FINANCIAL REVIEW

FINANCIAL REVIEW

FOR THE YEAR ENDED 31 DECEMBER 2011

SIGNIFICANT DISTRIBUTIONS TO SHAREHOLDERS

	“ The group has again posted outstanding financial results”
Vincent Uren, Chief financial officer

Kumba’s headline earnings for the year ended 31 December 2011 were a record R17.0 billion, 19% more than the R14.3 billion achieved in 2010. This financial performance was achieved mainly as a result of a weighted average increase of 26% in export iron ore prices realised and a 3% increase in export sales volumes. Attributable and headline earnings for the year were R53.11 and R53.13 per share respectively, on which a final cash dividend of R22.50 per share was declared, bringing the total dividend for 2011 to R44.20 per share.

We continue to deliver increasing value to our listed shareholders and also to Sishen Iron Ore Company’s Black Economic Empowerment shareholders by returning substantial cash dividends. The group announced the maturity of the first phase of Envision, its broad based employee share scheme with 6,209 permanent employee members, on 29 November 2011. Envision was valued at R2.7 billion at the conclusion of its first phase, resulting in employee members who have worked for Kumba over the five-year period since its inception in 2006, each receiving R576,045 (pre-tax). Envision is a broad based empowerment success story and sets a benchmark for empowerment goals and ideals in South Africa.

OPERATIONAL PERFORMANCE

The key indicators of our operating results during the past year were:

REVENUE (R billion)	CAGR:43%

REVENUE up 26% to R48.6bn

HEADLINE EARNINGS up 19% to R17.0bn

FINAL CASH DIVIDEND R22.50 per share

ENVISION Returns R2.7bn to employees

OPERATING PROFIT (R billion)	CAGR:52%		SISHEN MINE UNIT CASH COST (R/tonne)	CAGR:19%
			* The 2010 unit cash cost was restated to take into account non-cash share-based payment expenses

ATTRIBUTABLE EARNINGS AND DIVIDEND PER SHARE (Rand)	CAGR EPS:51%; CAGR DPS:56%

OPERATIONAL PERFORMANCE

Rand million	2011		2010		% change		2009
Revenue	48,553		38,704		25%		23,408
Operating expenses	(16,587)		(13,573)		22%		(10,528)
Operating expenses (excl. mineral royalty)	(14,825)		(12,163)		22%		(10,528)
Mineral royalty	(1,762)		(1,410)		25%		–
Operating profit	31,966		25,131		27%		12,880
Operating margin (%)	66		65		–		55
Headline earnings	17,048		14,328		19%		6,972
Cash from operations	32,631		25,555		28%		12,745
Capital expenditure	5,849		4,723		24%		3,996

REVENUE

The group’s total mining revenue (excluding shipping operations – R2.7 billion in 2011; R2.9 billion in 2010) of R45.8 billion for the year was 28% higher than the R35.8 billion of 2010.

The increase in mining revenue was driven by a weighted average increase of 26% in export iron ore prices compared to 2010, which added R9.6 billion. Spot iron ore prices traded at record highs during the first half of 2011 as the demand for iron ore exceeded supply. In 2011, global steel production was up by 6% to 1.5 billion tonnes, of which 683Mt was produced in China, an increase of 7%. To support this growth in steel production, China’s seaborne iron ore imports rose by 8% to 654Mt with the balance of China’s iron ore needs met by domestic iron ore production. However, the global economic uncertainty in the second half of the year, coupled with a credit liquidity squeeze in China, particularly affecting downstream steel stocking by end users and the construction sector, caused steel prices to fall. In turn, steel mills cut production, slowed purchasing of raw materials, focused on fine ore (rather than lump ore) and turned to sourcing lower grade ore to limit absolute costs. This halted increases in the spot price of iron ore. By the end of the third quarter, steel production had started to slow noticeably as steel prices continued to weaken and market sentiment remained uncertain. Spot iron ore prices fell to a low of US$116.75/tonne CFR at the end of October 2011, losing around 35% from the peak achieved in early September 2011. Similarly lump iron ore premiums came under severe pressure during the fourth quarter of 2011. Steel markets in China remain subdued but have stabilised with steel producers resuming the sourcing of iron ore during November 2011 as stocks had been run down and spot iron ore pricing found a support level provided by high cost Chinese domestic iron ore production. Spot prices have recovered and climbed to around US$140.00/tonne CFR to China.

