FINANCIAL ANALYSIS. A. Introduction

Transcription

1 Urban Water Supply and Wastewater Management Investment Project (RRP FIJ 491-2) A. Introduction FINANCIAL ANALYSIS 1. The Asian Development Bank (ADB) Urban Water Supply and Wastewater Management Investment Program in Fiji will have three main components. The first involves the construction of a 4, cubic meter per day (m 3 /day) intake and water treatment plant on the Rewa River on a design-build-operate basis and the reduction of nonrevenue water (NRW) in the Water Authority of Fiji (WAF) water supply system through improved leak detection and repairs. The second is the expansion of the capacity of the Kinoya wastewater treatment plant to 277, equivalent population, the upgrading of 31 existing wastewater pumping stations and about 18 kilometer (km) of wastewater trunk mains, the relining of about 13 km of wastewater trunk mains, and the extension of the wastewater network to service an additional 4,5 households currently using septic tanks. The third component will comprise project implementation support for the WAF and sector institutions. The project to be financed by tranche 1 of the ADB multitranche financing facility will cover the Rewa River plant construction and the activities to reduce the WAF s NRW. The financial analysis of tranche 1 for the water supply component was carried out in accordance with ADB s guidelines. 1 B. Methodology and major assumptions 2. All financial costs and benefits have been expressed in July 216 price levels. The cost streams used to calculate the financial internal rate of return (FIRR) were the capital investment and operation and maintenance (O&M) costs. The analysis was carried out on an incremental basis and developed without-project and with-project cashflow streams. The subprojects were analyzed over a 4-year period, excluding construction, with no residual value assumed at the end of their economic lives. The stream of incremental cashflow was discounted to its present value, and financial indicators such as the FIRR and the financial net present value (FNPV) were determined. The weighted average cost of capital (WACC) was based on the source and cost of financing and used as a benchmark for comparisons with the FIRR and the FNPV. C. Financial Cost Benefits Analysis I. Project Costs 3. The capital costs of the projects include the base cost, which covers the costs of civil and electromechanical works, pipelines, and physical contingencies. Since the financial analysis was based on constant prices, price contingencies were excluded. Also excluded were financing charges during implementation. The cost of asset replacement was factored into an annual O&M cost. The O&M costs comprised the costs of chemicals, electricity, repairs, salaries and wages, and contractor s overheads, since delivery is through a design-build-operate contract. II. Project Revenues 4. The greater Suva area (GSA), is supplied by two water treatment plants (WTPs) with a total capacity of 151, m3/day the Tamavua plant (58, m 3 /day) and Waila (93 m 3 /day). Both are running at full capacity. Water sales account for about half the plants production, and the rest is NRW. The proposed Investment Program will ensure security of water supply in the GSA. Without the project, it is expected that the capacity of the existing WTPs will decline by 1 ADB. 25. Financial Management and Analysis of Projects. Manila.

