BRRAY - Barloworld Limited (BRRAY) Q2 2023 Results Earnings Call Transcript
2023-05-22 11:57:08 ET
Barloworld Limited (BRRAY)
Q2 2023 Results Earnings Conference Call
May 22, 2023, 05:00 AM ET
Company Participants
Nwabisa Piki - Head Of Investor Relations
Dominic Malentsha Sewela - Group Chief Executive Officer
Nopasika Vuyelwa Lila - Group Finance Director
Emmy Leeka - Chief Executive Officer, Barloworld Equipment Southern Africa
Quinton McGeer - Outgoing Chief Executive Officer, Barloworld Equipment Eurasia
Chris Wierenga - Chief Executive Officer, Barloworld Consumer Industries
Andronicca Masemola - Finance Manager, Barloworld Equipment Rest of Africa
Conference Call Participants
Presentation
Nwabisa Piki
Good morning, all. Welcome to Barloworld's Interim Results for the Six Months Ended 31 March, 2023.
Today, we will present starting with our Group CEO, Mr. Dominic Sewela with group highlights and overview. We'll then move to Ms. Lila, our FD, for the financial overview. After that, she will be followed by the business unit heads, starting with Mr. Emmy Leeka from Equipment Southern Africa; Mr. Quinton McGeer, Equipment Eurasia; followed by Chris for our Consumer Industries vertical, presenting Ingrain's results. Thereafter, we'll have our CEO take you through our strategy update and outlook. And thereafter, we'll take questions from you online, over the telephone, on LinkedIn for those watching in LinkedIn. And yeah, we'll close off after that.
I will now hand you over to our CEO, Mr. Dominic Sewela.
Dominic Malentsha Sewela
Good morning, ladies and gentlemen. As Nwabisa said, welcome to Barloworld's interim results. As per usual, it's always important that we start with ESG. We at Barloworld have been in the habit of ensuring that we can integrate ESG as part of our business. And some of our key focus areas in ESG is financial inclusion because we operate in emerging markets. And in these markets, societies that are impacted negatively, so one of our main task is to ensure that our communities are included and we have Mbewu and Siyakhula that is used as a vehicle to do so.
It is known that we're leading in the areas of diversity and inclusion. And to that extent, we've also issued bonds that speaks to inclusion agenda, as well as sustainability. But of importance as well is that our board focuses on governance and it is important that we continue to have a balanced board, that it's got to keen interest and attention to what shareholders require.
Also importantly is that, from a people point of view, we look at people and the planet that we live in because, in many ways, our behavior as human beings to impact the planet, therefore from Barloworld point of view, we ensure that our employees are aligned, ensuring that we can reduce our footprint on to the planet.
And when you look at what we do as a business, we try and focus and saying whatever we focus on, it's got to be part of the business. When you look at the gender bond, when you look at the targets that we've set, it is already what we're doing, but trying to entrench that and saying, let's set targets that are in line with what we're doing. Therefore, diversity and inclusion is what we do well, and there are many other instances where I can show you, but I think what's notable is that we've been recognized and given an award on that ESG agenda link bond.
Prior to that, we've issued a sustainability linked bond. And key focus area in that was to reduce our footprint on the environment, and we're using it to roll out solar, PVs to reduce our reliance on coal-fired power stations or drawing electricity, but more importantly, is actually making sure that our employees are able to go home safely to their families as they come to work. So that is the focus. And I think come the end, we'll be able to give you even more numbers in terms of our targets and how we progressing there.
I think another highlight for us, notwithstanding the challenges we have in our various jurisdiction, it doesn't matter where we are, we've got even here in South Africa a lot of challenges, but notwithstanding that, our strategies that we embarked on five years ago, which was focused on saying we need to fix, optimize our business, and then get into growth has really been a strategy in action and has delivered the results that you're seeing here. We've been able to exit businesses that were dragging us down in terms of returns, in terms of earnings.
And now that we've simplified the portfolio and in the meantime also make acquisitions that are very accretive, whether you look at Mongolia and Ingrain, those services are very accretive to our business at all levels.
You can see that we've basically generated a revenue about 12.9% increase on a continuing operations. Notwithstanding the challenges we have in a jurisdiction like Russia, if you were to exclude, just for demonstration purposes, the revenue still strong at 34.5%. Very strong right up to the operating profit. I think you can see ZAR 2.1 billion compared to ZAR 1.8 billion of operating profit.
Similarly, when you look at the HEPS, 29% HEPS growth for continuing operations, very strong in this environment that we operate in.
Operating margins, I'm very pleased that we're now in the double-digits operating margin at the group. And as you'll see from the divisions, they will be able to demonstrate where it's all coming from.
