Kumba Annual Report 2003

OVERVIEW

Kumba’s second year as an independent entity was again marked by stable operational performance and an increased focus on cost containment and production efficiency. While turnover rose by 4%, attributable earnings decreased by 26%, due mainly to the sustained strengthening of the rand, lower iron ore prices for nine months of the financial year, and a severely depressed market for zinc.

Fortunately, as from 1 April 2003, the iron ore prices increased by 8,9% for lump ore and 9,0% for fine ore. These prices will remain in force until the end of March 2004.

Kumba has taken great strides in its reporting standards in that we have embraced sustainability reporting. We believe that triple bottom-line reporting actually has a fourth dimension – using our mineral resources wisely and in a sustainable manner, both through technology and innovative and responsible management.

As the chairman has noted, a volatile domestic currency affects the ability of most commodity companies to plan ahead, apart from the immediate effect of currency volatility on earnings. We will manage this risk proactively by increasing efficiencies to support earnings in the 2004 financial year, given our expectation that the rand will continue to be stronger than in the previous year.

While we accept the views of both the Reserve Bank and government that South Africa needs to adjust to a stronger rand environment, it must be recognised that many of the revenue and cost pressures making it difficult for local exporters to survive in a strong rand environment are beyond the control of industry. For example:

•	In the commodity business, exporters are price takers and cannot pass domestic cost increases on to customers.
•	In South Africa, almost half of the fixed capital assets of the economy is controlled by government either directly through parastatals or municipalities and the like. Business, therefore, has either limited or no choice in the procurement of certain goods and services and often has to contend with extraordinary cost increases. In Kumba’s case, the group contends with the following situations:
	–	General freight line tariffs for coal exports increased by 80% since 1 July 2002. This increase, coupled to the current dollar market prices and strong rand exchange rate, has rendered coal exports uneconomical.
	–	Government set a precedent for the country’s annual wage negotiations with the relatively high wage increases it granted to its employees, the second consecutive year that this has occurred.
•	The war in Iraq and ongoing conflict has left a legacy of relatively high oil prices. This seriously affects the cost structure of Kumba’s highly mechanised operations, which consume six million litres of diesel and other fuel products per month.

STABLE OPERATIONAL PERFORMANCE, INCREASED FOCUS ON COST CONTAINMENT AND PRODUCTION EFFICIENCY

If exporters are to cope with the strong rand environment, all service providers, including government, will have to remain focused on cost containment and efficiency improvement, otherwise the inevitable result will be the demise of exporters, particularly in the minerals industry. A strong case must be made here for close cooperation between industry and the various government agencies to ensure that solutions are found that serve the interests of South Africa best in the long run. A sterling example of such cooperation in recent years has been the excellent results achieved by Kumba and Spoornet in terms of improvements in efficiency levels on the Orex rail line. This has led to huge benefits for both parties and the country in general.

The issue of rationalisation of iron ore interests in the Northern Cape has been under discussion and negotiation for some time. Kumba supports the concept of a full amalgamation, with due regard to the interests of other parties, as we believe a consolidated operation would release the maximum synergistic value for all stakeholders through optimal development of the assets. However, we have in recent months concentrated on an exchange of mineral rights and the so-called North-South model, which also has the potential to unlock substantial, albeit lesser, value for both sets of shareholders. In the meantime, we have continued to plan the development of the proposed Sishen South mine. Our preferred option, as presented to government and other stakeholders, involves the optimal sustainable development of the resource base, extracting maximum synergies that exist between current regional assets, and the most efficient use of rail infrastructure, including the expansion of the Sishen-Saldanha rail and port infrastructure and the possible use of the general freight line for iron ore exports through the Port of Ngqura (Coega) near Port Elizabeth in the Eastern Cape. We believe that by managing and operating the regional assets and exploiting the iron ore reserves as a single business unit, best practices could be applied across the production sites to achieve additional savings on overheads. This model would also maximise profits arising from optimal product and logistical configuration, a single railway line user and would facilitate significant empowerment ownership.

