Investment columnist for the NZ Herald

Brian Gaynor: Profits only modest in booming economy

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The problem with the NZX is twofold. Photo / 123RF
The problem with the NZX is twofold. Photo / 123RF

•Brian Gaynor is an executive director of Milford Asset Management which holds shares in all 16 companies listed in the accompanying table.

The interim profit announcements for the six months to December 31 met market expectations but little more.

The problem is that most of our largest listed companies have a limited growth outlook as the domestic sharemarket is dominated by low-risk and high-dividend-yield companies with utility characteristics.

The accompanying table contains the normalised net profit after tax figures for 16 of the 25 largest listed companies that reported for the six months to December 31.

The other nine companies - F&P Healthcare (ranked 5th), Ryman Healthcare (6th), Z Energy (11th), Xero (15th), Mainfreight (17th), Kiwi Property (19th), Infratil (22nd), Goodman Property (23rd) and Trustpower (24th) - have different balance dates.

As the sixteen companies have a total sharemarket value of $60.2 billion, representing just over 50 per cent of the total value of the NZX, they give a good indication of the earnings performance of our largest listed companies.

The first point to note is that the combined net profit of these 16 companies increased by only 4.2 per cent, from $1.535 billion for the six months to December 2015 to $1.599b in the latest period. This compares with an 18.9 per cent increase in the previous corresponding periods, from $1.291b to $1.535b.

However, these figures are strongly influenced by Air New Zealand which reported net earnings of $133m for the six months to December 2014, followed by $338m for the following interim period and $256m for the latest six months. Air New Zealand's net earnings declined by 24.3 per cent in the six months to December 2016 but this still represented an impressive result that was ahead of analysts' expectations.

If Air New Zealand is excluded from the accompanying table the remaining 15 companies had a combined net profit increase of 12.2 per cent between the December 2015 and December 2016 ending periods compared with a minimal 3.4 per cent growth between the December 2014 and December 2015 interim periods.

These are modest profit increases in the current booming economic environment.

The problem with the NZX is twofold. Firstly, it is strongly influenced by the performance of five electricity companies, Meridian Energy, Mercury NZ, Contact Energy, Genesis Energy and Vector, as well as Spark and Chorus. These seven companies have a combined market value of $28.3 billion yet their total net earnings have increased from only $610m to $611m to $694m in the last three December-ending interim periods.

The other issue is that a large number of cyclical companies, particularly in the building and construction sectors, have not been able to take full advantage of the buoyant economic conditions. This is extremely frustrating as one of the clear signs of a competent management team is its ability to maximise earnings when industry conditions are favourable.

Fletcher Building revealed a large loss on one of its major fixed-priced construction contracts. There are also reports that other listed building supply companies are failing to deliver orders on time and, when they are on time, they often have to be returned because they haven't met specifications.

The clear message from recent results is that senior management teams in New Zealand are extremely good at managing low-growth utility companies but the stewardship of cyclical and high-growth companies leaves a lot to be desired.

This issue is highlighted in recent reports on Wynyard Group and Pumpkin Patch, which are covered in the associated article.

The standout performer in the accompanying table has been A2 Milk, which has grown earnings from just .1m in the six months to December 2014 to $10.1m in the following corresponding period and $39.4m in the latest six month period. This growth has been achieved since A2 effectively moved to Australia and has had a senior Australian management team.

A2 is a typical growth company as it doesn't pay a dividend.

However, the company had $108.4m of cash and short-term deposits at the end of December 2016 and "the board expects to adopt a dividend policy following the completion of FY17".

Sky Network Television has been the worst performer as it reported a 32 per cent decrease in net earnings in the latest six-month period following a 5.4 per cent fall in the previous corresponding period. The company has been the subject of a particularly harsh decision by the Commerce Commission and will be challenged to repeat the net earnings of $92m achieved in the first half of 2014/15.

The dividend growth of the 16 companies was steady, if not spectacular, in the latest six-month period. Total dividends per share increased by 5 per cent on a year-on-year basis in the interim period to December 2016 compared with 17.3 per cent in the previous corresponding period. The latter increase was mainly because Chorus went from paying no dividend for the six months to December 2014 to 8c a share for the first half of the 2015/16 year.

The largest increase in interim dividends between the December 2014 and December 2016 interim periods have been as follows; Air New Zealand 53.8 per cent, Spark 38.9 per cent, Auckland International Airport 37.0 per cent and Ebos 36.4 per cent.

Investors can be reasonably satisfied with the recent interim results but the NZX is unlikely to sustain its performance over the longer term until non-utility companies can take advantage of the booming economy and we can create far more successful long-term listed growth companies.

Wynyard and Pumpkin Patch

Two recently released reports on Wynyard Group and Pumpkin Patch, under section 239AU of the Companies Act 1993, highlight issues with how these growth companies were run.

The 24 page Wynyard report, which was prepared by KordaMentha, derived most of its information from public documents.

In summary, the company raised $65m through its IPO with $35.6m going to Jade Software Corporation, $25.8m to support Wynyard's growth strategy and $3.6m for IPO costs.

The security and risk management software company expanded rapidly in Asia Pacific, Europe, Middle East, Africa and the Americas with staff numbers increasing from 151 to 297 between 2013 and 2015.

However, revenue per employee declined from $162,000 to $100,000 over this period and the company was heavily reliant on capital raisings to fund its day-to-day operations.

Last year, the company advised that it would reduce its monthly cash losses from $4.8m to $2.4m but this was not achieved and it was placed in voluntary administration on October 25, 2016.

KordaMentha concluded: "The cost base of operations was too great for the revenue Wynyard was able to generate from its products."

It is clear that this fatal issue was not due to any unexpected external event.

McGrathNicol's detailed 53-page report into the collapse of Pumpkin Patch paints a similar gloomy picture of the company's governance. Pumpkin Patch had "an inefficient retail network", "failed expansion into the UK and US, funded by debt", had "inadequate merchandise planning" and lack of capital because "almost all (95 per cent) of accumulated NPAT from FY05 to FY11 of $90.7m was paid out as dividends".

These Wynyard and Pumpkin Patch reports should be compulsory reading for listed company directors as our sharemarket will continue to be dominated by low-growth utility type entities unless we do a far better job of managing our cyclical and growth-oriented companies.

- NZ Herald

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Investment columnist for the NZ Herald

Brian Gaynor has written a weekly investment column for the Weekend Herald since April 1997. He has a particular passion for the NZX and its regulation. He has experienced - and suffered through - the non-regulated period prior to the establishment of the Securities Commission in 1978 and the Commission’s weak stewardship until it was replaced by the FMA in 2011. He is also a Portfolio Manager at Milford Asset Management.

Read more by Brian Gaynor

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