Many ports may struggle to maintain revenue now because shipping companies plan to use bigger ships at larger hub ports in order to make fewer stops.

However, against the trend Port of Tauranga (POT) is poised to surge further ahead. Because of its readily expandable infrastructure and strong balance sheet, this port is well placed to accommodate larger ships. During the past year it increased container volumes 35% to almost 800,000 TEU’s. Transhipment containers rose by 88%, demonstrating POT’s emerging role as New Zealand’s hub port for international trade.

Rated by the Australasia Productivity Commission as Australasia’s most efficient port, POT seems well set to lead the way in investing in the new infrastructure needed to handle the bigger ships.

Named by research company New River as New Zealand’s “most exciting” international freight company, the port has delivered a stunning 24% compounding return to shareholders over the last 20 years (includes reinvesting dividends). This makes POT the best performing share on the NZ Stock Exchange over the last fifteen years with a return well ahead of the benchmark NZX50 Index.

This is no accident. For years Tauranga has used its capital resources astutely to lift cargo volumes and improve efficiency to grow economic value for its shareholders. Excellent return on capital objectives are matched by meeting environmental, regulatory, and health and safety standards. POT has an outstanding record in kicking for the right goal posts when determining strategic capital development.

That POT is well set to lead the way in investing in the infrastructure required to handle the bigger ships’ results from years of forward looking, efficient management.

Indeed, the company’s mission statement is “Leading through innovation and commitment.” However as US-based, Boston Consulting Group’s global head of innovation, James P. Andrew states : “Innovation without payback, is just an invention, just an idea”.

For POT, a vital key has been to back innovation-driven capital investment with rigorous economic and financial analysis. Proposed capital improvements are assessed on length of payback and discounted cash flow modelling is constantly used to compare different project alternatives. CFO Steven Gray says:  “Profit and loss forecasts using measures such as NOPAT, EBIT and EBITDA are not enough. They cannot track the true costs of capital expenditure because they ignore the cost of shareholders’ equity”.

To efficiently expand port infrastructure, many capital expenditure proposals must be assessed. For the past decade, POT has systemised this important task, ensuring all projects are evaluated consistently against the same hurdles. The discipline is uncompromising because board and management well know overall return on capital depends on each individual investment proposal’s success.  Notwithstanding this, “must-do” capex (which may not have economic benefits) is deemed essential to meet environmental, staff health and safety, service quality, regulatory, and compliance objectives.

To better handle such make-or-break decisions, Steven Gray in 1999 rejected ad hoc spreadsheet building as inconsistent, time-wasting and error-prone. “As a lean organisation we instead use software to save time and increase confidence levels. It guards against poor investment by alerting us when business cases have faults. We find that testing assumptions, evaluating alternatives, assessing risks and analysing true value are crucially important parts of the capital management process,” he says.

“Thus when deciding the best time to replace a piece of major plant, for example, we make an assessment using Capex® software”, says Steven. “And for many ‘must-do’ projects, alternative (often innovative) solutions may have financial and risk management impacts to consider.”

Both shareholders and lenders take comfort from the port’s professional management of its capital expenditure programmes and its refusal to spend hard earned capital resources on mere “gut feel” or arguably “strategic” projects. These stakeholders know that “need to grow” shouldn’t drive investments – rather, returns within a reasonable time-frame should. No doubt they will welcome Tauranga’s expansion plans – knowing the port’s history of delivering on its capital investments.

International evidence backs the port’s capex approach. A McKinsey and Co study of 200 institutional investors found good corporate governance achieves a triple win: attracting capital, increasing the share price and reducing cost of capital. A stunning 75 percent said good governance practices (commitment to shareholder value, majority of independent directors and transparent reporting) were as important as financial performance when evaluating investments. Institutional investors were found willing to pay a 20% premium for good governance. In POT’s case, it is currently tracking as the highest priced NZ company on the NZX.

In stark contrast to the Port of Tauranga experience, a study in 2011 by KPMG of 100 New Zealand companies and their project planning practice raises serious concerns. It found many companies began projects with only a vague hope of achieving a return. KPMG’s Perry Woolley commented: “If a firm makes a plan, it can then make regular checks through the course of the venture that the objectives set out at the beginning are being accomplished. The firm can then pull the plug on the scheme and avoid wasting capital if it is not proving successful”.

