Fund managers fume as Tranz Rail sinks

By Nick Stride

Friday 12th July 2002

Michael Beard

Fund managers are hopping mad after being caught out by Tranz Rail's earnings downgrade.

The rail operator's eight largest shareholder institutions, which own nearly 53% of the company, have seen the market value of the shares they bought in February from Fay, Richwhite, Canadian National Rail, and Berkshire Partners fall by some $50 million, or more than 28%, based on this week's all-time low of $2.30.

Hardest hit is Commonwealth Bank of Australia, with a 12.5% holding. Axa Asia Pacific has 8.3% and US-based The Capital Group 6.3%.

Armstrong Jones has 6.1% while Britain's Marathon Asset Management, US-based Principal Financial Group, and AMP have holdings of more than 5%.

ING had 6.1% but sold down to 3.8% in late May.

The Stock Exchange yesterday denied it was investigating Tranz Rail. A newspaper report had on Wednesday claimed the exchange was looking at the company's accounting policies relating to track maintenance.

Tranz Rail also rubbished the report, which it described as "erroneous and ill-informed."

The company's fall from market darling to underdog has taken only three months. In early April the shares were trading at over $4.

Transport analysts at ABN Amro, Credit Suisse First Boston (now First New Zealand Securities), JB Were, Macquarie Equities, Salomon Smith Barney and UBS Warburg all rated the shares a "buy" or equivalent.

The institutions had paid $3.60 to $3.70 to relieve Fay, Richwhite and its partners of their 42% holding. Brokers and fund managers enthused about the restructuring programme set in place by managing director Michael Beard.

Not everybody, though, bought the company line. Credit rating agency Moody's Investor Services in mid-March cut the outlook on Tranz rail's debt from stable to negative following a downgrade inflicted the previous November.

Some bankers were privately pessimistic, saying the market hadn't yet grasped the drain the company's operating leases would be on cash flow.

The National Business Review's Shoeshine column of April 5 warned investors to be wary, citing "a worrying cocktail of overvalued assets and shrinking profits."

The shares began to slide from around that time but brokers and fund managers remained positive, blaming the falls on market conditions. Company executives lobbied the financial community heavily, promising big gains from the restructuring initiatives.

So the market was caught by surprise when Tranz Rail announced last Friday that its results for the June fourth quarter were expected to be significantly below market expectations of earnings before interest, tax, depreciation and amortisation (ebitda) of around $36 million. It is now forecasting an operating profit (ebitda) of $24 to $26 million.

It also foreshadowed "substantial" asset writedowns would arise from accounting adjustments and changes to accounting policies, leaving the market to guess how substantial these might be and what policies would be changed.

Questions about Tranz Rail's track maintenance accounting have been aired for some weeks.

Tranz Rail chief financial officer Wayne Collins conceded deciding what was capex and what was opex could be "a blurry area."

But investors could be reassured companies were getting it right if there was no big disparity between capex and depreciation. There was no such gap at Tranz Rail.

Mr Collins said it was important to note the company was not seeking to downgrade analysts' expectations for the 2003 year.

When the company's year-end results are released in early August all eyes will be on its cash flows. A $250 million debt facility with BNZ, Citibank, National Bank and WestpacTrust expires on October 15 and the company will have to renegotiate its terms and covenants. It will release its strategic plan on July 23.

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