Barloworld Limited (BAW) Earnings Call Transcript & Summary

Good day, ladies and gentlemen, and welcome to the Barloworld Pre-close Trading Update Conference Call. [Operator Instructions] Please note that this call is being recorded. I'd now like to turn the conference over to Mr. Dominic Sewela. Please go ahead, sir.

Thank you. Good afternoon, ladies and gentlemen. Welcome to the voluntary trading update with 11 months to 31st August, 2022. And I hope most of you on the call, we have seen the trade segment that we released and this morning. I must say it's very pleasing to have released the trading update, given the fact that we had a lot of headwinds in terms of global tropical issues as whether supply chain from -- as a result of COVID over the last 2 years. But notwithstanding, I think what is pleasing for us is to see the Equipment Southern Africa business, generating revenues, double-digit revenue as well as the business in Russia. The challenging environment was in Mongolia, interestingly, given the fact that Mongolia is landlocked between Russia and China. And we've done -- the COVID lockdown in China basically closed the border, and we couldn't really be able to deliver our machines, organ parts to our customers because the borders were closed. And obviously, it's been very challenging for that business. Whereas I think if you look at Ingrain, Ingrain did exceptionally well under the current environment, obviously assisted by the fact that the supply challenges that push maize price up. And therefore, that business, if you look at the margin improvement, we have seen a significant improvement on that front. But I think it's important to note that the trading updates leads to -- we compare 11 months of this year to 10 months of last year because we had this business last year for 10 months on a comparable time frame, but notwithstanding, I think one is pleasing to see the business performing exceptionally well. If we get to discontinued operation, it's also very pleasing to see the improvement in the Avis business, particularly at the operating profit level, if you compare to 2019, on the same time frame, the Avis business has done exceptionally well, particularly, as I said, on the operating profit because revenue still is lower than 2019, but significantly up on last year. And that speaks to the work done by management in that business. And I guess, there's a reason why we say without having had a very convincing offer from potential buyers, our views that this business is well placed for it to go to an unbundling. And we are at a onstage to pursue that process that the business should [ Avis ] the model before the end of the calendar year. And we've made progress as well in the sale of Logistics business that we have to buy for that business, and we are now going through regulatory approval for the Logistics business. And this sticks to the pivot that we've been involved in trying to simplify the business to mainly focus it on being an equipment distribution business and services as well as a fully immediate business comprising of Ingrain and our Caterpillar Distribution business. I think something to note, we have also made progress to derisk the liability of the insurance in the U.K. where we were able to sell that risk to the insurance company, where now both asset and liability are matched and therefore, we will not be seeing volatility in terms of that risk flowing, we just create more stability that we don't have to give it to trustees, we can be able to move capital between South Africa and the U.K. with ease. We don't have to pay 50% of our dividend to the proceeds, and that has been a [indiscernible] move. I think the timing of it was also good in that with the global market volatility, it would be very difficult to predict the impact it would have had to our financials. So that has been a very good progress in that regard. I think as you can imagine, we had a huge product books, particularly in South Africa and huge demand for fleet from a capital point of view. Working capital was -- if there was huge capital required rather in the first 6 months, but as we deliver the equipment to customers, we've seen that unwound. So my view is that year-to-date, we are seeing a positive cash position in South Africa. But when you look at the Avis business, it has still consumed quite a lot of cash just to see that business. So I think, ladies and gentlemen, I'm going to just pause here for questions, if there are any questions on the line, we'll take that. And I'm joined by the prospective Cs of the division as well as the FDs with me in the room. They're very responsible for M&A strategy. And [ Nandu ] is here and our Investor Relations [indiscernible] the rest of the other colleagues are on the line. Maybe let me pause here and see if any questions from the listeners.

[Operator Instructions] The first question comes from Roy Campbell from RMB Morgan Stanley.

Just 2 questions just on Russia, if you will, please. So obviously, having benefited from the strengthening in the ruble, if you can just give us some idea of what happens at the cash in Russia? Does it stay there? Or can that be repatriated? And then secondly is on the order book of $30 million, do you have any available working capital to service that to say that's a safe order book? And then also just in terms of the aftermarket and servicing and we've got added working capital to continue to operate in the foreseeable future?

Excellent -- but that last -- you have additional more question right before this one or the last one? Quinton, do you want to answer Roy on those 3 questions?

