Client Advisory

---

May 12 2010



MARKET COMMENT:


No shortage of discussion topics this week.


Perhaps scariest was the near-1000 point dive by the Dow Jones during lunchtime trading last Thursday that was largely recouped by the time most traders had digested their Big Mac combos and returned to their dealing stations. Down and up 8% in the time it takes to drink a grande frappucino … by any standards that is thrilling stuff!


Relief that the temporary Wall St collapse proved to be just that, temporary, alleviated some of the market’s worst fears that any European sovereign debt crisis might eventually dwarf the 2008/09 American private-sector (colloquially referred to as the “sub-prime”) debt crisis. And within twenty-four hours the European Union – encouraged by a wary Barack Obama fearful that European debt problems might hurt the US financial sector (please refrain from choking on the irony of that one!) – came to the party with a humungous $US700b credit-guarantee plan that effectively removed sovereign-debt failure as a market risk.


For now.


The markets celebrated for a day, the Euro soared … and then both the currency and equities markets eased back towards whence they came. Why? Without a plunging Euro and collapsing bond markets to spur transgressing European nations into action, there is concern the imbedded fiscal ill-disciplines among the weaker Mediterranean economies will now go back on to the back-burner i.e. they will not be addressed with the same urgency as had Greece when confronted with a sky falling around it. The guarantee of sovereign debt issues by the likes of Portugal, Spain and Italy (and these are merely at the top of the ‘worry’ list) will essentially lead to a transfer of “wealth” from the more efficient northern European countries to their more wasteful southern neighbors. The wealth transfer will be in the form of sacrificed growth in the north (as they pay the bills), and as the south continues its half-hearted efforts to reform in already-difficult economic conditions.


The upshot of all this, and the reason the Euro will renew its journey south after the brief short-covering rally, is the future revival of the European consumer is now even more distant. Debt is being piled on top of debt in all corners of the Euro-zone. On the horizon is that dreaded two-pronged fiscal attack long feared by equities investors: Higher taxes and reduced Government spending. None of the major European countries will be spared a move to more austere economic management strategies, and the medium-term consequence will be subdued economic growth.


No cause for undue despair, though. The collapse of the Euro will ultimately help European countries to restore their finances. It will boost their competitive positions in export markets, and make their own countries more enticing as tourist destinations (for most economies there, this is a key sectoral performer).


Recovery won’t happen overnight, though, and it places even more emphasis on the emerging Asian economies to drive global economic growth in the short term. Especially China. But Chinese authorities have their own problems to resolve, and they are vastly different to Europe’s. China’s economy has been artificially stimulated (via unduly-lax credit priming) to such a degree that asset bubbles are occurring in residential and commercial property, and in industrial/manufacturing capacity. Inflation is at three-year highs, and rising. And three small incremental increases in lending rates (as well as regulatory changes to tighten property-sector speculation) haven’t taken any heat from property-sector values that are sizzling at an accelerating rate.


China is committed to slowing things down. That means higher interest rates and, eventually, a higher yuan. It may also mean the Chinese consumer will not be there to take up the slack when Europe slows. Which leaves the American consumer as the buyer most likely, medium term. Thankfully, recent US economic data suggests the employment sector there is turning the corner, and growth is at hand. And the housing market’s outlook at last seems a tad more prospective. Whether any broad-based US economic recovery proves sufficiently vigorous to fulfil the optimistic expectations of equities investors remains to be seen.


Australian commentators yesterday suggested the markets might have already hit their 2010 highs, and that European debt “issues” will re-emerge in short order to further unnerve the markets and prompt further weakness. It is difficult to argue against the assessment. If so, the resources and banking sectors will be places not to be for the rest of the year.


What to do in our little corner of the world? It should be assumed that any further upheaval in world financial markets will cause Alan Bollard to defer plans to raise interest rates in mid-year … we believe any move will occur in September at the earliest. The upcoming profit-reporting season (for periods ending March 31) will further separate the winners from the losers in these sluggish economic times. There is no reason to think companies that have outperformed the rest recently, in similarly difficult conditions, cannot continue to do so (and, indeed, outperform further when circumstances permit). The likes of Nuplex, Restaurant Brands, even Air NZ at the right price, neatly fit into this space. Yield, too, is a precious commodity at this point in the cycle, and gives comfort while share-price fluctuations work their way through the low point of the share-price cycle. Hallenstein Glasson, NZ Refining, and property stocks Goodman Property Trust and ING Property Trust remain best bets.




