Fitch Downgrades Aveng Limited to ‘BB+(zaf)’; Withdraws Ratings

The following is from Fitch Ratings on April 6:

Fitch Ratings has downgraded Aveng Limited's (Aveng) National Long-term Rating to 'BB+(zaf)' from 'BBB(zaf)' and National Short- term rating to 'B(zaf)' from 'F2(zaf)'.

The Outlook is Negative.

Fitch has simultaneously withdrawn the ratings as they are no longer considered by Fitch to be relevant to the agency's coverage. Accordingly, Fitch will no longer provide ratings or analytical coverage for Aveng.

The downgrade reflects the group's deterioration in revenue and profitability generation and significant working capital outflow for 1H15. This financial performance combined with increased debt levels for FY14 resulted in worsening trends for both coverage and leverage metrics for FY14. The Negative Outlook is based on the difficulties faced in Aveng's key mining and construction markets, uncertainties in the turnaround of negative working capital outflows and the uncertainty surrounding the timing of the claims being pursued by the group.

We note that despite the financial performance and weaker credit metrics in FY14, the group managed to reduce the cash burn seen over the past few periods. However, the cash outflow from operations remains significant and has deteriorated in 1H15. Fitch believes management is taking steps to improve its position by selling non- core assets and Fitch expects the group's disposal of the Electrix business and potential disposal of non-core properties (yet to be concluded) to improve leverage metrics for FY15, but significant downside risks remain from the group's trading conditions.

KEY RATING DRIVERS

Cash Burn Remains Negative

In FY14 the group managed to reduce negative free cash flow to ZAR1.5bn (FY13: ZAR1.9bn) which helped improve the cash position. Nonetheless, the cash burn remains significant despite decreases in capex and dividends paid. In 1H15 there has been an increase in negative free cash flow (Fitch defined pre-disposal) compared with 1H14 and Fitch expects a significant outflow for the full year. With a decline in the order book since FY14, Fitch continues to expect revenue generation to remain under pressure with lower prepayments impacting the cash position.

Margin Under Pressure

Fitch expects margins to remain under pressure in the short term with difficult macro-economic and sector conditions in South Africa and Australia for the group. For 1H15 Aveng delivered lower revenues, due to the wind-down of major projects and non-renewal of certain mining contracts but also partially due to the Electrix disposal, and EBIT margins declined to 1.7 percent (1H14: 1.8 percent). This was contrasted with FY14, where despite the lower levels of revenue growth, Aveng managed to contain cost increases leading to an increase in EBIT margins to 1.5 percent (FY13: 1.3 percent) with improved performance from the parts of the South African operations offset by declining profits in the Australian operations. We note that while progress was made on reducing losses in Grinaker LTA, the division remained significantly loss-making in FY14 and continues to remain so in 1H15.

Leverage Increasing

The group increased leverage in FY14 and, with the accompanying increase in interest costs and reduced profitability, coverage and leverage metrics have weakened. Fitch expects some improvement in the metrics in FY15 with the completion of the Electrix disposal, but credit metrics are expected to remain weaker than FY13. The completion of the potential non-core property sales will have a positive impact on metrics if proceeds are applied to deleveraging. The net cash position of the group at 1H15 has improved compared with FY14. The group's Australian net cash position has improved to ZAR2.7bn (FY14:ZAR2.0bn), but the South African net debt position has declined to negative ZAR1.0bn (FY14: negative ZAR0.7bn).

Restricted Australian Cash Flow

The restriction to cash movements from Australia to South Africa (limited to 50 percent of the former's after tax net profit, without approval from bank lenders in Australia) is considered a constraint on the ratings. Dividends had been regularly paid from Australia to South Africa in the past with the exception of 2013 and 2014 due to working capital requirements in Australia for the completion of major projects.

New Management and Risk Management

The group introduced new management in FY14 with new appointments to the CEO, FD and key operational management positions. While external people have been brought in to address areas in which this was required, this has been balanced by internal appointments to strengthen leadership and ensure continuity. The new management teams are expected to address growth and profitability issues. The group has also appointed further high level individuals to the key risk committees to ensure better monitoring of execution risk and contributory profitability generation for new business.

Additional information is available on fitchratings.com

(a) No part of the rating was influenced by any other business activities of the credit rating agency;

(b) The rating was based solely on the merits of the rated entity, security or financial instrument being rated;

(c) Such rating was an independent evaluation of the risks and merits of the rated entity, security or financial instrument.

Applicable criteria, Corporate Rating Methodology', dated 28 May 2014, are available at fitchratings.com.

Applicable Criteria and Related Research:

Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage

Additional Disclosure

Solicitation Status

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