Transnet risks ratings downgrade

Ratings agency S&P Global has placed embattled state-owned logistics company Transnet on CreditWatch.

“The CreditWatch placement reflects our view that Transnet’s cash flow will not improve sufficiently or quickly enough to maintain its existing leverage, and capital structure,” said S&P Global Ratings in a statement.

This means that there is a higher chance of a ratings downgrade if Transnet’s business performance and cash flow do not improve soon enough to manage its debt and financial structure.

The agency said that a negative rating action may occur if Transnet fails to present a viable plan to lower leverage and if negative free operating cash flow (FOCF) worsens due to slower-than-expected operational improvements.

In response, Transnet outlined that its Recovery Plan, approved in October 2023, is crucial to improve its financial and operational performance.

CEO Michelle Phillips emphasised efforts to enhance rolling stock and rail infrastructure, boost productivity, reduce downtime, and improve service delivery are crucial to improve performance, and progress has been made.

Management said that it will regularly update S&P on progress, capital investments, and capital structure adjustments.

“Cash flow will not improve sufficiently or quickly enough“

The agency said that it expects Transnet’s leverage to remain high without government support, leading to ongoing negative free operating cash flow (FOCF).

It is projected that Transnet’s gross debt will rise to R151 billion by the end of fiscal 2025, up from R134.7 billion in fiscal 2024. As a result, annual interest expenses are expected to stay between R15 billion and R17 billion.

With substantial capital expenditure (R26.5 billion in fiscal 2025 and R30.5 billion in fiscal 2026), negative adjusted FOCF of ZAR15 billion to ZAR16 billion will continue.

“Therefore, we expect Transnet’s cash flow will not improve sufficiently or quickly enough to retain a long-term capital structure commensurate with our ‘BB-‘ issuer credit rating,” said S&P Global Ratings.

“We also think that our forecast level of cash generation leaves management with limited room for operational underperformance,” it added.

“High likelihood of Transnet receiving extraordinary support from the government”

The South African government has provided significant support to Transnet, including ZAR5.8 billion for repairs and capex in fiscal 2023, and a R47 billion guarantee in fiscal 2024.

Additionally, Transnet will receive further guarantees, including R19.6 billion from two new facilities.

The National Treasury is also exploring funding options for infrastructure projects to reduce Transnet’s capex burden. Plans include the Cape Town Container Terminal Expansion and the Ukuvuselela Gauteng-Eastern Cape Rail Corridor.

Transnet’s persisting liquidity and capital structure challenges still imply additional government support.   

S&P said that the likelihood of extraordinary government support results in an uplift of the stand-alone credit risk profile and issuer credit rating to ‘BB-‘.

However, if the certainty of future support decreases, it may lower its assessment.

The focus will be on the timing and sustainability of government assistance, which S&P said is crucial for Transnet’s capital and operational transformation, especially as sector-wide reforms reshape its long-term prospects.

“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,” said the agency.

“Transnet has a dominant position in rail freight and monopoly positions in regulated port and pipeline activities.

“Consequently, it enjoys good diversity and some revenue visibility due to TFR’s take-or-pay contracts and pipelines and national ports regulated tariff-linked revenue,” added S&P.

Financial performance and credit metrics are expected to improve in 2025 and 2026 but remain weak 

Transnet launched a recovery plan in October 2023, aiming for improved rail and port volumes by March 2025.

While progress is being made in optimising infrastructure and efficiency, significant capex is needed to meet volume targets, and operational challenges like rail vandalism persist.

In fiscal 2024, freight volumes rose to 151.7 million mt, ending a five-year decline.

For fiscal 2025, Transnet aims for 170 million mt and expects better locomotive availability to support recovery.

S&P now forecasts revenue to reach R82 billion–ZAR88 billion, up from R72 billion–R74 billion, but with EBITDA margins of 36%-38%, still below historic levels.

Due to high debt, adjusted FFO is expected to be R11 billion–R16 billion in fiscal 2024 and 2025, keeping Transnet’s credit metrics within a highly leveraged financial risk profile.

Going forward

The agency said that CreditWatch could be resolved if Transnet addresses operational challenges more swiftly, leading to better cash flows, and if its balance sheet optimisation plan or additional government support is seen as credible enough to support a sustainable long-term capital structure.

Social and governance factors weigh negatively on Transnet’s rating.

Social risks, such as unrest and infrastructure damage from crime, pose safety and operational challenges. For instance, in 2021, train derailments and a cyberattack disrupted operations.

Governance issues, including past mismanagement and misconduct under the former board, have hurt the company’s efficiency.

S&P emphasised that while improvements have been made, ongoing executive turnover and governance reforms will be key to ensuring long-term stability and stronger risk management.

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