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Corporate Performance and Military Production in South Africa
Peter Batchelor, Paul Dunne and Sepideh Parsa
Centre for Conflict Resolution, University of Cape Town, South Africa
and
Middlesex University Business School, United Kingdom
January 1999
Abstract
With the end of the Cold War and apartheid, a process of demilitarisation and dramatic cuts
in military spending has marked the transition to democracy in South Africa. Between 1989
and 1997 the South African defence budget was cut by more than 50% in real terms, with
most of the cuts coming from the procurement budget, which was cut by nearly 70% in real
terms during the same period. These cuts have had a significant impact on the country’s
defence industrial base. However, there has been surprisingly little research on the changes
to defence companies that have taken place since the late 1980s. This paper makes a start
at rectifying that deficiency by providing an analysis of the restructuring of the major defence
dependent companies over the period 1988-97. It uses a number of financial ratios and
other measures of corporate performance to compare their experience with non-defence
companies in the rest of the South African economy during the same period.
1
This paper is based on research currently being undertaken as part of a project on Defence Industrial
Restructuring, Conversion and Economic Growth in South Africa, funded by the Leverhulme Trust
whose support is gratefully acknowledged. A version was presented at the International Conference
on Defence Economics and Security in Mediterranean and Sub-Saharan Africa, CesA/IDN, Lisbon,
June 1998. We are grateful to participants, in particular Keith Hartley, and to Guy Liu for comments.
1. Introduction
One of the most striking aspects of South Africa’s transition to democracy has been the
marked decline in defence spending that has occurred since the late 1980s. The defence
cuts, and in particular the cuts in procurement expenditure have led to a downsizing and
restructuring of the country’s defence industrial base, which was built up during the presence
of the UN arms embargo. These developments make South Africa an extremely valuable
case study for understanding defence industrial restructuring in the face of reduced demand.
The fact that South Africa has such a large and sophisticated defence industry for a country
at its stage of development, plus fairly detailed and reliable company data have added to its
interest for researchers. In addition, its mix of private and public ownership of defence
production makes it possible to compare the performance of both private and public
defence companies.
One aspect of the process of defence industrial adjustment that has so far not been studied
is the impact and response at company level. This paper provides a contribution to the
debate by examining corporate restructuring and performance amongst defence companies
compared with non-defence companies in South Africa during the period 1988-1997.
Section 2 reviews the existing literature on defence industrial restructuring and firm
performance, and considers the various hypotheses of the impact of defence purchasing on
firm performance. Section 3 describes South Africa’s macroeconomic environment and the
performance of the country’s manufacturing economy during the period 1989-1997 in order
to provide a context for examining the restructuring and performance of the defence industry
during this period. Section 4 describes the changing structure and size of South Africa’s
defence market since the late 1980s. Section 5 compares the performance of both public
and private sector defence companies using financial and economic data for Denel and
South Africa’s 3 largest private sector defence companies: Reunert, Altech and Grintek.
Section 6 examines firm performance in the private sector defence industry using a sample
of defence and non-defence companies. Financial ratio analysis is used to compare
performance in terms of profitability, asset utilisation, gearing and labour productivity.
Finally, Section 7 provides some concluding remarks.
2. Defence Industrial Restructuring and Firm Performance
Much of the existing literature on the restructuring of military industry has tended to focus at
a relatively aggregate level and there has been little analysis of the individual companies. This
is particularly true for developing countries where there is a dearth of relevant information.
Brzoska & Lock (1992) and Wulf (1993) provide surveys. The defence industrial sector
can be defined as a number of industries that have the economic, as well as the military,
characteristics of strategic industries. The economic characteristics of defence companies
include: decreasing costs reflecting scale and learning economies; high technology industries
requiring large research and development (R&D) outlays and long development periods
resulting in technical spin-offs; and imperfect competition based on domestic monopolies
and oligopolies. Defence companies also have a high dependence on government both as a
major (or often the only) buyer of their output and as a regulator (e.g. of profitability)
(Martin, 1996: 325). This can also lead to inefficiencies and an inability to compete in civil
markets, reflected in low capital investment, low productivity, low profitability and a
relatively poor export performance (Levitt and Joyce, 1987). The often cosy relationship
which exists between the MoD and defence dependent companies, and which is often
characterised by monopoly markets, cost-plus and cost-based contracts, preferential
purchasing and a culture of dependency may result in X-inefficiency. Dependence on
government may, however, have positive effects, on a company's performance. It could
improve competitiveness through the Ministry of Defence (MoD) acting as a competitive
buyer opening up the domestic market; through its support for R&D and through
government providing a larger home market leading to scale economies. Studies by Dunne
(1995) and Dunne and Schofield (1997) discuss in detail the ways in which dependence on
government impacts on the performance of defence companies.
Overall, whether defence companies will perform less well than non-defence companies is
an empirical question worthy of careful research. Also of interest is how these companies
have coped with the marked reductions in domestic arms procurement and the increasing
competitiveness of the international arms market since the end of the Cold War.
To provide a more specific focus for our empirical analysis, we follow Martin et al (1996) in
specifying a number of hypotheses with which we confront with the data:
1. Firms that are dependent upon the MoD for sales are likely to be more financially
leveraged through borrowing, because their preferential position (as a result of cost-plus
or cost-based contracts and protectionist policies) gives them a lower risk of bankruptcy.
The possibility of government bailout for these firms is also higher than for non-defence
firms. The financial managers of these defence firms realise that they face less business risk
than other firms and thus seek to get pecuniary benefits through increased financial
leverage.
2. Government dependence is likely to result in defence firms investing less in plant and
equipment than other comparable firms. Capital investment is important for its contribution
to factor productivity, for if defence firms invest less in capital equipment than other firms,
then productivity growth is likely to be less than in civilian firms.
3. Defence dependence can have adverse effects on the level and growth of labour
productivity. The nature of the defence market, low levels of capital investment, a culture
of dependency on MoD purchases, local monopolies, preferential treatment and cost plus
contracts tend to stifle innovation. Furthermore, the level and growth in productivity is
likely to decrease as dependence on MoD purchases increases.
