Report Card

Friday 6th April 2001

Utilities are not the sort to show 33% annual share price gains yet energy lines company United Networks last year achieved just that.

Its annual report highlights this performance but doesn't say what might have caused it.

One contributing factor may have been anticipation of its first triple-digit net profit, which turned in at $109.3 million for the year to December. Another is likely to have been enthusiasm for its expansion into high-bandwidth telecommunications through the installation of a fibre-optic network in central Auckland and Wellington. A third element could have been anticipated growth following the $550 million purchase of the Orion gas network last April.

These are all selected as highlights in the chairman's and chief executive's reports, without further elucidation of their contribution.

The performance of the company is difficult to judge because it changed its balance date in 1999 from March to December. The report gives figures for the ensuing nine months and 12 months, but neither of these can be compared with the previous 12 months to March 1999. Trying to extrapolate earnings and profit figures for the year to March 2000 from the nine-month figures is no easy task either because of seasonal fluctuations in business. United Networks undoubtedly makes most of its money during autumn and winter.

Balance date items become much more worthwhile in such circumstances and the company shows shareholders' funds have risen from $774.5 million in December 1999 to $806.7 million a year later, an increase of 4.2%. Total assets rose from $1.72 billion to $2.26 billion, an improvement of 31.4%.

However, these positives are more than offset by liabilities, which have grown from $949 million to $1.45 billion, up 53%.

Thanks to a five-year table of ratios, we see the company's "gearing ratio" (undefined but apparently net debt to total assets) has ballooned from 0.2% in 1996 to 61%. For a utility, this is rather an aggressive gearing, although understandable for a company focused on rapid growth.

Such leverage will be needed if the company is to meet the goal laid out by chairman Bob Green of "becoming a high performer able to achieve 10% earnings growth per annum." However, it also raises the risk profile of the company above that of the standard utility.

One example of risk is the company's use of short-term borrowings. Notes to the accounts show that loans payable within one year have risen from $50 million at December 31,1999 to $960 million a year later. The rest of the company's $1.37 billion in borrowings are due within three years. This is a very short-term borrowing profile considering the returns from its core assets will be spread over decades.

Curiously, the short-term loans are shown in the accounts at the front of the report as non-current, meaning not due for repayment for at least one year. This is not the case and could mislead those who don't read the fine print. Notes to the accounts show that $760 million of the company's debt has been financed with bridging loans due for repayment this month. "These have been classified as long term borrowings on the basis that the loans are currently in the process of being refinanced ..."

This is not good enough. Short-term loans should be recorded as such until the ink has dried on long-term contracts and not before.

United Networks has a high credit rating and is unlikely to have problems refinancing. However, investors should cross their fingers that this creative definition of debt exposure is not abused by less financially secure companies. This apparent loophole in accounting standards needs to be plugged immediately.

Despite this, investors can take reassurance from United Networks' superior corporate governance practices and statement. Examples include allowing directors to seek independent advice at the company's expense if they come across an "irregularity in a company-related matter" and prohibiting trading in its shares by directors without consent of the company secretary.

It may not be the only company to have these practices, but it is the first I am aware of that makes details of them available to shareholders.

David McEwen is an investment adviser and author of weekly share market newsletter McEwen's Investment Report. Web and email: www.mcewen.co.nz, davidm@mcewen.co.nz

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