January 20 2010



2010 Prospects … and `What We Wouldn’t Give for a Decent Round of Earnings Upgrades!’


Re-engaging the grey matter in early-2010 after the festive break is much like driving the ol’ Morrie 1000 home from the garage after yet another engine re-bore … you’re hopeful a new era of surprise-free adventure is at hand but the ear remains keenly sensitive to any of the strange sounds that heralded yesteryear’s problems. Early trading in the US was initially positive – possibly too positive – but the past week things turned a bit pear-shaped as up-beat results from Intel and JP Morgan failed to inspire further investor buying. And when share prices don’t react to good news … well, it’s not a good sign. It says that investors have become too optimistic, that market expectations have got ahead of reality. Add into the mix a string of sobering economic numbers (among them disappointing December retail sales, accelerating home foreclosures, and stagnating new house-building data) and it is no surprise that Wall St is having trouble adding meaningfully to 2009’s big rally.


The local market has similarly suffered from investor apathy in the first weeks of January. News has been scarce, and little of it we have seen has been less than inspiring. Auckland Airport (AIA) had rallied nicely over Xmas – up from about 190c to nearly 210c - ahead of its announcement it was buying 25% of the Cairns/Mackay airports for about $166m. The stock has since lost all the ground it gained. The market thus sent AIA a none-too-subtle message: “Stick to your knitting! Trading is not so buoyant, and operational execution at home is not so precise, that you can blow hard-earned cash on minority positions in second-tier airports abroad.”


News from retail operators has also been ambiguous. The Warehouse lost ground when it reported flat Xmas sales, whereas Michael Hill surprised on the upside with its numbers. Hallenstein Glasson and Postie Plus are expected to sustain an evident recent trend that has smaller, specialist retailers (especially those operating at the value end of the market) doing better than the more diversified operators.


Apart from largely-anecdotal data reaching the market about trading fortunes in fourth quarter 2009, investors have been keeping a close eye on the currency and interest-rate markets. These, in turn, have been influenced more by trends on international equities markets than by domestic factors. As the rally on world equities markets was sustained in the run up to Xmas, increased appetite for “riskier” (commodity) currencies like the $NZ became evident. Thus as Wall St rose, the $NZ rose. This tended to impede the ability of NZ shares to replicate the gains enjoyed by overseas peers. It would be logical to assume than any underperformance by Wall St in 2010 that might occur in the event of a stagnating economic recovery there might be trigger a downward correction in the $NZ. This would not be unwelcome.


The NZ equities market, which (as said) has lagged the recoveries on Asian/US/European/Australian markets last year, will not get the earnings upgrades it craves to drive a meaningful, broad-based rally higher unless the currency weakens. A lower $NZ (preferably as much as 10% down on current levels), and a further six months of basement-level short-term interest rates, should give a decent enough shot-in-the-arm for domestic operators to encourage a lift in profit expectations for FY11 and beyond.


Meantime, investors should retain focus on the short list of stocks that (amazingly) have already started to generate earnings upgrades. In this camp are the likes of Restaurant Brands, Tower, Nuplex (now a tad expensive, though), and retailers Postie Plus/Hallenstein Glasson. A watchful eye should also be kept on stocks that are trading at deeply-discounted values, the share prices of which should rally aggressively when signs of recovery eventually surface … in this space are stocks like Air New Zealand, PGG Wrightson, Guinness Peat Group and Fisher & Paykel Appliances.


Income-sensitive investors will like the near double-digit (gross) dividend yields offered by Hallenstein Glasson and Vector. However, conservative types should stick with the premium property-sector listings like Goodman Property Trust (gross 11.7% yield) and AMP NZ Office Trust (11.6%), and patiently wait for the inevitable sectoral up-cycle to take care of their capital-growth expectations.







