Chief financial officer's review
“In difficult trading conditions, impressive performances were registered by several divisions.”
|R billion||Year ended June 30 2016||Year ended June 30 2015||%
|Gross profit (%)*||29,2||28,8|
|Trading margin (%)*||8,4||8,4|
|HEPS cents||1 054,1||1 028,9||2,5|
|EBITDA interest cover (x)||8,0||8,7|
|Net debt/equity (%)||27,5||21,4|
|Weighted number of shares (m)||330,0||326,4||1,1|
|*As % of revenue|
The unbundling transaction and separate listing of the foodservices operations, Bid Corporation Limited (Bidcorp) effective May 30 2016, elicited a significant change in the overall Bidvest Group financial scale and landscape. Despite this fundamental change, our balance sheet and financial ratios remain strong.
The objective of the unbundling was to unlock value for the benefit of our shareholders and this was successfully delivered. The market capitalisation of the combined groups increased from R124,2 billion as at May 27 2016, being the day prior to unbundling, to R141,5 billion, a short three months later.
The foodservices business has been treated as a discontinued operation in our financial results and comparatives have been re-presented accordingly. Details thereof have been disclosed in the financial statements.
The transaction was a significant milestone in the history of our Group. The separation will give the remaining Bidvest businesses and management greater focus to grow and expand. The decentralised nature of our Group allowed for the unbundling to be a clean break and non-disruptive to the remaining businesses where we continued to conduct business as usual. We wish our foodservices colleagues well in their new independent lives going forward.
The business environment
Economic conditions remained challenging throughout the year. Interest rates rose, the rand weakened, commodities remained subdued and the economy delivered almost no growth. Every Bidvest business was impacted, but despite these headwinds, our overall operating margins were well maintained, revenue grew modestly and trading profit increased.
Impressive performances in difficult trading conditions were registered by several divisions. These included Commercial Products which also benefited from the Plumblink acquisition, as well as Financial Services and the Services division. Lower infrastructural spend impacted our Electrical division, Freight continued to be affected by low commodity volumes, and lower consumer spend affected vehicle sales in Automotive. Crossborder, our Namibian business faced continued pressure, in particular from its fishing operations.
Interest rates climbed steadily in the current financial period in four successive increases, exacerbated by uncertainties around a potential credit downgrade during the year by the global rating agencies.
Rand weakness was also a feature of the year with severe currency volatility, which has continued into the new financial year. Offshore earnings no longer have a significant impact on Bidvest’s balance sheet, but currency risks still have to be managed by most of our businesses. The principal impacts are on inventories and pricing, as currency weakness drives up input costs at many of our businesses. These pressures challenged trading for all divisional teams. They responded well and for the most part, Bidvest prices kept pace with the weakening rand and margins were maintained.
South Africa’s sovereign rating was under pressure as the year progressed, and concerns rose that our rating could be downgraded to “junk” status by the international ratings agencies but has thus far been avoided and we remain investment grade. A review of the sovereign rating is expected in December 2016.
On July 4 2016, Moody’s upgraded Bidvest’s national long-term rating from an A1.za with a stable outlook, to Aa1.za with a negative outlook (the latter reflects the potential credit implications from the unbundling of Bidvest’s foodservices businesses, which became effective on May 30 2016). The short-term rating at P-1.za remained unchanged. The rating upgrade is testament to Bidvest’s sound balance sheet, proven cash generating model and solid prospects of continued growth.
Turnover rose 3,5% to R91,8 billion (2015: R88,6 billion). Revenue increased 3,6% to R68,2 billion (2015: R65,9 billion). Gross profit margin increased to 29,2% (2015: 28,8%). This improvement is a consequence of portfolio mix benefits achieved by shedding low margin revenue through the disposal of the Cash-in-Transit business in 2015 and the acquisition of better margin businesses such as Novel and Plumblink in 2016. Operating expenses increased by 6,3%, while the operating expense ratio at 21,4% (2015: 20,8%) edged up slightly.
Trading profit rose by 3,0% to R5,8 billion (2015: R5,6 billion) and the trading profit margin was stable at 8,4%. The main contributors to the increase were the Commercial Products, Financial Services, Electrical and Services divisions, as well as Bidvest Properties.
