SAA results, media address by Public Enterprises Minister

South African Airways (SAA) today released its Annual Financial Statements after its Annual General Meeting (AGM) was held at the award-winning airline’s headquarters this morning.

The declining demand for air travel emanating from the economic downturn, coupled with increased fuel costs resulted in the airline reporting an operating loss of R1.3 billion.

SAA recorded a bottom-line profit of R60 million, which includes a tax credit of R514 million as a result of the recognition of a deferred tax asset, as well as the surplus of R823 million recognized on the revaluation of the SAA Group’s property portfolio.

The average Brent crude price increased by 36% (from $84.10 to $113.70) per barrel – Fuel costs for the year comprised 33% of the airlines total operating expenditure which is up from 28% in the previous financial year. In addition, the airline experienced a significant increase in uncontrollable operating costs such as aircraft maintenance, leasing, navigation, landing and parking. Controllable expenditure increased by 5%.

In a tough year for many major global airlines, some of SAA’s financial highlights include an increase of freight and mail revenue by 8%, an increase of passenger revenue by 3%, increase of Voyager income by 48% and an increase of commission received by 8%.

In June 2012, the Oxford Economics study highlighted SAA’s annual contribution to the South African GDP as R8.6billion (0.3%) through its catalytic demand effects as well as an additional R11billion in its positive impact on tourism, supporting 35 000 (mostly highly skilled) jobs, R1.3billion in tax (net) VAT and R1.1billion in aviation taxes.

In the year under review (2011-2012), SAA set to achieve eliminating R1.3billion of its operating expenditure for the 2012-2013 financial year through a comprehensive internal cost containment drive.

SAA also launched its Flight Academy to strengthen SAA’s support of skills development and job growth policy objectives. Furthermore, the airline strengthened its brand through winning, for the tenth consecutive year in a row, the Skytrax award for Best Airline in Africa and Best Customer Service for the third year in a row.

Please attribute quotes to SAA’s Chief Financial Officer, Mr Wolf Meyer.

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Media Address by Mr. Malusi Gigaba MP, Minister of Public Enterprises, on the occasion of the SAA Post-AGM Briefing at Airways Park on 15 October 2012

INTRODUCTION

The financial year 2011/12 has been a tough and challenging year for the airline industry.

Earlier today, I addressed both the Annual and Special General Meetings of SAA.

At these meetings, I reflected on the state of the aviation sector, the state of the airline and its performance for the year under review, the challenges it faces and the measures that should be taken to set the airline on a path of recovery.

What I can state without any fear of contradiction this afternoon is that I am determined to see to it that this airline gets on the path of recovery.

We do not have the luxury to fail and I shall hence brook no indecision!

GLOBAL CONTEXT

The airline industry is a highly dynamic environment with growth and profits sensitive to any changes in the global and national economic environment.

The prolonged economic downturn and the bleak economic outlook have led to a decline in global trade, business and leisure tourism.

This has further been exacerbated by the spiralling increase in the fuel price due to the decline in the global oil supply which increased from an average of $84 to $114 per barrel in the year ended 31 March 2012.

Aviation will be both a driver and a beneficiary of this growth.

Airlines in the world have taken a hit this year as total profits are forecast to fall to $3 billion from $6 billion the previous year.

Recession in Western countries, notably the United States, the United Kingdom, Spain, Portugal, Italy and Greece have severely affected the global travel business.

Air transport to, from and within South Africa creates three distinct types of economic benefit, that is, its contribution to GDP, jobs and tax revenues generated by the sector and its supply chain.

The connections created between cities and markets represent an important infrastructure asset that generates benefits through enabling foreign direct investment, business clusters, specialisation and other spill-over impacts on an economy’s productive capacity.

SAA, as a group, contributes R1.3 billion to public finance in income tax and VAT (Net) including its subsidiaries and a further R1.1 billion is paid via air passenger duties and other aviation specific taxes.

The distributive impact of SAA to the South African economy is significant and unquestionable.

FINANCIAL PERFORMANCE

However, SAA has performed below expectations during the 2011/12 financial year.

Although such performance may be attributed to the adverse global economic environment, SAA still fared poorer compared to its peers across the globe.

Given the difficult environment, a prudent Shareholder is compelled to ask whether SAA responded adequately and timeously with a responsive business strategy to mitigate or cushion the airline against these exogenous factors.

For the year under review the airline has increased its revenue from R22.6 billion to R23.8 billion, and yet still recorded an operating loss of R1.3 billion.

Fuel costs accounted for 33% of the Group’s operating expenditure, up from 28% in the previous year, which amounted to a R2.2 billion increase.

Aircraft maintenance costs were also higher than targeted.

Of grave concern to the Shareholder is the decline of the airline’s liquidity position over the last 2 years.

The cash balance as at 31 March 2010 was R3.4 billion.

