Underground Mining + Oil & Gas + Power & Water
HENRY LAAS | GROUP CHIEF EXECUTIVE
DANIËL GROBLER | GROUP FINANCIAL DIRECTOR
The Group’s ability to sustainably deliver profitability relies on achieving strategic maturity. This entails diversifying our exposure across the natural resources market sectors in which we operate, across selected geographic regions with different market dynamics, and across the different phases of the engineering and construction project life cycle.
Implementation of the New Strategic Future plan gathered momentum in the year, with our business platforms making headway in consolidating their strategic positions, competitive advantages and growth prospects. A quality order book of R46,8 billion and near orders of R14,4 billion, supports confidence that the Group’s strategy is beginning to deliver.
The Underground Mining platform delivered an outstanding performance in a buoyant commodities environment. The Oil & Gas platform endured a difficult year. Several of its large projects in the Australasian LNG market came to an end and potential new projects to substitute its income were delayed. The platform has secured a strong order book in the Australian infrastructure market, providing a good base for the short to medium term. In the Power & Water platform, a lack of project opportunities in the South African market has hampered its ability to rebuild its order book as the Medupi and Kusile power station projects have wound down. In both these platforms, extensive effort has gone into repositioning them for opportunities in complementary markets, although project wins have not come fast enough to stem the decline in revenues during the past year.
Weak market conditions for the Oil & Gas and Power & Water platforms weighed heavily on the Group’s profitability in the year under review. However, the strategic acquisitions in each of the platforms have further diversified our market position, strengthening the Group’s resilience and ability to withstand future market cyclicality.
The policies, systems and processes that manifest the philosophy of Engineered Excellence throughout the Group are entrenched and supported by a culture of continuous improvement. The Group delivered an outstanding safety performance and recorded zero fatalities during the year, a first in the history of Murray & Roberts. The financial losses experienced on a few of our projects were a setback and strained our financial performance.
The Group reported revenue from continuing operations of R20,2 billion (FY2018: R21,8 billion). Attributable earnings increased by 26% to R337 million (FY2018: R267 million). Diluted continuing HEPS decreased by 10% to 101 cents (FY2018: 112 cents). Cash, net of debt, remained strong at R1,8 billion (30 June 2018: R2 billion).
The order book for continuing operations increased by 55% to R46,8 billion (FY2018: R30,1 billion).
The Underground Mining platform delivered an outstanding result by achieving a record operating profit of R814 million (FY2018: R471 million) in a buoyant market. The business, which is well positioned across all regions and in the context of a recovery in commodity markets, has done well to capitalise fully on its growth potential and substantially growing its regional market shares. The platform order book remains strong at R22,8 billion (FY2018: R22,1 billion).
The Oil & Gas platform delivered an operating loss of R98 million (FY2018: R209 million operating profit) in a competitive market. The loss is primarily due to a delay in the progressing and awarding of new projects resulting in insufficient project earnings to cover overhead costs, and losses incurred on two, now largely completed projects. Considering the large and growing order book, the platform is expected to return to profitability in FY2020 and to grow earnings steadily thereafter.
The Power & Water platform delivered an operating loss of R32 million (FY2018: R134 million operating profit). The loss is due to reducing levels of revenue with limited new project opportunities in South Africa, as well as a loss incurred on a project for Sasol, which is in dispute. The platform is strategically positioned to target maintenance contracts for Eskom, projects in transmission and distribution, renewable energy and new fuel storage terminals, as well as wastewater treatment, which should provide complementary market opportunities.
The Group’s investment in BCC continues to yield strong cash returns of 18% after tax. The current year earnings included a R306 million (FY2018: R277 million) fair value adjustment.
In FY2016 the Board decided to close the business in the Middle East. The final four projects have been completed during the year and the business recorded an operating loss of R56 million (FY2018: R34 million operating loss), primarily due to ongoing legal costs and a small overhead cost. Going forward, this business is expected to be accounted for as a discontinued operation.
Unfortunately, the arbitration outcome of the Dubai Airport claim was inconclusive and the claims and counter claims will have to be finally settled by agreement between the parties. Current deliberations with our legal team are focused on defining the best possible way forward in determining the final account for this project.
Capital expenditure for the year was R816 million (FY2018: R436 million) of which R775 million (FY2018: R358 million) was for expansion and R41 million (FY2018: R78 million) for replacement. The capital expenditure was largely incurred in the Underground Mining platform.
Net financing costs marginally increased to R53 million (FY2018: R41 million).
