Nov 13 - Fitch Ratings has affirmed Denel (SOC) Ltd's (Denel) National
Long-term rating at 'AA(zaf)'. The agency also affirmed the South African
state-owned defence company's National Short-term rating at 'F1+(zaf)'.
The Outlook for the Long-term rating has been revised to Stable from Negative.
The Outlook revision reflects the renewed demonstration of tangible financial
commitment and support received from the South African government, in the form
of an imminent R700m equity capital injection and the renewal of the R1.85bn
DMTN guarantee for another five years. Fitch understands that management plans
to replace outstanding commercial paper with a five year state-guaranteed
corporate bond. A successful execution of Denel's turnaround strategy and the
capacity of the business to achieve a sustainable operating and financial
profile remain in doubt.
The affirmation primarily reflects Fitch's view that Denel remains a strategic
asset for the Republic of South Africa, given its status as a wholly state-owned
company and as a strategic defence supplier to key South African security
forces. As such, the ratings incorporate Fitch's top-down assessment of the
company in relation to South Africa's sovereign ratings (Long-Term foreign
currency IDR 'BBB+'/Negative, Long-Term local currency IDR 'A'/Negative)
reflecting an expectation of timely support being provided to Denel by the state
to service and repay its debts.
Geopolitical, macroeconomic and public procurement trends as well as past
strategic misjudgements have resulted in many years of poor sales and loss
making and a weak solvency position for Denel, necessitating explicit state
support. Fitch recognises the efforts of management to restructure and
reposition Denel to help the business achieve sustainable viability. Exposures
to loss making contracts have been materially reduced and this has helped the
business to materially reduce reported losses. Nevertheless the business needs
to achieve and sustain revenue, profitability and cash flow improvements against
a background of arguably the most challenged market environment ever for the
defence industry to achieve a sustainable profile. Denel has entered into some
new international contracts that may support profitability and cash flow
generation over the next three or four years, however market conditions remain
challenging. The recent draft South African Defence Review has reaffirmed the
importance the government attaches to Denel and its position within the local
defence industry, although local defence spending remains under pressure.
FY12 revenue grew by 9.7% largely driven by the Aviation group and Land Systems
group. In terms of profitability, the EBIT margin was -3.6% in FY12 compared to
-11.4% in FY11. The negative EBIT level is largely driven by the Aerostructure
group. Overall, the improvement in the performance of Denel in FY12 was due to
the strong confirmed order book in FY11 translating into higher revenue and
EBIT. However, Fitch expects revenue growth to return to negative territory due
to the weak confirmed order book in FY12 and subdue defence spending in South
Africa (49% of revenue).
Denel has been loss making over the past 10 years with negative funds from
operations (FFO) and EBIT margin with FY12 being the only exception. The
underperformance of the group has led to a major capital injection by the South
African government which amounts to R3.5bn since 2006 with an additional R700m
to be injected into the company during the current 2012/13 financial year.
Nonetheless, the ratings continue to be supported by 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. As such, Fitch notes that any change in Denel's strategic and/or
legal ties with the South African government could have a potential impact on
Denel operates in the aerospace and defence industry. Its business activities
include engineering, manufacturing, research and development.
WHAT COULD TRIGGER A RATING ACTION?
Positive: Future developments that may, individually or collectively, lead to
positive rating action include
- Closer alignment with the government-
Negative: Future developments that may, individually or collectively, lead to
negative rating action include
- Withdrawal of government support- Weakening of government support- Any
weakening in financial support leading to a stand-alone assessment of Denel