infratil update 2012-09

7/31/2019 Infratil Update 2012-09

1/121

InratIl

UPDatE

Ove he s decde he Ii goup

ivesed $3,060 miio d is cosoided

u EBItDa* (eigs beoe iees,

, depeciio d vue djusmes)

ose om $35 miio o $520 miio. Ove

he sme peiod Iis compoud e-

eu o shehodes ws 13.7% pe

um (sice isig eus hve bee

16.7% pe um).

Over 23,000 people own Inratil shares,

presumably in expectation o earnings and

value growth taking into account the risks

associated with both Inratil and the nancial

market in general. Its likely that shareholders

goals are medium-long term as by ar the

majority hold their shares or over ve years.

This Update addresses one key element o how

Inratil goes about delivering to those earnings

and value expectations; by investing.

Investment is both a core part o how Inratil

creates value and a distinctive eature o its

activities (or rom the other perspective, Inratil

would look very dierent today had it ceased

investing a ew years ago). In the ve years to

31 March 2012 consolidated investment was

$1,592 million, over the last 10 years it was

$3,060 million. The spend was in several

sectors with approximately one third involving

Inratil buying new holdings such as the 50%

shareholding in Z Energy and two thirds applied

by companies Inratil has invested in growing

their own businesses.

The upshot o this investment is earnings

growth and good returns or Inrati l s

shareholders.

Iis busiesses coiue o gow d

Ii coiues o ives.

Investment, earnings growth,shareholder returns

GrOWtH InraStrUCtUrE rEQUIrES

CaPItal anD rEWarDS CaPItal

PaGE 2

BUYInG GOOD BUSInESSES at

aIr ValUE

PaGE 4

InratIlS tarGEt rEtUrn

tO SHarEHOlDErS

PaGE 8

SEPtEMBEr2012

*EBITDAF is a useul non-GAAP nancial measure as it shows the contribution to earnings prior to non-cash items such as depreciation

and amortisation, air value adjustments and the cost o nancing and taxation. A reconciliation o Inratils EBITDAF to Net Surplus can

be ound on page 45 o the Inratils 2012 Annual Report.


2/122

InratIl

SEPTEMBER UPDATE

2012

Growth infrastructure requires capitalGrowth infrastructure requires capitaland rewards capitaland rewards capital

Ii hs chieved compoud e

eu ove eighee d h yes o

16.7% pe um.

Actual returns o individual shareholders will

depend on when shares were purchased,

whether dividends were taken as cash or

shares, and whether the warrants and rights

Inratil has issued were taken up or sold. For

instance, someone who invested on 1 April

2007 immediately prior to the Global Financial

Crisis would have had a subsequent return o

almost exactly 0% per annum. Someone who

purchased Inratil shares 2 years later would

have earned 16.4% per annum.Historic returns are mainly interesting or

what they say about uture prospects. What

were the ingredients o Inratils past success

and will they bake the same cake over the next

ew years?

...The right method in investment is to put

airly large sums into enterprises which one

knows something about and in management o

which one thoroughly believes; John Maynard

Keynes explanation o his investment approach,

and it (with some additional eatures) also

describes Inratils model. Keynes is worth

quoting as he was an enormously successul

and innovative investment manager o the Kings

College Cambridge endowment und. A detailed

report on Keynes as an investment manager

was released earlier this year and is summarised

later in this Update.

Inratils main businesses; Wellington Airport,

TrustPower, Inratil Energy Australia, Z Energy,

NZ Bus; are distinct and largely unconnected,

but a common eature is capital intensive

growth; that is growth which requires money;

to nance terminal expansion, power stations,

working capital and customer management

systems, service stations, port acilities, feet,

and so on.

The relationship between demand growth,

investment and earnings growth is illustrated

by Wellington Airport. Inratils 66% stake cost

$96 million in 1998 at a time when the Airport

catered to 3.5 million passengers and annualEBITDAF was $15 million.

Over the subsequent 14 years the business

has been expanded to accommodate 5.2 million

passengers with over $300 million absorbed to

nance runway extension, new terminals, land

transport acilities, etc. Last year EBITDAF was

$76 million.