REVENUE 2011 (R million)	2010 (R million)

ANALYSIS OF THE INCREASE IN REVENUE (R million)

REVENUE – SEGMENT ANALYSIS
2011 (R million)	2010 (R million)

REVENUE – GEOGRAPHICAL ANALYSIS
2011 (R million)	2010 (R million)

In addition we increased our export sales volume by 3% or 1.0Mt on which these higher prices were realised – this increased
revenue by R764 million.

The average Rand/US$ exchange rate of R7.25 to the dollar was marginally stronger than the R7.30 achieved during 2010 which resulted in a decline in revenue of R335 million.

Due to lower freight rates, the revenue from shipping operations of R2.7 billion was R168 million down on the R2.9 billion earned during 2010. This revenue was earned on 21.7Mt shipped on behalf of our customers. The margin achieved has been sustained delivering a profit of R337 million for the year.

Revenue generated from Sishen mine increased significantly by 28% due to increased export prices and sales volumes, Thabazimbi mine’s revenue was up 36%, revenue of R32 million was generated on the sale of first ore by Kolomela mine and revenue from our shipping operations decreased by 6%, as compared to 2010.

62% of revenue was earned from sales to customers in China, 19% from customers based in the rest of Asia and 11% from European customers. A geographical analysis of revenue earned based on the country of origin is provided above.

OPERATING EXPENDITURE

Operating expenses increased by 22% year on year from R13.6 billion to R16.6 billion. Mining operating expenses increased by R2.8 billion or 30% from 2010 (calculated on operating expenses excluding shipping expenses and the mineral royalty). As with the rest of the industry, Kumba experienced mining inflation well in excess of CPI. A number of cost items increased well in excess of inflation, such as the price of diesel which increased by 24%. In addition, operating costs remained under pressure due to large planned increases in waste mining activities across all our sites.

Operating expenses was favourably affected by higher finance gains realised from the revaluation of US$ denominated monetary assets and derivative instruments, to the value of R587 million.

Selling and distribution costs rose by 22% year on year to R3.7 billion. This was primarily driven by rail and port tariff contractual increases, a 7% increase in volumes railed by Transnet to 39.1Mt and a 3% increase in volumes loaded at the port, to 37.6Mt.

Sishen mine unit cash cost

Sishen mine produced 38.9Mt, 6% lower year on year as operations were disrupted during the first half of 2011. The mine managed to mitigate some of the production shortfall by producing 9% more in the second half of 2011. This production shortfall had a significant impact on Sishen mine’s unit cash cost which has a substantial fixed cost element. As a result unit cash costs increased by 35% to R150/tonne from the R111/tonne achieved in 2010. However, at US$21/tonne the mine remains well positioned in the lower part of the cash cost curve.

OPERATING EXPENDITURE

Rand million	2011		2010		% change		2009
Production costs	9,497		7,317		30		5,960
Movement in inventories	(149)		(459)		(68)		(600)
Finished products	247		(171)		–		(440)
Work-in-progress	(396)		(288)		38		(160)
Finance gains	(587)		(286)		105		(329)
Other	–		(2)		–		(30)
Cost of goods sold	8,761		6,570		33		5,001
Selling and distribution costs	3,698		3,041		22		2,838
Sublease rent received	(8)		(8)		–		(8)
Mining operating expenses	12,451		9,603		30		7,831
Mineral royalty	1,762		1,410		25		–
Cost of services rendered – shipping	2,374		2,560		(7)		2,697
Operating expenses	16,587		13,573		22		10,528

