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Chairman’s Address 2002 Annual Meeting

CHAIRMAN’S ADDRESS
2002 ANNUAL MEETING


The past 12 months has been another year of intense activity for your Board, management and employees. Following on from the successful amalgamation of the former Powerco and CentralPower and the subsequent main board listing on the New Zealand Stock Exchange the Company has continued to pursue growth opportunities.

Whilst Powerco is a stakeholder driven company it maintains a clear intent on improving earnings to shareholders through increased dividends and share market value. The strong steady cashflow of the Company will enable it to continue with its growth strategy by maximising its leverage.

As reported in our 2002 Annual Report, Powerco had another successful year recording a net profit after tax of $33m, approximately 10% up on the equivalent pro-forma result for the previous year. This result allowed Directors to approve total dividends of 13.1 cents per share for the year, up 4.8% on the previous year and higher than that previously forecast in the amalgamation prospectus.


Regulatory Review

Powerco’s revenue stream comes from two prime sources; from the ownership of electricity line and gas pipe distribution assets, and from the service activities associated with asset management, field services and network control centres. The network ownership activity is generally regarded as having monopoly characteristics and as such, is governed by Government legislation and regulation. The service activities on the other hand, are competitive with some network owners contracting out such activities and other network owners and independent third party providers providing such activities. Powerco out-sources certain low skill activities but retains the higher skill activities where it can offer a competitive service to others. The Board sees growth potential in all these activities by providing these services to other network owners in New Zealand and Australia, as well as to ourselves.

The Labour Government, when elected in 1999, undertook to conduct a review of the electricity and gas regulations. As part of that process, the Electricity Industry Act 2000 was enacted in response to the Ministerial inquiry. This Act provided, what some regard as, unconstitutional powers to the Minister to invoke heavy regulation and control on network companies who don’t conform to the objectives of the Act and the wishes of the Minister as promulgated from time to time. The Act also required the establishment of a new Electricity Industry Governance Board to provide self-governance to the industry. Consumer organisations as well as electricity generators, retailers and distributors including Transpower, will elect the seven members to this Board. Also, as part of the process, the Commerce Commission were charged to conduct a number of reviews including a review of the valuations used by electricity distributors and the establishment of new disclosure rules and performance thresholds.

The Powerco senior management team, led by the Chief Executive Steven Boulton, have been at the forefront of industry regulatory development. Powerco has led the charge in producing its blueprint for the future regulatory framework in publishing its “Power Plan”. This plan advocates that the whole industry and not just distributors should be subjected to regulatory disclosure so that it is transparent to consumers where changes in their electricity prices are occurring. The Plan also advocates a benchmarking approach of disclosed information to ensure industry participants stay within international thresholds. A recent report on electricity prices for OECD countries now ranks New Zealand with the lowest electricity prices. This outcome can be partly attributed to the light handed regulatory regime that has been in place for the past 10 years, which has encouraged innovative approaches that resulted in effective cost control whilst also improving network reliability. The intrusive regulatory approach in most other countries eventually heads down a cost plus path providing no long-term benefit to consumers.

From Powerco’s perspective, the option to continue with the present light handed regime where risks and rewards are shared with consumers and shareholders alike, is far more beneficial to the economy than the alternative heavily regulated regime where all risks are transferred to the consumer who eventually pays an increased price for their power supply. Powerco has held its average line charges to residential consumers at the same level since 1997 resulting in a real price reduction of close to 10% whilst also improving our network reliability. Powerco recently announced that the current charges for residential consumers would continue at least for another year until March 2003. Powerco also reduced its fixed daily charge to zero for residential consumers in response to the Minister’s request to charge no more than 10% of total charges as a fixed daily fee.

It is interesting to note that retailers have not passed these changes on in their tariffs. It is also disappointing to see the substantial increases in prices charged by retailers to consumers in recent announcements. Our Powerco Power Plan reinforces the importance of ensuring that all sectors of the electricity industry are regulated in an even-handed manner to ensure that consumers receive sustainable fair value.

Powerco accepts that future price increases from its network ownership activity, as a means to ensure sustainable value to shareholders may be limited. Whilst growth in connections and consumption are likely to be maintained, any real organisational performance growth will come from two sources - the un-regulated competitive activity of asset management, field services and control centre services and the ongoing asset purchases, acquisitions and mergers that will continue in a marketplace where the distribution sector continues to be constrained with an excess number of companies.


