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Engineering
* F2012 (F2011) secured order book. |
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Engineering contributed 18.0% (2010: 13.1%) to group revenue and 22.4% (2010: 16.8%) to group total operating profit.
Engineering consists of Projects and Engineering and Construction (E+C). Projects is involved in structural, mechanical, electrical, instrumentation and piping (SMEIP) contracts. It is a total plant builder with a specific focus on the mining sector.
E+C is a developing engineer, procure and construct (EPC) business and is currently involved in power and oil and gas contracts, as well as operations and maintenance services. E+C offers multi-disciplinary project delivery from feasibility through to supporting bankability and front-end design, as well as project management of contracts during execution to completion.
As communicated previously, the group’s strategy is to establish E+C as a fifth cluster of operations within the group. Market conditions have slowed the intended growth plan of this business. For F2011 the unit was therefore still managed and reported as part of the Engineering segment.
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Market review - Projects
Projects
Projects is a structural, mechanical, electrical, instrumentation and piping (SMEIP) contractor which has traditionally operated within the sub-Saharan African private mining sector. However, in recent times, certain South African public sector work was undertaken for Transnet in the oil and gas sector. In the South African private sector, construction took place for a power plant for Sasol.
Tender activity within the South African public sector remained erratic, with occasional bids for Eskom’s Kusile and Medupi power station contracts becoming available. The volatility is expected to continue, although we do expect an increase in private public partnership (PPP) power contracts.
The African mining sector remains our most active market. This is set to continue with the improvement in commodity prices which will fuel further development. We have successfully completed contracts in the Democratic Republic of Congo (DRC), Ghana, Mozambique and Burkina Faso in the year under review. With recent contract awards, we re-entered Namibia, Malawi and Tanzania.
Tender activity within the Zambian/DRC copper belts is at an all-time high and is expected to continue on the back of the favourable copper price. The gold price continues to drive the establishment of new mines, which extends across the African continent. The demand for coal is driving growth in a number of countries, with new contracts coming on stream and some at a planning stage, in particularly Mozambique. The West African iron ore market looks set to expand on the back of continued demand from India and China, with major contracts in the pipeline. The group is also tendering on contracts within the uranium, diamond, zinc and other base metals sectors.
During the year, we followed a focused strategy of re-entering the South African private market. We achieved this with a R330 million contract for Exxaro on the Grootegeluk coal mine expansion and a R30 million contract for Xstrata on their ATCOM mine. Going forward, we expect coal contracts to dominate the local mining market. In contrast, there was not much activity within the industrial sector during the year. The sector is expected to remain relatively slow for at least another 12 to 18 months. -
Market review - Engineering and Construction
Engineering and Construction
Engineering and Construction (E+C) focuses on building the capability to deliver turnkey solutions in South Africa, the rest of Africa, Middle East and Eastern Europe. Development of contracts associated with power, oil and gas and the water sectors are particularly evenly spread across local and international markets, with similar distribution between public and private prospects. The business’ markets have slowed, with contract awards sporadic and difficult to forecast. However, looking forward, the pipeline of power, oil and gas and water contracts is growing.
In South Africa, the continued slow response by government to initiate and implement a framework to facilitate private and public investment into infrastructure contracts such as PPPs, IPPs and concessions is causing uncertainty and difficulty in planning and implementation. This apparent lack of urgency and direction has also caused international investors and technology suppliers to question their immediate role in the local markets.
In the rest of Africa, the public sector brings a different set of challenges. Although the framework for implementation of contracts is more effective, the complexity of the tender process, off-take agreements, increased competition and compliance processes result in very uncertain finalisation times. Several contracts therefore lose momentum, are cancelled or postponed.Private sector contracts are more predictable, both in Africa as well as South Africa. Oil and gas contracts tend to be well supported, with clear requirements from the owners. Although these contracts are seldom of a turnkey nature, they remain complex and challenging. Definite growth is envisaged for refined products such as fuels, lubricants and chemicals, which is leading to the increased need for fuel storage capacity both in South Africa and Africa. New oil and gas finds in Uganda and southern Sudan will challenge the traditional African majors of Nigeria and Angola and will provide new growth opportunities for Group Five.
Growth in private power, as well as in captive power plants, is seen throughout South Africa and the rest of Africa. The shortage of power and constant interruptions of supply continues to impact production consistency and therefore profitability of mines, industries and enterprise in most developing countries.
The high price of distillate fuel continues to lead to owners questioning the cost-effectiveness of base load power and high speed diesel engines used as back up. Increased feasibility studies and enquiries therefore continue to be conducted on alternative forms of energy, such as biofuels, off-gas installations, liquid nitrogen gas (LNG) and natural gas. Although renewable energy like solar and wind are being investigated, it is a significant challenge for private power investors and captive power owners to secure debt for contracts of this nature. Lender finance availability is currently more controlled and harder to secure, although access to finance seems to be improving for renewable energy contracts.
