Saturday, November 28, 2015

Brian Gaynor: Liveable city faces some tough choices

The Ernst &Young (EY) and Cameron Partners reports on Auckland Council’s long term $18.7 billion capital expenditure programme raise a number of important issues. These include:
  • Should rates increases be used to fund these projects?
  • Can the council rely primarily on debt funding?
  • Should the capital expenditure programme be partly funded through the sale of council assets?
Auckland’s infrastructure demands are soaring because the region’s population grew by 33,800 people, to 1,527,000, in the June 2014 year and by a further 43,500, to 1,570,500, in the latest June year.

The population is expected to grow by a further 440,000, to 2 million, by 2033 and is expected to reach 2.2 million by 2043.

Based on recent growth trends, these projections could be far too conservative and Auckland’s population could be in excess of 2.3 million by 2033 and 2.6 million by 2043.

This will create a huge demand for additional infrastructure assets, most of which will have to be organised and financed by the Auckland Council.

The council’s Long Term Plan, which is from 2015 to 2025, requires total capital expenditure of $18.7 billion over the 10-year period. This includes the construction of new infrastructure assets and the upgrade of existing assets.

Auckland’s five major 2015-25 infrastructure projects are:
  • City Rail Link ($2.5 billion). This is the 3.4km rail tunnel connecting Britomart to new stations near Aotea Square and Karangahape Rd. These will be linked to a redeveloped Mount Eden station
  • Central Interceptor ($966 million). A new wastewater conveyancing and storage pipeline
  • AMETI ($552 million). Transport improvements to the Glen Innes, Panmure, Pakuranga and Botany corridor
  • Waikato Water Treatment Plant No 2 ($400 million). Additional treatment plant capacity from the Waikato River
  • Huia Water Treatment Plant ($241 million). The replacement of the Huia Water Treatment Plant.

Nearly $8 billion, or 42 per cent, of the total capital expenditure will be on transport facilities; $4.7 billion, or 25 per cent, on water assets; and $3.4 billion, or 18 per cent, will be on environmental, social and community projects.

Approximately 70 per cent of the total spend will be on new assets, with the remaining 30 per cent on the upgrade of existing infrastructure.

The council has the following objective: “Auckland’s vision is to become the world’s most liveable city”.

Achieving this goal will be difficult and costly – probably far in excess of $18.7 billion – because the council faces enormous pressure, primarily from changing demographics. It will be a huge task to turn Auckland into the “world’s most liveable city” because of burgeoning immigration, a massive increase in population and an ageing existing population.

The situation is exacerbated because the council has to fund its day to day operating activities in addition to its ambitious Long Term Plan.

At present, 47.8 per cent of its day to day activities are funded by rates, 33.9 per cent by fees, 9.3 per cent through subsidies and grants, 6.5 per cent from fuel tax, fines and infringement fees and 2.5 per cent from interest and dividends from investments.

How will the council finance its $18.7 billion infrastructure programme if rates, fees, parking fines and dividends are all committed to day to day activities?

Cameron Partners identifies two main options – borrowing and asset sales – while the council’s projections indicate that its annual operating surplus will make the largest contribution to its infrastructure spend.

Rates, which are projected to increase by 3.5 per cent per annum over 2015-25, are not a direct option but they could be raised by more than 3.5 per cent per annum to boost the council’s annual operating surplus.

Cameron argues there is no “free lunch” but notes that the 2015-25 Long Term Plan reveals that “Aucklanders … have no appetite for large increases in rates or council debt”.

This is a huge contradiction. We want world class transport, recreational facilities and water but don’t want to raise rates, increase debt or sell assets to pay for these.

The council will have to rely on a combination of borrowings, asset realisations and rates increases in excess of 3.5 per cent per annum (to boost its annual operating surplus) in order to fund its Long Term Plan.

Debt is a viable option but EY warns that “the downside of debt is the interest payments incurred and the risk of adverse interest rate or inflation movements”.

Interest rate increases would have to be funded from operating expenditure that could result in rates increases in excess of the 3.5 per cent per annum forecast over the 2015-25 period.

Cameron and EY believe that the Council has additional debt capacity of no more than $1 billion to $2 billion – well short of the $18.7 billion required over the next decade.

Consequently, Cameron believes that asset sales could partly fund the region’s Long Term Plan.

The investment bank has a number of comments on these assets, particularly the council’s commercial assets, which are listed in the accompanying table.

Auckland Council owns 22.4 per cent of Auckland International Airport, with a market value of $1.4 billion. Cameron notes that a selldown of the council’s airport stake from 22.4 per cent to 10 per cent would realise nearly $750 million. A 10 per cent stake should be maintained because this would block any attempted takeover offer.

Cameron notes “it is impractical to consider the sale of Ports of Auckland (or part sale) until the council review process currently underway is completed. The uncertainty regarding business plan and valuation would likely see a material discount to value”.

However, the report suggests that the land should be separated from the port operations and the council should consider selling the latter, with the land remaining in public ownership.

The sale of the council’s commercial parking assets could create issues because the new owners could raise prices or reduce the number of downtown parking spaces, particularly if these assets are sold with associated development rights.

The council’s Diversified Financial Asset Portfolio consists of stocks and bonds which are held in reserve to meet any unforeseen liquidity or funding events.

The housing for older persons could be moved to central government or private sector operators could provide these services under contract. The marinas, which consist of Westhaven, Silo, Hobson West and Viaduct Harbour assets, could be sold, with public objections met through contractual and regulatory means.

Two other interesting assets are the 13 golf courses, which have a rateable value of $61.2 million but an alternative use value of $2.1 billion, and Watercare.

The five most valuable alternative use golf courses are Remuera ($517 million), Chamberlain Park ($316 million), Pupuke ($307 million), Takapuna ($230 million) and Waitemata ($212 million).

Cameron doesn’t recommend the disposal of golf courses, parks and community facilities but recommends that each of these assets should be analysed carefully to assess the value that is forgone by continuing to operate them as non-commercial assets.

Finally, Watercare, which is classified by Cameron as an infrastructure asset and is valued at $8.4 billion. Cameron doesn’t recommend the full or partial sale of Watercare but gives a clear message that the company should consider selling surplus land.

The EY and Cameron reports are balanced and do not recommend the wholesale disposal of the council’s assets.

However, they do give a very clear message that Auckland Council needs to adopt a far more rigorous approach to its financial position as it cannot rely mainly on an annual operating surplus to fund its massive $18.7 billion infrastructure spend over the next decade.

Brian Gaynor is an investment analyst and the Executive Director of Milford Asset Management. 

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