This figure declined by R1.2 billion in the 2010/11 financial year and by a further R2.3 billion in the 2011/12 financial year.

Unlike its peers which experienced an increase in the operating costs, SAA has not experienced corresponding increase in revenue.

We have raised this matter in our monthly standing meetings with SAA and the National Treasury.

As such we have requested SAA to take urgent measures to mitigate the adverse effect of a prolonged cash burn.

The liquidity challenges resulting from the cash burn questioned the status of SAA as a going concern.

Furthermore, the Auditors have raised an emphasis of matter in the financial statement relating to the restatement of corresponding figures and irregular expenditure.

In the year under review, the restatement relates to maintenance reserves and voyager income, a situation which has persisted for the past three years.

Although this is an acceptable accounting practice, I am concerned that it cast aspersions on the integrity of the numbers year on year.

For example, last year’s financial statements showed the equity balance at R2.9 billion as at 31 March 2011; and yet after the change in the accounting policy and restatement, the equity as at 31 March 2012 was reduced to R475 million.

The fact that these restatements are not prevalent in other comparable airlines is equally disconcerting.

Henceforth, all further changes in accounting policies and revaluation of assets require my approval before implementation, which would therefore require a review of the Significance and Materiality Framework.

In addition, the Auditors also raised emphasis of matter on the irregular expenditure of R128m which has increased from R85m in the previous year.

Although the Directors report states that the expenditure did not result in monetary loss to the airline, I am concerned about the recurrence which reflects weak internal controls.

I have implored the Board and Management to improve the controls around procurement and not continue condoning irregular transactions.

Furthermore, the fruitless and wasteful expenditure amounted to R4 million, up from R2m in 2011, R3m of which was due to baggage claims.

The current status and the inability of the airline to continue operating without government support has left the Department with no option but to instruct the airline to draft and implement a long-term turnaround strategy to sustain the airline for the foreseeable future.

This increases undue pressure on the Shareholder continuously to have to justify why we are maintaining a national carrier; why Government is involved in the business of airlines at all.

This is a situation that is totally unacceptable as there are other very well run, competitive, sustainable, financially-viable and even profitable state-owned national carriers and there is no reason why SAA should not be like them!

However, I am pleased to announce that I have approved the Company AGM’s motion that the Executive Directors’ remuneration for 2012 / 2013 financial year be increased by 0%.

PERFORMANCE AGAINST THE SHAREHOLDER’S COMPACT

In the year under review, SAA achieved only 13 out of the 29 key performance indicators of the Shareholder Compact, which constitutes only 44% of the key performance areas that have been met.

It is disconcerting that the majority of those targets not met relates to the key performance areas of financial value creation or commercial objectives as stipulated by the Shareholder.

SAA LIQUIDITY

As a result of, amongst other things, the changes in the accounting policies and the concomitant restatement of corresponding figures, the airline’s debt to equity position had deteriorated to such an extent that it casted doubt on the SAA status of going concern.

The latter also had the potential to trigger events of defaults in contracts between SAA and third parties.

Furthermore, the cash burn suffered by the airline depleted the working capital of the airline presenting an immediate risk of the company not being able to meet its obligations.

Both the cash burn and the deterioration of the debt equity position of the company required the intervention of the Shareholder to stabilise the company.

In February 2012, we requested the external auditors to work with SAA to determine the minimum financial support required to ensure that SAA continued to trade as a going concern.

We received the first draft report and recommendations in April 2012 and the final report and recommendations in June 2012.

In tandem to this process, as the Shareholder, we requested international consultants reputable in the airline business to conduct a diagnostic study which revealed that SAA required financial support to stabilise its operating environment.

In June 2012, I met with the Minister of Finance and discussed the liquidity challenges of SAA and possible solutions.

We then encouraged SAA to explore other sources of funding prior to approaching the fiscus, which included funding from DFIs and commercial banks.

We worked with SAA to explore these options.

In August 2012, it became clear that no suitable financial solution could be secured given the financial position of the airline.

As an interim measure, and after extensive engagements with the National Treasury, the Shareholder provided an air-traffic liability guarantee on behalf of SAA which improved the airline’s cash position.

In August 2012, we approached the National Treasury on behalf of SAA and motivated for a guarantee to be granted to maintain SAA as a going concern.

This triggered very involved and robust negotiations between the National Treasury and the Department of Public Enterprises considering that SAA had received extensive financial support from the Shareholder for the past 10 years in excess of more than R15 billion.

At all times, SAA and the Department knew that the external auditors would not sign the audit report declaring SAA as a going concern without the liquidity challenges being resolved.

Whilst the National Treasury approval of the guarantee was still pending, and understanding the consequences of the airline not being declared a going concern by the external auditors, I, as the Shareholder Representative, requested the postponement of the AGM which was initially scheduled for 6 September 2012 to 25 September 2012.

