Chairman's and Chief Executive Officer's Addresses 18/10/06
VECTOR LIMITED ANNUAL MEETING
11.00am, WEDNESDAY, 18 OCTOBER 2006
Sky City Theatre
Level 3, Sky City
Cnr Wellesley St & Hobson St, Auckland
Level 3, Sky City
Cnr Wellesley St & Hobson St, Auckland
Address by the Chairman, Mr Michael Stiassny
Ladies and gentlemen,
It is certainly a privilege to address the inaugural annual meeting of Vector as a listed share issuer.
Four years ago we embarked on a strategy to build this company into a significant nationwide utility services provider – one that could make an important contribution to the future success of New Zealand.
The foundation for this strategy was our long pedigree as an electricity distributor in Auckland.
We have been singularly successful in achieving our objectives.
Our acquisition of UnitedNetworks in 2002 was both a growth and a business diversification initiative.
It extended our electricity networks interests to the north and west of Auckland, as well as to Wellington. Our business portfolio expanded to include for the first time gas distribution, fibre-optics telecommunications networks, and services businesses in industry skills training and specialised vegetation management.
The acquisition of full ownership of NGC during the past year completed this phase of our growth strategy.
NGC’s complementary businesses further broadened our interests, this time into gas transmission, processing and sales and energy metering. It created in Vector a unique multi-utility company with a New Zealand wide presence, and diversified earnings streams.
Having achieved the critical mass we believe is required to make a real difference in helping New Zealand improve its infrastructure services, our strategic intent has now evolved to one of utilising our assets, skills and resources to contribute to our full potential in both the utility infrastructure sector and the wider business community.
And, of course, to add value to the company for our investors.
While our strategic intentions have struck some unexpected and serious regulatory turbulence – which I’ll expand upon shortly - we nonetheless remain committed to these fundamental goals as we look to the longer term future.
Results
Turning now to our results, we clearly have the financial strength and operational flexibility to succeed in our strategies.
The impact of the NGC acquisition is apparent throughout the financial statements.
There has been a measurable strengthening of our cash generation capability, with operating cash flows increasing by 44 percent to 353.1 million dollars.
Revenue from our diversified businesses was up 30 percent on the corresponding previous year and while there was also higher operating expenditure associated with the new businesses, earnings before interest, tax, depreciation and amortisation were 24 percent higher at 578.6 million dollars.
Allowing also for increased depreciation and amortisation – including an additional 17.6 million dollars of goodwill amortisation arising from the NGC acquisition - earnings before interest and tax grew by 18 percent to 362.7 million dollars.
We achieved net earnings after tax of 45.1 million dollars, which were 10.5 percent higher than in the previous 2005 financial year.
Factors influencing the net earnings included an 18 percent increase in debt servicing costs, as a result of the higher debt incurred when we took full ownership of NGC in August last year.
Astute interest cost management, however, contributed to the higher than expected earnings for the year.
In addition, our move to 100 percent ownership of NGC was earlier than originally expected and came with a 5 million dollar benefit in the form of a reduced minority interests deduction.
As stated in our IPO documents, our dividend policy is to distribute to shareholders all funds surplus to the investment and operating requirements of the company, with a target dividend payout ratio for each financial year of 60 percent of free cash flows.
An important number for you, as shareholders, however, is our net earnings after tax, but before amortisation – or NPATA. This is because, in practice, we use NPATA as the proxy to determine free cash flows.
In effect, therefore, the 60 percent target referred to in the dividend policy relates to NPATA, which is the basis for assessing the level of dividend payment.
I am pleased to say we reported NPATA of 143.7 million dollars, an increase of almost 38 percent over the previous year.
Dividends
This enabled the directors to declare a total dividend for the year of 12 cents per share – or 120 million dollars, which equates to 83.5 percent of NPATA and is well above our target level.
The 12 cents per share dividend comprised equal, fully-imputed interim and final dividends of 6 cents per share, on the one billion shares on issue following our IPO and share listing.
This is slightly higher than the 11.5 cents per share total dividend foreshadowed in the IPO prospectus.
The total dividend for the 2005 financial year amounted to 53.6 million dollars, or 7.1 cents per share that was paid to our then sole shareholder, the AECT, on the basis of the 751 million shares then on issue.