Delays in the implementation of the project to expand the Sishen-Saldanha rail line and port to 29Mtpa by June 2005 have the potential to curtail hard currency inflow into the country and the creation of jobs, by limiting exports. These expansions will allow Kumba to rail about 23,5Mtpa of which 1,8Mtpa is to Saldanha Steel (Iscor Limited).

Concurrently, Kumba, Spoornet and SA Port Operations are also exploring the feasibility of a further increase in the capacity of the Sishen-Saldanha rail line and the Saldanha port by at least 8,5Mtpa to 38Mtpa to cater for the expansion of Kumba’s iron ore production in the Northern Cape through its Sishen South project or some variation of the North-South model.

The Chinese market demand for iron ore continues to expand at unprecedented rates. If South Africa is to maintain its position in this rapidly expanding market, it is essential that the implementation of the expansion programme at the port of Saldanha and the plans to increase the Orex rail line’s annual capacity to 38Mtpa be completed as soon as possible.

The negative effect of very high general freight rail tariff increases during the year has made certain of Kumba’s products, particularly coal, uneconomical in the export market. This highlights the importance of the Richards Bay Coal Terminal Phase V (South Dunes Coal Terminal) expansion to be given the go-ahead with the concomitant resolution of the common user tonnage issues. Phase V stands on its own merit and we firmly believe it should not be delayed by broader issues concerning Richards Bay Coal Terminal and SA Ports Authority. As was indicated by our chairman, we contend that this would seriously jeopardise the very empowerment that government is seeking to encourage and promote.

At the time of the group’s formation, Kumba chose to position itself as a South African-based company in the true spirit of citizenship. This is the foundation on which we built our approach and engagement with all stakeholders, particularly with the major changes happening in the legislative environment.

Kumba has embraced the concept of corporate citizenship on its journey towards sustainability. This initiative aims to integrate all activities currently undertaken across the group in areas of social investment, safety, health, environment, human resources development, employment equity, preferential procurement and black economic empowerment.

The mining charter and its attendant mining scorecard developed during the course of the year under review form an integral part of the Minerals Act. The charter requires that the industry assists companies owned by historically disadvantaged South Africans (HDSAs) to secure financing to fund their participation in an amount of R100 billion within the first five years. This equates to roughly 15% of the value of the industry, and is in pursuance of a longer-term (ten-year) target of 26% based on a willing buyer –willing seller basis, at fair market value. Kumba is already well down the track in meeting the requirements of the charter. We view all the targets as realistic and achievable, and they are in line with the strategy we set for ourselves from the outset when we created the group. In some cases, such as empowering women, we have already met the set requirements and will continue to strive to reach even higher levels. We are confident of achieving our empowerment targets sooner rather than later, however timing of the conversion of our mineral rights depends on the final outcome of the Royalties Bill.

EMBRACED THE CONCEPT OF CORPORATE CITIZENSHIP ON OUR JOURNEY TOWARDS SUSTAINABILITY

HIGHLIGHTS

In March 2003, in line with the strategy of developing our heavy minerals business through Ticor Limited (Ticor), Kumba increased its shareholding in the Australian-listed heavy minerals group to 51,4%, making it a subsidiary of the group. Accordingly, Ticor’s results are now fully consolidated (since 1 April 2003), and Ticor’s financial year end will change from December to June to reflect that of its holding company, Kumba. The partnership between Kumba and Ticor has made a significant contribution to the latter’s success in the heavy minerals industry in both Australia and South Africa.

Our investment in the Ticor SA heavy minerals project is beginning to reap dividends, with the first furnace of the Empangeni smelter starting up on schedule and commissioning beginning in March 2003. Production at the mine and minerals separation plant has already yielded excellent results. This division has very promising prospects and is likely to become the second-largest contributor to Kumba’s revenue and earnings after iron ore by 2006.

The development of Sishen, specifically Sishen South, is at an important stage. The Sishen South, project’s technical feasibility study has been completed and is currently being evaluated. Kumba is thus well placed to participate in regional industry rationalisation, as noted earlier. Should a North-South model or some other form of rationalisation emerge from the current negotiations in the Northern Cape as being economically more favourable, the planned capacity expansion could be achieved through implementation of the revised configuration.

