SAA and Eskom Annual Reports 2008/09

NCOP Public Enterprises and Communication

13 October 2009
Chairperson: Ms M Themba (ANC, Mpumalanga)
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Meeting Summary

SAA’s new board chairperson, Cheryl Carolus, emphasised that the board wanted to fix the systemic challenges at SAA, continuing the turnaround process started by the previous board. She emphasised SAA’s importance as a national asset. A process of recruitment for a permanent CEO was underway. The Acting CEO and CFO were upbeat about SAA’s performance in 2008/09. The industry had been hard hit by the economic downturn with at least 50 airlines closed down around the world. SAA was comparatively lucky because it was a major player on the African continent where the impact of the global recession was less severe and it had undergone restructuring during a boom period that enabled it to withstand the downturn. Down-sizing had been achieved by voluntary retrenchments and no dismissals. SAA had managed to increase it share of the local market, increase passenger revenue and operating profit. The SAA had received an unqualified audit for 2008/09, although there were some concerns in terms of the Public Finance Management Act. The Airbus dispute had finally been settled. Approximately 8000 people were directly employed but indirectly substantially more jobs were generated. They expected SAA to break even for 2009/10, if flight demand continued not to fall, fuel prices did not rise and the rand did not weaken. Questions from the Committee including the grounded 747s, the use of labour brokers, the use of Upington as a storage facility for grounded planes and the impact of the cost of fuel.

The Eskom CEO said that Eskom was currently spending unprecedented amounts in capital building new stations. There were some challenges in managing its credit rating, but this had improved, as one credit agency had moved Eskom out of the negative zone. Eskom had not received the increase they had requested from the National Energy Regulator of South Africa and were experiencing a shortfall, but their first priority was to ensure that there were no blackouts. Challenges faced by Eskom included the cost and delivery of coal, employee safety, the negative public perception of Eskom due to the blackouts and tariff increases. He reiterated the claim that South Africa supplied the cheapest power in the world. R47 billion had been invested in capital expansion and they were aiming for R87 billion this year. Eskom had been preparing for the World Cup for some time, to ensure there was sufficient stock. The power supply crisis was a result of failure to plan, as far back as 1998.

Asked about nuclear power as a solution, the Eskom CEO replied that it cost more to build a nuclear power station, but that the running costs were lower, as nuclear fuel, in proportion to coal, was cheaper. On alternative energy sources, such as wind energy, Eskom had renewed its commitment to continue with coal-fired stations, but this did not mean its commitment to renewable energy was any less. It was simply more economic to stick with coal at this point. In deciding the tariffs, they were not funding capital directly from tariffs –which were VAT inclusive – but the ability to borrow money to fund expansion was dependant on the tariffs charged.

Meeting report

SAA Annual Report 2008/09
The SAA delegation presented their Annual Report led by Board Chairperson, Cheryl Carolus, and assisted by Acting CEO, Chris Smith, and Chief Financial Officer, Kaushik Patel.

Ms Carolus provided the introduction, requesting indulgence from the Committee for the newly inducted board. She emphasised that the board wanted to fix the systemic challenges at SAA. She believed that SAA was important as a critical player for the 2010 World Cup, emphasising its importance as a national asset. She said a process of recruitment for a permanent CEO was currently under way, and that the new board was continuing the turnaround process started by the previous board.

Looking at the operating environment, Mr Smith stated that the industry had been hard hit by the economic downturn, emphasising the role of the increasing price of fuel as a factor. He emphasised that unlike most other industries, fuel did not represent 40 –50% of expenses, exacerbated by price fluctuations. He knew of at least 50 airlines that had closed and that Upington was used to store many of their grounded aircraft. SAA was comparatively lucky, for two reasons: it was a major player on the African continent where the impact of the global recession was less severe and it had undergone restructuring during a boom period that enabled it to withstand a downturn. The restructuring involved grounding 747s and reducing the headcount, from senior management down. He emphasised that this was undertaken through voluntary retrenchments and that no one needed to be dismissed because of downsizing.