Net finance charges were 13,7% higher at R922 million (2015: R811 million), with the increase largely attributable to the various acquisitions, an increased prime interest rate, as well as finance raised to acquire additional Adcock Ingram shares.
Profits from associate earnings reflected a decline of 25,9% after the write-off of non-headline items in associates. Prior to these non-headline items, the share of profit from associates increased by 5%.
Headline earnings increased by 3,6% to R3,5 billion. A total distribution of 714,0 cents per share was declared by the board (2015: 909,0 cents). The lower final distribution post-unbundling should be read together with the final distribution of Bidcorp.
Our businesses remain strongly cash generative. Cash generated by operations at R7,0 billion was, on a like-for-like basis, 17% higher than the R6,0 billion generated in the prior year. The Group released R297 million of working capital in 2016, compared to an absorption of R725 million in 2015. This reflects an excellent working capital management result.
The Group undertook capital expenditure of R2,2 billion (2015: R2,8 billion), reflecting continued investment in South Africa’s future. The prior year comparative included a strong uptick in investment in assets to be leased by the Financial Services division.
Return on funds employed (ROFE) is a long-standing metric of performance and operational efficiency in our Group. Each business is measured monthly on a trading profit and ROFE result, and over 12 months this translates into an average return relevant to that business. It is an uncomplicated and highly effective measurement and all our managers understand and apply it.
The South African (industrial) component of the Group delivered a good performance. Average funds employed was R15,98 billion (2015: R15,24 billion), up 4,8%, and generated a ROFE of 33,2% (2015: 33,8%). As a result of this constant scrutiny, lazy underperforming assets are identified and dealt with on an ongoing basis.
Bidvest Namibia’s ROFE result declined to 17,1% (2015: 28,8%), as profits continue to be affected by the decline in performance of our fishing interests.
Inventory is a significant component of the ROFE measurement and was well managed in spite of our weakening currency. The currency effect was particularly evident at Automotive where reduced units on the showroom floor did not translate into an equivalent rand value decrease.
Accounts receivable, also a significant component, continued to receive rigorous focus on collections and credit extension across the Group, as economic pressure mounted on South African businesses and consumers.
The total ROFE performance for the Group includes assets such as our investment in associates and other investments, and this change consequently dilutes this metric considerably to a percentage in the low twenties, relative to the ROFE in the mid-thirties generated in the industrial operations. The role of these assets in the portfolio is currently being reviewed.
Cash flows and group debt
Our cash conversion metric is also a long-standing measure of performance, and links strongly to the management of our funds employed. The metric is calculated by summing cash generated by operations after working capital movement and net capital expenditure as a percentage of trading profit.
Our divisions showed a commendable capacity for converting profits to cash. The divisional average for the year was 75% of trading profit converted to cash, rising in some divisions to as high as 90%.
Net group debt was R5,0 billion. EBITDA interest cover is 8,0 times (2015: 8,7 times), and debt to EBITDA is 0,7:1. This is comfortably above the Group’s conservative self-imposed targets, providing ample capacity for further expansion and acquisitive growth.
Enhanced autonomy is reflected in a change of legal structure into seven subsidiary group structures, one for each Bidvest division. Each division own their funding and their strategy to a much greater extent than previously. They have the necessary critical mass and strength in their balance sheet to withstand macro-pressures and generate continued growth.
While the divisions continue to be responsible for their growth, they are now also taking ownership of the long-term positioning of their businesses. In the past, senior divisional teams were responsible for small bolt-on acquisitions and their impact on ROFE. In our new structure, teams have also been given the responsibility and the freedom to engage in major strategic acquisitions involving a substantial allocation of funds.
Clearly, support is still provided by the corporate team, but the driving force comes from within each division, and as always, there are no blank cheques at Bidvest. Prudence and rigorous examination of each opportunity still apply, but “big picture” thinking and distinct legal status represent a material shift for the broader management team, with the potential to drive focused growth at each division.
