Denel Aeronautics – Combining Forces

Brochure

With the general decline of the South African National Defence Force’s demand for equipment, Denel Aeronautics’ has found itself in a difficult position compared to other defence contractors. However, a recent restructuring and the promise of further overseas business offers considerable hope.

 The May merger between Denel Aerostructures and Denel Aviation makes perfect sense on paper. The two departments often worked on the same projects – Aerostructures make the drop tanks for the Rooivalk attack helicopter, which Aviation designed and built, and both worked together on projects before like the Small African Regional Aircraft (SARA), a light 24-seat transport designed to be affordable, reliable and rugged enough to be perfect for the growing short-haul aviation market on the continent.

Now, Aeronautics has a laundry list of projects – The Rooivalk, which is flown by the SAAF’s 16 Squadron, the continued manufacture of components for the Air Force’s Hawk jet trainers and A109 helicopters and for civilian aircraft and transport planes, among many others.

Practicality is not the only driver for this merger though – Denel Aerostructures was sufficiently unprofitable that it was a notable event in 2016 when it made its first profit of R7 million after years of sometimes heavy losses. Despite lucrative deals with Airbus, it took a major turnaround strategy to reduce rental footprint, outsource activities, restructure numerous operations and reduce the workforce to keep Aerostructures going, even before this merger.

Challenges

Denel has been under pressure since 1994 thanks to a heavily reduced SANDF budget putting it in an unusual position compared to other state-owned arms contractors. Most defence companies primarily supply their national military or its close allies, with a combination of demand and restrictions meaning that they don’t export much more than 14-15% of their products. Denel, on the other hand, exports 63%, primarily to customers in the Middle East and Asia/the Pacific.

Given the difficulties of state-level arms exports to begin with, this puts Denel at a disadvantage and has led to poor performance of many of its high profile projects. The Rooivalk is one of the most notable – despite a high profile only twelve  the aircraft are currently only in service with the SANDF, although it has driven technological development in the industry. The South African government and military are not the supporters of the company that they once were – South Africa spends only 1% of its GDP on defence, and only gave out a one year loan guarantee to Denel this year despite the company asking for five.

Denel’s total revenue has been falling, with 2016/7 amounting to just R8.057bn, down from R8.228bn the year before, with net profit at just R333m compared to R395m in 2015/16. The company has cut employees slightly, down to 4,900, and several divisions making net losses.

One of the reasons for low cashflow has been contracting conditions. Many of Denel’s contracts across their fields have been paid on completion, leaving nothing but the dividends of previous projects to pay their high operating costs. The Denel Group’s CFO, Odwa Mhlwana, said in an interview with Defenceweb that “We have major contracts that are straining us because of contract terms’, pointing out that many of these projects require extensive support from subcontractors which can pose difficulties.

This is especially problematic for expensive scratch designs built from the ground up, which frequently overrun their deadlines and budgets. The company also has endemic problems with the high costs of supplies and materials.

 Turning it Around

The merger which resulted in Denel Aeronautics is part of the company’s much larger ‘One Denel’ initiative, which aims to turn the various sub-units of the company into a single, streamlined and more efficient business once again. The company aims to leverage synergies to reduce costs, provide a better and cheaper atmosphere for R&D, in which it is currently lagging behind, and to sell off non-core assets to meet their rising debts. Borrowings for the Denel Group in 2017 have already reached R3.265bn, and the company’s debt/equity ratio dropped to 1.2 compared to 1.6 in 2016.

The company’s order book has also shrunk this year from R30 billion worth of orders to just R18 billion, although while Mhlwana admitted that this was a cause for concern he noted that this was a short-term issue and not a sign of an underlying larger problem. Denel is stated to have opportunities worth more than R40 billion on the way, of which at least 50% are achievable, and the company is well on the way to its target of a sustained R30bn in orders. Part of the sharp drop was a result of the company shifting some orders to production contracts.

While the company is looking to sell to more African clients, particularly with the SARA project, it is in the Middle East that Denel is seeing most of its business. The company has been particularly boosted by a Memorandum of Understanding signed between the South African and Pakistani governments to boost joint defensive capability, which specifically mentioned Denel Aeronautics. The PAF is looking to arm their new fifth-generation JF-17 Multirole fighters, and Denel is interested in their Project Azm programme to develop long-range drones. With new business like this on the horizon and a sustained belt-tightening at home, Denel is adapting fully to the new conditions it finds itself in.