Friday 30th May 2003
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Infratil's objective is to outperform other utilities on a risk-adjusted basis by investing in infrastructure activities where it has management expertise and influence. Infratil invests for the long term and is comfortable with returns being initially low if there is confidence of future gains.
In the late 1990s Infratil pursued this strategy by moving capital from electricity distribution, which had high cash-returns, into renewable-electricity generation and airport investments as these were considered to have greater long term value. In the year to 31 March 2003 the outcome of these decisions has become apparent. We are seeing satisfactory, and growing, returns from each of TrustPower, Wellington International Airport and Glasgow Prestwick International Airport.
The willingness to take a long term view naturally has the risk that something unexpected disrupts the targeted outcome. Not all our investments have been successful. This year we have written down our investment in Tranz Rail.
A major risk for long term investors is Government policy. Market factors like supply and demand and even technology changes can be managed, but unwarranted regulation and Government initiatives are unpredictable and often unmanageable. In this context, the Minister of Commerce's recent decision to not impose further regulation on Wellington International Airport, and her explicit recognition of the cost and inefficiency that results from regulation, are important messages. In its analysis of the case for the further regulation of airports, the Ministry of Economic Development expressly addressed Infratil's position as an investor and noted the need for a stable and predictable investment environment if investors were not to be deterred.
Infratil was willing to accept modest initial returns on the price it had paid the Crown for its stake in Wellington International Airport. The Airport was investing $116 million in its new terminal and had granted the airlines a rent-holiday until July 2002. However, from that point charges were to be reset to provide a fair return on the investment. Until the Ministerial decision the achievement of a fair return had been at risk.
Statement of Financial Position and Funding
As at 31 March 2003 Infratil's shareholders' funds, after minorities, were $329.40 million from $319.97 million recorded a year earlier.
Infratil had no bank borrowings, unutilised bank facilities of $70.00 million and $14.70 million on deposit.
Infratil has $170.60 million of Bonds on issue, which did not change over the year. In the year ahead $101.25 million of these Bonds mature and steps are being taken now to ensure that the Company retains an efficient balance sheet.
Dividend & Buyback
As noted above, a fully imputed dividend of 4 cents per share will be paid in respect of the year. As has been signalled to shareholders the availability of imputation credits is an important factor in determining the level of dividend and this was the reason no interim dividend was paid.
The improved performance of Wellington International Airport and TrustPower means that both of these companies are likely to pay imputed dividends going forward, which will flow through to Infratil's shareholders.
During the year Infratil bought back 2.5 million shares at a cost of $4.75 million. Infratil is monitoring the market for further buyback opportunities. 42,000 warrants were exercised resulting in the issue of a like number of shares.
Wellington International Airport (66% ownership)
Wellington International Airport's (WIAL) earnings before, interest, tax and depreciation (EBITD) to 31 March 2003 increased to $33.79 million from $24.62 million the previous year. Infratil's net earnings from WIAL rose 62% to $10.22 million.
WIAL's passenger numbers rose 5.3% to 3.90 million, reflecting a 4.9% fall in international and 6.8% increase in domestic. Over the last five years average passenger growth has been 2.2%pa. Passenger numbers depend on airfares and services, which are determined by the airlines.
Over the same five years, WIAL's income from terminal facilities (such as retail concessions) has increased 19% pa aeronautical income rose 11% pa and operating costs fell 2% pa.
Other than the marked improvement in domestic air passenger activities over the second half of the year, the other major development was the re-determination of aeronautical charges, which took effect 1 July 2002. This price rise was factored into Infratil's value of WIAL when it acquired its shares from the Crown in 1998. It was therefore very disconcerting when, in August 2002, the Commerce Commission recommended that Government regulate the Airport in a way that would have expropriated up to $40 million of its value. Infratil submitted its case to the Ministry of Economic Development review of the Commission's findings, and Infratil's position was supported by the Ministry. The Minister of Commerce has decided that no further controls are necessary.
Another positive regulatory development during the year was the Commerce Commission's provisional rejection of the alliance between Air New Zealand and Qantas.
It would be a negative for New Zealand if the airlines were allowed to create a monopoly or near monopoly on most New Zealand air routes and the links with North America, Australia and Japan. The loss of connections to one of One World and Star airline alliances, which make up 18% and 22% of global air travel respectively) should also be an insurmountable hurdle to the Qantas transaction progressing.
Glasgow Prestwick International Airport (67% ownership)
Earnings before interest, tax and depreciation in the twelve months to 31 March 2003 were £5.04 million, up from £3.55 million. Net profit after tax was £1.19 million up from £0.63 million.
Activity and revenue growth were mostly strong:
Port of Tauranga (10% ownership)
Port of Tauranga (POT) achieved a record net after tax profit of $25.90 million in the year to 30 June 2002 and followed with $14.53 million in the six months to 31 December 2002.
For the six months, POT's earnings before interest, tax and depreciation were $33.45 million from $25.49 million for the interim period in the previous year. Net profit increased 18.1% and revenue 63%. Tauranga throughput was 6,094,729 tonnes, up 4.5%, including 169,740 containers, up 4.7%.
In addition to growth at Tauranga, the year also saw further development of POT's wider port and freight activities:
Tranz Rail (7%)
Infratil's $21.54 million write-down of its Tranz Rail investment reflects the Board's view that this investment has permanently diminished in value. While this is a disappointment, the outcome illustrates Infratil's investment rules. Infratil invested in expectation of being able to partner with other industry investors as Wisconsin and FayRichwhite sold out. When no credible partner arose Infratil did not invest further (other than to take up its rights) but looked to exit. Infratil's understanding of publicly available information had not pointed to the share price decline that has now occurred.
