Transnet and South African Airways Financial Results: briefings

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Public Enterprises

12 October 2005
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PUBLIC ENTERPRISES PORTFOLIO COMMITTEE

PUBLIC ENTERPRISES PORTFOLIO COMMITTEE
12 October 2005
TRANSNET AND SOUTH AFRICAN AIRWAYS FINANCIAL RESULTS: BRIEFINGS

Chairperson:
Mr Y Carrim (ANC)

Documents handed out:
Treasury briefing: Financial analysis of Transnet financial results 31 March 2005
Transnet annual report presentation 2004/2005
South African Airways financial results presentation: 12 October 2005
South African Airways briefing: SAA Annual Report 2004/2005 (please email
[email protected])

SUMMARY
Transnet officials reported a major tunaround in their financial situation to the Committee. Their non-core businesses, notably South African Airways (SAA), had been shed. What remained was the bulk freight operation Spoornet which still constituted a major challenge, harbours where both South African Ports Operations (SAPO) and the National Ports Authority (NPA) were steady performers, and the pipeline company Petronet which did well. There was every chance that the good performance would be sustained in future.

Committee Members expressed concern about job losses due to business unit sales and streamlining of operations at Transnet; enquired into initiatives for treating HIV / Aids and suggested that the limiting of tariffs to bring them into line with world benchmarks should be pursued. The Committee was impressed with the performance of Transnet and congratulated the officials on the good work that had been done.

SAA officials reported that in 2005 the airline had responded well to major restructuring after an extremely torrid previous two years, but much hard work would still be required in an extremely challenging industry and times. They apologised for not managing the recent strike by airline employees well but were better prepared for the future.

Members expressed concern about problems with baggage being lost on SAA flights; the termination of flights to the Eastern Cape, and what they perceived as a lack of initiative in opening and/or increasing flights to overseas destinations. They were satisfied with the good results that had been achieved.

MINUTES

Transnet briefing
Mr F Phaswana, Chairman of the Board of Transnet, said that, compared to a year before, Transnet was in the favourable position of having cleared up the uncertainty about the respective responsibilities and powers of the Board and the chief executive officer. With clarity, it was possible to see ahead and start working and moving. The envisaged R40 billion capital investment in infrastructure would require large increases in implementation capacity. The challenge was to get it right in a particular time-frame.

Ms Maria Ramos, Group Chief Executive of Transnet, said that Transnet had become too unwieldy, with too high costs of doing business contributing to uncompetitiveness. The strategy adopted and approved in November 2004 was to focus on three core businesses: freight rail transport, ports and pipelines. Two other vital divisions were to remain with Transnet: Transwerk involved in rails, engineering and maintenance; and Protekon in project management. Everything else was to be migrated out of Transnet. The biggest challenge and opportunity was to turn Spoornet around. This would require considerable re-engineering and capital spending, with concomitant added capacity in skills and project management. The technical insolvency of South African Airways (SAA) in 2003 and 2004 was dealt with by Transnet infusing R4 billion, of which SAA had already repaid R1, 6 billion, as well as a credit facility and guarantee to SAA from Transnet of R1, 5 billion, The unwinding of MTN was in progress, and the South African Revenue Services (SARS) were soon to rule whether income or capital gains tax was applicable.

Mr Chris Wells, Group Chief Financial Officer of Transnet, took the meeting through the Transnet financial results for 2004/2005. The 6% rise in turnover for 2005/2004 indicated a 2% increase in real terms after allowance for an inflation rate of about 4% per annum. The large allowances for impairment of assets were made according to standard accounting formulae and could not be fudged. The operating margin of close to 13% was the best in at least 6 years. Transnet had not applied for relief, due to uncertainty and volatility, from the high (about 50%) tax rate for 2005. They would apply for deferred tax for 2006. The Transnet operating profit margin should in future stabilise at about 12%.

Ms Ramos announced that the prognosis for freight volumes to be handled by Spoornet was very promising. An expected growth in iron ore tonnage from 28 million to 41 million per annum was already contracted and might well be exceeded. Railing of coal could grow from 67 to 86 million tons in five to six years. General freight, which in the past amounted to more than 100 million tons per annum could increase from 86 million to 88 million tons per annum over the short term (2 years). The loss at Spoornet for 2005 was R21 million compared to R220 million in 2004.

Improving efficiency and developing human capital were major foci. Although Spoornet had to compete with road transport there was a lot of potential. The National Ports Authority (NPA) ran a very steady business, and South African Port Operations (SAPO) had delivered a strong increase in turnover, based predominantly on the handling of containers and vehicles. Petronet also performed strongly, with turnover topping R1 billion for the first time. Forthcoming regulation and the proposed new pipeline would influence future performance. A decision on the size of the pipeline (either 16" or 20" diameter) would be taken soon.

