Devon Funds Morning Note - 27 May 2024

Monday 27th May 2024

Easing pressures

Global

The Nasdaq Composite closed at a record high on Friday, with the index leaping 1.1% to 16,920. The S&P500 added 0.7%, and the Dow was flat. Nvidia hit a new record high, rising nearly 3% to a market cap of US$2.62 trillion. Nvidia rose 15% last week on the back of a knockout result. Tesla and Meta Platforms rose 3% on Friday. Optimism around AI continues to spur sentiment, while a leading consumer survey showed that expectations around inflation are easing, paving the way for rate cuts later in the year. The Nasdaq rose 1.4% over the course of the week, the S&P500 was flat, and the Dow shed 1.3%, its first negative showing in five weeks. The focus this week will be on inflation numbers in the US (being the PCE, the Fed’s preferred inflation gauge) and Europe.

The latest University of Michigan survey found that US consumers were somewhat less concerned about inflation, bolstering hopes for a pivot to rate cuts later this year. Prices are expected to rise at a 3.3% over the next year, down from a 3.5% reading earlier in May (but up from 3.2% in April).

Consumers don’t set inflation, but the data will be encouraging, as it can be self-perpetuating and also flow through to wage demands (although this is becoming less relevant with tightness in the employment market dissipating). However, American consumers are feeling less confident. The index fell from a reading of 77.2 for April to 69.1 in May, the lowest since November 2023. Still, sentiment remains almost 20% above a year ago and about 40% above the all-time historic low in June 2022. With inflationary pressures easing, waning confidence could help spark the Fed to cut rates. Markets are pricing a 50/50 chance of one in September.

Lower interest rates could provide a helping hand to consumers who are feeling the pinch. This is weighing the most on the inclination to buy houses and cars as opposed to other long-lasting goods. US durable goods orders rose 0.7% in April, far better than consensus estimates for a 1% decline.

After a deluge of results, it was a bit quieter on the earnings front on Friday. Discount apparel and homeward retailer Ross Stores rallied 8% on strong quarterly results, boosted by cost-cutting. The interestingly named Booz Allen Hamilton jumped 4% after the defence contractor (which specialises in intelligence) swung to a profit, and delivered quarterly revenues of US$2.77b, ahead of forecasts. Elsewhere shares of crypto platform Coinbase jumped nearly 9% - the SEC has approved a rule change to allow the creation of ETFs for ether, the world’s second-largest cryptocurrency, which powers the Ethereum network.

Across the Atlantic, European indices were generally flat. On the continent, Germany's economy grew by 0.2% in the first quarter of 2024, confirming earlier estimates. It followed a 0.5% contraction in the fourth quarter of the prior year. The growth rate for the same period in 2023 was 0.3%.

The FTSE100 dipped 0.26%. UK retail sales volumes fell by 2.3% last month, following a revised 0.2% decline in March, and estimates for a drop of around 0.5%. The decline was attributed to poor weather. Non-food store sales volumes fell by 4.1%. Despite the monthly drop, sales rose by 0.7% in the three months to April compared to the previous quarter. Year-on-year sales were down 2.7%, and are 3.8% below pre-pandemic levels.

The dip in UK retail sales contrasted with improved consumer confidence. The GfK consumer confidence index rose two points to -17, driven by increased optimism about the economy and personal finances. Brits are still wary of big ticket spends - the major purchase index dipped one point to -26. UK consumers are though sensing that conditions are improving, with a potential rate cut next month also on the horizon.

Asian markets were generally softer. The Nikkei fell 1.2% on Friday. Japanese inflation has slowed more than expected, making a rate hike by the Bank of Japan in June unlikely. Headline annual CPI in Japan rose 2.5% in April, a deceleration from March’s 2.7% rate. Services inflation fell, and core inflation slowed to 2.2% from 2.6% in March, in line with expectations.

Japanese investment giant SoftBank was in the AI news, signalling it is prepared to spend US$9bn a year on AI investments. The company is in the hunt for deals that can support the group’s key asset, UK-based chip designer Arm, which has surged in valuation since it went public last year. SoftBank this month led an investment of more than US$1bn into UK self-driving car start-up Wayve, marking Europe’s largest AI deal to date. The company though has said that it doesn’t plan to start manufacturing AI chips to compete with Nivida.

The CSI300 in China fell 1.1%. On the subject of Nvidia the company is seeing a big pick up in competition in China where it is being forced to discount heavily. Nvidia has had to tailor make chips for China amid U.S. sanctions that prevented the firm from selling its most advanced AI chips in the country. This has helped competitors such as Huawei. At the earnings call last week, Nvidia warned that China was becoming an increasingly competitive market, and that the firm’s data centre revenue in China fell “significantly.”

New Zealand

The Kiwi market was 0.7% higher for the week despite a 0.2% dip on Friday. A big surge in Nvidia post its results didn’t help our market too much, which was instead dimmed by a higher-than-expected Purchasing Managers’ Index print in the US which reduced optimism around rate cuts. It was a week where the RBNZ signalled that rates cuts won’t come till later next year – the reality may prove somewhat different. Markets are pricing in a switch to an easing bias by August.

The RBNZ appears worried about persistent inflation as it relates to rents, insurance and rates. It is hard to see how keeping the OCR elevated will help with any of those. Arguably it will make rent inflation even worse. Higher rates sit more with what councils are doing, while rising premium rates lay partially with reinsurers which are reducing their exposure to NZ.

Fisher & Paykel Healthcare eased 0.6%, while Auckland Airport dipped 0.1%, Mainfreight declined 0.4% and Fletcher Building fell nearly 6%. At the other end Meridian rose 0.6%, Contact Energy jumped 1.1% and A2 Milk leapt 1.4%.

