Capex : A capital affair

Many New Zealand ports will struggle to maintain revenue with plans by shipping companies to make fewer stops – using bigger ships, at larger ports.
However, against the trend, Port of Tauranga is poised to surge further ahead. Its readily expandable infrastructure and strong balance sheet mean the port is well placed to accommodate larger ships. For relatively little outlay, capacity at Tauranga can be expanded to one million containers year, thus attracting bigger ships.
Rated by the Australian Productivity Commission as Australasia’s most efficient port, Tauranga seems well set to lead the way in investing in the infrastructure needed to handle the bigger ships that will soon be here.
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 is matched by meeting environmental standards, and community and staff aspirations.
Hailed by research company New River as New Zealand’s “most exciting” international freight company, the port has delivered 24 percent compounding return to shareholders over the past 10 years – compared to the 5.6 percent NZX Index average.
A 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 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 manage port infrastructure investment many capital expenditure proposals must be assessed. For the past decade, Port of Tauranga 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 these make-or-break decisions, Gray in 1999 rejected ad-hoc spreadsheet building as inconsistent, time wasting and error-prone.
“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 and analysing true value are crucially important parts of the capital management process,” he says.
“Thus when deciding the best time to replace piece of major plant – such as pilot boat, for example, we make an assessment using Capex ValueAnalyser software,” says Gray.
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 “gutfeel” or arguably “strategic” projects.
These stakeholders know that “need to grow” shouldn’t drive investments – rather, returns within 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. McKinsey and Co study of 200 institutional investors found good corporate governance achieves triple win: attracting capital, increasing the share price and reducing the 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 20 percent premium for good governance.
In stark contrast to the Port of Tauranga experience, new study by KPMG of 100 New Zealand companies and their project planning practices raises serious concerns.
It found many companies began projects with only vague hope of achieving return.
KPMG’s Perry Woolley commented: “If firm makes 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.”
The study also found that 60 percent of entities did not measure project bene-fits, 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.
As Woolley states, “The productivity and profits of New Zealand companies are being impacted by their inability to consistently deliver projects that fulfil the expected objectives.”
In 2002 in his book Corporate Governance and Wealth Creation in NZ, Joseph Healy, former ANZ regional investment banking head, also pinpointed poorly specified or non-existent return on capital objectives as key corporate weakness and noted systemic failure to place capital where it could produce the required returns.
Tony Street is director of Hamilton consultancy Capex Systems. He recalls the difference made by eliminating paperwork when Capex ValueAnalyser software was introduced at the Port in 1999.
“Capital investment decisions are among the most important any company can make,” he points out. “So naturally, an independently audited software application systemised the business case compilation process. Certainly, enabling tools such as this greatly help users to achieve better outcomes.”
The system first categorises proposals, then prioritises them within the capital planning process. Categories have predetermined hurdle rates.
While “must do” proposals usually generate no additional revenue, “business case” projects (operational improvements, new business, capacity increases, etc) must produce return above the weighted average cost of capital (WACC). Total capital budget should achieve return at least equal to the WACC.
As to “must-dos”, system users can objectively assess risks and determine priority scores with simple-to-use graphical user interface, dynamically linked to database. Thus ‘needs’ are met before ‘wants’, and risks of adverse outcomes are effectively managed.
Better outcomes aside, substantial in-house time savings are gained – both by initiators and approvers of capex requests. For example, the workflow and collaboration process in most medium to large organisations can be streamlined, and reporting automated.
For Street, both the exceptional shareholder returns achieved by the Port of Tauranga and the results of the recent survey, came as no surprise.
“All other things being equal, corporate with good capex discipline and systems will always deliver better shareholder returns than one without,” he said. M