Fitch revises Denel’s outlook to negative


Fitch Ratings has revised South African state arsenal Denel (Pty) Ltd’s outlook to negative from stable, a move that will increase the cost of its R1.9 billion in debt. Its national ratings have been affirmed at long-term ‘AA(zaf)’ and short-term ‘F1+(zaf)’. Denel reported interest payments of R130 million for the year to March.

The outlook revision reflects the continued operational challenges faced by Denel in supporting a recovery in its medium-term credit profile, the ratings agency says. The review comes days after the Department of Public Enterprises (DPE) said Denel was overloaded with debt and not generating enough gross profit to secure its survival. The DPE added that “although net equity is in the black” the business has been relying, to a large extent, on debt financing with the help of government guarantees. “The use of guarantees to finance the business is not sustainable.”

Due to the group’s continued losses, most notably in its aerostructures business, Denel’s financial profile remains under extreme pressure, I-Net Bridge reports Fitch as saying. This is despite support from the South African government, the company’s 100% shareholder, in the form of short-term loan guarantees of R1.85 billion. The “Negative Outlook” also reflects the lack of a further significant equity injection from the South African government and delays in the planned turnaround strategy to profitability, due to the significant losses posted by Denel Saab Aerostructures.

Denel is expected to post continued losses in the short- to medium-term, I-Net Bridge adds. Fitch views the additional equity injection and longer term debt guarantees as critical for Denel to successfully complete its turnaround strategy. Such measures would, in Fitch’s view, contribute to improved prospects for funds from operations generation as a result of reduced interest expenses and improved liquidity, and reduced refinancing risk due to an extension of its debt maturity profile. At the current rating levels, Fitch assumes that the South African government will, via the DPE, increase its commitment to Denel’s turnaround strategy by providing the necessary additional financial support.

Fitch believes that Denel’s ratings could come under pressure should it not obtain further material long-term financial support from the government. Reflecting Denel’s strong linkages with the South African government, the ratings incorporate Fitch’s top-down assessment of the company in relation to South Africa’s sovereign ratings (Long-term local currency IDR’A’ /Negative).
“The ratings reflect Denel’s position as the largest manufacturer of defence equipment in South Africa (military aerospace and landward equipment) and its strong strategic ties with its ultimate shareholder, the Republic of South Africa,” I-Net Bridge adds.

Denel last posted a net profit in 2001 when it recorded R24.1 million. The only other profit recorded since its formation in 1992 was in 1997, when it reported R81.5 million. Its worst loss was in 2006 when it posted a deficit of some R1.6 billion. A turn-around strategy was put in place that included government guarantees for debt raised commercially. This project has been mostly successful with the state arsenal in August posting an operating profit of R200 million for the year to March 31, 2010. But CE Talib Sadik again complained of the debt and interest burden.

Sadik lamented Denel would have posted a R200 million profit but for a R328 million loss at Denel Saab Aerostructures (DSA) caused by delays with the Airbus A400M project and the interest payments due “in the absence of recapitalisation requested from the National Treasury.”
“Without the losses incurred at DSA, Denel would have returned to profitability,” Sadik said. The stronger financial performance reflects progress in line with its turnaround strategy instituted some four years ago, the Denel chief added. “That strategy has been refined to ensure continued turnaround aimed at improving market access and better operational performance and relationships with key clients and suppliers.”

As a result Denel posted an overall net loss of R246 million, down from R533 million for the previous financial period.