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It is pleasing to report in a year of significant economic turbulence that the Company recorded a profit before tax of $52.4 million, an increase of $32.9 million over the previous 12 months.
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Profit after tax declined by $123.3 million as 2007-08 was impacted by a significant one-off tax benefit
of $153.2 million.
On an underlying basis, the profit after tax for 2008-09 was up $24.3 million to a record $35.6 million,compared with an underlying profit after tax of $11.3 million in 2007-08.
The Company performed very well against most of its operational measures, and a return to normal weather assisted revenues and our bottom-line result.
During the year the Board undertook a number of capital market initiatives to better enable it to ride out the substantial uncertainties in capital markets. These included debt consolidation, conducting a Rights Issue and reducing distributions to shareholders in the face of Standard & Poor’s downgrading the Company’s credit outlook (subsequently retracted after the completion of the Rights Issue in February 2009).
In February 2009, we completed a $111 million Rights Issue, which was underwritten by our largest shareholder, Australian Pipeline Limited (APA). The offer received strong support with more than 5,300, or 28%, of shareholders participating, and around 371 million new securities being issued. APA’s holding in Envestra is now 30.4% and our second largest shareholder, Cheung Kong Infrastructure Holdings (Malaysian) Limited, holds 18.4%.
In May 2009, the loan note component of our stapled security was redeemed when the final amount of principal was repaid to shareholders. This greatly simplified the equity structure of the Company. Following this payment, equity is in the form of ordinary shares. It is anticipated that unfranked dividends will be paid on these shares for the foreseeable future.
SHARE MARKET PERFORMANCE
It is extremely disappointing that shareholder returns were flat for the year and negative for those who did not participate in the Rights Issue.
This was a consequence of the material, ongoing decline in the prices of listed infrastructure securities generally, which occurred in conjunction with the turmoil in world financial markets, the substantial escalation in the cost of debt and general investor concerns regarding the ongoing availability of capital to support corporate refinancing requirements.
The Board deemed it prudent to reduce annual distributions from 9.5 cents to 5.5 cents to conserve capital in response to the global financial crisis and in recognition of the fact that the number of securities on issue increased by over 40% during the year as a result of the Rights Issue. Distributions for 2008-09 totalled 7.25 cents (4.5 cents in November and 2.75 cents in May), and are expected to be 5.5 cents in 2009-10, payable in equal half-yearly instalments.
FINANCIAL STRATEGY
Envestra’s financing strategy for many years has been to extend the duration of its debt portfolio, aim to have refinancing in place at least six months prior to maturity, and set a limit of 15% of the debt portfolio to mature in any one year. At 30 June 2009, the average loan maturity for the Envestra group was just over nine years.
During the year the Company refinanced $255 million of debt. However, the margins were substantially above those that applied to the maturing facilities, and the new loan periods were shorter than those which were
available in the past. These terms are symptomatic of the current global financial crisis. These additional costs are potentially recoverable via future regulatory resets, and in part, under our current access arrangements.
There are no further significant debt refinancing requirements until May 2011, other than a $100 million facility due in July 2010 which was undrawn at 30 June 2009.
The Company’s exposure to interest rate risk is minimal as over 95% of floating rate debt is hedged in line with the regulatory reset periods through to 2011 for South Australia and Queensland, and 2012 for Victoria.
At 30 June 2009 the Company had undrawn bank facilities amounting to $236 million with terms extending from 2009 to 2012. These credit facilities, in conjunction with the cash being generated by the business, are more than sufficient to support our capital expenditure program and fund operating costs over the next several years.
During the year, $250.9 million of debt was repaid whilst $180.7 million of new debt was drawn down. Our capital expenditure program was largely financed by internal cash generation and equity raisings.
More than 80% of the credit-wrapped Capital Indexed Bonds issued by the Envestra Group are guaranteed by the monoline insurer, FSA, which has maintained its AAA credit rating during these difficult financial times.
