Aveng near-death from dividend diversion, Newsline

By Ryk de Klerk

JOHANNESBURG – Once a blue chip and favourite among fund managers, Aveng slumped to trade at 3cents per share from a top of more than R44 per share in 2010 subsequent to the 2008/09 global financial crisis. It is imperative to understand why the slump happened before you ask whether the company is worthless or not.

While the share price in 2010 traded at a premium to its stated net asset value, the first hint of troubles ahead was when Aveng in 2011 reported that three large offshore projects of the company’s major offshore subsidiary, McConnell Dowell, were experiencing difficulty with a number of commercial issues which posed a material risk in respect of completion and project cost overruns.

Despite the risks Aveng decided to divert from previous dividend policies and paid out 47percent of earnings instead of 25percent. It means that the company paid excess dividends of R370million in 2011 and 2012.

Aveng near-death from dividend diversion, Newsline

This created the space where short-sellers roam. Mr Market started to price in the project cost overruns by factoring in the possible write-offs of uncertified claims against customers as the market capitalisation started to reflect the company’s shareholders’ interest minus the uncertified claims.

Extremely poor operating performance in specifically the 2014 financial year saw profits drop from R459m in 2013 to a loss of R376m – yes, a reversal of R835m.

That, together with a huge increase in unsettled claims caused a major weakening of Aveng’s net cash position and borrowings increased by nearly R1.9billion from 2012. The company at that stage was still confident that the claims recognised as uncertified revenue would still be paid.

To diversify its funding sources and reduce its reliance on bank debt Aveng successfully placed 7.25percent coupon senior unsecured convertible bonds for a principal amount of R2bn with South African and international institutional investors.

The bonds were convertible into 69.8million Aveng shares at R28.76 per share, or according to my calculations a discount of 10percent to net asset value (NAV) at the end of June 2014 (financial year-end).

That added more fuel to the fire as it is normal practice to hedge at least some of the bonds by selling shares short to guard against significant adverse share price movements.

At the time the NAV adjusted for the claims recognised as uncertified revenue was about R16 per share and the conversion price was therefore 80percent higher than the adjusted NAV. By December 2014, the share price had slumped to R17.

Aveng eventually accounted for non-cash impairments and write-downs on long-outstanding uncertified revenue of nearly R6bn in the 2017 financial year. In 2018 it was evident that Aveng had entered my debt death cross where borrowings exceeded shareholders’ interest.

By the end of March 2018, the share price fell to 100c per share.

A massive rights issue followed to recapitalise the company by R493m through the issue of about 12 shares for every one share held, at a subscription price of 10c per share.

That as such, resulted in an ex-rights price of 16c per share, given the close of 100c at the end of March 2018 as the issued shares increased to 5421 million shares from 417 million pre the rights issue.

In addition, the Aveng bondholders agreed to an early redemption of the convertible bonds which inter alia consisted of the issue of 14046 million new ordinary shares to bond holders at an issue price of 10c per share. Yes, a massive dilution.

The net asset value per share at the 2020-interim stage on December 31, 2019, amounted to 12c per share. The net realisable NAV is probably closer to 6c per share if it is assumed that existing claims recognised as uncertified revenue will be written down and impaired.

Aveng’s three-year business plan, announced in 2018, focused on completing the disposal of non-core assets in 2020 and reduce debt and finance charges.

The turnaround of the group’s core holdings, Moolmans and McConnell Dowell, was already evident in the results for the six months to December 31, 2019.

McConnell Dowell is a major engineering, construction and maintenance contractor, delivering complex projects in the building, infrastructure and resources sectors in Australia, New Zealand, Pacific Islands, Southeast Asia and the Middle East.

Moolmans is a South African-based leader in open-cut contract mining, offering services across the mining value chain.

Aveng’s core order book was 72percent international and 28percent South Africa at the interim stage and leaned even more to the international side after being awarded A$1bn (about R12bn) in new contracts with government customers and span McConnell Dowell’s geographic regions since December.

The disposal of non-core assets is at an advanced stage with R750m cash received while R450m of new bank debt was repaid.

The impact of the lockdowns due to the coronavirus on Aveng’s financials would probably be reflected in higher borrowings, but I am confident that the banks would extend the repayment terms, specifically in light of the growth in McConnell Dowell’s order book.

Aveng is turning the corner for the better and while dividend payments are many years away, growth in the net asset value per share or shareholders’ interest is on the horizon.

The problem with a share like Aveng that has traded in a range between 1c and 5c over the past two years is that it is open for possible manipulation. The daily average standard deviation (a risk measure) over the past year was nearly 30percent. That certainly is not a true and fair reflection of the actual market in Aveng shares.

I am, therefore, of the opinion that it will be in the interest of all shareholders if Aveng’s board of directors decides to consolidate Aveng shares in the ratio of 1 share for every 100 shares currently held.

Yes, penny stocks should not be scoffed at, but you should ascertain why they are trading at, what it seems to be, ridiculously low levels.

Ryk de Klerk is analyst-at-large. Contact [email protected] His views expressed above are his own. He has no direct interest in Aveng and no other companies mentioned. You should consult your broker and/or investment adviser for advice. Past performance is no guarantee of future results.