4. Defence dependent firms will have different levels of profitability to civil companies as
measured by various ratios such as return on assets. Profitability might be the same if
defence production is no riskier than other industrial activities. Profitability might be higher
as a result of domestic monopolies or preferential purchasing in favour of national firms.
Profitability might be lower as a result of the monopsony power of the MoD and export
restrictions that reduce sales and increase unit production costs.
These hypotheses are considered in Section 6 when the performance of a sample of nondefence companies and a sample of private sector defence dependent companies are
compared. First we provide some background information on the South African economy
and its recent development.
3. South Africa’s Macroeconomic Environment
South Africa is Africa’s largest and most sophisticated economy. The country is richly
endowed with national resources, and the economy was built up on the basis of mining and
agriculture. However, in recent years, the secondary (i.e. manufacturing) and tertiary (e.g.
transport, financial services) sectors have come to dominate the economy.
The South African economy experienced its longest and most severe recession - since the
depression of the 1930s- between 1989 and 1993. During this period GDP growth
averaged less than 1% per annum in real terms, while GNP per capita declined every year in
real terms. Total employment in the non-agricultural sectors of the economy declined by an
average of 1% between 1989 and 1993 while Gross Domestic Fixed Investment (GDFI)
declined by an average of more than 2% per annum. Inflation remained stubbornly high
during this period, averaging 13.6% per annum. Exports also showed little positive growth
during this period, largely because of the continued presence of trade and financial sanctions
(see Table 1).
Table 1: South Africa, Economic Indicators, 1989-1996
Figures are annual real growth rates.
Year
GDP
1989
1990
1991
1992
1993
1994
1995
1996
2.4
-0.3
-1
-2.2
1.3
2.7
3.4
3.1
GNP per
capita
-1.2
-3.8
-2.7
-4.5
-0.5
2.0
0.8
1.6
GDFI
Exports
Inflation
Employment
6.5
-2.3
-7.4
-5.3
-2.8
8.7
10.3
6.8
5.4
1.7
-0.1
2.5
4.8
1.0
9.3
7.8
14.7
14.4
15.3
13.9
9.7
9.0
8.7
7.4
0.9
-0.3
-1.7
-2.0
-2.1
-0.6
0.7
-1.5
Average
1989-93
0.0
-2.5
-2.3
2.9
1993-96
2.6
1.0
5.8
5.7
1989-96
1.2
-1.0
1.8
4.1
Source: South African Reserve Bank, Quarterly Bulletin, various issues.
13.6
8.7
11.6
-1.0
-0.9
-0.8
Since 1993, however, the South African economy has experienced positive GDP growth for
four consecutive years. GDP growth averaged 2.6% between 1993 and 1996 while GNP
per capita also witnessed positive growth, averaging 1% per annum. Gross Domestic Fixed
Investment recovered quite dramatically and experienced average growth of nearly 6% per
annum between 1993 and 1996. Exports also experienced positive growth, largely as a
result of the lifting of trade sanctions, which accompanied the ending of apartheid. Inflation
was brought under control, largely as a result of tighter monetary policies, and averaged less
than 9% for the period 1993-1996. In 1996 inflation was 7.4%, the lowest rate since 1972.
The only disappointing economic indicator since 1993 has been the trend in formal
employment. Total employment in the non-agricultural sectors of the economy continued to
decline between 1993 and 1996 despite the sustained growth in economy activity, thus
constituting a situation of ‘jobless growth’.
Despite the dramatic improvement in economic activity since 1993, the South African
economy remains beset by a number of structural problems (e.g. shortage of skilled labour,
low foreign exchange reserves), which are largely a function of the legacy of apartheid. In
terms of income distribution, the country has one of the highest levels of income inequality in
the world. The country has also experienced very high levels of crime and violence in the last
few years.
The performance of South Africa’s manufacturing sector since the late 1980s has also been
particularly disappointing, reflecting the severity of the recession. The value and volume of
manufacturing sales grew by less than 1% per annum between 1989 and 1996. Both
indicators declined after 1989, bottomed out in 1993, and then started to improve after
1994. Manufacturing employment declined by more than 1% per annum between 1989 and
1996, and by 1996 total employment was nearly 10% less than in 1989. In fact
manufacturing employment declined faster per annum than total employment in the South
African economy between 1989 and 1996. Manufacturing output grew by an average of
0.02% per annum between 1989 and 1996. This was considerably slower than the average
growth of GDP (1.2% per annum) during the same period. Thus the performance of the
manufacturing sector between 1989 and 1996 was even worse than the performance of the
macroeconomy (see Table 2).
Table 2. South Africa Manufacturing Sector Performance, 1989-1996
Figures in italics are in percentages.
Year
(1)
1989
100.5
1990
100
-0.5
100
-0.4
1581
1991
96.5
-3.5
96.4
-3.6
1992
92.6
-4.0
93.5
1993
91.9
-0.8
1994
94.1
2.4
1995
100.8
1996
101.9
Avg: 89-96
Change: 89Notes:96
% change
(2)
64813
%
change
-0.1
63064
-2.7
1546
-2.2
60183
-4.6
-3.0
1504
-2.7
58209
-3.3
93.3
-0.2
1477
-1.8
58316
0.2
95.8
2.7
1480
0.2
59791
2.5
7.1
103
7.5
1493
0.9
64351
7.6
1.1
103.3
0.3
1437
-3.8
64581
0.4
100.4
0.3
1.4
% change
(3)
% change
1583
0.5
2.9
(4)
-1.4
-9.2
0.02
-0.4
(1) Value of Manufacturing Sales (1990=100)
(2) Volume of Manufacturing Sales (1990=100)
(3) Manufacturing Employment (‘000)
(4) Value of Manufacturing Output (1990 Rand Million)
Source: South African Reserve Bank, Quarterly Bulletin, various issues.
4. South Africa’s Defence Market
The size and structure of South Africa’s defence market has changed quite dramatically
since the late 1980s (Batchelor & Willett, 1998). Between 1989 and 1996 South Africa’s
defence budget was cut by 50% in real terms, while procurement expenditure declined by
nearly 70% during the same period. While the overall defence market declined by nearly
70% between 1989 and 1996 (average of 15% per annum), the domestic market only
declined by 53% (average of 10% per annum) during the same period (see table 3).
