Peru - Railway Rehabilitation Project

RESTRICTED Report No. TO-313d This report was prepared for use within the Bank and its affiliated organizations. They do not accept responsibility for its accuracy or completeness. The report may not be published nor may it be quoted as representing their views. INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT INTERNATIONAL DEVELOPMENT ASSOCIATION PERUVIAN CORPORATION LTD. RAILWAY REHABILITATION PROJECT PERU March 4, 1963 Department of Technical Operations  CURRENCY EQUIVALENTS 1 U.S. Dollar = 27.00 Soles 1 Sol = 0. 037 U.S. Dollars 1,000 U.S. Dollars = 27,000 Soles 1, 000 Soles = 37.00 U. S. Dollars 1 E Sterling = 75. 00 Soles Corporation's Fiscal Year July 1 - June 30  REPORT ON THE PERUVIAN CORPORATION LTD. RAILWAY REHABILITATION PROJECT Table of Contents Page No. SUM1,1ARY i-iv I. INTRODUCTION 1 II. BACKGROUND 2 III. THE RAILWAYS 3-6 A. Organization and Management 3 B. Manpower, Wages and Labor Relations 4 C. Peruvian Corporationts Properties 4 D. Operating Efficiency 5 IV. FINANCIAL POS ITION AND RECENT OPERATING RESULTS 6-9 V. TRAFFIC AND RATES 9-14 A. Traffic Composition and Traffic Development 9 B. Tariff Structure and Rate Level .1 C. Highway Competition 13 VI. FUTURE TRAFFIC PROSPECTS 14-16 A. Central Railway 14 B. Southern Railway 15 VII. MODERNIZATION AND REHABILITATION PROGRAM FOR THE CENTRAL AND SOUTHERN RAILWAYS 16-19 A. The Project 16 B. Savings from Dieselization 18 VIII. FINANCIAL ASPECTS 19-24 A. Financial Plan 19 B. Earnings and Liquidity 21 IX. ECONOMIC JUSTIFICATION 25-26 X. CONCLUSIONS AND RECOMMENDATIONS 26-27 (Conttd on Page 2)  Table of Contents Annex 1 - List of Directors Annex 2 - Comparative Summary Balance Sheets Annex 3 - Inccne Statement Annex 4 - Freight Traffic of the Central Railway and Southern Railway Annex 5 - Passenger Traffic of the Central Railway and Southern Railway Annex 6 - Modernization and Rehabilitation Progran of the Central and Southern Railways Annex 7 - Cash Flow Forecast Annex 7a - Modification of Cash Flow Forecast Annex 8 - Income Account Forecast Annex Ba - Modification of Income Account Forecast Appendix A - Pages 1-3 Appendix B - Pages 1-2 Map - Peruvian Railwayt  REPORT OM THR- FER1TVThN CORPORATION RAIHWJAY REHABILITATION PKTOJECT SUD1ARY i. The Peruvian Corporation Ltd. has asked the Bank for a loan of US413.25 million equivalent to help finance a four-year program (1961/2 - 196h/5) of modernization and rehabilitation of the Central and Southern Railways in Peru. The total cost of this program is estimated at US$21.3 million equivalent or S/. 575 million. ii. A previous Bank loan of US15 million equivalent for a US3t20 million program for the same purpose was made in April 1958, but as it became evident that the Corporation and the Government would not have been able successfully to carry out the project, the loan was terminated in August 1959 by agreement among the parties concerned. iii. Since that time a firm of railway consultants employed by the Peruvian Corporation has made studies of its financial position and physical needs. It was not until March 1961, on the strength of improving economic conditions in Peru that the consultants could recommend the program for consideration by the Bank for financing; prior thereto - 1959 - they had recorrmended a smaller program for financing with equity capital. A Bank mission visited Peru in June 1961 to appraise the program. iv. The program is well conceived and it meets the essential minimum requirements of the Central and Southern Railways. The managements of these RAilways are competent, operations are reasonably efficient, and the prop- erties are well maintained, There are, however, arrears of track renewals. v. The financial record of the Peruvian Corporation Ltd. has been affected by great difficulties. A climax was reached in 1956 when a reorgani- zation resulted in the Corporation becoming the wholly-owned subsidiary of the Peruvian Transport Corporation Ltd. (parent company), which was formed for this purpose, and part of the outstanding debt of the Corporation was can- celled. The balance of this debt was redeemed by issuing the parent companyls debentures and making cash payments. vi. Since 1956 the Corporation's operations have been unprofitable, substantial losses being suffered in the last five years. The reasons were the reduction in world demand for non-ferrous metals and the general trade recession in this period, labor strikes and rising wage costs, unregulated road transport competition, and in 1959 serious landslides that disrapted operations for several weeks on the Central Railway. Important elements in the Corporation's failure to cover its operating costs and fixed charges have been the inadequacy of rate increases authorized by the Government and the delays which attended the Government's approval of such increases.  - ii - vii. Resulting from a 34-day strike of workers on the Central Railway, the main shipper on the Railway, Cerro de Pasco, threatened to move all its freight by truck. Negotiations between the two corporations have produced an agreement that Cerro will continue to use the Railway exclusively, pro- vided its rates in new tariff structures which Cerro have accepted, remain competitive with truck rates. viii. Conditions should now become more favorable for the Corporation: a) the Government has established a Transport Commission to regulate all modes of transportation and to prescribe equitable rates for services; the effect of such regulation should enable the Corporation to increase its rates almost simultaneously with any substantial increase in costs, and make it possible for the Railways to compete on more equal terms with road transport; and b) economic activity in Peru justifies the conservative fore- casts of increasing freight traffic for the Central and Southern Railways. ix. The modernization and rehabilitation program (1961/62 - 1964/65) constitutes the project for which the proposed Bank loan of US$13.25 million (including an allowance for contingencies and interest during construction) would be made; it consists essentially of the ccmpletion of dieselization of the Central and Southern Railways, track rehabilitation and the acquisition of freight cars. x. Substantial economies will result from execution of the program, the savings from dieselization alone would repay the purchase price of the locomotives in 8 years at 6% interest. There would al so be savings in main- tenance costs for way and equipment from the track improvements. The working costs of the Railways would be substantially reduced, their ability to com- pete with road transport would be enhanced, and the functions of the Railways would be more efficiently performed. xi. Income account forecasts 1962/63 - 1969/70 indicate annual losses, after fixed charges, for the first two years and thereafter gradually in- creasing net earnings. On the basis of the financing plan for the program and the forecasts of traffic and of financial results from operations, the annual cash flow would be adequate to cover expenditure on capital works and debt service. Debt service coverage would not fall below 1.3 times, the ratio for 1967/68. xii. The forecasts assume constant wage, price and exchange rate levels; if inflation of any of these factors were to occur without timely and ade- quate rate increases, or if there were to be a sustained traffic shortfall, the Corporation's financial capacity would be impaired. As previously mentioned, a Transport Commission has been established, among other things, to assure equitable rates, and timely rate adjustments when necessary, for transport services, and the forecasts of traffic increases have been moderate- ly estimated. The prospects are therefore more promising than they were in the past, but the history of the Corporation clearly illustrates that while it efficiently manages its railway operations, its financial viability is largely dependent on circumstances beyond its control.  - iii - xiii. The Corporation's financial position at the outset of the program is weak and it would be unrealistic to ignore the risks for the Corporation in assuming substantial long-term debt and for the Bank in providing the major part of the financing. There are however compelling reasons for financing the program:_ a) the vital importance of the Central and Southern Railways to the economy of Peru, and b) the essentiality of dieselizing and rehabilitating these Railways so that they may economically and effective'ly perform their functions. xiv. The program would be financed by a line of credit from the Eximbank US11.5 million (S/. Ll million) obtained in 1961 and already used, the pro- posed Bank loan of US$13.25 million (SI. 358 million) and a credit of US$4.75 million (S/. 128 million) now under negotiations with Eximbank, for which a term of seven years at 6% has been assumed in this report; the sum of these amounts represents 92% of total program requirements. The juxtaposition of Bank loan and a credit from another source was determined to be the most practical solution for this financing when exhaustive discussions with the Corporation and its parent company revealed that additional equity capital and other forms of finance were not available, The Corporation's cash needs for the program, for other minor capital works and for debt service would be US:26.2 million (SI. 706 million) of which 25% would be provided from the Corporationls own resources. Financing as indicated would assure the availa- bil-i-iy of funds to guarantee execution of the program, and also relieve pressure on the Corporationts cash position during the critical program period. xv, To provide proteetion for the Bank and the Corporation against the risks inherent in this loan operation, the following terms and conditions have been agreed with the Corporation:- a) The term of the Bank loan would include a 4 years period of grace to June 30, 1967. This is approximately two years after comi-etion of the program, by which date the full benefits of dieselization are expected to be realized. b) During the period to June 30, 1965, by which date all program goods are scheduled to be delivered and the dieselization