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Delivery
Find below how we delivered on our objectives outlined in our F2010 integrated report.
Key focus areas Desired results Status Projects Further opportunities in new African and Middle East countries. Secure new contracts in these regions. Recent awards resulted in our re-entry into Namibia, Malawi and Tanzania. We were successful in accessing the coal mining market in Mozambique for the first time.
We expect to enter the West African iron ore market within the near future.
We are not actively pursuing contracts in the Middle East and North Africa due to the opportunities within the sub-Saharan mining sector.Incorporate Electrical and Instrumentation (E&I) into Projects. Through the new structure, ensure the successful roll out of an SMEIP service to our clients. Re-integration of E&I was successful and added to our ability to execute a total SMEIP service to our clients. Secure work within the South African power sector. Secure new contracts within the sector We did not secure work on either of Eskom’s Kusile or Medupi contracts.
We are actively pursuing contracts within the gas-fired power market on the back of our successful track record.Roll out an extensive materials tracking system. Cost savings associated with loss, identification and sequencing of materials. The system is up and running on its first contract. Enhance our reputation as SMEIP contractors within the South African oil and gas and power sectors in support of the group’s sector strategy. Successful delivery on the Sasol and New Multi Products Pipeline (NMPP) contracts and new contact awards. Both contracts at Sasol have been successfully completed and the NMPP contracts are well underway. 
Key focus areas Desired results Status Engineering and Construction (E+C) Establish the E+C business. A permanent structure through which we will develop, bid, secure and execute large multi-disciplinary contracts. Recent awards resulted in our re-entry into Namibia, Malawi and Tanzania. We were successful in accessing the coal mining market in Mozambique for the first time.
We expect to enter the West African iron ore market within the near future.
We are not actively pursuing contracts in the Middle East and North Africa due to the opportunities within the sub-Saharan mining sector.Expand the group’s footprint into new sectors and ensure alignment with technology providers and engineering skills. Establish the group’s position within the strong growth sectors in infrastructure. Strategic target sectors were identifi ed and structures implemented to maximise opportunities. During the year, the team further aligned itself with technology manufacturers and suppliers associated with its target sectors. Capacity building in the power sector. Secure next round of IPP and renewable energy contracts. In South Africa, there were government delays in the renewables programme. Requests for quotations are expected to be issued during the first quarter of F2012, with possible awards towards the end of F2012.
In Africa and Eastern Europe, project fi nance for contracts have been slow due to the global market slowdown. The fi nalisation criteria for contracts have also become more stringent and time consuming. However, we expect certain contracts to be awarded in F2012.Geographic expansion in support of technology partners. Secure work in additional territories aligned to our group and partner strategy and in terms of the group’s pre-determined risk hurdle rates. In parallel with our strategy of focusing on sectors, we evaluated opportunities to expand certain offerings into new regions. In support of Group Five’s identifi ed regional hubs in West, East and Central Africa, we expect improved prospects in oil and gas and the expansion of power. Opportunities were identified in Eastern Europe, specifi cally in the power sector. -
Financial overview
R million Year ended
30 June 2011Year ended
30 June 2010Revenue 1 659 218 1 488 007 Total operating profit 6.7 9.9 Core operating margin 6.7 9.4 Engineering experienced a marked recovery in its markets. Revenue increased by 12% from R1,5 billion (50% local) to R1,7 billion (52% local). However, the increase in the South African content of the revenue at lower margins resulted in a core operating profit decrease of 20% from R139,9 million to R111,5 million. The core operating profit margin decreased to 6.7% (2010: 9.4%).
A recovery in enquiry levels from the sub-Saharan African mining and energy markets is underway, which resulted in new contract awards. This trend is expected to continue in certain minerals categories. There was also significant progression in the South African power, oil and gas and mining markets over the last six months, which augurs well for a sustained recovery ahead, albeit lumpy in nature.The secured one-year order book remained at R1,4 billion (75% local) compared to 30 June 2010 when 51% was local. The full secured order book stands at R2,1 billion (83% local) (2010: R1,9 billion (64% local).
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Material issues within the business and how these have been managed
Projects
Foreign exchange risk
The Rand/Dollar exchange rate remains volatile. As over-border contracts are tendered and priced in foreign currency, fluctuations in exchange rates can materially affect contract profitability from the date of tender through to the date of contract completion. To address this, the business follows the group’s internal risk management guidelines and hedging strategies.
African political risk
Due to our focus on over-border mining contracts, we encounter various risks associated with operating on the African continent. These risks can change swiftly without advance indications of change. We manage this through detailed risk reviews on a country by country basis, with security and evacuation plans pertinent to each region in place.
Skills development in South Africa
Within the SMEIP market, skills development is one of the major factors which impacts on our ability to deliver contracts in South Africa due to skills shortages. Although the industry often supplements skills with foreign nationals, this has in the past led to unrest on sites, as recently seen on the Eskom Medupi power station. The group therefore aims to balance skills supply between local skills and specialist imported skills.
