Taking Stock 22 October, 2020

Johnny Lee writes:

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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David Colman writes:

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

High Court approval will also be required.

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

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

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

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Investment Opportunities

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

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

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

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

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TRAVEL

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

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

Johnny Lee will be in Christchurch on 25 November.

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

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

Chris Lee & Partners Ltd