Transnet briefing

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Public Enterprises

13 October 2004
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Meeting report

 

PUBLIC ENTERPRISES PORTFOLIO COMMITTEE
13 October 2004
TRANSNET BRIEFING

Chairperson:
Mr Y Carrim (ANC)

Documents handed out:
Transnet PowerPoint briefing
Transnet Annual Report 2004
Transnet Year-end results

SUMMARY
The aim of the first half of the meeting was to inform the Committee Members of the status of the transport market, and about Transnet’s strategy. The Chief Executive Officer of Transnet outlined the problems and strategies of the following arms of Transnet: Spoornet, South African Port Operations, National Port Authority, Petronet and South African Airways. Their strategy was geared at reducing the cost of doing business in the country and to establish South Africa as competitive in the transport sector. A major part of this restructuring entailed cutting jobs and making Transnet and all its other institutions more efficient.

In the second half of the meeting, Committee was briefed by Transnet on its recently published Annual Report and proposed strategic plans for the Group as a whole and Spoornet in particular. Detail was provided on key issues within the financial statements and reasons for poor performance in certain cases. Concerns were raised over future accountability of the Board and the continued financial difficulties of key components such as SA Airways. Remuneration within the Group was discussed as was future interaction with the Portfolio Committee.

MINUTES

Transnet briefing
Ms Maria Ramos (CEO Transnet) stated that in 2003 alone there had been 745 million tonnes of goods imported into South Africa and the bulk of these goods were in the mining and manufacturing sectors. This 745 million tonnes results in a total transport cost of R135 billion to the South African economy. The biggest portion of this cost is attributable to long haul road transport that is a more expensive form of transportation. She noted that the last decade had seen growth in road traffic while rail traffic had declined. Shifts in the South African economy means that there are some changes that have to be made to ensure South Africa’s competitiveness in the market. Transnet’s strategic direction is to focus on rail and ports operations and focus on improving the key corridors and clusters. Their integrated strategy is focused on ensuring that Transnet provides an efficient transport platform that facilitates trade growth in South Africa. Its strategy entails vertical separation, infrastructure planning, head office restructuring, divestment and operational synergies. At the heart of the turnaround plan is the operational efficiency that will reduce supply chain costs.

Spoornet briefing
In world terms, Spoornet was a smaller freight based railway, seeking to leverage heavy haul technology. On the African continent however, Spoornet was a large railway business and is the most significant player in Africa. A look at the statistics showed that Spoornet was a stagnant and dying business unless changes are made to the institution. In terms of resources there have not been any investments and the business is not growing. The Chief Executive Officer, Mrs Dolly Mokgatle, focussed on operation efficiency by getting more of management to go out into the field to try and identify problem areas. Their strategic focus was customer service, operational efficiency, safety and profitability.

South African Port Operations briefing
For the past two years the focus of SAPO had been on splitting itself from NPSASA, setting up systems, corporate offices and creating an independent and sustainable SAPO culture. Revenue for the 2004/5 financial year was R3.2 billion and SAPO is expected to grow by 9% per annum. Key in the strategic objectives was to anticipate market demand in order to timeously plan and create capacity in line with UNCTAD standards.

National Ports Authority briefing
The main aim is to make it a world-class port system. With the changes that are going to be made they hope to see more big liners and traffic coming into South Africa. Its future role is to set, monitor and sustain efficiency standards to meet customer expectations. It is to play a key developmental role in furtherance of national and regional objectives of economic growth and sustainability, country competitiveness and broadening the economic base. The main challenges faced by the organisation are the reduced tariff income versus the increased capital investments, which are expected to be R16.3 billion for the next five years. Ms Ramos noted that they needed to look at the cost structure inside the business. The other challenge is to lower the cost of doing business.

Petronet briefing
Petronet’s core business is the bulk transportation of energy. Petronet transports approximately 40% of the SA refined product fuel requirements and 100% of the Natref refinery’s crude oil requirements. Ms Ramos noted that all the above entities contributed positively to Transnet. South African Airways (SAA) and the other entities under Transnet however were liabilities.

South African Airways briefing
South African Airways’ new fleet was set to ensure that its products and services will be world class. South African Airways owned seven of its planes and the rest were leased to them. In two years SAA has lost R11 billion worth in hedging deals.

Discussion
Mr Manie (ANC) noted that it appears as if reducing the cost of doing business in South Africa was a key component, but if government was the single shareholder in Transnet, then Transnet should align its mandate with that of government and still consider the social responsibility of Government. He asked how Transnet strategically linked with government.

