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GROUP FIVE LIMITED - Update on the Kpone contract, general trading conditions and the strategy for the group's clusters

Release Date: 19/12/2017 08:01
Code(s): GRF     PDF:  
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Update on the Kpone contract, general trading conditions and the strategy for the group's clusters

Group Five Limited
(Incorporated in the Republic of South Africa)
(Registration number: 1969/000032/06)
Share code: GRF ISIN: ZAE000027405
("Group Five” or “the Company”)



   In Group Five’s annual results for the year ended to 30 June 2017, the group noted that
   delays had been encountered on the USD 410 million independent gas- and oil-fired
   combined cycle power plant EPC contract (“Kpone contract”) for the design, engineering,
   procurement, construction, commissioning and testing of the 350 megawatt facility in the
   municipality of Kpone in Ghana.

   Design delays, together with the late arrival of procured items on site following a change
   in Ghanaian law during the Kpone contract, were two key factors which impacted the
   original contractual completion date of 13 September 2017. The Kpone contract was also
   impacted by seawater tunnelling delays, which were resolved by the time of the group’s
   annual results release. The group reported that the completion of the steam pipe system,
   as well as the on-shore and off-shore seawater intake chamber system, were, at that time,
   on the critical path to completion.

   It was indicated that the above-mentioned delays would result in a completion date post
   the contractual date, which could incur penalties. However, when considered together with
   claims on the Kpone contract, for which the group had assessed its entitlement, the group
   did not expect these penalties to further negatively impact the Kpone contract’s profit
   recognition in F2018.

   The Kpone contract is now 97% complete, with the only major remaining component,
   namely commissioning, nearing completion. Unfortunately, further delays have been
   encountered since the update in the annual results. These include:

    -   ongoing unknown marine conditions and poor weather on the seawater intake section
        of the Kpone contract;
    -   further late delivery of key components to site;
    -   late delivery and problematic and faulty equipment from the main equipment sub-
        contractors; and
    -   ongoing design challenges, which include inaccurate and late design submissions
        from the engineering sub-contractor and inadequate fire system design, which
        necessitated a major rework by the group.

These delays have impacted:

-   the sea water intake process, which is now nearing completion, as well as the steam
    piping activities. These are both due to be completed by the end of December 2017;
-   the first fire of the turbines, with turbine one complete and turbine two on schedule for
    completion by mid-January 2018;
-   the process and control cabling rewiring related to the steam turbine control system;
-   the plant commissioning progress.

These delays have changed the date for the expected completion of the construction and
commissioning activities from December 2017 to the end of February 2018, with
performance testing and reliability runs potentially taking place in March 2018. The delays
were reduced somewhat by improved construction delivery.

There are two key financial consequences to the delays:

1. Milestone payments have been delayed and costs to complete the Kpone contract
    have increased. This will require funding by the group. The Kpone contract is now
    expected to reflect an overall life-to-date loss (excluding the negative impact of
    possible delay penalties or the positive impact of claims on the contract to which the
    group has assessed its entitlement). These will impact the H1 F2018 group earnings
    and cash.

    To fund the Kpone contract to its completion date, the group will be required to apply
    approximately 50% of the Euro 40 million free cash held by its Investments &
    Concessions (I&C) business in Europe to the Kpone contract.

2. Possible delay penalties due to the later completion date. Delay penalties are
    quantified at USD 310 000 per day, up to a maximum cap of USD 62,5 million. Against
    these possible delay penalties the group is progressing its own entitlement to
    contractual claims. These contractual claims include, but are not limited to:
          a. claims as a result of the late arrival on site of procured goods due to port
             delays following a change in Ghanaian law affecting the clearing of the
             goods. These represent a material “extension of time with costs” claim in
             terms of the Kpone contract , which would result in an amendment of the
             contractual completion date of 13 September 2017 to a later date;
          b. a substantial claim against the design engineer sub-contractor;
          c. claims against certain sub-contractors due to poor design, delays and
             additional work having to be undertaken by the group on the Kpone contract;
          d. other material claims for extension of time with costs, in terms of the Kpone
             contract, which could result in the contractual completion being restated to
             a later date, which will lessen potential penalties.

   These claims are progressing to finalisation with the various counterparties to which they
   relate and could be of substantial benefit to the group. However, the timing of the
   settlements is uncertain as each claim progresses independently. It should be noted that
   the Kpone contract does provide for the swifter resolution of claims compared to traditional

   The contract continues to receive dedicated senior and executive management attention,
   with two executives based on site to assist with the completion of the contract, CEO and
   CFO direct intervention and support from the Main Board Risk Sub-Committee specific to
   this contract.

   Group Five reported a loss per share of 302 cents and a headline loss per share of 310
   cents for the six month ended 31 December 2016.

   Although the group has not finalised its review of the financial results for H1 F2018, trading
   within the Construction and EPC cluster is below the short term guidance provided at
   year-end. This, coupled with the impact of the additional costs expected to complete the
   Kpone contract, will impact both H1 F2018 and the F2018 full-year results, as well as
   available free cash reserves.

