Next: CEO Report
Dear fellow shareholder,
On behalf of the Board, I am pleased to present NZX’s Annual Report for 2016, and welcome this opportunity to communicate with you, our shareholders.
NZX sits at the heart of New Zealand’s capital markets. As the operator of the local stock exchange it is a privilege to serve at the centre of this network – and as the Chairman of NZX it is a role on which I place tremendous importance.
2016 was a year of repositioning for NZX. The Ralec litigation concluded, we reshaped our Agri business, and transitioned our SuperLife and Smartshares businesses to the Financial Markets Conduct Act (FMCA). The costs associated with these activities weighed on earnings. The Funds Services business remains in an investment phase and the Agri business did not meet expectations in a difficult market. As a result, earnings for the year are well below the Board's desired level. Nevertheless, our efforts during the year created a solid foundation for future earnings growth.
In a year headlined by global economic uncertainties and volatility, the New Zealand equity market remained in good health. This is evident in the increase in the S&P/NZX 50 Index (Gross) which was up 8.8% for the year to 31 December 2016. It is worth noting that the five year return of this index to the end of 2016 was 110.1%, which equates to an exceptional compound annual growth rate over the same period of 16.0% p.a.1
This illustrates the strong performance of the New Zealand market compared to major international market indices, including the Hong Kong Hang Seng Index (annualised return of 6.1% over the same five year period), the Australian S&P/ASX 200 Accumulation Index (6.7%), the UK FTSE 100 Total Return Index (6.7%), and the USA S&P 500 Total Return Index (17.4%).
The 12 month forward weighted PE ratio for the New Zealand market is currently 18.9x, which is 10% above the five year historic average.2 These combined figures indicate that New Zealand’s capital markets remain open for business, particularly during a period of global economic uncertainty.
On this note, I am pleased to welcome Tegel Group Holdings, NZME, Investore Property, New Zealand King Salmon and Tilt Renewables, all of which listed on the NZX Main Board in 2016.
S&P/NZX 50 Index performance compared to S&P/ASX 200 and S&P 500 Indices
Progress with creating stronger and deeper capital markets is more graphically illustrated by the increase in the ratio of equity market capitalisation to Gross Domestic Product, which peaked at 50.1% in July. This is a significant milestone given this ratio was as low as 25.0% in February 2009 and in mid-2012 had still only risen to 27.6%. In addition, our benchmark index, the S&P/NZX 50 Gross Index exceeded 7,000 points for the first time in May.
NZX Equity Market Capitalisation
The performance of New Zealand’s listed debt market was another notable highlight of 2016. Debt market capitalisation was up 29.7% to $25.7 billion following the listing of $6.4 billion of new debt in 2016, demonstrating that this product is meeting the needs of the market extremely well, and highlighting its attractiveness as a capital raising option for corporates, banks and local and central government. I would like to acknowledge the wide range of loyal supporters of the market who have issued further debt and welcome The Co-operative Bank who joined the NZX Debt Market in 2016.
NZX Debt Market Capitalisation
The above statistics are impressive and validate the sustained run and competitive advantage of NZX’s equity and debt markets. The markets have benefited from several large, high quality companies listing, raising capital and diversifying their funding sources here in recent years, a low interest rate environment, and the investment of significant KiwiSaver funds.
2016 in review
NZX’s Earnings Before Interest, Tax, Depreciation and Amortisation (EDITDA) were $22.5 million in 2016, at the bottom of the guidance range that NZX provided in February 2016 and consistent with the update provided in October 2016. Growth in operating expenses of 13.3% reflected several one-time costs, including professional fees for the Ralec litigation, Financial Markets Conduct Act (FMCA) and CEO transition costs, and the targeted investments made in our Funds Services business.
Reported net earnings in 2015 included a gain of $11.8 million realised on the sale of the Group’s 50% stake in Link Market Services (NZ). Excluding this gain, the decline in 2016 net earnings was 23.9%, reflecting lower operating earnings, the loss on sale of businesses sold during the year and increased depreciation and amortisation expenses.
I acknowledge the Group’s financial performance is not satisfactory. It failed to meet the Board’s expectations and those of our shareholders. The Board and executive team are determined to drive earnings growth for shareholders as we operate an increasingly integrated set of businesses. Our 2017 earnings guidance reflects this.
More information about NZX’s 2016 financial and operational performance is provided in the CEO Report and Management Commentary.
Our Markets business demonstrated pleasing growth with revenue up 6.0% to $52.9 million, while operating costs were down 4.5%. This operating leverage resulted in 9.5% growth in segment earnings.
Our Fund Services business remained in investment mode, reflecting the deliberate strategic investments made to grow our SuperLife, Smartshares and NZX Wealth Technologies businesses for the long-term. The momentum of the Funds Services business accelerated in Q3 when NZX Wealth Technologies announced two major new clients, Craigs Investment Partners and Hobson Wealth (formerly Macquarie Equities New Zealand). These developments reinforce the Board’s high-level of confidence in NZX’s decision to increase its presence within the passive funds management sector and the provision of funds services infrastructure. The focus for this business in 2017 is on translating customer growth into earnings growth.
It was a difficult year for NZX Agri, as we repositioned our New Zealand and Australia businesses and market conditions adversely impacted advertising revenues. Our reshaped Trans-Tasman business now has a greater focus on data and analytics, which have more attractive earnings prospects and stronger linkages to our Markets business.