It has to be noted that while illustrating the company’s growth as a result of the NGC acquisition, the 2006 and 2005 financial year results aren’t directly comparable because the NGC businesses contributed to only about a half of the 2005 year outcome.
Of greater interest to you is whether we lived up to our IPO promises.
It is very satisfying to report that we not only exceeded our IPO earnings projections, but we met quite challenging profit upgrades which we announced to the market as it became evident that debt management efficiency and cost containment were leading to a higher than anticipated outcome for the year.
Earnings before interest, tax, depreciation and amortisation were in line with the prospectus forecast of 578.8 million dollars. This reflects quite challenging trading conditions and primarily the revenue effects of the unexpectedly warmer 2005 winter on our electricity and gas businesses.
The warmer winter conditions were only partly offset by the cold weather in the last few weeks of the financial year and masked a good rate of new customer connections to our electricity and gas networks.
The 45.1 million dollar net earnings after tax, however, were 23.6 percent higher than the prospectus forecast of 36.5 million dollars, and in the middle range of the upgraded forecast of 43 to 47 million dollars, announced in May this year.
There is a similar story with NPATA. At 143.7 million dollars this was 6.6 percent above the prospectus forecast and comfortably within the revised forecast in May of 142 to 146 million dollars.
As we look to further improve our revenue and earnings performance, so too are we constantly seeking improved balance sheet efficiency.
Capital Management
As reported, we successfully completed a number of major transactions associated with our acquisition of the remaining 32.8 percent of NGC for 493.6 million dollars on the 10th of August 2005.
Two have particular significance.
First, we utilised proceeds from our fully subscribed public offering to repay 354.4 million dollars of outstanding debt in the form of the pre-IPO equity securities.
The second involved the refinancing of 1 billion dollars of debt, representing acquisition facilities as well as NGC’s own debt.
With our issue of 10, 12 and 15 year credit wrapped floating rate notes, we were able to take advantage of attractive rates in the domestic debt markets with a consequent significant improvement in the term of our debt portfolio.
There are further capital management tasks ahead of us this year, the most imminent being the scheduled reset of the 307.2 million dollar capital bonds on the 15th of December.
We will provide bond holders with an election notice with respect to the reset next month, as provided for in the current terms and conditions of the bonds.
We are also preparing to repay 200 million dollars of medium term notes on the 7th of April next year.
Our balance sheet is strong and capacity is available for Vector to consider future appropriate growth opportunities in a favourable investment climate.
Our year-end debt of approximately 3.1 billion dollars is slightly above the prospectus forecast, but below the position as at the 30th of June 2005.
Our net debt to net debt plus equity gearing of 61.5 percent is well within our target range of 60 to 65 percent and is at a level we believe to be appropriate for a utility company of our size.
Also of note is the increased 33.7 percent proportion of equity in our financial position as a result of the IPO.
I earlier commented on the make-up of our balance sheet as at the 30th of June 2006. I note here that the total asset value of 5.7 billion dollars also reflects a scheduled
revaluation of our electricity networks and our Auckland gas network, as well as the commitment of an unprecedented 225 million dollars in our capital improvement programme during the year.
A significant proportion of this was directed to our electricity and gas networks and is consistent with our focus on expanding and improving our infrastructure assets to meet urban growth and to improve our network reliability.
Our capital expenditure during the year was divided relatively evenly between investment for growth and asset maintenance and improvement.
Regulatory Developments
As we turn to the future, the rate and nature of our development will be influenced by the regulatory environment – and how that in turn affects the climate for infrastructure investment.
The Annual Report sets out in some detail the events leading to the decision by the Commerce Commission on the 9th of August to initiate a process towards full regulatory control of our electricity networks.
I don’t propose to repeat all that detail today, but rather to reflect on a very important and positive development last week.
Our ongoing discussions with the Commission reached an important milestone on Friday with the Commission accepting in principle our administrative settlement offer in relation to the rebalancing of historic target return differentials between customer classes and regions across our electricity networks.
Our offer is subject to a final decision by the Commission following a public consultation process, but we are hopeful it will be formally accepted and therefore avoid direct regulatory control over our electricity networks.
