October was a crazy month for financial markets.

As the accompanying table shows it was definitely a month of two halves with Ebola, Isis, weak European economic data and the looming end of quantitative easing having a negative impact on investors during the first two weeks.

The first half of the month gave the strong impression that the lights had been turned off with Japan’s Nikkei 225 Index plunging 10.1 per cent, Germany’s DAX off 9.5 per cent, New York’s Nasdaq Composite falling 6.2 per cent and the NZX 50 Gross Index down 2.3 per cent.

October 2014; A huge down and up month          


First half

Second half

Full month

United States




  S&P 500




  Nasdaq Composite








  UK FTSE 100




  Germany DAX 30








  Japan Nikkei 225




  Hong Kong Hang Seng








  Australia S&P/ASX 200




  New Zealand NZX 50 Gross





There was also a massive global shift from high to low-risk investments, particularly from sharemarkets and high yielding corporate bond funds to money market and global government bond funds.

However, there was a gigantic change in sentiment mid-month and during the last two weeks Japan’s Nikkei 225 Index soared 12.9 per cent, the Nasdaq Composite 9.9 per cent and Germany’s DAX appreciated 8.8 per cent.

The last week of the month was particularly strong for sharemarkets with total global sharemarket fund inflows of US$20.4 billion compared to outflows of US$25 billion in the previous three weeks. There was also a small outflow from global government bond funds in the final week and a relatively strong flow to high-yielding corporate bond funds.

Sharemarkets have recovered strongly from their global financial crisis lows in 2009 and they are now fairly fully priced, particularly in price/earnings terms. Most investors are aware of this and become extremely nervous when negative news dominates the headlines.

It is not surprising therefore that European sharemarkets didn’t fully recover during the second half of month because the region’s economic data was particularly gloomy.

On the other hand, global inflation and interest rates remain low and investors rush back into sharemarkets when storms blow over. It is worth noting that money continued to flow into sharemarket dividend funds throughout October. These dividend funds invest in sharemarket companies with high dividend yields.

So it is not surprising that the NZX listed electricity companies have performed particularly well in recent months as investors search for companies offering above-average dividend yields.

The NZX also had a volatile October although not as extreme as most international markets, partly because of our high dividend yields.

The New Zealand sharemarket has a 4.5 per cent dividend yield compared with 1.4 per cent for New York’s S&P 500, 1.6 per cent for the Nasdaq Composite, 1.6 per cent for Japan’s Nikkei 225 and 4.7 per cent for Australia’s S&P/ASX 200 Index.

The performance of our five largest listed companies was varied in October and in the 12 months ended October 31 as illustrated by:

• Fletcher Building, the largest NZX company, had a negative 2 per cent return in October and a negative 9.6 per cent for the October year.

• Spark delivered an impressive 6.2 per cent in October and 44 per cent for the past 12 months.

• Contact Energy had positive figures of 3.7 per cent and 25 per cent respectively.

• Auckland International Airport had a gross return of 3 per cent for October and 16.8 per cent for the past 12 months.

• Mighty River Power, the fifth largest NZX company, had total shareholder returns of 9.9 per cent for October and 34.9 per cent for the October 2014 year.

These figures compare with NZX 50 Gross Index returns of 2.5 per cent for October and 9.7 per cent for the past 12 months.

Fletcher Building has been a big disappointment, particularly when residential housing activity is at exceptionally high levels on both sides of the Tasman.

Investors no longer have full confidence in our largest listed company which has prospective dividend yields of 4.6 per cent for the June 2015 year and 5.1 per cent for the 2016 year based on broker analyst forecasts.

One of the problems with Fletcher Building – and its predecessor Fletcher Challenge – has been its flawed overseas acquisition strategy.

Fletcher Challenge (FCL) was established in 1981 through the merger of Fletcher Holdings, Challenge Corporation and Tasman Pulp & Paper. One of its primary objectives was to become a major Pacific Rim pulp and paper company, mainly through acquisition.

It purchased an 84 per cent shareholding in Vancouver based Crown Zellerbach Canada (CZC) for $400 million in October 1982. Five years later it acquired a 48 per cent stake in British Columbia Forest Products (BCFP), another major Canadian producer, for $600 million.

The minority shareholders in CZC and BCFP were bought out and the entities merged to form Fletcher Challenge Canada.

FCL continued to acquire pulp and paper interests in South America and Australia and at the end of 1989 it purchased UK Paper for a massive $800 million.

FCL was generating huge cash flow from its New Zealand operations and was using this cash – together with an abundant supply of borrowings funds – to expand overseas.

Fletcher’s traditional New Zealand activities are exceptionally profitable because domestic developers tend to build two to five houses at a time, they have no bargaining power and pay fairly full prices for building materials purchased from Fletcher.

These building material operations are far less profitable overseas because developers build 100 plus houses and use their buying power to negotiate much lower prices from suppliers.

Fletcher Challenge was systematically broken up and sold off in the 1990s because of too much debt and inadequate earnings. Fletcher Building, which was established at the end of 2000 out of the remnants, has also had an aggressive overseas acquisition strategy.

It purchased Laminex Group for $785 million in 2002, Tasman Building Products for $272 million in 2003, Amatex for $581 million in 2005, Formica for $981 million in 2007, Australian Construction Products for $56 million in 2010 and Crane Group for $1.05 billion in 2011.

This is a total outlay of $3.725 billion, mostly for overseas assets, yet total group earnings before interest and tax (ebit) from overseas operations was only $262 million for the June 2014 year.

Fletcher Building generated an ebit/revenue margin of 9 per cent from its New Zealand operations in the 2013/14 year compared with just 6 per cent for its overseas operations.

Fletcher Building should have stayed in New Zealand in 2002 instead of initiating its overseas expansion strategy through the purchase of Laminex.

It could have diversified into the retirement village industry, which would have been a great outlet for its construction and building materials sectors, by making a takeover offer for Ryman Healthcare which was worth only $170 million at the time.

A $250 million to $275 million bid for Ryman would likely have been successful.

It could also have established a new retirement village company with a joint venture partner.

Ryman Healthcare’s sharemarket value has risen from $170 million to $3.865 billion since September 2012 and it would have been a far, far better purchase then the collection of overseas companies purchased for $3.725 billion.

When is the Fletcher board going to realise that it has a very strong competitive advantage in New Zealand and overseas organic growth is probably a far better and lower risk proposition that growth through acquisition?

Brian Gaynor
Portfolio Manager

Disclosure of interests: Milford Asset Management holds shares in Fletcher Building, Spark, Contact Energy, Auckland International Airport, Mighty River Power and Ryman Health Care on behalf of clients.