Philosophically, this enforces rather than departs from Bidvest’s founding vision. The core concept was always based on autonomy, decentralisation and entrepreneurship. These qualities remain as strong as ever at Bidvest post-unbundling.
The attitude to financial management has remained constant and continues to contribute to strong performance by divisional teams.
Divisional chief executives receive strong support from divisional chief financial officers, who are expected to be operationally as well as financially focused. Together, they drive the business.
We remain financially prudent. The maintenance of a strong balance sheet with sufficient capacity for sustained growth remains a priority. We take a conservative stance on debt and gearing, and continue to apply ROFE as the key yardstick when measuring managerial performance within individual businesses and across our seven divisions.
Acquisitions and disposals
The acquisition of Plumblink, effective July 1 2015, was successfully brought on board and reported pleasing results. Bidvest Namibia acquired Novel Ford, effective August 1 2015, in line with its strategy to diversify its income and also delivered pleasing results. Bidvest Insurance acquired Glassock & Associates. Our divisions continue to make smaller bolt-on acquisitions that bring the benefits of synergies, niche markets and new management.
After year-end, Bidvest announced the acquisition of 100% of Brandcorp, which will enable Bidvest to add various niche industrial and consumer products into its portfolio of existing services and offerings. This remains subject to regulatory approval. Once completed, the Brandcorp portfolio will form part of Bidvest’s Commercial Products division.
Several smaller non-profitable businesses in our divisions were either closed or disposed of just prior to the financial year-end. This process has continued into the new financial year.
Associates and other investments
Improved dividend contributions were made by associate companies Adcock Ingram (in which we have a 38,4% stake), Comair (27,2%) and Cullinan Holdings (19,5%). Among our other investments, Ontime Automotive UK (100% owned) faced challenges while Mumbai Airport (6,75% effective holding) remains an investment with upside potential in the long term.
Our investments in associates, in particular Adcock and Comair, suffered significant mark to market impairments at the year end.
The unbundling transaction included a 50/50 split of our Bidvest treasury shares after which both parties ended the period invested in each other. The Bidcorp holding is less than 1%.
Total carrying value of associates and investments declined to R7,1 billion (2015: R7,4 billion). Certain of these investments are currently under review as to their relevance and fit in our portfolio.
Bidvest’s internal divisional restructuring and the unbundling of the foodservices unit, has positioned the Group well for its next growth phase. Bidvest’s management teams, which are unchanged following the restructuring initiatives, remain focused on moving their respective divisions further up the value curve.
The Group’s financial position remains sound, cash generation is strong and it retains adequate headroom to accommodate expansion opportunities. At corporate and operational level, management is assessing and implementing plans for real growth and pursuing selective local and international opportunities to complement the existing product and service offering.
Some macro factors provide hopeful signs that the South African economy have reached a turning point. Power supplies have become more stable and our over-sold currency is steadily gaining ground against hard currencies, especially versus the pound sterling. International investor sentiment toward emerging markets is becoming more favourable and upward pressure on local interest rates appear to be easing.
Unfortunately, food inflation remains high as a result of the drought while higher utility charges can be expected to impact household budgets as tariff increases take effect.
New car sales – a traditional guide to the consumer’s propensity to spend – continue to fall, suggesting continued caution is in order.
Road freight volumes are also expected to remain low.
Most commentators expect world demand for South African commodities to be sluggish for some time in view of the slow rate of economic recovery worldwide. This suggests our mining industry will continue to take strain, with knock-on effects across the economy. Several of our divisions will continue to be negatively impacted by this trend.
A stronger rand has the potential to hurt the export of South African manufactured goods; impacting those Bidvest divisions that serve the industrial and manufacturing sectors. Brexit factors also deserve consideration despite having little direct effect on our businesses. Indirect effects could be considerable as many of our customers have strong links with a UK economy that is expected to slow down.
In South Africa, zero economic growth is forecast for calendar 2016; another signal that recovery is some way off.
The year ahead therefore looks challenging as the few macro-positives are so often offset by macro-negatives.
The performance of the South African economy in 2017 remains uncertain. Despite these challenges, Bidvest businesses are well positioned to put in another creditable performance and will seek continued organic and acquisitive growth.
Chief financial officer