COMMERCIAL Higher Costs May Upset N.Z. Steel’s Plans

Press, Volume CVIII, Issue 31773, 2 September 1968, Page 16

COMMERCIAL Higher Costs May Upset N.Z. Steel’s Plans

The latest estimate bv New Zealand Steel showing that the cost of setting up the steel mill at Waiuku may be about 23 per cent more than originally planned is likely to have an adverse effect on projected profit-ability of the group and possibly payment of dividends.

In the annual accounts for the year to March 31, directors say that the capital costs could be s43m, or sBm more than outlined in the 1966 prospectus.

They add that profitability, after allowing for the cost of servicing the additional capital borrowed, will still compare satisfactorily with earlier estimates and support forecasts made in the prospectus.

The major forecasts of interest to investors made in the prospectus were that the company would have recovered its establishment deficit by the end of the fourth full vear of production—l 972 —and that the net profit in the next year. 1973, should be sufficient for a dividend payment From inference from other data in the prospectus, this dividend could be 6 per cent Two Factors The rise in the cost of the steel works has arisen from two factors. One is devaluation, the other an increase in production levels over those originally planned. The first factor will affect only contracts made since devaluation with overseas firms. In the prospectus, about 58 per cent of the original cost of S3sm (or S2o.3m> was to be spent overseas, but some of this would have been let out before devaluation. Also affected will be the pre-devaluation loan of $7.14m from New York, which carries an interest rate of 7 per cent The principal will have to be paid back at postdevaluation rates, which will work out at about sB.9m. Production Levels An increase in production levels, although it may in the end reduce the cost a unit of output through economies of scale, will in the short run also meet the impact of higher overseas costs through devaluation.

The economic position which has seriously disrupted the building industry in New Zealand could create a lower than expected demand for New Zealand Steel products in the short run. This initially will apply to galvanised products which are to begin flowing from the mill in November, and the stage one production of steel which will begin next year. The company's consulting engineers estimated in the prospectus that the annual growth of demand from 1963 to 1980 would be 4.2 per cent. While this may be so at the

'end of this period, the growth rate in the last two years, slowed down by the economic recession, should be less than that projected for the early years of production. This slackening of the growth rate plus the higher capital costs could upset the original calculations that the establishment deficit will be recovered by the end of the fourth full year of production.

If this were so, then it might be possible to consider a dividend in the fifth year (1973) but the rate could be less than that originally proj posed. A reasonable maiden dividend would have been 6 per cent and this is hinted at in the prospectus relating to the S6m loan by the Government for 20 years. The interest rate on this loan is 5} per cent, subject to review every five years, but the Government, which is also the largest shareholder, has agreed to defer payment of interest either for five years once production of steel from ironsands begins or until the company pays or is able to pay a dividend of more than 6 per cent The directors’ comments in the latest accounts that profitability will still compare

satisfactorily with earlier estimates and support forecasts made in the 1966 prospectus seem centred on the conservative statement made in it. The annual growth rate of 4.3 per cent from 1963 to 1980, stated in the prospectus, appeared by 1965 to be well ahead of this forecast. From the figures in the prospectus, a 4.3 per cent annual increase would have raised demand for steel to about 460.000 tons a year by 1965, whereas it was 582,400 —an increase of 81.3 per cent since about 1957 instead of an eight-year average worked back from a 17-year period of about 44.7 per cent This leeway in the early years would compensate for any drop in demand in the last two years and possibly allow the company to recoup the extra income required to finance the sBm in excess of original estimates. Equity Gearing One other problem this surplus cost brings is the question of gearing. The original cost of S3sm would have been financed 37 per cent or Sl3m, by equity capital, and the rest by borrowing. A capital cost of s43m reduces this equity gearing to slightly over 30 per cent. Presumably the company had planned to use retained earnings from the fifth year on to raise this gearing to a more appropriate level of at least 40 per cent and this ex-

tra cost could mean the advancement of plans to raise more equity capital in the future.

Paper Clothing

Paper clothing appears to be the reason behind the sudden rise in prices of U.E.B. and R. W. Saunders shares last week. R. W. Saunders, the Christ-church-based lingerie manufacturer, rose 25c to 210 c to give a yield of 5.7 per cent on the 12 per cent dividend, while U.E.B. rose 5c to 107 c, after touching 109 c on Thursday. The paper clothing manufacturer in Australia is OstiBolton, and Saunders manufactures and distributes Osti garments in New Zealand. U.E.B. holds 25 per cent in Saunders. Bonus Issues Three bonus issues were announced last week and this will help to keep the already very firm sharemarket strong. Two of the companies, Coulls Somerville Wilkie and E. Lichtenstein, hope to maintain the current dividends on the higher capital so that shareholders will gain two ways higher dividend cheques and perhaps higher share prices once the shares go ex issue. In the past, and especially after the spate of bonus issues before March, 1965. dividends were generally not maintained and shareholders got little reward, just a dilution of their company’s reserves.