Jones Gondo, senior research analyst for credit at Nedbank CIB, shares his views on the challenges facing South Africa’s SOEs and details the technicalities involved when assessing the long-term viability of these companies.
SOE portfolio – simple aspirations, complex reality
SOEs are a complex set of large companies across many industry verticals. The institutional arrangement is what government and its policy thrust is focusing on right now. The complexity is that a lot of these companies are customers to each other, and a lot of our major industries are key off-takers and customers to many of these institutions. Reorganization is happening at Transnet and Eskom and we're starting to make some headway towards streamlining and creating efficiencies. The DFI sits at the centre of government's thrust to use capital to drive growth, but their size, scale and capital base lacks the aspiration government has for them. The shift to go to rail is a big focus for Transnet and PRASA while SANRAL continues to have trouble in Gauteng.
State-led growth first needs state-led reforms
Government policy assumes ‘business-as-usual’ and that these entities are not in financial distress. They want to create growth and want infrastructure and SOEs at the centre of that thrust. But, because they're not in good financial standing, they need the real economy to do the heavy lifting for them to be viable and play that role. The focus needs to be on the private sector to break that cycle. At the centre of the credit transmission risks is that municipalities face the real economy, but pass on that revenue to Eskom. DFIs lend to municipalities. Unless the government focuses on the municipal sector, we're going to continue to have revenue losses and shortfalls.
Revenue growth has collapsed
If you’re unable to create earnings growth above your cost of debt, you will have a big liquidity problem. The gap is not closing at the moment. A lot of the operational efforts must look at a catalyst for revenue growth. If the real sector as the main customer of GDP continues to pump along, then this this will shift on the revenue side for them. This also assumes that in some of the disruption there is no substitution effect and customers can't look to alternative services. The proportion of doubtful receivables is climbing for Eskom and SANRAL and no cash flow is coming in. This is the structural issue at hand for those of us who are looking at the sources of revenue and how they're going to deploy or manage capital going forward.
Profitability and debt serviceability
We are in a classic ‘zombie’ firm structure where net income margins are negative and cash cover ratios are below 1. For the next decade this is not going to shift until we do some of the fundamental reforms to operations. Where entities are embarking on reorganization, we need to understand the efficiency and whether it improves operating leverage because they have high fixed capital bases in these businesses.
SOE listed debt maturity profiles
Outside of Eskom and Transnet, there isn't a big, listed debt burden relatively speaking. We need to look at the rest of the SOEs in the portfolio, the weak operational capabilities and if it's not about cutting debt and fixed costs, they need to look at the revenue side. It is about creating operational leverage - business rescues do not close the gap.
Lessons from SOE defaulters and debt solutions
We’ve seen Land Bank, SAA and Denel in a real bind. What we can take out of Land Banks’ process is that extraordinary support from the sovereign is limited. They changed their guarantee framework requirements for Land Bank. Guarantees in the future will only be for developmental mandates and not growth capital. From a bank’s perspective, equity injection is not there to absorb loss, it's there for growth. For domestic investors, the international comparison is that we lack investor representatives to take the collective rights of investors and push the debt default resolution process to be faster. With SAA, there was a lot of political interference. We are still waiting to see if privatization can take root, and what kind of strategic equity partners step up to the plate and what their strategy is. Shareholder departments and national treasury see this process differently. Eskom’s just transition process needs to not only translate into political rhetoric, but also into their business strategy with some specificity about what it means for the operating model. We've seen that process in Eskom’s unbundling, but we will see how measurable that will be in the long run.
Eskom management is doing reasonably well
If we consider the just-transition-mandate, they must slow the process of change because climate change is coming. They need to decarbonize and do this while maintaining some revenue. Government doesn't want them to cut costs via retrenchments. It's a tricky balance for them and there is still no debt resolution in place. The board has been insulating the company from political interference. In terms of Eskom doing reasonably well, they are chasing revenue and almost garnishing municipal accounts. They've got a decommissioning strategy for their old coal fleet. Under climate risk standards they are the scope to risk for all entities in South Africa. We need to see the pathway for how their emissions can reduce faster than they’ve targeted. The presidential climate change committee has a lot of input into this process.
Eskom debt solution within the next 12-18 months?
Eskom’s debt needs to be solved within the next 12 to 18 months because the bailout schedule that national treasury has put out doesn't necessarily cover everything over the next 10 years. Something needs to give in the short term. If nothing happens, they will have to front-end some of the bailout for 2026 and 2027 and bring it forward.
Debt solution – what works for Eskom may not work for all stakeholders
We would prefer them to swap Eskom debt into South African government. National treasury doesn't want to crystallize the debt onto the balance sheet and for that an SPV solution that shifts the debt off balance sheet seems to be the compromise. This won’t remove the liability from Eskom’s balance sheet, but it will be serviced by someone else and it's not officially on the sovereign's balance sheet. A debt-for-equity swap has been spoken about but it's complicated. Eskom just wants the debt service lowered so they can deploy capital where it really matters, which is the transition to get to 40% renewables by 2030.