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Denel Consolidates

September 20, 2017

In a year of challenging economic conditions, Denel, like many South African government owned companies and parastatals, received negative publicity due to alleged links with the Guptas – a joint venture with VR Laser Asia. On 25 August, at the company’s annual financial results announcement, Denel explained that the joint venture had been exited, that the company continues to make a profit and maintain its revenue, but that consolidation has been necessary.

 

 

 

Denel’s 2016/2017 financial report is “better than expected,” according to Acting Group CEO, Zwalekhe Ntshepe. The company managed to maintain revenue levels above the R8 billion mark, despite recording a 2.5% reduction – from R8,228 billion to R8,057 billion – in turnover from 2015/2016. Exports increased by 5%, and the company says its future business outlook is bolstered by strong orders in the pipeline in excess of R40 billion. However, these orders are not secured, and the order book is currently sitting at R19 billion, down from R30 billion in the previous year. Odwa Mhlwana, Group CFO, says that for Denel to maintain profitability, the order book needs to stay over R30 billion. Thus, Denel is under “strained liquidity” and is battling on a day-to-day basis with working capital.

“Profitability continues to be satisfactory and exceeded set targets by 9%, posting a total of R333 million in net profit after tax (NPAT). Return on sales dropped slightly from 4.8% to 4% over the past year. Year-to-year maintenance of profitability was achieved despite a reduction in sales in real terms (inflation factored). The Group is embarking on a strategic drive to further reduce the operating expense percentage to sales, currently at 18%, towards 14%. With the tough and volatile international trading conditions, Denel retained profitability despite a forex loss of R232 million booked for the year. The current debt to equity ratio of 1.2:1 is still not at acceptable levels,” Denel said in its statement.

South Africa has seen a continual, gradual decline in local defence spending in recent years, forcing Denel to look to international markets to meet its commercial mandate. 63 percent of Denel’s revenue now comes from exports, and Ntshepe says that the Asia-Pacific and Middle East markets are key focus areas for the company.

The Asia-Pacific region has seen a year-on-year increase in spending on defence equipment of over 20 percent. Denel established Denel Asia as a joint venture with VR Laser Asia in 2016 to capitalise on this market. It subsequently emerged that Salim Essa, a business associate of the Gupta brothers, is the sole shareholder of VR Laser Asia, resulting in negative media attention “to the detriment of the Denel brand.”

Denel stresses that “since its establishment, Denel Asia has not traded due to differences of opinion with National Treasury.” Furthermore, Ntshepe says that assessment of the untenable atmosphere caused by the joint venture resulted in a decision to end all Denel’s involvement with Denel Asia and VR Laser Asia, and explore alternative marketing approaches to access the Asia-Pacific market.

The potentially profitable efforts have, therefore, been set back by over a year. This, when South Africa’s defence industry as a whole has been challenged in terms of growing profitability in a cost-sensitive and competitive defence market. Denel admits that it has not been immune to the difficult economic conditions, and has had to make cost cutting decisions to maintain acceptable performance.

The different sectors within Denel have in the past operated independently. A short to medium term goal is to achieve what Odwa refers to as a ‘One Denel’ and grow synergies within the company. This has already happened at Denel’s Kempton Park Campus, where, in May this year, Denel Aerostructures and Denel Aviation were consolidated into Denel Aeronautics.

Denel Aviation built and supports the Rooivalk helicopter, assembled most of the South African Air Force’s Hawk jet trainers and A109 helicopters, and provided maintenance, repair and overhaul services to military and civilian customers. It is an accredited maintenance facility for Russian Helicopters (the only one in Africa) and accredited service facility for numerous Airbus Helicopters models and Lockheed Martin’s C-130/L-100 transports.

The Aerostructures business’s major contract is to manufacture components for the Airbus A400M military airlifter, and has extended its services into the commercial sector by making parts for the Airbus A350. Theo Kleynhans, CEO Denel Aerostructures, says that their A400M operations are stable, that they are ahead of targets and have reached a high level of maturity and repeatability with the products they provide.

In terms of finance, Kleynhans says that the business made a profit over the past year without any outside support. The consolidation with Aviation is a ‘service level agreement’ to share finance, HR, and IT services to reduce overheads, improve efficiency and productivity, and optimise cost structures.

The merger also allows for an integration of “scarce” skills and knowledge between the two companies, making for a more effective skills base, says Kleynhans. A focus for Denel Aeronautics, going forward, is the upgrading of the current Rooivalk Mk1 fleet, and the company has entered ongoing discussions with the South African Air Force and the Department of Defence. They are also looking to relaunch production of the Mk1 Rooivalk, although there are none on order at present.

In an effort to ensure the SAAF’s capabilities are retained, Denel Aeronautics has taken full acquisition of Turbomeca Africa (TMA). TMA manufactures engine components – including gears, gearbox casings, shafts and couplings – for Safran Helicopter Engines which power the Super Puma.

A large portion of South Africa’s Super Puma fleet has been grounded due to technical problems. According to Kleynhans, the helicopter support market in South Africa has reduced substantially and MRO engine work has come under pressure. The intention, therefore, is to consolidate Turbomeca support in South Africa within Denel Aeronautics and develop a “strategic Turbomeca MRO for Turbomeca/Safran engines to maintain the capabilities of the SAAF and SANDF,” says Kleynhans.

To grow research and development within the company, as well as develop skills, Denel Aeronautics is continuing with the South African Regional Aircraft (SARA) programme. The aircraft is still in the ‘conceptual design phase’, and although R40 million has already been invested in the project, progress is being limited by funding. Denel Aeronautics has submitted SARA to the Joint Aerospace Steering Committee (JASC) to be recognised as part of the committee’s National Flagship Programme. The JASC coordinates research agendas and financing mechanisms within South Africa’s aerospace and defence industry. The goal is to secure funding that will enable SARA to progress to the end of the ‘preliminary design phase’. Kleynhans says that Denel’s marketing study indicates that there is a good market for SARA, and as such, although funding is not secure, Denel is continuing with the concept.

Although Denel is moving towards being an export-heavy business, Ntshepe says, “The Ministry of Defence and Veterans, Armscor and the SANDF remain our anchor client and we are indebted to them for much of our product portfolio and technology funding.”

Overall, Ntshepe says he is not concerned with Denel’s financial situation, but that the order book needs to grow. There are promising orders in the pipeline of up to R40 billion, but if they do not materialise and the order book remains around the R20 billion mark, there is cause for concern.

 

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