INTEGRATED ANNUAL
REPORT 2020

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INDEPENDENT AUDITOR’S REPORT
To the Shareholders of Tsogo Sun Hotels Limited

Report on the audit of the consolidated financial statements

OUR OPINION

In our opinion, the consolidated financial statements present fairly, in all material respects, the consolidated financial position of Tsogo Sun Hotels Limited and its subsidiaries (together the Group) as at 31 March 2020, and its consolidated financial performance and its consolidated cash flows for the year then ended in accordance with International Financial Reporting Standards and the requirements of the Companies Act of South Africa.

What we have audited

Tsogo Sun Hotels Limited’s consolidated financial statements set out here comprise:

BASIS FOR OPINION

We conducted our audit in accordance with International Standards on Auditing (ISAs). Our responsibilities under those standards are further described in the Auditor’s responsibilities for the audit of the consolidated financial statements section of our report.

We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our opinion.

Independence

We are independent of the Group in accordance with the sections 290 and 291 of the Independent Regulatory Board for Auditors’ Code of Professional Conduct for Registered Auditors (Revised January 2018), parts 1 and 3 of the Independent Regulatory Board for Auditors’ Code of Professional Conduct for Registered Auditors (Revised November 2018) (together the IRBA Codes) and other independence requirements applicable to performing audits of financial statements in South Africa. We have fulfilled our other ethical responsibilities, as applicable, in accordance with the IRBA Codes and in accordance with other ethical requirements applicable to performing audits in South Africa. The IRBA Codes are consistent with the corresponding sections of the International Ethics Standards Board for Accountants’ Code of Ethics for Professional Accountants and the International Ethics Standards Board for Accountants’ International Code of Ethics for Professional Accountants (including International Independence Standards) respectively.

OUR AUDIT APPROACH

Overview

Audit approach  

Overall group materiality

  • R32.1 million, which represents 5% of the average consolidated profit/loss before tax from continuing operations of the past three years adjusted for items that are not considered to be part of the normal operations of the Group.
 

Group audit scope

  • The Group has a portfolio of over 100 hotels in operation in Africa and the Middle East. The Group further has centralised functions and holding companies domiciled in South Africa and Mauritius.
  • We performed full scope audits on all significant components based on their financial significance and risk to the Group results as well as on all components with centralised functions.
  • Remaining components are not considered to be significant to the Group and analytical procedures have been performed on these components.
 

Key audit matters

  • Valuation of investment properties at year end of R4.15 billion; and
  • Impairment of property, plant and equipment of R716 million.

As part of designing our audit, we determined materiality and assessed the risks of material misstatement in the consolidated financial statements. In particular, we considered where the directors made subjective judgements; for example, in respect of significant accounting estimates that involved making assumptions and considering future events that are inherently uncertain. As in all of our audits, we also addressed the risk of management override of internal controls, including among other matters, consideration of whether there was evidence of bias that represented a risk of material misstatement due to fraud.

Materiality

The scope of our audit was influenced by our application of materiality. An audit is designed to obtain reasonable assurance whether the financial statements are free from material misstatement. Misstatements may arise due to fraud or error. They are considered material if individually or in aggregate, they could reasonably be expected to influence the economic decisions of users taken on the basis of the consolidated financial statements.

Based on our professional judgement, we determined certain quantitative thresholds for materiality, including the overall group materiality for the consolidated financial statements as a whole as set out in the table below. These, together with qualitative considerations, helped us to determine the scope of our audit and the nature, timing and extent of our audit procedures and to evaluate the effect of misstatements, both individually and in aggregate on the financial statements as a whole.

Overall group materiality  

R32.1 million.
How we determined it  

5% of the average consolidated profit/loss before tax from continuing operations of the past three years adjusted for items that are not considered to be part of the normal operations of the Group.
Rationale for the materiality benchmark applied  

We chose the consolidated profit/loss before tax from continuing operations as the benchmark because, in our view, it is the benchmark against which the performance of the Group is most commonly measured by users, and is a generally accepted benchmark.

The average consolidated profit over the past three years was used due to the performance of the Group over the past three years being volatile and comprising both profits and losses. Profit before taxation was adjusted to exclude the fair value gains and losses on investment property; impairments of property, plant and equipment; impairments of investments in associates; and interest on intercompany loans, as these are not considered to be part of the normal operations of the Group.

We chose 5% which is consistent with quantitative materiality thresholds used for profit-oriented companies in this sector.

