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Organisational overview and business model

Commentary to business model

Our external environment

The Aveng Group operates in a challenging external environment with a number of acute short-term challenges but attractive medium and long-term prospects and opportunities. The following analysis sets out some of the key drivers in the external environment that affect the sectors and geographies in which we operate:

Intensive market competition

In more established markets, the Group experienced a slowdown in growth with excess capacity leading to increased competition.

Africa, which is seen as an area of growth for most industries, is attracting higher levels of global trade and investment and therefore increased competition, not only from African-based competitors.

Barriers to entry in many of the sectors in which Aveng operates are quite low.

Increased competition may lead to pricing and commercial terms that are often unsustainable, impacting negatively on profit margins, liquidity and growth for the business.

The competitive landscape in Australia is also in transition. As a consequence of greater risk transfer than was historically the case, there has been an increase in the power held by customers, and growth in the number of major overseas contractors.

Delays in major infrastructure projects and order placement

While the South African Government has substantial infrastructure development plans, implementation and funding are significant impediments. Energy and transport make up a large proportion of the proposed government spend through state-owned companies, Eskom and Transnet. It is anticipated that an uplift in infrastructure spend will remain slow until 2015, at the earliest.

Eskom recently announced approval of a new power station, Coal 3, to commence after completion of Kusile and Medupi. The completion delays at both power stations, however, raise questions on timing.

While an investment in new nuclear generation capacity appears likely, the timing remains uncertain.

The Australian market remains difficult with construction in the mining and oil and gas sectors both off their peak, only partially offset by transport infrastructure. Along with water infrastructure, these sectors have driven growth over the past decade.

Increased claims and extended dispute resolution in tough economic conditions

Legacy contract performances and delays in the resolution of claims have led to negative cash flow and impacted profitability, as well as absorbing valuable management time. The current economic conditions experienced globally contribute to the delays in resolving claims as clients also have reduced liquidity.

Depressed global economic environment

South Africa has a relatively subdued outlook in most sectors, with notable exceptions in renewable energy and rail infrastructure. Growth in South Africa is likely to remain subdued in the medium term due to low business confidence and perceived policy uncertainty, electricity constraints, a weaker global mining environment, and slow growth in traditional export markets coupled with inertia in government investment in infrastructure, and an unstable labour environment.

Australian growth prospects remain positive with low budget deficits and a friendly business climate.

The strongest growth is expected to come from sub-Saharan Africa and Southeast Asia, particularly in the construction and transportation industries.

Uncertain and disruptive South African labour market

Labour unrest in South Africa has been prevalent in the construction, mining, steel and motor industry sectors, affecting almost all of the Aveng Group's businesses directly or indirectly.

The labour environment is increasingly pressured and construction site lock-outs can occur even when our own labour force is not on strike. Competition between unions has led to a militant approach, extended strikes and often significant disruption to business.

Increased competition regulation and scrutiny

The Competition Commission's Fast-Track Settlement Process and attention in the media has negatively affected the industry's reputation. The threat of ongoing civil claims for damages, blacklistings and prosecutions remains an issue, and the need to restore trust with all affected and future stakeholders remains a priority.

Our risk management and material issues determination process seeks to assimilate the current status and trends of our external environment to ensure that appropriate strategic responses and controls are put in place by the Group.

For additional information on material issues, refer to here.

Our capital capabilities

Our capital analysis provides insight into the resource capabilities and challenges that the Group faces with the objective of ensuring that Aveng has the required resources to execute against its strategy and that the business model is adapted accordingly. The analysis below sets out a synopsis of the current status of the capabilities of the Group and the aspirations to build capabilities to the desired and required levels to effectively execute the Group's strategy.

Financial capital

The measure of the Group's future success will be its ability to operate profitably and generate positive free cash flows for growth, servicing of borrowings and regular dividend payments to shareholders.

Increased contract claims and operating losses have strained group cash flows, resulting in increased gross borrowings and reduced net cash on hand at year end.

The current recovery and stabilisation strategy includes an intensive focus on cash management initiatives in the short, medium and long term to address the strength of the financial position and improve the cash generative ability of the Group.

The issue of a convertible bond, disposal of non-core assets and alternative funding structures will contribute to reducing overall borrowings levels and improved maturity and interest rate profiles on borrowings.

For additional commentary by the group financial director, refer to here.

Human capital

The ability of the Group to effectively execute against its strategic priorities will depend on the quality and decisiveness of leadership and the skills and experience of its people.

