TTNGL – THE ISSUE OF IMPAIRMENT OR IF YOU PREFER CAN A PHOENIX RISE FROM THE ASHES?

20 August 2015


Who are TTNGL?

Trinidad and Tobago NGL Limited (TTNGL) was incorporated in the Republic of Trinidad and Tobago on the 13th September 2013 and acts as an investment holding company following its acquisition of 39% of the share capital of Phoenix Park Gas Processors Limited (PPGPL) in the form of class B shares.
The PPGPL shares that were acquired by TTNGL were previously held by Trinidad and Tobago Holdings LLC, the sole shareholder of which was the National Gas Company of Trinidad and Tobago Limited (NGC).
TTNGL is currently a wholly owned subsidiary of NGC which is itself owned by the Government of the Republic of Trinidad and Tobago (GORTT).
Pursuant to a mandate issued by GORTT, NGC is on the verge of offering 49% of its total 39% ownership in PPGPL to investors in Trinidad and Tobago through a public offering of class B shares in TTNGL.
As at 31st December 2014 TTNGL’s investment in PPGPL represented 93% of the total net assets of TTNGL.
TTNGL prepare its accounts annually expressed in Trinidad and Tobago dollars.

Who are PPGPL?

PPGPL was incorporated in the Republic of Trinidad and Tobago in May 1989 and operates one of the largest gas processing facilities in the Americas.
From its plant located in the heart of Trinidad and Tobago’s petrochemical sector at Point Lisas PPGPL provides clean  natural gas of a high quality to its customers by processing wet natural gas.
Processing involves the extraction of natural gas liquids (NGL’s). Processed natural gas is delivered by PPGPL’s customers to downstream facilities that use it as a feedstock.
PPGPL  fractionates the extracted NGL’s into propane, butane, and natural gasoline. Both the propane and the butane are marketed in the Caribbean and Central America principally via Trafigura, and the natural gasoline is marketed internationally via Glencore.
PPGPL prepare its accounts annually expressed in United States dollars.

How TTNGL accounts for its investment in PPGPL

TTNGL has a 39% investment in PPGPL and accounts for this investment as a joint venture.
Effectively a joint venture is a joint arrangement whereby the parties involved in the venture have rights to the net assets of the joint arrangement depending upon the size of their shareholding relative to the total share capital issued and the size of the other shareholdings within the venture.
Since TTNGL does not exercise control over PPGPL (a shareholding of greater than 50% would be required to achieve control) TTNGL accounts for its investment in PPGPL using the equity method of accounting.

What is the equity method of accounting?

Under the equity method TTNGL begins as a baseline with the cost of its original investment in the PPGPL. Then in subsequent accounting periods TTNGL will recognise its share of the earnings or losses of PPGPL.
TTNGL recognises its share of PPGPL’s profits or losses as an adjustment to the value of its original investment as recorded on its balance sheet, and also in the in its income and expenditure account.
The share of the PPGPL’s earnings that TTNGL recognises is calculated based on TTNGL’s ownership percentage (39%) of the PPGPL’s ordinary shares.
When TTNGL calculates its share of the PPGPL’s earnings it has to take account of the dividends that it has already received from PPGPL. The dividends received are deducted from the carrying amount of TTNGL’s investment in PPGPL as recorded in the accounts of TTNGL.
The value of the investment in PPGPL recorded in the balance sheet of TTNGL has to be tested annually for impairment.

What is impairment – does it really pay to be prudent?

Impairment primarily relates to the use of an asset or in some cases a cash generating unit (CGU).
In the simplest of terms if an asset or CGU’s carrying value exceeds the amount that could be received through the continued use of the asset/CGU or the selling of the asset/CGU, then the asset/CGU is said to be impaired.
The accounting rules in respect of accounting for an impaired asset/CGU’s are contained in a number of International Accounting Standards. However the bulk of those rules can be found in IAS 36, “Impairment of Assets”.
The aim of IAS 36 is to ensure that assets are carried at no more than their recoverable amount. In other words the rules reflect the aged principle that accountants should always aim to be prudent.

What is an impairment loss – a big hit to the income and expenditure account?