An attraction o this type o growth and

investment is that it provides compound returns

(as opposed to one-o gains) and it has

optionality. More money will be put to work i

the investments returns appear attractive, or

allocated elsewhere i not. Additional capital

will be available to Wellington Airport (and

Inratils other businesses) so long as the

prospective returns are suitable. I the Airport

cant identiy such opportunities then the unds

can be allocated elsewhere. Eectively each

o Inratils businesses is obliged to compete

or capital which should mean only the better

plans are progressed.

Discipline is imposed on the management o

Inratils subsidiaries and associates, and a range

o investment options will be available to enable

comparison o risk and return characteristics

While the majority o Inratils allocation o

growth capital has been (and is likely to continue

to be) to internal projects, some is to the

acquisition o new shareholdings. The most

material recent example was the 2010 purchase

o 50% o Z Energy.

Inratil s management are continually

reviewing external opportunities, but despite

several potential transactions since the Z Energy

acquisition none has progressed. Good deals arehard to do but are worth looking and waiting or.

Someone who invested $1,000 when Infratil listed in March 1994 and who thenpurchased more shares with all dividends and the proceeds of all rights issued(ie. who following the initial investment neither put more money in nor tookmoney out) would now have a shareholding with a market value of $17,460.


3/123

100

200

300

400

500

600

700

800

900

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

0

$ Million

Internal Capital SpendingBusiness Acquisition

InratIl InVEStMEnt (BUSInESS aCQUISItIOn & IntErnal CaPItal SPEnDInG)

100

200

300

400

500

600

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Earnings before interest, tax, depreciation and values changes Net Operating Cashflow

0

$ Million

InratIlS EBItDa & nEt OPEratInG CaSH lOW (atEr IntErESt anD tax)

Note: A reconciliation o Inratils EBITDAF to Net Surplus can be ound on page 45 o the Inratils 2012 Annual Report.


4/124

InratIl

SEPTEMBER UPDATE

2012

$ Million

0

100

200

300

400

500

600

700

800

900

1996 1998 2000 2002 2004 2006 2008 2010 2012

TrustPower

Other Wellington Airport

Infratil Energy Australia

NZ Bus

Z Energy

Buying good businesses at fair value, thenBuying good businesses at fair value, thensupporting disciplined internal growthsupporting disciplined internal growth

Over the last decade Infratil has allocated $3,060 million either to businessacquisitions or internal capital spending. The increase in earnings andshareholder value over that period indicates that average returns on thiscapital has been good, however the average includes positives and negatives.Four brief case studies are outlined below.

a idusy udegoig pooud chge

ceed he oppouiy o puchse he Z

Eegy shehodig ecepio pice

d o he dive eigs gowh by

chgig mgemes ocus

In March 2010 Inratil acquired a 50%

shareholding in Z Energy at a cost o $210

million. Since then the holding has provided

cash returns (interest and dividends) to Inratil

o $61 million and now has an average broker

analyst valuation o $405 million.

In addit ion, Z Energy has init iated a

programme o internal investment to create

urther growth in throughput and returns.

The recipe or a low purchase price and a

great deal o subsequent value-add? Among the

dozens o ingredients the salient one was a

decade o uncertainty and change surrounding

the New Zealand liquid uel industry. That, along

with poor nancial returns, would have inuenced

Shells decision to exit, discouraged other

buyers, and created opportunities or a local as

opposed to multinational management ocus.

The uel processing and distribution industry

is changing rom the historic model o an oil

major, such as Shell, nding and extracting oil

(upstream activities) and also processing,

distributing and marketing the oil and uels

(downstream). For some years it has been

dicult, or just not possible, to be consistently

successul at all the stages. Shell and other

integrated oil companies are now selling out o

reining and distribution to ree up capital or

upstream and exploration activities.

In New Zealand the industry had poor returns

and shareholders have maximised cash

extraction through under-investment or in the

case o Shell, sale o its downstream operations.

The success o Inratils Z Energy investment

reects a low entry price and a new management

team taking advantage o the opportunities

created by a restructuring industry.

InratIl InVEStMEnt (BY COMPanY)Ii aipos Euope; igh igedies

wog oucome

In the 1990s Australia and New Zealand were

amongst the rst countries to sell state-owned

airports and to allow their commercial

operation. The resulting value uplit encouraged

Australasian investors to look at markets where

similar developments were occurring, which

led to Europe.