The high effective taxation rate of 40% (FY2018: 36%) was mainly due to withholding tax in foreign jurisdictions, as well as losses incurred in jurisdictions where a deferred tax asset cannot be recognised.
Losses from equity accounted investments reflects marginal losses from joint ventures. The prior year reflected a profit of R22 million earned in the Bombela Operating Company, which the Group divested from at the end of FY2018.
The loss from discontinued operations was R91 million (FY2018: R278 million). The loss mainly relates to final costs associated with the disposal of Genrec and the infrastructure and buildings businesses.
The Group’s ability to sustainably deliver profitability relies on it achieving strategic maturity. This requires diversifying our exposure across the natural resources market sectors in which we operate, across selected geographic regions with different market dynamics, and across the different phases of the engineering and construction project life cycle. Furthermore, to protect revenues during protracted down-cycles in natural resources markets, and without diluting core market focus in anticipation of an upturn, our business platforms will leverage their competencies to secure work in selected complementary markets.
This strategic flexibility is critical to the near-term recovery in earnings in the Oil & Gas platform. Considerable work over the last two years has positioned the platform in the buoyant Australian infrastructure and metals and minerals sectors, with the ability to deliver complex projects differentiating the platform in these markets. Its credibility as a tier-one contractor was made evident in the award of the Snowy Hydro-Electric scheme to the Future Generation Joint Venture, in which the platform has a 35% stake. This AU$5 billion mega project is to be delivered over five years. The metals and minerals sector in Australia promises to provide a large and reliable pipeline of surface infrastructure work, as mining companies seek to maintain production output by extending existing or developing new mines. Importantly, the platform is maintaining its capability to pursue opportunities in its core market sector, with signs of the recovery in capital expenditure in the global oil and gas market becoming more persuasive.
A strategic milestone in the internationalisation of the Oil & Gas platform was the acquisition of Saulsbury’s Gulf Coast downstream and chemical EPC division, for US$8,5 million. Rebranded as Clough USA, this has given the platform a relatively low-risk entry to the fast-growing gas and petrochemical market in the USA. This business has a good track record and is based in Houston, Texas. Early focus on building a project pipeline has been successful with the award in August 2019 (thus not included in the June FY2019 order book) of a US$620 million greenfield project in the USA. The multi-year project scope includes the engineering, construction and commissioning of a petrochemical facility. Clough USA’s longer-term growth will entail expanding its service offering and market presence by leveraging synergies across the platform’s international footprint. For management purposes, CH•IV in the USA and Clough Enercore in Canada will be consolidated with Clough USA.
In the context of a recovery in commodity markets, the Underground Mining platform has done well to capitalise fully on its growth potential, outperforming its peers and substantially growing its regional market shares. As the largest contractor in Africa and North America, and among the top three in Australasia, the Underground Mining platform’s organic growth potential is limited. However, during the year we acquired Terra Nova Technologies (TNT), an international provider of material handling solutions for underground and aboveground mines, for US$38 million. Based in the USA, TNT adds a new capability to the platform’s service offering, diversifying its revenue and risk profile. The business is expected to grow meaningfully in the years ahead, benefitting from the platform’s strong client relationships and global footprint.
A further two, small but strategic acquisitions were completed in this platform. In South Africa, we established a 49% JV called Boipelo Mining Contractors, a business providing contract mining services to coal mines. This further extends the platform’s contract mining exposure. As a less cyclical source of revenue, we aim to grow contract mining to some 50% of the platform’s revenue in the medium term. In Australia, we took a 30% stake in Insig Technologies, a specialist in the application of automation technology. This partnership is expected to provide significant competitive advantage in our contract mining operations, especially in reducing safety risk and improving productivity.
The hard reality for the Power & Water platform is that as the Medupi and Kusile power station projects come to an end, there currently is insufficient investment in its core markets in South Africa to maintain its earnings potential. As such, it completed another major restructuring to right-size the business for weak market conditions and smaller project opportunities. Significant project flow is required to secure the platform’s sustainability, which depends largely on accelerated investment in the power and water sectors in South Africa in the near term. The platform must also convert its market engagement efforts into project wins, but this is often subject to flawed public sector procurement procedures. Despite these significant challenges, the platform has done extensive work to gain a foothold in its core market segments, as well as the mining, oil and gas, pulp and paper, and chemical industries.
