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Is Eskom living on borrowed time?

Jul 21 2017 06:00
*Stephen Labson

The worst of times may still lie ahead for Eskom, says Dr Stephen Labson, who delves into the details behind the figures presented in the power utility's financial results.

WITH the presentation of Eskom’s 2017 financial results delayed by a week to manage the fallout of a qualified audit, an interim board announcing that it will pursue disciplinary actions against a former acting CEO and questions surrounding a R500m payment to a consultancy without a contract, it was difficult for either Eskom or the media attending Wednesday’s presentation of results to focus on the relatively mundane matter of year-end profits and losses.

ICYMI: News on Eskom's financial results

This also gave cause for Eskom’s interim chairperson Zethembe Khoza to cite Charles Dickens in asking the rhetorical question of whether “it was the best of times, (or) it was the worst of times”, for this important South African institution.

After offering the obligatory commitment to address failings in corporate governance, probity and procurement, the directors then segued to a theme of turnaround in the company’s operational and financial performance.

On the first point, Eskom has indeed turned the corner. New power generating units at Ingula, Medupi and Kusile have been commissioned, independent power producers are feeding power supply into the grid, and the high voltage power lines that transmit electricity across the country have been strengthened.

These measures should ensure South Africa’s security of supply for the foreseeable future. 

In speaking to financial performance, Eskom led with headlines of a 14.4% increase in earnings before interest, tax, and depreciation; revenue increasing to R177bn for the year; a decrease in own generation costs of roughly 23%; and a strong start in securing this year’s funding requirements.

But is it really a turnaround?

Taking a quick scan of Eskom’s financial statements for 2017, revenue did indeed increase by 8%, but this was largely on the back of the 9.4% increase in regulated tariffs awarded for 2017.  Eskom is working with a 2.2% increase in tariffs this year, and with sales volumes falling in tandem with a weak economy, 2018 revenue is likely to follow.

To counter depressed sales volumes, Eskom will no doubt be hopeful of tariff increases to come – reportedly asking for a revenue allowance of R218bn for 2019, and waiting on two additional claims of unrecovered expenses of more than R40bn. 

But Eskom has not fared well in regulatory proceedings over the last few years. On the other hand, the National Energy Regulator’s (NERSA’s) mettle will be tested in assessing the merit of Eskom’s claims. Added to this, litigants appear to be preparing challenges to any decision that allows for tariff increases, and matters that had in the past been quickly decided in closed door sessions – such as an application to waive tariff filing requirements - are now marked by delay in decision making.

Against this background, the outcome of these tariff applications is anybody’s guess.

Cost containment

On the cost front, Eskom rightfully highlighted savings of almost R8.5bn in operating costs associated with running a small fleet of open cycle gas turbines. Unfortunately, the capital costs of those units will need to be paid off over the coming years whether running or not.

More importantly, Eskom’s huge coal bill shows signs of stabilising, with the real cost per tonne of coal purchases showing a modest decrease year-on-year, and total own generation operating costs decreasing by some R6bn. 

But the cost of power purchased from non-Eskom generation increased by 30%, to almost R20bn in 2017. With this potentially growing to over R30bn over the next several years in implementation of government programmes, there is still some way to go if hoping for cost containment here. 

And there are employee benefit costs, and “other operating expenses” to manage - dwarfing total revenue of most of South Africa’s state-owned enterprises.

Accounting profits and other misnomers

Eskom has been quick to highlight the strength of reported earnings before interest, tax, depreciation and amortisation (Ebitda) and its close cousin, the Ebitda margin over revenue. With values achieved in 2017 of some R37.5bn, and 21.2% respectively, why not?

Without going into the details, and also being fair to Eskom, Ebitda has its place in performance monitoring, and is often used in tracking trend operational efficiency in the controllable areas of the business, and in comparison against industry norms.

That said, be warned of confusing Ebitda with a commonsense understanding of profitability.

Perhaps the most expedient way of illustrating the disconnect is to compare Eskom’s Ebitda of R37.5bn for 2017, to a paltry after-tax profit of less than R888m for the same period. Even this bottom line measure of profits is not as it might appear.

Consider Eskom’s borrowings

It is common practice to capitalise the cost of borrowings on major capital projects, with finance costs only hitting the income statement (and reported profits) when plant is commissioned.

To the uninitiated, this appears to inflate commonsense ideas of profitability while projects are under construction – only to hit the bottom line with its full force once plant is commissioned. This alone translated to a hit on Eskom’s bottom line of some R6bn last year, and there is much more to come.

Eskom plans to borrow another R338bn through March 31 2022. This could add well over R35bn per year to Eskom’s cash outlay on interest charges – but only hitting Eskom’s after tax profits on a time delay.

Bearing Khosa’s rhetorical question in mind -  for Eskom, the worst of times may still lie ahead.

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Disclosure statement

*Dr Stephen Labson has previously acted as an external adviser to Eskom. He has received no payment for writing this article or any other financial benefit. The views expressed are solely his and based entirely on information found in Eskom’s Integrated Report for 2017, and the writings of Mr Charles Dickens.

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eskom  |  earnings reports  |  opinion  |  sa economy
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