How we tailored our group audit scope

We tailored the scope of our audit in order to perform sufficient work to enable us to provide an opinion on the consolidated financial statements as a whole, taking into account the structure of the Group, the accounting processes and controls, and the industry in which the Group operates.

The Group has hotel operations in Africa and the Middle East and associate investments in the United Kingdom. The Group further has centralised functions and holding companies domiciled in South Africa and Mauritius.

The Group financial statements are a consolidation of the Group’s operating businesses, holding companies and centralised functions. We performed full scope audits on all significant components based on their financial significance and risk to the Group results as well as on all components with centralised functions.

We ensured that the teams at all levels, including the South African and Offshore operations, included the appropriate skills and competencies required for the audit of a hotels operator and real estate investment trust, including industry specific knowledge as well as specialists and experts such as information technology audit, actuarial, tax and valuation specialists.

We determined the level of involvement needed in the audit work of PwC component auditors and other auditors operating under our instructions to be satisfied that sufficient audit evidence was obtained for purposes of our opinion. We maintained regular communication with local audit teams throughout the year and maintained group involvement at operational levels.

Further audit procedures were performed by the group audit engagement team, including substantive procedures over the consolidation process. The work performed at operational levels as well as the procedures performed at the group level, provided us with sufficient evidence to express an opinion on the consolidated financial statements as a whole.

Key audit matters

Key audit matters are those matters that, in our professional judgment, were of most significance in our audit of the consolidated financial statements of the current period. These matters were addressed in the context of our audit of the consolidated financial statements as a whole, and in forming our opinion thereon, and we do not provide a separate opinion on these matters.

  KEY AUDIT MATTER     HOW OUR AUDIT ADDRESSED THE KEY AUDIT MATTER
 

Valuation of Investment Properties at year end of R4.15 billion

The majority of the Group’s investment properties comprise hotel properties. At 31 March 2020, the carrying value of the Group’s total investment property portfolio was R4,149 million representing a R732 million decrease compared to the prior year (refer to note 18 ‘Investment properties’ to the consolidated financial statements).

This overall decrease comprises a decrease in the fair value of the hotel properties of R888 million and a decrease of R4 million due to a disposal of investment property, offset by an increase of R160 million in capital expenditure.

The Group’s accounting policy is to measure investment properties at fair value using the discounted cash flow approach. The value of investment properties is dependent on the operating results of the respective hotel operations and the inputs into the valuation model. Factors such as prevailing market conditions and country-specific risks directly impact fair values, and are taken into account in calculation of the discount rate by use of a risk premium.

The impact of Covid-19 and the associated impact on the hospitality industry has resulted in changes to the expected growth rate and cash flows. Cash flows are expected to decrease significantly in year one and two. These have resulted in a decrease in the fair value of the hotel properties.

The following assumptions are key in determining the fair value:

  • The discount rate applied by management;
  • Net cash flows; and
  • The expected growth rate which drives the exit capitalisation rate assumption.

The valuation accounting policy applied during the year requires properties to be externally valued by a qualified real estate appraiser (‘the appraiser’), which was performed on the entire portfolio of investment properties.

We considered the valuation of the investment properties to be a matter of most significance to our current year audit due to the following:

  • significant judgements made by management in determining the net cash flows, growth rate, exit capitalisation and discount rates; and
  • the magnitude of the balance of the investment properties recorded in the consolidated balance sheet as at 31 March 2020.
    

We updated our understanding of and tested the relevant controls related to the budgeting process, which included controls in relation to the following:

  • the entering and amending of leases in support of contractual rental income;
  • the setting and approval of budgets by the Group; and
  • board approval of the valuations obtained.

We tested capital expenditure incurred and capitalised on existing investment properties, by agreeing the consideration amounts capitalised to underlying documents, in order to assess whether the capitalisation criteria had appropriately been met. No exceptions were noted.

In respect of the appraiser (management’s expert), we:

  • considered his objectivity, independence and expertise by inspecting the external appraiser’s valuation reports for a statement of independence and compliance with generally accepted valuation standards; and
  • confirmed the external appraiser’s affiliation with the relevant professional body.

