Commentary

Kumba delivered an exceptional operational and sales performance in 2009 with substantial increases in mining, production and export sales volumes and strong cash flows driven by an increase in export revenues and tight cost management, notwithstanding the backdrop of global economic recession. Kumba’s revenue increased by 10% to R23.4 billion on the back of a 37% increase in export sales volumes driven by strong demand from China, though tempered by lower export volumes to Europe and Japan. Despite starting the year with concerns over the visibility and sustainability of export sales, the group increased revenue through higher export sales volumes which was mostly offset by the 40% reduction in benchmark iron ore export prices resulting in a 5% decrease in operating profit. Through focused cost management and a 16% increase in production, mainly from the Jig plant, the small increase in Sishen Mine’s unit cash cost on a like-for-like basis was well below inflationary cost escalations. Sishen Mine’s unit cash cost for 2009 was R98.83 (US$11.78) per tonne compared to R96.53 (US$11.70) per tonne at the end of 2008.

Attributable and headline earnings for the year were R21.88 per share and R21.82 per share respectively, on which a final cash dividend of R7.40 per share has been declared. The group’s strong cash flow generation has enabled the consistent payment of an interim and final dividend since listing on the JSE Limited in November 2006 aggregating to R43.90 per share. This return of cash to shareholders has enabled our community trust and employee shareholders to redeem substantial portions of the original funding required to invest in Sishen Iron Ore Company (Pty) Limited in early 2010, with full repayment possible within the next year for the trust.

A favourable award was received in the arbitration with ArcelorMittal SA Limited (‘ArcelorMittal’) and it has been determined that ArcelorMittal is not entitled to participate in the development of the Sishen South Project currently under construction.

Safety performance

Kumba’s commitment to zero harm continues to deliver marked achievements. At existing operations the group improved on its safety performance during the year, with only ten lost-time injuries (‘LTI’s’) being recorded. This translated into a losttime injury frequency rate (‘LTIFR’) of 0.07 per 200,000 hours compared to the 0.12 incurred in 2008 (a 42% improvement). Thabazimbi Mine continued its excellent performance by completing its second year without recording a single LTI. Sishen and Thabazimbi mines worked the full year without a fatality. In Sishen Mine’s case this was the first time in five years that the mine worked fatality free. Kolomela Mine (Sishen South Project) achieved 4.3 million LTI-free man-hours to date.

Notwithstanding this improvement during the year, it was regrettable that we had suffered one fatality for the year when Mr Tebogo David Marope, a 23 year old contractor of Concor, was fatally injured during road construction at the Sishen South Project on 28 January 2009.

Market overview

World crude steel production started to recover during the second half of 2009 with most major steel producing countries posting an increase in output, compared to the first half of 2009 and second half of 2008. However, world crude steel production for 2009 was 8% down on the previous year’s output, reaching 1 220Mt, compared to the previous year’s 1 327Mt. Chinese steel production for 2009 reached 568Mt, compared to 500Mt in 2008, representing a 13.6% increase year-on-year, and increased in excess of consumption by 30Mt. The increase in steel production coupled with lower Chinese domestic iron ore production, resulted in record seaborne iron ore imports into China. The European, Japanese and Korean markets have started a tentative recovery and an improvement in iron ore demand has been experienced during the second half of the year due to some production increases and restocking by the steel industry.

Operational performance

Total tonnes mined at Sishen Mine increased by 18% from 108.8Mt in 2008 to 128.3Mt, of which waste mined was 82.1Mt, an increase of 28% from the prior year. This increase in waste mining activity is undertaken to mitigate the increasing depth of the ore body, geological constraints in the pit and to secure the future of the mine. Total production at Sishen Mine increased by 16% from 34.0Mt in 2008 to 39.4Mt. Production from the Dense Media Separation (‘DMS’) plant increased by 0.6Mt to 29.0Mt, which was above expectations. The ramp up of production from the Jig plant has seen a substantial increase during the year, with production more than doubling that of the prior year. The 10.4Mt produced by the Jig plant during the year accounted for 26% of Sishen Mine’s production. Kumba remains on schedule to achieve about 13Mtpa from the Jig plant during 2010.

