A closer look at Transnet – creating a more sustainable rail sector

Back to rail - a ‘no brainer’?

South Africa wants to move freight from road to rail. This is because rail has a lower carbon footprint than most road transport and high volumes of heavy goods vehicles on the intercity roads are a serious threat to road safety.

Transnet’s Market Demand Strategy (MDS), which has seen over R300bn ploughed into rail infrastructure enhancement and new locomotives in the past five years alone, is all about back to rail.

‘Transnet grabs market share despite weak economy’

This headline from Railways Africa’s, 11 November report on Transnet’s ‘Reviewed, Condensed, Consolidated Interim Results’ for the six months ended 30 September 2016 includes Transnet’s own summary of their road to rail performance in this period: Revenue increased by 1.2% to R32.6 billion for the period, driven by a 12.8% increase in railed containers and automotive volumes as a result of concerted efforts to shift rail-friendly cargo from road to rail.

The report goes on to note that, despite having to slow the pace of investment because of market conditions, Transnet continues to be able to raise sufficient capital to fund its investments on the back of its commercial performance, without recourse to state guarantees.

Although this sounds very healthy commercially, a closer look at the numbers in this same interim statement, together with some unusually frank admissions from last years full financial report, reveal a different picture.

EBITDA and the ability to attract funding

EBITDA – earnings before interest, tax, depreciation and amortisation – is a short-term measure of a business’s ability to fund itself. It reveals what is available once immediate costs of running a business are covered.  It doesn’t include cost of financing investment (interest), amounts payable to Government including taxes, allowance for the declining value of assets over time (depreciation), or the repayment of the principle on borrowings (amortisation).

The higher that EBITDA is as a proportion of total business revenue, the better a business is placed to attract the investment it needs. The table shows the ratio of EBITDA to total revenue for the different business sectors of Transnet.

Source: Transnet Interim Results for 6 months to 30 September 2016

Rail funding dependent on ports and pipelines

The table shows that while TFR is by far Transnet’s largest business sector, with 58% of group revenue, its contribution to EBITDA is proportional to this share at 57%.  The National Ports Authority (NPA) and Transnet Pipelines (TP), by contrast, though they account for just 24% of total group revenue, together generate 41% of group EBITDA.  Transnet’s ability to fund the MDS investments, 70% of which go to TFR, is therefore highly dependent on the cash-rich NPA and TP.

What’s the problem with this, some may ask. As long as the entity as a whole is sound, shouldn’t funders be content that their investments are safe?

Massive commercial risk

The problem with this situation is that it creates an artificially attractive reflection of the sustainability of Transnet’s MDS investment programme. Moreover, the cash flush position, of the NPA especially, arises largely because the NPA charges container ships calling at SA’s ports up to four times as much as comparable ports in other countries.

The National Ports Act of 2005 seeks to address this abuse of monopoly power by making provision for the NPA to become a separate corporate entity.  But Transnet is resisting the implementation of the Act, knowing that this would highlight both the excessive NPA profits and the fact that the huge scale of MDS investment could not be motivated based on rail’s balance sheet alone.

Do Transnet, (and the banks) acknowledge this risk?

Evidence that this commercially risky situation is known is found in Transnet’s 2015 Annual Financial Statement. Notes to the accounts warn that any change to the current institutional arrangements which underwrite Transnet’s borrowing capability, could lead to failure of the MDS programme, or default on debt servicing, or both. Instead of highlighting this, it was tucked away in the 810^th line of the 3 700-line spreadsheet of notes to the accounts (where no-one but an inquisitive transport economist might find it!).

Transnet cannot be the only ones who are aware of the risk. National Treasury in its oversight role of the finances of state-owned companies must know.  The institutions lending to Transnet will also know but are perhaps trusting in an implicit Government institutional underwriting of this state-owned entity.

This might be excusable if there were good economic reasons for hiding the need for explicit subsidies behind these irregular institutional arrangements. But, quite the opposite is the case. The high NPA port charges lead to slower trade growth; slower trade growth means lower GDP growth; and lower GDP growth means higher unemployment. The situation cries out for intervention.

What should be done?

Firstly, acknowledge the enormous commercial risk situation that is faced.

Secondly, corporatise the NPA and let its tariffs relate to its business only.

Thirdly, pull out of head to head competition with road freight. The fact that most of the investment going into TFR is sustaining capital, not enhancements, shows that the infrastructure is not fit for this purpose.

Fourthly, refocus available investment on the very high bulk sectors in order to be ready for an upturn in the international commodities market.

Fifthly, find capable, even majority-owner/partners for the best parts of the business, not the dregs.

Sixthly, set aside a large fund for the retraining and resettlement of staff who may need to be retrenched to save the business.

If all these things were done, a debt trap would be avoided and, after a couple of years of painful adjustment, South Africa could find itself with a smaller, differently focused, but more sustainable rail sector.