And I'm also pleased that, from a capital allocation framework that the board uses, the board has declared a dividend of ZAR 2, which is about 21.2% up on last year, and so we are actually living up to and making sure that we remain very accretive to our stakeholders. And this, for me, is a major step towards that.
And I think we continue to focus on cash conversion. I think when you look at our EBITDA in the first half, it's significantly up to ZAR 2.7 billion compared to ZAR 2.4 billion, even having taken Avis off, which is very good.
Let me hand you over to Ms. Lila to take us through the numbers in detail. Thanks, Ms. Lila.
Nopasika Vuyelwa Lila
Thank you, Mr. Sewela. And welcome all to Barloworld 2023 interim results. My task is pleasant today as I present exceptional strong results for the group. And thank you to team Barloworld.
As Mr. Sewela has mentioned, we've successfully exited our automotive pillar. Avis was unbundled on the 13th of December, 2022. Logistics disposed of on the 31st of March, 2023. So what remains within the group now is our two core businesses being the pillar consumer industries, as well as industrial equipment, and services.
I'm delighted to present the financial highlights. Stellar performance coming through our revenue, EBITDA, operating profit and core trading activities, as well as headline earnings per share.
Our gearing has remained within our targets. And as expected, with a net asset value per share, the number would have decreased because we did unbundle Zeda during this period.
I move on to the income statement. And there you can see the strong performance coming through in the revenue where we've delivered ZAR 20.8 billion in revenue, which is a significant 12.9% up compared to the prior financial period. Also on the operating profit side, reporting at ZAR 2.1 billion is 16.5% ahead of the previous year.
The finance costs have increased. And we all know and have experienced the increase in interest rates. So it is also – we were also impacted by that as well as increasing our investments in working capital.
When we look at discontinued operations, as I've indicated, we've seen great delivery coming through from discontinued operation, which gave ZAR 243 million in terms of performance.
On this slide, we show the performance of Barloworld excluding the Russian operation. And what is outstanding for me to note is a remarkable resilience of the group, displaying the power of geographic diversification.
I move on to segment numbers and I start with Equipment Southern Africa, which performed exceptionally well with a 38.4% increase compared to the previous financial year. And this increase was as a result of the increase in machine sales, as well as the increase in the sale of parts. The mining also saw increasing activities, which the business did certainly benefit from.
The opening of the Chinese borders have certainly contributed favorably to the performance of Mongolia, and it's clear with the increase in performance of 73.2%. And also contributing to that good performance was the prime product sales in the business.
Also with Ingrain at 15.3% was an improvement compared to the previous year. And this one was as a result of the commodity price increase, as well as the increasing volumes from export sales.
A lot of the unpacking of these numbers, the CEOs will talk to them as they deliver their part of the – during their presentations.
Mongolia has delivered exceptional operating profit at 164.3%. And this improvement is also driven by the margin improvement. This year, they delivered a 16.1% margin compared to the 10.6% in the previous year. Equipment Southern Africa has delivered a 31.5% operating profit. And this is really as a result of the change in product mix. And they had increased on the machine sales side. And the machine sales side would generally attract a lower margin than other categories. But the positive of this is we expect an improvement in the after sales in the future years. Ingrain is behind marginally there and this is as a result of the increase in maintenance cost as well as the overhead costs.
Taxation as a percentage of operating profit before tax is impacted by the devaluation of the ruble, as well as the Zambian kwacha against the US dollar functional currency. In the prior period, you will note that we did report an impairment and that was as a result of the impairment of our Russian business at that point in time.
Great performance coming through from our joint ventures and associates. Bartrac delivering a very dignified 48.5% performance. On the NMI side, its profit was impacted by the increase in interest rates, which has also equally impacted their margins. But what is important to note when one looks at the numbers delivered by NMI is that the revenue, top line, has improved by 14.1% compared to the previous financial period.
We delivered sustainable earnings from core business, reflected there through the increase in our HEPS at ZAR 5.78 from ZAR 4.47 per share in the previous financial period.
Our income statement shows a reduction in total assets as well as equity and this is expected considering the fact that we have unbundled Zeda during the period. You will also observe the reduction in cash. And this is as a result of the dividend that we did pay last year, and you may recall that as well as increasing working capital.
Also on the trade and other receivables, there, we reflect also the loan that we had given to Zeda. It was initially ZAR 1.5 billion when we unbundled in December, but they have paid off a substantial amount of the debt. And what remains now in our accounts is ZAR 825 million.
The free cash flow outflow of ZAR 3.3 billion demonstrates the increasing working capital, which I had spoken about earlier. But what is comforting with this number is that it is expected to unwind in the second half of the financial year.