The group increased total sales volumes by 21% from 33.0Mt in 2008 to 40.0Mt. Export sales volumes from Sishen Mine for the year increased by 9.3Mt or 37% from 24.9Mt in 2008 to 34.2Mt on the back of increasing volumes from the Jig plant, the successful introduction of a new blended fines product and an increase in demand from China. Export sales volumes to China totalled 75% (43% in 2008) of total export volumes for the year. Total domestic sales volumes for the year of 5.8Mt are down by 28% or 2.3Mt due to lower demand from ArcelorMittal.

Logistics and export operations have performed adequately in transporting the increased production achieved for 2009. Volumes railed on the Sishen-Saldanha export channel increased by 23% to 34.6Mt, whilst a 38% increase in the volumes shipped from the port at Saldanha was achieved. A record 134 vessels shipped 21.5Mt by Kumba on behalf of its customers.

Production at Thabazimbi Mine reduced by 7% to 2.5Mt for the year as a result of lower off-take by ArcelorMittal. The decrease in domestic demand resulted in a build up of ArcelorMittal’s finished product stock at Thabazimbi Mine, from 0.8Mt to 1.1Mt.

Operating results

Kumba’s strong operational performance underlaid a solid financial performance for the year ended 31 December 2009. R12.9 billion operating profit was achieved for the year, a reduction of R633 million or 5% from the R13.5 billion in 2008. Kumba’s operating profit margin of 55% for the year (61% from mining activities), decreased by 8% from 63% (69% from mining activities) in 2008 as benchmark iron ore prices decreased on average by 40% for the 2009/2010 iron ore year.

The drop-off in demand for iron ore from Kumba’s traditional markets (Europe, Japan and Korea), which had started in the fourth quarter of 2008, continued in 2009. Chinese demand for iron ore, however, continued to grow – not only because of increased crude steel production, but also because of markedly lower domestic iron ore production. Kumba was able to divert volumes from Europe, Japan and Korea into China, which accounted for 75% (43% in 2008) of Kumba’s export volumes in 2009. 35% of iron ore was sold on an index basis, and more than 30 new customers were developed. In all, export sales increased by 37% year-on-year, and sales into China grew by 130%.

Kumba settled benchmark prices in Europe, Japan and Korea in the third quarter of 2009, applying retroactively from 1 April 2009. Settlements were in line with other settlements in these markets, and resulted in approximately a 40% reduction in benchmark prices. No formal, industry-wide settlement was concluded in China, but sales were effected at prices similar to settlements in other markets.

Operating profit decreased by 5% or R633 million, principally as a result of:

• Increased export sales volumes added R6.6 billion to operating profit; offset by the year-on-year weighted average decrease of 40% in benchmark iron ore prices, which reduced operating profit by R5.4 billion; and lower domestic sales volumes due to the decline in domestic demand, which reduced operating profit by R377 million. The net effect of these factors was an increase in operating profit of R0.8 billion.
• A R308 million increase in profit from shipping operations. Total tonnes shipped by Kumba increased by 15.3Mt from 6.2Mt to 21.5Mt during 2009. This increase in volume was offset by a decrease in the shipping margin achieved (average shipping margin – US$3/tonne in 2009). The unused portion of the provision raised in 2008 amounting to US$22.8 million (R191 million) was released during the year.
• The weakening of the average exchange rate of the Rand to the US Dollar (average exchange rates – R8.39/US$1.00 in 2009 compared with R8.25/US$1.00 in 2008), which contributed R301 million to operating profit, and lower net valuation gains over 2008 from US$ denominated monetary assets and derivative instruments, which reduced operating profit by R665 million.
• All of which was further offset by a R1.4 billion or 36% increase in operating expenses (excluding shipping expenses), as a result of the 28% increase in waste mined at Sishen Mine, 14% increase in volumes produced, and a 36% increase in logistics costs driven by increased sales volumes during the year. This increase was further fuelled by inflation, though offset by lower costs of diesel and blasting products and strict cost management.

Kumba has implemented a number of revenue enhancing and cost management initiatives as part of the asset optimisation programme which have realised R2.0 billion in operating profit during the year, including once-off revenue enhancement activities that contributed R1.4 billion for 2009. The recurring nature of certain of these initiatives will assist in enhancing the financial performance of the group and protecting operating profit margins in the future. These initiatives include, amongst others: increasing export sales volumes on which shipping services were provided; decreasing maintenance shutdown intervals; producing and selling niche products to enhance the premia received and procurement and operating efficiency cost savings. The flagship Sishen Mine transformation programme launched during the year (“Bokamoso”) has started to deliver cost savings in the important area of operating efficiency in mining. Further value from this programme will be unlocked as it progresses to the next stages of the production process of the mine.

