Johannesburg, 31 May, 2018—Global Credit Ratings has today downgraded the long term and short term national scale Issuer ratings assigned to Group Five Limited to BB(ZA) and B(ZA) respectively. A rating watch has been accorded to the ratings, and another rating review will be undertaken by the end of November 2018.
SUMMARY RATING RATIONALE
Global Credit Ratings (“GCR”) has accorded the above credit ratings to Group Five Limited (“Group Five” or “the group”) based on the following key criteria:
The downgrade reflects the significant deterioration in the free cash position at 1H FY18, as well as net losses reported from continuing operations in FY17 and 1H FY18 of R774m and R761m respectively. Especially compounding the group’s woes was a R649m operating loss arising from the Kpone engineering, procurement and construction contract in Ghana. Further cash pressure mainly came from unsecured work materialising later than planned and unwinding of excess billings as South African contracts have drawn to a close.
The poor earnings performance has largely emanated from the drawn-out weakness in the domestic construction industry, as fixed capital formation remains materially constrained amidst lacklustre macroeconomic fundamentals, and despite expectations of enhanced deal flow post the signing of the domestic Voluntary Rebuild Programme (“VRP”) with the government. Specifically, the constrained state fiscus continues to force the deferral of major capital projects, while private sector investment remains under pressure despite stronger commodity prices. Accordingly, Group Five’s volumes are expected to remain low until public contracts pick up substantively, especially as 85% of the group’s secured construction order book is domestic. As such, the main challenge relates to the certainty of future cash flows. Positively, this is countered by a secured order book, to first review date only, of R5.7bn that is mostly over border in Eastern Europe, which provides steady and geographically diversified earnings and cash.
While Group Five remains cash positive and is consistently compliant with its original covenants, it suffered a material decline in free cash from around R640m at FY17 to an estimated R140m at 1H FY18, mainly due to additional cash required to be applied to costs to completion related to Kpone and a dwindling South African contracting order book. The group is solvent, with assets available to support this reduction in free cash, unwinding order book and completion of the Kpone contract. To support its short-term cash requirements and address the timing mismatch between the short-term funding needs and when cash from asset and other assets could be realised, Group Five secured a 12-month, R650m Bridge Facility Agreement and a Standstill Agreement.
The Standstill Agreement will primarily ensure that the lenders “do not terminate any of their existing facilities or cancel or reduce any available commitment or limit terms of their existing facilities and will provide a temporary suspension of any enforcement action under the existing funding documents.” The Standstill Period shall terminate on the earlier of the 12 months from 11 May 2018 or any event of default.
The Bridge Facility Agreement entails fairly onerous financial covenants typical of transactions of this nature. That said, Group Five may also voluntarily pre-pay the loan without penalty. The Bridge Facility Agreement Security, which includes both the new facility and existing lending agreements, is secured by Group Five’s manufacturing assets, the service concessions investments and the European operations & maintenance businesses. Repayment of the Bridge Funding by way of shareholder funding options that would avoid the unplanned disposal of core Group Five assets would provide
the group with sufficient time to stabilise and further de-risk the construction business, and would be positively considered.
GCR considers positively the restructure of the business. Specifically, staff and occupancy costs have been drastically reduced, while Group Five has exited divisions that could not meet profitability targets. Reflecting the weak environment and deliberate pull out from unviable sectors, Group Five’s total secured construction order book stood at R7.7bn (FY17: R8.7bn), well off the FY15 high of R14.1bn.
With respect to progress on Kpone, GCR has noted the mechanical completion achieved, with two thirds of power capacity successfully feeding to the grid during testing as at the group’s interim results release date of 12 April 2018. According to management, the plant is in its final commissioning phase, with the only remaining phase of reliability and performance testing to commence imminently. Group Five is progressing its own entitlement to contractual claims, whose materiality GCR has duly considered.
The Rating Watch reflects the substantial challenges that Group Five is facing. In this regard, further unexpected losses due to (inter alia) poor deal flow, low margin contracts, cost overruns, and poor contract execution would lead to a further rating downgrade. Similarly, if projected cash inflows do not materialise, the liquidity position could deteriorate, resulting in a breach in the Bridging Facility covenants, which would necessitate the unintended selling of core assets. Rating stability would only be considered when an adequate liquidity position is restored, and the group begins to show an uptick in project flow and profitability.
|NATIONAL SCALE RATINGS HISTORY|
|Initial rating (December 2006)||Last rating (April 2018)|
|Long term: A(ZA); Short term: A1(ZA)||Long term: BBB(ZA); Short term: A2(ZA)|
|Outlook: Stable||Outlook: Rating Watch|
|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
Global Master Criteria for Rating Corporate Entities, updated February 2018
Group Five Limited rating reports, 2006-17
Group Five Limited Market Alert, April 2018
RATING LIMITATIONS AND DISCLAIMERS
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|Capital||The sum of money that is invested to generate proceeds.|
|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.|
|Covenant||A provision that is indicative of performance. Covenants are either positive or negative. Positive covenants are activities that the borrower commits to, typically in its normal course of business. Negative covenants are certain limits and restrictions on the borrowers’ activities.|
|Debt||An obligation to repay a sum of money. More specifically, it is funds passed from a creditor to a debtor in exchange for interest and a commitment to repay the principal in full on a specified date or over a specified period.|
|Default||Failure to meet the payment obligation of either interest or principal on a debt or bond. Technically, a borrower does not default, the initiative comes from the lender who declares that the borrower is in default.|
|Downgrade||The assignment of a lower credit rating to a corporate or sovereign borrower’s debt by a credit rating agency. Opposite of upgrade.|
|Fixed Capital||Fixed capital is the part of a company’s total capital that is invested in fixed assets such as land, buildings and equipment that remains on the balance sheet, usually for years, but for at least one accounting period.|
|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.|
|Margin||A term whose meaning depends on the context. In the widest sense, it means the difference between two values.|
|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.|
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:
- Group Five interim December 2017 results presentation booklet
- Five years comparative audited results
- SENS: 16.05.18 09:15 Group Five Finalises Agreement with Funders and Obtains R650m Secured Senior Bridge Funding
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 BB(ZA); Rating Watch