Financial Statement Analysis

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Page 66 of 162 company’s profitability and capital structure. When Ørsted chooses to lease its assets, it will have an artificially low operating profit because the related interest expense is included in the rental expenses (Ibid.). Interest expenses are a financing item and therefore should be added back to EBITA. Accordingly, taxes need to be adjusted so the interest tax shield is removed (Ibid.). Furthermore, the leased asset needs to be capitalised on the balance sheet, which is included in the next section on invested capital. Information about operating leases can be found in the footnotes in Ørsted’s annual reports (Ørsted, 2017a). From 2012 onwards, Ørsted has provided a sufficient calculation of the present value of the operating leases. However, there is no information about the present value for earlier years. Thus, the asset value must be estimated (Koller et al., 2010).

Asset Value_t−1=Rental Expense_t k_d+ 1

Asset Life

In 2012, 2013, 2014, 2015 and 2016, Ørsted uses 4.5% to discount their lease payments, and therefore this rate will be used to discount the previous years. By having the asset value for 2012 already calculated by Ørsted (2012), an implied asset lifetime can be found by reformulating the original equation seen above:

Implied Asset Life = Asset Value_t−1

Rental Expense − kd∗ Asset Valuet−1

It turns out that the implied asset life for 2012 is 12.58, which is reasonable when looking at the notes since Ørsted had natural gas storage facilities in Germany until 2025 (Ørsted, 2012). As a comparison, the median asset life among 7,000 firms over 20 years was 10.9 years (Lim et al., 2003). EBITA will be adjusted with the implicit interest expense calculated below.

Table 2 – Implicit interest expense

Source: Authors’ own creation from Ørsted’s annual reports from 2007-2017

Operating Cash Taxes on EBITA

The accounting item, tax on profit (loss) for the year, relates to operating as well as financing items. Since accounting practice does not distinguish between tax on operations and tax on financial items, there is a need to divide income tax expenses into tax on operations and tax on financing (Petersen & Plenborg, 2012). The tax on financing must be added back as they are not related to EBITA. This segregation is accomplished by

Year 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

Lease Payment 6 55 87 850 529 414 401 354 545 753 746 885

Interest rate 4,5% 4,5% 4,5% 4,5% 4,5% 4,5% 4,5% 4,5% 4,5% 4,5% 4,5% 3,5%

Median Asset Life 12,58 12,58 12,58 12,58 12,58 12,58 12,58 12,58 10,69 8,16 7,66 5,35

Asset Value 442 699 6.828 4.249 3.326 3.221 2.844 3.933 4.495 4.248 3.986 6.095

Implicit Interest 20 31 307 191 150 145 128 153 217 219 194 234

Page 67 of 162 estimating the tax shield from net financial expenses and the operating lease interest expense. This is done by multiplying each item by the Danish corporate tax rate of 22% to estimate the tax shield (KPMG, 2018).

Finally, Koller et al. (2010) recommends using the cash taxes actually paid instead of the taxes reported. This is done by subtracting the increase in deferred tax liabilities from operating taxes on EBITA. From 2007-2011, Ørsted’s deferred tax liabilities have been growing over time, so reported taxes overstate actual cash taxes and vice versa in the later years. When using cash taxes, deferred tax liabilities are treated as an equity equivalent, as seen in the analytical balance sheet in appendix 5.

Other items

Share of profit (loss) in associates and joint ventures: The classification of this item depends on whether the investments are considered to be part of the firm’s core-business or not (Petersen & Plenborg, 2012). The item has been present all years, and a major part of it is related to Ørsted’s core business (Ørsted, 2017a). Therefore, it is included in NOPLAT and will be a part of invested capital.

Gain on divestment of enterprises: This item relates to Ørsted’s divestment of non-core businesses. It is related to Ørsted’s divestment of their oil & gas business. In 2016, the post consisted primarily of a gain on the divestment of Gas Distribution to Energinet (Ørsted, 2016c). This item is excluded from NOPLAT, and the related receivable from the divestment must be considered as a financial item in the analytical balance sheet.

This way, Ørsted’s profitability is not impacted by single divestments.

5.1.2. Analytical Balance Sheet

The reformulation of the balance sheet leads to the invested capital, which represents the total capital needed to fund operations (Petersen & Plenborg, 2012). The analytical balance sheet can be found in Appendix 5 and summarised in Appendix 6.

Operating Assets − Operating Liabilities = Invested Capital = Debt + Equity

Hybrid Capital (HC)

The HC that was issued by Ørsted in January of 2011 was classified as 100% equity by the rating agencies (Ørsted, 2016a). HC is treated as less important than other debt and features characteristics of both debt and equity (Koller et al, 2010). Ørsted chose this type of financing as part of their mix with credit ratings in mind, as a higher level of HC was translated into a higher credit rating, meaning a higher solvency ratio (Ørsted, 2016a). Recently, however, the rating agencies have changed their definition of HC, classifying the old HC as debt rather than 100% equity, putting pressure on the credit ratings (Ibid.). This meant that, in July 2013, Ørsted had to exchange their former HC and issue new HC (Ibid.). As described, the old HC was classified as 100% equity. However, the new HC was classified with a 50% weighting on equity and 50% debt. In order to

Page 68 of 162 achieve investment grade credit ratings of BBB+, a DKK 13bn. equity injection was made in 2014 to increase the equity portion in the capital structure (Ibid.). The reformulated balance sheet accounts for the 50/50 split as classified by the credit rating agencies by adjusting the debt up by half of the hybrid capital and the equity down by 50%. For the above reasons, it is important to be aware of the impact of HC when comparing Ørsted to its competitors.

Operating leases

The operating leases must be capitalised as part of invested capital and as a debt-equivalent liability (Petersen

& Plenborg, 2012). Ørsted’s debt is increased by the earlier calculated asset value associated with the operating leases. To ensure consistency, it is important when calculating cost of capital that the operating lease is included in the estimation of debt.

Cash and cash equivalent

Ørsted holds a relatively large amount of cash, which cannot be considered a part of their operating asset (Koller et al., 2010). However, a proportion is assumed to be working cash as Ørsted needs cash for daily operations and collateral. Ørsted does not disclose which part of their cash is operating cash and which part is excess cash. Koller et al. (2010) estimates that 2% of revenue is a good estimation for working cash. Plenborg

& Petersen (2012) argues that if the cash position remains stable across time, it seems fair to treat cash and cash equivalents as excess cash. Ørsted’s cash holding is fairly stable from 2010-2017. Therefore, 1% of revenue is assumed to be working cash. The residual excess cash will be classified as a financial, interest-bearing asset.

Other items

Investments in associates: The item is treated as operating since the corresponding item “Share of profit (loss) in associates and joint ventures” is classified as operating in the income statement.

Gain on divestment of enterprises: As mentioned in the analytical income statement, the item is classified as a non-core item and therefore the relating receivable must be a financing item.

Asset held for sale Ørsted classifies “assets held for sale” and the associated liabilities as separate items in the balance sheet. The items are instead classified as financial items, as the disposal of those assets will reduce Ørsted’s borrowings or increase their cash holding. Therefore, they are excluded from operating working capital and treated as part of financing.

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