Transnet Ltd 2010 Annual Report

Meeting report

Transnet Annual Report 2010/11
Mr Anoj Singh, Acting Chief Financial Officer, Transnet, tabled and briefed the Committee on the Annual Report of Transnet for 2010/11. He noted that Transnet performed quite well from a financial perspective, with revenue rising 6.6%, earnings before tax and depreciation rising 9.4%, and cash generated from operations after changes in working capital increasing 13.5%, which was an important indicator for Transnet as part of its capital expenditure programme. Transnet spent R21.5 billion in capital expenditure (Capex), a16.6% increase on the prior year.

Mr Singh explained that the two critical financial ratios that enabled Transnet to access the capital market were its gearing ratio and its cash interest cover ratio. The gearing ratio increased marginally by 1%, notwithstanding the mass capital expansion programme rolled out in this year, whilst the cash interest ratio was 3:9. Although Transnet had a 1%  decline in return on average total assets, at 6.6%, this was expected because of its mass capital expenditure programme, with R120 billion expected to be spent over the last seven years. He also outlined the profit from continuing operations, which showed a 32.8% increase on the previous year, and revenue increases averaging 9% over the last five years, about twice the inflation rate (see attached presentation for full details). The biggest contributor was Trans Freight Rail (TFR), followed by the National Ports Authority (TNPA), and Transnet Port Terminals. Operating expenses increased by 8.1%
over the last five years, due to increased costs of energy from Eskom, and crude oil price increases. In 2010/11, operating expenses increased by 4.7%, but cost saving initiatives saved a substantial amount.

Earnings before tax and depreciation (EBITDA) grew by 9.4% year on year, showing Transnet’s ability to grow at about twice the inflation rate. Depreciation increased by 18% year on year, in line with expectations, attributable to the capital investment programme and revaluations of port facilities and pipeline networks. Net finance costs increased by 18.1%, due to increased long-term borrowings to fund the capital investment programme.

The balance sheet showed the total assets of the company at R170 billion, a significant strengthening on its position some four or five years ago. Transnet’s strong financial position enabled the execution of the borrowing programme without government guarantees. Mr Singh then set out the growth in property, plant and equipment and long-term borrowings (see attached presentation) and noted that the increase of 18.1% in long-term borrowings was due to funding raised for the capital investment programme, which was creating capacity ahead of demand. The gearing remained below the Board limit, reflecting adequate capacity to fund future capital investments.

Cash generated from operations reflected a 13.5% increase, and R23 million was invested in the capital expenditure programme, leaving a borrowing requirement of R12.8 million. Sources of funding were the Global Medium Transfer programme (GMTN), which were global bonds issued on the international markets, the Domestic Medium Transfer programme (DMTN) of domestic bonds, a commercial paper programme, bank loans and asset backed finance, and Development Finance Institutions (DFIs) and Export Credit Agency (ECA), a foreign government backed agency that allowed access to funding at a cost effective rate if imported from that country. Total funding from those sources amounted to R18.4 billion.

Transnet received an unqualified audit report, but the auditors did raise Matters of Emphasis in relation to irregular expenditure, and noted, in respect of performance information, that processes were needed to measure and track the Key Performance Indicators (KPIs).

Mr Singh noted that the Auditor-General (AG) requested specific procedures on procurement contracts, so 104 contracts, worth R22 billion, were reviewed, and found to be in order. 111 control mechanisms were assessed and found to be effective. However, some improvements were required on the operational side. Spending of R7.2 billion was classified as “irregular expenditure” because it did not comply with Transnet’s procurement processes and practices for evaluation of the tender. He stressed that there was not a deliberate act by any person that led to the irregular expenditure, and also emphasised that in all cases, value for service rendered was obtained, and all non-compliance had been rectified. Disciplinary action required by the Public Finance Management Act (PFMA) was taken against all but one individual. The irregular practices arose several years previously and there had since been significant improvement. A recent tender audit performed by Transnet Internal Audit resulted in a ‘requires improvement’ rating and there was only one finding relating to non-compliance to procurement policy.

Mr Singh noted that measures taken to prevent irregular expenditure resulting from non-compliance to the procurement policy were improvements to the procurement policy and procedures, to make them user-friendly, as well as training on that revised policy. Internal Audit must in future monitor tenders above R50 million. The delegation of authority was revised, so that only the Group Chief Executive may authorise, and all instances were investigated, in order to determine the root cause and take corrective measures, as well as to follow up on disciplinary action.  