Our net debt has reduced. It's currently at ZAR 1.1 billion from ZAR 1.3 billion in the previous financial year. And this number includes the ZAR 825 million that I spoke about earlier to Zeda. And if one excludes that ZAR 825 million being the amount owed by Zeda, the true debt of Barloworld at this point in time is ZAR 6.3 billion.
When one looks forward into the next few months, as I've indicated, we expect the unwinding of the working capital coming through in the second half. Therefore, one would expect a lower net debt at the end of the financial year-end.
The group remains well below its covenants, affirming the strong financial health of Barloworld as a group. Impressive performance of the group resulted in both ROE as well as ROIC being ahead of prior year and also ahead of our targets.
In conclusion, as our chief, Mr. Dominic Malentsha Sewela, had mentioned, the board has declared a dividend of ZAR 2 cents per share. And this is achieving a 2.9 times cover, which is very much in line with our policy and also capital allocation framework.
I must also indicate and mention that this ZAR 2 per share is 21.2% higher than what we declared in the previous year. It's quite an outstanding amount, quite an outstanding from a growth from year to year. You may recall we had declared ZAR 1.65 prior year.
So for me, this demonstrates the commitment that we have in delivering value for our shareholders. And we'll continue to do our best in ensuring that we declare dividends.
With that, I'd like to hand over to Mr. Emmy Leeka.
Emmy Leeka
Thank you, Nopasika. Good morning, ladies and gentleman. The division delivered strong results with revenue up 38.4%, headlined by a 60% growth in the prime product and a 28.4% growth in our part sales, also with 11.3% growth in our rental business.
Operating profit was up 31.5%. But also pleasing, as indicated by Nopasika, is the positive results that we are getting from our joint venture in the Democratic Republic of Congo. And I will unpack that later.
Overall returns at 19.7%.
Turning to the new equipment sales by segment. Significant growth in new equipment sales across all customer segments, up at about 65%, mainly driven by our mining houses. If you look at the bottom of the left graph, the mining contribution in terms of new equipment sales were up 203%. If you combine both contract mining as well as mining, the overall contribution to the new equipment sales, we saw an improvement of about 67%. And that contribution overall, despite the fact that we've seen a significant growth compared to prior year remain at 70% overall contribution.
Now turning to commodity mix. Just to mention prior, as we delivered machines to the greenfield project in Botswana, we've seen significant contribution then, but it's pleasing to see that that continued in terms of the mining sector, in terms of the machine replacement, mostly brownfields, contribution for iron ore, copper, as well as the PGMs and coal maintaining their contribution.
Nopasika did highlight the impact of the sales mix. If you look at the first half, given the fact that we had a very strong aftermarket and as well as equipment sales, the product support or the aftermarket contribution compared to prior year moved from 56% to 51%. Given that growth as well, with the sales mix changes, as well as the dilution in terms of our parts margin, but continuous focus in terms of delivering on our digital transformation resulted in our op margin moving from 10.3% to that 9%.
Positive results indeed from the joint venture in the DRC where the share of profits moved from ZAR 52 million to ZAR 77 million, which is a 49% uplift on the back of improved trading activity, as we've mentioned the turnaround plans that we're focusing on as well in terms of the cost base restructuring and the diversification strategy.
For the second half, we have a positive outlook with activity levels expected to be sustained.
We have achieved great strides in executing our divisional strategy, with a laser focus in making sure that we focus on the growth agenda, services growth, double-digit growth, population growth, in seeding machines, but also making sure that we improve our turnaround time as well as, as you've seen, that we've increased our inventory, so that we can improve our customer experience.
On the digital transformation front, we have increased ecommerce penetration for our retail customers and also focusing on digitizing our processes. We continue to embed the execution culture through BBS that will help us to drive operational excellence.
In conclusion, we remain cautiously optimistic for the remainder of the year, a strong order book at ZAR 5.7 billion, but also with the growth trajectory expected on the aftermarket for the second half. We will continue to focus on unwinding the prime product inventory, to continue to optimize our profit margins as we generate positive cash.
With that, I would like to thank you and hand over to Mr. McGeer who will share the Equipment Eurasia.
Quinton McGeer
Thank you, Emmy. Good morning, ladies and gentleman. I'm very pleased to announce the Eurasia division's results for the half year 2023 on the back of a strong trading result that has been supported by a good turnaround in Mongolia.
Mongolia contributed 34% of the revenue of the Eurasia division, up from 14% prior year. Margin realization was good in both countries, in both segments, both in aftermarket as well as in prime product. This supported the operating profit growth of 2.3% in rand terms, but down in 10.5% in USD.
