Town Electrification Investment Program (RRP PNG 41504) FINANCIAL ANALYSIS OF TRANCHE 1 A. Financial Analysis 1. Introduction 1. The financial analysis of the project covers the first three subprojects under tranche 1 of the Town Electrification Investment Program. The proposed projects include (i) the construction of a 3-megawatt hydropower plant at Divune; (ii) the construction of a 2.5-megawatt hydropower plant at Ramazon; and (iii) the construction of a 150-kilometer transmission line to be built from Bialla to Kimbe to allow interconnection of excess capacity of Lake Hargy hydropower plant and interconnection of power generated from three palm oil mills from methane capture. 2. The financial analysis of the tranche 1 project has been carried out in accordance with the Financial Management and Analysis of Projects of the Asian Development Bank (ADB). 1 All financial costs and benefits have been expressed in May 2010 price levels. Cost streams used for calculating the financial internal rate of return (FIRR) are capital investment and operation and maintenance (O&M) costs. 2. Financial Assumptions 3. The capital cost includes the base cost of the three subprojects, including the investment cost for the associated transmission facilities for the hydropower plants. It also includes physical contingencies but excludes price contingencies and financial charges during development (as a result of debt financing). O&M costs are based on the specific operating characteristics of individual power systems. O&M costs include personnel salaries and welfare, plant maintenance costs, administration, insurance, diesel plant fuel costs, and other expenses. O&M cost for the hydropower facilities is assumed to be K0.307 per kilowatt-hour. 4. The revenues from the projects are derived from sales of electricity generated by the power plant based on the projected yearly net generation. Energy sale revenues are estimated using 2010 tariffs. The weighted average cost of capital (WACC) of each hydropower plant is compared with the FIRR to ascertain the financial viability of the subproject. WACC is calculated based on percentage of debt and equity to total investment cost. Net cash flows are determined after income taxes, which are calculated at 30%. The subprojects are analyzed over a 20-year period excluding construction. Civil works are assumed to have a useful economic life of 50 years after construction and a life of 30 years is assumed for transmission facilities. A residual value is assumed in year 20. 3. Calculation of the Weighted Average Cost of Capital 5. WACC is calculated on a post-tax basis and is based on the London interbank offered rate plus ADB margin (0.4%), cost of equity (15%), income tax (30%), domestic inflation rate (0.4%), and international inflation rate (5.3%). The average WACC for tranche 1 is 2.4%. 1 ADB. 2005. Financial Management and Analysis of Projects. Manila.
2 Item Table 1: Calculation of the Weighted Average Cost of Capital for Tranche 1 Financing Component ADB (ADF) ADB (OCR) PNG Total Amount (K million) 52.00 80.04 33.01 165.05 Weighting 31.5% 48.5% 20.0% 100.0% Nominal cost of funds 1.0% 2.9% 15.0% Tax rate 0.0% 0.0% 30.0% Tax-adjusted nominal cost 1.0% 2.9% 10.5% Inflation rate 0.4% 0.4% 5.3% Real cost 0.6% 2.5% 4.9% Weighted component of WACC 0.002 0.012 0.010 2.4% Weighted Average Cost of Capital 2.4% ADB = Asian Development Bank, ADF = Asian Development Fund, K = kina, OCR = ordinary capital resources, PNG = Papua New Guinea, WACC = weighted average cost of capital. Source: Asian Development Bank estimates. 4. Financial Internal Rate of Return 6. The consolidated FIRR for tranche 1 is 13.1%, and is higher than the WACC of 2.4%. Tranche 1 is therefore considered financially feasible. The FIRR of individual tranche 1 subprojects was also calculated and is shown in Table 2. Each individual subproject is financially viable in its own right. The financial viability of the project was subjected to sensitivity analysis, which shows that the FIRR remains robust under the following adverse conditions: (i) 10% increase in capital costs, (ii) 10% reduction in benefits, (iii) 2-year delay in project implementation, and (iv) case 1 and case 2 combined. Table 2: Financial Internal Rate of Return and Sensitivity Analysis (%) Divune Lake Hargy Ramazon Sensitivity Case Scenario Hydropower Interconnection Hydropower A. Base Case 11.7 19.3 10.5 B. Sensitivity Cases Case 1: Increase in capital cost by 10% 10.7 17.7 9.5 Case 2: Decrease in revenues by 10% 9.6 15.6 8.2 Case 3: Combination of case 1 and case 2 8.7 14.2 7.3 Two-year delay in implementation 11.1 14.0 9.8 C. WACC 2.4% WACC = weighted average cost of capital. Source: Asian Development Bank estimates.
