Taking Stock

Read the latest Taking Stock

Johnny Lee writes:

As our reporting season rumbles on, equity markets both here and abroad continue to fluctuate as the world considers its next step.

The New Zealand market is down 8% for the year, largely on the back of a pull-back in the share price of Contact Energy and Meridian Energy – both of which surged in the final week of 2020 following buying pressure from overseas funds.

Listed Property Trusts, including the likes of Argosy and Precinct, have also had softer share prices.

With long-term underlying interest swap rates rising in the last month, those with long lease terms will become comparatively less attractive if interest rates were to rise. The Reserve Bank Monetary Policy Statement yesterday highlighted that the Reserve Bank is in no rush to lift interest rates in response to short-term inflationary signals. All policy settings (including the OCR) were maintained at prior levels. The Committee believes that the recent uplift in inflation was being supported by temporary factors, and will not adjust settings until inflation is reported consistently around the 2% target. This appeared to catch the market traders off-guard. Clearly, the Committee is taking a long-term stance.

While there have been some laggards on the exchange, some sectors have rebounded significantly.

The banking and retailing sectors have both started strongly, coming off a low base to lead our market. Heartland, ANZ and Westpac have seen double digit gains, while the likes of The Warehouse, Briscoes and Hallensteins have rallied after the big declines seen last March.

Nevertheless, the New Zealand market now lags its international peers. Underlying results reported by the companies on our exchange are more positive, most focusing on reducing debt, controlling costs and managing cashflow. These steps increase resilience, providing flexibility in a world where economies can be shut down by Government decree.

Those reporting this week include Heartland Bank, Spark, Summerset and A2 Milk.

_ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _

Heartland Bank saw another jump in net profit, as the company announced a 4 cents per share dividend and forecasted a record profit for the full year result in six months time.

For long standing shareholders, the announcement was reminiscent of the pre-COVID era and illustrated further steps being taken to focus the company towards areas where it sees itself having a competitive advantage and greater margins.

Rural and Livestock lending both fell, while Reverse Mortgage and Motor lending continued to surge. Australian Reverse Mortgage lending continues to be a key driver of long-term growth. Pleasingly, market share is still growing in this space. Home Loan lending looks set for impressive growth in the coming 12 months, after a slow period during COVID.

The return to stronger dividends will be welcomed by shareholders. Despite its record profits, the company has been constrained following restrictions set by the Reserve Bank during the height of the pandemic. If dividends were to return to historical pay out levels (the dividend in 2019 was 10 cents per share and growing each year) then the current share price would offer a compelling yield.

Readers may recall that in the height of the pandemic panic, the CEO of the company was among those buying, when the price was less than half of what it is today. His confidence in the company has been rewarded, as has those who followed his lead.

Heartland remains one of the year’s best share price performers, alongside the two Australian banks. Its pathway forward, strategically, has not changed - using digitalisation to control costs and target new markets, while expanding its Australian offerings for older customers, as they transition from employment to retirement, and eventually to aged care.

_ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _

Spark shareholders will be satisfied with its result, with dividends stable as the core business (mobile and broadband services) remained flat.

With population growth from migration remaining low (COVID related) and higher-margin roaming mobile data use falling (also COVID related), overall revenue fell, although a decline in expenses helped offset this.

Early concerns about the slow payment from COVID-affected customers have been put to bed, with bad debts lower than expected. A modest increase in net debt is likely to unwind over the second half of the year.

Spark’s expansion into streaming of live sport remains a curious one. Broadcasting rights is a business fraught with risk – where competition for rights often leads to ballooning costs, which inevitably find their way into customers monthly invoices. Sky TV shareholders will be keenly aware of how valuable these broadcasting rights are – but the value is ultimately irrelevant if they cannot be profitably utilised. Sky TV’s warning that its sports offering would need to increase in cost again highlights these risks.

Spark also made progress towards offering a digital health platform and launched a water metering platform. Ultimately, these areas represent strategic goals and pathways to long-term growth and are not yet relevant to the company’s bottom line, which will remain anchored by the performance of its Mobile, Broadband and Cloud offerings.

Spark’s dividend yield, in excess of 7% gross, has made it a staple in income investor’s portfolios. With its share price remaining remarkably steady over the last 18 months, the half year update contained no surprises and illustrated its value to those seeking reliable dividend paying shares.

_ _ _ _ _ _ _ _ _ _ _ _ _ _ _

For shareholders of Summerset, the result will depend on your perspective.

