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Review from the CEO


Current over-border revenue

Over-border revenue target
Mike Upton
  Mike Upton
 

Last year Group Five’s management expected “sufficient opportunities to emerge in its current and targeted markets to be optimistic that during F2011 the following few years will become better defined and that the markets we serve, as well as those we plan to serve, will recover and offer good growth potential”.

Although the construction industry in the group’s targeted geographies and sectors still has solid medium and long term prospects, the reality that has emerged over the short term is that conditions have been much worse than envisaged during the business planning and budgeting undertaken in F2010.

  • Market weakness

    The slowdown within the construction sector in the last two years following the global market crisis has worsened trading conditions in the construction and materials markets in which Group Five operates. This has negatively impacted performance in the current year, in contrast to the 2010 financial year when the group still benefited from the majority of large public sector contracts awarded ahead of the 2010 FIFA World Cup. In the interim, to mitigate this environment to the extent possible, the group has successfully re-entered targeted African markets where it has an established track record.

    The domestic building and civil engineering tender market has seen limited work flow. There is currently over-capacity in the industry following the completion of large public sector infrastructure contracts awarded up to June 2010. Current contracts are therefore heavily contested by large and small contractors with wide pricing spreads. This results in high risks in terms of sub-standard cost estimating by some and extremely aggressive pricing by others.

    The group has well-defined estimating systems and has been able to determine that many bids are being awarded to contractors with limited operational experience and at pricing below cost to execute.

  • Dealing with the challenges

    Against these challenging times, the group has not deviated from its stated strategy, which includes:

    Further geographic expansion into familiar African territories
    Developing our own contracts through the group’s capabilities of design and build and concessions
    Turnkey construction supporting technology partnerships, with a particular emphasis on mining, power and transport

    In a purposefully defensive strategy, the group exercised strong discipline during the year to avoid the potential for future losses from low to zero margin work that could be currently secured.

    To rebuild order books in a sustainable manner, we have focused on a broader international stance, with an immediate emphasis on a larger African footprint involving more of our businesses re-establishing a viable Middle East business and achieving early wins in the reemergence of the mining and energy markets in Africa. Establishing a connection to the long term growth prospects in the Australian market as well as China’s quest for African resources and infrastructure is work in progress.

    Our approach to withstand current market conditions is to avoid, for as long as is possible, securing an order book of low margin work with poor cash flows. This has allowed the group to maintain a healthy balance sheet supported with an appropriate gearing and liquidity position.  

    In line with our strategy of entering alternative markets with stronger margin and cash prospects than domestic tender work, we commenced business development activities and have submitted bids into several new African countries which meet the group’s risk requirements. More of the group’s business units established themselves in countries where the group has previous operating experience. The migration of resources back into Africa was successful, with the over-border order book increasing from 24% last year to 27% this year.

    We also demonstrated our competence in design and build, as well as engineer, procure and construct (EPC) contracting capability. In line with this, we successfully executed the combined power/steam plant for Sasol at Secunda and secured a US$206 million (R1,4 billion) contract financed by the Development Bank of South Africa (DBSA) for the master planning, design, construction and operation of the first phase of a new road transport network for the Zimbabwean National Roads Authority.

    The group is hopeful of securing two private public partnership (PPP) contracts in South Africa for the Department of Rural Development and Land Reform’s head office and the Tswane Munitoria office precinct. The group has been selected as the preferred bidder on both these contracts.

    The Group Five-led consortium was selected as one of two bidders to submit best and final offers (BAFOs) for the significant N1 – N2 Winelands toll road concession in the Western Cape. The group is also on track to develop the Kalahari Solar Energy PPP in the Northern Cape, as well as a gas power PPP in Bulgaria. These are progressing well, although regulatory delays have slowed both programmes.

    Internally, attention has been applied to managing costs. Consolidation of certain Construction business units’ support structures was completed during the first half of the financial year and an invasive restructuring was completed at all sites and locations of our Construction Materials businesses in the second half. Cost reductions were also implemented in our Manufacturing cluster in parallel with a focus on product export expansion. The group’s corporate office cost base was reduced and approved budgets consistently monitored. The group’s capital expenditure was reviewed and strictly limited to essential expenditure supported by acceptable returns in line with the group policy implemented a few years ago.

    Despite difficult conditions, the group did not reduce its commitment to its knowledge base and sustainable future and maintained its training and skills development budgets.

  • Operating results

    With the exception of the Middle East, the group’s largest cluster, Construction, held up well, based on good contract execution and the benefit of a number of longer term and certain African contracts which were strategically secured in previous periods.

    The Middle East results were affected by a number of once-off costs. These include resources focused on regional business development and the successful progressive commercial and financial close of legacy contracts in Dubai, the time discounting effect of reflecting the present value of unchanged certified debt on one of the group’s previously reported cancelled contracts and costs for corrective action on a Jordanian pipeline contract.

    Manufacturing and Construction Materials suffered from a combination of declining volumes, delayed contract awards, a strong rand and pricing pressures. In addition, the Construction Materials cluster is capital intensive with a material long term asset base. In the financial year the business bore high plant lease costs and suffered an impairment of R550 million, as outlined in February 2011.

    In spite of sluggish domestic concessions and PPP activities and the economic pressures in Europe, the performance of our Investments and Concessions cluster remained stable as new toll roads came on line in Eastern Europe and South Africa.

  • Safety

    Group Five further increased its management focus on safety during the reporting period. Tragically, we suffered six fatalities within our sub-contractor base. The group considers zero harm as the only acceptable performance benchmark and is committed to reversing this trend. We empathise with the families of each of the people who so sadly lost their lives.