He said that SAA had managed to increase it share of its own market and had a similar share of domestic passengers as other national airlines such as Qantas did in Australia or Lufthansa in Germany. He said that yields had also increased – whereby the amount of revenue received per passenger per kilometre had been increased but without necessarily increasing prices, by attracting the “right kind” of passenger.

Mr Smith stated that departmental initiatives had been undertaken to lower costs, through rooting out unnecessary costs and renegotiating contracts. For example, SAA had been paying the highest of all airlines to fly to the US via Dakar; but they were now paying the lowest.

He emphasised that had SAA not gone through a restructuring process, it would not have survived. The restructuring phase was now over and they now needed to look at “softer “issues, such as treatment of customers.

Mr Smith then briefly presented a number of tables to the Committee, including on-time arrivals, revenue by province and staff distribution past and present.

He noted that the cost of fuel – a 45% increase in two years and a 20% drop in the rand during the same period affected its profitability and that the latter was especially important in respect of landing fees, which were based on a foreign currency.

He noted that the Airbus dispute had been settled, and that the previously cancelled contract had been reaffirmed. Deposits that had previously been written off had been resurrected when the contract was revived, thus increasing their asset base.

Mr Kaushik Patel, Chief Financial Officer for SAA, stated that the turnaround had produced an operating profit of over R9 billion. The increase in income was ascribed mainly to an increase in passenger revenue. He noted that cargo revenue had dropped, but that it had dropped by an average of 40% worldwide and that SAA had only experienced a 26% drop. The technical services provided by SAA had increased, most notably that provided to Comair, which had increased from 20 000 to 39 000 hours. He said that operating costs had only increased by 4%.

Mr Smith continued to describe the future of SAA and its import to the economy and the country as a whole. He said that SAA was an African airline with a global reach. This meant that SAA saw itself as an African player; it no longer had aspirations of being a major global player but would maintain a presence on all continents. SAA accounted for 40% of international arrivals into SA. SAA had an alliance with some of the biggest players, and through them offered SAA in 159 countries in over a 1000 cities. He noted that in Africa, SAA was the dominant player and that almost 50% of African arrivals were served by SAA.

He stated that approximately 8000 people were directly employed but indirectly substantially more jobs were generated in other fields, especially in tourism and hospitality.

He mentioned that SAA was heavily involved in training and development, not just of pilots but also engineers and technical staff, as well as accounting skills specific to the airline field. SAA was an enabler for economic growth due to its role in transporting goods, paying out billions to local suppliers and in salaries. Furthermore, Mr Smith stated that over 45% of Airport Company South Africa’s revenue had come from SAA.

He said that SAA had an important safety role to perform in Africa given its dominant position, which could be used to improve safety in African skies. He emphasised the need to open up African skies to enable flight across the African continent without hindrance.

Mr Smith said that SAA was energised by 2010, that it saw it as an opportunity to showcase SAA and South Africa to the world. They were in the process of finalising an agreement with accommodation provider, Match, and would be conducting transportation on behalf of Match.

In conclusion, he said he expected SAA to break even for 2009 /10, if passenger and flight demand continues to fall, fuel prices did not rise and the rand did not weaken.

Discussion
Mr M Sibande (ANC, Mpumalanga) asked about the failure of SAA to account in terms of the PFMA which SAA had failed to do for the past three years.

Mr Smith responded that the PFMA issue related to two areas of concern. Firstly, there were problems with the procurement process. Independent consultants had been hired to address this and the situation was improving. The second issue related to a current investigation of which he could not comment on. Once he could, he would address it as expeditiously as possible. He drew attention to the fact that SAA had been audited by an independent agency and had received an unqualified audit.

Mr Sibande asked whether government would be able to sustain SAA if it kept losing large amounts of money. He also asked a question about the purchase of aircraft.

