South Africa’s missed opportunity

South Africa’s economy could have grown by 4% this year were it not for Transnet’s struggles and the severe transport constraints it placed on the country’s exports.

This is according to Investec chief economist Annabel Bishop, who said that while there has been some progress in reforming the embattled port and rail authority, there is still a long way to go.

Transnet is over one year into an 18-month turnaround plan it embarked on in late 2023.

Transnet told Daily Investor that its leadership remains cautiously optimistic about the progress achieved under this plan. 

“We have seen encouraging developments, particularly in areas like operational efficiency, strategic collaborations, and financial discipline,” the utility said. 

This progress can be seen in South Africa’s latest trade balance. The country recorded a substantial trade balance this year to date of R116.1 billion versus last year’s cumulative R30.2 billion.

Bishop attributed this largely to rising commodities prices compared to last year, as well as a stronger rand and a stronger term of trade.

In addition, she said some improvements in Transnet’s port congestion and rail freight capacity played a modest role as payload volumes increased slightly.

“While the lift in commodities prices drove the value of exports higher, South Africa has also seen some progress at Transnet,” Bishop said. 

However, Bishop said capacity constraints at Transnet remain dire overall and added that the progress made is limited compared to the extent needed.

She said the SOE is still stifling South Africa’s GDP growth by around 3.0% per year. “South Africa could have seen economic growth of over 4.0% y/y this year in the absence of the severe transport constraints,” she said. 

“Deep-seated problems at the state-owned entity cannot be resolved quickly or easily.”

This belief was recently reinforced when rating agency S&P placed the entity on a credit watch. 

A credit watch is a precursor to a rating downgrade, and S&P explained that the placement reflects its view that Transnet’s cash flow will not improve sufficiently or quickly enough to maintain its existing leverage and capital structure.

“The CreditWatch placement reflects the increased likelihood of a downgrade if the anticipated turnaround in Transnet’s business performance and cash flow generation does not materialize soon enough to control the current leverage levels and capital structure,” the firm said.

“At the same time, the company’s capital expenditure requirements and debt servicing costs are elevated, in our view, leaving limited room for operational underperformance.”

S&P further pointed out that Transnet also has a weaker governance structure and risk management framework relative to peers. 

It said governance failures and irregularities, allegedly involving the company’s former board and executive team, enabled operational mismanagement and misconduct related to procurement processes before 2019.

“We could resolve the CreditWatch placement if the company addresses operational challenges faster than expected, leading to enhanced cash flows,” it said. 

“In resolving the CreditWatch, we will also determine if Transnet’s balance sheet optimization plan and/or additional government support are, in our view, credible and sufficient to achieve a long-term capital structure commensurate with our ‘BB-‘ issuer credit rating.”

Bishop said it is key to note that the freight capacity at Transnet’s port and rail services continue to run substantially below the country’s demand for these services, with the monopoly negatively impacting the country’s growth potential.

However, Transnet’s turnaround cannot solely be focused on improving its capacity.

S&P expects Transnet’s performance to gradually improve as its turnaround initiatives and government-instituted freight logistics sector reforms slowly take effect.

However, it noted that leverage and debt service costs remain very high.

“While the company continues to make progress in optimizing the use of existing infrastructure and improving its operational efficiency, significant capex is required for the company to realize expected turnaround plan volumes,” it said.

“Notwithstanding the challenges facing Transnet, we think the company continues to play an instrumental role in South Africa’s transport industry and, by extension, its economic growth due to its control of all major logistics infrastructure.”

Bishop said the constraints Transnet imposes on freight transport in the economy, economic activity and real GDP growth are still dire, limiting GDP growth to below 1.0% this year.

“While continued and substantial work on turning Transnet around is expected to continue, this will take several years due to the deep-rooted structural problems at the SOE, which will inhibit trade more so than tariffs from the Trump administration,” she said.