The development of the administrative settlement has been the result of constructive and co-operative discussions between ourselves and the Commission.
It is very pleasing that such significant progress has been made as I believe the offer is in the best interests of our customers and you, our shareholders.
The main features of the settlement offer are that we will complete the four-year rebalancing programme that we voluntarily commenced in 2005 in two equal steps by the 31st of March 2009.
We will do this within the regulated price path thresholds and in a revenue neutral manner.
We will also bring differentials in rates of return across our different customer classes and regions to within a 1.5 percent range at the completion of the rebalancing process.
An external audit of each of the two remaining rebalancing steps will be provided to the Commission.
For its part, the Commission has extended the timeframe for submissions on its existing intention to declare control to allow consultation on our settlement offer.
Effectively, the settlement offer formalises our four-year rebalancing programme and, if accepted, the Commission will clear Vector of the technical price and quality threshold breaches of 2003/2004 and will discontinue the price control process.
We will continue to invest in our three electricity networks to ensure safe, secure and reliable supply to customers and to protect the long term sustainability of our business. This commitment to our customers has never been compromised.
The board’s decision to defer large, long-life new investments remains in place and will be reviewed once we know the outcome of the administrative settlement offer.
The progress made with the Commission, coupled with recent initiatives by the Government to incentivise urgently-needed infrastructure investment, is encouraging and indicate that due attention is being paid to these important issues.
This, in itself, is positive for companies like Vector and for the New Zealand economy, and we will continue to work with the Commission to build on the positive progress of the last two months.
As a general observation, Vector recognises that workable regulation is required for essential services, but we believe it must be consistent, stable and transparent.
We have been particularly encouraged by the Government’s initiatives.
Its policy statement on the 7th of August is a source of considerable optimism with its emphasis on providing investors with the confidence to make long-life investments, ensuring regulated rates of return are commercially realistic and recognising the longer term risks to consumers of under-investment in basic infrastructure.
We support all of these objectives and we will participate fully in another Government initiative to conduct a Ministerial review of regulatory frameworks, including key parts of the Commerce Act, to address regulatory duplication and impediments to investment.
The review will also consider whether Commerce Commission decisions should be subject to merits-based appeals – something we see as desirable in the interests of regulatory transparency and confidence in regulatory processes.
I look forward to reporting future developments to you.
Address by the Chief Executive Officer, Mr Mark Franklin
Ladies and gentlemen, I would like to address a number of topics.
Firstly, the good progress we have made with business integration following our acquisition of full ownership of NGC.
I’ll then touch on the highlights of each business unit performance and important areas of company-wide policy implementation, and finally I’ll talk about energy supply security.
Business Integration
As reported, a key management focus in the past year has been to bring together two large, complex and culturally different companies into a single entity with a unified strategic purpose.
This is a major undertaking for any company.
But with our experience with the integration of UnitedNetworks three years previously, together with the firm commitment of all staff to make the NGC integration work just as well, we have successfully achieved this objective through a carefully phased programme.
That is substantially completed, and our attention is concentrated now on further developing the internal management systems and culture that fit the new organisation, and to creatively harness the considerable people talent residing in the company.
Organisation Structure
We are confident that we have created an efficient business structure to meet our needs for today as well as for the next stage of our development.
It is centred on our current core activities in electricity and gas infrastructure, but fully recognises, at one level, the potential for ongoing value creation from our related energy sales and industry services activities.
At another, increasingly important level, it recognises the capability that our multi utility business mix gives us to take advantage of emerging business growth opportunities
arising from society’s demand for smart technological solutions to utility service delivery.
arising from society’s demand for smart technological solutions to utility service delivery.
The business units are supported by a strong shared services network providing centres of excellence across a wide range of professional disciplines.
I’m the first to admit that organisation structure is never a completed task and that we must retain flexibility to ensure we can make appropriate structural changes as our business, and our business environment, continue to evolve.
It is about being in a state of perpetual readiness - to anticipate consumer needs and to move proactively on opportunities as they present themselves.
It has been a very busy and, I must say an inherently unsettling year for our staff and it would have been easy to become diverted from the basic ongoing operating needs of the company.
We ensured that was not going to happen.
