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Feisty small cap to feel pain in Angola

Likely pressure on CIL margins.

Investors in JSE-listed engineering company Consolidated Infrastructure Group (CIL), are assuming the worst when it comes to the company’s recent investment in Angolan oil business Angola Environmental Services (AES).

The Angolan government has ordered the Ministry of Finance to temporarily suspend payments abroad for public contracts and an immediate review of the state budget.

“That means no South African company operating in Angola is going to be able to repatriate profits or dividends and no South African supplier can expect to be paid for services,” says Roger Ballard-Tremeer, honorary CEO of the South Africa-Angola Chamber of Commerce (see more here).

Some investors in CIL are assuming that the value of the investment will have to be written down as falling oil prices are also expected to play havoc with industry profitability.

The share price reflects this disquiet and has fallen from a high of R32 last October to R28.00 on Tuesday.

CIL acquired a 30.5% stake of AES, effective February 2014, and investors paid attention when group revenues for the year to August 2014 rose 29% to R2.6 billion, and profit after tax rose 50% to R258 million. AES contributed a healthy 32% of profit for the year.

It was expected that the business, which manages oil production waste for Angola’s local and international producers, would be a significant source of earnings in 2015 as the government strove to drive production from 1.7 million barrels of oil per day to 2.2 million. Strict environmental laws require that waste be disposed of in line with global standards.

The Angolan government has not managed to ramp up production. “It is a very interesting time,” says Raoul Gamsu, CIL CEO. “It’s hard to see clarity. While we know there is a point at which oil prices diminish the appetite for deep water drilling it’s hard to know where that is.”

According to a report by Frost & Sullivan, Angola and Nigeria are two of the world’s lower cost producers, producing oil at anywhere between $20 and $50/barrel. In comparison the cost of production from Canadian oil sands is between $50 and $100/barrel; in the US it’s $40 to $70; in Russia $40 to $50 and in Saudi Arabia, $10/barrel.

“From a country stability point of view the Angolan government is cutting back on its expenditure,” Gamsu says. “Last year the budget was based on an oil price of $85/barrel and this year it’s based on $50/barrel. There is a freeze on government employment and promotions and they are rearranging their infrastructure investment. My view is that they will hold their own for now,” he says.

The oil companies are also significantly invested in the industry and will adopt a long-term view. “Take Total, that company has invested $18 billion in one block – block 17 – over a 15-year period,” Gamsu says.

Sonangol Group, the State-owned oil company, has seen its expenses trimmed and efficiencies improved over the past 18 months.

But the macro-economy will impact AES. “We have had no material contract changes, but we have had requests from our clients for price reductions.”

In some cases AES has conceded a reduction, but negotiated better contract terms. “One client asked for $2 million to $3 million reduction per year,” Gamsu says. The company agreed to a $500 000 reduction along with the recommendation that they move their business to AES’s new waste facility in Soyo, northern Angola. The facility will be up and running in the next two months. “This will save them $30 to $40 million/year in logistics costs.”

Margins will be affected and growth may taper off in the short term. “We are trying to manage it, but it may be hard to claw back some of the margin. We will be happy to take flat growth this year,” he says.

While AES is Angolan registered, the ability to remit cash flows is an issue. Fortunately there were no plans to remit funds for two to three years. “There are some management fees, but for the rest we are reinvesting in the business in Angola.”

Brian Pyle, portfolio manager at Old Mutual Investment Group, has taken a sanguine view on events. “AES is not the key driver of the business, Conco [the power transmission business] is. If AES contributed 80% of the profits I would be concerned.”

Maybe the market pushed the share too far to R32 and now it has over reacted on the downside. “We are not there to trade between bands. When we buy into a small cap like this, we buy into the long-term vision. That means we buy and forget – unless there is a fundamental change in the business.”

CIL management has followed a strategy to diversify the group, to ensure it is not dependent on one sector or region.

Conco earns the bulk of profits, but the company has a growing operations and maintenance business – also in the power sector. CIL also supplies building materials and last year it added Tractionel which builds and operates electrical infrastructure for rail operators, to its rail business.

The Eskom power crisis has arguably had a beneficial effect on Conco. “Round three [of the renewable energy IPP programme] is now certain. We still have some contract closures to negotiate, but four of a possible seven are in the bag.”

In the meantime round four of the Renewable Energy Independent Power Producer Procurement Programme (REIPPP) looks set to go ahead. “At one point Eskom was flexing its muscles and trying to involve itself [further]. But I am now certain round four will go ahead which could mean another R1.5 billion worth of orders for us.”

The lower oil price could also impact the power business in oil importing countries like Kenya, South Africa and Mozambique. “Oil imports are a drain on any economy. This should free up additional money for the power business.”

This reflects the benefits of a diversified offering. Whether this will be enough to mitigate the impact on AES remains to be seen.

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