Brian Gaynor 's Opinion

Brian Gaynor is a Weekend Herald columnist.

Brian Gaynor: Good and bad news in reporting season

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Company results show loss of faith in accounting standards

Photo / David White
Photo / David White

Our failure to establish widely accepted accounting standards creates major problems as far as the effective allocation of the country's capital is concerned.

The reporting season, which ended for most of our major listed companies this week, was a combination of good news and bad.

The good news is the combined net earnings of the 24 companies covered in this column increased by 11.5 per cent compared with the previous year while total dividends rose by 10.3 per cent.

And most of the outlook commentary for the next six and 12 months is reasonably positive.

The bad news is the majority of companies have lost confidence in our accounting standards and are now highlighting their underlying, normalised or adjusted earnings instead of audited profit. This is a very worrying trend, particularly for those who experienced the creative accounting excesses of the 1980s.

Lax accounting policies resulted in a disastrous misallocation of capital 30 years ago as investors poured money into companies that reported inflated and unrealistic profits.

Why is the accounting profession allowing this practice to develop again? Is there any leadership at the New Zealand Institute of Chartered Accountants?

How do we reconcile statements in the auditors' report that a company's financial statements "give a true and fair view of the financial position of the company and its financial performance and cash flows for the year" when the company is telling shareholders that its realistic net profit figure is totally different?

Twenty-four companies made profit announcements in the past few weeks. They are all included in the benchmark NZX50 Gross Index and account for 60.8 per cent of the index in terms of weighting.

Fletcher Building is the largest company, with an 11.6 per cent index weighting, followed by Telecom on 8 per cent and Auckland International Airport, 6.5 per cent.

Sixteen of these 24 companies highlighted different adjusted profit figures to those signed off by auditors. This indicates a high proportion of our listed companies do not believe conventional accounting policies give a realistic assessment of their performance.

Ten of the 16 profit adjustments were up, with the remaining six, down. Many of these adjustments are large and inconsistent.

For example, Telecom made a positive net-profit adjustment of $104 million, from $238 million to $342 million. Mighty River Power raised its net earnings by $64.7 million, from $114.8 million to $179.5 million and Heartland adjusted upwards by $17.5 million, from $6.9 million to $24.4 million.

The largest downward adjustments were Metlifecare, by $88.2 million; Port of Tauranga, by $34.9 million; and New Zealand Oil & Gas, by $9.2 million.

Fletcher Building made no adjustments for capital profits or write-offs while other companies exclude these in their underlying, normalised or adjusted earnings.

Our failure to establish widely accepted accounting standards creates major problems as far as the effective allocation of the country's capital is concerned.

Last year Fletcher Building had audited net earnings of $185 million but the company adjusted this figure upwards to $317 million and the latter figure was widely accepted by analysts and fund managers.

However, some share data, including the Business Herald's daily table, used the $185 million to calculate the company's price/earnings ratio (P/E).

As a result Fletcher Building had a P/E of around 30 in these share tables for most of the past 12 months and many investors are believed to have made decisions based on this P/E.

Following the latest result Metlifecare has a P/E of just 5 based on net earnings of $120.2 million and the earnings per share figure of 65.8c included in the audited accounts. The company's 5 times P/E in share tables is correctly based on these audited figures. However, the retirement village operator also released an underlying profit figure of $32.1 million, giving it earnings per share of 17.5c and a P/E of 21.

How can investors make a clear decision when Metlifecare has a P/E of 5 in some share tables and a P/E of 21 in another analysis?

At the other end of the spectrum is Heartland, which has a P/E of nearly 50 in share tables but this comes down to around 14 if June 2013 adjusted earnings are used.

Our accounting standards are a shambles with two-thirds of our largest listed companies believing their audited results do not truly reflect the performance of their companies. Subsequent adjustments create massive confusion for investors and could allow unscrupulous directors to be particularly creative as far as their underlying, normalised or adjusted profits are concerned.

These loose accounting standards had disastrous consequences in the 1980s.

Nevertheless, the good news is that total adjusted net earnings for the 24 companies increased by 11.5 per cent from $2.22 billion in the same period last year to $2.48 billion in the latest period.

The outstanding performances were Air New Zealand, which posted a net profit increase of 163.8 per cent, and retirement village operators Metlifecare and Summerset.

Air New Zealand said its impressive profit growth was due to cost containment, growth in passenger demand and yield and the improved performance of its international long-haul network.

The company is "focused on further improving on this result in the 2014 financial year" and "early results and forward bookings are encouraging".

Metlifecare is "looking forward to another successful year" and Summerset, which reported for the six months to June 30, is "working steadily towards its full-year result".

Mighty River Power's result was highly anticipated and it did not disappoint. The company's audited profit was $114.8 million but this was adjusted up to $179.5 million after it deducted and added back a number of items including changes in fair value of financial instruments, restructuring costs and impairments.

The problem with these large profit adjustments is that there is usually no auditor signoff to confirm these post-adjusted figures are a realistic assessment of the company's true performance.

However there were positive signals that Mighty River Power's June 2014 dividend may be higher than the 13c a share forecast in its IPO prospectus.

As far as dividends are concerned 16 of the 24 companies covered in this column raised their dividend compared with the previous corresponding period, four were flat, two were cut and a further two paid no dividend.

Total dividends for the reported period were $1.91 billion, a 10.3 per cent increase over the same period in the previous year.

This represents a payout ratio of 79.8 per cent based on adjusted profits, which is exceptionally high by international standards. For example the Australian Financial Review recently reported that the Australian benchmark S&P/ASX200 companies has a current payout ratio of 70 per cent, just short of the record 72 per cent dividend payout rate during the 1992 recession.

The NZX's high dividend payout is a timely reminder that many of our largest listed companies have limited growth opportunities. As a result they have large dividend payout ratios and relatively high, fully imputed, dividend yields.

This is why the NZX is very keen to attract a large number of new high-growth company listings. The Stock Exchange also needs accounting standards that are widely accepted by companies and investors.

It definitely doesn't want more and more companies reporting underlying, normalised or adjusted net earnings figures.

Brian Gaynor is an executive director of Milford Asset Management which holds shares on behalf of its clients in most of the companies mentioned in this column.

- NZ Herald

Brian Gaynor

Brian Gaynor is a Weekend Herald columnist.

Brian Gaynor has written a weekly investment column for the Weekend Herald since April 1997. He has a particular particular passion for the NZX and its regulation. He has experienced - and suffered through - the non-regulated period prior to the establishment of the Securities Commission in 1978 and the Commission’s weak stewardship until it was replaced by the Financial Markets Authority (FMA) in 2011. He is also a Portfolio Manager at Milford Asset Management.

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