Underlying profit, which fuels dividends, fell 7% due to costs associated with the COVID pandemic. Without this $9.2 million dollar expense, underlying profit would have risen slightly.

The dividend did fall, from 7.7 cents per share to 7 cents per share. The annual dividend fell from 14.1 cents last year to 13 cents this year.

However, headline net profit, with includes non-cash items such as property revaluations, rose significantly. Summerset’s assets, including its land bank, continue to increase in value as the overall property market reaches for the stratosphere.

Assuming the vaccine rollout is successful (and the vaccine has the desired effect) then next year should see Summerset continue on its path of profit growth and dividend growth. The fear of house price depreciation has not yet been justified, and the twenty-three sites currently in the development pipeline promise significant growth for shareholders. Two of these sites are in Victoria, Australia, as Summerset joins Ryman in seeking to expand its model outside these shores.

Summerset’s share price rose after the announcement, approaching fresh highs.

_ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _

A2 Milk’s dream run on our exchange took a stumble following the release of its half year update, with the impact of COVID continuing to hurt sales from within China. The share price slumped after the announcement.

A2 Milk relies heavily on Daigou exporting – or the purchase of goods abroad by Chinese nationals who return with the goods for sale within China – to drive sales, particularly from Australia. COVID continues to impact this distribution channel.

The company forecasted this result in December last year, but the short-term outlook provided this morning, for the full year result due in August this year, was towards the bottom end of the range previously given. It also, perhaps optimistically, assumes that the Daigou channel will see ‘’significant improvement’’ over the final quarter.

For longer term investors, the strategic update is worth reading. The company sees potential for growth in the ‘’offline retail channels’’ in China, in-roads are being made within the US, an agreement is in place for distribution within Canada, and the company maintains a large cash pile on hand for investment.

The pandemic continues to cause havoc for businesses around the world, but for A2 Milk, it has highlighted a significant vulnerability on a particular part of its distribution network. The company will be hoping for continued success from the vaccine rollout, while working to improve resiliency to future disruptions.

_ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _

Chris Lee writes:

Intuitively, most of us recognize that democracy is a poor system by which to choose our governors. Moving to a better system is a problem.

No one has found a consistently better system, though Singapore might argue that benevolent dictatorships, such as it had when under Lee Kwan Yew in earlier decades, produce much more strategic leadership and greatly improved living standards.

Here, whether it is choosing Governments, councils or business governors, by accepting democracy we have had to accept bleak mediocrity and avert our eyes from levels of corruption or interference, from those who fund the campaigns to win office.

As an obvious example, we could look at how the National Party, under its president Peter Goodfellow and its telegenic leader John Key, have embraced Chinese funders and, in some cases, other self-focused funders. Naturally, anyone offering money wants, at the very least, the right to propose changes.

Anyone reading the book written by a New Zealand journalist “In the Jaws of the Dragon” would have been mortified by the accusations made, and by the evidence of political cooperation with stronger- foreign powers.

As Wellington and Dunedin have long discovered, councils are also elected after fund raising, raising doubts about the promises made, to attract election funds.

In my own home town Kapiti has previously had a mayor, a man of miserably low social and business skills, funded by private sector interests, who wanted land re-zoning to facilitate their developments. The re-zoning process became rather less formal than might have been the case previously.

Film production genius Peter Jackson openly funded a campaign to elect Wellington’s current hapless mayor, and in Dunedin the ‘’Tartan Mafia’’ has had a strong hand in ‘’guiding’’ Dunedin’s decision-making for decades.

Those who aspire to political appointments rely heavily on raising money to support their need to be noticed at a higher level, where the advertising and personal promotion budgets are substantial.

Whether or not the biggest budgets always achieve electorate success is unknown to me, but there is no doubt face and name recognition dictates the votes of people who cheerfully admit they ‘’have not got a clue’’ but want to exercise their democratic right to vote.

Of course list-created politicians have much less promotional costs, their targets being the party leaders, who influence the composition of the list, there being no need to interact with the public.

It is not hard to recall ‘’list’’ politicians who would never have been successful at the polls.

From all this, companies and investors have much to learn.

Investors cannot prevent distinctly ‘’average’’ people from being appointed by Governments or companies to position requiring a vote, explaining some of the appalling choice on many public boards, including the old Securities Commission, and any number of district health boards.

Investors have the right to be heard when there are votes on directors or on corporate matters, or when an election is required.