In China, the joint venture between our base metals division, the Chifeng Hongye Zinc Smelting Company and the Baiyinnuoer Lead Zinc Mine Company Limited received final approval from the Kumba board in February 2003. This has signalled the start of the expansion and joint operation of the Hongye zinc refinery and the roaster at Lindong (as detailed in the review of growth opportunities). It will give Kumba a better understanding and stronger foothold in China, which is the world’s most important market for base metals.

Kumba has made significant progress in enhancing its risk management systems, which are now on par with best practice in our industry. These systems are reviewed regularly, from operational to corporate level and results are reported to the board bi-annually.

Our determination to make our value system a tangible reality was entrenched in November 2002, with the launch of the Kumba Way, which embodies commitment, teamwork, a shared vision, seeking better ways to do things and encouraging the aspirations of all. The Kumba Way is founded on identifying best practices throughout the group or externally and using these to realise our goal and practice of continuous improvement.

In April 2003, our subsidiary ZnERGY (Zinc-air Energy Systems), started manufacturing zinc-air fuel cells at a plant site in Pretoria. This project was announced at the World Summit for Sustainable Development in Johannesburg in 2002. Manufacturing under licence from a German firm, ZOXY Energy Systems AG (ZOXY), ZnERGY will meet the growing demand for high-density, long-life and low-cost battery systems. It is a practical and recyclable means of energy storage that will help reduce the environmental impact of using conventional batteries to generate power, particularly in areas with little or no access to conventional electricity. ZOXY has achieved great success in breaking into the European uninterrupted power supply markets.

Sustainable development and corporate citizenship are now a fundamental part of Kumba’s strategy. Kumba is committed to ensuring that, at all times and in all our operations, the operating standards we maintain and the legacy we leave behind is positive for the surrounding communities and the environment.

Kumba continued to honour its commitment to training and development of its employees as part of the group’s socio-economic empowerment strategy and to further improve efficiency levels. During the year, Kumba invested R62,2 million in training and developing employees, equating to 5,7% of total payroll. This is above the Mining Qualifications Authority’s average of 3,8% for mining companies with more than 5 000 employees. Kumba is proud to have trained 24% of the total number of artisan trainees in the mining industry during the year under review.

APPRECIATION

In just two years, Kumba has taken truly giant strides, underpinned by one of the best teams in the mining industry – people determined to make it happen. Our technical and managerial competencies compare with the best in the industry. The integrity, the ethics by which our people live and work set us apart and I thank them most sincerely.

Special tribute also needs to be paid to our customers for their loyal support, to our suppliers from whom we have enjoyed excellent service delivery and to our trade unions with whom we maintain sound relationships and who have supported all the major initiatives in the group.

On behalf of management, I thank our board of directors for their support, independence and commitment to good corporate governance. In particular, our chairman, Dawn Marole, is adding tremendous value to the group and we look forward to continued guidance and counsel from the board under her leadership.

OUTLOOK

Kumba faces a challenging year ahead, but there are several positive factors that we believe will assist our performance, including the increase negotiated for iron ore prices until March 2004. Equally, following the successful ramp-up of heavy minerals production, the first shipments of titanium slag will be made soon. Kumba will benefit from the expected reduction in interest rates as we are in a net borrowed position. Finally, underscoring the fundamental strength of the group, all our operations are expected to produce good physical performance during the new financial year.

As noted, sustained rand strength affects all exporters, and Kumba is no exception. The global outlook for commodities, other than iron ore, is expected to remain weak to muted. This outlook, coupled to input cost structure increases such as rail tariffs and high oil prices, will test the mettle of all Kumba’s people to further improve efficiencies.

Earnings are expected to remain under pressure in the new financial year. However, we are clearly focused on steps that can be taken to ensure that we continue to operate efficiently and are confident of again producing outstanding operating results that should underpin earnings in these tough market conditions.

Con Fauconnier

Chief Executive

10 September 2003

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