August 1 2007

SUDDEN SWITCH TO LOW-RISK FINANCIAL ASSETS HEIGHTENS VOLATILITY ON GLOBAL MARKETS ... BUT IT AIN'T ALL BAD ...
As unnerving as the heightened volatility on global financial markets is – and it has certainly been exactly that during the past 24 hours - there comes with it a welcome silver-lining for NZ investors. The scramble for low-risk financial assets has brought to an abrupt and, to many, premature end to the carry-trade phenomenon ... for the medium-term at least. The $NZ has consequently dived, and will unlikely revisit the extreme levels of last month. The carry-trade strategy that saw big institutional players join with Japanese mums and dads to borrow yen at very low cost and invest in high-yielding $NZ assets had been behind the $NZ's ascent. Now the shoe's on the other foot, and the indecently rapid decline of the $NZ has inevitably caused damage to the sizeable paper profits boasted by most of those carry-traders. The lack of liquidity in the $NZ, particularly in times of market uncertainty, has been brutally exposed. It is likely that by the time international investors regain some semblance of confidence in higher-risk currencies/markets, the signs of economic weakness slowly becoming apparent now in NZ will be more evident. The lower $NZ value will thus be reinforced by that deteriorating data. And the probability the next major move in interest rates will be down rather than up should deter investors from delving en masse into long $NZ positions. The NZ sharemarket gave a hint of what is likely to happen, particularly to exporters and stocks with big offshore positions, when the currency started to weaken (and before wider global equities markets started to ease sharply). Best performances come from the Fisher & Paykel companies, and the likes of Pumpkin Patch and Rakon. GPG may also participate but there remains sufficient doubt about the quality of its mainstay Coats Group plc investment to restrain investor enthusiasm until signs of recovery are more concrete.

RICHINA PACIFIC: BIG SURGE IN FIRST-HALF PROFIT ... IS MARKET OVERLOOKING THIS EMERGING GROWTH PROSPECT?
The road to recovery for Richina Pacific (RPL) has been littered with numerous nasty pot-holes. A loss-making contract secured by its Mainzeal construction unit to build the Vector Arena was the latest in a string of hiccups that for five years has kept RPL firmly in the `could do better if only ...' investment category. But RPL's latest interim result suggests the group is about to cash in on an operational model that has been years in the making. Long-time investors in RPL may have originally bought into 1980s investment-sector favourite, Leyland Growth. After the 1987 crash, the company morphed into Mainzeal Group and, ultimately, RPL. Its only NZ operation now is Mainzeal. Long gone are its NZ-based leather-processing operation, a venison and game-meat marketing arm, and the sizeable Mobil-on-the-Park building in Wellington. Yesteryear's hotch-potch spread of assets has been narrowed significantly. The bulk of its existing assets lie offshore, as does its profitability and (more importantly) prospects. The divisional heavyweight is its 90%-owned leather-making subsidiary in China, Shanghai Richina Leather. It also has the Blue Zoo underwater aquarium in Beijing that this year returned a profit for the first time. The aquarium has the potential to generate a nice surprise next year as tourist numbers surge with the 2008 Beijing Olympics. But back to the interim result. The June 30 profit was $US4.9m (profits are reported in $US because the group is headquartered in Bermuda for tax reasons), up 36% on $US3.6m earned in the FY06 interim. The bulk of the $US9.3m of operating profits came from Shanghai Leather ($US6.7m), with lesser contributions from Richina Land ($US2.1m) and Blue Zoo Beijing ($US0.5m). Richina Land comprises the Mainzeal operation and certain Shanghai properties acquired in tandem with the leather-company purchase. The rental income from the Shanghai properties is improving but at a slower rate than the wider market because many remain subject to long-running leases (signed prior to the RPL takeover). These leases are gradually rolling over at better yields. RPL management says group profit in the second half will at least match the level of the first six months. Investors can therefore reasonably expect a full-year profit of about $US10m (or $NZ13.3m using a US75c exchange rate). In earnings per share, this equates to NZ8.8c ... or a P:E of just over 6 times earnings (RPL's last sale price 55c). The average P:E of NZX50 stocks is 18 times prospective earnings. In other words, the NZX market, generally, is priced nearly three times more expensively than RPL. Yes, RPL has had a chequered trading history and its main operating businesses are housed on distant shores. But it is for these reasons that stocks like RPL can slip below the radar of mainstream market-watchers.The offers good exposure to an expected weakening of the $NZ, and to an ever-improving Chinese economy. In FY06 RPL resumed dividend payments for the first time since 1998, paying out NZ2c of its NZ6.5c of profits. It is likely RPL will be in a position to double the payout this year, providing a yield commensurate with the risk profile of the group. It's not one for conservative types but more aggressive investors may see potential for attractive returns. SPECULATIVE BUY