Mr Smith replied that it was very expensive to purchase airplanes. A single Airbus, for example cost R1 billion and SAA would purchase 21. SAA’s net asset base was only R2.5 billion. There were two ways of financing aircraft. The first used mainly for older aircraft, was through a standard lease agreement. The second method was through an export credit agency which would provide a guarantee. With this guarantee an airline could raise money from a bank. SAA looked at the most cost-efficient way of leasing aircraft.

Mr Sibande asked why there were so few direct flights from South Africa to Europe, at least in his experience.

Mr Smith responded that SAA was currently deciding whether it was an organ of state that provided as wide an access as possible or whether it was a commercial enterprise. The answer received from the Department of Public Enterprises (DPE) was that SAA should be self-sustaining. This meant that SAA could not operate routes that were not profitable and that it was not possible to service every single European airport. One could fly via BA to say Istanbul or to Munich, and then catch a connecting flight.

Mr Sibande asked whether there were effective risk management practices at SAA.

Mr Smith deferred the question to Mr Andrew Shaw, Deputy Director General: Transport of the DPE. Mr Shaw stated that they had done their own risk assessment of the airline. This was different from SAA’s own risk assessment as the airline focused on shareholder concerns rather than safety. The DPE was satisfied that SAA was in the clear, despite concerns around financial stability and monitoring processes.

Mr Smith continued, speaking on the topic of staff retention. He said that this was not a reward but a method of retaining staff. The SAA had undergone a restructuring process which inevitably had dented morale, and when morale was low, people started looking for work elsewhere. In order to retain staff, they paid them an amount on top of the salary that would need to be returned if they left. He claimed that every person who left under this scheme has paid back the money received, and the attrition rate of those under this scheme was less than half that of those who were not.

Mr Sibande asked about the investigation by the US competition commission into practices by SAA.

Mr Smith replied that this was an ongoing matter over the period 1999 – 2006. He reassured the Committee that this kind of uncompetitive and predatory behaviour no longer happened. In terms of the fine to be paid, it remained a contingent liability in the account books.

Mr Sibande mentioned a problem he had experienced with El Al airline officials.

Mr Smith replied that this issue would be best addressed by ACSA.

Mr H Groenewald (DA, NW) asked a question about the use of Upington as a storage area for planes and asked if it was a dumping ground for other countries.

Mr Smith replied that from SAA’s perspective, it was not a dumping ground and this would be best addressed by local airport authorities. He said that Upington was ideal for plane storage as they required a place that was hot dry and at a high altitude and that this was similar to the Mojave Desert in America where more than 2000 planes were stored.

Mr Groenewald asked what had happened to the grounded 747s.

Mr Smith replied that SAA was in the process of selling them. Three had already been sold, two would be returned at the end of their leases at end of 2010 with just one remaining to be sold.

Mr Groenewald asked whether the Mabatha airport was profitable for SAA.

Mr Smith replied that it was too small to be of interest to SAA, but might be of interest to feeder airlines. He reiterated the need for the parastatal to be profitable.

Mr Groenewald asked if SAA had been turned around, why did it require funds from government.

Mr Smith replied that SAA was not and did not intend asking for further funds, because of the successful turnaround.

Mr Groenewald expressed concern over the cost of the Voyager programme.

Mr Smith replied that it was not a profit-making scheme but a customer retention scheme and that it was a part of marketing, attracting high-income customers who fly frequently. He conceded that it was expensive but that SAA was looking at merging it with other loyalty schemes.

A DA member asked how the SAA planned to increase revenue, as he assumed that cost-cutting measures had taken place and that there was no room for further measures of this kind. He added that he had seen very little marketing of SAA.

Mr Smith replied that this was not easy to answer; he noted that SAA serviced 19 countries in Africa, a continent of 53 countries, and acknowledged that SAA had a lot of work to do in this regard. A number of flight increases had been launched and SAA would take advantage of any opportunities. For it to do so it would need more aircraft and this was part of the expansion process. He stated that airline economics was a bit different from other businesses; most require funds before expanding, airlines would expand before having the cash at hand. Current marketing was largely concentrated on sponsorships, but that they would attempt to reduce the sponsorship footprint.