Before 1992 the state-owned company Armscor acted as the procurement agency for the
South African Defence Force (SADF). It also owned a number of arms production
subsidiary companies, and was the major domestic producer of armaments. In 1992
Armscor was split into Denel, a new state-owned industrial company, which inherited all of
Armscor’s former arms production and research facilities; and Armscor, which retained
responsibility for procurement for the SADF (Batchelor & Willett, 1998).
Table 3. South African Defence Market, 1989-1996
Figures are in Rand million in constant 1990 prices. Figures in italics are in percentages.
Year
Total
Market*
6236
5126
3931
3242
3162
2427
2167
1984
% change
Domestic
Market +
3618
2973
3123
2696
2625
2093
1808
1707
% change
Domestic/
Total (%)
58
58
79
83
83
86
83
86
77
1989
1990
-17.8
-17.8
1991
-23.3
5.1
1992
-17.5
-13.7
1993
-2.5
-2.6
1994
-23.2
-20.3
1995
-10.7
-13.6
1996
-8.4
-5.6
Average
-14.8
-9.8
89-96
Notes
* Based on total value of Armscor Acquisition Spending for Departments of Defence, Safety and
Security (Police) and Correctional Services (Prisons).
+ Value of Domestic Acquisition Spending
Source: Armscor; Armscor Annual Report (various years)
Apart from the creation of Denel, there has been a marked change in the structure of the
supply side of the market. This has resulted from South Africa’s re-admittance into the
international community and the lifting of the United Nations mandatory arms embargo in
May 1994, which has allowed South Africa to purchase armaments from foreign suppliers
for the first time since 1977. The value of arms imports has declined since the late 1980s,
largely as a result of lower levels of procurement spending, while the share of imports in total
procurement spending has remained relatively constant since the early 1990s. Between
1992 and 1996, the share of imports in the overall defence market fluctuated between 17%
and 14% (average of 16%). Denel’s share fluctuated between 34% and 44% (average of
40%) between 1992 and 1996, while the private sector’s share has fluctuated between
40% and 49% (average 44%) during the same period (see Table 4).
Table 4. Structure of South African Defence Market, 1992-96
Figures are percentages.
Year
1992
1993
1994
1995
1996
Average 1992-96
Imports
17
17
14
17
14
16
Denel
43
34
38
42
44
40
Private Sector
40
49
48
42
42
44
Total
100
100
100
100
100
100
Sources: Armscor Annual Report (various years); Denel Annual Report (various years).
The structure of the domestic defence market has also changed in the last few years. Denel
has continued to dominate the domestic defence market, averaging 48% of the domestic
market since 1992, while the private sector’s share has averaged 52%. However, Denel’s
current share of the domestic market is significantly lower than in the 1980s, when the
former Armscor subsidiary companies (now part of Denel) accounted for nearly 70% of the
domestic market (Batchelor & Willett, 1998).
In addition to its 48% aggregate share of the domestic defence market, Denel continues to
dominate most of the seven major sectors of the domestic defence market, particularly
aerospace, ammunition (small, medium and large calibre), weapons systems (including
infantry weapons, cannons, artillery systems and missiles) and military vehicles. The other
major sectors of the domestic defence
market, namely electronics, maritime and support equipment are dominated by the
three largest private sector defence firms, namely Reunert, Altech and Grintek. Denel also
dominates many of the sub-sectors of the domestic defence market such as information
technology, and testing.
The three largest private sector defence firms (Reunert, Grintek and Altech) completely
dominate the private sector’s share of the domestic defence market. In 1996, the three firms
accounted for over 80% of the private sector’s share of the domestic defence market. Since
the early 1990s these three firms have acquired many small and medium sized private
defence firms in an attempt to consolidate their positions in the domestic market. These
firms, like Denel, have also attempted to vertically integrate, by outsourcing far less of their
defence business than in the past. This process of vertical integration has had a very negative
impact on the hundreds of smaller defence firms, particularly those that act as suppliers and
sub-contractors for the larger defence firms.
In the last few years many small and medium-sized private defence firms have exited the
defence market, merged with, or been acquired by, larger defence firms (e.g. Reunert
acquired the armoured car division of TFM in early 1997). As a result, the domestic
defence market (excluding imports) has become increasingly concentrated. In 1996 Denel
and the three largest private sector defence firms accounted for over 90% of total domestic
acquisition spending.
Although Denel dominates a number of sectors of the domestic defence market, the private
sector defence industry is still extremely important. In 1996, Denel was smaller than Reunert
in terms of turnover (see Table 5), but larger than Altech and Grintek. By 1996, according
to interviews with company officials, none of the private sector companies had defence
taking up more than 20% of turnover. Denel is clearly much more dependent on arms
production and exports than the private sector companies, and in 1996 Denel’s defence
sales, including exports, accounted for 64% of turnover (Denel Annual Report, 1996/97).
5. Firm Performance in South Africa’s Public and Private Sector Defence Industry
The dramatic cuts in defence spending, and particularly procurement spending, have had a
significant impact on the performance of South Africa’s public and private sector defence
industry. Denel’s financial performance since its establishment in 1992 has not been
particularly impressive. Over the period 1992-96 its turnover declined by an average of
nearly 6% per annum in real terms, while the three largest private sector companies,
Reunert, Altech and Grintek, witnessed positive average annual increases in turnover during
the same period. The average annual growth in Denel’s net profit between 1992 and 1996
was better than Altech and Grintek but worse than Reunert.
It is striking that Denel has a much higher level of total assets relative to turnover than the
private sector companies, suggesting it retains poorly performing assets. The relatively high
value of Denel’s total assets relative to the private sector companies is largely a result of the
fact that Denel’s assets are valued at book value rather than market value.
Denel’s total employment declined by nearly 9 percent between 1992 and 1996, and by an
average of 2 percent per annum (see Table 5). During the same period Reunert's
employment declined by slightly less than Denel's. Both Altech and Grintek witnessed
declines in total employment by over 20%.
Table 5. Denel and Private Sector Defence Firms, 1992-1996
Figures are in 1996 Rand Million. Figures in italics are in percentages.