   The main H1 F2018 and F2018 results and free cash impacts are therefore:

      -   the additional cost to complete the Kpone contract (as discussed above);
      -   a general unwind in the South African construction order book, only partially offset
          by a pleasing improvement in the rest of Africa construction order book:
       o   work previously anticipated in both Housing and EPC had to be revised
           downward following either client delays or a shift in project timing;
       o   a reduction in the expected revenue, and thus profit, to be derived from the
           South African Roads and Civil Engineering discipline as a result of the
           downscaling of this business, including closure costs;
       o   although not material to the anticipated earnings, an unexpected loss on a
           South African oil and gas contract; and
       o   increased overhead allocation to the rest of Africa operations to support the
           group’s growth focus areas in line with the strategic update reported to the

   To minimise the downward pressure on earnings, and expand on capital and risk
   management, the group remains focused on implementing significant restructuring in
   support of its revised strategy. This includes:

   -   finalisation of the strategic evaluation of each construction-related business;
   -   closing down of unsustainable businesses which do not have the potential to meet
       the group’s return on capital targets;
   -   aggressive rationalisation of those businesses which have the potential to be
       sustainable and meet the group’s return on capital targets in the medium-term, but
       where there is limited market demand in the short-term; and
   -   further rationalisation of those businesses that are deemed sustainable in the short
       term. This is in addition to the rationalisation completed in late F2017 and includes:
       o   a focus on additional consolidation, reducing support and overhead costs,
           including reduction in employee costs; and
       o   a further cost reduction intervention within the corporate office. This is in
           addition to the R100 million forecast restructuring savings implemented in Q1
           F2018, which was already factored into the short-term guidance provided to
           the market at year-end.

   Collectively these interventions, once successfully implemented in H2 F2018, will result
   in the residual construction businesses in the group being sustainable and providing an
   adequate return on capital. Capital risk management, including the allocation of capital as
   well as an increased focus on risk management, has been a key area of focus when
   determining the strategic decisions taken for these businesses. The potential cost of
   retrenchments from this next round of interventions, as well as the cost savings, have not
   been included in the forecasts below.
   The decreasing order book, along with the above-mentioned rationalisation of the
   business to remove further overheads, has resulted in ongoing pressure on the South
   African construction business and its cash resources. This has been, and continues to be,
   managed through a focused recovery on cash opportunities identified by the group. These
   include the close out of outstanding claims and commercial matters due to the group,
   recovery of long outstanding debtors and repatriation of funds from operations in the rest
   of Africa. The group’s debt levels remain unchanged.

   The Manufacturing and I&C clusters continue to trade in line with expectation.


   In terms of the JSE Limited Listings Requirements, companies are required to publish a
   trading statement as soon as they are reasonably certain that the financial results for the
   current reporting period will be more than 20% different from those of the prior
   comparative period.

   Although the group has not finalised its review of the interim financial results for the six
   months ending 31 December 2017, the factors outlined in this announcement are
   expected to result in a group loss of approximately 409 cents per share and headline loss
   of approximately 415 cents per share in H1 F2018, which represents a 35,5% increase in
   the loss per share (31 December 2016: 302 cents loss per share) and 33,8% increase in
   the headline loss per share (31 December 2016: 310 cents loss per share) over that of
   the prior period’s comparative number.

   These numbers include the downward earnings pressure from the Construction cluster
   described earlier as well as the cost to complete the Kpone contract, but exclude any
   impact of the potential delay penalties and benefit of the group’s assessed claims to which
   it deems itself to be entitled. A further trading statement will be released on SENS as soon
   as the group finalises its interim results.


   As per the SENS release of 7 November 2017, Group Five announced that it would exit
   the construction businesses where the group does not see the potential to establish
   sustainable businesses, the potential to achieve targeted returns on capital or which are
   not core to the revised strategy.
   These businesses will either be sold or closed. Pleasing progress has been made with
   the requisite legal and internal consultation process. Construction will eventually consist
   of a Buildings & Housing business, despite the reduction of work anticipated in H1 F2018,
   where the group has a proven track record, and a small, nimble Civil Engineering business
   in South Africa. The Structural Mechanical Electrical Instrumentation and Piping
   (“SMEIP”) business (previously housed in Projects trading in South Africa and the rest of
   Africa), as well as the Energy business will be retained separately.

   In addition and as announced on SENS on 22 November 2017, the group has commenced
   the disposal of its Manufacturing cluster with the sale of Group Five Pipe to black-owned
   LB Pipes Proprietary Limited (effective 1 November 2017). LB Pipes is owned 51% by
   black industrialist Mr Kuseni Dlamini, 26% by Marine Civil Proprietary Limited and 23%
   by the Industrial Development Corporation. Group Five Construction will receive proceeds
   amounting to R80 million, as well as the realisation of cash on hand in Group Five Pipe
   of approximately R25 million. These proceeds will be retained in Group Five Construction
   and applied to its activities as required.

   The group has also commenced a disposal process for the remaining assets within the
   Manufacturing cluster.

   Expressions of interest continue to be received for the group’s Investments &
   Concessions assets and operations. The board of directors of Group Five continues to
   objectively assess the credible expressions of interest received, with a view to maximising
   shareholder value, notwithstanding that these assets and operations are deemed to be
   core to the group.


   The information contained in this announcement has not been reviewed or reported on by
   the group’s auditors.

19 December 2017
Nedbank Corporate and Investment Banking

Date: 19/12/2017 08:01:00 Produced by the JSE SENS Department. The SENS service is an information dissemination service administered by the JSE Limited ('JSE'). 
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