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Investment policy, price pass-on buffers Afrox from gloomy market

Afrox CFO Nick Thomson discusses what led to the industrial gas supplier's improved performance despite challenging market conditions.

28th February 2014

By: Natalie Greve

Creamer Media Contributing Editor Online

  

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Industrial gas supplier Afrox’s strategy of investing in plant modernisation, additional capacity creation and efficiency enhancements appears to be paying off, with the Linde Group subsidiary posting an 8% increase in headline earnings a share to 95.3c for the year ended December 31, and a 10% jump in earnings before interest, taxation, depreciation and amortisation (Ebitda) to R880-million.

This came on the back of “difficult” trading conditions in South Africa, which affected all the company’s major market segments and was a situation Afrox expected to prevail for the foreseeable future, given the low growth environment reflected in the gross domestic product (GDP) forecast.

However, the “challenging” market conditions in South Africa were not enough to dampen a 5% increase in overall revenue to R5.82-billion for the 12 months, Afrox stated at its results presentation on Friday.

MD Brett Kimber said, owing to the company’s ongoing capital programme, the focus on developing its business in the rest of Africa and the recent realignment of Afrox’s South African business into integrated business lines, “the building blocks for future growth are firmly in place.”

Afrox invested R507-million in 2013, while profit for the year of R324-million reflected an increase of 18% on that achieved in 2012.

Meanwhile, group CFO Nick Thomson outlined that prolonged uncertainty in the South African economy, coupled with low GDP growth, continued to impact upon demand for products in key sectors.

An unsettled labour environment, characterised by strikes and violence, resulted in production in key industries, such as mining and manufacturing, also being impacted negatively.

Market activity remained depressed, while cost pressures continued, as rising labour, fuel and electricity prices, along with a falling rand, had a negative impact on margins and production.

“[However], we were able to pass on the majority of these price increases to the customer, which is reflected in the 5% yearly increase in overall revenue,” Thomson noted.

Kimber added that, in anticipation of depressed market conditions, Afrox had implemented a new integrated operating model in the first quarter of 2013, which had provided a greater degree of accountability for revenue, profit and loss as well as cost and asset use for each business line.

“This allowed the company to deliver higher levels of customer service through clearer accountability, improved decision-making and faster execution across the
business,” he commented.

These measures also enabled the realisation of an Ebitda margin improvement from 14.3% to 15.1% in 2013.

The group ended the year with net borrowings of R649-million and gearing of 14.6%.

Afrox declared a final cash divided of 20c a share for the year under review.

CAPITAL SPEND

Advancing its focus on expanding its capabilities, Afrox invested R507-million in capital expenditure (capex) over the period, including bolstering its fleet by 22 tankers to 106, as part of its transport fleet replacement plan.

Capex included further investment in cylinders, which formed part of the group’s overall R1.5-billion capital plan announced in 2012.

In addition to the current year’s expenditure, R300-million was being spent on delivery of a new 150 t/d atmospheric gas separation unit (ASU), in the Eastern Cape, the “epicenter” of South Africa’s motoring industry.

“This project is progressing, with all governance permissions and environmental-impact assessments in place and production expected to start early next year,” said Kimber.

Meanwhile, the “state-of-the-art” R400-million KwaZulu-Natal filling plant, also announced last year, was well into its planning phase.

Commenting on funding sources, Thomson stated that, during the year, a syndicated R1.8-billion loan structure was negotiated and would be serviced in various tranches of seven-, five- and three-year loan terms.

This would be used to fund Afrox’s capex programme, as well as a R300-million revolving credit facility to meet peak working capital requirements.

The drawn facilities of R1-billion were at fixed interest rates.

SEGMENTAL REVIEW

Owing in part to a “mild winter” in South Africa and reduced demand from key industrial users, liquefied petroleum gas (LPG) volumes were down 3.2% while, in line with Afrox’s customer commitment, LPG was imported to act as a buffer for expected winter shortages and refinery shutdowns.

However, price recovery of the additional import costs and the resulting increased distribution costs was “made difficult” by the prevailing trading conditions.

“In our atmospheric gas segment, 2013 was challenging for tonnage plants, which continued to be impacted by the rising cost of electricity and the
reduced demand for product, especially from the steel industry,” Thomson said.

Meanwhile, production availability of ASU installations remained “world class” at 98%.

In addition, prevailing economic conditions resulted in an output fall-off at key large customers and, as a result, demand for atmospheric bulk gases reduced by 1.6% and sales of compressed gases declined 0.6%.

Merchant carbon dioxide volumes were in line with those achieved in 2012.

“It is pleasing to report that in the hard goods business volumes were up 6.5% despite sluggish demand. Our factories also won the contract to manufacture the new Linde medical valve, with our first deliveries to start in late 2014,” noted Thomson.

Operations in African countries outside South Africa contributed 20% of the group’s total gross profit after distribution expenses, with these businesses having been the focus of “intense” information technology investment, focused financial processes and improved governance controls.

“In addition, they have benefitted from an injection of experienced management resources, positioning these businesses to benefit from the opportunities presented by the rapid growth in their local economies.

“Exciting new plans to capitalise on growth opportunities in the rest of Africa were approved by the board in the last quarter of 2013,” Kimber revealed.

THE YEAR AHEAD

Afrox hoped to this year enter arbitration over an ongoing take-or-pay contract dispute with multinational steel manufacturing corporation ArcelorMittal South Africa (AMSA).

“We’re hoping to enter arbitration this year but, as we’re the guys wanting to get paid, we want it to happen quickly, [as opposed to AMSA], which wants to delay [paying] for as long as possible,” said Thomson.

In 1996, the two companies entered into a stainless steel supply agreement that would see the gas supplier providing oxygen and nitrogen until December 31, 2012, and argon until December 31, 2019.

While the oxygen and nitrogen agreement expired at the end of 2012, the argon provision agreement alone was worth some R50-million a year before tax until its maturation in 2019.

Afrox claimed that AMSA had only partially settled amounts owing in respect of the take-or-pay agreements and had only paid for the volumes that it had consumed and not those contractually outlined.

Edited by Tracy Hancock
Creamer Media Contributing Editor

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