Kumba: Mining

THE COMPANY: Kumba is a listed iron ore miner and a 65% subsidiary of global diversified miner Anglo American, benefitting from group procurement and mine optimisation strategies, for example. 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 simultaneously became the Black Economic Empowerment (BEE) equity shareholder of Kumba’s subsidiary Sishen Iron Ore Company.

Kumba’s principal operations are currently Sishen mine (41m tonnes per annum), Thabametsi (1m tonnes per annum but approaching the end of its life in 2016) and an expansion project which was commissioned in late 2011, Kolomela (projecting 9m tonnes per annum when fully ramped up in 2013).

Kumba exported 85% of its 2011 iron ore production to Asia and Europe, most of which went to China (66%). 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 90 and 93m tonnes per annum.

Kumba is a low-cost producer with cash costs of under $20 per tonne (in the lower quartile of the global cost curve). Given average iron ore prices in 2011 of $159 per tonne, Kumba achieved a group operating profit margin of 65.8% and cash flow of R35.3bn ($4.32bn) before mineral royalty. Some 60% of Kumba’s production is lump-sized, which can attract a premium price. Kumba’s dividend cover for 2011 was 1.2 and historical dividend yield was 8.4% in March 2012, high in the context of a Johannesburg Stock Exchange top 40 dividend yield of 2.6% at the time, Bloomberg reported.

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 with customers and government 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, but this decision has been appealed by the DMR and ICT and the timing of ultimate resolution is now uncertain.

In addition, 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. As a mining company operating in South Africa, Kumba is also affected by current uncertainty over African National Congress policy with respect to potential increased state intervention in mining (for example, through higher taxes), electricity cost inflation and short-term supply uncertainty plus wage cost inflation.

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) due to a change in Sishen, which involves increased waste stripping. 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. Kumba would undertake this African expansion in partnership with its parent company Anglo American. Kumba does not own freight vessels but it is using a wider portfolio of freight instruments. For example, two contracts are in place for 6m tonnes per annum in total – both over a 10-year period and at relatively lower freight rates.