Year
1992
1993
1994
1995
1996
3839
3507
3376
3506
3013
-9
-4
4
-14
2906
3933
4890
4915
-6
35
24
1
1147
1206
1379
1593
-5
5
14
15
1687
1887
2106
2230
0
12
12
6
294
348
390
82
-8
18
12
-79
134
181
195
203
8
36
7
4
110
68
66
5
-12
-38
-3
-92
36
46
53
7
-33
29
15
-87
5771
4562
4520
4253
-6
-21
-1
-6
1687
2452
2689
2532
0
45
10
-6
1053
1024
1001
1048
15
-3
-2
5
791
920
1071
1598
7
16
16
49
13895
13826
14150
14200
-11
0
2
0
13251
15323
15938
12733
-4
16
4
-20
3966
3641
3730
3494
-12
-8
2
-6
3201
2827
3009
2319
-3
-12
6
-23
Avg: 92-96
Turnover
Denel
% change
Reunert
3104
% change
Altech
1214
% change
Grintek
1683
% change
-5.8
13.5
7.4
7.4
Net Profit
Denel
320
% change
Reunert
124
% change
Altech
125
% change
Grintek
53
% change
-14.2
13.8
-36.5
-19.0
Total Assets
Denel
6166
% change
Reunert
1683
% change
Altech
916
% change
Grintek
740
% change
Employment
(numbers)
Denel
15572
% change
Reunert
13863
% change
Altech
4514
% change
Grintek
% change
3299
Sources: Company Annual Reports, various years.
-8.5
12.4
3.7
22.2
-2.1
-1.2
-6.1
-7.8
Although Denel has managed to remain profitable for the first few years of its corporate
existence, the company’s financial performance relative to the large private sector defence
groups has not been particularly impressive (see Table 6). Denel’s net profit margin (net
profit/turnover) was on average higher than the private sector companies for the period
1992-96. However its return on assets (net profit/ total assets) was on average lower than
the private sector companies, except for Grintek. Denel's relatively poor return on assets
was due to the capital-intensive and non-performing nature of many of its assets. It was also
a function of the fact that the company’s assets were valued at book value rather than
market value. Denel’s return on assets improved slightly after 1993, as a result of the fact
that the company’s assets were revalued through a capital reduction of R700 million during
1994/95 as a result of the termination of the space program at Houwteq.
Denel’s economic performance between 1992 and 1996 relative to the 3 major private
sector defence groups was also mixed (see table 6). Denel’s labour productivity, as
measured by turnover per employee was lower on average than the 3 private sector
companies. However, the company's labour efficiency (net profit per employee) was higher
on average than the private sector companies.
Table 6. Denel and Private Sector Firms, Corporate Performance, 1992-96
Figures are in Rand in 1996 prices. Figures in italics are in percentages.
Year
1992
1993
1994
1995
1996
Avg: 1992-96
Net Profit
Margin(1)
Denel
8.3
8.4
10.3
11.1
2.7
8.2
Reunert
4.0
4.6
4.6
4.0
4.1
4.3
Altech
10.3
9.6
5.7
4.8
0.3
6.1
Grintek
3.2
2.1
2.4
2.5
0.3
2.1
Return on
Assets (2)
Denel
5.2
5.1
7.6
8.6
1.9
5.7
Reunert
7.4
7.9
7.4
7.2
8.0
7.6
Altech
13.7
10.5
6.7
6.6
0.5
7.6
Grintek
7.2
4.5
5.0
4.9
0.4
4.4
Labour
Productivity (3)
Denel
246532
252393
244178
247774
212183
240612
Reunert
223872
219268
256661
306794
386005
278520
Altech
268918
289269
331241
369807
455924
343032
Grintek
510022
527059
667456
699962
961621
673224
Labour
Efficiency (4)
Denel
20550
21159
25170
27562
5775
20043
Reunert
8943
10093
11839
12225
15943
11809
Altech
27767
27844
18761
17689
1431
18698
Grintek
16106
11116
16241
17473
3019
12791
Notes: (1) Net Profit/Turnover
(2) Net Profit/Total Assets
(3) Turnover/Employment
(4) Net Profit/Employment
Sources: Company Annual Reports, various years.
6. Defence and Non-defence Company Performance
It is clear that the defence sector and its constituent companies have undergone considerable
changes since the start of the transition to democracy. To better understand the influence of
their dependence on defence procurement it is important to be able to compare their
performance with that of other non-defence companies. This section uses various financial
ratios to undertake such a comparison. Appendix 1 discusses the methodology of
constructing the samples used.
There are 7 companies in the sample of defence companies - Reunert, Altech, Grintek,
Logtek, Spescom, Dorbyl and Plessey. All of the companies except Dorbyl are listed in the
electronics sector of the Johannesburg Stock Exchange (JSE). The sample of 33 nondefence companies represents a range of firms in various industries such as beverages and
hotels; building and construction; chemicals and oils; electronics; engineering; food; paper
and packaging; retail; steel allied and transport. For each sample the mean values of six
financial variables (total assets, market capitalisation, equity funds, net profit, turnover and
employment) were computed. In addition the growth between the first and last year of the
sample period (1988 and 1997) was computed for each sample.
As Table 7 shows, a simple comparison of the growth rates for various size indicators for
each sample suggests that the performance of non-defence companies has been better than
defence companies during the sample period. Between 1988 and 1997, the turnover of the
defence sample grew by almost 124%, while that of the non-defence sample grew by more
then double that, 314%. Across all of the other measures total assets, market capitalisation,
equity funds, net profit and employment the non-defence companies have outperformed the
defence ones by a considerable margin.
To evaluate the relative performance of the two samples, various aspects of firm
performance for both defence and non-defence companies were analysed using various
financial ratios. Appendix 1 provides definitions of all the financial ratios used in the following
section and Table 8 gives the computed values.
Table 7. Financial Information, 1988-1997
Figures are mean values in current Rand Million. Figures in italics are in percentages.