DEBT CONSOLIDATION
During the year we sought approval from our financiers to consolidate the debt packages of Envestra Limited and Envestra Victoria Pty Ltd, and to have covenants under the financing arrangements measured on a consolidated basis in the future. A pre-condition of the consolidation was the raising of $100 million in equity, which was achieved via the Rights Issue. The consolidation enabled the Group to access the relatively stronger financial metrics of the Parent Company and avoid the tight interest coverage covenants in Envestra Victoria which could have restricted capital expenditure in that State in the future. The consolidation also assisted in having the “Outlook Negative” classification on the Group’s investment grade rating being removed by Standard & Poor’s.
OUR FINANCIAL PERFORMANCE
Haulage and services revenue, which is generated mainly from the delivery of natural gas for retailers, increased 12% over the previous year to $372.9 million due mainly to a return to normal winter conditions in South Australia and Victoria, the annual increase in tariffs, the addition of over 23,000 new consumers to the networks, and mains relocation work associated with the Brisbane Airport Link project.
Gas volumes were in line with the previous year at 1.15 petajoules, but more importantly the volume delivered to domestic and small commercial consumers was up 5%. The Company generates around 90% of its haulage revenue from these consumers.
Operating costs were up 1.7% on the previous year as a result of increased maintenance on the networks due to leak repairs, and the associated cost of system use gas (that is, replacing the gas “lost” due to leakage and other factors), and higher APA management fees payable in reward for Envestra’s improved revenue.
Finance costs were $158.3 million, up 9.3% or $13.5 million on the previous year due to increased interest rates on hedges put in place to match the Victorian regulatory reset in December 2007, higher margins on refinanced debt and higher indexation on the Company’s Capital Indexed Bonds.
The cost of indexation on our Capital Indexed Bonds was up $5.2 million to $17.6 million; however, these non-cash costs are mostly recovered through the annual increase in tariffs, the adjustments to which are linked to movements in the consumer price index.
Underlying cash flow from operating activities was $121.3 million, 15% higher than in the previous year, due mainly to higher haulage and services revenue.
After allowing for replacement capital expenditure, cash flow available for distributions amounted to $103.9 million, with a distribution cover ratio of 137%. It is expected that this ratio will steadily improve over the next few years as a result of the recent capital management initiatives undertaken by the Company, and increases in revenue.
Distributions to shareholders were reduced from 9.5 cents to 7.25 cents per security, with total distributions being $75.8 million, down $5.9 million on the prior year, notwithstanding the additional amount paid on new securities issued during the year under the Company’s Distribution Reinvestment Plan and the Rights Issue.
The balance owing to shareholders on the loan note component of our stapled securities was 4.94 cents at 30 June 2008. The final repayment on the loan note occurred as part of the distribution made in May 2009.
THE REGULATORY REGIME
Envestra’s monopoly position as a gas distributor has been subject to regulatory oversight by State Regulators, and since 1 July 2008 by the Australian Energy Regulator (AER). The AER reviews the Company’s Access Arrangements at five-yearly intervals under the National Gas Law and Rules. This process determines revenue, and as a consequence, tariffs, as well as contractual terms for retailers and some large volume consumers over the following five years.
We reported last year that the Company had lodged an appeal in relation to a range of matters associated with the review (by the previous Regulator, the Essential Services Commission of Victoria) of the Victorian and Albury Access Arrangements. These included the allowed rate of return that can be earned on investments (known as Weighted Average Cost of Capital) and the disallowance of 50% of the network management fee paid to APA Asset Management (our operator).
In November 2008, the Appeal Panel ruled that the full network management fee is recoverable by Envestra.
The Panel also ruled favourably on a component of the “Efficiency Sharing Mechanism”. These adjustments will result in increased revenue of around $8 million over the remaining four-year period of the Victorian and
Albury Access Arrangements, to 2012.
We are hopeful that the move to the AER from State-based Regulators will deliver a more equitable approach to balancing the interests of distributors and their shareholders, and the interests of gas consumers.
In the past, asset owners have sometimes been provided only marginal encouragement to spend the significant capital required to ensure their networks deliver a reliable supply of gas through the most demanding weather conditions, and to make gas more widely available in the community.
