Gunns in a bet-the-company project, says pundit

GOVERNMENT approval of Gunns’ proposed Tasmanian pulp mill is one issue, but few seem to be focusing on the fact that the development is literally a bet-the-company project.

The pulp mill scheme has long had a significant financial engineering component, relying on a revaluation of its plantation assets to support the potential extra $1.7 billion in debt. Even that will leave its interest cover at just above two times and that all depends on the project being executed to perfection while the currency and world pulp markets fall into line.

The company’s net debt of around $728 million will increase to around $2.2 billion by 2010 and the additional interest bill of at least $140 million on top of the $42.6 million paid last year compares with earnings before interest and tax of $163.9 million. Net debt to equity at the end of last year already stood at 65 per cent with an interest cover of 3.8 times. This is a mammoth increase but Gunns boss John Gay says that once the full details are available, it will be seen that the project will pay its way from year one.

That’s a big claim and one which will test the patience of its loyal shareholders, like 13.7 per cent owner Perpetual and its new best friend DFA, which has just over 5 per cent of the company. Cash flow from operations last year was actually negative $23.3 million because, the company says, harvesting was put on hold.

Over the past 12 months, Gunns has underperformed the market by some 5.8 per cent, having underperformed by 30.5 per cent in the year ended September 2006, by 43.6 per cent in the year ended September 2005 and outperforming by 6.9 per cent in the 2004 year. While Gay has a loyal shareholder base and a good track record with projects, the independent directors on his board face a huge decision if any approval is granted.

Rarely do listed companies approve projects which are bigger than the company’s total value at the time of the decision.

All going well, of course, Gunns will have Auspine under its belt by then, and a much needed expansion into softwood timber on the mainland with a new source of revenues in the building market. In today’s climate with big capital projects invariably facing cost increases and debt more expensive, the Gunns board is taking on an extraordinary risk when you consider its market capitalisation today is $1.2 billion and, if federal Environment Minister Malcolm Turnbull gives it the tick, it is about to make a $2 billion commitment.

Gunns’ long-term banker ANZ will also be firmly in the spotlight in view of its new-claimed status as an environmentally friendly bank. For its part, the bank says it will look at the project in line with its commitments to the so-called Equator principles, which means it must consider the environmental consequences.
Clearly, if the Government approves the project, this part will be made easier for the bank.

Gay is widely considered to dominate the company board because he is chairman and chief executive officer. He confided yesterday that all being well, if he gets approval from the Feds in October, the board would then consider the project and, assuming it flashes the green light, it will be under way in January.
The chances of a decision in October would seem remote in the middle of a federal election and in one sense a delay at least might allow global credit markets more time to settle.

But in every other respect, the longer the delay, the more expensive the project becomes. Shareholders would already be expecting another capital raising to help fund the Auspine takeover and if the Bell Bay pulp mill gets the go-ahead, a big equity raising would seem inevitable. Gay is also unapologetic about his plans if the mill is rejected, saying he is already exploring offshore sites in joint ventures with the Chinese, among others. Gunns’ plantation assets are in the books at around $750 million but this value will be substantially increased if the mill is approved because with an in-house buyer they would be worth more.

The original project was drawn up four years ago with a $1.3 billion price tag and pulp prices at $US520 a tonne with funding in place even if prices fell to $US420 a tonne. Pulp prices are now $US520 a tonne. Likewise if the $A reached parity with the $US, the mill would still be bankable, according to Gay.
If the $A fell from present levels, it would obviously be highly beneficial for Gunns.

Step one is to get government approval but in the scheme of things, this might prove to be a minor hurdle unless of course Gay turns out to be a project financing maestro.

John Durie | September 18, 2007
The Australian

Earlier The Australian September 17: Mill or not, Gunns plans to expand