Positive earnings for Denel as turnaround kicks into high gear

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Denel has, for the first time in years, posted positive earnings, with R390 million before interest and tax (EBIT) for the year ending March 2023, it told Parliament’s Standing Committee on Public Accounts (SCOPA) on Wednesday 14 June.

Denel reported a loss of R1.5 billion in 2020; a loss of R859 million in 2021; and a loss of R747 million in 2022. Denel last made a profit, of R395 million, in the 2015/16 financial year, before the effects of state capture and subsequent mismanagement took their toll.

In briefing SCOPA on key developments at the company, including the status of its turnaround plan, the status of its annual reports, and irregular, fruitless and wasteful expenditure, Denel also revealed that it plans to finalise the appointment of its Group Chief Executive Officer (GCEO) and Group Chief Financial Officer (CFO) by October this year.

Board Chair Gloria Serobe told SCOPA that until recently it was difficult to attract top management talent to the embattled state-owned company but now it aims to fill critical vacancies by 31 August and have built leadership and capacity by year-end (headcount dropped from 2 587 in 2021 to 1 670 in 2023).

Denel is optimistic about its turnaround and future prospects, and in a statement following the SCOPA briefing said, “The restructuring of Denel will be completed within the next six months which will reposition the state-owned defence and technology company to efficiently execute existing orders and grow its business through the existing opportunity pipeline.”

Since the 2020 financial year, Denel has remained insolvent and with poor liquidity, in spite of receiving R416 million, R3.03 billion and R205 million in FY2021, FY2022 and FY2023 respectively. R992 million was last year unlocked from the Denel Medical Benefit Trust (DMBT) and in March this year Denel received R1.8 billion in bailout funding from National Treasury, and is using this to resume production (another R1.5 billion is being withheld while Denel proceeds with the sale of remaining non-core assets as part of its turnaround plan, including property, Denel Gear Ratio, and its Hensoldt stake).

The DMBT and recapitalisation allowed Denel to successfully defend liquidation applications by suppliers, including Saab Grintek, and asset attachments by unions and employees. The extra funds are now mainly being used as working capital to restart operations and “normalise labour relations”. This recapitalisation has “allowed significant progress to be made on implementation of the sustainability phase of the turnaround plan. The balance of the funds will largely be spent to clear legacy obligations and support the growth phase of the plan,” Denel told SCOPA.

Legacy obligations amount to R521 million and cover the Airbus A400M contract, the failed delivery of vehicles to Chad, T5-52 howitzers, and a Democratic Republic of Congo contract, amongst others.

Denel also owes R600 million to Armscor, R75 million to the South African Revenue Service (down from R908 million), and creditors R753 million (down from R963 million). Exiting loss-making contracts will cost R118 million.

New capability areas

Denel interim chief executive Michael Kgobe said Denel is migrating to a new operating model and this will see Denel comprising four “capability areas” – guided weapons, integrated systems solutions (ISS), landward systems and air.

Existing Denel operating divisions will be arranged to fit in with this structure and be accompanied by a reduction in the company’s property footprint as well as what the statement says is a “rationalisation of facilities”.

Denel’s Lyttelton, Centurion, campus will be the primary site of the landward business and will see Denel Vehicle Systems (DVS) in Benoni relocated to the Denel Land Systems campus. “The once off cost to relocate and restore the DVS capability at the Lyttleton facility is estimated to be around R46 million with an annualised benefit of R68 million and a return from the sale of the property expected to be approximately R80 million,” Denel told SCOPA.

Unmanned aerial vehicles (UAVs) will be consolidated into the air capability area based at Denel’s Kempton Park campus as there is overlap with Denel Aeronautics, at Kempton Park, and Denel Dynamics, in Irene. The once-off cost to relocate and restore the UAV capability at the Kempton Park facility is estimated to be around R3 million with a return from the property expected at R40 million. An overall reduction of the Irene footprint is expected to save/earn up to R60 million a year going forward.

Denel Integrated Systems Solutions (ISS) will become a separate division to grow Denel capabilities in advanced technologies diversifying into cyber and civil security solutions.

Shared services will see rationalisation of resources and costs in support functions including human resources, business development, supply chain management as well as information and communication technology (ICT).

Denel said it is confident that it can secure new orders by March 2024 and that the company will be fully back on a growth trajectory by the middle of next year.

“Whilst revenues remain at conservative levels, the improved financial position following the recapitalisation of the business by the Shareholder to deal with the repayment of government guaranteed debt as well as other legacy obligations and working capital to restart operations positions the business to enter a growth phase through the unlocking of the opportunity pipeline and improved efficiencies and productivity. Further unlocking of cash into the business will be realised through the sale of non-core assets,” Denel said.

Irregular expenditure

Denel’s irregular expenditure stands at R3.2 billion, including legacy amounts and covers entities liquidated or being liquidated (LMT: R700 million, and Aerostructures: R250 million).

Serobe told SCOPA there has been “quite a lot of work done” to reduce irregular expenditure while dealing with legacy amounts; annual incurred irregular expenditure decreased by 98% since April 2018.

Irregular expenditure for the 2023 financial year stood at R20.193 million. The main contributors to this were deviations from competitive bidding processes (R9.6 million) and tax clearance certificates not being obtained (R10.17 million).

Annual reports

Regarding its outstanding annual reports, Denel told SCOPA that the timeous submission of annual financial statements for FY2021 and FY2022 “was not achieved due to the high turnover of personnel in Denel as a result of non-payment of salaries. Furthermore, AGSA [Auditor General of South Africa] was unable to commence with the audit until some payment was made as it was owed fees from the previous years.”

Denel added that the 2021/21, 2021/22 and 2022/23 reports have been submitted to the AGSA for audit and after paying the AGSA in March, auditing has commenced. This process will be completed at the end of June and Denel will then advise when all three annual reports will be tabled.

Denel has been chastised for failing to submit its annual reports, as well as failing to appear before SCOPA on 6 June. Serobe apologised for missing the last meeting, saying Denel was informed of its need to be at SCOPA late, and its executives were travelling. The fact that the meeting was a physical one in Cape Town made it even more difficult to attend. Serobe said Denel has in the past never missed a meeting but SCOPA chair Mkhuleko Hlengwa was not happy with this response and thought adequate notice was given for Denel appear through a letter to the Department of Public Enterprises. He threatened to contact board members directly in future if necessary to ensure SCOPA attendance.