Inratil invested in Prestwick, Kent and

Lbeck airports and purchased an option over

an airport near Berlin. These airports were

acquired at well below replacement cost as

rapid growth in European air travel made it likely

that their capacity would soon become needed

and valuable.

Kent or instance cost less than 20 million

and the next London runway will cost over

2 billion (Mayor Boris Johnsons preerred site

in the Thames Estuary is likely to cost over

20 billion).

Notwithstanding this enormous potential,

Inratil has now called it quits. European air

trac growth has slowed so that the need oradditional airield capacity is postponed, and

Inratils assessment o the relative benets o

waiting (and continuing to meet operating cost)

versus reocussing elsewhere have avoured exit.


5/125

tusPowes ece ivesme ocus hs

shied om buidig geeio i

new Zed o wid ms i ausi d

iigio i Cebuy. this is esu o

cpi discipie d biiy o use

epeise ouside o coe ucios

TrustPower owns 21 power schemes around

New Zealand and retails energy to approx-

imately 210,000 customers. Since 2000

TrustPower has increased its New Zealand

generation capacity by approximately 40%,

however the recent investment ocus has been

on irrigation in Canterbury and wind arms in

Australia, especially the latter.

TrustPower is expanding its Snowtown wind

arm at a cost o $550 million and has over

$1 billion o other projects in Australia.

This shit in investment ocus relects

discipline and a willingness to look outside o

the usual while still taking advantage o in-

house expertise. At present New Zealand does

not need more electricity generation capacity,

the economy has not grown or ve years and

nor has electricity consumption. Companies

which have recently invested in New Zealand

generation are likely to have inadequate returnsor several years on that capital. TrustPower

however is able to undertake attractive large-

scale investment by applying its capital and

expertise to construct wind arms in Australia

which benet rom that countys policy target o

20% renewable generation by 2020.

The table below compares the disclosed

economics o TrustPowers Snowtown project

and a recent ly in i t iated wind arm in

New Zealand. It gives some indication o why

TrustPower is building in South Australia and

why it is able to create value with its investment.

Recognising that dierent sites will have

diferent output prices and operating costs so

cost per unit o expected generation will explain

only part o a projects economics.

Compy to Cpi CosPojecedau Oupu Cos/Oupu Ui

TrustPower $550 million 985GWh $560,000

Meridian $169 million 235GWh $720,000

$ Million

EBITDAF

0

50

100

150

200

250

300

350

400

1996 1998 2000 2002 2004 2006 2008 2010 2012

Capital Spend

trUStPOWEr CaPEx anD EBItDa Ii Eegy ausi goup,ow cos ey

New Zealands electricity industry was

deregulated in the 1990s and over the next

decade it became vigorously competitive and

mergers and acquisitions were common.

A decade or so later the Victorian electricity

market was the irst in Australia to ollow

New Zealand and it created an opportunity or

New Zealand experience to be applied building a

business across the Tasman.

The Inratil Energy Australia group (retailing

and peaker-generation in the south and eastern

states, and generation and energy sales to

wholesale customers in the west) was started

rom nothing by applying New Zealand

electricity market expertise to the deregulated

and restructuring Australian electricity and gas

markets. It was a window o opportunity which

is now less open as re-regulation makes start-

ups more diicult and raises the costs oacquiring customers. The industry is also

changing as it consolidates into a small number

o large and medium sized companies.

Segy

Inratils investment strategy is to look or low-

cost entry into businesses which are well

understood by management and to then build

capacity and value as demand expands.

The approach has mainly delivered, but not

always. European airports were not successul

or Inratil. They itted the strategy, but the

European economic crisis stiled air traic

growth raising the holding cost and extending

the period beore underutilised airelds would

be needed.

At t imes even extremely successul

businesses will ace a lack o demand in their

core markets and a pause in growth unless

investment in adjacent elds can be developed,

which or TrustPower has meant wind arms

in Australia.

However, sometimes good investments willnot be ound and Inratil is prepared to deer

capital spending or cancel projects i that is the

best option.

Note: A reconciliation o TrustPowers EBITDAF to Prot beore Income Tax can be ound on page 50 o TrustPowers 2012

Annual Report.


