Michael Sachs, former head of the National Treasury's budget office, has never been one to mince his words, and I’m told while his utterances irk a few in the Treasury — especially when it comes to the basic income grant debate — he nailed it when he told the “On the Record” gathering at Media24 that the country is “drowning, and the struggle we are in right now is to reach surface water”.
It may already be too late given the global inflationary and interest rate storm clouds. So far much has been made by the president of his diagnosis of the problems, and while slow progress is being made in energy and rail reform — so vital to our farmers and miners — our primary industrial base, key export earners and currency support, has run off track.
Writing in his weekly Monday missive in May the president trumpeted: “The White Paper on National Rail Policy, which was approved by cabinet in March, outlines plans to revitalise rail infrastructure and enables third‐party access to the freight rail network. Transnet Freight Rail is already in the process of making slots available for private rail operators on the network.”
The application for third-party access process closed on Thursday. But private operators are still letting off steam about being railroaded into accepting suboptimal terms. Does Ramaphosa know what’s actually going on inside Transnet Freight Rail? Is he aware of the disdain with which CEO Siza Mzimela is treating these private rail operators, who are frankly our last hope?
Let’s dig into the Transnet balance sheet a little. At a headline level in 2022 Transnet generated R5bn in profit after tax and interest. Of that, R10bn is attributed to fair value adjustment (an accounting non-cash adjustment on assets). Of the R10bn revaluation, R9.8bn is attributed to investment property, in effect rescuing Transnet from a R5bn loss.
Any property analyst will tell you that these “fair value adjustments” are the most malleable items on a balance sheet, since they make assumptions on capitalisation rates, a measure of the perceived risk associated with the stability of the income stream produced by the property. The higher the rate, the higher the perceived risk and the lower the fair value; and conversely for a lower cap rate.
In 2012 Transnet spent R3.4bn on maintenance. Taking the time value of money into account, the same maintenance expenditure equates to R5.57bn annually if inflated by consumer price index (CPI). Over the past decade Transnet has been falling short in its maintenance expenditure, illustrated by the maintenance backlog accumulating to R26.8bn. Yet Transnet reports R13.2bn in fair value adjustments on property, plant & equipment, on assets that are poorly maintained in the 2022 financial year. How?
Planned maintenance deferred means R1 not spent today results in an exponential deterioration of the infrastructure, so Transnet Freight Rail will have to spend say R5 in future. This means the “bail out” by taxpayers to return the network to its condition in 2012 will be far more than R26bn. Industry experts place it at closer to R50bn.
Peering deeper into the balance sheet reveals the extent to which Transnet has run out of track. The gearing ratio measures the financing structure of the entity through debt relative to equity as a measure of the company's debt tolerance. Transnet’s covenant is that gearing has to be less than 50%. It reported gearing of 45.5% in 2022, down from 49% in 2021.
But excluding the revaluations for property, plant & equipment and investment properties in 2022 and 2021, Transnet’s gearing increases to 48.8% and actually beaches the covenant in 2021 at 50.1%. Another important covenant is for Transnet to show interest cover of 2.5 times. It reported 2.6 in 2022 and 2021 required waivers from lenders due to the covenant breach at 2.1.
It is also clear that at the end of 2022 Transnet stopped paying creditors to bloat its cash position with the increase in trade payables at R3.45bn. When excluding the increase in trade payables the debt cover ratio drops to 2.4 and 2.2 in 2021.
This means Transnet would have been in breach of the covenant if it had continued to pay creditors as normal. A wandering albatross tells me management were asked to accept a 10% pay cut until the midyear results cut-off, again to preserve cash for the same reason.
Transnet’s balance sheet is so anaemic that it is relying on asset revaluations, deferring creditors and salary reductions to meet its debt covenants. How long can this continue, and with falling revenue and failing infrastructure is there a big impairment coming from the auditors?
Now the rail monopoly wants to add a further R40bn to its stressed balance sheet. When you toss in the alarming decline in productivity it appears a no-brainer for the private sector to be offered the chance to operate and fund the repair of the general freight lines of the Natal Corridor (Natcor), Northeast, Cape and Central Corridors, while Transnet maintains control and ownership of the profitable heavy haul coal and iron ore lines.
This would immediately free up about R10bn of capex and return it to an operating profit without the accounting chicanery. In five years our railways could be world class again.
Ramaphosa should be asking the CEO of Transnet Freight Rail why she would be against that.
• Avery, a financial journalist and broadcaster, produces BDTV's Business Watch. Contact him at Badger@businesslive.co.za.
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