Opinion & Analysis
OPINION: Last century a European mathematician devised a thought experiment involving an accountant, a simplified statement of profit and loss, and a cardboard box.
The accountant and the P&L are placed in the box along with a particle of radioactive material and a cat, because cats like boxes. According to the European gent the radioactive material will interact with the accountant's brainwaves to cause the bottom line of the P&L to be simultaneously positive and negative until the box is opened, whereupon it is observed by a shareholder and assumes a singular state as one or the other.
The concept proved highly influential in the accounting profession and it has since been refined considerably. Great minds can now show that the coexistent realities implied by quantum accounting need not be merely binary - plus or minus X - but can accommodate a range of integers whose state of flux can persist even at balance date.
This has become known as thinking outside the box.
However, although financial professionals are well schooled in these altered states, Chalkie reckons most of us find them a flummox, which could be a problem for the float of Z Energy - lead managers have been appointed and an offer is expected in the third quarter.
There was an example in Z's full year results released on Friday. Amid a blizzard of numbers, a presentation explained the company's operating profit had increased in each of the last two years and was up 13 per cent to $195 million in the year to March. On the other hand it had fallen in each of the last two years and was down 18 per cent to $170m this year.
Which is the real figure? Er, both. One is the real figure, as in the one that represents the most accurate view of the business; the other is the real figure, as in the one that represents what the company's reported results and bank balance will show.
The difference relates to a common complaint of motorists - why does the petrol price at the local service station go up in lockstep with the price of crude oil on a distant trading floor?
The answer is about two accounting conventions - historic cost and current cost. The former is what is required by financial reporting rules, the latter is what Z Energy uses to run its business.
It works like this. Suppose a businessman invests $1000 to buy widgets for retail. After two months of trading he has sold his 1000 widgets for $1500. The businessman takes out the $500 and reinvests the $1000 in more widgets, only to find the cost of 1000 widgets has risen to $1200.
So is the profit $500 - the revenue less the original (historic) cost? Or is it $300 - the revenue less replacement (current) cost?
A prudent businessman might well say $300 is the more realistic number, even though his reported accounts and cash flow will show a $500 gain. And indeed, this is what Z Energy does in valuing the fuel in its service stations at the current market cost rather than what it actually spent to bring it to New Zealand on a ship.
Or as Z Energy chief executive Mike Bennetts put it at the results presentation, "we pretend we bought the crude last night, manufactured [the fuel] overnight, and sold it today."
Petrol companies all pretend the same thing.
However, while this explains the volatility of fuel pricing, it doesn't necessarily explain why motorists perceive prices to move more readily upwards than downwards.
Chalkie drives like a nana and fills up once a month so has less experience of petrol prices than many, but reckons the common view on petrol pricing is a fallacy. Rather than prices bearing some fixed relationship to cost, as is often believed, they are set to maximise profit subject only to demand from consumers and competition from rivals.
So falling crude prices will lead to lower petrol prices only if competitors take the opportunity to drop their rates and sell more fuel, which they may not want to do. Z Energy, for one, has made no secret of its willingness to sacrifice market share rather than drop prices. In a presentation in March last year, Bennetts said "I'm happy to give up market share to improve returns," and went on to prove it, with Z's market share dropping from about 33 per cent to about 28 per cent in the next 12 months.
In the same presentation Bennetts complained about the overall state of the industry, saying it "seems trapped in an economically unsustainable state" and "some of the pricing behaviour we see in the market today is a little odd".
Coincidentally, an official measure of industry gross profitability indicates a significant improvement since he made those remarks.
The figure is the importer margin, published by the Ministry of Business, Innovation and Employment - basically a calculation of what's left after deducting the costs of importing a litre of fuel from the prices advertised on forecourts in four main cities.
Between 2004 and 2011, the annual average importer margin varied between 12c and 17c a litre. In 2012 the average jumped to 22c and is 25c so far in 2013.
This increase is not easy to explain. Bennetts had a go, noting that the ministry's figure is an estimate of gross margins that doesn't take account of other costs, such as AA Smartfuel discounts.
"What I suspect has possibly happened is [retailers have] given with one hand and taken with the other," he told Chalkie. "The margin has gone up but it has gone up by a similar level to what the Smartfuel offerings are. We do other things, but I suggest the overall costs within the industry have gone up.
"If you look at our set of accounts our bottom line profit is similar to what it was a year ago in cents a litre."
According to Z's results presentation last week, the bottom line profit was 2.3c a litre, up about 10 per cent from 2.1c a litre a year ago.
Unfortunately Chalkie can't really tell which bottom line Bennetts was talking about, because there are three to choose from and, after adjusting for current cost, none of them seem to translate to a profit of 2.3c a litre.
Making things more awkward is that the results Z talks about in presentations are the ones it does not disclose - we can see the full numbers for Z Energy and for Z's parent Aotea Energy, but not for group company Aotea Energy Holdings, which is where the shareholder debt lies.
Chalkie reckons this all adds up to a headache for investors thinking about acquiring a few shares from owners Infratil and the Super Fund in Z's partial float, if it happens.
The company may be a decent infrastructure business with a good brand, economies of scale and gradually improving margins, but, like talking to someone with a squint, it's hard to be sure which numbers to look at. And if Z is increasing its margins, perhaps it's only because the whole industry is becoming more profitable. And if the industry is becoming more profitable, is it a sign of anti-competitive behaviour that will attract the regulator's eye?
Chalkie reckons what we have here is a large probability cloud around an oscillating core, whose value has yet to be determined. When it comes to an initial public share offer, it'll be a tough sell.
- Chalkie is written by Fairfax Business Bureau deputy editor Tim Hunter.
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