Johannesburg, 27 October, 2017—Global Credit Ratings has today downgraded the long term national scale Issuer rating assigned to Group Five Limited to BBB(ZA), and affirmed the short term national scale Issuer rating of A2(ZA). A stable rating outlook has been accorded to the ratings.
SUMMARY RATING RATIONALE
Global Credit Ratings (“GCR”) has accorded the above credit ratings to Group Five Limited (“Group Five”) based on the following key criteria:
Group Five’s construction business continues to face challenges presented by a protracted weakness in the construction industry, on the back of significantly curtailed investment on fixed capital formation domestically. In view of constrained economic growth, and the country’s weak fiscal position amidst pressure on the sovereign ratings, the public sector continues to defer most of its planned infrastructure spend, while private sector demand remains subdued despite the progressive recovery in global commodity prices. Against this backdrop, the value of the group’s secured contracts to be traded declined to R14.5bn at FY17 (FY16: R17.3bn), with the secured contracting order book down to R8.7bn, from R11.2bn at FY16.
Construction contract volumes are expected to remain restrained until public contracts strengthen definitively, although note is also taken of projects being tendered for in the rest of Africa. Revenues continued to contract, falling by 22% to R10.8bn in FY17. The concomitant negative operating leverage saw Group Five register its first normalised loss before depreciation interest and taxation, while contract-related impairments and the Voluntary Rebuild Programme (“VRP”) provision inflated the net loss after tax for the year. A sizeable operating cash outflow, driven by the resultant operating and working capital pressures, led to negative debt service and earnings based gearing ratios, placing downward pressure on the ratings.
Amidst these challenges, shareholders called for the replacement of non-executive directors of the board. The newly established board of directors is in the process of reviewing the group’s strategic direction. Group Five is also currently rationalising its construction operations to achieve a leaner cost base, enhancing its resource allocation, focusing on accountability and oversight, and improving adherence to risk protocols. The effectiveness of the new governance and corporate structures will only be proven in the medium term, and will be assessed in terms of profitability, quality of the order book, and conservatism of the funding profile. The board is also expected to secure an empowerment transaction that will meet the group’s broader VRP commitments and transformation objectives.
Variability in the contracting loss ratio, which is attributed to poor execution with weak oversight at the construction cluster level, is noted with concern, as it increases the potential for earnings volatility in a difficult operating climate. The ratio spiked to 33% (48% including a Transnet contract impairment), from 24% in FY16, with pressure mostly emanating from Projects and Civils Engineering contracts. Cognisance is taken of remedial action implemented, including the decision to close certain businesses, and the realignment of projects to focus on Group Five’s proven areas of specialisation. Management will be expected to demonstrate the effectiveness of these initiatives through stronger construction cash flows in order to stabilise the ratings.
Notwithstanding the decline in liquidity on the balance sheet, the group remains in a strong net cash position, with liquid assets covering total debt 3.8x (FY16: 4.3x). This robust liquidity position underpins the stable rating outlook, but can only be sustained through a return to sound profitability. Other key liquidity considerations include ample bank facilities, the annuity income flows from the burgeoning concessions interests, long standing relationships with bankers and insurance counterparties, and the improved debt maturity profile.
Upward rating migration is only likely when the construction environment stabilises. That said, a restructured business, which has been right-sized to cater for prevailing market conditions, and a focus on core competencies that enables the group to sustain strong free cash flows through the cycle, would be positively viewed. Conversely, negative rating pressure would arise from the persistence of the weak operating climate, resulting in an erratic profitability profile on the back of (inter alia) low margin contracts, cost overruns, poor contract execution and project disruptions. In addition, the disposal of the group’s European concessions interests would compromise its credit protection factors, and could warrant negative rating action.