6/126

InratIl

SEPTEMBER UPDATE

2012

A recent study of a highly successful funds manager operating from 1924 to 1946illustrates the consistency of what works. Most of that managers rules would fitInfratil today

Joh Myd Keyes me is bsed o his

oes i ecoomics d hisoy, bu s he

bus o Kigs Coege Cmbidge he ws

so ecepioy successu ud

mge o he Coeges edowme ud.

Over the 22 years between 1924 and 1946 the

discretionary und managed by Keynes returned

a compound 13.7% per annum. The period

included the 29 Crash, the Great Depression

and World War II.

Earlier this year Proessors David Chambers

o Cambridge and Elroy Dimson o the London

Business School produced an extensive review

o Keynes und management perormance in

which they note His portolios were idiosyncratic

and his approach unconventional. He was aleader among institutional investors Keynes

experiences in managing the endowment

remain o great relevance to investors today.

Although Keynes succinctly summarised his

approach as ...the right method in investment is

to put airly large sums into enterprises which

one knows something about and in management

o which one thoroughly bel ieves the

academics study identitied several actors

which contributed to the outperormance o

Keynes as a und manager.

Kowedge

Keynes knew a lot o people and was well

abreast o the news. His stock-picking was the

product o undamental security analysis... and

on a judicious reading o the nancial press,

on the one hand, and the use o his personal

network o City and industry contacts, on

the other.

Mge/ud muu iees

His interests and those o the College were

closely aligned. 75% o his personal share-

holdings were in the same companies as the

College unds.

Good imig (supisig give he peiod)

Keynes was highly committed to investing in

equities, and on average 74% o the managed

unds were in shares. His timing in this regard

was good. From 1900 to 1923 the UK equity risk

premium over UK government bonds was

1.3%. Over the period o Keynes management,

1924 to 1946, the premium rose to 4.5% (rom

1946, when Keynes died, to 2000 it rose urther

to 6.8%).

Although Keynes was investing at a time

when shares did re lat ively better than

government bonds, competition or good shares

was muted as UK insurance companies had only

3% o their unds in equities in 1920 and had not

reached 10% by 1937.

Sme compies d ocus

Funds were mainly invested in smaller and

mid-sized irms and the portolio was not

diversied, or instance Keynes avoided shares

in banks and nancial companies.

Vue ivesme

Initially Keynes was a top down investor who

used a credit cycle theory o investment to

structure his investments in accordance with

his view o the economy and nancial markets

as a whole. But by the early 1930s, having not

oreseen the 29 Crash, he had concluded that

this approach was unsatisactory and moved

to concentrating on a ew core holdings,

considered cheap relative to their intrinsic

value and held or several years.

He also shited rom buying shares which had

recently risen in value, to largely buying shares

out o avour with the market, ie he had adopted

a contrarian approach.

The Crash, The Depression, WWIIThe Crash, The Depression, WWII1924 to 19461924 to 1946

thee is ie i Keyes ppoch

wih which Iis mgeme

woud disgee, hough uy

hee e sigic difeeces

bewee how Kigs Coege d

Ii impeme hei segies.

the ome ws cive de o

ised shes whie Iis ppoch

is buy d hod d he mjoiy o

is hodigs e uised.


7/127

index

1924 1926 1928 1930 1932 1934 1936 1938 1940 1942 1944 1946

Kings Col Cumulative UK Shares Cumulative UK Bonds Cumulative

0

400

800

1200

1600

2000Kings Col

Annual Return 13.7

UK SharesAnnual Return 6.8

Index

Infratil Cumulative NZX Cumulative NZ Bonds Cumulative

16.7Infratil

Annual Return

6.4NZ Shares

Annual Return

0

400

800

1200

1600

2000

19961994 1998 2000 2002 2004 2006 2008 2010 2012

rEtUrnS nZ

Index

0

500

1000

1500

2000

2500

1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011

Buett Cumulative S&P 500 Cumulative US Bonds Cumulative

15.4Buett

Annual Return

US Shares

Annual Return 8.1

The graphs show the relative perormance o

the unds managed by Keynes over 22 years

and by Inratil or the eighteen and a hal years

since listing. To provide a third reerence

Warren Bufetts last 22 years o perormance

is also shown.

