Taking Stock 11 July 2024

PATIENCE, said a sage a century ago, is nature’s special secret.

Patience, combined with diligence and energy, is what moves a mountain, another said.

New Zealand’s sharpest financial market mind, sharpest and best, believes the hardest discipline to teach directors and shareholders is patience.

My own observation is that short-termism is a modern curse which in financial markets is spread by short-term incentive plans, quarterly goal setting, a largely unthinking media, greedy young men, and by nearly all who govern or manage other people’s money.

Maoridom’s elders might observe that pine trees grow fast, and fall over easily, while kauri trees, like rimu, produce wonderful outcomes for the patient.

Lack of patience, fertilised by the relatively new breed of index funds, creates false share prices, up or down every day.

Conversely, farmers generally understand well the concept of patience, though often they have to dance to the beat of impatient, city-based bankers while they seek to build great farms.

One could not avoid reflecting on the value of patience in recent days after attending private briefings with the Ryman financial team.

The issue also arises when one looks at recent announcements by ERoad and Heartland Bank, and even Santana Minerals, all of them companies where medium and long-term plans are underway.

Ryman Healthcare, I recall, reached a nonsensical share price of $16 in very recent years, driven by index funds and those similar investment structures that employ exactly no people with analytical skill or financial market knowledge or relevance, turkeys often kidding the world that they are peacocks.

Ryman’s share price is now nearer $3.50. Both prices were and are absurd.

Would a wise, patient investor have bought when the share price was in the stratosphere, or would he be buying today?

Ryman’s wild price swing was blown up by the index funds but then punctured by a series of errors by its directors and executives, perhaps intoxicated by the thin oxygen levels as their company’s share price left this planet.

Those human errors have had repercussions.

Ryman’s basic model is excellent. Its quality of product is high and in demand. Its clients (residents) have very high levels of satisfaction (though short of the perfect score), and its future looks assured, at least in the world as I understand it today. To replace its various properties would cost billions more than Ryman has spent.

Ryman had built its momentum during a demonstrably unsustainable period of “free” money, resulting in misleading property valuation increases. It generated a mindset that disregarded the financial market songbook that many veterans, including me, have either hummed, whistled or sung, almost to the point of tedium.

The words behind our music are “nett profit after tax (NPAT)” and “cash flow”.

Instead, encouraged by the impatient, Ryman adopted the refrain of “profit after revaluations” and “return on equity”.

A few analysts were smart enough to ignore the modern nonsense and drilled into the numbers to identify sustainable NPAT and cash flow. They were never fooled.

They fretted that the shares were grossly over-valued and sold them to the index funds and to simpletons who lack the skill to assess true value.

Another measurement of concern was the rapid speed of chasing growth funded by free money.

Yet another was the reliance on relatively short-term syndicated bank loans that were always reviewable well before developments produced cash. Ryman did not solve this with long-dated bond issues or cash issues.

Bankers are impatient by nature. Bond investors are not.

Eventually, a most unwise acceptance of conditions from second-tier lenders in America led to Ryman borrowing long-term money (a good idea), that could be recalled at any time, a bad idea. Ryman’s financial measurements deteriorated. 

Inevitably $700 million had to be repaid at an inconvenient time, and with it, additional penalties totalling $132 million, or thereabouts. Even in today’s blasé world, $132m is a huge sum – several years of NPAT, let alone dividends.

Perhaps this penalty triggered the wake-up alarm for Ryman’s governors.

Today the board has been almost fully refreshed with newcomers who can truthfully refer past mistakes to the previous directors.

The management team has been refreshed. The four executives our CEO (Edward Lee) and I met were all relative newcomers, all with relevant experience, the Chief Financial Officer arriving after a stint as CFO with the admirable Fulton Hogan group, which itself has long-term goals.

The new board and management understand that Ryman has a great business model, supplying what the market demands, a high-quality product (close to 5-star living). Generally, the villages are well managed but always staffed by excellent people, the care people, clearly angels.

There is nothing to condemn in this.

But the restoration of Ryman, to regather its industry lead position and excite its investors, requires the new team to address the following issues: -

- Head office costs, where the ratio of head office staff to residents has almost doubled.

- The lack of diversity in its debt providers and the mismatch between its long-term assets and its short-term funding. A continuing bond programme might fix this.