Growth Activity

Field service activity is an integral part of the Powerco business. This activity employs the linesmen and tradesmen experienced in maintaining, repairing and installing electricity lines, substations, transformers, and gas pipes in all weather conditions to ensure that the Company provides a service of the expected quality. These people “keep the lights on” and work in all manner of adverse weather conditions to restore supply as quickly as possible if it is lost.

In the first quarter of 2001-02, United Networks Limited placed their field service activities out to tender. The Powerco management and Board spent time investigating this possibility with the contract eventually being awarded to Siemens Ltd in July 2001. Whilst disappointed by the outcome, Powerco will only enter into transaction that provide sustainable value to shareholders.

Field service activity investment opportunities were also investigated in southeast Queensland. An initial small investment was made in a contracting company S&D Contractors in October 2001, which helped to obtain a better appreciation of the market conditions. Within a 90-minute travel radius of Brisbane there are a similar number of electricity consumers compared to those in the whole of New Zealand and they are growing at a faster rate. In May this year Powerco acquired a further three companies to provide increased geographical spread, increased breath of experience and improved diversity of revenue streams. The total cost of these Australian acquisitions was $NZ10m and turnover for the first year is expected to reach $NZ25m. This investment increases our non-regulated income whilst building on the Company’s inherent experience and strength as a core activity.

The 2002 Annual Report commented on the acquisition of the Hutt Valley and Porirua Basin gas distribution network. This network was acquired from the Australian Gaslight Company (AGL) in July 2001 for $118m. The operational staff were employed by Powerco from January 2002. Since acquiring this network, Powerco has benefited from increased gas consumption and connection growth, as well as from streamlining the cost structure. We believe that there is potential to increase the penetration for new connections further.

For several months during 2001 we were involved in negotiations with the Eastland Energy Trust, the 77% shareholder in the listed company, Horizon Energy Limited the owner of the electricity distribution network in the Eastern Bay of Plenty surrounding the Whakatane region. During this period, Powerco acquired a 4.9% shareholding in Horizon for $2.84m. The objective of the negotiations was to make an offer to all minorities and enter into a management contract with the company. Unfortunately, the negotiations were not successful at that time as we were unable to put our offer terms to shareholders. The current market value of our shareholding currently exceeds $4m and we continue to hold these shares.

United Networks announced last month on 12 June a sale process for its entire operation. The principal shareholder, UtiliCorp NZ Ltd, whose ultimate parent company is Aquila Inc of USA, wants to realise their New Zealand investment, initiated the process. United Networks currently has a market capitalisation of $1.3b - $1.4b and an enterprise value of $2.6b – approximately three times the size of Powerco. Powerco has publicly announced its expression of interest in these assets and if successful in moving through the process would be seeking an arrangement with potential consortium partners. The announced timetable is extremely tight with the lodging of binding bids due by late August and the announcement of the successful parties shortly after. If Powerco is successful in its bid to acquire some of these assets, approval for the proposal will be required from shareholders.


Financial Activity

The Board recognised that the optimisation of the capital structure of its balance sheet and the minimisation of its interest costs were essential risk mitigation objectives to be achieved. To this end, the Board established a Finance Committee in September 2001 to focus on these aspects of the Company’s operations. We were pleased that Mr James Ogden, an executive of Macquarie New Zealand Ltd until March 2002, was able to join the Board and Chair this committee.

The Committee has been very active reviewing and establishing the parameters for the capital structure of the Company within the thresholds to maintain it’s A- long-term credit rating with Standard & Poor’s. The Committee engaged the assistance of Deloitte Touché Tohmatsu Financial Services to provide an in-depth analysis of the present and future funding needs with recommendations for refinancing the short-term bank loan utilised to fund the Hutt Valley gas pipeline purchase, as well as a range of treasury policies.

Based on this analysis, the Committee recommended to the Board that a $100m Capital Bond issue be made to replace the short-term bank finance. This issue was announced in February this year and was closed fully subscribed at the end of May 2002. The issue required intense activity from the Finance Committee to manage the process, appoint the Lead and Co Managers, appoint the Trustee, establish the terms including the interest rate set, prepare and publish the Investment Statement and Prospectus. The Audit Committee of the Board played a strong role monitoring the due diligence process to ensure compliance with all aspects of the Securities Act.