On a sample basis we tested the fair values in the appraiser’s valuation reports by performing the following procedures:

  • utilising our internal property valuation expertise, we assessed the appropriateness of the valuation methodology used;
  • we evaluated the cash flows in year one and two of the valuation. The cash flows were expected to be significantly affected by the restrictions as a result of Covid-19. Based on our work performed, we accepted the impact that management has projected;
  • we evaluated the cash flows in the valuations from year three to assess the reasonableness of the expected cash flows with reference to historical cash flows;
  • we assessed the reasonableness of the growth, exit capitalisation and discount rates used in the valuations by independently calculating a range of rates which would be considered reasonable against similar properties; and
  • we determined a range of acceptable valuations of a sample of hotels based on industry benchmarks and noted that the valuations prepared by the appraiser fell within these ranges.

We agreed all of the fair values in the final valuation reports to the fair values recorded in the Group’s accounting records as at 31 March 2020.
         
  KEY AUDIT MATTER     HOW OUR AUDIT ADDRESSED THE KEY AUDIT MATTER
 

Impairment of Property, Plant and Equipment of R716 million

The Group’s property, plant and equipment (‘PPE’) comprises land and buildings, of which the majority is represented by hotel buildings, operating equipment and plant and equipment. Hotel buildings which are owned and occupied by the Group are classified as PPE, in contrast to investment properties which are buildings owned by the Group but occupied by third parties.

As at 31 March 2020, the carrying value of the Group’s PPE amounted to R7.6 billion after recognition of a total impairment loss related to land and buildings of R716 million. Of the total impairment loss, R377 million related to hotel properties in the offshore operations and R339 million related to hotel properties in the South African operations. Refer to note 16 ‘Property, plant and equipment’ to the consolidated financial statements.

The Group’s policy is to assess PPE at each reporting date for indicators of impairment as required by International Accounting Standard 36 ‘Impairment of Assets’ (IAS 36). Where indicators of impairment are identified, impairment assessments are performed. The value of the impairment is determined as the difference between the recoverable amount of an asset, being the higher of the value in use and the fair value less cost to sell, and the carrying amount of the asset.

The recoverable amount for each hotel has been determined by calculating the higher of the value in use and the fair value less costs to sell.

The value in use was calculated using a discounted cash flow approach (DCF) based on the net cash flows of the underlying hotels. The following key assumptions were applied in the valuations:

  • Net cash flows and terminal growth rates: Net cash flows were forecasted, taking into account expected changes in the trading environment due to the Covid-19 pandemic and recovery thereafter, with appropriate terminal growth rates applicable to the various hotel operations.
  • Discount rates:

    Factors such as prevailing market conditions and country specific risks are taken into account in calculation of the discount rates by use of the risk premium.

The fair value less costs to sell was calculated using a DCF approach by discounting the forecasted cash flows using the assumptions mentioned above, and after considering the capital expenditure requirements and deducting the costs to sell.

Based on management’s impairment assessments, as a result of the downward medium-term trading expectations due to the current economic environment and negative impact of the global Covid-19 pandemic, the carrying values of the hotel properties were impaired during the year.

The impairment of property, plant and equipment is considered to be a matter of most significance to our current year audit due to:

  • the significant judgements made by management in determining the net cash flows, terminal growth rates and discount rates; and
  • the magnitude of the impairment loss recorded in the consolidated income statement for the year ended 31 March 2020.
    

We updated our understanding of and tested the relevant controls related to the budgeting process, which included controls in relation to the following:

  • setting, approval and review of budgets by the Group; and
  • approval of budgets by the Board of Directors.

We assessed the reliability of the Group’s budgets included in the business plans (which form the basis of the cash flow forecasts), by comparing prior period budgets to actual results, and accepted management’s budgeting techniques applied.

We tested the reasonability of the Covid-19 related and other adjustments made to the approved budgets by evaluating the adjusted prices and expected demand, taking into account the trading environment and regulatory requirements at the time and based on discussions held with management. We accepted the adjustments made, based on our assessment above.

We further assessed whether there were any impairment indicators for all items of PPE in terms of IAS 36. For PPE items that had indicators of impairment we performed the following procedures:

  • We assessed the appropriateness of the valuation methodology against industry practice and IAS 36 requirements and found the methodology used by management to be in line with industry practice;
  • We tested the cash flows in year one and two of the valuation. The cash flows were expected to be significantly affected by the restrictions as a result of Covid-19. Based on our work performed, we accepted the impact that management has projected; and
  • We evaluated the cash flows in the valuations from year three to assess the reasonableness of the expected cash flows with reference to historical cash flows.