The group continued to generate substantial cash from its operations, with R12.6 billion generated during the year. These cash flows were used to pay taxation of R3.2 billion and aggregate dividends of R8.2 billion during the year. Capital expenditure of R4.0 billion was incurred, of which R1.2 billion was to maintain operations and R2.8 billion to expand operations, mainly on Kolomela Mine. At 31 December 2009 the group had a net debt position of R3 billion. Interest cover remained strong at 43 times (33 times at the end of 2008).

During July 2009 Kumba successfully negotiated a new three-year term debt facility of R3.2 billion to replace the R2.8 billion revolving debt facility that would have matured in November 2009.

The Board reviewed the cash flow generation, growth plans and the capital structure of Kumba and is pleased to approve a final dividend of R7.40 per share (interim dividend R7.20 per share).

Kolomela Mine

The development of the Kolomela Mine continues and remains on budget and on schedule to deliver initial production during the first half of 2012, ramping up to full capacity of 9Mtpa in 2013. Construction on the project is progressing well and mining operations commenced after the first blast on 17 September 2009. To date 4Mt of material has been moved; project engineering is substantially complete; and significant progress has been made on manufacturing and construction. R3.2 billion of capital expenditure (including R189 million of capitalised mining operating expenses) has been incurred to date, of which R2.5 billion has been incurred during the year ended 31 December 2009.

Mineral resources and ore reserves

There have been no material changes to the ore reserves as disclosed in the 2008 Kumba Annual Report.

New information from exploration around Sishen Mine and the Zandrivierspoort Project has led to model updates and a subsequent 12% decrease in mineral resoures from those shown in the Kumba 2008 Annual Report. The Sishen Mine mineral resources outside the current life of mine plan decreased from 1 628.5Mt to 1 438.5Mt. Mineral resources for the Zandrivierspoort Project decreased from 421.9Mt to 347.4Mt.

Prospects

Analyst forecasts indicate that global steel consumption should grow in excess of 5% per annum over the next three years, which would lead to increasing iron ore demand. Chinese demand for iron ore is expected to grow by at least 5% during 2010. With Chinese domestic iron ore production falling this has placed increased pressure on seaborne iron ore imports and spot prices. A further recovery outside of China is expected during 2010 and pressures on seaborne iron ore supply continue to rise. Overall, the global seaborne iron ore market remains structurally tight. The growing demand for seaborne iron ore is also manifested in the sharp rise in steel scrap and spot iron ore prices, with the latter indicating a significant premium to 2009 contract prices. Current market consensus indicates an increase in iron ore export prices for the 2010/2011 iron ore year. Although global steel demand is expected to return to growth in 2010, this is likely to be moderate and the sustainability of increase in demand outside of China remains uncertain. Domestic sales volumes from Thabazimbi and Sishen mines remain dependent on the off-take requirements from ArcelorMittal.

Kumba is committed to a further increase in production volumes during 2010, with the continued ramp up of the Jig plant. Waste mining at Sishen Mine is anticipated to increase as the pit gets deeper and wider. Export sales volumes into China are expected to normalise at around 60% of the geographical sales mix.

Kumba’s operating profit remains highly sensitive to the Rand/US Dollar exchange rate. Relative to the US Dollar, the South African Rand has strengthened ~20% over the past year. The first mining royalty is payable by Kumba’s mining operations from March 2010. Management focus will be on asset optimisation initiatives, cost management and additional production and sales volumes to lessen the adverse effects of the stronger rand, mining royalty and the cost pressures from an increase in waste mining.

Changes in directorate

The Board of directors of Kumba announced the resignation of Dr Nkosana Moyo and Mr Philip Baum as non-executive directors on 12 January 2010. Both Dr Moyo and Mr Baum were members of the Board of Kumba since its inception in November 2006.

The chairman of the Board, Mr Lazarus Zim, expresses the Board and management’s gratitude to Dr Moyo and Mr Baum for their contribution during their tenure.

Mr David Weston, Anglo American plc’s Group Director of Business Performance and Projects, was appointed as a nonexecutive director on 10 February 2010.