🔒 View from London: Even with half current debt, Eskom not sustainable

South Africa’s debt-ridden power utility, Eskom reported a record annual loss of R20.7bn at the end of July. To keep it afloat the government has committed a R128bn bailout over the next three fiscal years. Despite expectations that the Government will move forward in splitting up the utility into three units; no announcement has been forthcoming. This week, Energy Minister Gwede Mantashe said he believed that the unions which remain one of the stumbling blocks in moving forward with Eskom’s plans, would come around to supporting the plan. In an interview with Nick Smith-Saville, the Global Head of Credit Research at Debtwire, he said even at half its current debt burden, he believes Eskom is not sustainable but at least clear steps were being taken for sustainability. – Linda van Tilburg

Nick Smith-Saville said that the most recent financial statements of Eskom had been expected, given the severe challenges that Eskom was facing. “It will take time to turn around this business.” He thinks it is too early to expect an improvement in the reported numbers. Saville-Smith did not want to comment on where Eskom would have been if it kept its previous management, but said that the dollar bond that was issued last year when Eskom came to the market started trading down almost immediately after being issued on a low to mid 90s level. It became clear that a concerted effort would be needed in turning around Eskom.

The Chief Financial Officer Calib Cassim had stated that Eskom needed to cut its debt by half and that the government needed to take over 50% of debt but Smith-Saville said even if you reduced Eskom’s debt by half, the business would still be nearly eight times levered, eight times its annual profits to its debt. That was substantially above where other power generating and transmission companies were levered. Coupled with that, there was the significant investment needed at Eskom; it had to refurbish its fleet, it had to invest into a new generation of capacity utilisation and execute on the resource plan to ensure that its generating capacity was sustainable for South Africa into the middle of the century and beyond.

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“Without truly understanding the unbundling, it is very difficult to say whether Eskom’s level of debt is sustainable.” He said you had to understand the financial engineering and exactly where the debt was going to be placed to understand what the sustainable level of debt for Eskom really was.

Smith-Saville said the unbundling of Eskom was being talked about but there was no real detail. The Chief Restructuring Officer had recently been appointed; it was his job to follow through on the commitment to restructuring. He said one of the things that was noted in the annual report, was that the board was starting to work on the separation of the business units to allow for legal separation. What was clear at this stage, was that it was going to be a multi-year process to allow full separation of all the business units.

No load shedding has been seen in South Africa in the past months which Smith-Saville believed is due to a clear and concerted effort to improve Eskom’s ability to avoid load shedding.

But does Debtwire believe buying Eskom bonds is a good investment? Smith-Saville said he was not regulated to answer that, but Debtwire has discussed at length how investors should be thinking about the guaranteed bonds and how they related to the South African government bonds. He said the South African bonds trade tighter than the Eskom bonds, but Debtwire thinks that the risk of those two bonds was the same.

Smith-Saville said there was a 1.7% difference in yield to maturity between Eskom bonds guaranteed by the government and non-guaranteed bonds that are both maturing in 2028. “If you bought a government-guaranteed Eskom bond today compared to a non-guaranteed bond; the guaranteed bonds, (the US dollar bonds) are 2.5% and the non-guaranteed bonds are 6.92%, which is a big difference.”

Smith-Saville commented on whether policy makers in South Africa were getting their hands around the problem, saying it had taken longer than Debtwire would have liked as every investor would like more detail sooner. However, there were clear steps being taken to address the sustainability of Eskom and that had to be positive compared to where the business sat 18 months ago.