A DA member asked whether a profit was made in respect of repairs done for Comair and if Comair was a profitable enterprise, why not SAA?

Mr Smith replied that Comair was an entirely different animal. Comair picked and chose which flights while SAA was constrained by being a public entity. Comair chose to operate where there was no competition other than SAA while SAA had to compete with international airlines. This did not mean that SAA could not learn from the Comair experience.

A DA member asked about an apparent disparity between fuel cost, saying Mr Smith had cited fuel as consisting of 50% of its operating cost but it was reflected as 30% in the financial account.

Mr Smith said that he had said it varied between 30- 50%; it was fifty at its highest, but maintained an average increase of 38%.

A DA member mentioned that Mr Smith had stated that the domestic market was fairly regulated and asked whether he would like to see it deregulated.

Mr Smith replied that the only area not open was the African continent. Bilateral agreements were signed between governments to determine the number of flights between countries.

A DA member asked about SAA’s relationship with SA Express.

Mr Smith replied that SAA cooperated with them, that they fly the SAA brand and as such, hey have an interest in ensuring that they maintain certain standards and can link up with SAA flights. As such he was less concerned about who owned SA Express.

Mr Sibande asked a question about reduction of staff and outsourcing, especially in light of the controversy around labour brokers.

Mr Smith responded that this was always a hot potato. The demand for labour was uneven, with peaks in the early hours of the morning, again between eleven and one and again in the evening. Thus, there was a need for a flexible labour force. However, the SAA accepted that this was a morally contentious issue and was looking for alternatives.

An ANC member asked what would happen to those implicated by the process looking into past mismanagement.

Mr Smith responded that hearings would be conducted and that the parties concerned would be given a fair opportunity to state their case.

The Chairperson asked why there were no direct links to Africa, mentioning Lagos in particular.

Mr Smith replied that all Lagos flights were direct.

The Chairperson raised the problem of pilferage.

Mr Smith replied that pilferage was a serious problem, that both ACSA and SAA were concerned about, as were visitors, but it had been reduced.

Mr D Feldman (ANC, Gauteng) asked a question about privatisation.

Mr Smith replied that it was not important who ran SAA, that the importance lay in how it was run.
It was only relevant if it was treated differently from private sector bodies.

Mr Feldman asked a question about the cost of the Airbus.

Mr Smith replied that a 25% deposit was standard practice; only the total amount could be negotiated.

Mr Feldman asked what SAA was doing to facilitate job creation.

Mr Smith replied that SAA could not just fix jobs, but mentioned that as the company grew so too would their need for labour and this was the only way to grow sustainable job creation.

The Chairperson thanked SAA for their attendance.

Eskom Annual Report 2008/09
Mr Phirwa Jacob Maroga, Chief Executive of Eskom, said that Eskom had been in crisis for a number of years, referring to January 2008 when the entire country nearly shut down. Since then mothballed power stations had been brought back on stream. The economic slowdown had provided space for critical maintenance to take place and Eskom had secured a guaranteed R175 billion for its build programme over the next five years. Eskom was currently spending unprecedented amounts in capital building new stations. He conceded that there were some challenges in managing its credit rating, but that this had improved, as one credit agency had moved Eskom out of the negative zone. He pointed out that Eskom had not received the increase they had requested from the National Energy Regulator of South Africa and were experiencing a shortfall, but their first priority was to ensure that there were no blackouts.

He outlined the challenges faced by Eskom which included the cost and delivery of coal. This was their biggest cost item. Safety was also highlighted as an issue, as there had been a number of staff deaths. Another challenge was that of public perception, which was negative due to the blackouts and tariff increases. He reiterated the claim that South Africa supplied the cheapest power in the world.