The division continues to generate excellent ROIC. And from a division perspective, ROIC of 30.4% was generated. And one were to in dollar terms and if one were to reverse the impairment that was booked last year, the ROIC would still have been 22.6%, well above the group threshold of 14%.
If we analyze the new equipment sales, it's still dominated by mining, with 52% of prime products sold to the segment, significantly down from a 70% compared to the prior year. Aftermarket remains the backbone from the profitability perspective and 57% of the revenue were generated from this segment.
When we look at the commodity exposure from the division, one can see the impact of the Chinese borders opening in Mongolia, with 60% of sales to the coal segment, 92% of this coal that was exported was coking coal, the good coal that was exported to China.
From a Russian perspective, a very similar picture compared to prior year, with a well-diversified mining mix, albeit in a lot smaller numbers from a real term perspective.
In terms of the outlook, I think the firm order book is self-explanatory in terms of what's happened in Russia. But what is very pleasing to see is the recovery of Mongolia. And we do expect this strong recovery to continue in the second half. Also pleasing is that the results that we've delivered in the first half already exceeds – is ahead of expectations against the business case that was tabled to the board in 2020.
From a Russian perspective, the environment remains fluid. And we will continue to align our business on a constant basis based on opportunities that is in front of us. think our focus areas remains our employees, first and foremost, the safety as well as the well-being of all employees. Compliance is an important factor in our division. And that gets a very high priority.
And then, we will continue to focus on what we can control – our cost containment, looking after our customers, cost preservation, working capital management and focusing on continuing the Mongolia recovery.
And with that, I would like to say thank you and hand over to Chris Wierenga from Ingrain.
Chris Wierenga
Thank you, Quinton. Good morning, ladies and gentlemen. It gives me great pleasure to announce the results for Ingrain for the six months.
I think despite some of the operating challenges we've had, the business remains really well positioned and performing well ahead of our investment thesis into the business.
And if we unpack those results a little bit, our top line has grown nicely, 15% in the period, that has been supported by strong commodity prices last year, and those contracts running through into this year. We expect that to continue for the remainder of this particular year and into next.
We've improved cash generation in the business during the six months, and are very pleased with the 65% increase in cash flow at six months on six months in the division.
And as I indicated, we did have some operating challenges and our efficiency losses and some lower volumes delivered out of our Germiston Mill have impacted both EBITDA and operating profit slightly. But we're seeing some recovery in that post the half year results.
If we quickly look through the revenue for the business, our domestic sales have been supported by stable volumes across most of the sectors. We've seen good growth in the export market where the weaker end has certainly supported demand for the product. And that's also in line with our overall strategy to utilize some of that excess capacity to take advantage of a favored position that we're in in the business at the moment.
On the agri side, our products remain in high demand with more demand than what we've got capacity in the plant at the moment, which bodes well. But we have seen the lower grind rates coming through, impacting the revenue potential in that particular segment.
If we turn our attention then to the sales, which are the biggest driver for this business, the domestic market was relatively flat six months on six months. We've done well in the confectionery sector, where we've got actively gone out to try and displace imports coming into this particular segment. And we have seen some strong growth in the alcoholic beverages sector in real terms.
Coffee creamers continued to come off slightly, and we're continuing to see that decline post COVID come through and requiring us to divert that capacity into some of the other channels available to us.
But I think, overall, the business is well positioned with a diverse customer base and also a diverse offtake into various segments.
If we look at overall, we're very pleased about the export sales growth that I spoke about earlier, 7.9% growth in that segment in the six months is certainly very welcome across the business.
If we look at the operations, I think very, very pleasing is we've continued to unlock plant capacity through BBS. You can see Kliprivier, Meyerton and Belville have all seen volume growth in the sector that has been supported by the capital replacement that we've put into the business and the ongoing commitment that we've got as a business to reinvest into these facilities. Germiston was plagued by some outages and some end of life plant, which was replaced just after the half year, and we're seeing that improve with Germiston back on stream now in the month of May and performing at these historic levels. So we're quite pleased with the progress that we've made across the operations generally.
If we look at the focus for the division, we need to do a lot more work on safety. And we're implementing some safety initiatives and some technology to support our safety journey in the business. We're seeing BBS really deliver efficiencies in our operations and also driving the culture change that is much needed in the business.
And then, overall, our product portfolio, we're looking at how we optimize that, looking at products that make sense for us to make and the streamlining of our operations to meet demand and also yield the capacity that we've got for better margin realization and then using our supply chain efficiencies through our new central DC to better serve customers and also import certain products, which we think would be more attractive for us to import than to manufacture in low volumes locally. So, a range of issues underway to try and strengthen the division and then also support our overall capital investment program in the business.