The R38 million acquisition of OptiPower Projects has given the Power & Water platform the capability to undertake work in the transmission, distribution and substation sub-sectors of the power market. We see substantial growth potential in these segments in the next few years in both South Africa and sub-Saharan Africa. OptiPower Projects provides turnkey construction of overhead power transmission lines and substations, with extensive experience in Southern Africa. This acquired capability, combined with the Group’s capacity to undertake large projects, will enable it to offer EPC turnkey project and funding solutions, increasingly the preferred contracting model for utilities across the continent. Besides this positive development, the platform has established joint ventures to secure repair and maintenance work from Eskom, and has been awarded two projects in complementary markets.
Considering the country’s aging municipal water infrastructure and vulnerability to water scarcity, the water sector in South Africa must inevitably present significant opportunities. This, however, will require a far more decisive response from the public sector than we have seen so far. Although the Organica Water resource recovery demonstration plant achieved good results in its one-year test cycle, the interest in this innovative water treatment technology has not converted into uptake. In the industrial water sector, the platform has partnered with technology providers that specialise in the treatment of effluent and it continues to seek suitable empowerment partners to unlock public private partnerships in municipal water treatment.
The ability of our business platforms to realise their growth potential rests ultimately on Engineered Excellence. This philosophy informs our interrelated aspirations to be a contractor and an employer of choice; a provider of specialist services that is clearly differentiated by excellence, not only in project delivery but in every aspect of how we operate.
Safety, in this respect, is a main priority. All business platforms have adopted the Group Safety Framework and compliance is reviewed on an ongoing basis. Platform leadership are expected to demonstrate consistent commitment, vigilance and innovation to avoid plateaus in performance. Zero Harm has been achieved by several projects across the Group, despite considerable safety challenges and substantial hours worked.
The Underground Mining platform achieved a 43% improvement in LTIFR and sustained improvement in TRCR. In the year ahead, it will focus on reducing safety risk through pre-work hazard identification, risk assessment and work planning and ensuring that all critical controls are consistently applied. In the Oil & Gas platform, a focus on lead indicators, real-time reporting and maintaining high engagement among employees supported another world-class safety performance. The Power & Water platform piloted a Neuroleadership programme at a project in Polokwane, with training delivered and implementation scheduled for FY2020. In the year ahead, attention will be given to managing the higher safety risk associated with significant growth in the Group’s order book. A key focus in integrating the acquired businesses will be to implement the initiatives and practices that have proven most effective in deepening the Group’s safety culture.
The Group continues to improve and implement best people practices. Its specialist service offerings, demonstrated in a remarkable profile of projects around the world, are a feature of our value proposition to our people. Career advancement opportunities through job experience on high-profile projects are supported by extensive skills development and coaching, and the Group is recognised by clients for setting the benchmark in training and developing employees from local communities. Our investment in being an employer of choice underpins our ability to effectively resource our projects. This extends to the unfortunate reality of retrenchments to right-size operations during market downturns and project demobilisation at completion, which are dealt with responsibly and consultatively.
Another critical aspect of Engineered Excellence is the maturity of the Group’s risk recognition and management systems. However, the loss-making projects in the year were a harsh reminder that market dynamics and the many variables at play make it impossible to eliminate all project risk. This is especially the case where tenders are awarded on a competitive basis, in which price is of primary importance and negotiating power vests in the hands of clients. With limited opportunity to negotiate favourable commercial terms or price sufficiently for assessed risk, there is a narrow margin for error in project implementation. Where risk drivers are not within our control, we endeavour to limit the risk of potential project losses through appropriate commercial arrangements.
Key to de-risking our projects to the extent possible in highly competitive markets is that we are a learning organisation. Our lessons learnt and contracting principles schedules are regularly updated in response to specific issues, which in turn inform the new project mandates that guide platforms. More broadly, we anticipate shifts in the Group’s opportunity and risk profile and amend these frameworks accordingly. A current instance is the higher proportion of fixed-price EPC contracts in the Group’s order book. To mitigate this risk, a new Group contracting standard has been implemented, which requires additional levels of oversight in tender processes, to mitigate the higher project risk associated with this type of commercial arrangement. Another development has been to make cost-reimbursable commercial arrangements a condition of taking over partly implemented work from contractors that have failed on a project.
Being recognised by clients as a specialist in the services we offer, opens the door for early involvement in project design. This enables us to propose solutions that improve project constructability, which mitigates risk and enhances delivery. As the most strategically mature business, the Underground Mining platform is being engaged during the project development phase more frequently and has had instances where finance providers have made the platform’s involvement a condition of funding. This degree of recognised specialism and competitive edge is the strategic outcome we are working towards in all our platforms.