In addition, we finally concluded the Ralec litigation in November, which the Judge described as ‘a nil all draw’. This litigation was again a drain on corporate earnings and management attention in 2016. Although we had hoped to resolve the matter without needing to go to a costly trial, we are very pleased to have it conclusively behind us, with all outstanding matters resolved, and no further costs going forward.
With the key deliverables of the Ralec litigation, the Agri business restructure, major client wins by NZX Wealth Technologies and SuperLife and Smartshares’ transition to the FMCA (which required a significant short-term investment of resources), all successfully delivered in 2016, the stage has been set for a step change in earnings in 2017.
As such, NZX expects full year 2017 EBITDA to be in the range of $27 million to $30 million, compared to $22.5 million in 2016. This represents expected growth in EBITDA of 20% to 33%. This is subject to market outcomes, particularly with respect to initial public offerings, secondary capital raising, and equity and derivatives trading volumes. This guidance assumes no material adverse events, significant one-off expenses or major accounting adjustments. It also assumes no acquisitions or divestments.
Capital structure and dividend
The company continues to maintain a gearing position that the Board considers is consistent with its role as a systemically important financial institution at the centre of the New Zealand capital markets. The Board continues to monitor the company’s capital position in light of the future growth potential of our derivatives business, and contingent earnout payments for previous acquisitions. The Board remains comfortable with current capital levels.
The Board declared fully imputed dividends of 6 cents per share in respect of the 2016 year. While this significantly exceeds the target payout ratio of 80% of free cash flow in NZX’s current dividend policy, the Board considers this to be an appropriate level of payout in light of the non-recurring factors that reduced 2016 earnings, and NZX’s balance sheet and cash position. Total shareholder return for NZX in the year to 31 December 2016 was 4.02%. As I mentioned above, our share price underperformed in 2016. Improving the Group’s future earnings and our share price will continue to have the full focus of the Board and executive team in 2017.
Regulation and Policy update
The quality of NZX's regulatory function, core technology and operations was formally recognised in June when NZX received a clean bill of health from the Financial Markets Authority (FMA) as part of its annual Market Operator Obligations Review. It concluded NZX complied with all of its market operator obligations and was not required to take any specific actions.
My thanks goes to our Head of Market Supervision Joost van Amelsfort who has managed our relationship with the FMA very well. We have seen a huge improvement in NZX’s regulatory practices under his leadership as he ensures the highest standards are maintained.
Effective market regulation is a by-product of the positive working relationship we have with the FMA and Special Division. We are grateful for their efforts and it is a privilege to serve our markets alongside them.
Under the leadership of Head of Policy and Legal Hamish Macdonald, our policy team will shortly publish the updated NZX Corporate Governance Best Practice Code. This is the first substantive update to the Code since 2003 and represents a significant step forward in reducing fragmentation between various reporting practices among Main Board listed issuers. I am a strong supporter of listed companies exhibiting good corporate governance as organisations can have a huge impact on the communities in which they operate. I hope this updated Code will lead to increased investor education and confidence in the broader marketplace. Feedback received as part of this review exceeded our expectations. Thank you to everyone who took the time to make a submission.
I would also like to acknowledge our former Minister for Commerce and Consumer Affairs the Hon Paul Goldsmith. On behalf of the Board, we have all benefited from your open working relationship and look forward to working with your successor the Hon Jacqui Dean in 2017.
As the Board looks to 2017 we remain acutely aware of the importance of not just running a well-functioning exchange that operates fair, orderly and transparent markets, but also a commercial business that delivers profitable growth for shareholders.
To achieve this, the first half of 2017 will see the Board focus on ensuring we have the right leadership in place to make the best decisions to drive future earnings growth. The Board has made good progress in its search for a new CEO, engaging global recruitment firm Korn Ferry to lead this process.
To ensure the characteristics of the successful candidate meet the needs of NZX and the markets we operate in, the Board appointed Propero Consulting to survey 80 of its stakeholders to ensure a very broad perspective on the skills needed for a role at the heart of our capital markets.
Feedback consistently emphasised that the most important leadership qualities were strong financial acumen, the ability to create wealth and seasoned judgement. Participants stated it was imperative the CEO was empathetic to markets needs and committed to working alongside stakeholders to build a healthy marketplace at the core of our economy.
Proactive engagement with the market remains a priority for the Board. Thank you to everyone who completed the survey for your invaluable insights. We will provide a further update to the market once the recruitment process is finalised.
Given the timeframes associated with the search for a new CEO, the Board appointed Head of Markets, Mark Peterson, as Interim CEO, effective 1 January 2017. On behalf of the Board I would like to thank Mark for leading NZX through this transition. Mark is a capable leader with a passion for NZX. We are confident that under his leadership earnings growth will be delivered.
We farewelled Tim Bennett at the end of 2016 following his resignation as CEO in October. The Board thanks Tim for his dedicated service.
I would also like to acknowledge former Chief Operating Officer Mandy Simpson and Head of Corporate Affairs Kate McLaughlin, who left in October 2016 and January 2017 respectively, for their contribution to NZX.
NZX recognises the importance of its position at the heart of New Zealand’s capital markets network.
We operate in a dynamic industry and the Board are grateful for the efforts of Mark Peterson and the executive team who delivered several important initiatives in 2016.
I would particularly like to thank all NZX employees and their families for their commitment to the organisation and enthusiasm.
I would also like to thank our customers, particularly our listed issuers and market participants. We look forward to working with you in 2017.
Finally, thank you to our shareholders for your loyal support as the Board and executive team worked through a year of significant transition. As our guidance reflects, I am confident we will execute on our growth opportunities and deliver growing profits for shareholders in the years to come.