We saw a R39/tonne increase in unit cash cost which was driven by a few key factors:

–	Inflationary pressures, principally on labour and contract mining, pushed up costs by almost R7/tonne;
–	A number of cost items increasing well in excess of inflation, such as the price of diesel which increased from R7.50 per litre to R9.30 per litre. This accounted for R7/tonne of the nearly R13/tonne increases in excess of inflation and increased maintenance cost on the larger mining fleet contributed a further R3/tonne;
–	The increased mining activity added almost R11/tonne or 10%; and
–	The production shortfalls added R9/tonne.

Further increases in unit cash costs are anticipated as the mine increases the waste stripping according to plan. The increased waste stripping is expected to add 10% per annum to unit cash costs (before mining inflation) for the next 2 to 3 years.

The group’s Asset Optimisation and Supply Chain programmes are now embedded in the business. Sishen mine’s Asset Optimisation initiatives are focused on improving the efficiency of mining operations on a sustainable basis. Through these initiatives and procurement savings we seek to contain some of the cost increases. The Sishen Mine unit cash cost structure per major cost component – both on a Rand per tonne as well as a percentage basis – is illustrated below. Compared to 2010, with the significant increase in the cost and utilisation of diesel, the relative contribution of this cost item to the mine’s cost structure saw an increase from 13% to 17%.

SISHEN MINE UNIT CASH COST STRUCTURE
2011 (R/tonne)	2010 (R/tonne)

2011 (%)	2010 (%)

SISHEN MINE UNIT CASH COST (R/tonne)

Operating profit (EBIT)

Operating profit increased by 27% from R25.1 billion to a record R32.0 billion. The group’s operating profit margin increased marginally to 66%. Excluding the margin earned from providing a shipping service to customers, the group’s mining operating margin remained stable at 69%. The operating profit achieved was impacted by the increase in operating expenses on the back of the growth in mining volumes across the group and above inflationary cost increases.

Operating profit improved principally as a result of:

• A weighted average increase of 26% in iron ore export prices, which added R8.9 billion to operating profit and a 3% growth in export sales volumes which contributed R954 million; and
• An R18 million rise in profit from shipping operations. Total tonnes shipped by Kumba on behalf of customers increased by 3.0Mt from 18.7Mt in 2010 to 21.7Mt for 2011.

This increase in operating profit was offset by:

• A R2.5 billion or 36% increase in operating expenses (excluding selling and distribution expenses, shipping expenses and the mineral royalty) driven by the substantial increase in waste mined at Sishen and Thabazimbi mines, and above inflationary pressures on costs;
• A R656 million increase in selling and distribution costs, mainly as a result of a 7% growth in total volumes railed at an increased tariff;
• The mineral royalty for 2011, at an effective rate of 4.4% of free-on-rail (‘FOR’) iron ore revenue, which added R352 million to operating expenditure; and
• The average Rand/US$ exchange rate of R7.25/USD1.00 was marginally stronger than the R7.30 achieved during 2010 and resulted in a decline in revenue of some R335 million.

The group’s operating profit per business segment is analysed below. Other segments, which include the Corporate Office, Project and Technical Services of the group, contributed to a net operating loss of R1.1 billion and R684 million for 2011 and 2010 respectively. Net finance income incurred on a centralised basis was R92 million for 2011 (R29 million net finance costs for 2010).

CAPITAL EXPENDITURE

Rand million	2011		2010
Capital expenditure	5,849		4,723
Comprising:
Expansion	3,104		3,099
Stay in business	2,745		1,624
Transfers from assets under construction to property, plant and equipment	8,951		1,519

Capital expenditure of R5.8 billion was incurred, of which R2.7 billion was to maintain operations, mainly for Sishen mine’s fleet expansion programme. R3.1 billion was invested to expand operations, mainly on Kolomela mine, and R317 million on the Sishen Westerly Expansion Project (SWEP) in 2011 (2010: R62 million).