In each case the und perormance is

compared against the relevant share and

government bond market returns. The

comparisons are not entirely level playing

ield as the individual circumstances o tax

paying investors would mean that net returns

are likely to difer rom those shown. Both the

Inratil and Keynes returns are ater tax in the

hands o Inratils shareholders and Kings

College. All the bond returns do not deduct tax

and Bufetts returns are gross o shareholder

tax on capital gains.

What stands out is that investment in the

equity o good companies can provide attractive

returns, even over periods amous or theireconomic and nancial upheaval. 1924 to 1946

included several worst o market crashes,

depressions and wars, but well inormed

investment in good companies by Keynes

was still able to post a compound return o

13.7% per annum. Perhaps more surprisingly the

average UK market return or the period was

6.8% per annum.

It is galling to note that the UK sharemarkets

compound rate o return between 1924 and

1946 was better than the New Zealand markets

since March 1994.

Also, since March 1994 the NZ sharemarket

index have provided a lower return than the

government bond index. Leaving aside tax,

$100 invested in shares in March 1994 would

have compounded to now be worth $313, while

$100 invested in government bonds would have

compounded to $378 over the same period.

rEtUrnS US

rEtUrnS UK


8/128

InratIl

SEPTEMBER UPDATE

2012

Infratils target return to shareholders.Infratils target return to shareholders.What should they be?

a umbe o yes go Ii beg

pubishig spiio ge o is

shehode eus o 20% pe um

e- ove he og-em.

In reality, no company can be precise about

equity returns, especially a company with a

relatively diverse portolio o businesses which

will usually be at dierent stages o their

business cycles. Even when operating and

nancial targets are met, no one can second-

guess how the share market will respond.

The aspirational target is not however

meaningless and it is used within Inratil to

judge inve stment pro jects and a lso to

benchmark whether businesses and assets

should be retained or sold. 20% is a high return

target and it precludes Inratil investing in or

retaining very low risk/return businesses.

However, it is also not a must meet goal

and targets change as market circumstances

shit. The graphs on the acing page show the

long-term trend or a number o interest rates

in our markets and illustrate the current

uniquely low cost o money. There is no direct

relationship between Inratils own return

objectives and international interest rates, but

major changes in the nancial markets are likely

to have wider connotations.

Even i return targets havent changed,

means to their delivery can. Since the 2007

Global Financial Crisis Inratil has placed greater

priority on the cash generation o its businesses

which has owed through to a higher dividend

to shareholders. Five years o nancial market

and economic uncertainty, even with interest

rates seemingly lower or longer, continue to

encourage investors to place a premium on cash

earnings and dividends.

The table copied above shows the average

returns investors have gained rom bonds and

shares in a number o markets, both in real and

nominal terms. The returns are also calculated

or a US$ investor to remove the impact ocurrency changes. All but the New Zealand

gures came rom a Deutsche Bank report.

In all these markets bonds have outperormed

shares over the last ve years. An anomalous

outcome which hints at the diiculty in

orecasting uture returns and help explain

why investors will be conservative now.

DEBt anD EQUItY rEtUrn COMParISOnS (all IGUrES arE COMPOUnD annUal rEtUrnS)

Peiod US

Equiy

US

Bods

Ii nZ

Equiy

nZ

Bods

aus

Equiy

aus

Bods

Jp

Equiy

Jp

Bods

UK

Equiy

UK

Bods

Nominal

5 years 0.8 7.4 1.6 (0.6) 8.2 (3.8) 10.3 (11.3) 2.4 1.1 6.0

10 years 6.6 5.7 13.7 5.0 7.8 7.9 7.1 0.2 1.4 8.0 5.3

25 years 9.5 8.0 16.7* 6.4 7.1* 9.2 10.3 (2.3) 4.1 8.8 7.7

Real

5 years (0.8) 5.7 (1.1) (3.3) 5.5 (6.0) 7.7 (11.1) 2.7 (1.8) 3.0

10 years 4.2 3.3 11.3 2.6 5.2 5.2 4.3 0.2 1.5 5.4 2.8

25 years 6.6 5.0 14.3* 4.0 4.7* 6.0 7.1 (2.7) 3.6 5.7 4.6

In US$

5 years 0.8 7.4 3.1 0.9 9.7 (0.2) 14.4 (4.8) 10.0 (3.6) 1.1

10 years 6.6 5.7 19.4 10.7 13.5 14.9 14.0 4.4 5.7 7.7 5.0

25 years 9.5 8.0 18.6* 8.3 9.0* 10.9 12.0 (0.6) 5.9 8.0 6.9

* 18.5 years or NZ, rom the time Inratil was listed in March 1994.