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
785.3
587.8
530.2
548.9
618.01
697.93
844.3
849.4
1117.2
1211.3
-25.1
-9.8
3.5
12.6
12.9
21.0
0.6
31.5
8.4
543.5
370.7
400.9
502.5
478.55
792.5
1177.4
1131.6
757.7
9.9
-31.8
8.1
25.3
-4.8
65.6
48.6
-3.9
-33.0
315.7
243.6
276.5
294.6
325.63
378.1
410.3
515.9
598.4
-9.0
-22.8
13.5
6.5
10.5
16.1
8.5
25.7
16.0
Defence Companies
Total Assets
1988-97
% change
Market Capitalisation
494.6
% change
Equity Funds
346.9
% change
Net Profit
49.4
57.7
45.7
49
46.2
31.97
38.1
56.6
68.3
67.6
16.8
-20.8
7.2
-5.7
-30.8
19.2
48.6
20.7
-1.0
921.4
862.8
973.9
1104.3
1092
1381.1
1482.5
1862.9
2053.1
0.5
-6.4
12.9
13.4
-1.1
26.5
7.3
25.7
10.2
14060
10956
9594.8
9323.8
8011.3
8195
6773.2
5405.3
5170.8
2.1
-22.1
-12.4
-2.8
-14.1
2.3
-17.3
-20.2
-4.3
1173.6
1670.4
1902.4
2225.1
2585.3
2887.5
3212
3900.3
4481.3
5193.9
42.3
13.9
17.0
16.2
11.7
11.2
21.4
14.9
15.9
763.3
1146
1267.4
1682.3
1671
2207.3
3552.8
3602
3761.5
3621.1
50.1
10.6
32.7
-0.7
32.1
61.0
1.4
4.4
-3.7
839.9
964
1069.4
1225.9
1325.9
1477.3
1754.5
1979.8
2344
59.8
14.8
10.9
14.6
8.2
11.4
18.8
12.8
18.4
159.4
170
148.8
143.7
144.5
165.4
254.8
265.2
278.5
80.9
6.6
-12.5
-3.4
0.6
14.5
54.1
4.1
5.0
1912.6
2226.1
2499.6
2813.2
3141.2
3532.3
4217.3
4866.4
5832.7
35.8
16.4
12.3
12.5
11.7
12.5
19.4
15.4
19.9
15482
15970.5
15319.5
15440.6
14978.6
14575.3
14645.4
13565.3
13965.2
14.3
3.2
-4.1
0.8
-3.0
-2.7
0.5
-7.4
2.9
% change
Turnover
916.8
% change
Employment
% Growth
13775.7
% change
54.2
53.2
72.5
36.8
123.9
-62.5
Non-Defence Companies
Total Assets
% change
Market Capitalisation
% change
Equity Funds
525.5
% change
Net Profit
88.1
% change
Turnover
1408.9
% change
Employment
% change
13541.3
342.6
374.4
346.1
216.1
314.0
3.1
Table 8. Financial Ratios, 1988-1997
Figures are in percentages based on mean values in current Rand Million.
Year
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
Defence Companies
Asset Turnover
1988-97
116.7
% change
Return on Equity
14.2
% change
Return on Assets
6.3
% change
Net Profit Margin
5.4
% change
Labour Productivity
6.7
% change
Labour Efficiency
0.4
% change
Gearing
29.9
% change
Capital Turnover
% Growth
185.4
% change
156.8
162.7
177.4
178.7
156.5
163.6
174.5
166.8
169.5
34.4
3.8
9.0
0.7
-12.4
4.5
6.7
-4.4
1.6
18.3
18.8
17.7
15.7
9.8
10.1
13.8
13.2
11.3
28.9
2.7
-5.9
-11.3
-37.6
3.1
36.6
-4.3
-14.4
9.8
8.6
8.9
7.5
4.6
4.5
6.7
6.1
5.6
55.6
-12.2
3.5
-15.7
-38.7
-2.2
48.9
-9.0
-8.2
6.3
5.3
5
4.2
2.9
2.8
3.8
3.7
3.3
16.7
-15.9
-5.7
-16.0
-31.0
-3.4
35.7
-2.6
-10.8
6.6
7.9
10.2
11.8
13.6
16.9
21.9
34.5
39.7
-1.5
19.7
29.1
15.7
15.3
24.3
29.6
57.5
15.1
0.4
0.4
0.5
0.5
0.4
0.5
0.8
1.3
1.3
0.0
0.0
25.0
0.0
-20.0
25.0
60.0
62.5
0.0
41.9
34.3
31
41.4
32
52.3
65.2
54.4
21
40.1
-18.1
-9.6
33.5
-22.7
63.4
24.7
-16.6
-61.4
169.5
232.7
243
219.7
228.2
174.3
125.9
164.6
271
-8.6
37.3
4.4
-9.6
3.9
-23.6
-27.8
30.7
64.6
114.5
117
112.3
108.8
108.8
110
108.1
108.6
112.3
162.3
14.3
6.9
4.3
17.0
0.7
40.3
201.4
Non-Defence Companies
Asset Turnover
120.1
% change
Return on Equity
16.8
% change
Return on Assets
7.5
% change
Net Profit Margin
6.3
% change
Labour Productivity
10.4
% change
Labour Efficiency
0.7
% change
Gearing
31.2
% change
Capital Turnover
184.6
-4.7
2.2
-4.0
-3.1
0.0
1.1
-1.7
0.5
3.4
19
17.6
13.9
11.7
10.9
11.2
14.5
13.4
11.9
13.1
-7.4
-21.0
-15.8
-6.8
2.8
29.5
-7.6
-11.2
9.5
8.9
6.7
5.6
5
5.1
6.5
5.9
5.4
26.7
-6.3
-24.7
-16.4
-10.7
2.0
27.5
-9.2
-8.5
8.3
7.6
6
5.1
4.6
4.7
6
5.4
4.8
31.7
-8.4
-21.1
-15.0
-9.8
2.2
27.7
-10.0
-11.1
12.4
13.9
16.3
18.2
21
24.2
28.8
35.9
41.8
19.2
12.1
17.3
11.7
15.4
15.2
19.0
24.7
16.4
1
1.1
1
0.9
1
1.1
1.7
2
2
42.9
10.0
-9.1
-10.0
11.1
10.0
54.5
17.6
0.0
26.7
23.9
36.4
26.6
39.9
58.4
51.3
47.4
35.3
-14.4
-10.5
52.3
-26.9
50.0
46.4
-12.2
-7.6
-25.5
166.9
175.6
148.6
168.4
142.3
99.4
117.1
129.4
161.1
112.1
14.1
6.6
5.9
22.3
1.3
37.7
149.3
% change
01:24, 1/22/00
-9.6
5.2
-15.4
13.3
-15.5
-30.1
19
17.8
10.5
24.5
6.1 Profitability
Martin et al (1996) suggest that defence dependent firms will have different levels of
profitability to civil ones. There are a number of debates surrounding the most appropriate
measure of profitability. Therefore, three measures of profitability were used:
•
Return on Equity = (Net Profit)/Equity
•
Return on Assets = (Net Profit)/(Total Assets)
•
Net Profit Margin = (Net Profit)/Turnover
The values for return on equity in Table 8 do not support their hypothesis and suggest that
the average level of return on equity for both defence and non-defence companies was fairly
similar (around 14%) for the period between 1988 and 1997. As Graph 1 illustrates
between 1990 and 1993 the defence companies were generally more profitable by this
measure, but after 1993 their profitability was lower than the non-defence companies. This
pattern might be explained by the fact that after 1993 the severity of the cuts in procurement
spending began to impact more significantly on the profitability of defence companies. The
return on assets ratios show a similar pattern in Graph 2. While defence companies had a
higher return on assets than non-defence companies in two distinct periods: 1991-92 and
1995-97, the general trend over the entire period is fairly similar for both. The findings for
return on equity and return on assets are in line with the results of a 1995 study in the UK
(Review Board, 1995).