The development of Kolomela mine was largely completed during 2011, and the mine commenced with commercial production in December 2011. On 1 December 2011 the capitalisation of mining operating expenses ceased as substantially all the activities for bringing the mine in the location and condition necessary for it to be capable of operating in the manner intended by management had been completed. R7.7 billion was subsequently transferred to property, plant, infrastructure and equipment from assets under construction.

Stay in business capital expenditure of some R3 billion is anticipated for 2012 and 2013 mainly due to the Sishen mining fleet replacement and associated infrastructure.

Cash flows

The group continued to generate substantial cash from its operations, with R34.3 billion (before the mineral royalty of R1.7 billion) generated during the year, 27% more than the R27.0 billion of 2010. These cash flows were used to pay aggregate dividends of R17.9 billion, taxation of R7.0 billion, the Envision payout of R2.7 billion and mineral royalties of R1.7 billion during 2011.

Cash generated during the year was utilised as follows:

EBIT – SEGMENT ANALYSIS
2011 (R million)	2010 (R million)

UTILISATION OF CASH GENERATED
2011 (%)	2010 (%)

Net debt

Kumba’s net cash position at 31 December was as follows:

Rand million	2011		2010
Long-term interest-bearing borrowings	–		3,185
Short-term portion of long-term interest-bearing borrowings	3,191		–
Total	3,191		3,185
Cash and cash equivalents	(4,742)		(4,855)
Net cash	(1,551)		(1,670)
Total equity	20,592		18,376
Interest cover (times)	206		77

At 31 December 2011 R3.2 billion of the total R8.6 billion long-term debt facilities has been drawn down to finance Kumba’s expansion. The R3.2 billion debt facility matures in 2012 and is due for repayment on 31 July 2012. We are well advanced with the process to put in place alternative funding options for the group.

Kumba was not in breach of any of its covenants during the year. The group had undrawn long-term borrowing and uncommitted short-term facilities at 31 December 2011 of R9 billion (2010: R9.3 billion). Kumba’s debt profile has a longer term bias,which reflects both our capital investment programme as well as the excellent results generated by our operations over the past
5 years. This has reduced the group’s dependency on short-term borrowing facilities.

SHAREHOLDER RETURNS

Share price

Kumba’s share price has shown a marked increase during the year, growing 39% from the closing price of R425 at 31 December 2010 to R500 at 31 December 2011. The share price has grown at a compound annual growth rate of 35% from the listing share price of R111 at the end of 2006. Kumba continued to outperform the mining index of the JSE during the year by some 25%.

Dividends

Kumba continues to return cash to its shareholders after considering the need to preserve cash to fund the future growth of the group. Kumba’s dividend policy of returning surplus cash to shareholders remains unchanged as does the desire to fund capital expenditure with debt instruments.

KUMBA CLOSING SHARE PRICE (Rand)

	Total dividend 2011		Final dividend 31 December 2011		Interim dividend 30 June 2011		Total dividend 2010		Total dividend 2009
Earnings per share (Rand per share)	53.11		24.88		28.23		44.66		21.94
Dividend per share (Rand per share)	44.20		22.50		21.70		34.50		14.60
Total dividend declared (Rm)	14,250		7,247		7,003		11,101		4 671
Dividend cover (times)	1.2		1.1		1.3		1.3		1.5

EMPOWERMENT

Rand million		2011		2010		2009		2008		2007
Dividend declared by SIOC		19,266		13,982		6,295		9,040		3,266
– Kumba		14,250		10,348		4,658		6,690		2,417
– Exxaro		3,851		2,796		1,259		1,808		653
– SIOC Community development trust		578		419		189		271		98
– Envision (Employee share ownership scheme)		587		419		189		271		98
Dividend cash flows to BEE hareholders1		4,170		1,876		1,811		1,076		392
– Exxaro		3,516		1,810		1,744		1,036		374
– SIOC Community development trust		527		4		8		8		7
– Envision (Employee share ownership scheme)		127		62		59		32		11

