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Netcare Limited | Annual Report 2009
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| Curently viewing: Chief Financial Officer’s review / Next: Five-year review - Statement of financial position |
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| Chief Financial Officer’s review
Despite the recessionary environment confronted by global players over the past year, the healthcare industry demonstrated ongoing resilience, and the Group delivered a strong performance. This confirms that healthcare services are essential in any economic environment. Although the SA economy has been relatively sheltered from the onslaught of the economic crisis, as experienced in the UK market, global markets have shared one common challenge – liquidity. Cautious investors have favoured companies which have prioritised and implemented effective debt management programmes. Netcare has implemented stringent capital expenditure and working capital management procedures over the past year, to ensure that covenant tests are adequately met and liquidity is preserved. The effectiveness of Netcare’s debt management programme has been demonstrated by the 25.7% growth in share price in the past year, from R8.25 (30 September 2008) to R10.37 (30 September 2009). This compares very well against the JSE ALSI growth of 4.5% during the same period. This review provides further insight into the financial position and operating performance of the Group, and should be read in conjunction with the Group annual financial statements presented on pages 117 to 215. It also reviews the initiatives implemented to mitigate financial and liquidity risk during the year. Corporate finance activities Acquisitions These economic times provide an opportunity for agile companies to take advantage of attractive acquisitions. The headroom in covenant levels has placed Netcare on a secure footing to expand its operations, albeit conservatively, with the following acquisitions in the UK:
Net financial expenses Net interest paid in the SA operations decreased by 10.6% to R463 million (2008: R518 million). In the second half of the year, the interest expense decreased to a greater degree following receipt of the Ampath sale proceeds at the end of March 2009, combined with lower interest rates and working capital containment. Further reductions in interest should continue in the 2010 financial year as the full benefits of the lower interest rate environment are realised. In the UK, net interest paid increased marginally from £129.2 million to £131.9 million as a result of the growing NHS debtors’ book. This was offset by lower interest on the property debt due to ongoing repayments. Net financial expenses were positively impacted by a £2.0 million credit, representing the amortisation of the cash flow hedge accounting reserve of £1.8 million and an ineffectiveness gain of £0.2 million. The risk of not achieving full hedge effectiveness for accounting purposes next year has increased significantly with the turmoil in financial markets. As such, the income statement could be negatively impacted by ineffectiveness in future years, although this would not result in any cash flow consequence for the Group. Attributable earnings of associates South African attributable earnings of associates showed a turnaround, from a loss of R8 million in 2008 to a R17 million profit in the year under review. This reflects continuing efforts to exit loss-making, non-core investments and to focus on the investment strategy in PPPs. All seven PPPs under management are now profitable after interest and taxation. UK attributable earnings of associates at R10 million was in line with the previous year. Profit from discontinued operations The profit from discontinued operations (Ampath) reflects the after-tax capital profit on the sale of the business of R588 million, as well as attributable profits of R46 million for the five months that the Group was still in effective control. Headline earnings Basic headline earnings per share (HEPS) increased by 27.2%, from 61.5 cents to 78.2 cents. If the exchange rate fluctuations are eliminated, HEPS increased by a further 3.3 cents. SA and the UK both contributed positively to the increased earnings. Statement of financial position Property, plant and equipment The carrying value of property, plant and equipment decreased by R4 635 million against the prior year, mainly due to exchange rate fluctuations of R4 703 million. Capital expenditure from continuing operations for the year amounted to R1 272 million, compared to R1 240 million in 2008. As a healthcare operator, certain replacement capital expenditure is essential for the safety of our patients, and this expenditure comprised 65.7% of the year’s total capital investment. All significant capital expenditure projects, both expansionary and replacement, are conditional on achieving stringent return hurdles. Goodwill The Group carries significant goodwill on its balance sheet which requires an impairment review in terms of IAS 36 Impairment of Assets. The Group assigns goodwill to the cash-generating units in a manner that is consistent with the way the Group manages its operations. R13 802 million (£1 156 million) of the total goodwill of R14 303 million has been assigned to the UK property operations (PropCo) and the hospital operations (OpCo) of General Healthcare Group (GHG). Goodwill has been tested for impairment using value-in-use calculations. The key judgement areas applicable to the impairment testing calculations relate primarily to future discount rates, residual values on properties and future cash flows. Working capital The composition of our working capital is:
Optimising working capital investment is a key focus area across the Group. The SA operations have reaped the benefit of this approach with working capital of R178 million at record levels. Much of this improvement is attributed to the shared services centres, which have tightly managed their key performance indicators in difficult market conditions. In the UK, growth in NHS caseload, which is settled on account, combined with a decline in self-pay cases, where payment is typically taken upfront, resulted in an additional investment in working capital of £36 million, funded out of existing facilities. An appropriate increase in the allowance for doubtful debts has been made to account for the shift in exposure. Post-retirement benefit obligations The Group has two post-retirement benefit obligations. In SA, the Group has an obligation to subsidise the medical aid contributions of certain pensioners and employees who joined the Netcare Medical Scheme prior to November 2006, amounting to R146 million. The scheme is now effectively closed and the Group is investigating methods to reduce the exposure. GHG has a defined benefit pension fund that has been closed to future accrual since 31 August 2008. A pension fund liability of £12.7 million has been recognised on the Group statement of financial position. Taxation payable The Group’s tax position remains under constant review. No new tax issues or risks arose during the current financial year. In SA, the Group’s effective tax rate approximates the statutory rate although, in addition, the Group incurred capital gains tax of R90 million arising from the sale of Ampath. At 14.4%, the UK effective tax rate is lower than the statutory rate, owing to the utilisation of £16.5 million of accumulated trading losses with a tax effect of £4.6 million. GHG has approximately £200.0 million of accumulated tax losses available to set-off against future taxable income, and a deferred tax asset has been recognised against £86.2 million of this future benefit. It is expected that all tax losses will be utilised by 2012; until then, the effective UK tax rate will remain significantly below the statutory rate. Financial liability – Derivative financial instruments SA manages its interest rate fluctuations on a pool of funds basis, with up to 75% of total debt hedged by interest rate swaps. At year-end, 56% of total debt is fixed, while the rest remains at a floating rate linked to prime and Jibar. The UK hedges its exposure to interest rate fluctuations through four interest rate swaps, which effectively hedge 97% of total debt. These swaps comprise:
The Group continues to apply hedge accounting on the interest rate swaps in accordance with IAS 39 Financial Instruments: Recognition and Measurement by using regression analysis modelling to determine hedge effectiveness, both in SA and the UK. The Group continues to employ a dynamic hedging strategy on certain interest rate swaps, where the portion of the swap designated for hedging purposes may be varied to achieve optimum hedge effectiveness. No hedge terminations or re-designations were made under this strategy during the year. However, this position will remain under review in the year ahead to ensure that the Group is able to respond to changing market dynamics. The scale and complexity of accounting for these instruments in difficult market conditions means that the risk of further volatility and potential income statement impact remains high, with material fair value movements that could flow through the income statement in future years. It should be noted that these fair value adjustments have no cash flow impact for the Group. Debt Net debt decreased by R6 135 million, from R32 589 million to R26 454 million at year-end. Of this, R22 551 million (2008: R27 752 million) relates to the UK and is without recourse to the SA business, being secured against the assets in the UK. The majority of the reduction in long-term debt is due to exchange rate fluctuations amounting to R5 267 million. Nevertheless, the net debt to EBITDA ratio continues to improve, moving from 7.1 to 5.4 times coverage by year-end. South Africa Given the market’s intolerance of uncertainty, the receipt of the Ampath sale proceeds afforded the Group the opportunity to repurchase R95 million of its convertible bonds at a profit of R3 million in May and June 2009. The Group applied the balance of the Ampath sale proceeds to repay expensive debt. The effectiveness of the debt management programme was demonstrated by the improvement in the year-on-year interest cover ratio, from 2.8 in 2008 to 4.4 times in the second half of the year, ending the year on a ratio of 3.6 times. The improvement in SA’s statement of financial position is shown in the chart that follows, which reflects a net debt to EBITDA improvement from 2.8 times in 2008 to 1.9 times in 2009. South African net debt:EBITDA
