per share.  Its fair value is now said to be $51.

It plans a share split, and then a capital raise in NZ and Australia to validate the assessed fair value, and is optimistic that at least in Australia, where its main projects currently are sited, it will attract commercial investors to facilitate a sharemarket listing.

It hopes the $51 will prove to be a conservative valuation.

Crop Logic is its second star performer.

It delivers agronomy services to growers using technology developed by the NZ Food Institute for Plant & Food Research.

It combines crop science, environmental data and mathematical models to optimise production, and to minimise losses, for example through crop stress caused by inadequate irrigation.

And Powerhouse is excited about another university invention, a robot that can climb flat surfaces and perform better and more safely the sort of work previously done by men up ladders.

For example the robots can inspect the huge storage facilities used in the dairy and oil industries.

These three companies are all on the verge of achieving commercial scale and positive cash flows and margins, according to Powerhouse.

Of the other 24 incubated ideas, the one with obvious appeal is the cats eye, used on roads with a solar battery that powers a thermometer that guides an LED light, that changes colour as the road surface cools and freezes.

The same cat’s eye can also measure traffic volume and speeds.

Very obviously this sort of device would be useful in winter on roads like those leading into Dunedin, which become dangerous as ice forms.

The lights signal temperature changes to motorists and the traffic movement data signals Transit as to where and how best to spend its roading budget.

The various councils will now be legislating to make the lights ‘’legal’’.

Powerhouse’s selection of ideas that it has helped fund and support are in its prospectus, for the offer which closes in 10 days, though the closing date may be extended.

Minimum subscription is $2000.

The prospectus contains all the required warnings about risks involved in ‘’patient’’ investing.

Interested people are welcome to contact us for a copy.

Disclosure: I hold shares in Powerhouse.

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NOT such useless information department.

Courtesy of Macquarie research, I can advise that in the USA the richest 0.1% of Americans own 12% of America’s wealth.

The top 10% own 64% of the wealth.

By simple arithmetic, those not in the 10%, are left with 36% of the wealth.  Heaven help those in the bottom 50%.

Before any reader of this gets pious, let me record that the average New Zealander would get into the top 10%.  Fifty three percent of New Zealanders are in the richest 10% of the world’s population.

There is not a single New Zealander in the poorest 42% of the world’s population.

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SINCE 1980 the United States debt level in real terms has multiplied by 14 times, while GDP has increased by 6.2 times.

Debt levels can never be addressed, unless there was extraordinary economic growth, or high inflation.

Inflation is easier to achieve than growth.

Some years ago the highly reputable Boston Consulting Group researched the various credible ways that the USA could ever service its debt levels sustainably.

It calculated that every American could keep in an untouched silo, the house he owned and $100,000 of other assets.

On all his other wealth he would need to pay a 25% immediate asset tax to Uncle Sam.

Quite how all Americans with wealth could convert assets into cash to pay for this tax, without swamping the market with sellers far outweighing buyers, was not explained.

Europeans should not grin at the US discomfort.

Boston Consultancy Group found that every home in Europe would need to be subjected to similar treatment to get Europe’s debt level down to a point where tax revenue could service debt sustainably.

The European problem is worse.

There, the asset tax would need to be 50%, of every asset other than the prime residence, and 100,000 Euros.

In New Zealand if every adult paid $20,000 today to the Crown, we would have no sovereign debt.

If we could just arrange for everyone to win second prize in the Golden Kiwi, we would soon come right!

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INVESTORS concerned about the absurdly rich 0.1% of Americans, whose wealth is so extreme, should know that at least a small number of those rich people are themselves concerned about the absurdity of their wealth.

One such multi-billionaire has written to his rich peers imploring them to reduce their wealth grab by significantly increasing the wages of its workers to at least double the current US minimum wage of US $7.25 per hour (say NZ $10).  Our minimum wage is $15.25.

Any reader wishing to read the letter sent to other wealthy gnomes can read it on

http://www.anonews.co/ultra-rich-mans-letter/

I found it refreshing and a beacon of hope.

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SMALL towns like Fairlie, Waikanae and Carterton dislike intensely losing a retail bank, so when Westpac announced its plans to close 19 of its least productive banks, it was logical that the affected towns would be unimpressed.

If the business passed up by Westpac was worth having, bet your boots that Kiwibank or someone else would move straight into the towns.

Their marketing would have been done for them.