If we look at the outlook for the business, I think things remain quite positive despite the challenging macros that we sit with in South Africa. I think the weaker rand will continue to support our export drive and we see good volume growth coming through in that sector.
In the domestic market, we should see a recovery now that we're back up to do the right level of production across the business, and our investment in capital projects will continue to accelerate over the remaining months in line with our stated capital allocation approach for the business.
On the growth side, I've spoken about the opportunities to leverage our DC and our supply chain capabilities to find new growth markets for us, and see what we can do to expand our presence in the food and ingredient market. And we think that that growth will certainly offset some of the higher commodity prices or the higher utility costs that we're going to be seeing coming through in the business. And then with softening those prices coming through, I think we will be able to hold prices, and that will bode well for domestic demand as well.
So I think all in all, we're looking forward to a better six months than the first six months this year. Thank you very much. I'd like to hand back to Dominic, please.
Dominic Malentsha Sewela
Thanks, Chris. I think I'd like to start with a slide because when you think about strategy, strategy is easy to articulate it, but you can articulate a great strategy, but if you don't execute on your strategy and ensure that you're able to measure that in quantifiable terms, you're not going to be able to get anywhere.
And I think six years ago, when I started with the process of being transparent in terms of where we are, the metrics that we've decided – set out continually be able to reflect this – for us to be able to reflect the journey that we've traveled thus far in terms of rolling out the strategy.
I think if you think about what's fixing, I said in the beginning, we've basically exited those businesses that we said we couldn't fix, starting with Iberia and lastly with logistics that we've just sold out.
But when you look at optimize, I think the deployment of Barloworld Business System in the equipment division has definitely yielded the results that we intended. You can actually, albeit interim , albeit rolling 12, but to achieve a 19.7% after having had 18.1% return on invested capital, that's sustainable.
And I think like Quinton just demonstrated that even if you took out impairment of this business – remember, we impaired, in 2020, this business, still it will achieve returns above the hurdle rate of 14%, which we've since adjusted from about 13% to 14%.
I think Quinton spoke largely to Eurasia and you can actually see that our Russian business has delivered – we've been in Russia for 25 years. And under Quinton's leadership, there's been clear focus on making sure that the things that you can control, you're able to continue to focus on them.
What was pleasing is that when we bought Mongolia, we deployed BBS, we've used the leverage of contiguous territory, and if you look at on rand terms, because I think Quinton spoke about dollar terms, Mongolia achieved about 16% return on invested capital. That's a credible result for a business that we bought, which is ahead of what we estimated at acquisition.
Similarly, what you look at Ingrain, which is one of those businesses that we bought in 2020, which we said it's going to be defensive and relatively asset-light and cash generative, and as you saw with Chris' results, at 9.8% which is better than last year this time. I think when we look at 11.3% of the previous year of 2020, it was because of once off from tax benefits, but I think I'm very comfortable that we still are ahead in terms of our estimates when we acquired this business.
From a group point of view, you should be seeing the group number being closer to about the equipment business, but I guess, when you look at some of non-productive debt that still sits on our books because we've basically capitalized Avis pre-unbundling, we've also funded the losses of logistics, but relatively speaking as we allocate capital, you'll see that return come through from investor capital point of view.
So, if you then look at return on equity, a similar trend line. And this is where you see the benefit of allocating capital in a disciplined way. When the market gives you the gift of mispricing the valuation of the business, it's always best to deploy that capital in buying back your shares. And we've been consistently buying back the shares. You can actually see that benefit that's come through in terms of returns as well as our HEPS. But 19.3% in return on equity is a very convincing, credible result. And similarly, if you look at it on a yearly basis, I gave you the numbers in 2022, this is a historic achievement for Barloworld.
And that is also show that our strategy didn't focus on bigger, but really saying, you can have a small business that gives you quality earnings and return. And this is what the Barloworld business is – having pivoted out of those business, we are now having a very simple business that is easy to evaluate and see how accretive it is and this number speaks for themselves.
And just to put that history in perspective, as you look at our review over from 2017 when we exited Iberia, we took the capital, allocated it to acquire Mongolia. We also took some of the capital to derisk the pension fund because where we're currently sitting, it would have been a very volatile environment. But I'm pleased to say, we've now since derisked the capital fund. We've also acquired a business, like I said, being Consumer Industries, and basically the pivoting out of the business has been punctuated by the unbundling and separate listing of Zeda and the disposal of our logistics business.
But what lies ahead, obviously, we operate in very tough jurisdictions. And notwithstanding we operate within the context of inflationary pressures that are driving higher interest rates and as we see various – Feds or ECB and even our own reserve bank trying to wrestle the scourge of inflation, from a business point of view, we see that persist over a couple of years in South Africa. I think we'll see the MPC meet this week, and one is expecting that there will be a move upward given the events over the last two weeks in South Africa. We saw that rent depreciates very steeply against other currencies, and therefore, from a capital allocation because we – as leaders in business, we say we need to control what we can control, we can't really determine what politicians do or what reserve bank governors do.
