Improvements needed at New Zealand Refining

Friday 3rd May 2002

It must be hard running a company that is a price taker rather than a price maker.

New Zealand Refining is such a company. Despite its near-monopoly position in New Zealand with products such as petroleum that customers need rather than merely want, it struggles to deliver consistent results.

In the year to December, it reported a net profit of $36.5 million, compared with 2000's $69.4 million. Operating revenue was down $15% to $176.7 million.

Although these figures are well down on the previous year, they are considerably better than 1999, indicating how volatile the company's earnings are.

As chairman Ian Farrant points out in the company's latest annual report, "factors beyond our control have major influences on our performance, the two most significant ones being refining margins and the $NZ/$US exchange rate."

Some might think refining margins should be under its control as they reflect the difference between the company's costs and its charges.

However, New Zealand Refining cannot control its major input cost, crude oil, whose price is volatile.

Meanwhile, it has to match the prices of competitors in Asia, where there is significant refining overcapacity, or risk losing business (even though its major customers, the big four petrol retailers, also own the company).

For its size, New Zealand Refining has an exceptionally amateurish annual report with minimal design input.

At least it demonstrates a commitment to minimising costs, important for a company that complains about the pressures on its margins.

Last year the company paid out more in dividends than it earned, a common practice in the late 1990s but avoided in the past two years.

This is often a warning sign to investors, especially if it occurs regularly, but the company states its case well.

"The directors have no hesitation in doing this as the company is performing well, the cash position is good and the company is virtually debt-free.

"The board is of the view that future project work should be able to be funded from attractively priced debt," Mr Farrant explains.

Chief executive Alan Davey's review mainly delves into the intricacies of block shutdowns, hydrocrackers and processing unit utilisation.

Few readers are likely to find these details interesting but the report is useful in that it demonstrates the company's willingness to disclose information.

The best part is his final paragraph where he gives a pithy description of the company and its outlook.

"While not worldscale, the refinery occupies an attractive niche that management must continue to protect and develop. Assuming continued progression toward operational excellence and equitable treatment by government on product quality and greenhouse gas issues, the refinery should be able to deliver attractive results over time."

The subject of greenhouse gases is one close to the company's heart as it faces heavy spending to produce cleaner fuels in line with the government's ratification of the Kyoto Protocol.

"The company is sensitive to the choice of policy options to address climate change as many of its closest competitors are based in countries not immediately obligated to reduce greenhouse gas emissions.

"A further sensitivity is that the production of 'cleaner fuels' inherently requires more energy so the company's emissions are bound to increase," he says.

Mr Davey's comments suggest that, despite the costs of meeting its politically charged, environmentally gentle criteria, the company could improve its performance.

If so, it is possible it could move from the 11% return on shareholders' funds it achieved last year, as shown in a trends page toward the back of the report, to the 15-16% mark it achieved in 1997 and 1998.

These were more stable years before its abnormally poor 1999 and exceptionally good 2000.

David McEwen is an investment adviser and author of weekly share market newsletter McEwen's Investment Report. Web: www.mcewen.co.nz; email davidm@mcewen.co.nz

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