Yes. Thank you, Dominic, and good afternoon to everyone. Roy, I'm going to try and remember all the questions. So I think your first question was about the cash. So what we've done is, since February, the Russian business has become self-sufficient. So self-funded. And they've managed to generate enough cash to firstly settle all liabilities in Russia. They didn't need any further funding from us in the U.K. In terms of cash repatriation, we actually declared quite a lot of dividends already last year up the group following our policies and procedures. So all that cash was generated. Russia, in terms of legislation, normal intercompany transactions can -- still happening. Russia is allowed to settle in the company debt as long as it's within the framework of the legislation. So that is still fully operating. The only difference is we've now converted to basically a cash basis, if Russia wants something and it's allowed within the legislation, they've got to pay for it upfront. So from that perspective, it's -- Russia has enough funds and they generated enough cash. The customers started buying basically cash for the inventory that were in Russia, then that supported also cash generation. In terms of supporting the working capital, I think just getting back to my first point, with the change in approach Russia generated enough cash to support that working capital. And as I alluded before, if anything has come from the U.K., they had to pay cash upfront for that. So there's nothing outstanding from Russia to the U.K. and they are generating cash to support the ongoing business operations within the -- what's allowed. In terms of -- I think you asked the question in terms of parts, obviously, we can only sell in terms of what's allowed from a legislation perspective, and we -- cap will only sell to us the part that is allowed to be sold. So that has reduced quite dramatically. I think we are up to, I think 50% or 60% of the parts that we in the past could sell, we could only sell now 50% or 60% in that region part. So that's coming down. And -- but we are still servicing our customers in terms of what we can purchase and then sell to the customers.

And you've got enough stock to service the $30 million order book?

Yes. So this order book is basically obviously inventory that's in territory already. So it's not -- it's inventory that's already been paid by our Russian subsidiary. They don't owe anybody any money for that. So we've got -- within that cut within the country, there's enough cash.

The next question comes from Anthony Geard from Investec.

Dominic and team, can you hear me all right?

Yes, we can hear you Anthony.

I'm just going to follow on directly from Roy's question, if I can. So firstly, I'm assuming that there was a significant drawdown in inventory in Russia. I mean, clearly, before the outbreak of hostilities, you had sufficient inventory in the normal course of business, and I imagine that you've drawn down on that very materially.

I presume you're talking in terms of parts. And if you remember, just before the war, we had a huge order book, almost $0.5 billion. And due to the sanctions, we had to basically cancel almost a large part of that order book and then some -- so some of the equipment didn't come across. But when Caterpillar suspended their operations, you could still draw parts in territory, we have also held inventory in our own warehouses. And therefore, that's what has been able to sort of help us attain the revenues that we've generated. But I think if you're talking about parts, yes, you're correct, however, the home goods, it was limited to what we have already in territory. That was already either on the border that we couldn't cancel. And it was to the clients that comply with sanctions. And that's what basically in our app, we've been able to deliver those holes in the mix.

So going forward, should we assume that the revenue is going to be made up almost entirely of parts? And in that respect, it's a limited range of parts.

So it will be a cost that are not functions that would be what it's allowed. But I think in this environment as well, you're likely to see used equipments. That or within -- because those will be brought by traders and in territory. But as you can understand that you have a huge, active machine population in that environment. And you are correct that by and large, you're going to see a significant revenue being mainly the aftermarket as opposed to whole goods because the bulk of the equipment is sanctioned. Quinton, do you want to just maybe add more, if I missed out, in terms of that question?

Yes, sure, Dominic, I think the products that we will be allowed to sell will be the ACM product, the mid-tier product from Caterpillar that comes from China. So we will have full access to that product line. And then as Dominic has alluded from a past perspective, it will obviously be limited. And then from a used perspective, if we can secure some used machines, then that will also be supporting the revenue line. So that's predominantly the outlook for going forward.

Okay. Excellent. And I'm sorry to press on this issue. So for instance, you could take a machine from South Africa, a second-hand machine and you could sell it in key Russia and there will be no restrictions on that?

Yes. In theory, yes, as long as it's not to a sanctioned customer. But obviously, it is not as simple as that because from a climate perspective, you are limited. We are mostly -- we are selling machines that work with optic conditions, whereas the rest of the world's machines is mostly in a different climate. So -- but in theory, at the high level, yes, you're correct.

Okay. Understood. And then just on that issue of sanctioned customers, I mean clearly some of your customers historically would have, let's say, be sensitive and they might well be sanctioned. I mean how many of your customers -- your previously good customers are now off limits?

There is quite a few customers that's off limits. But the biggest impact is actually not the customers, that's been sanctioned. I mean, that's a relatively small portion because Russia is quite big and there's a lot of junior miners within our portfolio. A big customer like Alrosa, they would be sanctioned. And then it's more the product that's been sanctioned that's hurting us where we predominantly are mining dealer and all mining product has been sanctioned. So from a customer perspective, if the mining product wasn't sanctioned then it would have impacted us likely 10% from a customer perspective, it would not have been a huge impact. And I think that's also potentially why the western governments went and sanctioned the mining product, I think, late July, somewhere there because that's actually where it really is impacting us negatively.

