An internal audit report forecasts a whopping R2-billion loss for South African Airways (SAA) in the 2002/03 financial year — despite the fact that it will notch up a healthy operating profit.
The heavy losses are linked to the sharp appreciation in the value of the rand, the report shows.
SAA and its parent company, Transnet, are due to report their results in June. However, an internal report prepared by Transnet Group Audit Services, coinciding with the financial year-end last month, gives a fascinating insight into expected results, risk factors and corporate governance issues.
The report, obtained by the Mail & Guardian, was scathing about the way some privatisation or restructuring measures and the demands of the government as shareholder may affect the group’s viability (see sidebar).
According to the report, the Transnet holding company was expected to post a healthy profit of R2,6-billion, against a budgeted loss of R61-million. The differential seems largely as a result of the sale, at a profit of more than R3-billion to Transnet, of MTN shares earlier warehoused with an offshore finance company.
A number of Transnet units were expected to declare losses way beyond those anticipated. B2B Africa, the Internet logistics and procurement company, was heading for a R35-million loss, against a budgeted profit of R16-million, while Marine Data Systems was heading for a R50-million loss, against a budgeted loss of about R8-million. A notable exception was SA Express, heading for a loss of under R5-million, against a budgeted loss of R36-million.
But SAA looked set to be the group’s worst performer by far. Budgeted to make a profit of R154-million, the estimated actual result was a loss of R2,09-billion.
For some time, Transnet and SAA have followed an accounting procedure designed to reflect the fair value of derivatives. If SAA, which does much of its trade in dollars, hedges against the depreciation of the rand, the value of those hedges is included in its balance sheet, even though the hedge gains or losses are unrealised.
In 2001/02 the Transnet group reported a R2,8-billion gain in derivative fair value — much of it presumably from SAA hedges. SAA’s results at the time reflected this: net profit after taxation was R2,14-billion, but headline profit excluding net derivative fair value gains was a more modest R553-million.
After the dramatic recovery of the rand, those “profits” had to
be reversed. Commenting that the projected loss was “of particular
concern”, the internal audit report said: “The losses posted by South African Airways are due to the reversal of some of the profits taken to book in the 2002 year from the unrealised gain on marking to market the forex hedging book … following the strengthening of the rand.”
Additional losses, it said, were due to the decrease in the rand value of SAA’s dollar-denominated offshore cash pile.
On the upside, the report said it was “pleasing to note that SAA has reported an operating profit”.
SAA is among six Transnet units that clearly worried Group Audit Services, which classed them as being in need of “urgent board-level intervention”. Particular concerns included not only SAA’s projected loss, but also strong competition from Kulula.com, “problematic” succession planning and weak contract control. Executive management was “too operationally committed to give due attention to improving internal controls”.
Transtel, which will form part of South Africa’s yet-to-be-licensed second national phone operator (SNO), was also singled out.
The audit report said the procurement spent on the SNO roll-out “has been substantial and has been identified as a key risk”. Weaknesses included inadequate processes to identify winning suppliers, non-compliance with empowerment
requirements, inadequate contract management and a lack of proof of the delivery of goods and services that had been paid for.
Other Transnet units identified as in need of urgent board attention were Freightdynamics, TSA Express, BSB Africa and Marine Data Systems.
Generic risks identified as threats to the group as a whole included the impact of HIV/Aids, information management and protection exposure, difficulties in complying with the Public Finance Management Act, a general shortage of skills, questions about profitability and future viability, management control and discipline weaknesses, risks relating to restructuring and privatisation, the need for significant infrastructural investment, safety exposures, treasury risks, procurement issues and continuity management.
The report cited two examples of management failures that had exposed Transnet:
When the group decided to sell Transwerk Foundries to private company Davel Steel Technologies, a Davel representative was appointed chief executive during the handover period. The report alleged the new CEO entered into irregular transactions costing Transnet millions. The sale later fell through, and Transwerk Foundries was attempting to recover some of the losses.
During 2002 various invoices were falsified within Transtel
and fraudulent payments totalling $360 000 were made to a bank
account in the Isle of Man. Half of the amount was recovered and a suspect identified, but the investigation came to a standstill as
offshore banks were unwilling to cooperate.
Chief financial officer Sindi Mabaso was out of the office for the week and Transnet could not comment.