3 B. Financial Performance and Projections 7. The financial analysis covers the capacity of the implementing agency to service debt obligations, to operate and maintain project assets and finance part of capital expenditures. The financial analysis has been conducted in accordance with the Guidelines for the Financial Governance and Management of Investment Projects Financed by ADB. 2 The financial performance and projections of PNG Power Limited (PPL) was assessed from the consolidated financial statements of all its activities. 1. Financial Performance 8. PPL experienced revenue growth from operations primarily as a result of increasing demand for electricity. Electricity sales doubled during the previous 5-year period. Income increased from K355 million in 2006 to K501 million in 2009, and tariffs increased at a rate of 4.0% per year over the same period. 9. The gross profit margin and net profits increased continuously over the last 5 years due to higher revenues. The company s net profit increased slightly from 12% of sales in 2006 to 14% in 2009. Return on net fixed assets increased from 8% in 2006 to 10% in 2009. 10. The interest coverage ratio and debt service coverage ratio were satisfactory, as indicated by the debt to debt plus equity ratio of below 40:60. This indicates that the company has enough capacity to handle further borrowing. The company retains all earnings and uses these to finance its ongoing projects. 11. The accounts receivable level is equivalent to less than 2 months of sales. In general, the financial performance of PPL is robust and its financial position is sound. 12. PPL s future financial performance will be influenced by the operations of the proposed hydropower plant subprojects, which will be commissioned in 2013. These subprojects were assessed as financially feasible and would result in additional financial benefits to PPL. The impact of tranche 2 and 3 subprojects is not included in the financial projections. 2. Assumptions Used in Financial Projections 13. The projected income statement over the next 10 years has been prepared on the basis of actual figures of all the provincial centers and major grids. All the results from the power plants are consolidated into the total projection for PPL. 14. For the balance sheet projection, it is assumed that the operating assets of the existing plants will not change significantly, while the increase in total assets will be predominantly due to the investment program. The retained earnings of all the power plants will also be combined into PPL s total. 2 ADB. 2002. Guidelines for the Financial Governance and Management of Investment Projects Financed by ADB. Manila.