Ms Ramos noted that what Transnet had to do was to ensure that it was the backbone of South Africa’s economic development. The way Transnet was being run previously was not effective and there was a need to reduce costs of doing business in South Africa and to get growth and development in the economy. She noted that Transnet needed to look at its competitors like Australia and Brazil and see how they managed to have their costs lower than South Africa.

Mr Manie (ANC) asked how the PFMA would be applied to those entities responsible for losses and non-compliance.

Ms Ramos noted that it is up to the shareholders to hold the Board accountable and in turn for the Board to hold the Chief Executive Officer accountable. She said government must set out the risks they want to manage at an aggregated level.

Mr Manie (ANC) asked about the role and responsibilities of the boards and who is acting on behalf of government and what is happening to ensure that government’s mandate is furthered.

Mr Manie (ANC) asked how Transnet exercises its oversight duties over all these bodies and how they report to reach other and come to decisions.

Mr Manie (ANC) referred to Spoornet’s R600 million loss and asked what was going to happen to turn things around.

The Chair asked Ms Ramos to explain how Boards can get away with what they do and what can be done to minimise this irresponsibility.

Mr H Bekker (IFP) asked for the cause of the train crashes experienced by Spoornet in the past year. He asked if the accidents were a result of the old signalling system and if so whether the use of the new electronic systems had improved conditions and if the accidents would have been avoided had the electronic signalling system been in place instead. He also asked if this introduction of the electronic signalling system was an integral part of the upgrading process.

Mr H Bekker (IFP) asked what the tonnage is that is being returned from Richard’s Bay to Mpumalanga and whether there have been innovative ways to use the space on these trains.

Mr I Davidson (DA) noted the losses on the hedging side as an international phenomenon. He asked Ms Ramos to explain what she meant by stating that they intended to make a profit and generating an economic return for government. He also asked where Transnet intended getting the R30 billion investment and how they would restructure to be able to get this financial investment.

Mr I Davidson (DA) noted that on the point of operational efficiency labour was a main concern but he wanted to know what other factors Transnet was looking at.

Mr I Davidson (DA) asked Ms Ramos to explain the vertical separation of Transnet operations that Ms Ramos had referred to and whether there was a time limit to implement this separation.

Mrs Kondlo (ANC) asked how many jobs Transnet would create and how the turnaround strategy would ensure that it would not compromise poverty and job creation.

Ms Ramos said that on its own Transnet will not create jobs but will contribute to a more efficient and effective economy that will create jobs. One of the reasons for the job losses was that the business had not grown and Transnet would not resort to sheltered employment because this would not result in the growth of the economy.

Mr Hendrikse (ANC) asked what impact the change in oil price affected the hedging by SAA. He also wanted to know what the repercussions were for the decision-makers of SAA.

Ms Ramos noted that hedging is about risk management and that the best hedging position should be one where exposure is minimal. She noted that hedging now is more holistic, the decision is made after looking at what the net currency exposure was and then it was decided how much of this will be covered. She noted that the ratio this time was definitely smaller than before.

Mr Hendrikse (ANC) asked from whom SAA was leasing their planes and who would own them once the lease period had ended.

Ms Ramos said that they leased these planes from domestic and international specialist leasing companies.

Mr Hendrikse(ANC) asked how the selling of the housing books would be beneficial to Transnet as they would not get R3 billion that they had loaned to the employees on selling the books.

Ms Ramos noted that it was capital that was tied up and it would generate some cash for Transnet. It would also mean that there would be no capital exposure for Transnet going forward and Transnet would not have to manage these loans.

Mr Hendrikse (ANC) asked whether the remuneration the CEO’s received was commensurate to their responsibilities.

Ms Ramos noted that their comparator for remuneration was the private sector and not the government. They were aiming for 50% of the private sector pay scale. She noted that the CEO’s of Transnet had taken a 0% pay increase and had also forgone bonuses because of the state of the companies.

The Chairperson asked how Transnet intended to align the Port Authority and NPA. He also questioned how Transnet decided what went into road and what goes on the rail. He lastly asked about the projected job losses.

Ms Ramos said she could not give an exact figure of job losses. Transnet’s approach was to look at the business, develop a strategy and minimise the job losses.

The Chairperson asked what the best debt equity ratio was.

Spoornet briefing
After the lunchbreak, Ms D Mokgatle (Chief Executive) stated that information was provided on proposed strategies to improve the efficiency of the overall operations making better use of limited investments and existing infrastructure. Spoornet was handicapped to some extent by a single line system which hindered increased utilisation of resources. Advances could be made with better scheduling of rail traffic and investments in locomotives. Loops existing on the present railway line system would be exploited to increase frequency of traffic. New locomotives acquired would be equipped with the latest technology to improve communication with controllers. Three main reasons were provided for the current losses experienced by Spoornet, namely, change of commodity prices with the iron-ore contract, high operating costs and an increase in maintenance costs.