Mr Maroga said that Eskom needed to remunerate competitively. As Eskom went through capital, it needed to borrow more and thus expose itself to finance charges and there would be problems with debt service cost as revenue was not rising. He noted that Eskom had excess capacity for 20 years and it had lived off its capacity in the 70s and 80s debt free. He said R47 billion had been invested in capital expansion and they were aiming for R87 billion this year. He believed demand would pick up next year; especially as South Africa would be hosting an important event. Eskom had been preparing for this for some time, to ensure all contingencies were in place and that the World Cup went off without a hitch. This included ensuring that there was sufficient stock and capacity for 2010. He concluded with statements on the role of Eskom in the South African economy.

Discussion
Mr Sibande said NERSA had called on government to lend money to Eskom. If government provided the means to Eskom, why was it demanding more?

A DA member noted that the funding model was yet to be to be determined, yet Eskom had determined it unofficially by asking for increased tariffs. He said that tariffs shouldn’t be directly funding expansion.

Mr Groenewald said that they were not really taking the public into consideration with these tariff increases. There was plenty of unemployment and poverty.

Mr Maroga said that some clarification was needed on this issue. An interim increase was awarded in June 2009. This would give Eskom the space to look at a funding model that took into account more than just the year ahead, and that interim increase was just what was needed for the immediate future.

He explained that in deciding the tariffs several factors were taken into account. They were not funding capital directly from tariffs –which were VAT inclusive – but the ability to borrow money to fund expansion was dependant on tariffs charged. The negative credit rating decisions was a result of over committing.

Mr Sibande sought assurance that load shedding would not happen again.

Mr Groenewald asked when South Africa could be assured that there was sufficient electricity.

Mr Maroga said that the power supply crisis was a result of failure to plan, as far back as 1998, and that Eskom needed to get to the point where it could say that load shedding was a thing of the past.

Mr Sibande noted that electricity not going directly to consumer, that it was going to Megawatt Park and then to the consumer. He asked why this was so.

Mr Maroga replied that this was an urban legend that electricity went straight into the transmission system.

Mr Sibande asked about the relationship with Koeberg, that some people felt strongly that the only solution was nuclear power.

Mr Maroga replied that it cost more to build a nuclear power station, but that the running costs were lower, as nuclear fuel, in proportion to coal, was cheaper.

A DA member mentioned that alternative energy sources, such as wind energy had been raised as an alternative to coal, a shortage of which had affected generation capacity in the past.

Mr Maroga replied that Eskom had renewed commitment to continue with coal-fired stations, but this did not mean its commitment to renewable energy was any less. It was simply more economic to stick with coal at this point.

A DA member referred to the issue of wastage (in the sense of entire vacant office blocks with lights left on for the entire night) and theft. He asked if Eskom was able to assess this and he saw no effort on their part to reduce this.

Mr Maroga said that if electricity were more expensive, there would be less incentive to waste it. Theft was an issue but in the bigger scheme not a major issue.

A DA member said that it took 8 years to bring power stations online and he had heard that the Chinese took just six months. He admitted that this was in all likelihood an urban legend, but the Chinese probably did bring a power station online quicker.

Mr Maroga replied that it was indeed an urban legend that stemmed from reports that a new power station was brought into operation every six months in China. This did not mean it was built in six months. He agreed that they probably did it quicker, but South Africa was a democracy where the surrounding affected communities need to be consulted and an environmental impact assessment done, all of which took time.

Mr Groenewald said that the Medupi power station in Limpopo was located in a very dry area. A power station required a lot of water and he wanted to know what Eskom was doing to address this.

Mr Maroga responded that water was a problem and they would construct a pipeline to bring in water. He said they were in contact with Water Affairs. An environmental impact assessment would also be done.

Mr Groenewald said that there were rumours that contractors at Medupi were not paid well and were walking off, leaving the job uncompleted.

Mr Maroga said that he was not aware of this.

Mr Groenewald said that the power station at Hammanskraal, one big enough to supply that part of the former Bophuthatswana, had been shut down and he wanted to know if it would be brought back into operation.

Mr Maroga replied that he was not sure, but that Eskom assessed all stations that it chose to bring into operation.

The Chairperson thank
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