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Denel remains a going concern… just

Denel remains a going concern… just
An Agusta A109 light utility helicopter comes in to land at the Chris Hani-Baragwanath Hospital in Soweto, South Africa, 23 August 2010. (PHOTO: EPA/JON HRUSA)

Military spending is growing around the world, particularly in the Middle East and Asia where it grew by 7.2% and 4.3% respectively in 2017. Despite this opportunity, corruption, inefficiency and misrule prevented South Africa’s defence equipment manufacturer Denel from capturing a slice of the growth. A new management team is trying to turn the tank around.

The audit report written by SA Auditor-General Kimi Makwetu on Denel’s annual financial statements runs to eight pages and reads like a horror story.

Accounting systems are outdated and processes almost non-existent. There is no record-keeping, no internal controls, no visible adherence to legislation such as the Public Finance Management Act, limited application of the new financial reporting standards and no implementation of basic financial management disciplines and controls over daily and monthly transactions.

This means management has been making decisions in the dark. So it should come as no surprise that just one of Denel’s operating divisions – the smallest – reported a profit for the year to 31 March 2019.

Source: Denel annual report

Revenue plunged by 36% to R3.7-billion in the year to 31 March 2019 as operational activity declined, in part because of cash-flow constraints. The company reported a net loss of R1.7-billion, 66% lower than 2018, driven by contract losses and reduced sales leading to cost under-recoveries. Net interest expense of R340-million, a R389-million provision for the exit of a loss-making contract within Denel and late delivery penalties exacerbated the situation.

Denel’s total assets have fallen to R8.6-billion while liabilities sit at R10.2-billion, raising questions about its going concern status.

To the dismay of taxpayers, but the relief of management, the government approved a R1.8-billion bailout in August 2019, enabling the payment of salaries and a slight reduction in debt. Government is likely to provide the funding necessary to recapitalise the company in the next financial year.

This was enough for the auditor-general to issue a going concern statement.

Given the mitigating steps taken, the auditors are satisfied that Denel will continue as a going concern for the foreseeable future,” he wrote.

He did, however, issue a disclaimer on the results, noting that the company’s financial records were in such a poor state that he could not issue an opinion on the audit.

In addition, following the intervention of the AG, the financial results for 2017 and 2018 have been restated.

The new board, under chair Monhla Hlahla, has been in place for 18 months and has not been sitting idle. It has developed a turnaround strategy for the group and overseen the appointment of all outstanding executive appointments, in particular that of CEO Danie du Toit in December 2018 and CFO Carmen le Grange in September 2019.

Whether it is truly effective will only be known in time. Meanwhile, the appointment of the executive team came in the nick of time as theft and corruption nearly destroyed the company.

The pervasiveness of State Capture is nowhere felt as much as in the numbers and we recognise the damage that this has done to Denel’s business,” Hlahla writes in the report.

Management has initiated several forensic investigations into alleged fraud and misappropriation of funds that occurred under the watch of the previous board and management, Du Toit notes in his message to shareholders. A turnaround plan has been crafted and improving governance is a priority.

Part of the financial restructuring has seen Denel exit onerous contracts to the value of R250-million, reduce operating costs by R500-million and head office costs by R15-million. No short-term bonuses were paid to any directors and a long-term incentive scheme is on the drawing board.

Further reductions in operating costs will be achieved in the coming year through the enhancement of supply chain processes. Non-core assets to the value of R1.5-billion will be sold and a further R2-billion in cash will be generated from strategic equity partnership activities.

Denel also has to become less reliant on sales to SA’s defence force, which account for 49% of revenue.

South Africa’s defence and security budget has reduced to 0.9 % of GDP which is low compared to international norms, which is around 2.5% of GDP,” says Du Toit.

But, to compete in global markets, Denel will have to consolidate its product portfolio, reduce its cost base, manage working capital better and become more efficient, he adds.

A skills audit is underway to ensure the company has the skills needed for its future strategy.

The turnaround plan plots a moderate growth in revenue from R3.86-billion in 2020 to R5.54-billion in 2021 and R7.14-billion in 2024.

Denel has secured an order backlog of R18-billion which covers roughly four years of sales revenue. Du Toit has set the company the task of winning orders worth R30-billion over the next 24 months.

Should these contracts be realised it will provide us with a solid base to secure our corporate plan.”

Despite 124 references to profit in the annual report, and detail on the turnaround plan, management lists few key performance indicators and provides no clues on when the company will be restored to profitability, which is what South African stakeholders want to know. BM

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