The next question comes from James Twyman from Prescient.

Yes. It's along the same lines. I think the first question is, as far as Caterpillar is concerned, which countries, which facilities that Cat has, in which countries are okay, is it China's okay? It'd be good to know what other countries are okay. And you've made an interesting point that you can get 50% to 60% of the parts that you need on the projects.

You were quite inaudible in the beginning. I think that there could be a connection stuff. Could you please repeat the question?

Yes. So just which countries that Caterpillar operates in, are you allowed to import into Russia from? You mentioned China, but also other countries. Secondly, you mentioned that 50% to 60% of the parts can be imported. What percentage of new equipment would it be? Obviously, it sounds smaller than that. And my final question, if it's okay, is have you started doing a cost-cutting program, yes, given the [ machete ] of the business going forward?

I guess, I think I'll answer the last question first, James. And I did indicate that I think when we release our 6 months update that we'll be able to give color on this time because it was very difficult because things are moving up and down as to what our view is going to be. It's still a moving situation, continuously offsetting what's happening in territory in terms of legislation. Others are the main focus. But I think when it comes to our operating model is to try and make sure that we run a breakeven business over the next couple of years. Therefore, for us, we have started looking at cost cutting. And within what's allowable in the law, in the country. And interestingly, we've had people just resign from the business since the beginning of the war. And that has helped in terms of when one looks at the cost of separating with the employees that would be impacted, unlikely in South Africa, where the law is quite rigid in terms of the process you follow but there is a level of productivity. I guess when -- the point that Quinton makes in terms of the products, I think various jurisdiction from the U.K., euro and the United States, the focus has been in sanction in certain products to certain customers. And as Quinton said, maybe these are to mining products just in for mining activities. All products whose parts could be utilized either in the military or in the mining segment. Therefore, when you look at the medium term, SCM, those products tend to be used in construction in the main, not so much in the mining sector. But there are no sanctions out of China. So therefore, I'm not in a position to exactly which countries we can be sourcing from. I know that if a country like Brazil, for instance, if there was a product that we could source from and the announced sanctions in terms of regulations, and by regulations here is that we've got to be very careful, and it's a 2-year process that requires a team in territory to go through all this process being properly advised by legal people as to where they can source our product from because I mean the onus is on us, but we also don't violate the U.S. or put Caterpillar in a precarious product. But also Caterpillar does give up this from time to time, if the norm of certain -- so I can't give you [indiscernible] dates. But I'm saying for now, the easier one is China because it's close to proximity and specifically products that are mid-tier.

Dominic, if I can just add to that, just while so -- so obviously, certain countries, you cannot -- there's clear sanctions. But then there's a secondary regulation that we also need to comply with or Caterpillar needs to comply with. And that is, if the product has got more than a certain percentage of U.S. content or U.S. technology, then irrespective if that there's a sanction from that territory, then that product will also not be allowed to sell. And I think that's where the complication is coming in, and that's where it constantly are changing. And so just to add to what Dominic has said, so that's basically the first rule is what is the country side. The second rule is, what's the content from that specific product.

The question 50% to 60% of the parts can be imported. Broadly, what sort of proportion would it be of equipment of [indiscernible] more like 10 or 20? And then just finally on Mongolia, you mentioned before that the orders need to open up for a while and the companies need to start generating cash before it impacts you, before you start to see the benefit of that. Is that still the case? Or reading between lines, it sounds that you're starting to benefit already from probably opening up in Mongolia?

Yes. And then that's it for me. Okay. I mean the one is really not that clear. But if I have you bet I think on the past percentages, it's very difficult, James, to give you the percentages in terms of the past breakdown. I mean, so as I said, what is in territory and not functioned, we'll be able to sell because it's that we have mainly in mining territory, it's safe to work on a onetime cover in terms of the revenue, it won't be like -- I don't think it would be like normally, if you look at Avis business or historically, Russia would have a 60-40 split in terms of whole goods vis-a-vis aftermarket here, you're likely to see more than 90% of the revenue going forward is likely to be the aftermarket, and that's so the whole goods. And when you think about Mongolia, I mean you can actually see China's issue on clamping down on COVID cases, it's rolling. And therefore, currently, the borders are open. We have gone through a very costly exercise moving some of the equipment from 1 border to the other only to get to the next what I find is very close because there's a huge compliance on the part of the Chinese people and government when it comes to COVID. But thus far, as I speak to you, the borders are open, but I can't predict where that's going to remain open. So in terms of logistics, there is a bit of a challenge moving products into Mongolia using the Chinese borders because I think the Russian borders are inaccessible at the moment at sanctions.