In contrast, Graph 3 shows that if the net profit margin ratio is used as a measure of
profitability (net profit relative to changes in the price of output, i.e. turnover), defence
companies had lower average profit margins than the non-defence companies for the entire
period 1988-1997. This is consistent with the hypothesis of Martin et al (1996), but does
suggest that any higher profit margins that defence companies may have received through the
use of cost plus contracts have been adversely effected by
the severity of the defence cuts, and the increasingly competitive domestic defence market.
The monopsony power of the Defence Ministry in awarding contracts, export restrictions
(which reduce sales and limit economies of scale), and the highly competitive nature of the
defence market (which forces defence contractors to charge unrealistically low prices in
order to win contracts) could all have influenced the relatively low profitability of the defence
companies. Gansler (1989) discusses this for US defence firms.
6.2. Gearing
The Gearing ratio is commonly used to evaluate the level of corporate borrowing or a firm’s
leverage. It is also used to determine the liquidity of a company, especially during either
recession or financial crisis.
•
2
Gearing Ratio = 1 - [(Equity Funds)/(Market Capitalisation Value)]
Martin et al (1996) suggest that firms dependent on defence procurement are likely to be
more financially leveraged, because their preferential position gives them a lower risk of
bankruptcy. The values in Table 8 suggest that the average gearing ratio was indeed higher
amongst defence companies than non-defence companies. As Graph 4 shows, however,
there were considerable fluctuations in the trends in gearing ratios for both defence and nondefence companies.
Generally, the level of gearing by defence companies showed a rising trend after 1990 a
steep fall in 1995. The cuts in defence spending which occurred after 1989 probably forced
defence companies to look for alternative sources of finance, and so increase their levels of
gearing There may be specific reasons for the relatively higher gearing ratios of defence
companies in 1992, 1995 and 1996. Defence companies may have used higher gearing as a
means of raising finance from government sources. In 1992, for instance, when the
government established Denel as a new state-owned armaments company, many private
defence companies may have considered this development as
2
Note this is the same as Debt/(Debt + Equity)
01:24, 1/22/00
21
a competitive threat. As a result, private defence companies may have raised their gearing
ratios to obtain more financing from the government and to secure their overall financial
positions. The same was repeated in 1995. After the lifting of the United Nations mandatory
arms embargo in May 1994, many private defence companies once again raised their
gearing ratios, perhaps in response to the prospect of a more competitive domestic defence
market and the entry of international suppliers.
6.3. Asset Utilisation
As mentioned above, changes in the level of gearing can be used by defence companies as a
means of raising finance from government sources. Managers who skilfully change their
gearing ratios are also expected to be able to control their financial resources efficiently. To
evaluate how efficiently defence companies use their financial resources, we examine the
capital turnover ratio:
•
Capital Turnover = (Turnover)/(Market Capitalisation)
This indicates the efficiency of use of shareholders’ funds in generating sales. Graph 5
suggests that defence companies had a higher average capital turnover ratio for most of the
period. These results may be due to more efficient management of financial resources in
defence companies, or the considerably lower market value of defence companies coupled
with considerably higher unit prices for defence products. The sharp rise in defence
companies’ capital turnover ratio in 1996 and 1997 was due to sharp drops in the market
capitalisation of defence companies (4% in 1996 and 33% in 1997) which were
accompanied by increases in turnover (26% in 1996 and 10% in 1997).
6.4 Labour Productivity
A company’s performance can also be assessed relative to its labour resources, evaluating
the efficiency of labour in generating turnover and profits. This can be measured by
examining labour productivity or labour efficiency:
•
Labour Productivity = (Turnover)/(Total Number of Employees)
01:24, 1/22/00
22
•
Labour Efficiency = (Net Profit)/(Total Number of Employees)
Martin et al (1996) suggested that government dependence was likely to have adverse
effects on labour productivity and Graph 6 would appear to support this. Non-defence
companies tended to have a higher average level of labour productivity than defence
companies during the period 1988-97. Labour productivity for both samples increased by
similar rates for most of the period, but labour productivity amongst defence companies
seemed to improve slightly faster in 1996 and 1997 (see Table 8). This could have been the
result of large retrenchments accompanied by significant increases in the value of total assets
(investment) and turnover (sales).
The results in Graph 7 show that non-defence companies had a higher average level of
labour efficiency than defence companies between 1988 and 1997. The difference between
the two samples was also relatively constant over the period, with both experiencing
significant increases in labour efficiency after 1994, largely as a result of retrenchments.