Mr Singh moved on to discuss the business operations of Transnet. In terms of volume growth, productivity and efficiency, the biggest driver was moving freight. The General Freight Business (GFB) grew by 2.2%, despite a loss of volumes due to industrial action in May 2010, as well as cable theft and rolling stock related faults. Overall productivity and service delivery deteriorated from the prior year, but measures were put in place to turn that around.

Containers on rail was a significant focus area for government and the Department of Public Enterprises (DPE or the Department). Volumes increased by 13.2%, and market share increased to 34%, representing a significant shift from road to rail. Domestic coal volumes grew by 12.4% despite operational challenges and customer cancellations. A key focus area for the next five years was to meet Eskom’s domestic coal requirements. Magnetite volumes increased by 3.7%, despite the negative impact of the Brakspruit Bridge collapse, and export manganese volumes increased by 23.1% compared to the prior year.

Export coal volumes (62mt) reflected marginal growth, but overall productivity and service delivery deteriorated from the prior year, mainly due to the impact of industrial action as well as rail infrastructure problems and operational challenges. Export iron ore volumes (46.2mt) increased by 3.4% despite an unprecedented number of derailments that resulted in lost volumes and impacted on operational performance levels. Ship loading rates increased at 9.7%, due to the successful implementation of dual and staggered ship loading at the Iron Ore Terminal. Maritime Container volumes reflected a 12.5% growth, primarily driven by an increase to imports in the Port of Ngqura for the 2010 FIFA Soccer World Cup, whilst container handling rates improved, and resulted in increased overall container port efficiencies. This would remain a focus area.

There was a 1.5% increase in petroleum volumes from the prior year, despite the constrained Durban-Johannesburg Pipeline (DJP). Capacity utilisation increased through continued use of drag-reducing agents (DRAs) and there was a 26.9% decrease in production interruptions due to internal causes. Security of supply to the inland market was achieved due to the successful implementation of the rail bridging plan.

Transnet spent R21.5 billion on capital investment, with the biggest portion in the rail and pipeline sectors. 94% of the planned spending was achieved. Over the last five years, Transnet had spent R86.8 billion on capital investment, without government guarantee, on the strength of its financial position. 63% of capital investment went to maintaining the revenue streams of the organisation, and 37% on expanding the activities of the organisation. The biggest impacts of capital expenditure on the rail business were seen in the Locomotive Acquisition programme, the Locomotive Refurbishment programme, and the Infrastructure Replacement programme.

Mr Singh then outlined the human capital in Transnet, noting that there were 1 412 apprentices and 427 engineers in Transnet. 52 engineering bursaries were granted for 2011,and there were 356 engineering technicians in the internship programme. There were 76% black employees, and the female employee representation had improved from 8.4% in 2001 to 20% currently. People with disabilities comprised 0.8% of Transnet’s workforce. Its Broad-Based Black Economic Empowerment spending was 75%, higher than both the Department of Trade and Industry (dti) target of 50%, and its own target of 65%.

Mr Singh outlined some of the achievements in procuring locomotives and stressed local procurement (see attached presentation).

He then turned to safety issues, noting that the Disabling Injury Frequency Rate (DIFR), which was calculated on fatalities and derailments, deteriorated by 11.4%. There were twelve fatalities during this year, compared to eight in the previous year. Public fatalities decreased by 12.7%. The cost of losses increased to R1 billion for the year, and was mainly due to derailments.

Mr Singh noted that the two operating divisions of Transnet were regulated by economic regulators, with the Transnet Pipelines (TPL) regulated by the National Energy Regulator of South Africa (NERSA), whilst Transnet National Ports Authority (TNPA) was regulated by the Ports Regulator of South Africa. There was significant variability in tariff increases, but greater certainty on future tariff applications with NERSA.

Transnet had a School of Rail, School of Ports, and School of Pipeline, to train future employees of Transnet, but in most cases more people were taken in than required by Transnet, so that it was training for the whole industry. It spent R180 million per year on its social investment, in six key portfolios. He highlighted the Phelophepa Health Care Train, a unique 18-coach train with onboard health clinic, optometry, dental clinic, psychology and pharmacy services, that travelled for nine months in every year to the rural countryside, reaching approximately 45 000 patients on board, 118 000 learners through its outreach programme comprising eye, ear and dental screening, mentors, and 750 health students. A second train started operating in March 2012.

