2019 Annual Report Highlights

Chief Executive report

Infratil has provided its shareholders with a 20.0% per annum compound return over the five years to 31 March 2019 (the NZX50 index returned 13.9% per annum and the ASX200 7.0% per annum).

I’ve chosen to highlight five years rather than one (+41.3% per annum) because last year’s sharemarket recognition reflects work which has been underway over a longer period. 

Chief Executive report

Over the last five years Infratil has realised $1,795 million from its divestment from Lumo, Z Energy and Metlifecare. Over the same period, Infratil has invested a similar sum and established interests in RetireAustralia, Canberra Data Centres, Longroad Energy and Tilt Renewables.

A range of factors were behind the changes in the portfolio, but the overarching theme was to position Infratil in businesses facing strong and growing demand where meeting that demand should present opportunities to make ongoing investment into facilities and services. Another factor is scale and complexity.

We believe that to warrant intensive management, an investment needs to have scale potential. Also, having many smaller holdings creates complexity which we have found impedes value recognition by the market. We prefer that Infratil doesn’t put its eggs in too few baskets, for reasons of diversity and optionality, but it is apparent that too much complexity results in shareholders being penalised with a discount in the share price.

 

Infratil’s divestments and investments are also influenced by the financial market in which we now operate. The defining feature of which is extraordinarily low interest rates. The 2% per annum yield on the government debt of New Zealand, Australia and Singapore is a generous offering to savers relative to the negative rates provided by Japanese, German or Swiss bonds. This has caused long-term saving institutions to seek out “bond-like” investments. Buying a low risk income stream in the form of student accommodation fees or contracted wind farm revenue to earn 6-8% per annum is perceived to be better than government bonds that yield 2% per annum.

In the last year we sold some lower risk assets to investors seeking bond-like returns; utility scale solar and wind electricity generation in Texas and the right to the income from student accommodation in Canberra. Going forward at least a part of how we expect to generate returns seems likely to involve building assets which can be de-risked to either generate value gains internally or via transactions with long-term savings institutions.

How long will this situation pertain? As others have noted, five years ago few forecast where we are now, and nothing about today makes forecasts more likely to be more accurate. But while the market may change, we are confident about the benefits of combining operational expertise and financial capability and discipline as this is part of Infratil’s DNA.

Financial

Over the year to 31 March 2019 the Infratil share price rose from $3.10 to $4.17 and dividends of 17cps cash and 5.68cps imputation credits were paid. 

The parent company net outcome was a loss of $19.5 million. The $90.9 million turnaround from FY2018’s $71.4 million surplus was due to a $102.6 million management performance fee. The fee is recorded against income while the corresponding investment value gains are reflected in the value of assets. The net impact was a significant rise in the value of Infratil’s assets which was reflected in the share price.

Along with good outcomes with its businesses, Infratil also had a good period with its capital management. $111.4 million of 6.85% per annum bonds matured in November 2018 and Infratil issued 4.75% per annum 2025 bonds and 4.85% per annum 2028 bonds, raising $100.0 million and $146.3 million respectively. Investor support for the bond offers is appreciated and indicative of the regard in which Infratil is held in the debt capital markets. 

Shareholders

Over the year to 31 March 2019 the Infratil share price rose from $3.10 to $4.17 and dividends of 17cps cash and 5.68cps imputation credits were paid. 

The final dividend for FY2019 of 11.0cps will be paid on 27 June 2019. It will carry 2.0cps imputation credits.

Infratil’s goal is to deliver total returns to its shareholders by investing in businesses which grow in value and provide good cash earnings as they mature. Over the last decade the second part of this objective has been realised resulting in a steady lift to the dividend.

However, the increasing share of Infratil’s earnings coming from outside of New Zealand has constrained the availability of imputation credits. Following consultation with shareholders we decided that Infratil should continue to pay a dividend which reflects free cash flow, even if not imputed to 28%. This situation is expected to be alleviated by Infratil undertaking further investment in New Zealand.

