Uganda’s National Social Security Fund is considering converting a loan extended to Uganda Clays Ltd (UCL) into equity to raise its shareholding to 60 per cent, and then sell the shares to a strategic investor.

An internal investment review compiled by equity analysts at the NSSF shows rising debt and a weak business outlook for UCL.

The surging debt levels are caused by UCL’s default on loan repayments owed to Standard Chartered Bank and the East African Development Bank, as well as the failure to service a Ush11.05 billion ($4.2 million) loan disbursed by the Fund in 2010.

Consequently the NSSF has decided to dispose of its investment in the listed company, citing high risks of financial distress.

The review shows that UCL’s total debt rose to Ush23.8 billion ($8.9 million) at the beginning of the year, from a market capitalisation value of Ush22.5 billion ($8.5 million). The Fund made a 100 per cent credit default provision for its loan during 2012/13.

The loan is currently valued at Ush16 billion ($6 million) inclusive of outstanding interest. The terms were an interest of 15 per cent per annum, over seven years; it was meant to clear some of UCL’s loans from local lenders.

NSSF owns 32.52 per cent of UCL, equivalent to 292,640,000 shares, making it the largest shareholder, followed by National Insurance Corporation, with about 18 per cent.

UCL recorded a half-year loss of Ush13.8 million ($5,213) in June 2013, and posted a full year loss of Ush3 billion ($1.1 million) at the end of 2013.

Its share price at the Uganda Securities Exchange had fallen to Ush20 ($0.008) by the end of June, from Ush25 ($0.009) recorded at the end of March.

The investment review document dated May 14, 2014 says “the company is currently crippled by debt,” which exceeds UCL’s market capitalisation.

UCL products are the most expensive on the local market, and are not competitive in Kenya, which was seen as an alternative market. South Sudan, another alternative market, is unstable.

Under NSSF’s debt to equity conversion plan, its loan facility would be transformed into shares worth 27.48 per cent, increasing its stake in UCL to 60 per cent, a move that offers the Fund strong leverage in negotiations with a strategic investor.

However, this increase in NSSF’s ownership would dilute other investors’ shares by 28 per cent, the document shows. This stake would then be sold to a strategic investor at Ush50 ($0.02) per share on condition that they repay the Ush16 billion ($6 million) owed by UCL.

In the event that this proposal is rejected by other shareholders, NSSF would sell its existing shares in UCL at Ush50 ($0.02) and ask the strategic investor to buy off its loan.

Local fund managers are equally keen on exiting their investments in UCL on account of weak growth forecasts.

“NSSF’s exit would help it minimise investment risk in case UCL goes into liquidation. Due to its poor performance, some fund managers are also contemplating selling their shares in the company to private equity firms that can restore profitability in its operations,” said Kenneth Owera, an investment analyst at Stanlib Uganda.

Mr Owera said UCL’s Kamonkoli factory in eastern Uganda has huge cash flow pressures and requires a very liquid investor to make it profitable.

“The biggest debt challenge lies with NSSF’s loan facility. For this reason, we agree with the proposal to convert its loan into equity so as to reduce the high finance cost pressures in our operations,” said Bonny Isabirye, UCL’s cost accountant.

He said steady growth in monthly sales that have averaged Ush2 billion ($755,554) is critical for funding regular loan repayments, but UCL is challenged by the shortage of big corporate clients in the real estate sector.

Stockbrokers expect UCL’s share price to remain stable at Ush20 ($0.008) for the rest of this year, citing cautious valuation attitudes among investors.

“Lack of a major shareholder with considerable experience in the construction industry has deeply affected UCL’s business strategy. As a result of UCL’s weaknesses, big players producing alternative roofing materials like Roofings Group have taken advantage of market trends and expanded output levels in order to consolidate market share.

“However, UCL’s share price is likely to remain flat  because most investors feel it’s closer to the company’s fair value while a discounted price would dangerously undervalue the business,” said Paul Bwiso, general manager at Dyer and Blair Uganda.