Review from the CEO

“We had to deal with two specific issues in the year. Loss-making Construction Materials businesses had to be disposed of and previously reported problems in the Middle East dealt with.”     Mike Upton

In the F2011 integrated report, we indicated that market weakness was expected to extend for longer, with a slow rate of market recovery materialising from the second half of F2012.

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

These statements of a year ago were reasonably accurate, given the measures of performance in terms of order book progression, revenue, margins and the outlook for F2013.

As outlined on pages 68 and 71, we had to deal with two specific issues in the year. The process of disposing of loss-making Construction Materials businesses had to be commenced and previously reported problems in the Middle East dealt with. This included the termination of a loss-making contract in Jordan with run-on costs in that region relating to the commercial and financial close out of a number of cancelled and completed contracts in the United Arab Emirates (UAE). We have learnt some hard and valuable lessons.

The low lights

Market conditions changed significantly over the last three years following the global financial crisis.

The group lost significant potential order book and incurred development costs in the last two years following postponements of concessions and private public partnerships (PPPs). These included prisons, toll roads and public building PPPs. Recent delayed decisions in the renewable power programme are a concern. The group is a preferred bidder or partner on three of those contracts.

In South Africa, although we were cushioned to some extent from the global turmoil, due to a severe lack of clarity on contract timescales from announcement to award in both public and private sectors, the construction sector has been hard hit.

Furthermore, South Africa’s political machinations and the economic impact of mixed ideologies on mining and private sector involvement in infrastructure has had a big impact on job destruction,with wasteful cost to business.

For a review of the group’s financial performance, refer to page 82.

ONE OF OUR CORE ACHIEVEMENTS THIS YEAR WAS NO FATALITIES AND AN IMPROVEMENT IN OUR OVERALL DISABLING INJURY FREQUENCY RATE TO 0.21 FROM 0.54, WHICH EXCEEDED OUR GOAL SET LAST YEAR.

Delivery

Below we outline how we performed against goals set in our F2011 integrated report.

Key focus areas for F2012		Desired results		Status
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		A cost reduction programmewascompleted in March 2012. The group was restructured from 1 July 2012. Further re-engineering is taking place, with progressive implementation by December 2013.
Review portfolio of businesses		• Thoroughly review current portfolio of businesses to ensure that the group consists of businesses in which it can add value and intervene to mitigate market cycles with returns aligned to its group measures		Portfolio reviewed with the board against a refreshed strategy. Two Construction Materials disposal agreements concluded by June 2012. Steel fabrication closed in the first half of F2012.
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 F2013 based on markets, capacity and retained business		Construction over-border order book stands at 38% as at June 2012. The group’s pipeline of Construction opportunities stands at 39% over-border. Fibre cement export sales represent 8% of its revenue. Refer to page 10 for details of the number of over-border regions each business is currently operating in.
Improved safety throughout the group		• A 20% improvement in the group’s DIFR, including sub-contractors, through a focus on appropriate sub-contractor selection		Achieved a 61% improvement in the group’s DIFR. No fatalities in the year.
Expand contribution from turnkey multidisciplinary construction		• Demonstrate the group’s capability in its target sectors through rebuilding the order book		43% of the group’s contracts in its full Construction order book are of a turnkey or multi-disciplinary nature.
continue to deliver on our stated strategy of concessions portfolio growth		• Establish future returns in power, PPPs and transport in the Southern African Development Community (SADC) through securing contract awards where the group is currently a preferred bidder or co-developer		The South African public sector has either postponed, cancelled or delayed PPP projects. The group is still positioned as a preferred bidder on a number of those. Southern Africa is a new and active market for our concessions business.

This year also saw severe competition on tenders, with industry order books and margins under pressure.

With commercial and payment terms hardening in favour of the buyer, cash retention has become more pressured.

We have also seen more stringent requirements on contracts in terms of local procurement and community expectations in the locality of the contract, as well as with health and labour issues. These required more people and monetary investment in already tough markets.

Weak liquidity continued to influence the pace of resolution of cancelled and completed contracts in the UAE.

The highlights

Despite the lack of capacity in government, state-owned enterprises provided 38% of the Construction revenue in the year and are set to sustain a high level of spending over the next few years.

The group secured its level 2 broad-based black economic empowerment (BBBEE) certification for the second year running despite having to cancel the iLima portion of its original black empowerment ownership shareholding.

African markets delivered growing opportunities and contributed across all of the group’s businesses. We saw early wins in particularly the re-emergence of the mining and energy markets, with 38% of the Construction order book of R11,3 billion being over-border.

The group’s annuity businesses of local and over-border investments and concessions and domestic manufacturing businesses contributed 60% of the operating profit in partial mitigation of the reduced construction performance.

Ensuring capacity for change

Against these conditions, we conducted a review of our markets to test and validate our strategy. We have invested in dedicated strategic project development resources and a lean support structure to further geographic expansion in African markets.

Operationally, in a purposefully defensive strategy, the group exercised strong discipline during the year to minimise the potential of future losses and undue cash absorption from low to zero margin work.

	In line with our evaluation, we concluded that:	Refer to page
	Our strategy of being a diversified construction, infrastructure concessions and services group primarily focused on Africa and Eastern Europe, whilst reviewing our presence in the Middle East, is correct
	Our portfolio of businesses required refreshing to ensure we can add value and are aligned with a full-house infrastructure delivery strategy
	The underlying core businesses demonstrated good resilience
	Our annuity-type businesses of Investments and Concessions and Manufacturing were very relevant against volatile construction markets. The concessions business is particularly well positioned for the current and new markets in power and regional transport infrastructure
	Our turnkey and engineer, procure and construct (EPC) delivery capability is an area of growth, with a particular emphasis on utilities and transport
	Our decision to dispose of Construction Materials at this time is appropriate
	The Middle East presence should currently be limited to recovery of debt and close-out of all legacy contracts
	Our geographic expansion progression with a specific African focus delivered benefits during the year
	We redefined some of our internal processes and structures to be agile and more efficient at lower cost

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 business units. The migration of resources back into Africa was successful, with the total over-border Construction order book increasing from 30% last year to 38% this year.

Looking forward

Competition Commission

As outlined previously, we proactively engaged with the Com petition 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 in light of our culture of transparency and integrity. Refer to page 88.

BBBEE

The group has achieved a level 2 BBBEE scorecard rating despite the failure of one of its black shareholders, iLima, based on defaulting on agreements. This is a strong indication of the internal and supply chain transformation that has been achieved.

As outlined in the online section of the report at www.groupfive.co.za, the group is actively reviewing its options for a future ownership structure. This will be presented to shareholders for their approval.

Target opportunity pipeline

Our target construction opportunity pipeline (TOP) is the indicator for medium to long term opportunities and expected performance. It is populated with targeted contracts that match the group’s capabilities and areas of operation. The pipeline is further filtered as contracts are developed to provide a base for forecasting financial performance. The profile indicates a substantial reduction in our reliance on the public sector and South Africa. However, the continued uncertain timing remains a risk to forecasting.

Construction target opportunity pipeline*

– contracts being targeted by the group as at 30 June 2012 by sector

Key focus areas for F2013

Appreciation

We experienced another year of unprecedented concentration of market and operational challenges. My sincere 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, all of whom were required to take on multiple additional responsibilities and work extraordinary hours to deliver this year’s results. Thank you to their families for supporting them.

Lastly, a special thank you to each and every Group Five employee who worked together with a common purpose to ensure the group came through a very tough period stronger and ready to take on what we hope will be a year of growth ahead.

Mike Upton
CEO

3 August 2012