Mr Singh concluded that Transnet had produced good financial results, maintained good financial sustainability, showed successful progression in productivity and efficiency in port and pipeline operations and continued capital investment to create additional capacity. He highlighted the focus on productivity and safety improvements in the rail business, alignment to the New Growth Path (NGP) and promotion of black empowerment and the local suppliers’ development programmes. In future, it aimed to meet market demand and create more capacity.

Discussion
Mr M Sibande (ANC, Mpumalanga) sought clarity as to how Transnet dealt with bonuses, noting that in this financial year, the Pipeline Division under performed, yet Mr Gama received a R2.5 million incentive bonus, after being suspended. This created the notion that Transnet executives would be handsomely rewarded for wrongdoing.

Mr Brian Molefe, Group Chief Executive, Transnet responded that bonuses were awarded according to a number of key performance indicators, which were weighed in line with scorecards, from 1 to 4. No bonuses were paid for scores of less than 2.5. A rating of 3 was considered to be on target, and above that was better than target. Transnet, when doing appraisals, looked at the Key Performance Indicators (KPIs) agreed to at the beginning of the year. Sometimes, although a division may not have performed well on a particular matrix, an individual may still have achieved on his or her overall score.

Mr Molefe explained that Mr Gama had authority to sign contracts of up to R10 million, but had signed one for R18 million. There was no suggestion of dishonesty and he conceded he had made a mistake, and noted that in such instances in the past, this behaviour had been condoned. The Board felt that his conduct did not warrant dismissal, and therefore recommended that he be given a final written warning. In addition, the salary that had been withheld during the period of his suspension would be paid, including the amount of bonus that he would have received, had he not been suspended. The figure appeared high, because it was recorded as paid in one financial year, but it covered a three-year suspension period.

Mr Sibande was concerned about the refurbishment of locomotives, asking how many were affected, and pointing out that some that were very old probably did not warrant refurbishment.

Mr Molefe responded that about 400 locomotives were refurbished during the financial year, in a continuing programme. He agreed that some locomotives that were not fit to be refurbished, and they were not upgraded, but where refurbishments were done, this also involved a revamping and upgrade of engines, so that the locomotives could operate as new, which resulted in considerable savings.

Mr Sibande referred to the question of tariffs and asked if the Regulators had done anything to improve the methodology for tariff increase applications, which might improve Transnet capital requirements.

Mr Singh responded that NERSA had improved the methodology for the tariff regulatory regime, and there was a narrowing of the difference between what Transnet applied for, and was granted.

Mr Sibande noted that Transnet received an unqualified audit report, but noted the matters of emphasis around procurement and contract expenditure, with fruitless and wasteful expenditure of R26 million on procurement of ship unloaders, as well as irregular expenditure of R8.3 billion. He asked how the internal systems had been improved, and whether risk management processes were not in place.

Mr Molefe responded that the fruitless and wasteful expenditure related to pneumatic ship loaders. Transnet had bought new ship loaders but, when they were being installed at Richards Bay, they were found to be faulty. Engineers bought parts and repaired them, instead of returning them to the suppliers as they were still under warranty. The engineers were given a disciplinary hearing and a warning.

Mr G de Beer (COPE, Western Cape) said Transnet had to be congratulated for performing well, particularly given the difficulties of the strike action.

Mr Molefe noted that the strike had lasted two weeks, and measures were put in place to minimise losses suffered by Transnet. In the fifty weeks that it was able to operate, good performance was maintained, to show an overall increase by the year-end.

Mr de Beer noted that Transnet had signed an agreement with its stakeholders regarding targets, but those were not met in all divisions. He noted that the targets were not met for coal and iron ore exports, on Freight Rail, as well as for safety, and he pointed in particular to the wide divergence between targets and performance for Port Terminals. These were considerable challenges, and he sought comment.

Mr Molefe responded that it was difficult to see how an organisation of 59 000 could achieve zero fatalities. He noted that fatalities sometimes had nothing to do with operations, because they covered all fatalities whilst on duty. In the last year, four of the fatalities were as a result of car accidents, although others arose because of non-adherence to the correct operating or safety measures. However, fewer fatalities were reported, and there was a significant improvement in safety, for 2011/12.