While considerable resources were indeed focused on finalising the NGC acquisition, our IPO and sharemarket listing – our hands were always on the controls of the day-to-day running of our unique and very much expanded operations portfolio.
Despite the potential diversions from the merger, and despite the challenges of climatic and regulatory surprises, we have met our key performance targets and have maintained a high standard of service to our customers.
Business Unit Performance
Each of our businesses recorded a solid performance during the year ended the 30th of June 2006.
Regulatory uncertainty aside, the increasing complexities in our trading environment were not helped during the past year by the erratic weather that Michael referred to.
This ranged from the unseasonably warm winter of last year to the series of severe cold southerly storms in the last few weeks of the financial year.
Unfortunately, the revenue effects of the warm winter on our electricity and gas businesses outweighed higher energy use during the cold snap.
As I reported, there is continuing pressure on our margins, particularly in gas where we are increasingly sourcing higher-priced reserves as Maui gas production winds down from the peak flows of the last three decades.
The operating revenues for 2005/2006 do reflect price increases for our electricity, gas transmission and non-Auckland gas distribution networks, but we keep these to a minimum.
For our electricity networks, the price movement was within the price path thresholds for Vector, and price movements for gas transmission and distribution were in line with inflation.
However, the results performance overall reflects our focus on cost management and conducting our business more efficiently.
I’ll now look at each business in turn. First, electricity.
Electricity Operations
Although affected by the warm winter of 2005, electricity distributed through our networks was slightly higher than in the previous year at 10,400 gigawatt hours, thanks largely to a pleasing rate of new customer connections.
EBITDA was also considerably helped by cost containment and increased by about 4 percent to 364.5 million dollars.
At over 146 million dollars, we committed significantly more expenditure to the growth, maintenance and improvement of our electricity networks during 2006 than in
previous years.
9,300 new customers joined our networks during the year and to cater for this, as well as anticipated future growth, development projects over our three electricity networks included 196 kilometres of new cables and lines and the installation or replacement of approximately 730 transformers to improve delivery capacity.
The annual report lists a number of significant projects designed to enhance network capacity and improve reliability to cater for increased electricity demand from an expanding and increasingly technology savvy population.
Excluding the impacts of extreme weather events, our electricity network availability during the regulatory year ended the 31st of March 2006 was within our regulated quality thresholds.
We have experienced bouts of further extreme weather since then – notably around the 12th of June - but we have a reasonable expectation of achieving a below-target network availability outcome for the full year.
Demand for electricity supply services continues to grow in line with urban expansion and increased population density close to the central business areas of the cities serviced by our networks.
In Auckland, particularly, we are seeing a number of commercial developments, each representing city-scale energy demand in their
own right.
own right.
Gas Operations
A look now at our substantially diversified gas business, which has resulted in significantly higher financial metrics on a year-on-year basis.
Revenues from the gas business increased by about 79 percent and, at 207 million dollars, its EBITDA contribution was almost 60 percent higher than in the 2005 financial year.
With more than 4,200 new customers during the year, we had just over 139,000 connections to our gas networks as at the 30th of June 2006.
Unfortunately, this connection growth did not fully offset reduced demand during the warm 2005 winter period, and gas distribution network throughput was about 3 percent
lower than in the 2005 year.
By contrast, higher demand from gas-fired power stations resulted in a 12 percent increase in gas transported through our North Island wide high pressure transmission system.
We committed 44.2 million dollars in further developing our gas business assets, which included laying over 100 kilometres of new gas mains throughout our distribution regions, replacing 31 kilometres of ageing pipes on the Auckland gas network, and improving gas deliverability into the Auckland CBD and the hospital.
Gas Resources
Vector manages a robust portfolio of 186 petajoules of gas sourced from the Maui, Kapuni and Pohokura fields – the three largest in New Zealand.
Based on the year’s total natural gas sales of 35.5 petajoules, this allows us to comfortably meet our supply commitments to customers in the next four to five years.
We have been revising our gas supply arrangements to align with the changing supply environment, in which the New Zealand gas industry is transitioning from a single dominant supply source – Maui – to a far more complex multi-field supply environment.
