It looks like the market is a finicky mistress.
It rewarded Tongaat Hulett with a friendly smile in the form of a 6% increase in the share price after it published its results on Tuesday morning, only to pout two hours later and wipe the gains off the table.
To be fair, she’s had to put up with a lot from Tongaat the last few years.
The 2019 financial year was a total disaster and while 2020 was much better, the 2021 figures show that there’s still a lot of work to be done.
Management noted that the 2021 financial results are presented against a challenging economic background, exacerbated by the continuation of the Covid-19 pandemic.
The majority of Tongaat’s businesses were able to continue operations during the various lockdowns, but were affected by shortages of critical spare parts due to border closures and an impact on production as employees had to self-isolate. But, says management, it wasn’t too bad.
“For the property business, however, the Covid-19 lockdown delayed planning approvals and infrastructure installation and restrained public participation in the various processes required to secure land development rights,” CEO Gavin Hudson advised shareholders. “Deals under negotiation were also halted or abandoned due to the uncertain economic environment, resulting in a material reduction in revenue and profit from the operation.”
In the end, operating profit from continuing operations declined by 44% to R1.8 billion from the prior year’s nearly R3.3 billion. High interest payments reduced this profit to a loss of R628 million.
However, things are not really that bad. Management points out that shareholders should look at the adjusted earnings before interest, tax, depreciation and amortisation (Ebitda) to get a feel for how things are going.
Adjusted Ebitda of just below R2.5 billion is only some 17% lower than the R3 billion in 2020. This figure is a non-IFRS measure to adjust profit for a lot of “funnies”, including the adjustment in the fair value of standing cane sugar. This has a huge impact on earnings, such as the valuation of Tongaat’s huge cane fields in Zimbabwe under a regime of hyperinflation.
A note to the financial statements explains that the reason for this is that hyperinflation distorts the fair value adjustments to biological assets reflected in the income statement.
During 2021, adjustments to fair value of assets due to hyperinflation in Zimbabwe amounted to a charge of R626 million. It was even bigger in the previous year – R1.2 billion.
Hudson reiterated in an interview with Moneyweb that the recovery and restructuring at Tongaat is proceeding well.
Most importantly, Tongaat reduced its net debt by nearly R4.8 billion during the last year, from R11.4 billion at end March 2020 to R6.6 billion at the date of the balance sheet. Gross borrowings decreased by nearly R5.4 billion due to cash balances being kept to a minimum to reduce finance costs.
Net finance costs (settled in cash) amounted to more than R1.1 billion in the past year, which management says is continuing to significantly constrain liquidity. It highlights the strategic imperative to reduce debt to an acceptable level and improve cash flows, according to the results announcement.
Hudson says the reduction in debt close to the end of the financial year will reduce interest charges in the new financial year, but adds that debt is still too high.
“A sustainable level of debt is below R3 billion, preferably around R2.5 billion,” says Hudson.
He noted that the recent renegotiation of credit terms has bought Tongaat “more time” to get its balance sheet in order. He says the extension will enable Tongaat to reduce what he terms the “excess debt” of around R3 billion in a responsible manner by disposing of some assets and – maybe – approaching shareholders for new capital in a rights issue.
The balance sheet shows that Tongaat is not out of the woods yet.
It has valuable assets in the form of huge sugar cane farms, sugar mills and large tracts of land that can be developed into commercial and residential property – according to the balance sheet all the assets are worth a cool R13.3 billion.
But liabilities exceed this and the balance sheet reflects negative shareholders’ equity of R1.1 billion.
The auditors’ statement draws attention to the “going concern note” included in the notes to the financial statements, which indicates that the group’s current liabilities exceed its current assets by R2.7 billion and the company’s current liabilities exceed the current assets by R5.7 billion.
“These notes disclose that the group’s South African debt has been refinanced with new repayment milestones, including ones that need to be met within 12 months of the date of this report, in order to reduce the group and company’s debt to a sustainable level,” say the auditors.
“This condition indicates that a material uncertainty exists that may cast significant doubt on the group and company’s ability to continue as a going concern.”
Hudson says a rights issue is still under consideration, depending on the level of asset sales over the next few months.
A big variable is the closing of pending property sales that were delayed by the various lockdowns of the past 18 months, as well how quickly confidence will recover in the property market.
Hudson makes reference to Tongaat’s low market capitalisation (around R1.3 billion) and remarks that the appetite for a rights issue will have to be considered carefully.
However, it is noteworthy that Hudson seems optimistic about the future.
“The debt restructuring gives us three years rather than three months,” he noted.
He also points out that the dynamics in the sugar market are very favourable. “Demand is strong. Prices have increased, exports have increased and world sugar prices are rising. Fundamentals are good. The business has a lot of promise.”
Tongaat mentions that the Zimbabwean operations are significant and continue to perform well. The country received good rains that will ensure water security for irrigation for at least three seasons, according to management.
In SA, Tongaat gained market share after the implementation of a Sugar Masterplan, as well as changing consumer behaviour that notably increased demand.
“It is noteworthy that these market share gains were achieved through lower costs rather than higher incentives, thereby protecting margins,” says management.
There is also scope for improving the performance of local sugar mills, which Hudson says “was disappointing”.
The sugar mills crushed 4.8 million tons of cane (5.1 million tons in 2020) and production of raw sugar decreased 10% from 603 000 tons to 535 000 tons.
The potential for recovery is there. The figures show that production of refined sugar increased by 39% to 450 000 tons to support the increased demand and commitments under the new sugar industry plan.
Management noted that this considerable production increase and pressure to meet demand for refined sugar led to some process inefficiencies which resulted in a (once-off) loss of around 27 400 tons of raw sugar, which had a negative impact of R369 million on earnings.
The Tongaat share price was 2% down at R7.35 by closing time with investors apparently signalling that they don’t care for the R8.22 headline loss per share, irrespective of the potential.