Throughout the engagements with the National Treasury, there were interfaces between the Director-General and the CEO as well as between the Chairperson and I.

On 21 September 2012, realising that the National Treasury process was far advanced but would not be concluded on time for the AGM, we informed SAA accordingly and requested that the AGM be further moved to 15 October 2012.

The SAA Board did not object or express any displeasure.

On 26 September 2012, the Minister of Finance notified me of his decision to grant SAA a guarantee R5bn subject to stringent conditions which include, amongst others, the development of a turnaround strategy and funding plan for the long and short haul fleet.

On 28 September 2012, and on the strength of the guarantee, the external auditors signed off the annual financial statements.

BOARD ROTATION

Prior to dealing with the rotation of the board, I wish to express my sincerest condolences to Mr Zakhele Sithole’s family who passed away on the 18th August this year having served SAA with tremendous distinction.

He served as the Chairperson of the audit committee, member of the procurement and tender processes committee and ad hoc committee on litigation.

We are truly grateful to him for his service to our SAA and to our nation.

The members of the Board of SAA are appointed for a three year term which is subject to review by the Shareholder annually at the AGM.

The term of office of the former members of the Board was due to expire at the AGM and this is acknowledged in the former Chairperson’s report attached to the annual report.

In anticipation of this eventuality, on Wednesday, 19th September 2012, I approached Cabinet and obtained its concurrence on the rotation of the Board.

Having analysed the state of the airline, the context within which it operates and the fundamental turnaround required, I formed a view that a fresh perspective was required to stabilise the airline.

It is unfortunate that the sudden departure of the past Board members got mired in controversy owing to the breach of confidence.

I must state it categorically clear that I take a very dim view of the repeated incidents of malicious leakages which have happened recently within the airline and have taken steps to address these lapses.

I wish to express my gratitude to the previous Board of SAA for their contribution and service.

I am mindful of the difficult terrain they had to traverse and the harsh economic condition under which they had to operate.

I am grateful for all they achieved whilst they had the custody of our national airline and thank them.

THE RESIGNATION OF THE CEO

On 8 October 2012, the new Board Chairperson informed me of the resignation of the CEO, the General Manager: Commercial and the General Manager: Legal, Risk and Compliance.

I was disheartened to learn of their resignation and the reasons proffered for such resignations.

I have been assured that the Board is handling the resignations according to the applicable contracts between the company and the said executives.

Further, I have been informed that the Board has decided to delegate its executive powers to the Chairperson pending the recruitment and appointment of the new CEO.

I wish to thank the CEO and her colleagues for their service.

The Department will continue to provide the necessary support and oversight to ensure that there is minimal disruption to the business and that the turnaround plan is developed and implemented in compliance with the guarantee conditions.

Based on the reports I have received; my assessment is that the company is stable and trading normally.

THE WAY FORWARD

Despite the challenges we have earlier alluded to, the airline has performed satisfactorily in the regional and domestic market.

However, it needs to explore ways to improve the profitability of its long haul – intercontinental routes.

The national carrier plays a critical role in that it is responsible for the significant share of international and regional arrivals to South Africa.

In addition to this, it plays a significant role in the current airlift of Southern Africa and plays a critical connectivity role in the global economy.

Knowing realistically that the airline is going to continue to need government support as its Shareholder, I have mandated the new Board primarily to turn the airline around to a position of financial independence and operational efficiency.

This requires a long-term vision and strategy to become a competitive and well-run airline, with clear plans and targets for the future, including on such issues as fleet procurement.

It is pivotal that the airline be immediately stabilised!

It is important that cost containment and revenue enhancement be the immediate focus of the airline.

The Board and management are to review the airline’s business model, structure and strategy.

In order to deal holistically with the challenges facing our airline assets, I have formed a task team made up of the Chairperson of the Board of Board of Directors of SAA, the Chairperson of the Board of Directors of the South African Express (SAX), the CEO of SAX, the CEO of Mango together with the Acting Deputy Director-General: Transport Enterprises in the Department to provide me with a view on the critical success factors for the turnaround and a roadmap for the turnaround.

I require the task team to report to me before 15 December 2012.

I have given the Board three months to finalise the recruitment of the new CEO and to fill the other vacant executive positions without delay.

I must assure fellow South Africans, staff members of SAA, its customers and suppliers, that we will continue to pose the difficult questions and to engage robustly with the Board in order to maximise shareholder value.

These questions might very well be uncomfortable, but they deserve to be asked without fear or favour.

We shall maintain close oversight and continue to be an active and responsible Shareholder.

I thank you

Author: Muzi Mohale

Hi there, am your host and I blog about the tourism industry in South Africa. You're also welcome to contribute your expert content on matters affecting the industry. You can reach me on muzi[at]tourismedition.com

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