There have been changes in supply arrangements with electricity generators and petrochemical producers, but our gas sales are under-pinned by a solid base of industrial and large commercial customers.
I believe there will be further opportunities to build our gas portfolio. New gas resources are either being developed or are awaiting development and I am further encouraged by recent reports that the Pohokura and Kapuni fields together could hold another 880 petajoules of gas.
LPG
In addition to transporting and selling natural gas, we have a growing business in selling gas in bulk, in cylinders and through localised reticulation systems in the form of LPG.
This has given Vector significant flexibility in gas supply solutions for customers and is a source of competitive advantage for us.
Our LPG customer base grew by a further 12 percent during the 2006 financial year and, while volume sales overall were relatively static at around 45,000 tonnes because of the warm 2005 winter, we expect to see volumes increase in line with customer growth in the longer term.
Gas Processing
Vector is well positioned to benefit from the expanding LPG market, not only in our direct sales, but through the LPG production capabilities of our Kapuni gas treatment plant and our role in LPG wholesaling and distribution through our subsidiary, Liquigas Limited.
Initiatives we have taken to improve the Kapuni plant’s operations have led to record levels of plant availability and utilisation and we continue to view it as a strategic asset.
The plant is located in the heart of New Zealand’s currently sole producing oil and gas region and is readily accessible for processing additional gas from new discoveries as they arise.
Market Branding
Finally with regards to gas, with the acquisition of NGC we found ourselves with multiple retail brands in the gas market, including separate brands for natural gas and LPG.
We have now consolidated all of these into a single “On Gas” retail brand, which uniquely provides a national offering of both LPG and reticulated natural gas.
The key objective of our marketing approach is to simplify the gas connection process for customers and we are delivering a number of promotional campaigns to support gas connection and utilisation initiatives.
It also reinforces the value we place on our relationships in the market, which include channel partners as well as direct customers.
Technology (telecoms/metering)
Our high performance fibre optic telecommunications and energy metering businesses represent a strategically important dimension to this company’s future development.
Together, these technology businesses contributed a 75 percent higher EBITDA of 41.9 million dollars during the 2006 financial year.
The application of smart technologies is especially important with the trend towards infrastructure convergence – as can be seen in our electricity, gas, energy metering and telecommunications capabilities.
From a technology viewpoint, Vector can’t sit still if we are to achieve our objectives of leading the delivery of first world utility services to New Zealand consumers.
An important consideration for Vector is the move towards intelligent networks. The future of our electricity and gas businesses will be more heavily dependent on technology and as such they will require extensive, modern communications systems.
Our telecommunications business recorded revenue growth of 28 percent from its high performance fibre optics networks, including a number of large new accounts.
We continue to extend our network, spending 12.6 million dollars during the year.
This involved adding a 35 kilometre fibre optic ring in Waitakere City to link important Vector electricity substations as part of our development of an intelligent network, and enhancing services on the North Shore of Auckland.
As with all of our businesses, we look at telecommunications from the perspective of growth and performance options. Our partnership with North Shore under the
Government’s MUSH programme is an example of this.
The Government’s announcement on local loop unbundling potentially opens other options for us and we will be assessing opportunities.
Energy costs are become more expensive worldwide and creating a consumer appetite for metering technology that can assist demand side management.
Through our Energy Services and Stream businesses, Vector holds an opportunity to leverage its strong market position to take a leadership role alongside other key industry participants to develop energy management solutions for customers.
As equally as important as providing the meter hardware is the market leading capability within Vector to gather and deliver the data that is crucial for end users to monitor their energy consumption and to manage usage efficiently.
Our metering businesses recorded improved revenues in the 2006 financial year, and we are looking forward to the significant opportunities and challenges presented by the evolution of the market as new technologies are introduced.
Industry Training
Not too distant from technology in terms of industry well being, is the provision of professional specialist training to meet a shortage of skills in the electricity and gas distribution sectors.
Our private training establishment, Utilitech, is responding proactively to the industries’ needs, by greatly expanding its live training facilities, the range and quality of its courses and engaging more specialist trainers.
Utilitech is a recognised and sought-after training establishment, with multiple accreditation for electricity distribution staff training.
Such has been the demand for its services, Utilitech recorded revenue growth of over 50 percent in the 2006 financial year – and that was without any movement in its charges.