Audit Activity

The collapse of Enron in USA last year raised a number of questions regarding the relationship with auditors of companies. The Powerco Audit Committee, ably led by Mr John Auld, has watched this development and has raised matters concerning the changing practice overseas accordingly.

The Audit Committee ensures that Powerco operates and maintains robust control practices and that potential conflict issues are raised, discussed and resolved to ensure appropriate processes and behaviour are in place. New Zealand is a small economy and it is difficult to completely avoid all potential conflicts. It has been Powerco’s practice to utilise the knowledge, skill and experience of Deloitte Touché Tohmatsu involving audit, due diligence, peer reviews, taxation advice, and capital structuring for the Company.

This past year has been a busy year for the Audit Committee and the Auditors, with due diligence reviews required for the Company acquisitions and capital bond issue, a review of the taxation status arising from the previous amalgamation, as well as routine internal control and accounting audits. In addition, this year was made particularly difficult with the requirement to produce audited accounts for the year ended 31 March 2002 by the 10 April. This requirement was necessary to include those accounts in the Prospectus for the Capital Bond issue. This is probably a record for a public listed company in New Zealand and thanks are due to the financial management team, Audit Committee and Auditors for co-ordinating and dealing and resolving issues promptly.


Remuneration Activity

The Remuneration and Personnel Committee, led by Mrs Judith Timpany, has also had a busy year supporting the Chief Executive in a number of management structural issues to strengthen and sustain the executive management capability and contribution to corporate value.

In addition, the Committee also considered aspects involved in a share option scheme for directors and management. Such schemes are now common with public listed companies focused on achieving growth results for shareholders. Institutional shareholders and investment analysts support such schemes that provide benefits to executives where shareholder wealth over a 3 – 5 year period has significantly increased. Whilst no scheme is being proposed at this time, Powerco will continue to monitor the development of such schemes.

The Committee obtains independent advice on salaries and fees from which it makes recommendations to the Board. A company of Powerco’s size and standing must remunerate its executives according to the market if it is to retain and attract the best people available. The Committee has also reviewed the heavy workload on the current Board and its committees and likewise recognises the contribution made by the Directors from a range of professional backgrounds often at rates far less than the equivalent earnings from their profession.

The success of the Company to date has been the interaction between Board and management. The Board made up of independent directors are able to question and offer management a range of views before determining an appropriate course of action. Through this process, decisions are made and implemented to further the success of the company.


Performance to Date

I am pleased to report that the Company has performed to forecast expectation for the first quarter of the current fiscal year. At this stage of the year we expect to achieve a full result slightly up on last year. However, we are mindful that we still have several months of potential storm damage to get through as well as having a risk of lower than forecast consumption from our residential consumers. We are also actively involved in reviewing possible acquisition options and we remain committed to continuing our contributions to the regulatory debate, which may be determined in this financial year.

On the negative side, we are starting to be hit with a number of new costs as result of Government actions. These costs include such items as local government rates, Commerce Commission and Electricity Governance Board costs, costs associated with new tree trimming regulations, and costs associated with new Transit road warning requirements. All in all, these costs could amount to $6m in a full year with local government rates at $4m being the most significant.

The matter of charging rates on utility companies creates some interesting outcomes. In the first instance, Powerco will endeavour to recover this cost back from that local authority through increased charges for services it currently provides to that authority so as to remain in a revenue neutral position. Any shortfall however will need to be recovered from consumers. Inevitably this will require the introduction of a new fixed charge per day to consumers in the rating area of that local authority (which also creates difficulty for the retailers to implement). The result of this change is that property owners rated by the authority are theoretically receiving a reduction in their rates and all electricity consumers are will be receiving an increase in their line charges. People in rental accommodation, who are more often pensioners or low-income earners, will be the significant group to be worse off by this change in the local authority rating base.

The balance sheet financial ratios continue to be strong with our Standard & Poor’s credit rating, following the capital bonds issue, being maintained. Directors are forecasting dividends for 2003 at least at the same level as for the 2002 year.

In conclusion I wish to express my sincere thanks to Steven Boulton the Powerco management team and our staff for the dedication and drive they have exerted on behalf of the Company. I also thank my fellow Directors for their collaboration on the vast number of decisions required to progress the Company during the past 12 months and the successful outcome.


ENDS

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