¹ Dividend cash flows in 2011 consists of the final cash dividend for 2010 and the interim dividend for 2011

Attributable and headline earnings for the year were R53.11 and R53.13 per share respectively (2010: R44.66 and R44.67 per share). The board reviewed the cash flow generation, growth plans and the capital structure of Kumba and declared a final dividend of R22.50 per share (interim dividend R21.70 per share), bringing the total dividend for the year to R44.20 (2010: R34.50). With the declaration of the final dividend the cover has reduced to 1.2 times for 2011 from 1.3 times in 2010. The total dividend declared to shareholders since listing is R122.60 per share.

The board will continue to consider the dividend payable at each declaration date after taking into account the financial position and prospects of the group.

Empowerment

Kumba continues to make a meaningful contribution towards South Africa’s broad based empowerment, through both capital appreciation and the payment of substantial cash dividends to the Black Economic Empowerment (BEE) shareholders of Sishen Iron Ore Company (Pty) Limited (SIOC):

• The group announced the maturity of the first phase of Envision, its broad based employee share scheme with 6,209 permanent employee members, on 29 November 2011. Envision was valued at R2.7 billion at the conclusion of its first phase, resulting in employee members who have worked for Kumba over the five-year period since its inception in 2006, each receiving R576,045 (pre tax). Members of the scheme have already received up to R55,000 in dividends through the course of the five year term. The second five year phase of the scheme commenced on 10 November 2011, through this second phase employees will receive their first dividend in March 2012 payable from the final SIOC 2011 dividend declared.
• The SIOC CDT, which owns an unencumbered 3% of SIOC, has received R1.3 billion in dividends since its inception five years ago, of which R527 million was received in cash during 2011 and R578 million will be paid in February 2012 from the final 2011 dividend declared by SIOC. These funds contribute towards sustainable community projects.
• Exxaro Resources Limited has received R8.5 billion in dividends since its listing five years ago.

KEY FACTORS AFFECTING FUTURE OPERATING RESULTS

Export iron ore sales prices and volumes

The short-term outlook for the global seaborne iron ore market is impacted by ongoing macro-economic uncertainty. Monetary tightening measures to control inflation in emerging economies such as China started to have the intended effect. In addition, a lack of co-ordinated policy response to tackle the European sovereign debt crisis also impacted demand. Despite the short-term macro-economic uncertainty, medium to long-term prospects for demand remains robust as China continues to industrialise and urbanise. Nevertheless, as China shifts from an investment intensive to consumption driven economy, the rate of growth for steel materials is expected to moderate to a more sustainable level.

PLATTS IODEX 62% Fe CFR (US Dollar)

While demand is a key driver for pricing, supply constraints also play a crucial role. In the short-term iron ore supply is anticipated to remain tight amid seasonal weather impacts in Brazil and Western Australia, and government’s moves in India to control export. Ongoing challenges producers face in delivering new supply will lead to increasing capital intensity and underpinned long-term pricing outlook.

Kumba’s ability to supply iron ore to the market will be enhanced by the ramping up of Kolomela mine during 2012 to produce between 4Mt and 5Mt in 2012. Export sales volumes in 2012 are anticipated to grow by ~3Mt from the volumes achieved in 2011 as volumes from Kolomela mine ramp up, offset by the fact that excess finished product stockpiles at Sishen mine have been depleted to operating levels.

Exchange rate

Relative to 2010, the US Dollar has weakened marginally against the South African Rand, remaining at pre-2008 levels, as can be seen from the graph below. A significant proportion of our turnover and capital expenditure is affected by Rand/US Dollar exchange rate, and as such Kumba’s operating profit remains highly sensitive to the Rand/US Dollar exchange rate.