So from a capital allocation point of view, we'll be prioritizing making sure that we keep our debt in check. We'll make sure that, from an efficiency point of view, that our costs continue to give us flexibility to be able to move fast, if we need to move fast should the things change quickly, but we also had a growth agenda.
And the growth agenda is around organic growth, first and foremost. And as you can see in Equipment Southern Africa, that organic growth has been very strong, but it requires working capital to be able to finance that working growth.
So as Ms. Lila said, the second half, you will see the unwind of that capital utilization in the first half, as per usual. But also, given the two platforms of business in industrials services, as well as equipment distribution where opportunities present themselves, we'll look at programmatic action in allocating capital that way because we are mindful of the fact that we've got this discipline going, of ensuring that we allocate capital where it is accretive and we shy away from just doing things by pure instinct, if it's going to detract us from our objective of delivering value to all our key stakeholders.
On that note, I'd like to pause here, but before I take question, this is the right time to acknowledge the good work that Quinton has been doing over the last 31 years. And Quinton, I salute you. You're retiring 31 years later, Quinton started in our business in automotive, did about a decade in the automotive business and then he saw the light and he came into equipment. And so his blood is infused in yellow.
And, Quinton, you can really be proud of your track record. Your track record speaks for itself. And you were in a tough environment in Russia, and then I deployed you in Spain, you had to deal with the Spanish. At no point you complained. You just kept on it. And we acquired Mongolia in a very difficult time. Literally, I say we bought a business during COVID, that it took me two years to go and see what I bought. But I was very pleasantly surprised when I got to Mongolia to look at the quality of the business.
I really wish you well. And I hope you have more time to play golf. But don't be surprised when I call you and ask your question on what did you do in some of those territories. But thanks, Quinton, for that. Really appreciate it.
And I also would like to acknowledge Emmy, who's got – he was wearing similar shoes, but I don't know whether it – was it Timberland or Cat, but I think it's more Cat boots that you're wearing. And I don't know what size Quinton was wearing, but I wish you well, Emmy, as you take over Eurasia in this interesting time. But I think you've shown the mettle of running Southern Africa over the years, so I wish you all the best as you do so.
But I also would like to acknowledge and congratulate Andronicca Masemola, who was the FD of Equipment South Africa, who's in the stripe to be able to now lead this division, Equipment South Africa. And Emmy has passed on the baton in a business that's solid. So I don't want to focus what type of returns you need to achieve. But I wish you the best of luck.
And this, ladies and gentlemen, speaks to the strength of our intellectual capital review that we focus on in making sure that, from a succession point of view, it's seamless, and I'm pleased that we're able to also replace people internally. So, I'm going to pause here and start taking questions online.
Question-and-Answer Session
A - Nwabisa Piki
Thank you, Dominic. I start with the questions on the webcast. We've got a question from Paul Steegers. And he wants us to talk to the average cost of debt in the first half and what we think it will be for 2023 financial year.
Nopasika Vuyelwa Lila
Yes, our interest financing cost is sitting at about 5.83%. But just to mention, with the makeup of the finance costs and what has contributed, so over and above what you would have seen as an interest rate, we have the floor plans, interest from the floor plans, which have increased as a result of our increase in working capital, as I had indicated earlier, and this is going to reduce in the second half.
And just by way of a number, that number is ZAR 85 million, being the floor plan contribution towards interest. We also have an amount of ZAR 25 million, which is a pure exchange rate number, which relates then also to the interest.
So if you have to compare ongoing and into the long term, I would say the number for interest would have been around 470 basis points. But in terms of percentage themselves, we had projected all – in fact, let me start by saying, last year, the interest rate was 5.86%. But with the increase in interest rates, we are sitting at about 7.9% for the half year, and that would be a good number to use and to measure the Barloworld interest rates for the first half
Dominic Malentsha Sewela
You're talking about basis points, 700 basis points.
Nopasika Vuyelwa Lila
Well, 700 basis point or 7.19%.
Nwabisa Piki
Assuming an average gross debt position of around ZAR 10 billion for the period, the average interest expense was 14.5% for the six months? Please elaborate or explain or could you guide us to second half finance costs?
Nopasika Vuyelwa Lila
I think it's very much similar to what I said. But to clarify, the difference is the floorplan which you don't see in the debt, but you will see in our accounts payable because that's where then the actual debt on the floor plan will be.