And so they should! They share the ownership of the company.

Last week in Taking Stock I recalled how insurance mutuals were long dominated by dopes, able to gather up votes from policy-holders, irrespective of their often invisible governance skills or suitability for the task.

This was also true of corporates where even the likes of Brierley Investments would bring in improbable people, its directors knowing those dopes would not disturb the status quo.

One company chairman of a rotten company in the 1980s told me how he paid $50,000 in cash, under the table, to lure in a prominent, but useless, national figure, because ‘’the institutions wanted a high profile, independent chairman’’.

The company, unsurprisingly, had a very short life on the NZX.

Regularly retired politicians, with zero useful knowledge, were and are appointed.

Well, all this can change and small investors can be part of that change.

Thanks to wily, eccentric Auckland accountant Bruce Sheppard, the New Zealand Shareholders Association was formed. It has now matured and has the potential to be an effective guard dog for investors.

Sheppard raised the early, necessary public attention by clowning, donning costumes and skylarking at annual meetings, while raising serious issues.

He was the only person willing to state unequivocally that the Hanover directors were misleading investors, and aggressively identified two of them, Eric Watson and Mark Hotchins, as ‘’enemies’ of the investors.

He conducted many campaigns, sometimes successfully, and from all the publicity gained the momentum that enabled the NZSA to become a large credible organization and a handbrake on public company excesses.

Sheppard has continued his campaign of doing ‘’God’s work’’ by becoming a director and shareholder of LPF, by far the country’s most effective litigation funder, specializing in holding public company directors to account. He joins an impressive board of directors in this role.

Meanwhile, the NZSA has matured into an organisation with a wide range of activities:

It attends annual meetings and uses knowledge and research to question directors and guide the shareholders.

It accepts proxies from any retail investor, voting on behalf of those who might not have the knowledge to vote, or the ability to attend these meetings.

It arranges regular meetings around the country for its members, inviting useful speakers, often the chief executives of public companies.

It arranges member-only visits to companies, where a bus-load of members will be treated to a full company presentation.

Michael Warrington has long been an NZSA member and talks highly of the value of membership. He also encourages all investors, who do not habitually vote on company matters, to award the NZSA their proxies.

The NZSA, and the litigation funder LPF, helped by the courts are the best ‘’friends’’ that investors can access, along with a Financial Markets Authority with at least some incisors, unlike the gummy Securities Commission.

Those organisations are doing what the under-powered Ministry of Business Innovation and Employment, and its struggling offshoots like the Companies Office, do not do; that is offsetting the still fragile work of auditors and directors, who assert that they work to uphold good standards.

Perhaps it is a shame that there is so little monitoring of the behaviour of politicians and local councils, the Auditor-General not having the resources to oversee the often dreadful processes and decision-making that characterize councils. Perhaps councils can rarely attract effective people with experience and useful knowledge.

The NZSA will itself need to be careful that its governance attracts people with pure motives, presumably beginning with the desire to use specialist knowledge, developed networks, and genuine experience to advance the interests of retail investors.

They, no more than companies, councils or government, will not want people grasping for their moment of fame, their two minutes on the telly, and their monthly emoluments.

The NZSA should be competent and thus able to sift out any board applicants who lack knowledge, relevant experience or lack the ethic of wanting to help others.

_ _ _ _ _ _ _ _ _ _ _ _

TRAVEL

Edward Lee will be in Auckland (Remuera) 11 March Auckland (CBD) 12 March, Nelson 14 April (PM only) and Blenheim 15 April.

Michael will be in Tauranga (Mount Maunganui Golf Clubon Monday 1 March, then Hamilton (Airport) on 3 March and in Auckland (Milford Cruising Club) on Thursday 4 March.

Johnny will be in Christchurch on 11 March.

Chris Lee

Managing Director

Chris Lee & Partners Limited

This emailed client newsletter is confidential and is sent only to those clients who have requested it. In requesting it, you have accepted that it will not be reproduced in part, or in total, without the expressed permission of Chris Lee & Partners Ltd. The email, as a client newsletter, has some legal privileges because it is a client newsletter.

Any member of the media receiving this newsletter is agreeing to the specific terms of it, that is not to copy, publish or distribute these pages or the content of it, without permission from the copyright owner. This work is Copyright © 2021 by Chris Lee & Partners Ltd. To enquire about copyright clearances contact: copyrightclearance@chrislee.co.nz