In general, the improvements in labour productivity appear to have occurred for all South
African companies over the period between 1988 and 1997. Certainly, the ending of
apartheid and the coming to power of the ANC (in alliance with COSATU) has helped to
reduce the number of work days lost to strikes and industrial action, which in turn has had a
positive impact on labour productivity. Significant investments in capital and technology after
1994 (reflected in increases in total assets), and a positive macroeconomic climate (reflected
in increases in turnover and net profit), together with significant retrenchments also
contributed to the improvements in labour productivity and labour utilisation (see Table 9).
Table 9. Growth Rates in Turnover, Total Assets, Net Profit and Employment
1988-97
Figures are in percentages, based on changes in current prices.
01:24, 1/22/00
23
Turnover
Total Assets
Net Profit
Employment
Growth: 1988-1997
Defence
Non-defence
123.9
314.0
54.2
342.6
36.8
216.1
-62.5
3.1
Average Annual Growth: 1988-97
Defence
Non-defence
9.9
17.3
6.2
18.3
6.0
16.7
-9.9
0.5
Source: Calculated from Tables 7 and 8.
7. Conclusions
This paper has provided an analysis of the changes in performance of defence companies in
South Africa during the period of military expenditure cuts and defence industry downsizing
which has occurred since the late 1980s. Despite the process of restructuring, the industry
remains dominated by one large state owned industrial company, Denel, and three large
private sector defence companies - Reunert, Altech and Grintek. Since its inception in 1992
Denel has pursued a policy of downsizing and diversification in order to fit the more limited
domestic defence market. At the same time, the large private sector defence firms have also
had to adjust to the changed market environment. However, the fact that these companies’
dependence on defence sales is less than 20% of turnover means that their problems are not
as severe as Denel’s. Both Denel and the large private sector defence companies have
engaged in policies of vertical integration, diversification and the acquisition of small and
medium sized defence firms. This has led to increasing concentration and monopolisation in
the domestic defence market and has threatened the viability of many smaller defence firms.
Comparing the performance of the seven main private sector defence companies to a
sample of non-defence companies for the period 1988-97 produces some interesting
results. An analysis of the growth rates in turnover, total assets and net profit amongst
defence companies suggested relatively slow growth and significant fluctuations
compared to non-defence companies. During the sample period the defence companies
experienced significant negative growth in employment, as a result of the dramatic cuts in
defence spending, while non-defence companies experienced marginal positive growth in
01:24, 1/22/00
24
employment.
Using financial ratio analysis it was evident that private sector defence companies in South
Africa have a lower net profit margin than non-defence companies, but a similar return on
assets and return on equity. Gearing was generally higher for defence companies, suggesting
higher levels of financial leverage, but there were considerable variations during the last few
years. As expected, defence companies were found to have a higher capital turnover ratio
than non-defence companies, suggesting that they were managing their financial resources
more efficiently than non-defence companies. Labour productivity and labour efficiency was
considerably lower for defence companies, indicating that they utilised their labour resources
less efficiently.
These results are generally consistent with the findings of other studies for countries with
large defence industries (Gansler, 1989, Martin et al, 1996). The defence companies
performed as well as the non-defence companies over the period 1988-97 when financial
ratios are considered, but they have performed much worse in terms of growth. This would
suggest a “hollowing out” of the companies with marked reductions in the relative size and
capacity of the defence companies. It is also important to bear in mind the nature of the
industry in South Africa. All of the main private defence contractors are part of larger more
diversified industrial conglomerates who could make up declines in defence business through
expansion in non-defence divisions. Thus the full impact of the cuts on the defence divisions
is likely to have been much greater. In addition, the impact of the cuts is likely to have been
more pronounced for small and medium sized privately owned companies that had high
levels of dependence on defence work, but for whom financial data is not readily available.
Overall, the results suggest that the private sector defence companies have been relatively
successful in downsizing their defence production without compromising their financial
performance relative to non-defence companies.
01:24, 1/22/00
25
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01:24, 1/22/00
29
APPENDIX
1. Sources and Methods
There are considerable problems in obtaining detailed disaggregated financial information on
defence companies, as Martin et al (1996) discuss. There is no clear definition of the South
Africa defence industrial base. Some definitions focus on the products (e.g. aircraft, missiles,
tanks) which are produced by firms in the country’s industrial base. Other definitions attempt
to include the supply chain and all manufacturing firms which act as contractors, subcontractors or suppliers to Armscor, the Ministry of Defence’s procurement agency. No
official South African government source provides data on the domestic defence industry. In
addition, South African national economic data also does not have a separate International
Standard Industrial Classification (ISIC) category for defence production.
In the absence of official information, information on defence companies was obtained from
a number of sources: 1) Armscor’s Acquisition Bulletin; 2) the South African Aerospace,
Maritime and Defence Industry Association (AMD) and 3) the South African Defence
Industry Directory, which is published bi-annually. From these sources it was possible to
construct a fairly complete list of the names of defence companies in South Africa.
However, none of these sources collect detailed disaggregated financial data for the various
defence companies.
For the purposes of this paper ‘defence companies’ are defined as those companies which
are directly and indirectly involved in some aspect of armaments production. Disaggregated
financial data for South African industrial companies is readily available. The Top
Companies Survey, which is published annually by the Financial Mail, includes detailed
financial information (total assets, market capitalisation, net profit, net equity, turnover and
total employment) on South Africa’s top 300 private sector industrial companies.
A sample of defence and non-defence companies was selected for the purposes of this
paper, utilising the constructed list of defence companies (as described above) and the
financial data contained in the annual Top Companies Survey. Additional information on
defence and non-defence companies was obtained from other sources, including
McGregors Who Owns Whom in order to verify and cross check the information obtained
from the Top Companies Survey. Financial data was collected for 7 defence and 33 nondefence companies for the sample period 1988-1997. The sample period was chosen to
capture the effects of the dramatic cuts in defence spending, which have take place since the
late 1980s, on firm performance. All of the companies in the defence and non-defence
sample are publicly quoted companies on the Johannesburg Stock Exchange (JSE).
Therefore detailed financial information on the companies is also publicly available through
annual reports, shareholder meetings etc.