TrustPower (28% ownership as at 31 March 2003)
For the year ended 31 March 2003 TrustPower reported a net surplus after tax of $47.00 million, close to double its previous best ever result. Earnings before interest, tax and depreciation were $112.94 million, against a highest previous level of $69.40 million.
TrustPower contributed $13.11 million to Infratil's net surplus for the year.
The results are a substantive improvement, and reflect the commencement of a period of adjustment in electricity prices from the unsustainably low levels of recent years. This adjustment had been anticipated and is not a windfall gain. Infratil invested in TrustPower in expectation of the electricity market moving towards more sustainable pricing levels.
Despite the improvement in 2003, TrustPower's return on assets remains low with retail electricity prices lagging the wholesale market, and below levels that will justify investment in new generation.
Events such as the current period of high prices should not be a major influence on profitability. Risk management should ensure that volatile short term prices are not as important as longer term movements, at both wholesale and retail ends of the market.
In respect of the recent debate about the electricity market, Infratil considers the poor availability of hedge or supply contracts to be the main inhibitor of the effective functioning of the electricity sector. Generator-Retailers prefer to grow their retail market share rather than offering electricity on longer term (say, 2 years and longer) contracts to wholesale buyers. TrustPower would be better able to serve a wider retail market if it were able to buy electricity from other generators on longer term contracts.
Government's recent policy announcement to limit so-called "dry-year" risk may be of limited importance to investors. Government intends to see "ordinary" generation investments driven by market prices. However the distinction between '"reserve" and "ordinary" plant is an important piece of detail that is yet to be resolved and such uncertainty will disturb plans to invest in new capacity.
It should be noted that the Huntly power station has been New Zealand's key source of "dry-year" reserve (typically it has pre-winter spare capacity, which, if used, can enable hydro storage to be maintained going into winter if a dry period is anticipated) Huntly's non-performance of this role has been an important contributor to this year's problems, which seems not to have been recognised by Government's "dry-year" initiatives.
There is a real risk that customers will pay twice for security, once through a compulsory levy and then again through their energy bill which will still need to be high enough for new "ordinary" plant to be built. Infratil is hopeful a mechanism can be found to allow customers to demonstrate they have taken responsibility for their own security and can then opt out of the levy system.
Still waiting to be addressed is how renewable generation, such as windfarms, can be encouraged to play a greater role. Given Kyoto and dwindling gas reservoirs it is inevitable that renewables and conservation will be more important in the future. TrustPower's recent commitment of $60 million to the expansion of the Tararua windfarm was helped by Government's allocation of Kyoto credits. Tararua has the advantage of being an existing windfarm and further greenfield developments seem unlikely without substantive, sustained and consistent assistance. Infratil expects this area will be addressed in time and TrustPower is well positioned to respond.
After balance date the Company announced that it is to buy back approximately 21% of its shares. TrustPower's increased use of debt reflects its higher and more stable level of income, which allows a higher level of debt to be comfortably serviced. Infratil did not participate in this buyback and if it progresses it will leave Infratil with approximately 35% of TrustPower. Infratil and its partner, Alliant Energy, will hold 59% of TrustPower if the buyback is completed. The extension of the Infratil-Alliant agreement to May 2007 provides a stable corporate position for TrustPower to be able to focus on the successful operation of its business.
Energy Developments (13% ownership)
Over the year, Infratil invested NZ$55.23 million (A$48.04 million) acquiring 13.2% of EDL, an Australian company that specialises in extracting energy from waste. EDL constructs, operates and owns small-scale power stations that run on the waste "greenhouse" gases from rubbish dumps and coal seams. Its modular power units also provide power in many remote areas of Australia. EDL has almost 400MW of plant operating in 7 countries.
In addition to this core energy business, EDL is working on a project to take household and industrial waste and gasify it so it can be immediately used to fuel power stations as an alternative to landfill. This process (known as Solid Waste Energy Recycling Facility "SWERF") is cleaner than incineration and has the benefit of minimising waste to be dumped while producing electricity. Internationally, dumping rubbish in landfills and large-scale incineration is becoming expensive and, in some instances, unacceptable. There is great demand, and potentially very solid returns, for efficient ways to recycle. However, set against the potential of the sector, are technical and operational difficulties in taking heterogeneous waste and cleanly converting it to energy.
EDL has encountered delays and technical issues, as have competing technologies, and many investors lost patience, and also confidence, in the project. SWERF was assumed by some investors to be a "certain winner" which resulted in a bubble in EDL's share price. Infratil bought in as this bubble deflated and Infratil's interest in EDL was acquired on the basis of the core waste-energy business, with SWERF as an additional upside.
More recently, EDL has also announced difficulties with the operation of a specific brand of engines at some of its landfill stations. This operational problem, although thought to be of a short-term nature, has resulted in a severe drop in EDL's market value. The current EDL share price is below the price paid by Infratil, but Infratil does not consider that there is any permanent diminution of value.
Infratil is supportive of recent management and Board changes at EDL and believes these will assist the Company to improve its results in the medium term.
New Investment Initiatives
Since establishing the IO Fund with Orion Limited and the Crown, Infratil has invested $1.52 million. It is expected that a restructure of the IO Fund will be announced in the near term.
Infratil's management continue to work on a number of emerging airport opportunities in Europe. Infratil was also chosen by Waitakere City Council as its partner on the commercial development of Whenuapai Airport as its use by Defence reduces over the next 5 years. By their nature such projects are long term.
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