Dominic Malentsha Sewela
But I think it's also important to point out that largely because of the order book of equipment, for the first half, if you exclude Avis and all those, you look at the movement in cash flow, about ZAR 4 billion of that has been working capital in there. So when you reverse that or you claw back on it, your gross debt is going to be significantly low. So, I think that guidance is very important that we have that.
Nwabisa Piki
Can I just ask one more question from [indiscernible], which is, please, could you elaborate on the impact to group profits from the current rand weakness? Will we see operational leverage in Southern Africa equipment and Ingrain as in high margins in the second half?
Emmy Leeka
If I look at South Africa in terms of the weakening of the rand to the top line, that contributed about 10% in terms of the uplift.
Dominic Malentsha Sewela
Andronicca, if you want to edit something.
Andronicca Masemola
Yeah, top line impact 10%. But we also have costs that are dollar denominated, so that will have an impact on our cost base. But to the question around the margin improvement, we have always been open about what is our definition of winning on margins, being minimum 10%. And in the second half, we'll continue towards achieving that.
Nwabisa Piki
Please keep the mic, Andronicca, because I've got another question from Vivesh Maharaj at Standard Bank. Congrats on the good performance overall. What is the long term view of Congo equipment and the tough operating environment it faces and the impact its cash flow constraints have or will have on Bartrac?
Andronicca Masemola
We have a 50-year JV agreement with Tractafric. And at this moment, we're not planning to exit Congo equipment. Our focus is really on optimizing performance and improving profitability.
And the question around cash outflow in the DRC, similar to Southern Africa, they had to bulk up on the inventory to respond to longer lead times. And the second element that impacted the cash position there is that one of the very key customers stopped exporting commodities, and that had a ripple effect, in that some of the equipment that was ordered for contract miners leaving that site, the conversion had to be delayed. The issue has been resolved. The stoppage was as a result of an issue that they needed to address with the government. That has been resolved, and we expect the delivery of the equipment to start taking effect.
Nwabisa Piki
Can we move to the Eurasia division? And I'll read two questions for you, Quinton. One is, please elaborate on the Mongolian margin at 16%. Why so high? And how sustainable is this?
Quinton McGeer
I think maybe just starting at the margin, a good operating margin one will find for a Cat dealer is anything between 10% to 12%. That's an excellent result.
From a Mongolian perspective, quite a few things impacted the operating margin in the first quarter. One is the fact that we had aged inventory, which we managed to dispose of during the first quarter. Secondly, the impact of the borders opening up meant that product came in and customers were looking to buy product and we were able to capitalize on a higher margin realization.
Another factor was the fact that Caterpillar announced quite a big price increase last year, which, with the stock in country already, we also were able to capitalize on a higher operating gross margin from a parts perspective. So that all supported quite – very good operating margin for the first half.
In terms of going forward, I think, definitely, it's going to be repeated in the second half without a doubt. And I think long term – medium to long term, we would be ecstatic if we can be in the region of 12% on an operating margin level.
Nwabisa Piki
And then, [indiscernible], while you're on Mongolia, just he was worried about the small or no order book in Mongolia specifically, stating that at $15 million, he sees that as low. Would you just like to give…?
Quinton McGeer
The Mongolian business environment is slightly different to our Russian business environment. The mining industry is a lot smaller. And with the long lead times to Mongolia, we tend to order the smaller mining equipment without having necessarily the signed contracts. And then as the products – then we've got about nine months to sign the contracts with the customer. So I think Mongolia will always operate with a smaller, firm order book, with the smaller mining equipment being sold as they arrive in Mongolia as what we've seen in the first half.
Nwabisa Piki
And just staying with you a little bit, Quinton, Malusi [ph] is just wanting to know the reduced order book in the Russian businesses as well, what is your outlook for the Russian order book? And are we likely to see break even problems, as he states?
Quinton McGeer
I think from a firm order book, obviously, with the mining industry no longer in play, there is already a significant reduction as one can see. We still do have access to the SCM product, we also basically sell basically from inventory. So, I think going forward, the Russian business, for the foreseeable future, will not really operate on a firm order book. But aftermarket remains very robust. And we are still able to support our customers, which at this point in time, taking the current conditions into account, is contributing significantly to the profitability of the business. So, based on the current situation, the second half should mirror the first half.
Nwabisa Piki
Mr. Wierenga, can I move over to you? As it relates to the Ingrain business, what is driving the efficiency losses for the business? That's from Axolile Majola at Ashburton?
Chris Wierenga
I think as we've guided in the trading update at the end of March, we had some unplanned plant breakdowns at the Germiston mill. I think that impacted our ability to deliver product.