January 20 2006
SHARP KIWI DOLLAR FALL THE BEST `GIMME' FOR 2006
Uncertain times face NZ investors. An anxiety-riddled central bank governor who sees consumer spending demons and housing bubbles around every corner has seen to that. Bollard's rhetoric about excesses at home ignores the simple fact that, were it not for a soaring oil price (and its effect on the domestic petrol price) NZ's inflation would not have risen beyond 2.7% last year. Which makes the need for the interest-rate rises in October and December redundant. We are now likely headed toward a recession we didn't need to have. And for all of Bollard's hand-ringing about the high kiwi dollar, he could fix it easily enough by promptly reversing his ill-advised fourth-quarter rate increases. But he won't. So the kiwi will stay artificially high for a little longer … or until offshore currency investors finally twig to the NZ economy hitting the wall. How do local investors make a bob out of this? Get funds into $A or $US financial assets pronto. The probability of a 15%-20% kiwi dollar fall through 2006 is the best `gimme' on offer in any of the financial markets. Why bother with higher-risk domestic stock selections in a temporarily bombed-out economy when buying, say, higher-yield defensive Australian stocks give up to 20% insurance protection via the likely currency move? One such stock, Spark Infrastructure, is highlighted below. It hurts to say it but … buy Australian. GULLIVERS TRAVEL IN THE WRONG PLACE AT THE WRONG TIME

Gullivers Travel Group (GLS) has known only of tough times since its listing on the NZX just over a year ago. Its 160c IPO price was at the bottom end of the pricing range, and it has rarely traded above that level since. Now, with investor anxiety about travel companies being aroused daily by bird-flu paranoia and airline-industry upheavals, the GLS price languishes about 125c. The reality is the group is performing pretty well, and perceptions of operating difficulty are being based more on fiction than fact. In the September 2005 half – GLS's most recent trading period – profits were a better-than-expected $5.7m and the full-year prospectus forecast of $9m was reiterated. Dividends have been in line with projections, and the share-price fall has stretched the prospective gross yield to a market-topping 12%! And with its $19m acquisition of global travel compant Pacific International Holdings (completed in October), some upside to our $9.6m FY07 forecast exists. Forecast dividends that year are 10.5c (gross yield 12.6%). Notwithstanding the inflated industry risks associated with travel, GLS's discounted price (7.2X P:E and double-digit yield) affords investors ample protection. Value investors with a more aggressive disposition should find GLS attractive below 130c. DEFENSIVE STRATEGIES TO FOCUS ATTENTION ON DIVIDEND ISSUES

A slowing NZ economy, bringing with it stagnant sales and tightening margins, will divert investor attention more keenly toward stock yields. Not so much absolute historic levels but companies' abilities to sustain payments over the next 18 months. Our top 10 list of yielders for each respective company's next full financial year is: Gullivers Travel (12%), Allied Workforce (11.8%), Steel & Tube (11.6%), Hallenstein Glassons (11.6%), Restaurant Brands (11.2%), Hellaby (10.9%), Tourism Holdings (10.3%), Turners Auctions (10.2%), Methven (9.9%) and Cavalier (9.5%). For the record, all of the above companies make twice-yearly payments. Some investors prefer to minimise their cash income by investing in companies that offer dividend reinvestment schemes. An added incentive to participate in these is the small discount to market price usually offered by these companies. A focus on cash payments in recent times has seen the number of such schemes fall away but there is still a reasonable range of choices. Companies offering dividend reinvestment plans include: Air NZ, AMP WiNZ Fund, Cavalier, CDL Hotels, Contact Energy, Feltex, Fletcher Building, Kingfish, Kiwi Income Property, Macquarie Goodman Property, NZX TeNZ Fund, Nuplex, Pacific Brands, Property For Industry, Restaurant Brands, Richina Pacific, Sky City, Telecom and Turners & Growers. SHOULD CARTER HOLT MINORITIES SELL WHEN HART'S BUYING?

Carter Holt (CAH) minorities have been bombarded with a zillion good reasons why they should sell into Graeme Hart's 250c bid. Profit downgrades, credit-ratings company warnings, negative broker-analyst recommendations … it makes you wonder why on earth Hart would have anything to do with CAH in the first place! But that's the point. Hart is bending over backwards to get all of CAH, using every weapon in his armoury to get his stake over 90% so he can compulsorily acquire the balance. He has stalled at about the 87% mark and success now looked unlikely unless there are major wider market upheavals. If it survives as a listed vehicle, CAH minorities will be in for an interesting journey. News from CAH's rank-and-file suggests that Hart's first initiatives (including the permanent evacuation of an entire six-level building of IT personnel in South Auckland) have raised some eyebrows … and productivity levels. If nothing else, the Burns Philp experience should have taught investors that theoretical stock valuations count for little when Hart gets hold of unwieldy, inefficient organisational structures. One other point, once the Hart bid lapses (and assuming he doesn't get all of the company), where does the next stock-seller come from. Much like when the TranzRail share price surged after the Toll bid came up marginally short, there's every likelihood CAH will do the same. Trader's BUY. HIGH-YIELD AUSSIE UTILITY GREAT PLACE TO WAIT FOR CURRENCY MOVE