- The mispricing of its development margin (rising costs are an issue), its care cost (unwisely, contracted not to rise), and its deferred management fees (set at a level 33% lower than its competitors). Clearly Ryman needs to reset its deferred fees, collectible on the demise of a resident, and cancel the lifetime commitment never to increase monthly fees, for all residents arriving from today.

- Better reporting standards focussed on NPAT and cashflow, and NOT on theoretical property valuations and on meaningless Return on Equity metrics. Property valuations can be displayed as required but should not be regarded as a key metric, or even as being of much significance.

- Better measurement of individual village financial models ensuring that those new villages being planned will have to produce cash and profit within reasonable time frames.

The good news is that these commitments to new disciplines will not affect existing residents and should lead to better decisions, and a narrowing between Ryman’s share price and its true asset backing, which is a higher figure, by far, than its share price implies.

There will still be variables and problems.

The cost of debt may well be higher for longer, for example.

Another issue to ponder is the reliability on the inferences to take from demographic statistics.

This is not a boring grey area.

Ryman has very long-term plans – multiple decades. It must plan. It must understand incremental change.

Population growth occurs and longevity increases, creating a natural market, drawn from aging people who, like me, own their home, but at some stage, if they live long enough, may need more comforts and care than is available at home.

The conundrum here is to predict the inclinations of tomorrow’s older people, and how changes may occur. How many will want to live in retirement villages?

New Zealand’s Maori, Pasifika and Asian sectors all contribute fully to population growth, their reproduction rates exceeding the national average (1 woman, 1.6 children).

Pakeha rates are well below 1.6. Pakeha will be a decreasing percentage of New Zealand.

Maori, Pasifika and Asians now provide around 40% of our population and soon will be 50%.

The population in 2060 will be very different in make-up and in attitudes towards the care of ageing families. 

The retirement village I chaired for decades had few residents other than Pakeha, because virtually none outside Pakeha wanted to live in the culture created by village living.

So the natural demand for villages may not be quite what the bare demographics imply. Ryman will have to prepare for changing demographics.

There is a further problem.

Increasingly, the large ageing family home is not selling for the premium over smaller homes that might have been expected in the past.

If the gold standard of retirement village dwellings cost ever greater sums to build, but the new resident is receiving less for the home being sold, then there will be issues of affordability, magnified by the growing cost of health providers and care.

If we live longer, and move in with less surplus cash, a problem awaits.

Those living in their own home will increasingly be needing to create pocket money with a reverse mortgage, a product virtually certain to rise in relevance even faster than it is today.

But those moving into retirement villages will own a licence to occupy, not a title of ownership, so the reverse mortgage model must adapt.

How will village dwellers top up, if the model does not change?

My guess is that either the likes of Heartland Bank will adapt its offerings, or else the villages themselves will need to hold the capital that enables the likes of Ryman to lend the money needed for pocket money, charge some sort of interest, and effectively retrieve these loans (and interest), as well as deferred fees, upon the demise of the resident and thus the sale of the dwelling.

Growing longevity might mean that the availability of that loan becomes critical to the decision to buy.

So more capital might be needed; much more.

Ryman, Summerset and Oceania all look like long-term survivors, needing patient bankers and patient shareholders.

Arvida is probably best suited to private ownership.

Radius should definitely be owned privately, its history comparable with privately-owned, third-tier operators. I would contend that it should never have been listed as a public company. I said that loudly when it listed (at 80c). Its price is now 20c.

In my view, the owners of the impressive villages that are NZX-listed (Ryman, Summerset, Oceania) will be rewarded provided they are patient, and provided the companies have skilled governors and executives who focus on sustainable excellence, delivered affordably, generating nett profits after tax, the residents top of mind, as they always should be.

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HEARTLAND, a supplier of reverse mortgages to the retired, is another company which should reward patient investors.

It is now the owner of a bank in New Zealand (soon to be Crown-guaranteed up to $100,000 a person) and a bank in Australia (already guaranteed up to $250,000 a person).

The acquisition of the Australian bank will enable Heartland to grow its impressive Australian reverse mortgage lending book, probably pricing it more sharply, now that it can raise money through its bank at a much lower rate than it was having to pay to attract non-guaranteed depositors.

The repayment of higher-cost funding will occur over the next year or two, and be replaced with lower cost guaranteed deposits, enabling Heartland to grow in volume, and in nett margin.

It is on that logic that Heartland’s directors forecast a doubling of profits after tax, by 2028, leading to higher dividends and, logically, a share price that reflects those higher dividends.

