NZ companies are world class

By JIM EAGLES

What is New Zealand's best-performing company when it comes to creating sharemarket value?

It should come as no great surprise to anyone who follows the sharemarket to discover that in terms of Market Value Added - a concept pioneered by global consultants Stern Stewart - it is Baycorp.

At the time Stern Stewart's latest MVA figures were compiled, Baycorp had expanded $92 million of investment into a market value of $915 million, or a relative MVA rating of 897 per cent.

What may come as a surprise to some is the fact that the best-performing company in terms of return on capital - or relative Economic Value Added - is Lyttelton Port.

Last year, according to the Stern Stewart figures, it produced a return on capital of 27.9 per cent, compared with a cost of capital of 12.6 per cent, amounting to an EVA margin of 15.3 per cent, worth $8 million.

But perhaps the biggest surprise of all is that, contrary to popular opinion, New Zealand companies as a whole are just as good as creating both market value and economic value as their equivalents overseas.

When some raw Stern Stewart ratings for New Zealand companies were publicised a few months ago, they were widely interpreted as proof of the incompetence of - as one commentator put it - "our scandalous management."

What sparked that outrage was the fact that 19 of the 40 companies in the New Zealand ratings actually had a negative EVA. In other words, their return on capital was less than their cost of capital.

But, far from demonstrating the ability of New Zealand managements to destroy value, the ratings merely confirmed the economic theory that, over time, EVA and MVA should both average out at zero.

The fact that only half the companies in the top 40 managed to cover their cost of capital is only to be expected.

By way of comparison, in the most recent Stern Stewart figures 53 per cent of Australian companies, 28 per cent of British companies and 55 per cent of Canadian companies also recorded a negative EVA.

Perhaps most telling of all, of 1000 American companies studied by Stern Stewart, 494 were unable to create positive EVA in 2000.

It is certainly true that in recent years the top 40 New Zealand companies, taken overall, have failed to cover their cost of capital. Last year, for instance, the Stern Stewart figures show an across-the-board shortfall of just over $1 billion. But that was mainly because two of the biggest companies, Carter Holt Harvey and Fletcher Challenge Forests, lost more than $1.1 billion between them.

Forestry companies do have the excuse that they operate in highly cyclical markets. But an international index of 25 forestry companies kept by Stern Stewart shows the New Zealanders to be the worst performing of the lot.

Without the disappointing performances of the two forestry companies, the top 40 did rather well in paying their way.

Indeed, Stern Stewart's calculations show the 40 companies had an average cost of capital of 10.8 per cent and an average return on capital of 11.7 per cent to give an overall EVA margin of 0.9 per cent.

The lack of breadth and depth in New Zealand companies is, of course, also a problem for our sharemarket.

In recent years the progress of the whole market has been dominated by a handful of damaging overseas purchases by some of its biggest companies: BIL and Thistle Hotels, Fletcher Challenge and UK Paper, Telecom and Pacific Star and, arguably, AAPT, Air New Zealand and Ansett Australia.

But the Stern Stewart figures show that the bulk of New Zealand companies, though they may be modest in size, have performed up to international standard.

Last year the best-performing companies in terms of relative EVA, behind Lyttelton Port, were The Warehouse, Hallenstein Glasson, Sanford, Ryman Healthcare and the ubiquitous Baycorp, all of which produced returns on capital of about 20 per cent or better, an impressive achievement by any standard.

But their efforts were balanced out by the worst-performing companies - Sky, Fletcher Forests, Carter Holt Harvey, INL and NZ Refining.

In terms of Market Value Added, however, New Zealand companies have in recent years done considerably better than achieve financial neutrality.

In 1998 the MVA of the 40 companies rated totalled $13.5 billion. In 1999 that figure jumped to $20 billion and last year it slid back to $16.6 billion.

In sheer size by far the biggest value creator was Telecom which last year was assessed as having an MVA of $10.2 billion. By way of comparison, the next on the list was Sky, with an MVA of $1.5 billion.

But in relative terms Telecom was only ninth on the list. The top performers behind Baycorp were Sky, The Warehouse, Lyttelton Port and Port of Tauranga.

The worst performers were DB, Air New Zealand, Fletcher Forests, Carter Holt Harvey, Steel & Tube and Tasman Agriculture. Notable among those rankings is the fact that last year Sky was one of the best performers in creating market value but one of the worst in producing return on capital.

That serves to highlight that MVA represents investor expectations of future EVA. Sky is obviously considered to be building a valuable strategic position which should generate good returns.

Of course the Stern Stewart assessments represent the situation only at a particular point - June last year for the latest figures - in a market which is constantly changing.

Bevan Wallace, of Ireland Wallace, Stern Stewart's New Zealand associates, points out that it is extremely difficult for a company to constantly turn in positive value-added figures because in a free market competitors will always seek to erode the position of successful operators.

"It is a situation which can only be sustained where a company has a special property right, such as Microsoft has created with Windows."

In the New Zealand market, he said, "Telecom could have been seen as occupying that position, which is probably why it has attracted Government regulation and a lot of competitors."

And, as economic theory would predict, Telecom's MVA has fallen from a high of $11.5 billion in 1999 to $10.3 billion in 2000 and looks likely to fall further this year.

Other telecommunications companies worldwide have followed much the same pattern for much the same reasons. A Stern Stewart international index of 12 telecommunications companies puts Telecom's performance pretty much in the middle.

So how does Baycorp manage to sustain its position at the top of the tree year after year? "Basically," according to Mr Wallace, "because it has developed a special property right in the form of its database and systems which it will be very hard for anyone else to catch up with. It also continues to develop new platforms with the aim of retaining that lead."

But for most companies, covering the cost of capital and creating positive market value, is always going to be a struggle against those hungry competitors. And it is a struggle in which about half will be winners and, inevitably, about half will be losers.