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Eskom financials: an economic reality check

When will government guarantees be reduced to dust?

International Financial Reporting Standards (IFRS) require that the financial statements of a company are prepared on a going concern basis, and that business and financial performance are “fairly presented”. The term “fairly presented” is subjective, hence IFRS contains rules to guide a decision.  

But in reviewing a set of financials, at what point should one introduce an economic reality check? Is it possible that a company who is compliant with IFRS, can nevertheless be seen to be running into problems?

As an example, I discuss capitalised interest. IFRS mandates that the borrowing costs attributable to the acquisition, construction or production of “qualifying assets” should be added to the cost of those assets, and depreciated over the useful lifespan of those assets. A qualifying asset would be one that would take a long time to get ready for use. The technical term for including the interest in the cost of the assets is the “capitalisation of borrowing costs”.

Eskom appears to have an aggressive policy of capitalising finance costs to plant, machinery and equipment. In 2017 48.09% was capitalised (2016: 62.93%, 2015: 65.63%, 2014: R64.71%). The effect of these adjustments is shown in the table below.

These finance costs would then be depreciated over the life of the qualifying assets. It is interesting to note that Eskom depreciates “generating” plant over six to 80 years, and “transmitting” plant over five to 40 years. Hence, an annual finance cost in regard to generating plant, instead of coming straight off income, can be spread over as long as 80 years. This results in a significant positive impact on profits. A certain amount of judgment will have to be applied in attributing the finance costs to the property, plant and equipment, and it is therefore not an accurate science. Although this is still in line with IFRS, does this policy artificially soften the economic burden of the finance costs paid?

It is to be noted that Eskom doesn’t provide the total amount of capitalised interest that is now part of the cost of property, plant and machinery. Nor does it give any information of the period of depreciation applied to capitalised interest. It would be interesting to know the percentage of property, plant and equipment that is attributable to finance costs. Which raises a further question, if the credit profile of an entity is such that it pays a much higher finance cost due to perceived higher risk, is it correct that this premium is also added to the cost of the plant?

In order to merely illustrate the impact of this policy, I have assumed that the finance costs are depreciated over 80 years, and expensed to the income statement as an eightieth. As this is simply an illustration, and the accumulated amount of capitalised finance costs is not available, only annual adjustments have been made. The effect on profits of including the total finance costs is shown in the table below.  

If you were a creditor or an investor, would you rely on the “fairly presented” profit of R888 million and comprehensive loss of R6.4 billion to make a decision? Or would you take into account the total finance costs for the year to arrive at an economic loss of R17.1 billion and comprehensive loss of R24.4 billion?

Not being in possession of the information in regard to the proportion of a company’s assets that are being financed with debt, it is not possible to calculate the asset ratio, which is used to determine the financial risk of a business. However, Eskom’s total debt securities and borrowings are R322.6 billion (note 25), representing 50.0% of total assets (2015: 48.6%).

The amount of capital introduced into Eskom by the government is growing. Additional share capital of R23 billion was issued to the government during the previous year, and a subordinated loan totalling R29.2 billion was converted to share capital. In effect, the government has now sunk a total of R83 billion into Eskom.

Eskom has approached Nersa for a further increase in its tariff, and has revalued its property, plant and equipment to justify this increase. However, a tariff increase, apart from being inflationary, will do little to cover the cost of borrowing, let alone put Eskom in a position where it can begin to pay off its debt.

The going concern status of Eskom is reliant on the assumption that the group has access to adequate resources. Presumably this takes into account the government guarantees of R134.8 billion, of which R33.8 billion was used during the year. It is perhaps time that the optimism placed on these apparent adequate resources is tempered by the current troubled economic conditions and the other financial demands being placed on government. A further downgrade will negatively impact government finances, and make it very difficult to raise further debt. This begs the ultimate question, how will Eskom survive?

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Surely further government guarantees will be issued if required. The SA government is the sole shareholder of Eskom

The government of a country with a sovereign currency can never run out of money (limited by the distant possibility of inflation).

Taxes do not fund government spending. As the sole shareholder the government is unlikely to let Eskom go under. Lots of scares and outages to justify price increases.

Let us not forget that a couple of trillion rand investment in nuclear has been suppressed but still bubbling under the surface. Eskom’s financials are petty cash in this environment. Economic inflation is the distant concern.

But to be clear, there are far better alternatives for government spending if full employment and the welfare of 99% of South Africans is the honest aim of government.

Prof L Randall Wray explains that in the US (and similarly in South Africa) still too many people including, financial reporters and some economists perpetuate an old economic myth that is used by most politicians.

https://www.youtube.com/watch?v=tEiNLmg2tYA&t=120s

It works pretty well for the USA because the USD has the status of reserve currency, they export the negative effects of money printing or devaluation to all countries who buy US bonds and hold dollars in reserves.

It is not that simple for South Africa. Nobody is much interested in
using the Rand as a reserve currency, we can’t export our internally-created inflation, so locals will be hit with the full, undiluted impact of money printing or devaluation. The shock will be like a flash-bang in a confined space – Zimbabwe-style.

In fact, where the confusion with Modern Monetary Policy starts, is with the “legality” or inherent value represented by “modern money” .
Before 1971 (The Nixon Shock) the dollar represented gold in the vault at Fort Knox. A dollar was simply a cheque that gave the beneficiary the right to a certain amount of gold once he cashed the cheque. The Rand was also a cheque that could be cashed for gold. On a 1970’s R10 note was Dr. de Jong’s signature along with the promise that this “cheque” could be turned in at the Reserve Bank for gold.

Now, since after Nixon unilaterally ended the convertibility of dollars for gold, implying a de-facto default of the US government, all dollars are simply bouncing cheques. All modern currencies are in fact bouncing cheques that are made out by governments without anything of value in “the bank” to honour that cheque.

It is no wonder then, that Modern Monetary Policy makes no logical sense to people. Very few businesses still accept payment by cheque today, because they fear the cheque may not represent payment from the bank. At the same time they fully accept cash, that is in fact a cheque that cannot be cashed.

Now we reached the point where monetary policy is so absurd that you need some intellectual to make hours of you-tube videos to explain it to you. People do not understand modern monetary policy because it is not logical, it is counter-intuitive and it is not even legal is the strict sense of the word.

The oldest form Modern Money is only 48 years old. Where did all the previous currencies on earth go? They were all “modern monetary policy” money for a while before people woke up to the fact that they are merely bouncing cheques exchanged for other bouncing cheques. What happens next, is what happened in Zimbabwe during the hyper-inflation, people shun the currency and use stuff that represents actual scarcity and has value- something such as tampons. People will put more trust in a tampon than in Modern Monetary Policy.

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