2 2 3% by 233. The new Rewa River WTP will add 4, m 3 /day to the overall treatment capacity in the GSA. This will ease the daily production pressure on the existing WTPs and allow the maintenance required to keep them running at their full capacity to take place. The current average water tariff is F$.46 per cubic meter (m 3 ) after adjusting for NRW. It is expected to remain unchanged. The project 1 aims to increase water supply service to 1% of population and reduce NRW to 3% by 233. Demand management measures aim to reduce daily per capita consumption from the current 22 liters to 18 liters by 233. III. Weighted Average Cost of Capital 5. The project s WACC in real terms has been calculated at 1.9%. ADB s ordinary capital resources loan will fund 23% of the project costs (Table 1). A European Investment Bank loan will fund 15%, a Green Climate Fund grant will cover 17%, and the Government of Fiji will fund 45%. ADB s ordinary capital resources loan will carry a 15-year London Interbank Offered Rate (LIBOR) U.S. dollar swap rate of 1.843%, 2 a contractual spread of.5%, and a maturity-based premium of.2%. The European Investment Bank loan will have the same rate. A cost of 5% per annum has been assumed for the government funds to recognize that the government could be using these funds in other financially attractive development projects instead. This represents the cost of a 1-year Viti bond issued by the Reserve Bank of Fiji. ADB currently forecasts a long-term annual local inflation rate of 2.5% and 1.5% of annual foreign inflation. Item Table 1: Tranche 1Weighted Average Cost of Capital ($ million) ADB OCR Loan EIB Loan GCF Grant GOF Total Amount Weighting (%) 23% 15% 17% 45% 1% Nominal cost (%) 2.54% 2.54% 5.% 5.% Tax rate (%) 2% 2% % % Tax-adjusted nominal cost [C*(1 D)] 1.7% 1.% 5.% 5.% Inflation rate (%) 1.5% 1.5% 1.5% 2.5% Real cost [(1+E)/(1+F) 1)].5%.5% 3.4% 2.4% Weighted component of WACC.1%.1%.6% 1.1% Weighted Average Cost of Capital (Real) 1.9% ADB = Asian Development Bank, EIB = European Investment Bank, GCF = Green Climate Fund, GOF = Government of Fiji, WACC = Weighted average cost of capital. Source: ADB estimates. IV. Financial Internal Rate of Return 6. Based on the assumption that water tariffs will not be raised, the financial internal rate of return (FIRR) for tranche 1 is 4.%, and the FNPV when discounted at the WACC is F$535 million (Table 2). The average incremental financial cost of water is F$.94/m 3. At the current weighted tariff of F$.46/m 3, cost recovery is about 5%. The government will continue to help cover operational costs by subsidizing the WAF through annual grants. Table 2: Tranche 1 Incremental Financial Analysis (F$ million) Year Capital Cost Revenue O&M Cost Net Cashflow 2 ADB Indicative Lending Rates for Loans under the LIBOR-Based Loan Facility. Manila.

3 Year Capital Cost Revenue O&M Cost Net Cashflow 216 (9.4) (9.4) 217 (19.1) (19.1) 218 (55.3) (55.3) 219 (81.6) (81.6) 22 (84.1) (84.1) 221 (42.1) (42.1) 222 (45.8) (45.8) 223 (5.2) 5.1 (.1) 224 (4.9) 5.4 (5.) (4.4) 225 (4.9) 5.8 (5.) (4.) 226 (4.9) 6.2 (5.) (3.7) 227 (4.9) 6.6 (5.) (3.3) 228 (4.9) 7. (5.) (2.9) 229 (5.4) 7.3 (5.) (3.1) 23 (5.4) 7.7 (5.) (2.7) 231 (5.4) 8.1 (5.) (2.3) 232 (5.4) 8.5 (5.) (1.9) 233 (5.4) 8.8 (5.) (1.6) (5.) 3.9 Net present value at WACC F$ (535) FIRR (4.%) FIRR = financial internal rate of return, O&M = operation and maintenance, WACC = weighted average cost of capital. Source: ADB estimates. D. Financial Performance and Projections of Water Authority of Fiji 7. The financial analysis covered the capacity of the WAF as the implementing agency to service debt obligations, to operate and maintain project assets, and to finance part of capital expenditures. The assessment of the WAF s financial performance and the financial projections were based on its financial statements for all activities. 8. Financial performance. The WAF was established as a commercial authority under the country s public enterprise act on 1 January 21 to take over the operations of the government s water and sewerage department. It has posted net losses since its inception, largely due to a tariff structure that has remained unchanged since However, it has managed to maintain a positive earnings before interest, taxes, depreciation and amortization. This means that depreciation is not being recovered through the current tariffs. Because water supply is a capital-intensive industry, depreciation is the WAF s largest single cost. Capital expenditure is funded by the government through annual grants, which also covers about half of the utility s operational costs due to the current low tariff regime. Although deemed a commercial entity in name, it does not therefore operate as a commercial organization in practice. 9. This is the approach that the government took to funding the utility when it was still a government department. The WAF reports both the operational grant and its tariff revenues, but the Office of the Auditor General of Fiji considers this to be double counting, since the water tariff revenues do not accrue to the WAF but to the Ministry of Economy. Although the WAF maintains that it is legally entitled to report tariff revenues, this contradicts the International Accounting Standards on revenue recognition applicable when amounts collected on behalf of third parties are not economic benefits which flow to the entity. It also runs counter to an accounting principle of recognizing substance over form. Although the tariff may legally belong to the WAF, it does not in substance receive the economic benefits arising from the tariff. Had tariff revenues been eliminated, losses would have been far greater, and earnings before 3

