Share Analysis: Kumba - Mining

The Company

Kumba is a listed iron ore mining company and 70% subsidiary of global diversified miner Anglo American, benefitting from group procurement and mine optimisation strategies. Kumba was formed in a 2001 demerger from South African integrated steel company Iscor and a subsequent demerger of coal mining operations in 2006 to form a separately listed company, Exxaro. Exxaro simultaneously became the 20% black economic empowerment equity shareholder of Kumba’s subsidiary, Sishen Iron Ore. Currently, Kumba’s principal operations are the Sishen mine (targeted steady state production of 38m tonnes per annum, tpa) and Kolomela (targeted steady state production of 13m tpa).

Kumba exported 85% of its 2014 iron ore production to Asia and Europe, most of which went to China (57%). Iron ore is exported via railroads owned and operated by state-owned enterprise Transnet. Transnet has completed expansion of its iron ore channel to 60m tonnes per annum, enabling Kumba to export from Kolomela. Transnet is currently conducting pre-feasibility studies to expand its operation to 90m-93m tpa in consultation with producers that include Kumba. Domestically, Kumba sells its iron ore mainly to ArcelorMittal South Africa (AMSA).

Although Kumba generates less than 9% of group profit from domestic iron ore sales, local stakeholder relationships with customers and government nonetheless remain important for its operations. In 2013 Kumba resolved litigation with AMSA, the Department of Mineral Resources and Imperial Crown Trading relating to the award of Sishen mining rights. An appeals court ultimately decided in favour of Kumba.

The company was also subsequently able to resolve a long-standing dispute with AMSA over the pricing arrangements for iron ore on a cost-plus basis. As an iron ore pure play, Kumba’s performance is inextricably linked to the price of iron ore which has fallen 70% from its 2011 peak and 25% since the start of 2015.

Development Strategy

Faced with the very real prospect of lower iron ore prices, Kumba’s primary focus is cash conservation. Kumba management announced plans to cut previously approved capital expenditures by R7.7bn ($665.3m) over the next three years, driven primarily by revisions to the respective plans of Sishen and Kolomela. In a bid to maintain the sustainable cash cost savings of 20% achieved in the year to date, Kumba management has reduced the permanent and fixed-term employee headcount by 60%, and has achieved a similar level of cost savings by substantially reducing corporate overheads and curtailing project and technical studies. Further highlighting the company’s commitment to cash conservation, Kumba’s board of directors took the decision to suspend the company’s interim dividend payment this year for the first time since the company began trading as a standalone entity in 2006.

Ultimately, Kumba targets a cash break-even price of $45 per tonne by the end of 2015, which we view as being achievable. Non-controllable costs such as freight, as well as the premium Kumba receives for the higher average lump content of its product could, however, act as a headwind against this aim in the event of a material adverse adjustment to either variable. That said a period of protracted weakness of the South African rand relative to the dollar ought to provide margin support for Kumba.

On the basis of sustainably lower cash costs and material near-term capital expenditure revisions, we expect Kumba’s balance sheet and cash flow metrics to gradually improve over the remainder of 2015 and into 2015. Increasingly cash generative from the second half of 2015, we believe Kumba will be comfortably positioned to declare a final dividend at yearend more than sufficiently covered by the company’s free cash flow. Cash surplus to the company’s capex and dividend commitments could then be utilised to reduce Kumba’s current R13bn ($1.1bn) debt balance.