Ms Phyllis Difeto, General Manager, Transnet, added that the reduction seen in 2011/12 was demonstrative of the serious way in which Transnet dealt with fatalities. They had to be reported immediately, and management had to do something for the families. Employees were also reminded of the importance of adhering to safety measures and requirements when performing their functions.

Mr Molefe asked the Committee for assistance in not allowing the media to publish pictures of accidents, since this caused great distress to family members.

Mr Sibande agreed that this was a very serious matter and the Committee would support that request.

Mr de Beer also noted that Rail Engineering did not meet the BBBEE target.

Mr de Beer was also concerned about access to opportunities. He congratulated Transnet on the efforts made in Saldanha, his constituency, to gear up the local business people through the infrastructure programme, and wondered if it was also being implemented in other terminuses. He noted that similar issues had been raised on oversight visits to other provinces, and noted that access to information was a challenge. He hoped that the opportunities rolled out in Saldanha would be rolled out in all the ports, including Ngqura.

Mr Molefe responded that Transnet would offer similar opportunities in the other areas where it was operating, such as Richards Bay, Port Elizabeth, and the Port of Ngqura. Transnet had visited most of the provinces, together with the Minister.

The Chairperson requested that when Transnet visited the provinces, it should notify the Committee, to allow Members to accompany it on these visits, and requested the Transnet programme for visits.

Mr de Beer asked there were so few people with disabilities and women in top management positions.

Mr Molefe said that was being addressed. In the current year, there were new performance operating divisions, to increase the number of women in senior positions, as well as people with disabilities. He mentioned that sometimes those with disabilities did not wish to be categorised as such.

Mr de Beer was pleased with Transnet’s skills development programme, and asked how Transnet created opportunities to empower the workforce.

Mr Molefe responded that Transnet had started programmes for artisan training, and training engineers, and was specifically targeting women. Transnet already had a very senior female welder, to weld to the highest standards, and also had female captains and traffic controllers in the various ports, as well as women who were trained in the maritime industry.

Mr de Beer questioned the contract for the supply of two rubber tyred RTG cranes, and noted also that the  auditor had highlighted concerns about staff accommodation

Mr Singh explained why these two items were categorised as irregular expenditure. There were certain omissions in the way in which the RTG crane tender was adjudicated, which came to light when the contracts were reviewed, and which led to this contract being regarded as irregular expenditure. In relation to the staff accommodation, which was required in rural areas, for locomotive staff after a change-over in shift the employee did not apply the appropriate procurement process, in that he had not issued a request to the public for supply of accommodation, but had merely extended an existing contract. Although this represented a breach of procurement methods, the services, in both cases, were necessary and were supplied.

Mr Molefe gave an illustrative example, saying that if a train broke down in the middle of nowhere, and the train driver went to the nearest guesthouse, it would be classed as irregular expenditure because the set procurement processes were not followed. The policy needed to be amended to state in what circumstances it would be acceptable to depart from policy.

Mr de Beer said Transnet was part of the Joint Initiative for Priority Skills programme (JIPSA) and asked how it had benefitted from this.

Mr de Beer also asked what best practices Transnet could pass on to other state owned companies.

Mr H Groenewald (DA, North West) asked how Transnet handled and controlled its asset register.

Mr Singh explained that all Transnet assets were noted in an electronic asset register, in a sophisticated process that ensured that everything was accounted for in that register. There was no manual intervention after the information was captured, so that all wear and tear allowances, depreciation, and final disposal was recorded electronically. No assets were listed outside of that register, which met all requirements.

Mr Groenewald was interested to know how much Transnet equipment was in neighbouring countries, and what benefit South Africa obtained from those neighbouring countries.

Mr Singh said Transnet did not have any assets in neighbouring countries. Its assets did traverse neighbouring countries, and wagons went into neighbouring countries on an exchange agreement , but there was a mechanism whereby those assets were returned. There had sometimes been a problem with the turnaround time, but all assets had been returned.

Mr Groenewald asked how much of the R22 billion was spent in contracts, and what else it comprised.

