Transnet Strategy and Challenges 2003/2004: briefing

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Public Enterprises

19 November 2003
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PUBLIC ENTERPRISES PORTFOLIO COMMITTEE

PUBLIC ENTERPRISES PORTFOLIO COMMITTEE
19 November, 2003
TRANSNET STRATEGY AND CHALLENGES 2003/2004: BRIEFING

Chairperson:
Mr B Martins (ANC)

Relevant documents
Transnet Corporate Profile(awaited)
Transnet Annual Report 2002/2003(will be available shortly at
www.transnet.co.za)
Transnet Strategy and Challenges 2003/2004 Presentation
News articles from Business Day - 20 November 2003 (Appendix)
Public Enterprises Portfolio Committee Annual Report

SUMMARY
Transnet designate Chief Executive Ms M Ramos gave a presentation on Transnet's corporate performance, its strategy in terms of restructuring and financing, and the challenges it faces in fulfilling its profitability and development imperatives. The 2003/4 budget reflected a funding shortfall of R9, 5 billion. The solvency and credit profile of company is deteriorating and this would have an impact on its investment programme.


Questions around Transnet's pension fund issue, the financial losses suffered by South African Airways were discussed, as were issues of the Transnet turnaround strategy and the importance of solvency in Transnet's investment programme. The Chief Executive contended that there was a long road ahead of them and that they needed to focus on cost containment vigorously.

The Committee's Annual Report was presented and approved.

MINUTES
Transnet Group Presentation
Mr M Mkwanazi (outgoing Transnet Chief Executive) thanked the Committee for assisting Transnet in his years as Chief Executive, in particular with the transformation of the organisation. Six black executives of Transnet had been instrumental in making significant changes to the organisation, and this had been facilitated by the positive influence of the Committee.

Ms Ramos (Transnet Chief Executive designate) gave the presentation on Transnet's Strategy and Challenges for 2003/2004. She discussed Transnet's mandate, strategic objectives, performance to date and budget. The investment requirements and core challenges facing Transnet in the future were described (see Powerpoint presentation).

She outlined Transnet's Strategic Objectives - its "14 Point Plan". Part of the business challenge for Spoornet was how to increase its market share. A snapshot of the performance to date was provided. The derivative losses for 2003/04 would amount to R2.3 billion, primarily due to South African Airways where they would amount to R1.8 billion and about R500 million from the rest of the Transnet group. Investment spending was below budget and this would impact on delivery.

Ms Ramos emphasised that Transnet had a big set of objectives that it had to deliver on but it could not deliver on these if it was not solvent. In putting the solvency challenge into context she explained that investment plans were highly significant as there was not much more space to finance through borrowing. The Group was also in the process of finalising solutions for dealing with the post-retirement liabilities.

Ms Ramos continued that Transnet had enormous potential but also huge challenges and they would have to think creatively and explore a number of different options including private public partnerships. Currently the ratios between debt and equity were not correct; however, these challenges could be overcome and turned around to achieve both improved profitability and the developmental goals of government.

In terms of the economic efficiency of the company, Ms Ramos felt the Group needed a more realistic cost structure, and quoted the concern of the CEO of Spoornet as to whether their asset base was being effectively used. Ms Ramos stressed that the major shareholder of Transnet was the government, and the South African people by proxy. She had no tolerance for lack of corporate governance and corruption, and a strong code of ethics was fundamental to any business and even more so to a business whose shareholder is government. The restructuring process of Transnet had to be intensified and a closer look at the core asset base was critical in order to see how overhead costs could be cut. She noted the importance of increasing safety and reliability for customers while realising an ethical, efficient and effective organisation.

Discussion
Mr J Theron (DA) welcomed Ms Ramos and wished her well in her new post. He asked how far Transnet was with the required turnaround strategy. He noted that, according to written correspondence he had received, the pension increase was a mere 2% and asked what could be done in the light of this insufficient increase to pensioners.

The Chair felt that it would be useful if Mr Theron could provide these letters as a point of reference.

Ms Ramos replied that the strategy was embodied in the fourteen-point plan that she had outlined in the presentation. There were many details behind these points, and the executives still needed to examine these in order to be certain that they addressed the needs of the shareholders.

With respect to the pension fund, Ms Ramos responded that during the 1999/2000 period, the single pension fund was split into three separate funds. The problematic fund was the closed defined benefits fund, with 96 000 beneficiaries. Because it was closed it could only pay out from revenues generated from its investments which was not sufficient to meet its demand. The allocation of these investments did not match the liabilities of this fund, and that was the essential problem. If one of the pensioners remarries, the new dependent or dependents automatically become members of the pension fund, thus causing disproportional liability. There was therefore no stability on the liability side of the fund as no new cash flows came in. They were working on strategies that would address the funds asset allocation. However, the issue had to be approached cautiously as there was a growing liability involved and in the last few years the increase had been 5%. They would try to deal with the containment of liability by changing the asset structure in the Fund. The rules of the fund presently prevented an increase in the two per cent increase in payouts.

Ms S Mabaso (Transnet Chief Financial Officer) confirmed this last point.

Mr M Sibiya (IFP) asked Ms Ramos to elaborate on the impact solvency problems could have on the investment programme.

Ms M Ramos explained that you had to finance investment somehow. There had to be revenue. If you could not borrow anymore and you did not have the capital equity, you could not invest. That is why this was so important. No one would be willing to lend you more money and you would have a tough time delivering. Tough decisions lay ahead to get an improvement in financial ratios and to contribute positively to government strategies.

Mr J Louw (ANC) asked to what Transnet could attribute the R1.8 billion loss for SAA because two years previously the events of 11 September was given as the reason for losses incurred.