Since we identified it as a strategic driver last year, there is heightened awareness of technology enabling a step-change in competitiveness and productivity. We are formalising our approach to digitalisation, and will undertake a digital readiness audit to inform the development of a strategy for technology investment. The audit will also assess the extent to which the existing digital capabilities in the Group can be transferred and leveraged across the platforms.
The intricate process of closing the business in the Middle East is reaching its final stage, after the last four projects were completed during the year. Unfortunately, the arbitration outcome of the Dubai Airport claim was inconclusive and the claims and counter claims will have to be settled by agreement between the parties. Current deliberations with our legal team are focused on finding the best possible way forward in determining the final account on this project. As part of the year-end audit and considering the arbitration award, there was an extensive review of our accounting position on the Dubai Airport project and it was concluded that no material adjustments were required.
The Group’s financial position, even after a number of years of subdued profits, is robust and sufficient to fund our organic and acquisitive growth plans. The Group is in a strong cash position and debt is within our targeted range. We do not expect to make further acquisitions in the next twelve months, although we will continue to identify and assess potential targets, specifically in the mining sector. An important focus in the coming year will be to grow the order books of our newly acquired businesses. Cost management will continue to be a focus and all platforms are targeting overhead costs of about 5% of revenue, through the cycle.
With several projects secured late in the year under review, the Oil & Gas platform is well positioned for opportunities in the Australian infrastructure and mining markets. In the oil and gas sector there are signs of a medium-term recovery. The International Energy Agency expects a 10% rise in oil consumption, mainly for petrochemicals, and demand for natural gas to grow sharply by 45% in the next decade. Natural gas is forecast to surpass coal to become the second-largest source of fuel worldwide in the same period. New capacity in North America is expected to show the greatest capital expenditure growth. This bodes well for our new business in that market, which secured a US$620 million project within months of the acquisition. The platform is targeting LNG projects in Australia, Canada, USA, Mozambique, Kazakhstan and PNG, with meaningful growth anticipated in the medium term as global energy producers move to meet demand. The platform is poised to return to profitability in the coming year – supported by its strong order book – and to grow earnings steadily thereafter.
Capital expenditure in the mining and mining services markets is expected to level off over the next three years. Although we believe there is still considerable opportunity for the Underground Mining platform, we expect earnings to show modest growth from current levels. Accelerating innovation is a key strategic theme for the platform, to ensure that it stays ahead of its competition and retains its leading position. However, market share gains will be incremental and organic growth within the platform’s existing capabilities and regions is not expected to yield the required returns. As such, the value-accretive potential of an acquisition in open cast mining is under consideration. Certain targets have been identified, given the expectation that future mining capital investment will be weighted towards this mining method. Adding this capability would lift the proportion of platform revenue generated from production or contract mining, thereby reducing vulnerability to commodity market cycles. However, these benefits will need to be weighed up against the capital intensity and lower profit margins associated with open cast contract mining.
For the Power & Water platform, the claims resolution and commercial close-out on the Medupi and Kusile power station projects is likely to be complicated and protracted. However, the accounting position on these projects is considered to be prudent and risk provisions to be adequate. The sustainability of this platform is dependent on the level of investment in the South African economy, which has been disappointing in recent years. Strategically, the platform is positioned well for the future, but there is a lack of project opportunity in the power and water sectors. It is essential that the platform secures further repair and maintenance projects from Eskom on its aging fleet of power stations. Investment in renewable energy and in fuel storage terminals for the clean fuels programme should provide complementary market opportunities in South Africa. We expect strong growth and sizeable projects in the transmission and distribution sub-sector in the short to medium term, for which OptiPower is well positioned. The platform is focused on converting its pipeline of opportunities into significant project wins, but it may take time for it to deliver results that match our expectations of its earnings potential.
Another way we diversify our revenue sources to counter market cyclicality is to participate in long-term investment opportunities that generate constant income at attractive rates of return, either as a project co-developer or operator. In particular, we will consider transmission project development opportunities in sub-Saharan Africa, which may unlock opportunities for the Power & Water platform to construct these projects.
We remain optimistic about the longer-term outlook for natural resources markets and our selected complementary markets to bring some balance to the impact of cyclicality. Besides the usual cycles, we expect no major structural shifts in our markets that would negatively impact demand for our services. Subject to unforeseen dynamics in our market sectors due to global economic or geopolitical events, we expect to meet our investment aspirations by 2021, as our strategic plans in each of our platforms come to fruition. Organic growth, at a Group level, is expected to be slow, however, mergers and acquisitions will continue to support our growth aspirations.
We thank the Board, our executive team and all our employees around the world. Your collective effort is moving the Group towards the outcomes envisaged in our New Strategic Future plan.