Also the study found that 60 percent of entities did not measure project benefits, so could not determine whether their investments proved worthwhile. The survey, KPMG concluded, reflected an inability by many firms to translate project investments into valuable returns. These results are remarkably consistent with the conclusions reached in former ANZ Head of Regional Banking’s Joseph Healy, in his 2002 book – Corporate Governance & Wealth Creation in NZ.

Specialist consultant Tony Street of Capex Systems recalls the difference made by eliminating paperwork when Capex software was introduced at the Port of Tauranga in 1999. “Capital investment decisions are of crucial importance,” he points out. “So naturally, an independently audited software application such as Capex® swiftly systemised the business case compilation process. Enabling tools such as this help users to find value and mitigate risks in a mere fraction of the time.”

These days commercially alert organisations such as POT see the need to “zero-base” capital budgets. A well structured capex system might first categorize proposals, then prioritises them within the capital planning process. Categories have predetermined hurdle rates. While it is accepted  “must do” proposals may generate no additional payback, “business case” projects (operational improvements, new business, capacity increases, etc) must produce a return above the weighted average cost of capital (WACC). Consistent with this capex approach, the overall capital budget should achieve a return at least equal to the WACC.

As to “must-dos”, Capex® system users can objectively assess risks and determine priority scores with the software’s dynamic but simple to use Graphical User Interface, integrated to a database Thus ‘needs’ are met before ‘wants’, and risks of adverse outcomes are effectively managed.

Importantly, substantial in-house time savings are gained – both by initiators and approvers of capex requests. For example, the workflow, collaboration and reporting process in most organisations can be streamlined, saving considerable time.

For Street, both the exceptional shareholder returns achieved by the Port of Tauranga and the results of the recent survey, come as no surprise. “All other things equal, a company with good capex discipline and systems will always deliver better shareholder returns than one without,” he asserts.

After a decade of neglecting the matter, it is encouraging that some New Zealand Boards are now sharply focused on capital expenditure’s crucial role in company wealth creation. For them C is the important word, with Capex the key to providing more effective governance.

Such Boards realise that innovation is a must but also that strategic planning must fully account for cost of capital. For them it is a given that corporate strategy consists of making vital choices to allocate scarce and often diminishing financial resources.

Better late than never, corporate New Zealand is waking up to the truth that assessing opportunity cost of capital should be fundamental to business strategy formulation, as should a disciplined program of capex priority setting. Board members must be satisfied that capex is being managed as a limited resource.

Consider how one Board approved a very poor investment:

An established Auckland corporate had 46 truck and trailers. The trailers (replacement cost $118K each) were nearly 15 years old and fully depreciated. Capex decision: replace all trailers at an all up cost of $5.4M. However, 40 of the old trailers were bought by a truck lease and hire firm. Aware the trailers had an economic life of 25-plus years they gave them a body makeover, repaint and refurbished the brakes and running gear. Cost: $26K per unit, little more than the annual leasing revenue per unit. Projected routine maintenance cost: just $3K a year for the next five years. Effect on unscheduled downtime : practically none.

It’s a prime example of how failure to robustly analyse project value results in shareholder wealth destruction. Many others could be cited to show the need for a corporate culture that demands innovative and lateral thinking by management.

And the focus must be long term. The NZ Shareholders Association warns that high short-term incentive payments focus executive attention on short-term goals to the future detriment of shareholders. Company workers and local communities also suffer, because without return on invested capital, companies are forced to down-size.

As Peter Drucker stated (1998): “… until a business returns a profit greater than its cost of capital, it operates at a loss…until then it does not create wealth; it destroys it”.

Capex lies at the heart of the “corporate performance crisis” highlighted in ANZ Regional Investment banking head Joseph Healy’s book “Corporate Governance and Wealth Creation in NZ”.

Healy complains that conventional measures of senior executive performance do not consider the cost of using shareholder funds. Worse, they encourage senior managers to build bigger businesses at the expense of destroying shareholder wealth. He pinpoints poorly specified or non-existent return on capital objectives. To ensure that capital is allocated where it can best boost returns, he advocates Economic Value Added (EVA) performance measures.

Positive corporate governance measures such as EVA, or implementing a robust capital management infrastructure, can achieve a triple win, attracting capital, increasing the share price and reducing the cost of capital. It is also a powerful risk management safeguard for shareholders and other key stakeholders.

