Kumba: Basic materials

The Company

Kumba is a listed iron ore miner and a 65%-held subsidiary of global diversified miner Anglo American, benefitting from group procurement and mine optimisation strategies. Kumba was formed by a demerger in 2001 from South African integrated steel company Iscor and a subsequent demerger of coal mining operations in 2006 to form a separate listed company, Exxaro. Exxaro became the Black Economic Empowerment (BEE) equity shareholder of Kumba’s subsidiary Sishen Iron Ore Company.

Kumba’s principal operations currently comprise the Sishen mine (41m tonnes per annum), Thabazimbi (1m tones per annum, but approaching the end of its life in 2016) and an expansion project which was commissioned in late 2011, Kolomela (on track to produce 9m tonnes in 2013). Kumba exported 89% of its 2012 iron ore production to Asia and Europe, most of which went to China (68%).

The iron ore is exported via railroads owned and operated by state-owned enterprise Transnet. Transnet has recently completed an expansion of its iron ore channel to 60m tonnes per annum, enabling Kumba to export from Kolomela in 2011. Transnet is currently conducting pre-feasibility studies to expand its operation to between 90m and 93m tonnes per annum. Kumba is a low-cost producer with cash costs at Kolomela of under $20 per tonne (in the lower quartile of the global cost curve). Given average iron ore prices in 2012 of $130 per tonne, Kumba achieved a group operating profit margin of 51% and cash flow of R25.3bn ($3.03bn) before mineral royalty. Some 60% of Kumba’s production is lump-sized, which can attract a premium price. Kumba’s dividend cover for 2012 was 1.2 and historical dividend yield was 7.3% in 2012, high in the context of a Johannesburg Stock Exchange top 40 dividend yield of 2.8% in the same period.

Domestically, Kumba sells its iron ore mainly to ArcelorMittal South Africa (AMSA, a subsidiary of global steel producer ArcelorMittal). Although Kumba generates less than 10% of group profit from domestic sales of iron ore, local stakeholder relationships remain important for its operations.

Kumba is currently involved in litigation with AMSA, the Department of Mineral Resources (DMR) and Imperial Crown Trading (ICT) relating to the award of Sishen mining rights. A court decision in December 2011 found in favour of Kumba and AMSA, and this decision was upheld by the appeals court in March 2013, Both ICT and the DMR have now lodged applications for leave to appeal to the Constitutional Court.

Additionally, Kumba and AMSA are in dispute over the pricing arrangements for iron ore. Historically, this was charged at cost plus 3%, but it is currently charged at a blended average of $65 per tonne and is the subject of arbitration which will be decided once the mining rights court case has been finalised.

Kumba’s operational and financial performance was affected in 2012 by unprotected strike action at the company’s Sishen mine, with some knock-on effects likely to continue to be felt in 2013.

Development Strategy

Kumba aims to maximise cost efficiencies – it is currently experiencing significant cost inflation (10% above usual levels of mining cost inflation in South Africa), in part due to the strike action in 2012 which has necessitated additional waste stripping at Sishen. Historical stripping ratios of below 2.0 are expected by management to increase towards 3.0 over the next three to four years, with an average stripping ratio of 3.5 times over the life of mine. Kumba has an extensive growth strategy which aims to reach production levels of 70m tonnes per annum by 2019 from South African expansion and an additional 10m to 20m tonnes per annum by 2020 from expansion into West Africa.

However, the company is evaluating any potential projects cautiously. In the nearer term, Kumba hopes to resolve its legal challenges with respect to mineral rights and ownership soon, while continuing to implement the company’s expansion strategy in partnership with its corporate parent Anglo American.