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Cost of Capital in the December Quarter
Estimation is currently challenging…. as it ever is!
A few points and my current (as always subject to the Rev. Bayes) estimate for N.Z.:
- the estimate is always expectational
- most important not to get overly side tracked by the short run
- most important not to confuse Govt “policy attempts” to set prices with what may happen
Thus I note:
Riskfree rate? 5 year govt stock may still be the best rough long run approximation. Say 4%
Equity Risk Premium (Rm – Rf)? Damodaran option estimate after tax and sovereign risk adjusted 4.7%
This gives us 8.7% as a market post investor tax based cost of equity capital for NZ. Say 9%.
For those interested in WACC, recent Commerce Commission work suggests that the average premium for corporate debt might be in the order of 2% at present, and observation of the NZX50 suggests a debt to total capital ratio of around 38%
When Financial Economics and Music Collide
In the late 80s it was popular amongst the more buttoned down and starchy of my investment banker and legal colleagues to be fairly sniffy about what were termed “buyout firms” which designed and implemented leveraged takeover bids for underperforming companies then seeking to re-structure, lift performance and add value to often moribund under performers with lazy balance sheets and extensive empires.
A favourite (and not always popular) LBO firm of mine, expert in this area, was Kohlberg, Kravis Roberts or KKR. Their first high profile success was a bid for RJR Nabisco. Management had made a bid to buy RJR for some $66 a share. A competitive bidding process ensued with KKR, eventually winning control of the company for $129 a share – a 95% premium on management’s claim of what was “fair value”.
The company was taken private and a total overhaul, including sale of the company’s management air travel fleet – known colloquially as the “RJR Airforce”. Once performing well – some three years later – RJR was floated again and that, at a significant premium to the $129 a share KKR paid. Consolidation of assets, management and a ruthless focus on customers had served to both add significant value to owners and for customers.
Much more recently another American icon, Gibson Guitars, whose products helped drive two generations of blues, rock, fusion and jazz and a bevy of household name guitar heroes (including, yes, purveyors of the unmentionable “Stairway”) to fame lost touch with its customers. Quality control was poor and pricing strategies were so bad that Gibson’s became known as “guitars for doctors and lawyers”. A travesty to us musicians and cause of much hand wringing.
Not a recipe for success and bankruptcy followed.
Enter my favourites – KKR. The company was bought by KKR (now regarded as a seasoned and respectable – or at least more respectable “Private Equity” firm) and a new CEO, formerly of Levi Strauss and a guitar enthusiast as well as turnaround manager was installed. A significant turnaround was implemented – quality improved, costly but failing innovation attempts were abandoned and pricing was re-worked to realistic levels.
The resulting recovery and success was accelerated by lockdown driven demand from Covid responses (home grown guitarist numbers soared), and currently demand outstrips supply by a heathy margin.
Lessons aplenty. Focus on shareholders is critical and the primary means to add value for shareholders is through satisfying all elements of customer demand in a comprehensive fashion.
And of course….. don’t be sniffy.
Making no difference outside of harm…
Matt Ridley in the Daily Mail:
It is almost tragi-comic that this crisis is happening while Boris Johnson is in New York, futilely trying to persuade an incredulous world to join us in committing eco self-harm by adopting a rigid policy of net zero by 2050 – a target that is almost certainly not achievable without deeply hurting the British economy and the lives of ordinary people, and which will only make the slightest difference to the climate anyway, given that the UK produces a meagre 1 per cent of global emissions.
As for the middle-class Extinction Rebellion poseurs and their road-closing chums from Insult Britain, sorry Insulate Britain, they are basing their apocalyptic predictions of ‘catastrophe’ and billions of deaths on gross exaggerations.
And while preventing working people earning a livelihood may make them feel good, it does nothing to solve the real problem of climate change.
LondonJazzCollector
Next to reading and, I suppose gardening, “collecting” must be close to the top of leisure activities. Who collects what, why and how defies categorisation but some characteristics seem to be common. A certain obsession, tenacity, unpredictability, enthusiasm, stubborn persistence – and, usefully if randomly, items of great interest to the non collecting free rider. In short, significant amounts of value are at times added for low cost.
Such is the case with the LondonJazzCollector
This is a wonderful treasure drove of quasi fanatical detail covering “Adventures in collecting “modern jazz: the classical music of America from the Fifties and Sixties, on original vinyl, on a budget, from England.”
