This report will discuss three specific stocks (a2 Milk, Fletcher Building and CBL), as investor interest in these stocks has been particularly high recently.
February is often a busy time for investment announcements, and this year has carried a number of surprises.
In the month of February, provisional return data indicates Harbour’s active NZ and Australasian equity funds and mandates, out-performed the market benchmark return. Similarly, year-to-date and longer-term data shows strong relative returns in our equity funds.[1]
a2 Milk
On the positive front among our holdings, a2 Milk was a huge standout; the stock price is up 40%, and it is now New Zealand’s largest listed company. In equity portfolios we have been significantly overweight in a2 Milk. We have strongly held the view that a2 was gaining market share across its major markets, and at the same time improving margins. This result beat our expectations at every level. In addition, the company announced a transformational deal with Fonterra that may provide significant growth opportunities in new markets. Our subsequent meeting with the company confirmed a very positive operating and strategic outlook for the business and despite the share price rise, we remain overweight the position across our equity portfolios.
The overall market return for the month was -0.8%, and, without a2, the market return would have been closer to -4.1%. This is possibly an unprecedented event for the New Zealand equity market.
Fletcher Building
On the contrary to these favourable outcomes, Fletcher Building announced a further unexpected significant provisioning in their B&I business. Although we expected further provisioning, the size of the blowout was several times larger than anticipated by the market and the stock price fell sharply. We had not expected such a large negative impact and had been rebuilding a position across our portfolios, moving back towards a benchmark weight; so relative to the market, our position did not impact performance, but in an absolute sense our holding in Fletcher Building was negative. We have more recently sold some Fletcher Building shares during the month as we think the potential for near term news is limited.
CBL
The sequence of announcements by CBL over the course of February has been disappointing for Harbour’s investment in the company.
Our previous investment thesis reflected the history of strong revenue and operating profit growth, the company beating prospectus forecasts and a reflection of positive meetings with the company in Auckland and Europe. CBL also traded on an attractive multiple of earnings. In addition, CBL had accumulated a $550mn cash balance, and appeared to be readying the market for a strong sales result.
However, the announcement in early February that a detailed actuarial review required a $100mn increase in capital reserves, and that they were taking an additional $44mn write-off against their newly acquired French insurance and broking business, was unexpected. The subsequent news flow reflected the response of regulators, the cessation of business lines and then the interim liquidation and following voluntary administration.
Throughout this process and updating of news flow, we have carefully assessed the valuation implications with the fund trustee and supervisor to provide a reasonable estimate of underlying fair value in the fund and portfolio prices. This has inevitably been an iterative process as we have responded to public announcements.
Towards the end of February, after the latest actions taken by the RBNZ, the Central Bank of Ireland and CBL, we requested an independent valuation to be undertaken for the suspended shares in CBL using a book value methodology. This approach assessed CBL’s share price at 88 cents. There remains a wide range of possible outcomes and we will continue to monitor public announcements and work with independent sources to assess CBL’s value while it remains unlisted.
The approach we have taken is one of many we could use to value CBL shares and reflects an expectation that some, or all, of CBL’s businesses will be sold. There remains a significant amount of uncertainty regarding CBL’s business. In the interest of full disclosure, it is worth noting that the business is now in the hands of the interim liquidators, the voluntary administrators and the NZ High Court. We now expect very limited information for the next few weeks. We understand an investment bank has been appointed to sell the European insurance business (and perhaps other businesses) which may release capital into the balance of the business. It is also possible that further sales occur, and/or the company pursues a capital raising once further disclosures are made.
The investment in CBL has been a relatively small part of our equity funds (not in the top 10 holdings). On a standalone basis CBL has been very disappointing and the final outcome is still unknown. However, the Harbour funds are diversified, with other companies making very strong contributions to performance over the month.
One question we have been asked is: why didn’t you value CBL shares at a zero price if it is “liquidation”? And if you used a zero price, what would have the return been for the month?
Harbour considered all publicly available information in making an assessment of CBL’s value. We used an independent source to provide advice and we accepted that advice. CBL is not today in liquidation as such, it is in an interim liquidation and under administration reflecting various alleged regulatory breaches and the decision of the company to protect assets.
We think it is better to provide our best assessment of value at any point in time rather than over-provision. Should a zero price have been assessed for CBL, the funds would have still have provided relatively a relatively strong return for the month.
Finally, thank you for your continued support. Although the investment team works hard to avoid higher risk investments, we also understand that investment risk requires diversification and deep research.
This analysis is reflected in our investments in strongly performing companies like Summerset and CSL for instance, and avoiding companies where we see structural challenges, such as Sky TV, Z- Energy and Chorus.
[1] These return estimates include an estimated price of CBL of 88 cents, reflecting an independent assessment of value commissioned by Harbour (CBL remains suspended from trading and last traded at $3.17 on 2 February).
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Harbour Asset Management Limited is the issuer and manager of the Harbour Investment Funds. Investors must receive and should read carefully the Product Disclosure Statement, available at www.harbourasset.co.nz. We are required to publish quarterly Fund updates showing returns and total fees during the previous year, also available at www.harbourasset.co.nz. Harbour Asset Management Limited also manages wholesale unit trusts. To invest as a Wholesale Investor, investors must fit the criteria as set out in the Financial Markets Conduct Act 2013. This publication is provided in good faith for general information purposes only. Information has been prepared from sources believed to be reliable and accurate at the time of publication, but this is not guaranteed. Information, analysis or views contained herein reflect a judgement at the date of publication and are subject to change without notice. This is not intended to constitute advice to any person. To the extent that any such information, analysis, opinions or views constitutes advice, it does not consider any person’s particular financial situation or goals and, accordingly, does not constitute personalised advice under the Financial Advisers Act 2008. This does not constitute advice of a legal, accounting, tax or other nature to any persons. You should consult your tax adviser in order to understand the impact of investment decisions on your tax position. The price, value and income derived from investments may fluctuate and investors may get back less than originally invested. Where an investment is denominated in a foreign currency, changes in rates of exchange may have an adverse effect on the value, price or income of the investment. Actual performance will be affected by fund charges as well as the timing of an investor’s cash flows into or out of the Fund. Past performance is not indicative of future results, and no representation or warranty, express or implied, is made regarding future performance. Neither Harbour Asset Management Limited nor any other person guarantees repayment of any capital or any returns on capital invested in the investments. To the maximum extent permitted by law, no liability or responsibility is accepted for any loss or damage, direct or consequential, arising from or in connection with this or its contents.