Utilising our valuation expertise we tested the reasonableness of management’s assumptions for the terminal growth rates and discount rates by performing the following procedures:

  • we assessed the reasonableness of the terminal growth rates by independently determining a range of rates comparable to forecasted CPI growth in the hotel industry. We compared the rate applied by management to our independently determined rates and found management’s rates to be within our range of rates.
  • we assessed the reasonableness of the discount rates used in the valuations by independently calculating a range of rates which would be considered reasonable against comparable companies in the hotel industry, adjusted for the Group’s target capital structure. We compared our range of rates to the rates applied by management. We found management’s rates to be within our independently computed range of rates.

We recalculated each of the recoverable amounts determined by management, as well as the impairment loss recognised for mathematical accuracy. We noted no material differences.

We tested the sensitivity analyses performed by management to determine the degree by which the key assumptions needed to change in order to trigger impairment, by comparing the changes in the discount rates, terminal growth rates and forecasted cash flows disclosed by management to our independently determined range of assumptions. We found management’s assumptions applied in the sensitivity analysis to be within our determined range of assumptions.

OTHER INFORMATION

The directors are responsible for the other information. The other information comprises the information included in the document titled “Tsogo Sun Hotels Integrated Annual Report 2020” and “Tsogo Sun Hotels Limited annual financial statements for the year ended March 31, 2020”, which includes the Directors’ Report, Report of the audit and risk committee and the Declaration by the Company Secretary as required by the Companies Act of South Africa. The other information does not include the consolidated or the separate financial statements and our auditor’s reports thereon.

Our opinion on the consolidated financial statements does not cover the other information and we do not express an audit opinion or any form of assurance conclusion thereon.

In connection with our audit of the consolidated financial statements, our responsibility is to read the other information identified above and, in doing so, consider whether the other information is materially inconsistent with the consolidated financial statements or our knowledge obtained in the audit, or otherwise appears to be materially misstated.

If, based on the work we have performed, we conclude that there is a material misstatement of this other information, we are required to report that fact. We have nothing to report in this regard.

RESPONSIBILITIES OF THE DIRECTORS FOR THE CONSOLIDATED FINANCIAL STATEMENTS

The directors are responsible for the preparation and fair presentation of the consolidated financial statements in accordance with International Financial Reporting Standards and the requirements of the Companies Act of South Africa, and for such internal control as the directors determine is necessary to enable the preparation of consolidated financial statements that are free from material misstatement, whether due to fraud or error.

In preparing the consolidated financial statements, the directors are responsible for assessing the Group’s ability to continue as a going concern, disclosing, as applicable, matters related to going concern and using the going concern basis of accounting unless the directors either intend to liquidate the Group or to cease operations, or have no realistic alternative but to do so.

AUDITOR’S RESPONSIBILITIES FOR THE AUDIT OF THE CONSOLIDATED FINANCIAL STATEMENTS

Our objectives are to obtain reasonable assurance about whether the consolidated financial statements as a whole are free from material misstatement, whether due to fraud or error, and to issue an auditor’s report that includes our opinion. Reasonable assurance is a high level of assurance, but is not a guarantee that an audit conducted in accordance with ISAs will always detect a material misstatement when it exists. Misstatements can arise from fraud or error and are considered material if, individually or in the aggregate, they could reasonably be expected to influence the economic decisions of users taken on the basis of these consolidated financial statements.

As part of an audit in accordance with ISAs, we exercise professional judgement and maintain professional scepticism throughout the audit. We also:

We communicate with the directors regarding, among other matters, the planned scope and timing of the audit and significant audit findings, including any significant deficiencies in internal control that we identify during our audit.

We also provide the directors with a statement that we have complied with relevant ethical requirements regarding independence, and to communicate with them all relationships and other matters that may reasonably be thought to bear on our independence, and where applicable, actions taken to eliminate threats or safeguards applied.

From the matters communicated with the directors, we determine those matters that were of most significance in the audit of the consolidated financial statements of the current period and are therefore the key audit matters. We describe these matters in our auditor’s report unless law or regulation precludes public disclosure about the matter or when, in extremely rare circumstances, we determine that a matter should not be communicated in our report because the adverse consequences of doing so would reasonably be expected to outweigh the public interest benefits of such communication.

REPORT ON OTHER LEGAL AND REGULATORY REQUIREMENTS

In terms of the IRBA Rule published in Government Gazette Number 39475 dated 4 December 2015, we report that PricewaterhouseCoopers Inc. has been the auditor of Tsogo Sun Hotels Limited for 51 years.

PricewaterhouseCoopers Inc.
Director: Pietro Calicchio
Registered Auditor

Johannesburg

14 August 2020

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