Operating expenses

Annual production volumes from Sishen mine are expected to increase back to design capacity which should aid in containing unit cost increases. Waste mining at Sishen mine is anticipated to increase in line with the planned ramp up that commenced in 2009, which will put upward pressure on unit cash costs of production.

Operating efficiencies and revenue enhancement

Kumba continues to focus on operational excellence, productivity improvements and efficiencies. Achieving this optimisation is currently a critical factor at Sishen mine, where management is facing a challenging period of increasing waste stripping set to continue for the next two to three years. The western-dipping ore body requires increased waste stripping and tight pit conditions constrain face lengths which, in turn, limits flexibility. Sishen mine’s productivity improvement project, ‘Bokamoso’ continues to deliver efficiency and productivity improvements required to partially offset cost pressures associated with increased mining activity.

SIGNIFICANT ACCOUNTING MATTERS

Change in accounting estimates

Management has revised the remaining estimated useful lives of certain items of property, plant and equipment at Sishen mine, as well as the estimated rehabilitation and decommissioning provisions at both Sishen and Kolomela mines. The change in estimate at Kolomela mine was mainly as a result of a decrease in the useful life resulting from the exclusion of inferred mineral resources from the LOM plan for accounting purposes. The LOM plan on which accounting estimates are based only includes proved and probable ore resources as disclosed in Kumba’s annual Ore Reserves and Mineral Resources statement. The effect of these changes is detailed below:

Rand million	31 December 2011
Increase in environmental rehabilitation provision	67
Increase in decommissioning provision	20
Increase in accumulated depreciation	55

The change in estimate in the environmental rehabilitation provision and accumulated depreciation was applied prospectively from 1 January 2011 and resulted in a decrease in attributable profit before taxation and headline earnings per share for the year ended 31 December 2011 of R122 million and 21 cents, respectively. The change in estimate in the decommissioning provision has been capitalised to the related property, plant and equipment.

Ore reserve and mineral resource – summary

Unwinding of phase one of Envision

Envision, SIOC’s broad-based equity participation scheme for employees below managerial level, was set up to provide a framework for the incentivisation and retention of certain employees, as well as effective participation in the equity transition of the group as contemplated in the Mining Charter.

Envision was structured as a ten year scheme, divided into two capital appreciation periods. The first capital appreciation period vested on 17 November 2011. The second capital appreciation period commenced on 10 November 2011 with the issue of 3.09% in the share capital of SIOC to the Envision trust. This resulted in a net increase in the non-controlling interest in SIOC of R4 million.

The unwind of phase one resulted in a net cash outflow for the group through the implementation of the specific share repurchase by Kumba undertaken to monetise the value for employee participants. The actual monetary impact was R2.7 billion, based on a Kumba 5 day average share price of R 508.82 per share on 17 November 2011.

EXCHANGE RATE (Rand/US Dollar)

 

Accounting policies

The following amendments to published standards and interpretations which became effective for the year commencing on 1 January 2011 were adopted by the group:

IAS 24 - RELATED PARTY DISCLOSURES (AMENDMENT)

This amendment simplifies the definition of a related party, clarifying its intended meaning and eliminating inconsistencies from the definition and provides a partial exemption from the disclosure requirements for government-related entities. This amendment did not have a significant impact on the reported results for the year ended 31 December 2011.

ANNUAL IMPROVEMENTS PROJECT 2010

The group adopted the amendments to various issued accounting standards issued by the International Accounting Standards Board (IASB) as part of its Annual Improvements Project 2010 that are effective for reporting periods that commenced on 1 January 2011. These amendments have not had an effect on the reported results or the group accounting policies.

CONCLUSION

The year under review has been very successful for the group. This has enabled us to consistently deliver on and exceed our financial targets and consequently return significant cash to our shareholders. Our strong balance sheet, together with our sustained financial performance, provides a solid foundation for sustainable growth.

Vincent Uren
Chief financial officer