Spoornet has engaged in a re-strategisation programme to identify all the key issues undermining efficacy of operation focusing on pertinent business principle responses. Unacceptably high accident rates within marshalling yards had to be addressed in order to rectify the loss of operational oversight. An ageing workforce and loss of valuable skills had contributed to the weakening of the business. Improved safety of workers and commuters was a priority as well as an injection of fresh skills. Embedded inefficiencies need to be rectified. A key component of the strategy was to better understand the needs of the customer base. Resources will now be applied in greater amounts to key business targets generating increased returns on investment. Maintenance and refurbishment will also be considered where appropriate. Increased rail traffic is sought at the expense of current road transportation attracting new business partners.

Resources will be applied in a segmented fashion focusing on large paying customers. Small irregular consignments could be catered for by means of road services allowing rail to handle large consignments. Spoornet tended to operate on a regional basis in the past with local tightly controlled operations and little co-operation and teamwork between sections. Local accountability and leadership of such operations needed to be restored to promote co-ordination and the total value chain. Wasteful expenditure had to be curtailed in accordance with the requirements of a new systems architecture. A National Operations Centre would be established to consider effective planning and monitoring of implementation in a holistic manner.

Discussion
The Chairperson asked that Spoornet return early in the new year to provide a more detailed account of the proposed strategy and further developments.

Mr S Manie (ANC) stated that the challenge for the Committee in the future lay in translating the broad concepts presented by Spoornet into clearly identifiable and manageable issues capable of monitoring and oversight. Implementable and measurable plans were needed to assist in this regard detailing targets and timeframes. Such information would be needed at the next meeting.

The Chairperson concurred that a plan was essential to ensure competent oversight. A shorter summary of the Annual Report would also be beneficial for the Committee highlighting salient points to be considered. The Committee remained acutely aware of the persistent challenges facing Transnet and desired a co-operative working relationship with the group. The involvement of the Committee in the group’s relationship with shareholders was an important issue to be discussed in future.

Transnet Annual Report
Ms M Ramos (Group Chief Executive) said that the Annual Report and financial statements had been produced in accordance with the Companies Act and the Public Finance Management Act. A summary of the Annual Report was provided with detail on key areas. The financial results indicated a low profit margin with emphasis on hedges incorporated. Key factors that impacted on the income statement were emphasised including asset impairments. Cash flow and capital reserves were down and total debt –to equity increased. Turnover increased but so did expenses. Hedges were closed off on 30 June 2004 with residue expenses. SA Airways experienced a large adjustment in aircraft valuation due to a drop in the market value of aircraft caused by exchange rate differentiations and the poor airline business environment. The book value of aircraft tends to become outdated over time. Market value of aircraft tended to be lower than the value in use.

Transtel engaged in numerous investments and its related single network operating value has been reduced by approximately R500 million. The valuation of derivatives had been affected by new accounting legislation reflected in AC133 requirements. Contracts existing within the Spoornet component are affected by two elements namely the rand/dollar exchange rate and the price of iron-ore which involve operating risk and can adversely affect embedded value of the contracts. The parlous state of the global airline industry was mentioned with regard to SAA’s figures as well as rising oil prices and the high cost structure, in particular expensive leases with high breakage costs. Adjustments have been made to the retirement and medical fund provision. The Group sought to understand the quality of its earnings excluding adjustments that had to be made with new accounting procedures etc. Close attention was paid to the consolidated balance sheet focusing on equity and reserves and current liabilities. Factors impacting on the balance sheet were considered and the concept of fair value adjustment.

he valuation process regarding embedded derivatives was explained emphasising the difficulty of predicting exchange rates and commodity prices. However, an option does exist to renegotiate certain contracts which will be utilised. Losses regarding derivatives must be recognised on the balance sheet until embedded liabilities have been expunged. The increase in current liabilities was explained due in part to the difficulties facing SAA which involved a cash injection of R6 billion. Much of this was used to close off the hedge book. Presently, the net forex exposure of SAA is $100 million which is a significant reduction. Loans are being converted into equities to improve the overall financial position which results in improved capitalisation. Cash flow statements were provided and a breakdown of the overall business structure was discussed. Reasons for underperformance were provided and the core of a turn-around plan was expressed. The key to a meaningful strategy is implementation with workable ideas. Existing perceptions, cultures and practices have to be challenged and skill levels increased within the staff component. The turn-around strategy will take time and success will not be immediate.