Deming (1990) asserted that poor capital allocation occurs when a business lacks a well-designed capital allocation system disciplining management to optimise shareholder value. NZ Management Magazine featured an article entitled “How EVA Exposes Non-Performers” in Aug 2002. Then Comalco CEO Kerry McDonald charged that “what’s lacking is effective management infrastructures – a lack of commitment to developing the tools, practices and processes that let good managers and leaders achieve the best results.”

Sensing growing shareholder concern, astute Boards now see the need for ‘best practice’ capex management systems to safeguard shareholder value.

Port of Tauranga (POT), for example, has achieved a stunning 24% compounding return for shareholders over the last decade – compared to the 5.6% NZX Index average. POT is the best performing share on the NZX over the past 15 years.  Judged the most efficient port in Australasia, POT’s key has been to back innovation-driven capital investment with rigorous economic and financial analysis.

Fourteen years ago, POT implemented Capex software to assist in business case compilation and priority setting. CFO Stephen Gray manages capex as a limited resource and rejects ad-hoc spreadsheet building as inconsistent, time-wasting and error prone. Even plant replacements undergo rigorous financial analysis, performed at the click of a mouse using a dynamic and independently audited system. POT refuses to spend hard-earned capital resources on “gut feel” or doubtful “strategic” projects.

POT know that “must do” capex – which may not have financial benefits – is deemed essential to meet environmental, staff health & safety, service quality, and compliance objectives.

Specialist consultant in the field, Tony Street applauds POT’s innovative approach to capital spending. “The need to rigorously evaluate alternatives, test assumptions, systematically assess risk and carefully analyse true value, very often falls through a crack in the floor. As a consequence, 20 – 35% of capital expenditure is unnecessary in many corporates. A spectacular opportunity for financial improvement exists in reaping these gains, and reinvesting the funds into value-adding projects that truly pay for themselves.”

Sadly, a 2011 KPMG study of 100 NZ companies and their project planning practices raises serious concerns. It found that many companies begin projects with only a vague hope of achieving a return. Sixty per cent do not measure project benefits, so cannot determine whether their investments prove worthwhile. KPMG’s conclusion: Many firms are unable to translate project investments into valuable returns.

KPMG’s Perry Woolley states: “The productivity and profits of NZ companies are being impacted by their inability to consistently deliver projects that fulfill the expected objectives”.

If shareholder value is not the focus, managers and directors may lack a principled criterion for measuring performance. Such a “stakeholder-based” business may fail if competing with a shareholder-value-based business. This is because politicking occurs as people promote projects based on loose criteria. “Woolly thinking” prevails and the organisation becomes dysfunctional.

The Board is the heart of corporate governance and as agent of the shareholders must monitor management performance. If management mis-manages, board members place themselves at risk of negligence if they do not take corrective action.

Today more than ever the Board should ensure appropriate financial management information systems are used to assess returns on invested capital. It must insist management use a robust capital management infrastructure based on current best practice. And compensation for the management team must be aligned with shareholder interests.

Tony Street is a director of Capex Systems Ltd, a leading Hamilton based capital planning consultancy and software development company. He can be contacted at www.capex.co

Seventy per cent of companies experienced at least one major project failure in the past year, says a survey by tax and business advisory firm KPMG. That figure was up on the previous New Zealand Project Management Survey, conducted in 2005, when 49 per cent of organizations reported a project failure. The survey found three main reasons for failed ventures – scope changes, competition for resources in the firm, and unrealistic deadlines.

The survey found that only one-third of companies always prepared a business case – a plan drafted before the beginning of a project, setting out what benefits needed to be achieved, at what cost.

Perry Woolley of KPMG said that many New Zealand companies were starting projects with only a vague assumption, or hope, of achieving a return !

If a firm made a plan, it could then make regular checks throughout the course of the venture, that the objectives set out at the beginning were being accomplished. The firm could then pull the plug on the scheme and avoid wasting capital if it was not proving successful, he said.

The survey also found that 60 per cent of organizations did not have a formal system in place to measure the benefits of an individual venture.

Gina Barlow of KPMG said “The lack of benefits measurement is particularly concerning – if organizations do not measure the benefits of their projects they cannot understand if the investment was worthwhile.”

“The productivity and profits of New Zealand companies are being impacted by their inability to consistently deliver projects that fulfill the expected objectives” said Woolley.

Forty-four per cent of the firms surveyed spent more than $15 million on their projects during the 12-month period. About 100 companies from public and private sectors took part.

KPMG’s survey found that high performing firms were characterized by high-quality business cases.

Source : New Zealand Herald Dec 7th 2010