Now, if you have a look at what we'd experiences is we typically go out and we cost to a standard costing. When the plants are not running efficiently, we do have production losses. And I think in the period that we spoke to, we had about a ZAR 50 million loss in efficiencies across the period. So, I think that impacted us in this particular period.
I just want to stress again, we've addressed that through the capital that we've put into the business. We're returning back to, let's call it, a more normalized operating environment in that plant. And I think those issues are largely behind us at Germiston as we sit here today.
Nwabisa Piki
There's a lot of questions on loadshedding. And I'll just maybe summarize them in general by saying, the impact of loadshedding on manufacturing operations, have you secured any sufficient amount of diesel, given the likely increasing strain on diesel supply chain through winter? And then what is the cost of diesel impact on EBITDA?
Chris Wierenga
I think to all on the line, we've said this consistently, Ingrain is part of the large energy user group at this point. So we are not subjected to loadshedding on our Reef mills. [indiscernible] in Bellville, we do get load curtailed from time to time within our previous sort of three days rolling average of demand, and have about a 30% reduction in available capacity to us.
So, currently, we are not reliant on diesel to operate our plants. And I think I also just want to stress that we do not have any diesel costs baked into our operating costs of any significance.
It would also not be possible for us to run our plants on diesel gensets for an extended period of time and we would have some capacity to finish up certain runs, et cetera. But, certainly, nothing longer than a than a 12 hour run on the plants. I think the power demands are too large.
So I think as things stand, we we're not necessarily directly impacted. Some of our customers are impacted, and we are seeing variations in offtake coming through. But largely that demand remains intact.
I think one of the issues that we have highlighted as well is some of the water supply issues that have come up from time to time because of extended periods of loadshedding, particularly in that East Rand manufacturing base where we've seen some of our customers have some short term impact because of that. But I think, overall, our results are largely unaffected by loadshedding.
Nwabisa Piki
Can I move on to Mr. Leeka? There are a few questions on the growing prime sales in South Africa. Are those just replacement seats or are market share gains being seen?
Emmy Leeka
We have slightly seen a level of market gain in terms of – because when you look at some of the mines, when they're doing push backs, they need additional equipment. But other areas, it was just pure replacement cycle.
Nwabisa Piki
An indication of how the lead times have changed with Caterpillar over the year?
Emmy Leeka
Yeah, we've seen a significant improvement compared to three years ago to where we're sitting now in terms of the lead times. And if we look at some product groups, they've actually improved significantly. But there are still others that are still battling. And also, overall, logistic challenges, depending on where you source your equipment. But, overall, we tried to mitigate that as well by making sure that we have inventory on the ground.
Nwabisa Piki
On that, just a follow-up on higher working capital use, particularly the inventory holding costs. Maybe it's an overall finance one as well. Please explain the expected seasonality.
Emmy Leeka
Look, we normally bulk up first half with an anticipation to reduce our working capital in the second half, as indicated before. So, we will see it actually coming down by the end of this financial year.
Nwabisa Piki
For you, Dominic, there are some questions on M&A opportunities. Are you seeing increased M&A opportunities as a result of the tough economy locally?
Dominic Malentsha Sewela
Yeah. I guess we get approached from time to time by people who are either experiencing financial stress that presents what they regard as opportunities. But, fortunately, we are very disciplined in our approach because we've confined our strategy to the two verticals. We're not seeing a lot of things that interest us in the local market. And hence, I emphasize that, in that vein, we will be focusing on our organic growth, both in consumer industries as well as industrial equipment and services.
Sort of my views that, as the interest rates continue to bite, you're likely to see private equity that would have taken advantage of low capital, letting go of assets that could interest us and where the valuations could also be interesting for us to start looking at the horizon, but I can't be specific because [indiscernible] continue to see a deal flow, it goes through our guardrails of it. Our guardrails are quite rigid in terms of how we look at things in asset. It's really about cash generation, the profit pool, the size of the profit pools. So, we look at those things.
And also, it's got to be within what we operate in. I wish I can buy more Caterpillar dealerships, if they could come our way, but those are closely held. And what adjacent businesses could there be to actually improve our services and our equipment business is going to be really the key issue.
For me, I want Chris to really focus on actually making sure that the thesis that we bought this business could be unlocked. But to an extent that we find something interesting in that area at an attractive value, for me, it is key that I talk about value because when you look at the share price of Barloworld, it's very attractive at this level. It's trading way below intrinsic. So I should be focusing on, say, between paying debt and buying back shares, for me, it's a no-brainer.
Nwabisa Piki
Thank you very much. We've reached 12 noon. And that is the last of our questions.
Dominic Malentsha Sewela
Thank you. Thanks, everybody.
For further details see:
Barloworld Limited (BRRAY) Q2 2023 Results Earnings Call Transcript