Mr Singh responded that much of the R22 billion went into acquiring assets, such as locomotives, infrastructure, rails, and cabling equipment, whilst other substantial spending related to Transnet Rail Engineering, which attended to the bulk of the refurbishment work on locomotives and wagons for Transnet Freight Rail.

Mr Molefe added that about 74% of Transnet’s total procurement was broad based black economic empowerment (BBBEE), and he explained how the Level 1, 2 and 3 contributors worked.  

The Chairperson asked whether there was a need to amend this legislation.

Mr Molefe referred to some problems of fronting, and thought that amendments were being discussed.

Mr Groenewald was pleased to see the positive shift of containers from road to rail, but commented that much cargo was still being transported by road. He asked how Transnet was aiming to get more moved to rail, and what the main problems were.

Mr Groenewald asked how many pipelines Transnet had under its control, and their location.

Mr Groenewald noted discussion in the past concerning the corridors and asked for a status and development update, especially on the Durban /Johannesburg corridor, as well as where other corridors were.

Mr Molefe clarified that currently there had been identification of the Maputo Corridor, the Richards Bay Corridor, the Durban/Johannesburg Corridor, the Sishen/Saldanha Corridor, the Johannesburg/Cape Town Corridor, and the corridor from Johannesburg to Port Elizabeth, Ngqura and East London. He also showed a slide of the pipeline locations, illustrating the main pipeline from Durban to Gauteng.

Mr Groenewald asked about Transnet’s investment and development in the rural areas, commenting that the road infrastructure was poor and contractors were battling to get their trucks on the road. He also asked about Transnet’s contribution to rural job creation.

Mr Molefe responded that, firstly, the rail lines would be linked to Swaziland. In other areas, Transnet was increasing its GFB facility, to start carrying agricultural products from rural areas. Transnet was also making a concerted effort to recruit from the rural areas into its training programmes for engineers, train drivers and marine skills. Transnet was trying to quantify the amount of Capex involved into activities based in the rural areas, and to quantify its intervention into rural development in South Africa.

Mr Groenewald asked what the future plans were for the Port of Ngqura, and how the Eastern Cape would benefit from that.

Mr Molefe responded that there had been a decision to establish a manganese terminal at the Port of Ngqura, with a budget of R300 million. The Port of Ngqura would be developed as the transhipment hub. Manganese was currently exported through Port Elizabeth, but would be moved to Ngqura. Cranes and equipment were bought, and paving was finished. Transnet had recently negotiated more transhipment traffic for the Port of Ngqura from Europe. He indicated some of the traditional sea trade routes, but noted that very large vessels, travelling at high speeds and therefore consuming a great deal of fuel, were needed to foil piracy off Somalia. For this reason, there had been interest in using a Mediterranean Sea to South Africa route. The South African Navy was appropriately resourced, through the Arms Deal procurement, to deal with those problems, as its frigates and aircraft were sufficient to deter piracy in South African waters. Although not reported in the Press, there had been unsuccessful attempts to capture vessels in South African waters, which were repelled by the South African Navy, and its reputation was improving because of that strong protection.

Mr Z Mlenzana (COPE, Eastern Cape) raised concerns of asset management and asked what relations Transnet had with municipalities. He noted that there were old Spoornet assets in some municipalities, and there was doubt as to whose responsibility they were, as they were apparently not handed over to municipalities for local economic development. He asked if Transnet had a record of these assets, and for information on what was happening in Qumbu, Mount Frere and Mount Ayliff  in the Eastern Cape.

Mr Molefe responded that one division that had not been operating well was Transnet Properties, which was in the process of appointing a Chief Executive, and needed to formulate a new strategy on how to deal with properties, especially those not properly used. He agreed that some hostels were over-crowded and not being maintained, that many houses in municipalities were empty, or were rented out, and hoped that there would be progress in dealing with them in the current year. However, some municipalities did not want to take over the properties, because of the costs of renovation and problems of overcrowding. De Aar municipality was worst affected, as the trains no longer stopped there.

Mr Mlenzana asked how much was being outsourced on the capital expenditure projects, and the impact of this on skills transfer at Transnet.

Mr Mlenzana was concerned about the Transnet shareholder compact. He asked what Transnet was doing on risk control environment.