|NATIONAL SCALE RATINGS HISTORY|
|Initial rating (December 2006)||Last rating (October 2016)|
|Long term: A(ZA); Short term: A1(ZA)||Long term: BBB+(ZA); Short term: A2(ZA)|
|Outlook: Stable||Outlook: Stable|
|Primary Analyst||Committee Chairperson|
|Patricia Zvarayi||Eyal Shevel|
|Senior Analyst||Sector Head: Corporate & Public Sector Debt Ratings|
|(011) 784-1771||(011) 784-1771|
APPLICABLE METHODOLOGIES AND RELATED RESEARCH
Criteria for Rating Corporate Entities, updated February 2017
Group Five Limited rating reports, 2006-2016
RATING LIMITATIONS AND DISCLAIMERS
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|Cash Flow||The inflow and outflow of cash and cash equivalents. Such flows arise from operating, investing and financing activities.|
|Commodity||Raw materials used in manufacturing industries or in the production of foodstuffs. These include metals, oil, grains and cereals, soft commodities such as sugar, cocoa, coffee and tea, as well as vegetable oils.|
|Credit Rating||An opinion regarding the creditworthiness of an entity, a security or financial instrument, or an issuer of securities or financial instruments, using an established and defined ranking system of rating categories.|
|Credit Rating Agency||An entity that provides credit rating services.|
|Downgrade||The assignment of a lower credit rating to a corporate or sovereign borrower’s debt by a credit rating agency. Opposite of upgrade.|
|Gearing||With regard to corporate analysis, gearing (or leverage) refers to the extent to which a company is funded by debt and can be calculated by dividing its debt by shareholders’ funds or by EBITDA.|
|Impairment||Reduction in the value of an asset because the asset is no longer expected to generate the same benefits, as determined by the company through periodic assessments.|
|Liquidity||The speed at which assets can be converted to cash. It can also refer to the ability of a company to service its debt obligations due to the presence of liquid assets such as cash and its equivalents. Market liquidity refers to the ease with which a security can be bought or sold quickly and in large volumes without substantially affecting the market price.|
|Long-Term Rating||A long term rating reflects an issuer’s ability to meet its financial obligations over the following three to five year period, including interest payments and debt redemptions. This encompasses an evaluation of the organisation’s current financial position, as well as how the position may change in the future with regard to meeting longer term financial obligations.|
|National Scale Rating||The national scale provides a relative measure of creditworthiness for rated entities only within the country concerned. Under this rating scale, a ‘AAA’ long term national scale rating will typically be assigned to the lowest relative risk within that country, which in most cases will be the sovereign state.|
|Order Book||This refers to the portfolio of confirmed contracts/orders that a corporate entity has at any point in time, and is jargon typically associated with construction and manufacturing companies in reference to their prospective business.|
|Rating Outlook||A Rating outlook indicates the potential direction of a rated entity’s rating over the medium term, typically one to two years. An outlook may be defined as: ‘Stable’ (nothing to suggest that the rating will change), ‘Positive’ (the rating symbol may be raised), ‘Negative’ (the rating symbol may be lowered) or ‘Evolving’ (the rating symbol may be raised or lowered).|
|Short-Term Rating||A short term rating is an opinion of an issuer’s ability to meet all financial obligations over the upcoming 12 month period, including interest payments and debt redemptions.|
|Working Capital||Working capital usually refers to the resources that a company uses to finance day-to-day operations. Changes in working capital are assessed to explain movements in debt and cash balances.|
SALIENT FEATURES OF ACCORDED RATINGS
GCR affirms that a.) no part of the rating process was influenced by any other business activities of the credit rating agency; b.) the ratings are based solely on the merits of the rated entity, security or financial instrument being rated; c.) such ratings are an independent evaluation of the risks and merits of the rated entity, security or financial instrument; and d.) the validity of the ratings is for a maximum of 12 months, or earlier as indicated by the applicable credit rating document.
Group Five Limited participated in the rating process via face-to-face management meetings, teleconferences and other written correspondence. Furthermore, the quality of information received was considered adequate and has been independently verified where possible.
The credit ratings have been disclosed to Group Five Limited with no contestation of the ratings.
The information received from Group Five Limited and other reliable third parties to accord the credit rating(s) included:
- The 2017 integrated report and related supplements
- Four years comparative audited results
- Group Five 2017 results presentation booklet
- Industry comparative data
The ratings above were solicited by, or on behalf of, the rated client, and therefore, GCR has been compensated for the provision of the ratings.
GCR downgrades Group Five Limited’s rating to BBB(ZA); Outlook Stable