Tongaat Hulett: Is a discount of 60 percent to NAV justifiable?
Share this article:
Ryk De Klerk
In early October, last year, I warned that my calculations indicated that Tongaat Hulett’s renegotiated agreement with its lenders of repaying R8.1 billion by 30 September, this year, could result in a possible negative net asset value (NAV), excluding Zimbabwe, by June. I suggested that it may be worthwhile for Tongaat to proceed with a rights issue to strengthen the company’s financial position.
Well, the company squandered a great chance to put the company on a more secure financial footing.
The share price recovered from 600 cent early in October and traded between 900c and 1 100c from December last year to April this year. Yes, the company had ample time to do a rights issue and they would have been encouraged by the lenders to do so.
On April 29, the South African lenders and the investment community were horrified by Tongaat’s announcement that debt reduction transaction agreements totalling R6.56 billion had been signed as at March 31, which fell short of the R8.1bn required by the South African lenders. The June 30 milestone remained unchanged, and still required Tongaat to sign cumulative debt reduction agreements amounting to R8.1 billion.
At the same time the company announced that to honour the South African sugar industry’s commitments in terms of the Sugar Master Plan, the extra pressure of this production ramp-up on Tongaat’s central sugar refinery led to increased production costs and process inefficiencies, and resulted in a 25 000 ton sugar production loss.
According to Tongaat’s 2021 financial statements, the negative impact of this event on revenue and operating profit of the South African sugar operations, amounted to R170 million and R369m, respectively.
What is worrying though, is that the South African sugar operations made an operating loss of R388m for the year compared to an operating profit of R254m in the first half of the 2021 financial year. It means that it made an operating loss of R642m in the second half or a loss of R273m if the once-off event is added back.
According to the 2021 financial statements, significant steps have been taken during the recent maintenance shutdown to rectify and enhance the refinery processes and controls in order to prevent a recurrence. A new leadership team has been appointed at both the refinery and the South African sugar operations. But Tongaat’s problems run deeper.
Tongaat breached certain financial covenants in the last quarter of its 2021 financial year, inter alia, as a result of the sugar stock loss at the refinery. Tongaat was also in deep financial trouble as the company’s existing facilities were maturing within 12 months of the reporting date.
Furthermore, the estimated fair value of Tongaat’s properties was slashed to R8.3bn from about R11bn in the previous financial year.
The shocking performance of the refinery and the inability to secure debt reduction transaction agreements were the last batch of straws that broke the camel's back.
The South African lenders have now cracked the whip to ensure that Tongaat’s capital and funding structures are finally sorted out.
Only on July 12, the South African lenders waived the covenant breach and agreed and signed a credit approved short-form term sheet with Tongaat to refinance the South African facilities until June 2024: of course, the South African lenders bent backwards, but only on their terms.
My reading of the terms, especially the payment-in-kind (PIK) loans, is that the lenders effectively get control of Tongaat. An equity capital raise of at least R2 000 million in 2022 is required. If insufficient equity is raised, debt reduction transactions should follow through the sale of non-South African sugar operations and properties. To the extent that an equity capital raise is not successful, Tongaat is required to implement a management incentive scheme in order to ensure repayment. Why they should be incentivised is questionable as it is their responsibility in any case.
All of Tongaat’s South African assets are lodged as security to the South African lenders. The South African lenders have the right to appoint an observer to the relevant subcommittees of the board of directors. Written consent will be required from the South African lenders prior to the incurring of capital expenditure in the South African sugar operation and infrastructure expenditure in the property business. Sugar production output reports are required.
Any replacement of key managers relating to Gavin Hudson (chief executive officer), Rob Aitken (chief financial officer) and/or Simon Harvey (managing director of sugar operations) requires approval from the South African lenders.
Although investors can look forward to a much improved first half of the 2021/22 financial year, compared to the second half last year, the recent unrest and mayhem in KwaZulu-Natal led to closures of the sugar mills and refineries. The cyberattack on Transnet’s systems also led to the closure of the Durban harbour for about three weeks.
To the present, Tongaat has been mum on the impact of the adversary events on sugar production and the financial impact, thereof, on the company. Perhaps, some debt covenants have also been breached, but will probably be waived by the South African lenders.
But, what is Tongaat worth? The consolidated total shareholders’ interest or net asset value (NAV) at the end of the 2021 financial year was a negative R1.1bn or minus R8.14 per share. Excluding the Zimbabwean operations, Tongaat’s NAV was a negative R3.2bn or minus R23.70 per share.
The fair value of Tongaat’s property portfolio ensures that the company is still a going concern.
After taking into account a carrying value of R1.6bn and applying a 20 percent tax rate, Tongaat’s total NAV, excluding Zimbabwe, was R2.2bn or R16 per share. That compares to Tongaat’s share price of R6.40 at the close on Friday.
In my opinion Tongaat will continue to trade at a significant discount to its Zimbabwe-adjusted NAV, especially in light of a looming equity capital raise and the prospect of no dividends over the next couple of years.
The effective takeover of Tongaat by the South African lenders until June 2024, will limit the rights of shareholders, but decisive intervention by lenders, should restore investor confidence in Tongaat.
Is a discount of 60 percent to NAV justifiable? In my opinion, no. Naspers trades at a discount of about 40 percent to its underlying value in Tencent and Tongaat’s property portfolio is virtually as illiquid as Naspers’s holding in Tencent. Fair value for Tongaat should also be a discount of about 40 percent to its Zimbabwe-adjusted NAV. Only time will tell when the discount will narrow, though.
Ryk de Klerk is analyst-at-large. Contact [email protected] His views expressed above are his own. You should consult your broker and/or investment advisor for advice. Past performance is no guarantee of future results.
BUSINESS REPORT ONLINE