Newsletter September 2009

September 1, 2009

Deposit Guarantee Scheme

The Government recently announced its intention to extend the Retail Deposit Guarantee Scheme. The current scheme ends on October 12, 2010 and the new scheme will end on December 31, 2011. This is great news for investors and financial institutions alike as it gives time for an orderly exit from the scheme. The rules have changed however, and not all institutions will be eligible for the scheme. Some may even opt not to participate, as it is not without cost. Some of the changes include:

  • Bank deposits will be covered up to a maximum of $500,000 per depositor
  • Non-bank deposits will be covered up to a maximum of $250,000 per depositor
  • To be eligible for the new scheme institutions must have a credit rating of BB or higher
  • Finance companies will pay higher fees than banks or building societies

At this stage I would still encourage finance company and building society investors to stay within the Government Guarantee, and I expect the Wairarapa Building Society, South Canterbury, UDC, Marac, and Equitable will all sign up to the new scheme. Whether or not investors support these companies from 2012 onwards may depend largely on the regulation of the non-bank deposit takers currently before parliament. Some of the key proposals being debated at present include:

  • All non bank deposit takers to have a credit rating by March 2010
  • A requirement for every deposit taker to have a risk management plan
  • Each deposit taker to have an emergency source of liquidity
  • Restrictions on related-party lending
  • Minimum capital requirements

 Hopefully these regulations will be enough to restore confidence in a sector that plays a very important role in our economy.

Sharemarket Terms

I am often asked to explain some of the terms associated with the financial pages in the newspaper. P/E ratios, NTA, imputation credits, and dividend yields can be confusing.

P/E (Price/Earnings) Ratios

The P/E ratio is the company’s share price divided by its earnings per share. It is a ratio used to compare companies. The higher the P/E ratio the more you are paying for each dollar of earnings. All other things remaining equal a company trading on a lower P/E ratio represents better buying. Of course other things never remain equal so you should not base a buying decision on this alone. A high P/E ratio may not mean the company is “expensive,” it may indicate an expectation from investors of higher future earnings.

NTA (Net Tangible Assets)

The NTA figure is a company’s tangible assets minus its liabilities, divided by the number of shares on issue. Intangible assets such as goodwill are not included. Net tangible assets are what should be realised if a company was wound up. We divide it by the number of shares on issue to see whether the company share price is at a premium or a discount to its asset backing. Like P/E ratios NTA cannot be looked at in isolation. Take a service company for example – it may generate strong revenues without much in the way of tangible assets. Its NTA is likely to be significantly less than its share price.

Imputation Credits

Dividend imputation credits are tax credits attached to the dividends you receive. When you receive a dividend from a company you are expected to pay tax on that income. But if the company paying the dividend has already paid tax on that income the Government is getting two bites at the cherry. Therefore companies are able to provide you with a tax credit if they have already paid tax on the income they are distributing. In some circumstances a company will pay a dividend even though they have failed to produce a profit, and have therefore not paid any tax. In this case the dividend will have no imputation credits attached, and you will be expected to pay the tax on the dividend you receive.

Dividend Yield

The dividend yield is the dividend (cents per share) divided by the share price. For example Fletcher Building paid 48.50 cents in dividends in the last year. Their share price is currently $7.82. Their dividend yield is therefore 6.20%. The newspaper will also show the gross yield, which includes the addition of any imputation credits that have been attached to the dividends paid. Remember the yield calculation is based on today’s share price and last year’s dividend, so there is no guarantee the company will continue to generate the same yield.

Babcock & Brown Limited

The administrators of Babcock and Brown have come to the conclusion that the company should be wound up. They have raised the possibility of bondholders funding an investigation into the affairs of BBL “to determine whether any valuable causes of action exist against any third party that might provide a return which would ultimately benefit noteholders and other creditors.” In my opinion these actions benefit the administrators and the lawyers at the expense of the people they are representing, and invariably take years to resolve. Feltex Carpets collapsed three years ago and investors funding legal action in that case have yet to see any resolution. All Babcock & Brown bondholders, regardless of the size of their investment, are being asked to contribute AU$400. I would only consider paying this money if: a) I had a large sum of money invested in BBL, and b) I could be guaranteed that any recoveries would be paid preferentially to those who provided the extra funding. Call the office if you would like to discuss your situation.

Bluestar Print

Bluestar Print is back in the news with an announcement that they are suspending interest payments on their bonds. It was a bizarre announcement to the Stock Exchange, headed “Bluestar Print Group Strengthens Financial Position.” Bluestar has renegotiated terms with its bankers and will have their covenants reset. As part of these new arrangements Bluestar are required to suspend interest payments to bondholders until they have made the required interest payments to their bankers. The penalty for suspending payments to bondholders is an increase in the interest rate from 9.10% to 13.10%. Clearly this is not good news for bondholders – any company in the current environment would be doing everything possible to avoid unnecessary cost. With $105 million of bonds on issue, an extra 4.10% interest could be a big cost, depending on how long interest payments are suspended.

On the positive side, Bluestar’s parent company has been provided with a further $10 million in equity funding. Bondholders will be hoping the company can turn things around within the next three years, when their bonds are due to be repaid. Sales in the secondary market have been going through at approximately $33 per hundred.

 Barramundi Warrants

The Barramundi share price continues to drift below 0.70cents, making the warrants that are due to expire in October virtually worthless. See the June newsletter for an explanation of how these warrants work.

Rights Issues

A number of companies sought more funding from shareholders over the last twelve months, and rights issues have been the main method used. How do rights work?  A right is type of option that allows a shareholder to purchase extra shares in a company. Rights usually have a short time-frame, and are also usually renounceable (the holder can sell the right to someone else). The offer is always at a discounted price because of the dilutionary effect the extra shares has on the price. During the rights trading period (usually two or three weeks) the right should trade at the difference between the current share price and the price at which the new shares are being offered.

Tower has just announced a rights issue, so we can use them as an example. Before the announcement was made Tower’s shares were trading at $1.80. They are offering shareholders the right to buy 5 new shares for every 16 they already hold, at a price of $1.34. Simple maths tells us that Tower’s share price should now be $1.69 (the average of the share you held at $1.80 plus 0.3125 of a new share at $1.34). Sure enough, the day after the announcement Tower’s shares were trading around $1.69. The rights start trading on September 03 and theory should see them trading at 0.35cents (the difference between the underlying share price of $1.69 and the price you are being asked to pay for the new shares – $1.34.

The important thing for investors is to ensure they take up one of the alternatives. Either take up the new shares at the discounted price, or sell the rights to someone else. Doing nothing will mean you are losing the value of the rights assigned to you. On any given day the difference (financially) between paying for the new shares or selling the rights is negligible. Taking up the new shares will be beneficial in the long-term, provided the company performs well in the future. Call the office if you need any guidance on what to do.

Skellerup are also issuing rights to shareholders. They are seeking $21.5million with a two for five renounceable rights issue. Once we have all the details we will be able to advise on the merits for and against.




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