Devon View April 2026 - Macro shocks and micro risks

Written by Josh Wilson, Portfolio Manager at Devon Funds.

The New Zealand share market has fallen -6% since the war broke out between the US, Israel and Iran. This is in stark contrast to the US share market which has risen +5% in the same period.

The divergent performance can be at least partly attributed to the anticipated impact of constrained fuel supply and higher prices on our respective economies: New Zealand is heavily dependent on the Middle East-Asian fuel supply chain, and we’re an export driven economy that suffers even more from the tyranny of distance when fuel (and freight) costs rise. Exports comprise nearly a quarter of our GDP. In contrast, the US is self-sufficient in oil and does a lot of business with itself (exports are about 10% of GDP).

Furthermore, for the struggling New Zealand economy, where it was finally looking like the ‘green shoots’ of recovery might grow into something more meaningful, the spike in fuel costs, inflation fears, and interest rate rises mean we may now be waiting until 2027 for this to eventuate. Consensus expectations for economic growth in 2026 have fallen from 2.4% to 1.8% since the start of the year and may fall further if the conflict and high fuel prices persist.

In contrast, the US economy entered the conflict in good shape, with economic growth above 2% in 2025 and projected to remain there in 2026. Some of this is due to the robust AI activity in the US tech sector, while its oil and gas sector has also benefited from higher oil prices, whereas this is a straight ‘tax’ on NZ, with very little offset.

With all that said, for Devon, as investment managers focused purely on the New Zealand and Australian share markets, our job is to navigate these shocks as best as possible on clients’ behalf, assessing where a macro shock leads to micro risks.

During these periods of market and economic stress, as well as working hard to anticipate the potential impact on companies’ financial performance (profit and loss), the state of their financial position (balance sheet) becomes more prominent in our thinking.

When performance comes under pressure, companies in weak financial positions are more likely to be forced into decisions that permanently impact shareholder value - for example, raising capital at a dilutive share price, divesting assets below fair value, or foregoing value accretive investments.

KMD Brands is a good current example of this. In April, the company completed a $65m capital raise by issuing 1.1 billion shares at six cents a share, a 69% discount to the last price. The cash raised was used to pay down debt. The raise heavily diluted existing shareholders and permanently impaired capital held in the company prior. KMD, owner of Kathmandu and Rip Curl, had been struggling with competitive and cost pressures for some time, but the downturn in consumer confidence in New Zealand and Australia following the outbreak of war was perhaps the straw that broke the camel’s back. Devon does not hold any KMD Brands shares, but we’ve watched closely for lessons on the dangers of over-stretched balance sheets in a weak economic environment.

Conducting a ‘post-mortem’ on KMD Brands highlights several warning signs:

• Weak and declining earnings: KMD’s earnings fell -65% at the EBITDA level in 2025. At the bottom line, the company made a net loss for the year.
• Cyclical earnings exposed to economic activity and consumer confidence: KMD operates in the consumer discretionary retail sector and is highly exposed to external shocks like we’re experiencing currently.
• A business model highly sensitive to demand changes due to the combination of operating and financial leverage: At the end of the 2025 financial year, KMD had bank debt of $87m and capitalised operating leases of $288m. Fixed charge cover, the ratio of earnings to interest and rent (‘fixed’) costs, was flashing a red warning sign at only 1.03x.
• Market valuation of equity lower than gross debt: prior to the capital raise, the market value of KMD shares was $138m, far lower than gross debt (borrowing and leases) of $375m. For lenders and landlords, this is not a comfortable position to be in and can be a catalyst for them to encourage the company to raise capital to address this imbalance.
• A lack of hard, liquid assets on the balance sheet: Intangible assets of $626m are by far the largest asset on KMD’s balance sheet. These may be worth substantially less or nothing to an external buyer. KMD had limited options to realise cash from asset sales.

When we look across the New Zealand market, there are other companies that display some of the same characteristics as KMD Brands. For us, Air New Zealand is a clear example. Earnings are weak and declining, it operates in a highly exposed sector and carries a substantial debt and lease load. Despite this, it was buying back its own shares as recently as November last year. Devon Funds is not a shareholder.

Others that tick some of these boxes, where we do have small exposures, include casino operator SkyCity and retirement village company Summerset. In both cases, we can see factors that mitigate the risk of balance sheet distress, but are also engaging closely with management and, in some cases, the board to ensure we fully understand the situation, are comfortable with the company’s strategy, and that the risk/reward equation still makes sense for our investors.

We hope the conflict in the Middle East reaches a peaceful and sustainable resolution soon, fuel prices subside, and New Zealand’s economic recovery gets back on track. If this does not happen, we’re confident in the quality of the businesses that we own and the valuation support that exists across them.