Discussion
Mr P Hendrikse (ANC), Dr P Rabie (DA) and the Chair enquired about the effect that the restructuring of Transnet, especially privatisation, might have on retrenchments and broad based black economic empowerment (BBBEE).

Ms Ramos replied that employees were protected by the Labour Relations Act. Consultation in camera with the Unions was ongoing. BBBEE was Transnet’s objective and everybody was informed up front of what it was. Assets were state assets and the best value had to be realised by their sale on a going concern basis. Road transportation was highly competitive and not core business, and passenger services could not be included. Transnet was most sensitive towards employees, but when businesses were running at a loss and were facing liquidation something had to be done. Most important was that Transnet should be instrumental in making the economy grow.

Mr P Maharaj, Group Executive: Strategy and Transformation of Transnet, said that the Labour Relations Act protected employees at the date of transfer. Head office restructuring had made 200 employees redundant. Particular benefits relating to leave and travel allowances were being renegotiated.

Mr C Gololo (ANC) pointed out that jobs were always lost, both when it went well or badly with business.

Ms Ramos said that, although everything in their power was done to minimise job losses, some job losses were inevitable. The number of head office employees grew and grew and there just was not enough work for them to do. An agreed social plan with the Unions was in place. The Transnet turnaround was not based on reducing the number of employees but on restructuring and only then deciding on employee redundancy. They had an aged work force and needed people with technical skills. A business like Transnet could not create thousands of jobs, but their clients would be in a position to do that if Transnet provided excellent services to them.

The Chair wondered why the proposed restructuring had not been done five years earlier, and Mr Gololo enquired about the HIV strategy at Transnet.

Mr Maharaj replied that they had an extensive wellness programme which included other diseases besides HIV and Aids. Their focus was on early identification, and a detailed actuarial study was being conducted for Transmed, Transnet’s medical aid scheme.

Ms D Ngcengwane (ANC) remarked that Transnet tariffs were high and enquired whether, in the case of speed of offloading, benchmarking with international counterparts like Brazil had been done.

Ms Ramos replied that tariff increases had on average been well below inflation. Transnet had a four-part strategy which focused on efficiency, reliability, safety and competitive tariffs. International benchmarks included Singapore, Hong Kong and Europe. Much IT was utilised to minimise time spent in loading activities, and every ship was seen as a business. Benchmarks for coal were Australia and Brazil; and for iron ore Brazil. They had negotiated successfully with the shipping companies to set aside their $100 fee on containers tied up in South African ports, which could have cost R1 billion a year.

The Chair said that the deadline for submitting an annual report to the Portfolio Committee on 30 September was too late and requested that it be advanced to 30 August. Ms Ramos replied that a PFMA deadline of 30 August was perfectly acceptable to Transnet.

Mr P Hendrikse tabled questions relating to the case where a Board member had been doing private business with Transnet; whether Transnet had qualms about the situation where road transporters, in competition with rail transport, were not bearing the cost of the road infrastructure which they were utilising; and whether there was any thought given to the sad situation of no rail transport for passengers between Cape Town and Port Elizabeth. Why was Arrivia.com sold off?

Mr Phaswana replied that Board members and Executives now had clear performance contracts. A shareholder compact with the Board was in process for completion in the following year. Board members had to declare interests, and suitable protocol, vigilance and governance were exercised. Transnet had to reduce the cost of doing business. Risk management was imperative.

Mr H Bekker (IFP) recommended that the larger (20") option for the proposed pipeline should be adopted as it would have 50% more capacity than the smaller (16") one.

Ms Ramos said that, although Transnet were not subsidised and paid a lot of tax, they did not want to hide behind legal protection for road transporters. Metrorail was a separate entity for passenger transport. The pipeline project had not been delayed as environmental impact assessment and technical studies were still being conducted. Construction was envisaged for 2008/10. Their policy was to use their own people to build expertise in capital expenditure where feasible, but available expertise was limited as the previous project in this field in South Africa had been 40 years before. Some components such as cranes and locomotives had to be imported.

Mr Hendrikse asked what was the main cause(s) for the phenomenal turnaround in the impairment of assets entry in the consolidated income statement. Ms Ramos replied that new accounting standards and the exchange rate volatility combined were responsible.

Mr Wells said that interest cover in 2005 had doubled and that they were aiming at increasing cover to three times. Two-thirds of the capital requirements of R40 billion would be covered by income from operations, and the remaining R12 billion, added to R13 billion for loan redemptions, would take the capital requirement to R25 billion. This was, however, a worst-case scenario and could well be vastly different. R30 billion of debts were short-dated and were going to be better matched to the duration of the assets.