Mr Molefe responded that the shareholder compact had been signed by the Ministry and Transnet, and the corporate plans had been finalised for this year and submitted to the Ministry on time. Transnet was on schedule to finalise its audit, and show the shareholder the audited financial statements, before announcement, and the Annual General Meeting was scheduled.

Mr Mlenzana referred to the internal audit overall assessment, noting that the comment had been made that improvements were needed on the operational side. He asked why those areas still needed improvement and what was being done to remedy the situation.

Mr Molefe said the issues raised in the last audit, for 2010/11, had been resolved during 2011/12.

Mr Mlenzana said there was a rail-gap between the Eastern Cape and KwaZulu-Natal. The Port of Ngqura was in place, and an Industrial Development Zone was established in East London, with another in KwaZulu Natal, and a port at Durban. However, there was no link to take cargo from road to rail, and a section of the rail line from Durban to Kokstad was closed. He asked what the plans were.

Mr Molefe stated that part of the problem was that Africans were cautious of using sea routes, although it made sense to transport by sea as it was cheaper than rail. He pointed out that two thirds of South African territory was the sea, and land was only one third. Water had enormous potential for economic growth and increased activity between the East and the West. He urged that children should be encouraged to swim at school, and develop careers on the sea, that South Africa should use the sea more for trade, transportation of goods and also for passenger vessels, gaining greater access to the rest of the world. South Africa should start thinking differently about the sea as a strategic asset and resource.

Mr Mlenzana asked about the fatalities and the costs associated with this.

Mr Sibande noted that during an oversight visit, the Committee had studied the Japanese train systems, and raised issues of cable theft. In South Africa, cable theft had increased from 41% to 51%, whereas in Japan cameras, public awareness and constant monitoring brought those incidents down.

Mr Molefe responded that cable theft had decreased in the last financial year. Transnet had recruited a former Crime Intelligence high-ranking official as head of Transnet Security, in a drive to reduce cable theft. It became apparent that 100% of Transnet security was outsourced, and the security companies were involved in the cable theft, with the copper being sold to China, and exported through the local ports in containers. Transnet was now buying scanners so that every container vessel driving through a port would be scanned, and be able to detect if the container was transporting copper, radioactive material, or contraband. This might not, short term, stop the theft, but it would not be exported from South Africa. Currently, thieves sold the copper scrap metal dealers, who, when they had sufficient quantities, would load it into containers for shipment to China.

Mr de Beer recalled that when the Committee visited Mbekweni, there had been several fatalities, and the community had requested a fence to be erected.

Mr Molefe said Transnet was building a wall in that area, between the community dwellings and the line, after two children were hit by a train. However, some of the community members would need to move, for the wall to be erected, and although the municipality had identified another place for them to go, it seemed that there was resistance.

Mr de Beer asked the reason for the decrease in revenue in the Pipeline Division in 2010/11. Mr de Beer said the Minister had announced that government wanted to engage the local authorities on the issue of the pipelines that went through the communities, so that those communities could benefit from the revenue raised. He asked how far that process had gone.

Mr Molefe said that was largely because of industry issues, that Transnet received less than projected. The pipeline was ready, commissioned and functioning very well.

The Chairperson raised concerns about on-time departures and arrivals, and their impact on productivity and efficiency, noting that the number of delays had risen.

Mr Molefe responded that GFB had improved dramatically over the past year. There was a 7.5% increase in containers on rail last year and, for the first time in the history of Transnet, more than 200 million tons of commodities were transported by rail. Over the next seven years, R200 billion of the R300 billion that Transnet was spending on Capex would be going into rail.

The Chairperson asked what Transnet was doing to involve communities and capacitate those who were most vulnerable, in the areas where Transnet was operating.

Mr Molefe said Transnet had not communicated its training programmes very effectively. Over the next seven years, R7 billion would go into training. There would be 2 000 artisans at Transnet at all times during the seven years. Transnet had not, however, advertised this effectively enough, and hoped to get the news out to constituencies, with the help of Parliament.

The Chairperson was concerned that there were only 0.8% disabled employees at Transnet. She also noted that the number of female employees had to increase, saying that the committee wanted to promote female engineers and technicians.

The Chairperson asked what Transnet was doing about its buildings in Nelspruit and other areas that had been vandalised, or were occupied by criminals.

The Chairperson thanked Transnet.

Committee Members adopted their Report on the deliberations.

The meeting was adjourned.