Infratil’s forecasts indicate that the cash dividends for FY2020 are likely to be consistent with those paid in respect of FY2019 and that imputation credits are likely to be in the range of 3-4cps.

Actual dividends will continue to reflect Infratil’s cash earnings and financial position as well as the preferences of shareholders. 

 

Management costs

Infratil’s management is provided on a contractual basis by Morrison & Co. 

For providing management and administration services Infratil makes three types of payments to Morrison & Co. Two reflect terms in the contract while the third is for services which the board decides to source from Morrison & Co because it has determined they will provide better value or efficiency relative to using a third party.

The two contracted payment obligations are a base fee and a performance fee. The base fee is approximately 0.8% of the market value of Infratil’s equity and wholly-owned group net debt. For the year this was $24.9 million. The performance fee is offered on Infratil’s non-New Zealand assets if they provide a return that is in excess of an agreed benchmark. For the period this was $102.6 million. The performance fee is explained in the Board Chair Report.

Marko Bogoievski CEO Report2

Markets, regulation, change

Over the year Infratil actively participated in several policy debates:

  • The most material as regards to eventual impact relates to New Zealand’s CO2 emissions. 

    Given the widespread support for reducing CO2 emissions it may be perplexing that policies are so slow to appear. This reflects the need for the policies to be effective, efficient and durable. For example, closing New Zealand’s aluminium smelter would reduce New Zealand’s CO2 emissions significantly. But it would increase global emissions (the New Zealand smelter uses hydro electricity, elsewhere most use energy from coal or gas) and impose huge economic and social costs on New Zealand which could cause policy U-turns.

    Infratil supports a gradual increase in emission costs augmented by government assistance with the take up of electric vehicles and electrification of industry, and the provision of better public transport (so people have choice) and social welfare for vulnerable people who cannot avoid the higher costs.

  • Government initiatives to improve urban water, transport and housing infrastructure are recognition that many regions in New Zealand have fallen well behind acceptable standards.

    The shortcomings reflect complex and difficult to remedy problems and unfortunately the policy focus is often on government imposed solutions as opposed to market remedies. It is ironic that New Zealand has only two privately controlled international airports and a massive regulatory apparatus to ensure they are safe, efficient and fair in their pricing. But sans any private water businesses there is much lighter regulation on that sector.

  • We submitted in opposition to changes to the Commerce Act that granted more power to the Commerce Commission. Whether the Commission makes good use of the powers was not the issue, it was whether Parliament should delegate yet more power to unelected officials who have only a tenuous accountability to elected representatives.

  • We applauded the aspirations behind the Provincial Growth Fund (PGF.) It makes good sense for government to seek to generate economic stimulation in regions which are struggling. In our view it has the potential to be more beneficial than investing the enormous sums required by Auckland commuter rail to accommodate that city’s population growth. But whether the folksy approach to distributing PGF funds results in the desired outcomes remains to be seen. It is to be hoped that transparency and accountability are enforced.

  • Infratil has also submitted on the Reserve Bank’s plan to increase the proportion of trading bank funding provided by their shareholders as equity. As noted in our submission, the trading banks are extremely important and our concern is that the Reserve Bank’s steps to improve their resilience could impose significant costs on everyone else.

    These are of course not the only law and policy areas where Infratil and its subsidiaries are active, but it is a reminder of the many regulatory currents running below the surface which can have profound consequences over time.

Report of the Board Chair

Directors are appointed by shareholders to represent their interests. 

That means maintaining a dialogue with shareholders to understand what those interests are and then ensuring that those interests are recognised in the way the Company is managed and the information it provides. The role includes making sure that management are undertaking their tasks effectively and at fair cost.

While directors’ responsibilities overlap with those of management they are distinct and the Annual Report provides separate Chief Executive and Chair reports.

Report of the Board Chair

Measuring management

Following requests from shareholders the board decided to publish a return target which reflects Infratil’s existing businesses and the expected return the Company should provide for shareholders after taking into account Infratil’s use and cost of debt and administration and management costs.

This gave us a target of 11%-15% per annum over the period to September 2028 (ten years).

