Fitch Ratings has removed its negative watch rating on Denel and given it a stable outlook in what Denel says is recognition of its efforts to restructure its business and implement a comprehensive turnaround plan.
On 10 February Fitch Ratings announced its rating actions “reflect the support provided to the group from the South African government, in particular a R1.8 billion equity injection to recapitalise the business. The group has finalised appointments to the board and its key executives, who have been instrumental in introducing a restructuring plan and agreeing a strategic corporate plan with the state and Denel’s line ministry, the Department of Public Enterprises.”
However, Fitch added that “the operating structure remains underutilised and will take time to resume normal levels of operations. This is in part due to continuing liquidity constraints, which although improved following the initial recapitalisation, will require resumption of normalised operating levels (in the absence of major disposals or additional equity contributions) to recover.”
Danie du Toit, the Group Chief Executive of Denel, today said the decision by Fitch Ratings to affirm its long-term rating and to assign a “stable outlook” to the business is encouraging and will give further momentum to the efforts to restore the company’s credibility after a period of state capture.
“We note the many concerns about aspects of the business that are still raised by Fitch and continue to implement measures to mitigate these factors,” said Du Toit. “But we are also heartened by the positive aspects of our turnaround plan that are highlighted in the rating report.”
In its report Fitch affirms Denel’s National Long-Term Rating at ‘B(zaf)’ and the National Short-Term Rating at ‘B(zaf)’. In addition, it has removed the previously assigned Rating Watch Negative and replaced it with a Stable Outlook. Fitch downgraded Denel’s rating in May 2019.
Du Toit said the Fitch decision provides Denel “breathing space” to continue with its efforts to restructure the business, exit from non-core entities and find new markets for its advanced defence and high-technology products and services.
It also recognises that the ongoing efforts by the Board and management to restore good corporate governance are producing results and affirms the wisdom of government’s decision to provide a R1.8 billion recapitalisation to the business.
“We are confident that we will receive further support from our shareholder and that we will meet all the expectations of government, our clients and the South African public to turn Denel into a viable business again,” said Du Toit.
Du Toit said Denel is taking note of concerns about liquidity constraints and poor operating performance of the underlying business units, which have an impact on its short-term risks.
“We are addressing all these issues in a structured manner and with the support of our stakeholders in government. It is, however, clear that the turnaround is gathering momentum and I am confident that this will be increasingly reflected in the views of analysts and the broader business community,” he said.
In elaborating on its rating decision, Fitch said Denel’s business profile remains constrained by the weak operating performance of underlying business units, with revenues dropping to R3.8 billion for the financial year to 31 March 2019 and continuing significant operating losses which have placed pressure on Denel to raise additional debt.
Fitch said the R1.8 billion recapitalisation improves liquidity, but the historical operating issues and current capital structure mean that short-term liquidity risk remains, as the group remains reliant on liquidity support from operating profitability arising from recently restarted key projects.
Fitch cautioned that operational challenges persist at Denel. “The group’s business profile remains constrained by the weak operating performance of the underlying individual business units. This is a consequence of historical late payments to suppliers limiting access to input materials and resulting in the business operating at 30%-40% capacity. Trade creditor payments have been addressed with key contracts prioritised in order to help drive short-term operational improvements, but there will necessarily be a period of adjustment to ramp-up operations again. The benefits from these operational improvements will be set against negative impacts from non-core contract exits and associated customer refunds.”
Denel’s turnaround plan was praised by Fitch, with a focus on operational cost reduction, exiting onerous contracts, divestment of non-core assets and realising value through strategic equity partnerships.
Despite recent trading disruptions, “Denel continues to display a solid order backlog and effective implementation of the turnaround strategy will stand the group in good stead to benefit from these orders,” Fitch said. The ratings agency also singled out the new board, appointed in April 2018, for making good progress in addressing the corporate governance problems within Denel.
Fitch expects Denel’s revenue will continue to decline but “return to solid growth” after the 2022 financial year as normal levels of deliveries from the backlog resume. Operating losses will be reduced, and the group is expected to return to profitability from the 2023 financial year.