4 4 interest, taxes, depreciation and amortization would have been negative since the WAF s inception. 1. The operational grant WAF receives from government was sufficient to finance operational costs in Depreciation remains unfinanced, which has resulted in a net loss each year. The government s capital grants have financed capital expenditures, and any unused capital and operational grants have added to a cash surplus. The WAF has a debt-free balance sheet and no cash outflow for debt servicing. Its small current liabilities are mainly outstanding payments to suppliers. Billing revenue has no impact on WAF cashflow, since it is remitted to the government. Table 3: Water Authority of Fiji Financial Performance, Fiscal Year (F$ million) Item Audited Audited Unaudited Unaudited Estimate Operational grant Operating cost (excluding depreciation) Depreciation Capital grant Capital expenditure Cash generated during the year (7) (1) Cash balance at the end of the year Cash generated during the Year (7) (1) Fixed assets employed WDV 1,811 1,87 1,783 1,773 1,889 Current assets Current liabilities WDV = written-down value. Sources: WAF = Water Authority of Fiji. 11. Water Authority of Fiji financial management assessment. Financial reporting has been adversely affected by a series of drawbacks since the WAF was established, including a very high staff turnover in the finance department. As a result, the 21 financial statements were audited only in 213, and that audit resulted in a disclaimer of opinion by the auditors. In 214, the WAF set up a reconciliation team to bring the financial statements up to date and reconcile differences between the general ledger and subledgers. This process was fruitful, and the WAF has submitted 214 financial statements for audit and is finalizing the 215 statements. Nevertheless, the auditor has issued a qualified opinion on the 212 and 213 financial statements, largely due to the issue of recognition of revenue. 12. Assumptions used in financial projections. The analysis prepared financial projections for the WAF for (Table 4). They are based on the following factors and assumptions: Incremental project benefits and project costs have been included in the WAF financial projections. The project costs will be financed by loans, grants, and counterpart funding. Debt service costs have been included in the WAF financial projections. Capital expenditure projections have been based on the average for These will continue to be funded through government capital grants. 13. The government s grants to cover the costs of WAF operations will continue at the 216 level of F$79.3 million for the years , and tariffs will not be raised. Operational profits (earnings before interest, taxes, depreciation and amortization) are projected for each year during the period, but net profits will remain negative due to depreciation. Interest payments will

5 be capitalized under the loan. When interest becomes payable, sufficient resources are projected to be available (as shown by the interest cover ratio). The analysis found the debt service coverage ratio to be well above the threshold of :1., indicating the WAF s ability to service the loan. 5 Table 4: Financial Performance and Projections Water Authority of Fiji, Audited Audited Audited Unaudited Estimate Projections Total revenue Operating costs Operating margin EBITDA/reven 15% 9% 27% 25% 32% 4% 39% 39% 39% 39% 35% ue (%) Interest Interest cover - 15:1 Net profit after tax (46) (47) (29) (33) (24) (14) (2) (21) (27) (32) (53) Cash generated during the year (7) (1) Fixed assets employed WDV 1,811 1,87 1,783 1,773 1,889 Debt equity ratio (%) 1% 2% 4% 7% 9% Debt service coverage 5:1 EBITDA = earnings before interest, tax, depreciation, and amortization; WDV = written down value 1 Includes revenues from both tariffs and grants. 2,4 2,6 9 2,13 3 2,23 2,33 2,4 2