The ten year period was chosen because it aligns with Infratil’s planning horizons, approximates how long most shareholders hold their Infratil shares, and because over that period financial market fluctuations should have less impact.

As a reference, over the last decade Infratil’s total shareholder return was a compound 16.7% per annum. 

We undertook this exercise in September 2018 at which point the return target was built up as depicted in the table copied at the bottom of the page.

It is intended that this provides shareholders with better understanding of Infratil’s risk appetite and return expectations, and that it assists shareholders in holding the board accountable for financial performance. 

Reporting on the target, performance relative to the target, and on management

Nothing has happened since September 2018 to cause the board to consider that the ten year shareholder return target doesn’t remain credible. 

In the short period since we set the target (six months), Infratil’s businesses have provided positive surprises, most notably from Canberra Data Centres and Longroad. All the other business and investment activities roughly fell within expectations. 

Shareholder returns were above the long-term target range, but six months is a very short period over which to judge performance. 

Over time we intend to provide a brief commentary on:

  • The long-term return target.

  • Performance relative to the return target.

  • The board’s assessment of management’s contribution relative to the benchmark target. 

  • We remain open to shareholder views around any of this. Our goal is to improve the accountability of Infratil’s governance and management and the Company’s transparency.

Management remuneration 

(NB. Details are set out on page 121 of this Annual Report.)

Infratil’s management remuneration comprises base and performance components. 

The base is calculated as approximately 0.8% of the market value of Infratil’s equity and the value of the net debt of Infratil and its wholly owned subsidiaries. Last year this amounted to $24.9 million indicating that the average value of equity and debt was approximately $3.1 billion. The comparable figures for FY2018 were $22.1 million and $2.7 billion respectively. This remuneration formula was agreed between Infratil and its Manager in 1994.

In 2002 Infratil made changes to its management contract which expanded management’s remit to include international assets and introduced the potential for performance payments on those assets. Management can receive performance pay if returns on certain offshore investments are above 12% per annum. 

Including FY2019, Infratil has made four such payments over the seventeen years the arrangement has existed; indicating the challenge of beating a 12% per annum benchmark. Prior to FY2019, $64.1 million was paid to reflect value created by Infratil’s Australian energy investments (Lumo, Infratil Energy Australia, Perth Energy) with $0.3 million related to a venture investment.

This year’s performance fee of $102.6 million applies to four investments, one of which is being sold. The table on page 18 shows Infratil’s net investment amounts, the 31 March 2019 values, the rate of return, and the performance fee components. The fee reflects performance over the period since those investments were made in FY2017.

 

 

Subsequent sections of the Annual Report provide details of the valuations relevant to the incentive fee.

The board continues to monitor and review the effectiveness and fairness of management’s remuneration terms. As noted in last year’s annual report, that year the independent directors commissioned an external review of the Management Agreement which considered all fees, including the performance fee arrangements. The review concluded that the fee structure, taken as a whole, is fair to Infratil shareholders.

We appreciate hearing the views of shareholders and make every effort to respond. Given the complexity of management contracts such as Infratil’s, we have particularly appreciated the thoughtful and considered input from the ACC investment team and the New Zealand Shareholders Association.

Mark Tume2

Performance fee apportionment

 $Millions 

Net Investment 

Valuation 

Return 

 Fee 

Canberra Data Centres

$455.1

$889.2

30.7% p.a.

$65.3

Longroad Energy

$2.61

$122.7

63.7% p.a.  

$21.2

Tilt Renewables

$608.72

$173.4

2.5% p.a.

$13.6

ANU Student Accommodation

$93.9

$174.8

29.9% p.a.

$13.6

 

 

 

 

 

 

 

1. The net of what Infratil has advanced to Longroad and received back from Longroad.

2. Tilt was demerged from Trustpower in October 2016 and at that time the market value of Infratil’s then 51% stake was assessed to be $326.8 million. A further $281.9 million has subsequently been invested by Infratil.

3. Internal rate of return after initial incentive fees. 

Infratil Annual Report 2019
Infratil Annual Report 2019
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