A pleasure to read, moments of enjoyment for the casual passer by and a serious jazz resource. Not to be missed.
Demography is Your Destiny
Satisfying Labels are Indeed Dangerous
Frequently it seems, we are inclined to rush for “satisfying” labels such as “racism”, “bigotry”, “chauvinism”, “foreigner”, or, even more dangerously “inequity”, when a little attention to demography offers a simple, understandable and surprisingly strong explanation for things we don’t understand at first glance.
Vaccination rates may well be a case in point. Noticing that vaccination rates amongst Maori and Pacific communities have been lower than amongst the wider population there has been no shortage of “influencers” and experts pointing to all sorts of labels which carry vast amounts of political and emotional freight to “explain” why this would be.
Yet these communities have different age structures to the wider population often with an over representation of the young in them. Vaccines were not even released for younger age groups until well after the older age groups (the 65+ sub groups) had had them available for a good while. The release for age groups was staggered (for various reasons having little or nothing to do with ethnicity) over a significant period.
Thus the arithmetic and the calendar tells us a good deal more about the difference in rates than melodramatic statements and labels.
The danger arises because once some phenomena is safely relegated to its satisfying “ism” then listening stops, exploration for better explanation stops, emotionally charged or ratings driven behaviour abounds and lessons are not learned.
That is no way to improve our welfare. It is also pointlessly wrong and unpleasant.
Next Quarter: Daylight Not Cash Saving
ASB expects: We expect the OCR to move up soon. Our forecasts have 50bps of OCR hikes by the end of the year and assume a historically low OCR endpoint of 1.50% by late 2022. Mortgage interest rates have already been on the move and look set to continue to climb. We envisage a historically low peak in average mortgage interest rates this cycle. How will moderately higher interest rates impact the household sector? There are 3 channels:
1) House prices – higher mortgage interest rates should sharply slow housing market momentum, with prices largely expected to flatline over 2022.
2) Economic activity – the gradual pace of OCR hikes that we envisage is unlikely to derail the economic expansion and so shouldn’t significantly weigh on household incomes and employment.
3) Cashflow – The average mortgage rate for housing lending of just under 3%, a record low, which has bolstered household debt servicing. NZ households are net borrowers from financial institutions, so an increase in customer interest rates will reduce household cashflows. Our estimates suggest a 100bp increase in customer interest rates will reduce household cashflows by roughly $2.6bn per annum, approximately 1% of household disposable incomes. It’s not immaterial, but our assessment is that the increase in debt servicing costs should be manageable for most households. Borrowers with large debt exposures will clearly fell the cashflow hit. Some will struggle.
Neither Guilt Nor Apocalypse are Sound Policy Instruments
Bjorn Lomborg reports in Business Day that the latest IPCC report – the “code red” document states that “frequency and intensity of cold extremes has decreased.” Just what we might expect.
The Lancet reports that half a million die from heat every year. At the same time 4.5 million people die from cold. The last 10 years have seen, globally, an increase of 116,000 deaths from heat but a decrease of 283,000 deaths from cold. We have then seen 167,000 lives saved per year
This is neither apocalypse nor anything to be guilty about. Code red? Code for – look at both benefits and costs. You might be surprised.
Reliable forecasts versus speculative opinion….
The apparently trivial here has a high degree of reliability and is, in a genuine rather than business jargon use of the term, robust – retains its truth across a wide variety of settings: “I very frequently get the question: “What’s going to change in the next 10 years?” That’s a very interesting question.
I almost never get the question: “What’s not going to change in the next 10 years?” And I submit to you that that second question is actually the more important of the two.
You can build a business strategy around the things that are stable in time. In our retail business, we know that customers want low prices, and I know that’s going to be true 10 years from now. They want fast delivery; they want vast selection. It’s impossible to imagine a future 10 years from now where a customer comes up and says, “Jeff I love Amazon, I just wish the prices were a little higher.” Or, “I love Amazon, I just wish you’d deliver a little slower.” Impossible.
So we know the energy we put into these things today will still be paying off dividends for our customers 10 years from now. When you have something that you know is true, even over the long term, you can afford to put a lot of energy into it.”
— Jeff Bezo
Eye2theLongRun 