Its current strength and its evolution into an impressive organisation is somewhat of a miracle given the ashes of the 2008 finance company bonfires, to which a very poorly managed Marac had contributed generously. Heartland’s origin was from the marriage of Marac and three smaller lending institutions.

Marac was rescued by a huge recapitalisation in which the mercurial George Kerr and Jarden were key players, followed by nearly 15 years of cautious, careful, occasionally inspired management by Jeff Greenslade and his team. Greenslade had been a well-regarded banker, a disciple of New Zealand’s greatest ever banker, the late Sir John Anderson.

Now 62, Greenslade is to retire within the next year, having overseen the rebuilding to a standard where the Australians eventually allowed Heartland to buy an Australian bank, a proposition that Ockers might have found awkward.

My guess is that the Heartland bank in Australia will become the core of the group.

Greenslade had been materially helped by the late Geoff Ricketts, who chaired the new bank until his recent death, and more recently by Greg Tomlinson, unarguably one of New Zealand’s greatest business leaders.

Tomlinson bought 10% of the bank in 2010 as it was being formed and is now its chairman. He is an astute, patient man with unusually high EQ and IQ.

Investors who are patient can expect Heartland to make incremental progress, measurable by slowly rising NPAT and dividends.

What a wonderful outcome for what was revealed as a dreadfully managed finance company 16 years ago. Patience, you see, does allow recovery.

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AND yet another reward is slowly emerging for the small number of patient investors, which does NOT include very many fund managers, who believed in the ability of ERoad to develop and sell its transport technology here, in Australia, and in the USA.

Less than a year ago ERoad was being ditched by impatient fund managers as it struggled to lift its income from the sales of its technology to a level that met its ambition to grow market share in Australia and the USA. Covid did not help. Fund managers made little attempt to understand ERoad’s ambition.

As an aside, It is hard to understand the value of public utterances of index fund salesmen, when they are approached by lazy reporters for a “rent-a-quote” response to complex business matters such as ERoad faced.

Index funds do not employ knowledgeable analysts or researchers. They simply sell Vanguard or the like, which invest to formulaic software. In some cases the index funds employ cheerful volunteers to perform the administrative roles. Analytical skill is not required.

ERoad had seen its share price hydraulicked by index funds to a high of $6.70 before Covid, and before its product range and sales progress stagnated.

The share price was then slaughtered by largely institutional and index fund selling.

The price slumped below 70 cents. The price today has risen by 80% from that low point. Patient investors have not quit.

I twice visited ERoad’s Albany headquarters, met with the company’s CEO and team, and was carefully shown its plans, its ways of measuring progress, and its very cautious publicly released forecasts.

In recent months its progress and share price recovery seem to have rewarded its cautious optimism.

It has achieved significant new sales numbers in Australia and the USA, developed a wider range of clever products and built on the $180 million of annual contracted income, making it a rare NZ technology company that generates a cash surplus.

If its sales continue to meet the company’s expectations, it would generate real surpluses, and justify its board’s decision to decline an opportunistic takeover offer last year.

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PATIENCE is also rewarding the investors in the Bendigo gold project near Cromwell, the project now owned by the ASX-listed Santana Minerals, which supplied the necessary cash for an expanded drilling programme.

Last week, Santana announced it would seek to dual list on the NZX, acknowledging the NZ ownership (40% of the shares).

In search of detail, sitting in a café out of town, I googled “Santana to seek NZX listing”.

Google supplied several links, the first of which was to a client newsletter I wrote, referring to a dual listing in the future.

Our newsletter was written more than two years ago and discussed the pathway to an NZX-listed future, while explaining the value of the discovery.

Patience has been rewarded. A listing now seems imminent.

Consent needs to be granted. And the gold price needs to be within two thirds of its current level, if the company is to deliver extreme value to its shareholders.

We would then have a major contributor to New Zealand’s prosperity and welfare, and hopefully have a miner that meets most of the hopes of those who prioritise environmental standards.

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Travel

Our advisors will be in the following locations on the dates below.  Please contact us if you wish to make an appointment:

19 July – Wairarapa – Fraser Hunter

24 July – Christchurch – Fraser Hunter

25 July – Ashburton (AM) – Fraser Hunter

25 July – Timaru (PM) – Fraser Hunter

26 July – Timaru – Fraser Hunter

25 July – Auckland (Ellerslie) – Edward Lee

26 July – Auckland (Albany) – Edward Lee

Chris Lee

Chris Lee & Partners Limited