S&P Global Ratings expresses grim view on Transnet’s financial position

Reverse engineering governance failures that have seeped into an organisation’s DNA over a prolonged period, is proving a difficult task at Transnet. 

Although politely packaged, that is the conclusion which can be deduced from S&P Global Ratings’ latest assessment of the state-owned logistics operator’s financials.  

In its review, S&P observes that, in addition to financial fragility, Transnet “has a weaker governance structure and risk management framework relative to peers”. 

Furthermore, S&P states that it has seen positive progress under the new leadership, but “governance challenges will take time to remediate”.

The lingering effects of past governance shortcomings — mixed in with the misfortunes brought on by the pandemic, the July 2021 unrest, the devastating KwaZulu-Natal floods and an onslaught on rail infrastructure — have created a toxic cocktail of factors dragging down Transnet’s ability to deliver.

S&P notes that Transnet’s post-pandemic earnings recovery has been “slower than we anticipated”. As a result, the credit ratings agency has instituted a downward revision of the company’s financial risk profile, deeming it “aggressive”.

Previously, S&P had categorised Transnet’s financial risk profile as “significant”. S&P maintains a negative outlook on the logistics parastatal, citing, among others, the heightened financial risk profile and less-than-adequate liquidity buffers.

S&P explains: “The negative outlook reflects our view that the current operational challenges and environment, as well as ongoing liquidity and refinancing risks, remain significant.”

In the six months ended 30 September 2022, the company admits that Transnet Freight Rail (TFR) underperformed, and points to the above-mentioned events, as well as the unavailability of locomotives, for undershooting targets. 

The problem with this, though, is TFR — as the biggest operating division — generates the bulk of the group’s revenue. In the period under review, TFR made a 45% contribution to revenue — and 51% overall in the 2022 financial year.

S&P projects that TFR’s operational challenges could drive customers to seek alternative solutions to preserve export volumes. Such a scenario playing out has the potential to undermine TFR’s earnings further, and S&P predicts an estimated 12% gross revenue decline for the division in the 2023 financial year.   

The S&P review reads: “We have seen increased use of road freight and non-Transnet-controlled ports in neighbouring countries by bulk commodity exporters, as companies wish to capitalise on supportive commodity prices and prioritise service reliability over price.”

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In its interim results statement, Transnet reports R36.1-billion in revenue and R36.1-billion in debt capital repayment and interest paid. 

The consequence of this delicate financial position is that the logistics parastatal has not met its cash interest cover metric for some lenders. Transnet assures that “all the affected lenders have provided the required waivers”.

In the year ended 31 March 2022, Transnet had a significant $1-billion bullet bond maturity, which the company successfully redeemed on deadline. 

This it did amid intense scrutiny from the market, with Transnet receiving a flurry of inquiries ahead of the cut-off date, the company disclosed at its full-year results presentation last July.

However, the redemption funds flowed from a patchwork of bridging finance instruments that are short-term in nature.

Moreover, similarly sizeable debt maturities are nearing full term. 

Transnet has not yet indicated whether the company has secured long-term funding to smooth over its maturity profile relative to its liquidity position. The next major maturity falls due in February 2023.

Transnet’s risk of breaching covenants remains high, according to S&P. However, recent experience has shown that the company enjoys good relations with its lenders and has been able to obtain waivers without much difficulty.

The group’s exemption from some Public Finance Management Act obligations gives Transnet breathing room not to worry about qualified audit opinions for the next two financial years. This will “serve… to reduce Transnet’s risk of events of default arising from audit qualifications” which would otherwise trigger further covenant breaches. 

Transnet, much like the country’s power utility, is too big to fail and is viewed as an important pillar of South Africa’s economy. 

Given this positioning, S&P expects more government support for the logistics operator.

This latest S&P note on Transnet represents a marked break from previous assessments, which were mostly backward-looking and ascribed the company’s shortcomings to the old guard. 

As the new leadership accumulates more years at the helm, greater scrutiny is being focused on its ability not only to clean up the pre-2019 mishaps, but also to demonstrate the efficacy of its own efforts. DM/BM