9/129

1900 1908 1916 1924 1932 1940 1948 1956 1964 1972 1980 1988 1996 2004 2012

% pa

0

5

10

15

20

25

nEW ZEalanD MOrtGaGE ratES SInCE 1900

% pa

0

4

8

12

16

20

1694 1714 1734 1754 1774 1794 1814 1834 1854 1874 1894 1914 1934 1954 1974 1994

UK BaSE ratE SInCE 1694

% pa

0

5

10

15

20

25

1517 1547 1577 1607 1637 1667 1697 1727 1757 1787 1817 1847 1877 1907 1937 1967 1997

nEtHErlanDS 10 YEar GOVErnMEnt BOnD YIElD SInCE 1517

% pa

0

4

8

12

16

20

1790 1810 1830 1850 1870 1890 1910 1930 1950 1970 1990 2010

US 10 YEar trEaSUrY YIElD SInCE 1790


10/1210

InratIl

SEPTEMBER UPDATE

2012

the Ii goup hs ppoimey

$800 miio o cpi pojecs ow udewy

d o sped his ci ye is ikey o

be i he ode o $500 miio. the sped o

he ivesme is se ou i he be.

This does not include NZ Reinings $365

million continuous catalytic converter project

which Z Energy supported.

The largest investment project now under

construction by the Inratil group is TrustPowers

$550 million.

This is not expected to be ully commissioned

until mid-2014 and is projected to provide annual

earnings beore interest, tax and depreciation o

$99 million and ree cash fows ater operating

costs, interest and tax o $53 million.

Infratils investment projectsnow underway

InratIl

SEPTEMBER UPDATE

2012

Compy Cpi Budge rge

TrustPower $40-50 million

TrustPower: Snowtown $550 million

Inratil Australia $40-45 million

Wellington Airport $20-30 million

NZ Bus $50-55 million

Z Energy $85-90 million

Other $5-10 million

Total $790-830 million


11/1211

udig d peships

$300 mil l ion a year is the average

investment outlay o the the Inratil group over

the last decade. The money has come rom

operating cash lows, borrowings, equity

issues and asset sales. What it doesnt include

is the use o co-investors in new ventures. The

most salient example o this was the $210

million contributed by the NZ Superannuation

Fund to acquire 50% o Z Energy.

Inratil has a long track record o investment

partnerships; Wellington City in Wellington

Airport, All iant Energy in TrustPower,

management in Inratil Energy Australia, and

Utilities Trust in Glasgow Prestwick Airport.

The partnerships have allowed Inratil to

participate in larger acquisitions than it could

otherwise accommodate, to share risk, and to

gain expertise and support. They are likely to

to be a eature o Inratils uture acquisitions,

especially i the scale o transactions increases

or they are made in sectors or locations where

Inratil would benet rom local knowledge.


12/12

InratIl

SEPTEMBER UPDATE

2012

Deis o he d souced om ii, used i

cosucig he gphs d bes i his Upde

e vibe om Ii ([email protected]).

uhe d d iomio ws souced om

he oowig:

*US returns data rom the Federal Reserve o St Louis

*Long term interest rates and return data ex-NZ rom

Deutsche Banks LT Asset Return Study by Jim Reid,

Nick Burns and Stephen Stakhiv, September 2012

*NZ share, bond and mortgage rates and returns rom

Bloomberg, ANZ and the Department o Statistics and

the National Library archive

*Warren Buett investment record rom Buetts

Alpha by Andrea Frazzini, David Kabiller, Lasse

Pedersen August 2012

*John Maynard Keynes investment record rom

Keynes the Stock Market Investor by David Chambers

infratil update 2012-09

Documents