An intensive ongoing process is in place to assess the leadership and skills requirements at each operating group and to develop action plans to identify leadership and skills gaps, including addressing reward systems and transformation needs of the Group.

There is also a drive to ensure that the right people are deployed in the right positions with roles that are compatible with their capabilities.

There is a clear need for transformation of businesses notwithstanding the challenge posed by the lack of availability of highly experienced and skilled staff required in the industry. Aveng also recognises the need to be sensitive to socio-economic development policies, while harnessing skills over a vast geographic spread of projects.

Instilling a revitalised Aveng culture across the Group is also key to achieving the strategy and vision of the Group. This includes analysing the latest culture baseline, setting goals for the ideal culture and driving programmes to achieve these.

This initiative includes driving a culture of performance and consequence management, with appropriate levels of accountability and management empowered to make timely and decisive decisions.

Social and relationship capital

Aveng recognises that a proactive and robust engagement process with stakeholders is critical in understanding their views and concerns. The ability to effectively identify material issues pertaining to stakeholders, including risks and opportunities, and effectively respond to these issues will enable us to create and maintain value.

Our stakeholder engagement and communication programmes are directed at re-establishing and building relationships and reputation with our key stakeholders.

More insight into our stakeholder engagement and relationship programmes has been provided here.

Intellectual capital

The corporate memory of the Aveng Group's construction, engineering and manufacturing processes and know-how are at the cornerstone of its competitive advantage in the industry. With 125 years of continued development and innovation, the Group has established capabilities and expertise in the sectors in which it operates.

The Group is particularly well placed with the mega-project capabilities of McConnell Dowell, specialised and broad-based project capability and expertise of Aveng Grinaker-LTA, deep-level shaft sinking and open cut mining capabilities of Aveng Mining and the automotive, steel and other patents and brands of Aveng Steel and Aveng Manufacturing.

The focus of the Group will be on the profitable commercialisation of the capabilities and expertise as well as innovative abilities contained within its business.

Manufactured capital

The nature of the Group's construction and mining operations is such that the equipment requirements are not particularly specialised and thus barriers to entry in this regard are not formidable. However, the equipment requirements of the mining and certain construction operations are capital intensive and require significant cash investments. Alternative models of financing such equipment are being pursued.

Within the South African and Australian construction businesses most manufactured capital is project specific and is therefore factored into project capex decisions and usually disposed of thereafter unless it can be used on further projects. For operations that require manufactured capital on an ongoing basis, such as Aveng Steel, these facilities are modern, well maintained and all still have considerable useful lives. Some facilities are quite specialised, designed to produce complex pipe-work for industrial plants as well as components for the new South African coal-fired power station build.

The Aveng Manufacturing operating group has a mixed variety of plant, with varying age, and a few examples of modern, state-of-the-art technology, such as paving and roof tile facilities. Similarly, mining assets operate within accepted life expectancy and maintenance levels. Where costs to run and maintain are not sustainable, these areas are reviewed for focused capital investment.

Natural capital

Access to construction and engineering materials is generally readily available. However, these input costs are volatile and change in response to underlying commodity price fluctuations.

Access to raw materials for the manufacturing and processing businesses, particularly automotive steel, is an imperative and similarly subject to commodity price fluctuations.

Aveng looks to strategically source many of the materials used in its operations and supply of services from suppliers that are aligned to the Group's transformation objectives.

Access to, and the cost of, electricity and water is essential for the manufacturing and mining businesses as well as certain parts of the engineering and construction businesses. Security of supply, business interruption and efficiency programmes are in place throughout the Group to ensure critical areas are adequately managed.

Our operating structure

Our operating structure has undergone rigorous streamlining and restructuring in recent years to the current focused yet integrated group structure. Businesses are focused on their key service and product offerings, sectors and geographies, while seeking to ensure that a synergistic and integrated approach is taken to market opportunities.

All group operations have undergone varying degrees of restructuring during the past two years to address areas of weakness, leverage synergies that exist across the Group, and optimise their financial performances and future growth prospects. The results of these interventions are evident in the performances of a number of operations that underperformed in 2013, notably the Aveng Steeledale and Aveng Steel Fabrication businesses of Aveng Steel and Rand Roads in Aveng Grinaker-LTA. Other operations, including Aveng Grinaker-LTA and Duraset in Aveng Manufacturing, are responding well to measures to stabilise and restore their strength.

We have also enhanced strategic guidance reinforcing our centre-led business operating structure, with a smaller optimised corporate office structure focused on strategic management of investments in underlying businesses, extracting synergies and providing selected group shared services and support.