One-Company Policies
I would now like to briefly touch on what we have been doing to co-ordinate key policies and practices across the businesses I’ve just been discussing.
Risk management and insurance have now been consolidated under a company-wide framework.
It is multi-purpose, but the primary objective of our risk management programme is to ensure all business continuity and emergency response plans are consistent, appropriate to the needs of the new organisation and fully cognisant of our responsibilities as a lifelines business owner.
We have freshly evaluated the company’s risk profile and are in the process of developing a consistent risk classification and management protocol as part of an over-arching risk management system.
As with many aspects of the NGC business integration, we have taken a best-of-the-best approach to implementing a new health, safety and environment management system within Vector.
This began with initiatives to facilitate targeted safety programmes suitable for the different characteristics of different parts of the business, but again is something that is being applied consistently across the Group.
As crucial elements of our business strategies are technology-driven, our IT capabilities play a fundamental role in achieving them.
We have implemented a company-wide approach to our IT needs to ensure consistency and compatibility of application, an efficient IT architecture, innovative software and solid financial management support systems.
Energy Supply Security
Turning to energy supply security, Vector takes some satisfaction from the fact that we maintain continuous electricity supplies to our customers for 99.98 percent of the time. That’s not too bad, but we’re not complacent about it.
I referred earlier to the network improvements we have completed or are currently working on, and you can be assured that we are constantly addressing network reliability as part of our normal operations.
Like many others, however, we are concerned about the vulnerability of Auckland to supply loss arising from the failure of the national grid or its associated installations.
The severe storms on the 12th of June this year had some localised effects on Vector’s Auckland networks, but certainly nothing of the scale that affected Transpower’s substation at Otahuhu.
We have been advocates of improved electricity supply into this region for some time, and we have willingly joined with other industry participants to strengthen the focus on finding enduring solutions.
As part of this co-operative approach, we have reached a memorandum of understanding with Transpower that will allow Transpower to access some of our electricity network assets and improve its supply to the greater Auckland region.
We are currently working towards finalising that arrangement.
In gas, I have confidence that New Zealand’s gas industry will continue to thrive.
Although we are seeing the end of an era that provided New Zealand with abundant, flexible and inexpensive gas reserves for the past three decades, there are replacement reserves already developed or about to be developed.
In addition, the producers of fields like Maui, Kapuni and Pohokura are finding more reserves than originally thought.
New Zealand is under-explored and there is considerable exploration, particularly onshore, with potential to find new reserves.
We would, however, like to see a bit more exploration effort offshore, where there’s a stronger likelihood of a major new discovery.
We are also monitoring industry investigations to import gas in the form of LNG or CNG should this be required in future to augment indigenous production.
Overall while there is much to be done, I believe that with a co-ordinated, co-operative approach of everyone involved, and with a commercially appropriate investment
environment, New Zealand will find solutions to its future energy requirements.
In conclusion, I would like to repeat what I said in the annual report. That our over-riding strategic goals continue to be to enhance our core business, and to be ready to pursue growth opportunities as they arise.
Our core business enhancement, in turn, is founded on cost efficiency, optimising asset utilisation, providing our customers with high service standards and developing the strategic partnerships that will help us tap into and develop the smart technologies of the future.
We are now a diversified infrastructure company with strong associated business activities. This gives us flexibility as we look to how we can most beneficially direct our capital investments.
At the heart of it all is our readiness to play our full part in helping to lift the standard of utility services in New Zealand.
Concluding Summary, Michael Stiassny - Chairman
Ladies and gentlemen, I think you will agree that the company is firmly grounded on a set of strong core businesses and is delivering high quality financial and operational results.
Regulatory stability and a positive investment climate are of major importance, not just for Vector, but for all infrastructure companies and to New Zealand generally.
We are determined to build on the excellent progress achieved with the Commerce Commission in recent weeks and we look forward to bringing our administrative settlement offer to a successful conclusion.
We can then direct our energies towards building this business and to making a strong and constructive contribution to the New Zealand economy.
All the while, you can be assured that the board remains firmly focused on enhancing the value of your investment in Vector through cost management efficiency and continuously improving how we run the business.