An impairment loss is the amount by which the carrying amount of as asset/CGU exceeds its recoverable amount. The recoverable amount of an asset/CGU is the higher of its fair value less any expected costs to sell and its value in continued use.
When the recoverable amount of an asset/CGU is less than its carrying amount, the carrying amount of the asset/CGU will be reduced to its recoverable amount. This reduction represents the impairment of the asset/CGU, and is recognised immediately in the income and expenditure account (unless the asset has been revalued in which case it is first charged against the revaluation reserve with any excess being charged to the income and expenditure account).
In respect of TTNGL management (assumed to be the management of NGC) engaged an independent valuation expert to conduct an impairment assessment of the 39% joint venture investment in Phoenix Park Gas Processors Limited (PPGPL) during the year ended 31st December 2014. Management engaged the expert because of the following factors:

  1. The accessibility of more economical sources of energy have compressed both demand and prices for natural gas products (PPGPL is essentially a price taker for the products it sells based on prevalent market conditions). Alternative energy sources have been more economical in many countries that have access to energy sources and processing structures at closer proximity to the end markets. In addition overall supply of natural gas products has now surpassed the demand for those products
  2. Both import and export volume levels directly impact on the degree of available natural gas supply. Accordingly global instability arising from political upheaval and conflicts in some global supply centres have applied downward pressure on prices
  3. The close correlation between natural gas liquids (NGL’s) prices and crude oil price benchmarks has decreased in recent years as a result of higher NGL’s production from shale gas. Consequently NGL’s prices have declined particularly in 2012 and 2014 and continue to fall in 2015 at the time of writing of this blog entry

As a result of the impairment assessment TTNGL have recognised a loss of $1.097.9 million. This loss has been recognised and disclosed in the statement of profit or loss and other comprehensive income for the year ended 31st December 2014.
The impact of the loss on earnings per share (EPS) is illustrated below:

Number 1 Diagram

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Including the impairment charge results in a basic loss per share of ($4.87). If TTNGL had not had to have made the impairment adjustment the earnings per share would have been $2.23 per share.

The effect on the carrying value of the investment

The effect on the carrying value of TTNGL’s investment in PPGPL for the year ended 31st December 2014 can be illustrated by the following table:

Number 2 Diagram

 

Effectively after accounting for TTNGL’s share of profits and dividends received from PPGPL, the impairment loss recognised in the year to 31st December 2014, and exchange adjustments relating to the translation of the PPGPL investment from PPGPL’s functional currency (United States dollars) into Trinidad and Tobago dollars, for the year ended 31st December 2014 TTNGL’s investment in PPGPL has fallen to 71% of its original recognised value.

How do you calculate the value in use – voodoo accounting?

When calculating the value in use an estimate is made of the future cash inflows and outflows from the asset/CGU taking into account if necessary the eventual sale or disposal of the asset.
A discount rate is then applied to those future cash flows in order to arrive at a value in use for today’s date. This is commonly referred to as a present value.

A word on the cash flow projections

It is vital that the cash flow projections are based upon reasonable and supportable assumptions. Usually cash flow projections are prepared for a maximum period of 5 years unless it can be safely assumed that longer projections would be more reliable. The cash flow projections are supposed to be based upon the most recent budgets and financial forecasts.
The cash flow projections used by TTNGL are based on financial information approved by the Board of Directors of PPGPL and cover a nineteen year period from 2015 to 2033 inclusive. Cash flows beyond the 19 year period have been extrapolated assuming zero growth after 2033.
The key assumption of the projections is that the selling prices of NGL’s are expected to recover from the depression in the current market conditions during 2018 and will steadily increase year on year from that point.
As with all cash flow projections the estimates are based on management’s best estimate taking into account current knowledge and current market conditions.

How is the impairment of TTNGL’s investment in PPGPL calculated?

