Financial commentary

Financial overview

In the period under review, the construction and engineering activity in the markets in which the group operates remained depressed. These conditions were further exacerbated by the unpredictable delays in some public infrastructure expenditure in South Africa and domestic over-capacity in the industry which was built up in the years preceding the 2010 infrastructure super-cycle.

Against these difficult markets, the group took a strategic decision to, as far as possible, avoid securing a low margin construction order book with cash negative returns.
The group instead searched for better quality work outside of South Africa, focusing on growing the concessions business and cutting rather than carrying costs.

Whilst the group’s Construction and Concessions businesses performed well in light of these tough market conditions, further adverse cyclical and fundamental changes in the Construction Materials markets, particularly in the aggregates and ready-mix markets, occurred. This resulted in the group taking a much more conservative view of the prospects for this cluster. We therefore processed a second impairment against the carrying value of the non-current assets of the construction materials business in December 2010, as outlined below and as previously reported.

The Manufacturing segment was also adversely affected through this severe down-cycle with volume and pricing pressure degrading revenue and margins.

Financial performance

Headline earnings per share (HEPS) decreased by 45.9% and fully diluted HEPS (FDHEPS) by 43.9%. Due to an impairment charge on property, plant and equipment and goodwill within the Construction Materials business, earnings per share (EPS) and fully diluted EPS (FDEPS) was a loss of 227 cents per share.

Group revenue decreased by 18.8% from R11,3 billion to R9,2 billion due to a reduction in activity levels within the buildings, housing and civil infrastructure markets,
client-driven contract delays and the group’s decision not to chase volumes at the expense of margin. These conditions, combined with increasing price competition, resulted in operating profit before fair value adjustments and impairment adjustments decreasing by 43.1% from R877 million to R499 million.

Included within operating profit is a deficit on the group’s pension fund of R2,0 million (2010: surplus of R55,2 million).

The group operating profit margin was 5.4% (2010: 7.7%). The decrease is attributable to the decline in the Construction Materials market and the weak performance by the Manufacturing business, somewhat offset by the sound results within tough market conditions from the heavy construction cluster and infrastructure concessions businesses.

Fair value net upward adjustments of R48,8 million (2010: R13,5 million) relating to the group’s interests in Eastern European road transport concessions, as well as the group’s investments in property developments and investment properties, positively affected the group’s results in the period under review.

In line with expectations, group net finance income of R18,4 million was recorded for the year compared to net finance income of R27,9 million in the prior year. This was assisted by stabilised interest rates, but negatively affected by the reduction in cash and cash equivalents, which were mainly realised in the first half of the financial year.

The effective tax rate of 33% (2010: 34%) on profit before the construction materials impairment adjustment was higher than the South African statutory tax rate of 28%, mainly due to secondary tax on companies paid, liabilities in jurisdictions with higher taxation rates and a conservative approach adopted to the raising of deferred taxation assets.

Financial position

The group balance sheet continues to be sound, with a nil net gearing ratio as at 30 June 2011.

Practice requires that the carrying values of non-current assets owned by the group, including property, plant and equipment and goodwill, are reviewed for impairment on an annual basis or when there is such an indication. The weakened market conditions applicable to the Construction Materials cluster therefore resulted in detailed impairment tests being conducted. As there is currently uncertainty around the timing of the recovery of construction materials markets and a delay in contract roll out and awards in the public sector, management adopted a cautious approach when considering the carrying value of these assets and therefore processed an impairment of R325,6 million in the 2010 financial year and a further R550,5 million in the first half of 2011. The impairment tests performed at year end indicated that a further impairment was not required.

Furthermore, during the year, an amount of R17,2 million (2010: R22,1 million) was charged to the income statement, mainly as a result of the prudent treatment of the amount due from contract claims on a terminated Indian toll road contract carried as a discontinued operation.

Cash flow

The group generated R756,3 million cash from operations before working capital changes. However, in line with expectations, working capital absorption of R1,2 billion
(2010: R58 million generated) resulted in a net cash outflow of R871 million in the period of which the majority (R706 million), occurred in the first half of the financial year.
As expected, the finalisation of the large local infrastructure contracts saw the unwinding of advance payments and the settlement of creditor final accounts. Pleasingly, working capital outflows reflect the settlement of trade and other payables only, whereas working capital continues to improve in all other areas of trade and other receivables and the management of inventory levels.

Dividends

The group’s adopted dividend policy is approximately four times basic earnings per share dividend cover. This policy is subject to review on a semi-annual basis, prior to dividend declaration, as distributions will be influenced by business growth, acquisition activity or movements in earnings as a result of fair value accounting adjustments.
In recognition of the non-cash nature of the Construction Materials impairment adjustment, the board has approved a dividend based on a cover of four times earnings per share of R2,89 before recording of impairment adjustments, non-cash fair value adjustments and pension fund deficits. A final dividend of 20 cents per share (2010: 74 cents) has thus been declared. This brings the total dividend for the year to 72 cents per share (2010: 137 cents). The dividend policy therefore remains unchanged and is based on the medium term business outlook and the availability of liquid resources.

Business combinations

There were no business combinations during the current financial year.

Shareholding

Further to the group’s previous statement regarding the unwinding of the iLima Consortium (iLima) shareholding, the courts have awarded in Group Five’s favour and instructed the return of the group’s shares by iLima. This process is currently being delayed due to the liquidation of iLima. As previously reported, the unwinding will have no material bearing on the group’s results. The group has excluded the iLima shareholding from its current broad-based black economic (BBBEE) scorecard and confirms that its scorecard has not been adversely affected. The group’s BBBEE status is currently a market-leading Level 2.

Industry matters

As announced on SENS on 1 February 2011, the group adopted a proactive stance in respect of the ongoing investigation by the Competition Commission into alleged anti-competitive behaviour within the construction industry. In 2008, the group took the lead and initiated an invasive internal investigation of its own. The group co-operated with the Commission for the last two years in the interest of determining if it had any exposure and to take advantage of the Commission’s leniency programme to limit the risk of any penalties and/or fines. The group believes it has no such exposure, although this cannot be guaranteed until the completion of the Commission’s investigation.
The group is able to advise that it has recently signed a conditional leniency agreement with The Commission without penalty pending conclusion of the industry investigation. The board of Group Five once again confirms its support for the Commission’s process and its commitment to assist the Commission in its objective to rid the sector of anti-competitive behaviour.

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