Australia hasn't been a great place, historically, for yield hunters … not by NZ standards. But things have changed for the better. A number of securities are now available that, because the companies don't pay tax and therefore can't attach imputation credits to their dividends, make large cash distributions instead. NZ investors who cannot utilise Australian imputation credits should find these securities particularly interesting. Adding to their appeal is that most of these are defensive-type investments, in the property and utilities sectors, which are characterised by stable cash-flows and profits (though limited growth prospects). Utilities fund Spark Infrastructure (SKICA) heads the short-term yield list. Floated in unspectacular fashion just a month ago to a sceptical Aussie investment community suffering from utilities-stock indigestion, SKICA was eventually priced below its indicative price range. Payable in two instalments, the first instalment was finally set at A126c in the IPO (the second, A60c, instalment is payable March 2007). The stock still trades below the (reduced) first instalment price, at A122c, having been as low as A116c. But it is moving up. Why? Mainly income. In calender 2006 SKICA says it will pay A14.07c in dividends … a whopping 11.4% yield. Next year the cash dividend is expected to rise to A17.06c which, after accounting for the second instalment payment, still represents a yield of 9.3%. These returns are a lot better thasn most on offer in the domestic market. So where do the risks lie? Obviously the spotlight must go on SKICA's investments and their ability to sustain cash flow. SKICA owns 49% of three electricity distribution networks in South Australia and Victoria (CitiPower, Powercor and ETSA). These cover 328,000 sq km and serve about 1.7m customers. Each have long-term regulatory certainty, with respective pricing regimes in place and set until at least June 2010.Cheung Kong Infrastructure (CKI) and its associate Hong Kong Electric, promoters of the SKICA issue, retain the other 51% interest in the electricity networks. CKI is the largest publicly-listed infrastructure company in Hong Kong, with a market capitalisation of $A9.5b. International credit-rating agency Standard & Poors gives the distribution businesses an investment grade A- rating. Gearing is conservatively set at just over 50%. Investors looking for a lower-risk, higher-yield place to park funds in Australian dollars to await the long-awaited currency move against the Kiwi dollar need look no further. BUY STATIC EMPEROR MINES SHARES IGNORE GOLD PRICE RALLY

The share price of Fijian gold producer Emperor Mines (EMP) has languished at about A40c the past month, ignoring the 10%-plus jump in bullion prices. EMP is in the midst of a major corporate transaction. Major shareholder, South African miner DRDGOLD (DRD), is selling its own Papua New Guinnean gold interests at Porgera and Tolukuma to EMP for $US230m. Payment will be $US30m cash and the balance in EMP shares. It will allow DRD to boost its EMP shareholding to 88%, which will then be sold down via a share placement. The prospect of a significant placement has caused investors to put EMP in the too-hard basket meantime. Institutional investors are reluctant to bid the EMP price up (in what is a relatively illiquid market) ahead of the sell-down. Smaller investors shouldn't be so reluctant … they won't be able to participate in the placement anyway. EMP will emerge from the deal as Australia's third largest listed gold producer. Annual production will more than treble to about 375,000oz, and group reserves will total about 2.2m oz. Voting on the planned transaction occurs in mid-February, soon after which the placement will take place. At prices about A40c we believe EMP offers excellent value. We expect gold to continue rising through 2006 and beyond, as investors fret about inflation and central banks diversify away from $US holdings. HELLABY HELLABY HOLDINGS: `IT'S BEEN TOO GOOD A STORY TO GIVE UP ON NOW'

The stellar run by Hellaby Holdings (HBY) that took the shares from 150c in mid-2001 to a 730c peak last year hit the wall in October. It was then that HBY warned a retail-sector slowdown was hurting its Hannahs and BBQ Factory subdiaries. Profits in FY06 could fall 15% below the $20m earned in FY05. A commensurate cut in dividends would see the total payout down to 33c from 39c … a telling adjustment for what has become the market's favourite value stock. The share price has dived to 450c, the gross yield (based on the lower 33c dividend) a smidgeon below 11%. Throughout HBY's inexorable climb in 2001-2005, warnings-inspired share price blow-outs invariably turned out to be excellent buying opportunities. There's no reason to believe this will prove any different. HBY's proven expertise at identifying undervalued opportunities and (by adding capital and operational expertise) fulfilling their potential is not being questioned. The swiftness of the economy's downturn caught HBY on the hop. Indeed, there may be more pain. But the interest-rate cycle is turning and HBY will be one of those to eventually lead the market higher. NZ investors will initally look for superior value bets when things improve. HBY will be one of them.