Tongaat: it’s much worse than you think

Sugar company Tongaat Hulett may be in a far more precarious financial position than it has officially told the market.

Adding to a widening accounting scandal, there are now concerns that dangerously high levels of debt at Tongaat might prove crippling to shareholder value, if its executives — now led by recently appointed CEO Gavin Hudson — are hesitant to grasp the nettle.

Last week Tongaat, currently in the throes of a "strategic and financial review", confirmed what many suspected: that past practices "appear to have resulted in financial statements that did not reflect Tongaat Hulett’s underlying business performance accurately".

It is this scandal that has led to the company’s share price plunging 75% over the past six months, as investors fled.

It also means Tongaat’s audited financial statements for the year ended March 2018 will need to be restated — a severe stab at the heart of a company’s credibility. Quite how deep the wound goes isn’t clear yet, but already Tongaat said it has to slash between R3.5bn and R4.5bn from the equity number it published last year.

Tongaat has said the adjustments were of a "noncash" nature. It would seem that the main problem was that land sales were incorrectly recorded in Tongaat’s book, using wonky revenue recognition criteria.

But shareholders worry that the rot runs deeper: that Tongaat’s valuations for its growing sugar cane were inflated, and that costs for projects, cane roots and maintenance were capitalised rather than put through the income statement as an expense.

In short, investors fear they have been led down the garden path, as is clear from the board’s statement that the 2018 figures "can no longer be relied upon". Those investors include a number of respected institutions, such as PSG Asset Management (7.7%), Allan Gray (6.3%) and Investec Asset Management (2.7%).

The main concern now is what has transpired since April 2018 — the start of financial 2019, for which there is no guidance. Outraged shareholders won’t feel any better for having to carry out blind number-crunching to "guestimate" Tongaat’s NAV.

The last accounts, in 2018, also reflected equity of R12bn. If you subtract R3.5bn-R4.5bn from this, it leaves Tongaat with equity of between R7.5bn and R8.5bn, against its last stated debt levels of around R10.7bn.

This would imply a claustrophobic debt:equity ratio of more than 100% — enough, you’d imagine, to cause its bankers sleepless nights.

Well, hold onto your seats: the true debt position is far more suffocating. Tongaat’s results for the year to end-March are expected to yield another big loss — which means another R1bn will need to be shaved off its equity. This will reduce the figure to between R6.5bn and R7.5bn.

One industry commentator says none of Tongaat’s announcements seems to factor in the likely further write-down of equity due to the collapse of the Zimbabwe economy and the introduction of the country’s new currency, the real-time gross settlement dollar.

It’s a big deal, since Tongaat earned R3.9bn in revenue and R563m in operating profit from Zimbabwe in its past financial year — more than 23% of its total figures on both counts. Add to that the significant cash reserves trapped within the country, and the likely revaluation of Tongaat’s Zimbabwean assets could smack its equity number by another few billion rands.

Looked at cumulatively, Tongaat’s equity might well be eroded by between R4bn and R6bn due to all these factors. And this would mean hair-raising gearing of between 150% and 225% of its equity.

Right now, it is unclear if there is any overlap between the pre-2019 restatements and the expected 2019 losses and probable impairment of its Zimbabwean arm. This lack of clarity will no doubt irk already jittery shareholders — some of whom have griped to the FM that Tongaat has resorted to drip-feeding tiny chunks of bad news into the market.

Unfortunately, Tongaat has indicated its audited results to March might be released only in October. Considering what happened at Steinhoff — where decoding the web of shady accounting practices led to delays in its audited results — there are fears it may not meet the October target.

These delays mean Tongaat finds itself in a pickle over a possible recapitalisation of the business by a rights issue. No institutional investor will back a rights issue, without access to reliable and up-to-date financials.

This means Tongaat’s bankers — who recently agreed to a debt standstill arrangement — will be in a position to dictate the outcome.

With the possibility of a further deterioration in trading conditions, Tongaat will have little choice but to sell certain operational assets.

Its property portfolio would, you’d imagine, be first on the block. But property sales, which have slowed alarmingly in recent months, are probably not going to pour in significant cash any time soon.

Instead, most analysts contacted by the FM reckon Tongaat’s stoutly profitable starch business is a prime candidate for sale — and tip Remgro’s RCL Foods as a possible suitor. Last year, the starch business made R572m in operating profit, on revenue of R3.9bn.

There is also talk that the 50% stake of the Hippo sugar farm in Zimbabwe should be sold, and possibly also the Swaziland operations.

Officially Tongaat has committed to "selling certain assets". And it has said that independent valuations of its various businesses, as well as its land portfolio, have been obtained.

Investors will still be hoping Hudson’s new team can salvage some value. "They need to move quickly, though. The last thing anyone wants is to smash apart the group to sell assets to repay the banks," says one analyst.

But at this point, things are not looking rosy. This week, Tongaat told investors "local sugar markets and trading conditions have deteriorated, resulting in lower-than-anticipated cash flows in the business and the sugar sector as a whole".

Slightly better news is that Tongaat — which did not sell any land in the second half of financial 2019 — has negotiated two sale agreements and is getting ready to obtain the planning approvals to conclude these deals.

Aside from the increasing fiscal fears at Tongaat, louder questions are being asked about corporate governance.

There are several key questions. How did things at Tongaat evolve to this point? How much blame should be laid at the door of former CEO Peter Staude, who "retired" last year after 41 years with the company? When did the company realise what had happened?

And perhaps most critically: when the directors realised Tongaat’s predicament, did they immediately perform their fiduciary duties, or did they go into self-preservation mode?

If the board knew in November 2018 that there were serious questions around the quality of Tongaat’s balance sheet and the sustainability of earnings, for example, it may not have been enough that it simply appointed an audit firm (PwC) to audit the group’s auditors (Deloitte).

Chris Logan, CEO of Opportune Investments and a former Tongaat shareholder, says that for some time "Tongaat’s disclosure was shocking".

Logan says no details were ever provided about the enormous amounts spent on expanding its sugar cane — even though this spending amounted to almost R13bn since 2006.

"They did not even break it down by country, despite some of the countries being calamities like Zimbabwe," he says.

Logan says that in 2014, Tongaat stopped disclosing details of its salaries and benefits, even as this amount soared from 14.1% of revenue in 2008 to 19.1% by 2013.

Quite how much of these disastrous "past practices" were deliberate, and how much was just bad or negligent management, remains to be seen. But at the very least, the board should be far more transparent about accounting for a disaster that has scary echoes of Steinhoff.