The average debt maturity has reduced to one and a half years. Short-term money market instruments are no higher than 21% of local debt, and local borrowing facilities of R6 billion are regarded as sufficient for future expansion opportunities. The R1.6 billion convertible bond listed on the Singapore Stock Exchange matures in September 2011. United Kingdom The gross debt in the UK amounted to £1 927.7 million at 30 September 2009 compared to £1 939.6 million in the prior year. The decrease arose from the repayment of £6.8 million of OpCo debt, £14.4 million of PropCo debt and £1.6 million of other debt, offset by additional finance leases to the value of £3.5 million, and the amortisation of debt raising fees of £7.4 million. UK debt financing is in place for the next four years. The UK debt is without recourse to the SA operations. The UK business met all of its debt covenants during the financial year. These are tested on a quarterly basis. Covenants are set on both the PropCo and the OpCo divisions. The PropCo covenants comprise:
The loan to value ratio is not tested unless the rent cover drops below 1.4 times. The Group currently enjoys headroom of approximately £49 million before the rent cover ratio drops below this hurdle. Interest cover is not considered to be a risk as both rental and interest are fixed through leases and interest rate swaps respectively. The OpCo covenants comprise:
The forecast covenant compliance is based on a number of key assumptions and permitted adjustments, which indicate that significant headroom exists on all covenants. The tightest covenant is the cash cover ratio which is forecast to have headroom of £36 million, increasing to £68 million if potential cures are activated. The UK has undrawn loan facilities of £72.7 million. Cash flow At R4 640 million, cash generated from operations is in line with the previous year’s result of R4 663 million. The Group cash conversion to EBITDA ratio of 94.2% is lower than the 2008 ratio of 101,1%. This decrease can be attributed to the increase in working capital balances in the UK. Cash generated from operations – SA
Cash generated from operations – UK
* Including capital charges. Net cash from operating activities was impacted by a R236 million increase in taxation paid to R526 million, and an increase of R24 million in capital reductions to R430 million. Ongoing necessary maintenance capital expenditure resulted in an increased spend of R15 million to R1 283 million. The net proceeds of R852 million from the sale of Ampath meant that cash from investing activities yielded a net outflow of R333 million. As a result of the cash flows mentioned above, the Group was able to settle R979 million in borrowings during the year. Risk management Netcare is exposed to a number of external risks which could significantly impact on results. These risks are monitored on an ongoing basis and, where possible and in line with our strategy, appropriate derivative instruments are entered into to mitigate risk. The Group’s financial risks are exposed are outlined in note 32 to the annual financial statements. Financial targets The Group’s targets and performance against these targets are summarised on page 7. Performance against these targets is continually monitored and targets are revised when necessary. The Group did not achieve its net debt to EBITDA ratio targets owing to two technical and unbudgeted factors namely the strength of the rand and the large increase in the derivative financial liability which had the effect of reducing the equity of the Group by approximately R2 950 million. The Group continues to focus on cash value add investment returns which improve the statement of financial position structure and generate cash flows. Accounting policies The Group has elected to early adopt the amendments to IAS 1 Revision of International Accounting Standard 1 Presentation of Financial Statements, which necessitates a number of additional disclosures and changes in presentation. While this has not had any material effect on the Group’s financial statements, in most instances it has given rise to additional disclosures. There are a number of new standards and interpretations that have been released and are not yet effective. These are dealt with more fully on pages 142 and 153. Capital reduction The Board of directors has declared a final capital reduction out of share premium of 22.0 cents per ordinary share, payable to shareholders recorded in the register of the Company as at 22 January 2010. Taken together with the interim capital reduction of 16.0 cents per share, the total capital reduction paid in respect of the 2009 financial year amounts to 38.0 cents (2008: 32.0 cents) per ordinary share, an increase of 18.8% over the prior period. Acknowledgements I would like to thank all our financial personnel in SA and the UK for their ongoing support and commitment. This has enabled us to consistently deliver quality financial information to our stakeholders. Vaughan Firman |
