Beware domino effect in service industry

By Peter V O'Brien

Friday 12th November 2004

The welcome increase in listed companies over the past year did little to improve the low representation of manufacturers on the Stock Exchange.

Only 27 companies from a significant sector of the economy had stock exchange listing this week out of a total 152 listings, the latter excluding overseas companies and investment funds with no New Zealand-based operations. Manufacturers were 17.8% of total listings.

There were 78 listed manufacturers in 1984, or 36.6% of the total 213. "Manufacturing" was defined liberally when establishing the companies that came within it last week to include groups such as meat processor Affco, where substantial process of a basic product could be said to "make" a different one.

Technology-based companies with products still in development stages were excluded as were those based in telecommunications and computer operations where other firms' manufactured products were utilised to provide services.

Telecom, for example, manufactures virtually nothing, applying systems' know-how to bought-in products.

Computer software specialists were harder to classify, so were also treated liberally when calculating the 27 current manufacturers.

Companies were easier to classify in 1984, a comparative date chosen because it was conveniently 20 years ago, before massive deregulation of the economy and yet to experience the full effect of the excesses that culminated in the 1987 crash.

The disappearance of manufacturing companies since 1984 was greater than the difference between that year's 78 listings and the current 27, the latter including those listed in later years.

Broadway Industries (a reincarnation of Brother Distributors), Carter Holt Harvey, Cavalier Corporation, Fisher & Paykel Appliance Holdings, Fisher & Paykel Healthcare Corporation, Feltex Carpets, Nuplex Industries (formerly Revertex) Richina Pacific (Mair Astley and Mainzeal Group), Lion Nathan and Steel & Tube Holdings (some activities) were the only 1984 listed manufacturers to remain on the stock exchange last week.

That observation could raise a "so what" comment, given the constant changes in economies, industrial and commercial activity and the development of new products and services.

The comment would be fair enough if new products and services had merely replaced outmoded forms (motor transport for horses, for example) and the companies specialising in them.

Developments over the past 20 years in New Zealand equity investment reflected developments in, and changes to, the economic structure, but went further through making an already lopsided sharemarket by international standards more lopsided.

The current situation also fails to reflect accurately the structure of the economy, irrespective of the general downgrading of manufacturers.

Utilities (telecommunications, ports, energy and transport companies) property investment, a few retailers (but no supermarket group), a mish-mash of sundry services and minor technology developers account for a high proportion of the sharemarket.

The situation should concern everyone involved in equity investment, whether as brokers, fund managers, or private investors, the last either directly on their own account or indirectly through managed funds.

A low level of manufacturing representation (and getting lower) affects investors in three ways.

It limits the ability to diversify investment through industry asset allocation and therefore immediately lifts the risk profile of any New Zealand-based equity portfolio.

Significant and profitable businesses are unavailable for public equity investment, a matter which has the secondary effect of adding to the risk profile of the remainder.

This discussion has concentrated on a lack of listed manufacturing companies, but "significant and profitable businesses" covers more than manufacturers.

The structure of the sharemarket fails to reflect the economy and consequently produces portfolios unrelated to economic reality.

That point might be a "good thing," because the New Zealand economy seems to have become more service-orientated in recent years, a trend which has appeared on the sharemarket.

Heavy reliance on service industries for economic effect can be dangerous when the service-users strike trouble.

The domino effect can occur, whereby a fall in the company at the head of the chain flows on to falls in the rest of the chain.

That situation has been seen on the sharemarket, so portfolios that failed to reflect fully the effect of service companies could be "good" but also "bad" through ignoring considerable manufacturing activity.

Current trends raise the intersting but probably far-fetched speculation of when there will be no Stock Exchange-listed manufacturers.

Equity investment would then be confined to companies that took in each other's washing, leading to portfolios guaranteed to lose substantial amounts in a downturn.

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