The total sample contains 40 companies. It is divided into two subsamples: 1) 7 defence
companies, and 2) 33 non-defence companies. Each sample covers differences in the size
(measured by turnover, assets and employment), ownership structure, products and
services, industrial sector and geographical location of companies. All 7 companies in the
defence sample are directly or indirectly involved in some aspect of armaments production,
but in none of companies is defence dependence (defence sales as a share of turnover)
amount to more than 20%. The sample of 33 non-defence companies covers 10 major
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sectors of the industrial economy:
• beverages and hotels (313)
• building and construction
• chemicals and oils (351/352)
• electronics (383)
• engineering (382)
• food (311/312)
• paper and packaging (341)
• retail
• steel allied (371)
• transport (385)
These 10 sectors correspond with most of the major ISIC categories of the manufacturing
sector (ISIC 3 digit categories in brackets).
Companies included in the sample are:
Defence Companies
Company
Sector
1.
2.
3.
4.
5.
6.
7.
Electronics
Electronics
Electronics
Electronics
Electronics
Engineering
Electronics
Reunert
Altech
Grintek
Logtek
Spescom
Dorbyl
Plessey
Non-defence Companies
Company
Sector
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
12.
13.
14.
15.
16.
17.
18.
19.
SA Breweries
Alpha
PPC
Group 5
Boumat
Sasol
AECI
Sentrachem
Powertech
ED L Bate
Metkor
Afrox
Haggie
NEI Africa
Tiger Oats
ICS
Rainbow
Tongaat-Hulett
Sappi
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Beverages & Hotels
Building & Construction
Building & Construction
Building & Construction
Building & Construction
Chemicals & Oils
Chemicals & Oils
Chemicals & Oils
Electronics
Engineering
Engineering
Engineering
Engineering
Engineering
Food
Food
Food
Food
Paper and Packaging
31
20.
21.
22.
23.
24.
25.
26.
27.
28.
29.
30.
31.
32.
33.
Nampak
Consol
Metcash
Pick n Pay
Pep
Wooltru
Waltons
Pepkor
Iscor
Hiveld
USKO
Trencor
Putco
Toyota
Paper and Packaging
Paper and Packaging
Retail
Retail
Retail
Retail
Retail
Retail
Steel Allied
Steel Allied
Steel Allied
Transport
Transport
Transport
2. Definitions of Company Information
In order to make comparisons between the performance of defence and non-defence
companies it is necessary to have basic financial information on each company. The
following 6 categories of financial information (with definitions) for all companies in the
sample was obtained from the annual Top Companies Survey, published by the Financial
Mail. The definitions for the 6 categories of financial information are:
Fixed Assets
Fixed as well as current assets are included. Investments are at market price or directors'
valuation, at latest balance sheet date. Other assets, such as land and buildings, are at book
value. Where revaluations were not taken into the balance sheet, these were ignored. Where
cash balances were netted off against bank overdraft, the cash balances were added back.
Tax paid in advance was netted off against tax payable, and only the gross amount included.
Cost of control and intangible assets, such as goodwill, patents and licences were not
included; mining assets were, however, included. Where amounts invoiced on contracts in
progress exceeded the value of contracts in progress, the difference was included with
retained income; or, if the amounts received consisted of deposits received, the difference
was included with creditors. If stock was valued using Lifo, it was adjusted to reflect the
Fifo or average value if this was disclosed.
Market Capitalisation
The market value of all fully paid and issued ordinary shares calculated in the closing price of
the last trading day of each year. Issued capital and closing prices were obtained from the
JSE's December Monthly Bulletin.
Equity Funds
Net assets attributable to ordinary shareholders were adjusted for the same items as total
assets. Provisions included with credit balance such as warranty provisions, provisions for
self-insurance and provisions for maintenance were included with distributable reserves.
Deferred tax was regarded as retained profit.
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Net Profit
Taxed profit attributable to ordinary shareholders, after excluding extraordinary items where
appropriate. Deferred tax and amounts transferred to provisions and reserves were
regarded as retained profit, thus increasing taxed profit disclosed. Also excluded are items
such as cost of control written off, prospecting expenditure, provisions against investments
and adjustments for prior year tax. The pre-tax difference in profit between Lifo and Fifo or
average stock values was added to net profit. Share of associated companies' retained
profits was also included.
Turnover
The total value of sales of goods and services.
Employment
The total number of employees, including contract and part time employees.
3. Definitions of Financial Ratios
Several aspects of financial performance can be analysed using different financial ratios.
Financial aspects to be compared are: profitability, asset utilisation, gearing and labour
utilisation.
Profitability
There are different measures of profitability. In this paper the three most commonly used
ratios are used.
• Return on Equity
This ratio measures the return on the investment made by the investors and was calculated
as follows:
Return on Equity = (Net Profit)/Equity
• Return on Assets
Another measure of profitability is return on assets ratio and was calculated as follows:
Return on Assets = (Net Profit)/(Total Assets)
• Net Profit Margin
Net profit margin ratio is another measure of profitability commonly used to assess
profitability by considering price changes of output, i.e. turnover. A high profit margin can be
achieved by charging higher prices on output but higher prices could be followed by a
decrease in demand and therefore lower turnover. Net profit margin was calculated as
follows:
Net Profit Margin = (Net Profit)/Turnover
Asset Utilisation
• Capital Turnover
Capital turnover refers to the return on shareholders’ equity which is represented here as
market Capitalisation. This ratio indicates the efficient use of shareholders’ funds in
generating profit by relating it to net profit. Capital turnover was calculated using the
following ratio:
Capital Turnover = (Turnover)/(Market Capitalisation)
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Gearing/Financial Leverage
• Gearing Ratio
The gearing ratio is commonly used to evaluate the level of corporate borrowing in a
company’s capital structure. This is significant in determining the liquidity of a company
especially during either recession or financial crisis. The gearing ratio was calculated as
follows:
Gearing Ratio = 1 - [(Equity Funds)/(Market Capitalisation Value)]
Labour Productivity
Labour productivity deals with the efficient use of labour in generating turnover and profit.
Two ratios were used.
• Labour Productivity
Labour productivity ratio is a measure of turnover generated relative to the number of
employees. This ratio was calculated as follows:
Labour Productivity = (Turnover)/(Total Number of Employees)
• Labour Efficiency
The other measure of labour productivity is labour efficiency which is calculated as a
measure of net profit to the total number of employees.
Labour Productivity = (Net Profit)/(Total Number of Employees)
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