Capex Discipline Helps Put Icing On Top Of NZX Performer’s Cake

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.

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