During the year the AER conducted a review of the rate of return to be applied to the electricity industry. Envestra participated with all energy distributors in an industry campaign aimed at ensuring that the Regulator understood the challenges currently being faced by these businesses.
The Final Determination of the AER provided an uplift of about 1% in the rate of return allowed in its Draft Determination. Although this does not have any direct impact on Envestra, it provides some guidance as to the rate of return that the Regulator might apply when they review our Access Arrangements in South Australia and Queensland in 2011 and in Victoria in 2012. In this regard we would expect the allowed return for the gas industry to be higher given the different nature of the gas industry regulatory structure and the inherently higher risk associated with the gas industry due to the fact that, as opposed to electricity, gas is a fuel of choice for consumers.
EQUITY RAISING
Almost $134 million of additional share capital was raised during the year under the Company’s Distribution Re-investment Plan ($23 million) and the Rights Issue ($111 million) announced in December. Around 15% of shareholders participated in the two DRPs and 28% in the Rights Issue.
It is pleasing to report that the Company’s two major shareholders, APA Group and Cheung Kong Infrastructure Holdings subscribed to the Rights Issue (with APA acting as underwriter to the equity raising), and both subscribed to the first DRP offer in November 2008. The funds raised were partially used to repay debt and to support the substantial capital investment program undertaken in 2008-09.
CAPITAL EXPENDITURE PROGRAM
The Company undertook a significant capital expenditure program in 2008-09 with $112.5 million spent on network extensions, capacity enhancements, mains replacement and meter changes. During the year 298 kilometres of new mains were laid, 114 kilometres of old mains were replaced, and a number of high pressure mains were laid to enhance the capacity of our networks.
Capital expenditure allowed under the Company’s three Access Arrangements was $175 million and $200 million for Queensland and South Australia respectively, over the five years from July 2006, and $352 million for Victoria, for the five-year period from January 2008. These levels of expenditure require significant support from investors and financiers and will only occur where we are satisfied that the returns expected from these investments are consistent with Envestra’s cost of capital. In this regard, due to the turmoil in world financial markets, the cost of raising debt and equity is currently in excess of that allowed by the Regulators, and as a result we reviewed our capital program for 2008-09 and reduced our spending for the year. In containing capital expenditure, we are mindful of our responsibilities to ensure that the networks continue to be operated in a safe and reliable manner, and that this is not compromised through any expenditure cuts.
Similar capital expenditure constraints will apply throughout 2009-10 and we forecast that our investments will be limited to around $115 million.
Our interest rate hedging program, together with the fact that we have put a range of financing facilities in place over many years at margins that are relatively attractive in comparison to current financial market conditions, will enable us to support the capital expenditure program in 2009-10. However, as noted, the program will be well below that which was envisaged by the South Australian and Victorian Regulators due to the high cost of debt and equity relative to that allowed under the regulatory regime.
Gas leakage (which forms part of system use gas or SUG) continues to be an issue for the Company. While the Regulators make an allowance in our operating costs for a certain rate of SUG, the level does not take into account recent trends. During the year, we did not meet the Regulator’s target rate for South Australia and Victoria and as a result incurred additional operating costs. This is despite having spent considerable effort over the past decade replacing some 2,000 kilometres of old cast iron and steel mains, via the insertion of polyethylene pipe in the
old mains.
We intend to increase our efforts in reducing SUG, by replacing 145 kilometres of “old” pipe in South Australia and Queensland in 2009-10 (up from 114 kilometres in 2008-09), at a cost of $19 million.
The Company has been contracted to undertake substantial mains relocation work associated with the Airport Link project in Brisbane. At 30 June, 2009, the value of this work was approximately $3.7 million. A further $5 million will be spent over the next 12 months.
OPERATOR PERFORMANCE
APA Asset Management, as operator of our networks, performed well. Operating costs rose 1.7% as a result of increased leak management activities. There were a number of relatively minor incidents throughout the year, primarily caused by third parties damaging the Company’s gas mains and associated assets, which required urgent attention by APA. These incidents were handled in a professional and efficient manner, which resulted in minimal disruption to gas consumers.
