Basil Read hits cashflow constraints

Conditions in SA have deteriorated to such a point that tenders for local construction work now carry just as much risk as work in the rest of Africa, says Basil Read CEO Marius Heyns

The battle to get paid for government contracts has become a perennial problem. Almost all large construction companies, including Murray & Roberts (see page 54), Aveng and Group Five, are in the same boat. Troubling contracts have spiralled, made worse by a subdued trading environment.

The problems include lack of payment, failure to honour contractual obligations and changes to the scope of contracts.

Traditionally, contracts elsewhere on the continent are priced at high margins because of higher risk (and less competition).

Locally, the average operating margin for the sector is around 1,1%. Basil Read reports a level of 4,2% for the six months to June.

In reaction to local nonpayment, Heyns believes companies have to raise margins for local tenders to manage the additional risk.

“As a listed entity, we are held responsible for paying our suppliers. But for some reason, many government departments seem to think they are not subject to the same rules,” says Heyns.

He says that companies are in the dark about when they will be paid and where the money will come from. In many cases, the government authority does not have the money to pay contractors, but advertises new tenders anyway.

“It’s like working in the rest of Africa now,” he says.

Basil Read’s construction division (others being developments, engineering and mining) has borne the brunt of nonpayment, with R300m tied up in both government and private contractual claims. These claims have not been accounted for in the period under review because their outcomes are uncertain.

However, the unit has come under severe liquidity pressure from delayed or unpaid contracts.

An operating loss of R51m was reported for the division in the year under review compared with a profit of R48m last year. The result was due to a number of loss-making contracts and pressure on margins in depressed and extremely competitive local market conditions.

A one-off loss of R27m on a building contract has been a particularly hard blow. And after years of problems in the Free State, the province has finally given Basil Read a written undertaking that it will pay the company outstanding money before December. About 20% of the amount has already been paid. However, the company will make a loss of R25m, for road rehabilitation work that it conducted in the province in 2010.

“These conditions have led to a natural progression to cross-border work and the [company] is now active in several African countries where opportunities are more prevalent,” Heyns says.

Cross-border work presents risks that include nonpayment, high logistics costs and lack of local construction materials. Most SA firms are hesitant to tender for work if payment guarantees from development finance institutions and upfront payments are not in place. But margins are favourable.

Heyns says that though construction contributes two-thirds of group revenue, its contribution to operating profit is just one-third. The rest is accrued from the group’s smaller mining and engineering divisions.

Revenue came in 13% higher at R3,3bn, with a 74% decline in adjusted operating profit to R38m resulting in the much lower operating margin of 1,2% (2011: 4,9%).

The group’s developments division is focused on large-scale integrated and affordable housing developments, particularly in and around Gauteng.

Heyns believes there is enough work to keep the company busy for now. But nonpayment has put a damper on this. It also makes him sceptical about how government’s infrastructure programme will be managed.

The company’s headline EPS declined to 14,75c/share, an 80% drop from 75,21c previously.

Heyns believes things will improve by year-end, when he says earnings for the 12 months to December will be between 15% and 25% lower than the previous corresponding period.