    With a reduction in the number of man-hours worked this year due to reduced revenue levels and a poor performance stemming from our sub-contractor statistics, the group’s disabling injury frequency rate (DIFR), including sub-contractors, worsened to 0.54 (F2010: 0.43). This is unacceptable to the group.

    To address the poor sub-contractor safety performance, the group will ensure improved vetting, selection and induction procedures as part of a more vigorous sub-contractor approval process.

  • Competition Commission

    As outlined in the review from the chairperson, we proactively engaged with the Competition Commission in its investigation into the construction sector. We have been granted conditional leniency by the Commission pending the finalisation of the broader industry investigation. We believe a proactive approach was required to ensure we adhere to our culture of transparency and integrity.

  • Outlook

    Looking forward, the current market weakness is expected to extend for longer, with a slow rate of a broader market recovery materialising from the second half of F2012, which will inform trading performance for F2013.

    The group’s expectations are therefore that margins will decline into F2012, with some order book recovery forecast for the second half which would provide a base for margins improving in F2013.

    Our Target Opportunity Pipeline (TOP) is the indicator for medium to long term opportunities and performance and is populated with targeted contracts which match the group’s capabilities and areas of operation. The pipeline is further filtered as contracts are developed to provide a base for forecasting of financial performance. The profile indicates a substantial reduction in our reliance on the public sector and South Africa. Timing uncertainty, however, is a risk to forecasting at present.

    Below we outline some key information around the potential for growth existing in Africa.

    Africa TODAY

     

    Africa TOMORROW

    Source: Ernst & Young’s 2011 “Africa attractiveness survey”.

    1. Demographic Indicators,
    www.africaneconomicoutlook.org, January 2011.
      7. The State of African Cities 2010, UN Habitat
    — Statistical Annex.
      12. “KFC intends to double its restaurants in Africa”,
    The Wall Street Journal Asia, 9 December 2010.
    2. 2010 PRB World Population data sheet, www.prb.org   8. “Africa – Growth Versus Corruption”, All Africa,
    20 December 2010.
      13. “In Africa, consumers pick up pace”,
    The Wall Street Journal Europe, 14 January 2011.
    3. World Bank data, January 2011.   9 “Domestic Resources and Diversification
    Key to Africa’s Economic Growth – UN Official”,
    All Africa, 28 October 2010.
      14. “Business in Africa, a whole new scramble”,
    Financial Mail, 25 June 2010.
    4. UN data, http://data.un.org, January 2011.   10 2010 PRB World Population data sheet, www.prb.org   15. The State of African Cities 2010, UN Habitat
    — Statistical Annex.
    5. Poverty and Income Distribution Indicators,
    www.africaneconomicoutlook.org, January 2011.
      11. 2010 PRB World Population data sheet, www.prb.org      
    6. 2010 PRB World Population data sheet, www.prb.org            

    Construction target opportunity pipeline* – contracts being targeted by the group as at 30 June 2011 by sector

       
    International
             
    Local
         
    Total
     
      Sector
    Private
     
    Public
     
    Total
     
    Private
     
    Public
     
    Total
         
    Mining 15     15   2     2  
    17
     
    Industrial 1     1   1     1  
    6
     
    Power 12     12   17   8   25  
    6
     
    Oil and gas       1   1   2  
    6
     
    Water and environment 2   6   8     2   2  
    10
     
    Building – Real estate 5   3   8   19   9   28  
    36
     
    Housing – Real estate 2     2   3   3   6  
    8
     
    Transport 2   7   9     13   13  
    22
     
      Total 39   16   55   43   36   79  
    134
     

    * Our Target Opportunity Pipeline is the group’s indicator of medium to long term opportunities and performance. It represents the group’s targeted contracts and includes only the value that could be traded by the group and not total contract values. In addition, it is not to be confused with the secured order book nor does the group expect to secure the full pipeline presented.
  • Looking forward

    Key focus areas for F2012 Desired results
    Focus on improved efficiencies and a more effective operating structure.
    Target cost cuts without impacting delivery
    Implement a revised structure and operating model to enable delivery in tough markets. Entrench the group’s sector and geographic focus in line with its strategy
    Review portfolio of businesses.
    Thoroughly review current portfolio of businesses to ensure that the group consists of businesses in which it can intervene to mitigate market cycles with returns aligned to its group measures
    Reduce reliance on the South African market with a sustainable geographic diversification.
    The current over-border target for group revenue is 40%. This will be reviewed during F2012 based on markets, capacity and retained business
    Improved safety throughout the group.
    A 20% improvement in the group’s DIFR, including sub-contractors, through a focus on appropriate sub-contractor selection
    Expanding contribution from turnkey multi-disciplinary construction.
    Demonstrate the group’s capability in its target sectors through rebuilding the order book
    Continue to deliver on our stated strategy of concessions portfolio growth.
    Establish future returns in power, PPP and transport in the Southern African Development Community (SADC) through securing of contract awards where the group is currently a preferred bidder or co-developer
  • Appreciation

    During this year we experienced an unprecedented concentration of market and operational challenges. Huge appreciation must therefore go to the group’s stakeholders who have supported the management team in a difficult time.

    I also thank the board and my executive management team and their families, all of whom were required to take on multiple additional responsibilities to deliver this year’s results.

    Lastly, a special thank you to each and every Group Five employee, many of whom worked extraordinary hours in the interest of seeing their Group Five succeed.

    MR (Mike) Upton
    Chief executive officer

    5 August 2011

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