Discussion
Mr Manie requested that a summarised version of the Annual Report be provided to the Committee in future to assist in understanding the overall implications of developments. The Annual Report refers to the Group and the Company with different figures and clarity was requested. Removal of implications of the rand/dollar exchange rate made the financial position appear more satisfactory which provides hope for the future. What steps would be taken to avoid a repeat of similar mistakes regarding ill-judged investment decisions? Would the Board of Transnet as the accounting officer remain committed to their fiduciary responsibilities? How would control be exercised over the myriad of companies within the Group by only engaging in regular meetings? The performance of each entity had to be evaluated and this appeared problematic. Could a performance related agreement be drawn up between the Board and the various entities indicating key performance areas? With regard to the performance management within the public sector, more attention needs to be given to disciplinary action relating to non-compliance and non-performance.

Mr I Davidson (DA) commented that benchmarking the performance of SAA to American and European industries was unfair as profits were being generated overseas and America had an over-traded domestic market. SAA suffered from incorrect cost structures. With regard to the hedge book and impairments, the cost of reducing the hedge would be reflected in the 2005 statements. What was the projected figure for the current year regarding impairments? The costs of wrong decisions had to be considered such as the decision to buy aircraft at a particular rate which resulted in impairments. Why are aircraft bought and then leased six months later? The further cost of capitalisation of SAA of R4 billion would be reflected as a liability which decreased the debt/equity ratio. The debt seemed to be increasing and write-offs still to be made. No profits were being made and the source of further capital infusion was questioned.

Mr P Hendrickse (ANC) sought clarity on the retirement funds situation and the impact of increased revenue on bonuses paid. The previous Board did not exercise its fiduciary duties and the current position of previous Board members required clarification.

The Chairperson stated that the Board still had to meet but the new Chairperson was invited to make comments if desired. Assets within Transnet were not being used properly and problems existed within State Owned Enterprises. Transnet was complemented for the openness and transparency of the Report and he reiterated the Committee’s understanding of the challenges facing the Group. The key was deciding on appropriate measures to avoid future mistakes. The declared earnings of management was applauded.

Ms Ramos stated that the management team was making sacrifices regarding remuneration and no increases were made in salary and no incentive bonuses were awarded. The points made by the Committee were valuable regarding the dissemination of information and financial statements in a more simplified way. The new accounting standards caused the management team to recognise the risks inherent in the operations and it was important not to hide risks. The overall declining position of the business remained a concern. The debt/equity ratio was problematic and the financing of improvements was a key issue although a positive response had been received from potential investors. The balance sheet had to be cleaned up and innovative ways found to recapitalise such as converting loans into equity. The future of certain assets could also be considered.

Mr P Maharaj (Group Executive- Transnet) stated that Transnet contained many operating divisions and each had to be accounted for. Included would be subsidiaries in which Transnet owned a stake and these had to be accounted for by the Group. A consolidated report had to include all the SOEs for the benefit of shareholders. Inter- company transactions are eliminated from the report.

Mr Manie asked where and how the consolidation occurred to capture all the performances of the subsidiaries.

Ms Ramos referred to an Annual Report tabled by SAA which had to account for divisions within the statement.

Mr Manie referred to annexure C of the Annual Report which listed all the subsidiaries. Would these form part of the Group as a whole but operate as companies in their own right? How would one exercise oversight over these entities?

Mr Maharaj declared that each of those companies would have individual financial statements that would be utilised in producing a consolidated report.

The Chairperson claimed that the Committee would have to be strategic in how oversight was carried out as many entities existed. Care should be taken on not taking on too much responsibility that could not be realised.

Mr Maharaj stated that a fair evaluation of assets was required in accordance with the market value. The valuation of assets on a regular basis had to occur in order to provide a true reflection of the financial status. The value of assets could increase or decrease depending on the current position of the market.

The Chairperson of the Transnet Board noted the open nature of the discussion and the visible level of trust between the participants which created a sound working foundation. The underlying business of Transnet remained strong and full of potential. However, the financial aspects of the business were important and the Board would consider this. Transparency of accountability was of paramount importance with each roleplayer clearly identified and understood by the Board. Plans and strategies have to be measurable and practical in order to ensure meaningful evaluation. A major challenge was to change the culture within the Group as a whole.

The Chairperson stated that the Committee was encouraged by the progress achieved in devising new approaches and strategies. The Committee remained open and accessible to discussion with Transnet on a regular basis.

The meeting was adjourned.




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