Westpac is New Zealand’s least popular bank, Westpac New Zealand always having been treated by Australia as the East Tasmanian branch of the bank.

Going back twenty years or more, it has had poor leadership, some very poor corporate lending staff and its presence in the capital markets has been decidedly lumpy, some of its practices a long way from the standards set by its competition.

However, it is the Crown’s bank, having won a tender in recent years, perhaps boosted by a $10 million donation to a Crown innovation fund, that needed seed-funding, it seems.

Having said all of that, I understand Westpac’s decision.

In effect it is exercising its right to turn away from areas where costs exceed revenue.

I find this easier to rationalise than the more extraordinary decision of Kiwibank/NZ Post to quit a direct role in Karori, a Wellington suburb of 30,000 people, not a rural town of a few thousand.

In Karori Kiwibank/NZ Post has moved its local branch from its own flagship to a counter in the local Mobil station!

Queues and a degree of bumbling service are accepted by Kiwibank customers, perhaps justified by the cut-price service it offers.

Similarly queues through under-staffing are problems faced by just about every customer in NZ Post.

But to be required to queue and then transact in a petrol station is surely not something ever envisaged.

Where next?  The local fish and chip shop?

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KIWIBANK seeks to cut costs, and so far has shown no signs of wanting to scale up, to be a credible threat to the dominant Australian banks.

But I would rather have its problems than those facing Deutsche Bank which recently scuttled off from New Zealand, and is now here only through its probably profitable position as a partner in the Tauranga based sharebroker Craig & Co.

Readers may recall from my notes published when I was in Berlin earlier in the month, that Deutsche Bank is immersed in a quagmire of its own making, in Germany.

It has been fined seven billion euros so far, for its manipulation of various markets, including the FX market, the gold market, and the Libor interest market.

It has paid huge penalties for its role in selling mis-described and useless sub-prime mortgage securities.

It has a bad debt problem.  Its share price is little more than a quarter of its previous high, it has sacked a CEO and bought in another, and it has not done well in derivative market trading.

And the tea lady at head office has been late with her morning delivery twice, in the last week.  Maybe not.

I wrote a fortnight ago about Deutsche Bank’s next migraine, which may stem from its illegal behaviour with the Russian oligarchs.

Deutsche Bank has a Russian operation, in sharebroking, headed by two Americans and two Russians.

I would expect their remuneration would become extreme if the contribution of their branch was extreme.

The Russian branch income was extreme!

They transacted billions of dollars of orders for Russian oligarchs who were wanting to get money illegally out of Russia.

The Russians would sell shares in Russia and buy them straight back in other countries and allow Deutsche Bank to charge them 0.1% to 0.15% on each deal.  This is called mirror trading.

The volumes over a period were in multi-billions.

Allegedly Putin’s family were clients, as were many of Russia’s oligarchy who made billions when the USSR was dismantled.

The transaction effectively turned roubles into dollars, pounds or euros.

DB’s compliance people in Britain found no reason to intervene.  (Britain seems very silent on any matters that result in London making a quid!)

If you clip a US$10 billion ticket at 0.1%, you make brokerage of $10 million, and these sort of volumes occurred regularly throughout a year, generated by a small office.

Deutsche Bank is now under siege.

The Russian market regulators found little to criticise in DB’s behaviour but fined them a token amount of around five thousand dollars.  Putin must have been relieved.

The American and European regulators have a record of fining such behaviour in billions not millions.

These illegal activities were revealed last year, and are now openly discussed in Germany.

Deutsche Bank is Germany’s most important bank, and has a long history.

Are we about to witness a follow up to the Volkswagen emission fraud?

German people believe DB will survive.

It may, but not with dignity.

Will the London end of this scandal also emerge?  Eventually it must emerge.

Watch this space.

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THE legal investigation into the treatment of South Canterbury Finance preference shares has now been completed.

The outcome of this investigation will be determined over the next weeks.

Those who funded the investigation, and perhaps all other SCF preference share investors, can expect to hear from me as soon as the outcome of the next stage is known.

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TRAVEL

Edward is in our Wellington office (Level 15, ANZ Tower, 171 Featherston St) on Tuesdays, available to meet new and existing clients who prefer to meet in Wellington - by appointment please.

Kevin will be in Christchurch on Friday 30 September.

I will be in Christchurch on Tuesday 20 and Wednesday 21 September.

Investors wishing to make an appointment are welcome to contact us.

Chris Lee

Managing Director

Chris Lee & Partners Ltd

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