Denel updates parliament on turnaround strategy

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Denel has updated parliament on its turnaround strategy, describing its numerous financial problems as well as progress made in exiting onerous contracts, restructuring and cutting costs, and pursuit of potential future business opportunities worth billions of rands.

In a presentation to parliament released on June 17, CEO Danie du Toit emphasised that the 2015 Defence Review classifies Denel as a national security asset while the National Defence Industry Council says if Denel fails, it will compromise South Africa’s national security; will implode the entire defence industry; expose South Africa to a mass exodus of skilled personnel in sensitive defence domains to countries that are not necessarily aligned to South Africa’s national interests; and result in the loss of critical defence capabilities, including sovereign and strategic capabilities.

The presentation showed how Denel has been in decline over the last five years, with revenues dropping from a peak of R8.2 billion in 2016 to R7.7 billion in 2017, R5.8 billion the following year and just R3.7 billion in 2019 – down to 2013 levels (Denel expects revenue of R2.4 billion in 2020, rising slowly to R3.6 billion in 2025). This has been compounded by the declining local defence budget (Armscor reduced spending by 40%), unsustainable cost structures and debt, poor programme management, poor working capital management and lack of commercial skills.

Of the R1.8 billion in recapitalisation Denel has received from government, R133 million has gone towards ‘sustainability investments’ (including the A400M contract), R225 million to overdue taxes, R842 million to re-start operations and pay creditors, and R528 million to interest and loans. Legacy costs absorbed R48 million and investigations into wrongdoing consumed R24 million.

Risks

Denel faces several risks to future sustainability, notably liquidity, the recall of advance payments/guarantees and a weak balance sheet. Project Hoefyster is a major concern for the company, which has received R2 billion in advance payments for the project but Denel only has R800 million in stock and WIP (work in progress) against this prepayment “and cannot repay this prepayment if the contract is cancelled or executed at negative margins”. The company also faces penalties of R653 million on Hoefyster (total potential penalties for the group are R857 million).

Other threats Denel outlined were the high cost of servicing debt and liquidity constraints – the company has an average working capital requirement of R370 million per month to ensure operations run smoothly, but has struggled to even pay salaries in recent months and has warned it might have difficulty paying salaries for June, but a decision will be made in the coming days. “Our typical employment cost is around R144 million a month – we can’t sustain that on the revenue of around R2.8 billion,” Du Toit said.

Denel has had to exit several onerous contracts, but at a cost. It had had to refund Chad a prepayment of R104 million, the Democratic Republic of Congo a prepayment of R54 million and Venezuela a prepayment of R18 million. Withdrawing from its A400M aerostructures manufacturing contract with Airbus cost Denel another R121 million.

“COVID-19 may further delay strategic actions of the turnaround identified, leading to further liquidity constraints. Low levels of liquidity opens Denel up to attack and business rescue proceedings from debt providers, creditors and even employees for non-payment of salaries,” the company said. Du Toit stated that the coronavirus has delayed export permits, with R400 million of invoicing it could do.

“Liquidity in the first 12 months is further negatively impacted by the outstanding legacy obligations of R866 million that still require payment but make no contribution to the financial recovery of the company. Creditors is R480 million as at 28 February 2020 of which R288 million is over 120 days,” Denel’s presentation stated.

Key achievements

In spite of its challenges, Denel said it has made progress on some areas of its turnaround strategy, including savings in excess of R1 billion since April 2018, driven mainly by a 27% reduction in employee numbers. Exiting the aerostructures business will generate an annualised benefit of R260 million from 30 June 2020 going forward.

Other highlights include exiting the loss-making Venezuela, DRC and Chad contracts; finalising the sale of Hensoldt; having Denel’s rating improved by Fitch; and closing the loss-making LMT subsidiary LMT Products, which is in business rescue and in its final stages of closure. It is anticipated that Denel will save another annualised R48 million in support costs.

The core tenets of Denel’s turnaround strategy are securing funding, improving programme deliveries, order intake and governance, reducing costs, resetting and executing Project Hoefyster, disposing of non-core assets and improving reputation and stakeholder relations.

As part of its turnaround, Denel intends to exit or dispose of Denel S3, Gear Ratio, its properties division, the PMP Foundry, the aerostructures business, Mechem, Spaceteq, Land Mobility Technologies (LMT), Densecure and Optronics. It aims to forge partnerships with regard to armoured vehicles, mechatronics, infantry weapons, unmanned aerial vehicles, the Rooivalk attack helicopter, maritime maintenance, repair and overhaul (MRO), and aircraft MRO.

There will be no change with regard to small, medium and large munitions (through PMP and Rheinmetall Denel Munition) and the Overberg Test Range while other areas will be targeted for growth, including missiles and guided weapons, artillery, infantry systems, systems integration and cyber.

Denel added that significant future business potential exists with an order pipeline in excess of R40 billion. It sees revenue opportunities in the areas of digital national security solutions, command and control, border management and control, maritime surveillance, aerospace MRO, cyber security, armed unmanned aerial vehicles, commercial spinoffs, work for other state-owned companies and research institutes and CBRN (chemical, biological, radiological and nuclear) detection systems.



Top ten opportunities for Denel over the next five years are the Umkhonto ground-based air defence system, Seeker 400 unmanned aerial vehicle, A-Darter missile production, G6 artillery upgrade, support contracts, and the NTW-20 weapon.