Employee retention
Over the last few years, the group has had a good employee retention rate. However, as there is currently a reduced number of opportunities in South Africa and local contractors are tendering over-border, good skills are often targeted by competitors. To address this, Projects continues to focus on its employees’ development and work satisfaction, as well as their performance management through consistent performance appraisals and succession planning.
Transformation
Employment equity remains one of the core focus areas for our business to ensure effective transformation. The group’s strategy has been to “grow our own talent”. A key area to address is senior employee development and retention due to the demand for senior skills along with other sectors offering attractive opportunities following the downturn in the construction sector. Projects continues to concentrate on fast-tracking black candidates in its aim to enhance transformation of its senior management.
Engineering and Construction (E+C)
Delays in contracts
The integrated electricity resource plan for South Africa is still awaiting promulgation. Independent power projects, especially those focused on renewable energy, have therefore been delayed. Any further delays will have a material impact on the group’s implementation strategy around solar and wind contracts as we have applied resources to develop this market. To mitigate against this, the group is strongly positioned to bid for contracts in the thermal and liquid/gas fuelled private power markets for IPPs, co-generation and captive power plants. Group Five is also in the process of ensuring nuclear construction readiness in anticipation of the South African nuclear programme, although this is a medium to long term opportunity.
African political risk
As outlined in Projects, operating in Africa has numerous challenges. The E+C business is exposed to the same risks. To mitigate against these, it closely follows the group’s risk management procedures.
Increased competition and margin pressure
The increased interest in African contracts by South African, European and Asian construction companies has significantly increased competition in all our markets and has placed downward pressure on margins. To address this, the group continuously expands its construction offer and develops its technology alliances to enhance its ability to develop bankable packaged solutions with clients.
Building EPC capacity
The group’s target markets require design and build, EPC and full service support capability. In the short term, this capacity building is an investment in future growth as this business will not provide an immediate return on its investment due to the current delay in contract awards. The EPC contracts which have been implemented have all been technically sound and financially beneficial.
Key achievements Projects
The consolidation of our operations in the DRC. We launched our small works operation which is developing well, we erected the Kipoi copper concentrate plant in under three months and completed the Kinsevere Stage II contract in the DRC with fi rst copper being produced in May 2011 Re-entry into the Southern African Development Community (SADC) mining arena with the successful award of the Grootegeluk and ATCOM coal contracts in South Africa, the award of the Benga coal contract in Mozambique and our return to the Langer Heinrich uranium mine in Namibia E+C E+C’s power business unit has now successfully executed 800 MW of power contracts, as well as 350 tonnes/hour of steam generated from combined cycle operations. All of these contracts have been in a turnkey contract environment and are based on EPC commercial terms and guarantees. These contracts have established the group as a solutions provider for power delivery in the African market. Our experience in thermal contracts is now being expanded into Eastern Europe, as well as into solar and wind power contracts The oil and gas business unit has successfully progressed into turnkey contracts and storage tank design and construction in South Africa. These contracts are aligned to the industry’s plans for capital upgrades and maintenance. To support this scheduled growth, it has become necessary for the business to improve its certifi cation with respect to welding techniques and standards. During the year, it successfully achieved ISO 3938 certifi cation in Cape Town and Durban, a fi rst for a construction company in South Africa The creation of a turnkey solutions business within Group Five has allowed E+C to focus on developing worldclass systems and resources. During the year, a full suite of contract and project management tools was implemented to ensure effi cient and professional execution of turnkey contracts In a group-wide and joint effort, we were successfully assessed and achieved conditional certifi cation by Eskom for multi-disciplinary construction within the highly specialised areas of a nuclear facility. The group qualifi ed to execute works in all areas of the Koeberg nuclear plant or any other Eskom nuclear plant -
Looking forward
Key focus areas for F2012 Desired results Projects Focus on iron ore contracts in West Africa.
Secure one of the large iron ore contracts Secure power contracts in South Africa.Secure further gas-fi red power contracts Target new engineer, procure and construct (EPC) mining opportunities.Complete our fi rst EPC mining contract and secure new EPC contracts Address employment equity targets at a senior level.Continue to hone our strategy in this regard to ensure traction Engineering and Construction (E+C) Expand the oil and gas business unit’s geographic footprint into selected over-border markets to take advantage of increased international tender activity.Increase in contract awards in refi nery and fuel storage infrastructure Establish an independent business focused on renewable power such as wind and solar.Strengthened capabilities to offer clients, developers and technology providers a turnkey solutions business covering all aspects associated with this sector Expand geographic footprint in the water sector to the rest of Africa.Establish Group Five as a solutions provider aligned to various technology partners to offer innovative and cost-effective solutions to the water infrastructure developers in Africa Diversify and strengthen engineering and design capacity to support improved execution and integration capabilities.Increase depth of skills in the management of engineering and design Reduction in rework, improvement in quality and process implementation, as well as lower cost 