Ms Ramos said that, although SAA had been divested from the new Transnet, it remained in the Transnet stable and would be given continued support. PFMA non-compliances in previous years would not persist. A sustainable solution for the pension fund would be achieved at the end of 2006. The unbundling transfer of SAA would be technically completed by 31 March 2006, but the required legislation might not be ready then. There were no short-cuts to a successful turnaround of Transnet and there was still a long way to go and the hard work had only started.

SA Airways briefing
Mr K Ngqula, President and Chief Executive Officer of SAA, said that to complete the turnaround of SAA would take another three to four years. Major setbacks for the airline had been the sharp rise in the price of oil and thus fuel; Hurricane Katrina and the SAA employee strike. Shareholders were not making money, though banks, manufacturers and everybody else in the industry were. They had learnt lessons from the strike and the prospects were exciting in this dynamic sector. The challenge was for them to grow capital and reserves, and their position had improved substantially, but they needed support. Most airlines were owned by governments which made it hard to exploit new markets. They were positioning themselves to get into Zimbabwe first, as soon as conditions improved. Gaining more access to Africa was their main strategy.

Discussion
Dr Rabie asked which countries in Africa were the most profitable for SAA, and whether the highly successful Singapore Airlines owned or leased their airplanes. Dr Ngqula replied that they owned most of their airplanes. The best African country for SAA to do business in was Angola. Ghana was also good, and Nigeria was the biggest and second best. SAA was aiming to increase their percentage of African cargo from 10% to 20%.

Ms T Ramano, Chief Financial Officer of SAA, explained that the profitability of the SAA flights to Angola was partly due to the fact that they slotted in between the London-Johannesburg and Johannesburg-London flights. The international norm for airplane ownership was 60% owned and 40% leased, while at SAA it was 100% leased. Claims from passengers for lost baggage had been R10 million during 2004 and R5 million in 2005. It was deducted from the payment to baggage handling companies. Baggage handling was still a big challenge, but the SAA were working towards the slogan: safe, arrive, nothing lost. The SAA had adopted a 30-day policy for settling of both accounts owed and receivable and had saved R749 million as a result of this policy.

Mr Hendrikse deplored the termination of the SAA flights to the Eastern Cape through the Nelson Mandela Metropole, especially as tourism was adversely affected. What was the practical meaning of the fact that SAA called themselves the national carrier? Would the surcharge on tickets for the higher fuel price be lifted when fuel costs went down? What was the loss in money and seats due to the recent strike, and why had the management of the strike been so poor at least in the eyes of the public? Complaints to SAA public relations invariably met with complete denial. What caused the high executive turnover? Had the removal of 7% commission to travel agents resulted in lower airfares? More flights to and from Atlanta and the United Kingdom were required.

Dr Ngqula replied that ticket prices had been reduced by 4% as a result of the scrapping of the commission. A national carrier had to insist on serving viable destinations. Low-cost carriers had a niche at one end of the market. Entering new markets was complex because the government-owned airlines protected their own turf. SAA worked closely with SATOUR to promote tourism. In 2005, the executive turnover was not an "exodus". Only one executive left to pursue other interests.

The Chair expressed the opinion that the strike had not been handled well, because the public was angry with the management and not the unions. How sustainable was the turnaround in view of the consistently high oil price? Why were these changes not effected earlier? Apartheid could no longer be blamed for what went wrong. The United Emirates wanted flights between Cape Town and Dubai.

Dr Ngqula stressed that viability was important when considering new routes. He apologised for the poor handling of the strike, and explained that they were learning, and did not communicate well with passengers. The strike was the first one in 71 years of operation. SAA, with a 70% market share, used to have a monopoly and was not prepared for competition. They were carrying 3000 too many employees out of 11 000. The Unions and the Board were running the airline.

Ms Ramano announced that the Government would decide what to do about the "illegal" sale of aircraft and bonuses of R100 000 paid out after a loss of R15 billion in two years. The strike cost R150 million, but an 8% salary increase would have meant extra expenditure of R1, 6 billion over 10 years. The sharing of lounges was allowed only with Lufthansa and Delta, but after the alignment with STAR it would be extended. Electronic sales were cheaper because paper tickets cost money, and would be the norm in a few years’ time. They were "cleaning up" by re-negotiating leases and levying surcharges to cover the rise in the oil price.

The Chair congratulated SAA on their overall strategy which he considered to be good in a very challenging industry and times. He welcomed the turnaround.

The meeting was adjourned.

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