As a holding company the most significant asset in TTNGL’s balance sheet is the investment it has in PPGPL.
As at 31st December 2014 (and after account has been taken of the impairment charge in respect of TTNGL’s investment in PPGPL) TTNGL’s investment in PPGPL represented 93% of the net assets of TTNGL.
In calculating the impairment of this investment TTNGL have taken account of the projections provided by the management of PPGPL and calculated TTNGL’s expected share of the profits and losses of PPGPL together with any expected dividends to be received from PPGPL for each of the years covered by the projections.
Applying the discount rate discussed above the present value of TTNGL’s 39% share of the results of PPNGL is less than the initial carrying value of the investment TTNGL initially recorded in its balance sheet.
The difference represents the impairment.

How sensitive are the cash flow projections to changes in key assumptions?

According to management a 1% increase/decrease in the selling prices of NGL’s while holding all other variables the same (often referred to by the Latin phrase “ceteris paribus”) will decrease/increase the impairment loss by $37.4m. A 5% increase/decrease would decrease/increase the impairment loss by $187.1m, while a 10% increase/decrease would decrease/increase the impairment loss by $374.3m.

What discount rate is used?

The discount rate that is used to measure the value in use should according to IAS 36 be a pre-tax rate that reflects current assessments of the time value of money, and the risks that relate to the asset for which the future cash flows have not yet been adjusted.
In respect of TTNGL the discount rate used was 11.94%. This rate was based on an estimate of the weighted average cost of capital (WACC) of the company.

How sensitive is the impairment charge to changes in the discount rate?

According to the management of TTNGL a 1% increase in the discount rate while holding all other variables the same will increase the impairment loss by $257.7m, while a 1% decrease in the discount rate will decrease the impairment loss by $308.3m.

How often must you test for impairment of an asset/CGU’s?

An asset/CGU must be tested at the end of each accounting or reporting date.

Could things get worse?

The short answer to this is yes. Since TTNGL have to reassess the impairment charge annually if conditions deteriorate then the impairment charge by definition will increase with a further charge against the income statement.

Can an impairment loss decrease in a future accounting period or if you prefer – can the Phoenix rise from the ashes?

An impairment loss can only be reversed if there has been a change in the estimates used to determine the asset/CGU’s recoverable amount since the last impairment loss had been recognised in the income and expenditure account.
If this is the case then the carrying amount of the asset/CGU is increased to its recoverable amount effectively reversing at least part of the previously recognised impairment loss.
Any reversal of the impairment loss is recognised immediately in the income and expenditure account, unless the asset/CGU is carried at a revalued amount, in which case the reversal would be treated as a valuation increase and credited to the reserves of the company.

Does the impairment charge impact on the distributable profits of TTNGL?

Although the impairment charge is effectively an accounting entry that does not involve the movement of cash, since the loss is charged to the income and expenditure account it effects the distributable profits of TTNGL and therefore the level of dividends it can pay.
Any further increase in the impairment loss in later years will reduce the distributable profits further while a reduction in the impairment loss would effectively increase the distributable profits of TTNGL to the extent that the reverse in the impairment flows through the income and expenditure account.

Is PPGPL itself impaired?

As a manufacturing company it is not surprising that the property plant and equipment of PPGPL represent 103% of the net assets of PPGPL as at 31st December 2014 (see Appendix one below).
As at 31st December 2014 the property plant and equipment of PPGPL consisted of the following:

 

 

Number 3 Diagram

 

 

 

 

 

 

 

 

 

 

Out of a total net book value (NBV) of $317,281, the gas plant and other projects was by far the most significant asset representing 92% of the total.
In testing for impairment of the assets of PPGPL one therefore has to focus on the value of the property plant and equipment and specifically the gas plant as this is the major item within property plant and equipment.
To ascertain whether the property plant and equipment of PPGPL is impaired one would have to compare the NBV (which represents the carrying value of the asset in the accounts of PPGPL since none of the items have been revalued) of the gas plant against the present value of the 100% of future income streams that would be derived from the continued operation of the plant.
If the present value of those flows was less than the current value of the investment in the plant (the NBV at 31st December 2014 for the plant is $291,295) then the plant would be considered to be impaired and its value would be reduced with any reduction flowing through the income and expenditure account.

The management have conducted this exercise and concluded that the plant is not impaired and as result no impairment losses have been recorded in the financial statements of PPGPL.

APPENDIX ONE

 

Number 4 Diagram

APPENDIX TWO

Number 5 Diagram

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