4 Table 3: Financial Performance and Projections PNG Power Limited US$ ('000) 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 Operating Revenue 220,353 264,817 266,897 317,512 344,487 373,871 405,885 440,378 477,979 519,261 564,134 Total Revenue 220,595 265,071 267,164 317,793 344,782 374,180 406,210 440,719 478,337 519,637 564,529 Operating Costs 126,739 167,906 182,206 222,043 233,145 244,803 257,043 269,895 283,390 297,559 312,437 Operating Profit 93,856 97,165 84,958 95,749 111,636 129,377 149,167 170,824 194,947 222,077 252,091 Operating Margin 42.5% 36.7% 31.8% 30.1% 32.4% 34.6% 36.7% 38.8% 40.8% 42.7% 44.7% EBITDA 82,168 89,458 77,968 86,823 102,263 119,535 138,833 159,973 183,554 210,115 239,531 EBIT 59,704 60,222 46,158 55,263 69,126 84,741 102,299 121,612 143,275 167,822 195,123 Interest 9,480 13,181 14,091 13,182 11,585 10,168 8,847 7,996 7,077 6,084 5,011 Interest Cover 6.3 4.6 3.3 4.2 6.0 8.3 11.6 15.2 20.2 27.6 38.9 Net Profit Before Tax 50,224 47,041 32,067 42,081 57,541 74,573 93,452 113,616 136,198 161,738 190,111 Net Profit After Tax 35,157 32,929 22,447 29,456 40,278 52,201 65,417 79,531 95,339 113,216 133,078 Net Margin After Tax 15.9% 12.4% 8.4% 9.3% 11.7% 14.0% 16.1% 18.0% 19.9% 21.8% 23.6% Cash Spend on Operations 108,437 143,689 155,198 194,804 204,544 214,771 225,510 236,785 248,624 261,055 274,108 Cash Conversion Factor 86.6% 67.6% 54.7% 49.2% 54.6% 60.2% 66.1% 72.1% 78.4% 85.1% 92.0%
US$ ('000) 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 Fixed Assets Employed - Cost 430,902 660,688 728,574 764,747 800,920 837,093 873,266 909,439 945,612 981,785 1,017,959 Fixed Assets Employed - WDV 268,107 450,523 486,600 491,213 494,248 495,627 495,266 493,078 488,972 482,852 474,618 Return on Fixed Assets Employed (WDV) 13.1% 7.3% 4.6% 6.0% 8.1% 10.5% 13.2% 16.1% 19.5% 23.4% 28.0% Net Assets 257,737 258,578 311,134 363,536 406,759 462,053 527,263 606,750 702,214 815,735 949,306 Return on Net Assets 13.6% 12.7% 7.2% 8.1% 9.9% 11.3% 12.4% 13.1% 13.6% 13.9% 14.0% Debt - Bank 106,010 207,131 168,222 128,000 110,158 94,735 85,280 74,965 63,719 51,468 38,132 Equity & Reserves 257,737 304,209 329,327 361,589 404,812 460,106 528,770 611,711 710,629 827,605 964,630 Debt to Equity Ratio 41.1% 68.1% 51.1% 35.4% 27.2% 20.6% 16.1% 12.3% 9.0% 6.2% 4.0% Debt to Debt plus Equity Ratio 29.1% 40.5% 33.8% 26.1% 21.4% 17.1% 13.9% 10.9% 8.2% 5.9% 3.8% No. of Employees - Direct 1,155 1,213 1,273 1,337 1,404 1,474 1,548 1,625 1,706 1,792 1,881 No. of Employees - Indirect 499 524 550 577 606 637 668 702 737 774 812 Total Employees 1,654 1,736 1,823 1,914 2,010 2,111 2,216 2,327 2,443 2,566 2,694 Operating Revenue per Direct Employee 73 84 81 91 94 98 101 104 108 111 115 Operating Revenue per Employee 51 59 56 64 66 68 70 73 75 78 81 Debtors 30,000 37,357 35,582 42,346 45,236 48,517 52,224 56,320 60,918 66,123 71,905 Debtors Days 45 47 44 44 44 43 43 42 42 42 42 Free Cash Flow 33,413 70,502 56,629 49,284 64,065 78,424 95,726 110,641 127,246 145,887 166,560 5
6 C. Financial Management Assessment 15. An assessment was undertaken of the financial management capacity of PPL to serve as the implementing agency of the investment program. Its financial management capacity was found to be adequate for project implementation. PPL was also assessed as having (i) adequate capacity to record the required financial transactions and balances, and provide regular and reliable financial statements and monitoring reports during implementation; and (ii) the ability to safeguard financial assets and provide the required financial documents to levels of audit acceptable to ADB. While PPL does not have recent experience in multilateral development bank financing, PPL has considerable experience in implementing medium- to large-scale construction projects using debt financing. Some training in ADB procedures especially procurement, disbursement, and project management procedure will be required. A capacity development component to strengthen financial management systems and provide training is included in the project.