On the announcement front, Oceania Healthcare (+0.4%) appointed a new CEO. Restaurant Brands held its shareholder meeting. The quick service restaurant operator (KFC, Pizza Hut, Carls Jnr, and Taco Bell) is not providing guidance for FY24 given a challenging operating environment. Management said the Group is 12-18 months away from achieving margin recovery to FY22 levels.

There was though some cause for minor encouragement over the kiwi consumer at the end of last week. The volume of retail sales rose 0.5% in the March quarter, breaking two years of declines. There were some interesting regional performances, with SailGP and ‘Warbirds over Wanaka’ propelling southern regions. The struggling Super Rugby team got one over Auckland on the weekend, and Canterbury retail sales increase trounced Auckland’s by nearly tenfold, growing by almost $150m over the quarter.

Some have put the overall numbers as simply being off a low base. But other data suggests this may not be a blip. Consumer confidence picked up in May according to the ANZ-Roy Morgan Consumer Confidence Index which lifted four points to 84.9. However this is still a weak level and well below the historical average of over 110.

It’s a start though and perhaps the shock that we are in “recession” is wearing off a bit.

Also contributing to the lift in confidence were falling inflation expectations which eased from 4.4% to 3.8% on a 2-year basis, which is the lowest read since October 2020 (also close to the pre-Covid average of 3.5%). Falling inflation expectations will be welcomed by the RBNZ. Expected house price inflation eased from 3.5% to 3.2%.

Kiwis are still doing it tough but are a little bit more optimistic about the future. The Future Conditions Index lifted five points to 90, while the Current Conditions Index was unchanged at 78. Perceptions of current personal financial situations lifted two points to -15%. A net 6% expect to be better off this time next year, up one point. That said, a net 29% think it’s a bad time to buy a major household item, down one point.

People though seem to be more optimistic about the economy and sense that maybe a turning point is at hand. Perceptions regarding the economic outlook in 12 months’ time rose 4 points to -36%. The 5-year-ahead measure rose eight points to -2%. Those with mortgages remain much more cautious about buying a major household item, but they are more optimistic about their personal financial situation a year from now, perhaps in anticipation of lower interest rates. Over to the RBNZ again on that one.

We will also see this week if there is a further helping hand coming from the government with the Budget. Tax cuts may be front and centre given election campaign promises. The cheque book is unlikely to be out too much, although health, education and law enforcement may be prioritised. In focus will be how the government sees the outlook for the economy, tax revenues, and debt levels along with when a surplus might be in the offing.

There are lots of results out this week, with Fisher & Paykel Healthcare and Mainfreight the big names to report on Wednesday.

Ryman Healthcare is out with results this morning, Total revenues for FY24 rose 18% to $689.9 million, up 18% on FY23. Reported net profit after tax of $4.8 million was down substantially from $257.8 million in FY23. The bottom line was weighed by a write-down in the carrying value of assets (~$280m), amid a softer trading environment, and weaker sales volumes and margins. Underlying profit of $270.0 million was down 11% on the prior year, and in-line with February revised guidance of $265-$285m. Cash flow from existing operations of $43.3 million was up $51.8 million on the prior year.

On the balance sheet side, year-end debt was $2.51 billion, up just $0.21 billion from March 2023 and in-line with September 2023. Gearing of 36.2% is slightly above medium-term targets of 30-35%. Ryman is moderating and looking to optimise the portfolio (via sales) and the pace of development. At year end, 10 villages are under active construction, nine of which have already opened to residents. Ryman’s land bank at 31 March 2024 has 5,371 units and beds available for development, including 2,627 at sites currently under active development, and 2,744 at the balance of sites. Dividends are still on hold, and the company continues to target positive free cash flow. 2024 is important for Ryman in more ways than one – being the 40th anniversary since it opened its first village and 25th anniversary of being listed on the NZX.

Kiwi Property Group is also out with numbers this morning. Net rental income fell 9.2% to $184.9m. Operating profit before tax was 16.5% lower at $108.2m. This follows the sale of non-core assets such as Northlands and Westgate Lifestyle.

On a like-for-like basis net rental income rose 5.8% in FY24. Rents were up 5.3% on new leases rising 5.3%. Leasing spreads on new office leases rose 18.7%, underpinned by the Vero Centre in Auckland (which the company is selling for $458m). Kiwi’s property portfolio was worth $3.2 billion on 31 March 2024. Kiwi continues to progress mixed used developments, including Resido which will bring residential accommodation to the Sylvia Park shopping complex for the first time.

Australia

On the subject of property sales, it has been reported that Lendlease is planning to exit property development and sell all its construction divisions offshore. The company is said to be ending aspirations to be a major global property builder. The offshore retreat would leave Lendlease’s construction and development activities focused on Australia, where it has historically been more profitable. Money raised from any asset sales would reportedly be used to pay down debt and return capital to shareholders.

It was fairly quiet on the Australian market on Friday. After making record highs earlier the previous week, the ASX200 fell 1.1% on Friday, and the same over the course of the five sessions, to 7,727. On Friday, all sectors were in the red, with consumer discretionary the weakest, down 2.5%. The banks were softer as were the miners.

Apologies the note is a bit longer today. It was great to be involved with members of the Devon investment team in presentations to various companies in Christchurch last week. The mood is good in the Garden City, and may tick up more with the Crusaders still in contention (just) for the playoffs. On the subject of miracles what another great win by a heavily depleted Warriors team. Up the Wahs!

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