Ms M Ramos said that from an operational point of view, the core business of SAA was quite healthy. They were a world class airline. SAA had undertaken an ambitious fleet replacement programme and 56% of its costs such as jet fuel are in dollars. They had thought they needed to cover their dollar exposure through hedging. However its profitability had been affected by hedging losses when SAA hedged against a weaker rand, but instead the rand appreciated. SAA covered forward all its costs but did not cover its revenues. Although it is a sound world class airline, its profitability is being impacted on by large financial loses due to the exchange rate.

Mr C Frolick (ANC) expressed his surprise that, although two "issues" of the ring-fenced pension fund and South African Airways had dominated discussions with Transnet over the past five years, neither had been resolved.

The Chairperson thanked the outgoing CEO, Mr Mafika Mkhwanazi, for his contribution to Transnet and for his constant willingness to being of assistance to the Portfolio Committee. He wished him well and extended a warm welcome to the new CEO, Ms Maria Ramos.

Committee Annual Report: 2003
The Public Enterprise Annual Report was tabled for adoption before the Portfolio Committee. Mr Theron (DA) proposed that the Annual Report be Adopted. Mr Frolick (ANC) seconded the proposal.

The meeting was adjourned.

Appendix: News articles from Business Day (20 November 2003)
Transnet choking on R33bn debt burden


Ramos says parastatal struggles to remain solvent, projects in jeopardy

Political Correspondent

CAPE TOWN Cash-strapped Transnet, overburdened with rising debt in the face of a strong rand and having almost reached the limits of its borrowing capacity, is struggling to remain solvent, according to CEO-designate Maria Ramos.

Unless its solvency was improved drastically, the parastatal could not embark on its planned multibillion-rand infrastructure investment programme over the next five years, Ramos said in Parliament yesterday.

This could severely undermine government's plan to use Transnet to invest in upgrading ports, roads, rail and other transport infrastructure. Good transport links were vital for government to meet its goal of exportled economic growth.

"The solvency and credit profile of the company is deteriorating," Ramos told Parliament's public enterprises committee. Unless solvency improved and more than R32bn in debt reduced, it would be difficult to finance investments as "there is not much space to finance investment through borrowings". Government, too, had no capital to inject into the group.

Adding to the parastatal's woes is a R2,3bn increase in its derivatives losses this financial year predominantly incurred by South African Airways. They totalled R6bn at the beginning of the year and have risen to R8,3bn, partly because of the rand's strength against the dollar.

The derivatives are long-term contracts, but Ramos said R1,4bn of the loss had already been realised this year and had affected the group's cash flow.

Ramos, who takes over the reins as CEO in January, said achieving the long-term financial sustainability of the group would be a tough challenge.

"Critical financial ratios are below minimum requirements," she said. Interest payments were covered only 1,2 times by net profit before interest costs, instead of the preferred two times, and gearing had risen from 58% last year to more than 65%.

Transnet's debt of R32,6bn had to be reduced by R15,5bn to R17,1bn to bring it in line with the group's equity. But post-retirement liabilities in the defined benefit fund of R5,5bn were increasing as pensions had to be paid to 96000 pensioners. The fund had an inappropriate investment portfolio and had suffered from the decline in equity prices.

A radical cost-cutting exercise was in the offing, Ramos said, with head-office expenses the first in line to be pruned. Unprofitable parts of the business would either be closed or sold off. She said that retrenchments would be the very last option considered.

Utility's debts a threat to infrastructure plans


Transnet CEO-designate Maria Ramos warns credit, solvency crisis put programme at risk

Editor at Large

TRANSNET's big debt burden has long been its greatest challenge. CEO-designate Maria Ramos sounded a warning in Parliament yesterday when she said the solvency and credit profile of the body had deteriorated to the extent that its infrastructure investment programme was now in danger.

The indebtedness of the state-owned transport utility is in part because of inefficiencies, but is also the result of Transnet striving to improve its profitability while seeking to meet the socioeconomic imperatives of government.

The most recent example of this is its capital investment drive, which will see an estimated R45bn ploughed into infrastructure and equipment in a 15-year period. This is part of government's bid to ratchet up economic growth by exports.

For the export drive to succeed, SA needs an efficient transport system. The ports, rail network, road system and airline market must all work smoothly to ferry goods and services nationwide.

There has been massive underspending on infrastructure for decades, so all these transport modes need to be overhauled to meet government's goal.

While Transnet's cash flow from operating activities has improved of late, increasing to R5,3bn in 2002-03 against R2,4bn the previous year and R925m in 2000-01, it is insufficient to meet investment needs. So the utility will need to borrow further to fund its capital investment drive.

The problem is Transnet is heavily indebted, to the tune of R32bn on turnover of R42bn. Borrowing further will be difficult. Gearing has come down from the 72% level seen in the mid-1990s. It fell to 52% in 2001-02 but rose to 58% in 200203 against an internal target of 54%.

Chief financial officer Sindi Mabaso has warned gearing will climb because of the requirements of the capital expenditure programme.

Clearly, the situation is unsustainable, when considered in tandem with the R6bn hedging losses of Transnet subsidiary South African Airways (SAA), and the continuing pension fund liabilities.

Government and Transnet spent several years restructuring the original ailing pension fund in a bid to remove onerous annual payments related to the T11 bond issued to mop up the deficit.

In June it emerged that one of the newly created pension funds faced a cash crunch. Pensioners have now urged the public protector to look into the state of the fund, amid claims it has sustained losses of R4bn during the past two years. Transnet's plan was to top up the fund.

Ramos stressed in Parliament yesterday that the core of SAA's business was operationally sound but its profitability had been affected by its hedging losses. She felt SAA had not been prudent in betting on the movement of the rand in one way only. SAA hedged against a weaker rand, when in fact it appreciated.

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