would be complete, the Corporation would use funds generated by it in excess of working needs (US'l.5 million equivalent net quick assets) to purchase goods provided for in the Bank loan, and thereafter to June 30, 1967 would apply such excess to reimbursing the proceeds of the loan. Thus to the extent practicable the amount of the loan would be reduced, possibly by as much as US35 million, but during the whole period the Corporation's cash position would be assLred by its drawing rights on the loan. c) Prohibition on payments from the Corporation to the parent company except:  - iv - i) for the equivalent of the annual service payments on the publicly held debentures of the parent company to June 30, 1967, and ii) after June 30, 1967, under specific conditions of earnings and quick assets tests. xvi. The project is suitable for a Bank loan of US$13.25 million equiva- lent, with a 16-year term, including a 1 years period of grace.  REPORT ON THE PEiUVIAN CORPORATION'S RAILWAY RMA-DILITATION PRDJECT I. INTfiDUCTION 1. The Peruvian Corporation Limited, owner and operator of the major railways in Peru, has asked the Bank for a loan of US$13.25 million equiva- lent to finance part of the modernization and rehabilitation program of the Central and Southern Ri lways in Peru. This is a four-year program which started July 1, 1961, and which is estimated to cost about US$21.3 million equivalent (s/575 million). The proceeds of a Bank loan would be spent dur- ing the two-and-a-half year period beginning January 1, 1963. Financing of the first year of the program was assisted by a loan of US$1.5 million from the Eximbank, 2. This is the Corporationts second reqiest for financial assistance to be considered by the Bank. The first resulted in the Loan and Guarantee Agreements (190-PE) of April 3, 1958, for US$15 million out of a total of a US$20 million equivalent program to rehabilitate the same Railways. Shortly after the agreements were signed, the Corporation's ability to make the agreement effective was adversely affected by a combination of circumstances. Although the Government authorized an increase in rates, it was less than half that sought by the Corporation and, therefore, was inadequate to give the Cor- poration a sound financial footing for the program. By the terms of the Guarantee Agreement the Government was to assure the Corporation a satisfactory level of gross revenue, and as part of the machinery for this purpose a Supreme Resolution established a railway tariff commission, but the Resolution was later revoked by the Government. 3. As conditions had turned against the successful execution of the project, the Bank, in agreement with the other parties, terminated the Loan Agreement in August 1959. Because of the importance of the Central and Southern Railways to the econj.:ic well-being of Peru, the Bank expressed its continuing interest in them, and further studies for their rehabilitation have been carried out by the Corporation. 4. In October 1959, Coverdale & Colpitts, a firm of railwTay consult- ants which had studied the Corporationts financial position and railway rehabilitation needs, recomnended a smaller program and concluded that this would have to be financed with equity capital if the Corporation were to operate on a sound financial basis. On evidence of improving economic conditions in Peru, the same consultants in Miarch 1961 recommended a program of rehabilitation and dieselization for the Central and Southern Railways, for which it thought financing might be considered by the Bank.  - 2 - 5. A Bank mission visited Peru in June 1961, to study the technical and financial aspects of the Corporation and to appraise the program. In June 1962 the Bank c-nducted negotiations with the Peruvian Corporation for a loan to rehabilitate the Central and Southern Railways, but it was agreed with the Peruvian Corporation that submission to the Bankts Board of Executive Directors would be deferred until after the Jute 1962 electior. and the new Government taking office. When the Junta took office the loan proposal was again deferred. 6. In September 1962, Cerro de Pasco, the main shipper of goods by the Central Railway, announced its intention to ship exclusively by truck. The loss of this traffic, about 68% of the total, would so seriously have affected the Railway's finances and the earnings of the Corporation that the loan could not have been made. Negotiations between the Corporation and Cerro de Pasco resulted in an agreement which provides for the continued use of the Railway for Cerrots total traffic as long as the railway rates are competitive with trucking rates. 7. This report is based on the information contained in the two consultants' reports, on the Bank Missionts findings during its visit to Peru, and on subsequent further information obtained from the Peruvian Corporation. II. BACKG'GROUND 8. The Peruvian Corporation Limited is an English limited liability company dating bac'k to 1890. It operates in Peru and is domiciled in the U.S.A. As a consequence of the March 1, 1956 reorganization its entire share capital,