Group Five’s outlook uncertain; H1 earnings down 47%: Eric Vemer – CEO, Group Five

‘In this reporting period our return on equity has been below our cost of capital.’

SIKI MGABADELI: Construction firm Group Five’s earnings were down 47% owing to retrenchment costs and a weak performance by its civil engineering department. My colleague Tumisang Ndlovu spoke to Erik Verner, CEO of Group Five, to give us some more clarity on this.

ERIC VERNER: Headline revenue numbers declined by 12% over the prior comparable period, which was really the result, I think, of a very high trading environment in the previous period, particularly in our civils business and in our energy business, where we had a large order book in renewable projects. So operating profit declined by circa  37%, headline earnings were down by 47% from just over R2 to now just over R1, around the R1.09 level.
   So fully diluted headline earnings per share from continuing operations are now at R1.07 and the dividend, maintaining our policy of four times cover, declined by 33% to 30c from the prior 45%.

TUMISANG NDLOVU: Analysts who have spoken to Moneyweb suggest that confidence in the South African construction sector has declined quite markedly in the last few months, fuelled by delayed projects and Eskom-related issues. Is this a fair assessment of the situation?

ERIC VERNER: Tumi, I’d say that we are seeing that the large infrastructure projects are not coming through. So in terms of general construction activities there are still pockets of activity within the roads environment. We have seen some water projects. Certainly the building and housing part of the market still remains relatively robust. But in terms of the large infrastructure spend to come through with the large infrastructure projects, big new road developments and so forth, that has been a particularly challenging environment for us.

TUMISANG NDLOVU: In your interim results you specifically identify the civil engineering division as one that’s under pressure. You also point out that the energy, civil engineering and projects businesses have negatively impacted the overall results and further reduced the group’s overall core operating margin from 4.3% in the prior comparable period to just 3.1%. Is this sustainable – and what level would you like to get this to?

ERIC VERNER: Firstly just to clarify – it’s certainly been a challenging for our civil engineering cluster, where we have incurred a loss-making contract which has dragged the performance significantly down in this reporting period, as well as some challenges on the completion of some of our projects in the renewables space. But our projects business continues to perform well. So no issue as far as that business is concerned.
   In terms of sustainable, no, we certainly would not want to see a repeat of the significant loss-making contracts as we have experienced in this reporting period. And whilst we are incurring retrenchment costs, both in the previous six months to December and we have also forecasted further retrenchment customers for the balance of the year, we would anticipate not to be carrying such a negative burden from loss-making contracts in the year ahead.
   So we do think we’ll be getting an improvement in our margin performance from the next financial year.

TUMISANG NDLOVU: Over the last five years your share price has lost around 25% and shareholders are understandably frustrated by the ongoing sectoral issues, including those that arise from the Competition Commission-related investigations. If shareholders were to measure your performance one year from now, what would you want them to judge you on?

ERIC VERNER: I think a critical factor for us, Tumi, is that we are very strongly focused on our returns. And ultimately, if you orientate the business to be looking at the returns that we make on the capital invested in the business, that needs to be exceeding our cost of capital. Disappointingly in this reporting period our return on equity has been below our cost of capital, sitting in the mid-8% region, and we need to get that return on our invested capital back to being in our target range of between 15 and 20%. That in turn will distil itself ultimately in a share price that appreciates – and that’s ultimately what the shareholders have employed us as executives to do, to make best use of the capital they allocate to us, and seek opportunities for driving returns on that capital.

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