Safety performance for APA’s 1,100 employees and contractors, whilst not meeting all targets, reflects a high standard, and is a direct result of their attention to this key performance measure. No injuries of major significance occurred in 2008-09.
During the year APA implemented a new safety program which is expected to improve performance in this area.
There were nine lost-time injuries sustained by APA employees, and seven for contractors compared to five and two respectively in the previous year. Whilst we continue to target reductions in conjunction with APA, the desired outcome is challenging given the difficult working conditions often confronting the operator’s field workers, and the ageing of APA’s workforce.
GROWTH STRATEGY
Our substantial capital program provides for long-term revenue growth as investments in new networks expand our regulatory asset base, and deliver sustained increases in revenue over many years.
Conditions in financial markets precluded any meaningful effort being directed to network acquisitions, and this situation was compounded by the fact that there were limited opportunities available during the year. We do not expect this situation to change in the near future with financial markets generally reluctant to support major acquisition initiatives in the current climate.
We connected more than 20,000 new consumers per year for over a decade and expect this to continue in 2009-10, despite the capital constraints discussed earlier. This historically strong demand is being supported by recent State and Federal Government policy decisions which recognise the environmental benefits of natural gas and promote the use of the fuel, as well as the First Home Owners Grant.
The previous increase in new consumer connections in Queensland, resulting from the introduction of an energy policy by the Queensland Government which requires the installation of gas hot water heaters wherever natural gas is available, continued in 2008-09. During the year 2,751 new consumers were connected compared with 2,163 in the previous period.
In the Northern Territory we constructed a spur pipeline off the Company owned Palm Valley transmission pipeline to supply gas to a new power station built by the Power and Water Corporation (PWC) to provide electricity to Alice Springs. The project cost around $7 million, which will be recovered via the tariffs under a 25-year haulage agreement with PWC.
We believe consolidation of the energy infrastructure sector will continue as companies seek to free-up the value of “non-core” assets, or seek mergers to facilitate further growth or to ensure long-term financial stability in the face of volatile debt and equity markets. Envestra’s participation in such moves will be determined by whether they provide an overall benefit to our shareholders.
GREENHOUSE GAS EMISSIONS REPORTING AND TRADING
The Federal Government has passed legislation that makes it mandatory for companies to report annually on greenhouse gas emissions, energy production and energy consumption at certain thresholds. The requirement applies to Envestra given the leakage of methane (a major component of natural gas) from our networks. The first report is due to be lodged by businesses with the Government in October 2009, for the year ended 30 June 2009.
The proposed introduction of an Emissions Trading Scheme (ETS) by the Federal Government has been delayed beyond the original timeframe of 2010. It is expected that any financial impost on Envestra resulting from the application of a charge for these emissions will ultimately be recovered from consumers through a combination of the regulatory Access Arrangements, and haulage agreements we have with retailers and directly with large businesses.
We continue to closely monitor this ETS initiative and its likely impact on Envestra, and will keep shareholders informed on developments.
ORGANISATION AND STAFFING
Most of our work is undertaken by the 1,100 employees and contractors of our operator, APA Asset Management. We appreciate the significant effort that these people have made throughout the year to the operation and maintenance of our networks and the provision of various support services. As with all businesses in the current climate we are closely monitoring our operating costs, and appreciate the assistance being provided by APA in arriving at solutions to meet the targets we have set for them.
Envestra has only a small management team, largely comprising experienced professionals with significant expertise across financial, engineering and regulatory disciplines. The finalisation of the Victorian regulatory appeal, participation in the AER rate of return review, the $111 million Rights Issue, debt consolidation and the refinancing of almost $400 million of debt are a few of the significant issues addressed by the team during the year. While not without challenge, particularly during these difficult times, all were delivered in an extremely professional manner.
On behalf of our Board, we take the opportunity to thank our employees, as well as the employees of APA for their substantial contributions to Envestra achieving its operating performance and record underlying profit in 2008-09.
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| J G Allpass Chairman |
I B Little
Managing Director |
28 August 2009
