Denel’s shrinking order book a cause for concern


Denel’s order book has dropped from more than R30 billion over a year ago to R18 billion, which the company says is a cause for concern, but is pursuing opportunities worth R40 billion.

Odwa Mhlwana, Denel Group CFO, said during the presentation of the company’s 2016/17 results last week that the shrinking order book “is a cause for concern,” but Denel is looking into a R40 billion opportunity pipeline, of which at least half is tenable and should lead to real contracts in a short space of time. He said it is a target to maintain the order book beyond R30 billion.

Denel is in talks with the United Arab Emirates’ International Golden Group (IGG) on one project that it hopes to sign within the next six months. Mhlwana said that Denel Vehicle Systems continues to execute a significant contract in the Middle East and hopes to sign another by the end of the year – this would be worth five times as much as the earlier contract.

Acting Denel Group CEO Zwelakhe Ntshepe said one of the reasons for the decline in the order book is that orders were turned into production contracts. He said he was not worried about the current state of the order book, but it would be worrisome next year if no new orders transpire.

Mhlwana said “the conditions in which we operate and trade are absolutely difficult,” as Denel’s peers elsewhere in the world are heavily supported locally whereas Denel needs to export to survive and as a result is export-based even though its primary customers are the Department of Defence and Armscor. Internationally, defence companies typically export 14% of their production but this figure was 63% for Denel in 2016/17. The majority of sales came from South Africa (37%), followed by the Middle East (24%), Asia-Pacific (13%), Europe (12%), Africa (9%) and North and South America.

As part of its efforts to sustain and grow the business, Denel is pursuing opportunities in Asia and the Middle East – Asia is experiencing some of the fastest growing defence budgets in the world, while the Middle East is Denel’s “bread and butter,” with a number of large armoured vehicle and missile contracts coming from the region. However, Mhlwana added that Denel cannot ignore the African market.

One of the most important aspects of Denel’s strategy is the ‘One Denel’ goal, which Mhlwana said aims to create the culture of a single Denel and leverage synergies to reduce costs. For instance, the recent merger of Denel Aerostructures and Denel Aviation into Denel Aeronautics has generated cost savings. The company is also moving into the cyber, command and control and maritime spaces.

Denel will try and create cost savings amongst its suppliers – 60% of Denel’s expenditure is on material. Mhlwana said that “all our suppliers are smiling to the bank except us.”

Another important element of Denel’s strategy is to improve liquidity and profitability. According to Mhlwana, the company is under strain regarding liquidity, and is living day to day on working capital. “We have major contracts that are straining us because of contract terms,” Mhlwana said. Referring to the Malaysia deal for turrets and weapons, he said the bulk of the money for that is only received on acceptance of the entire system, which is dependent on many other subcontractors. He said Denel was trying to re-look at those contract terms to improve the situation.

Another concern for the company is that “our major programmes are currently behind schedule.” Mhlwana said this is not because of a lack of capacity but the nature of developing things from scratch. For example, the Badger infantry fighting vehicle programme is behind schedule, and this has seen some advanced new technology developed, such as the 60 mm breech-loading mortar.

Other challenges Mhlwana pointed out include smaller than desired investment in research and development (R&D), a shrinking order book, excessive debt and drastically reduced local defence spending – the international defence spending benchmark is 2.2% of GDP but in South Africa this is only around 1%. Compounding this is the fact that Denel applied for a five year government loan guarantee but only received a one year guarantee.

According to Denel’s annual financial results, its borrowings for 2016/17 amounted to R3.265 billion, compared to R3.717 billion in 2015/16, and its debt/equity ratio dropped to 1.2 in 2017 compared to 1.6 in 2016. Its target is .3 by 2022.

Irregular expenditure is another cause for concern, but this is “receiving attention.” Denel Vehicle Systems (DVS) is the main culprit, contributing R83 million to the R116 million in irregular expenditure for 2016/17. This was because of the acquisition of Denel Vehicle Systems (formerly BAE Systems Land Systems South Africa) in April 2015 resulted in the company having to comply with the Preferential Procurement Policy Framework Act (PPPFA) once it moved into the Denel stable. Denel asked National Treasury to give it an exemption until December 2016 for it to comply. “All systems have now been implemented,” Denel said.

Denel said its 2016/17 revenue amounted to R8.057 billion, down from R8.228 billion the year before, and operating profit 5.8%, down from 6.1% the year previous. Net profit for 2016/17 amounted to R333 million (compared to R395 million for 2016). 2016/17 employee numbers are slightly down, from 5 114 in 2016 to 4 941.