Operational review and commentary

The group

The group’s markets are located predominantly outside of southern Africa. In protecting the interests of all the group’s stakeholders, management strives to ensure that the customer base is developed in a manner that does not expose it to levels of unacceptable risk, principally in its activities to collect cash from the sales it has concluded. Due to the recent economic slowdowns experienced in Europe and to a lesser extent in the United States, the performance of the group has become far more dependent on Chinese demand for the sale of its products. The impact of the factors that influence the volumes of product sold, and the performance of the group on a per-commodity basis, is more fully set out below. The contribution to the group’s headline earnings of its commodities and other transactions is as follows:

The group, through its wholly owned subsidiary, Ore & Metal, is the sole marketing and distribution agent for all the group’s products, including those of Assmang.

The sales volumes for Assmang for the current and previous year are as follows:

Iron ore

Iron ore is mined in the Northern Cape in open-cast operations at the Khumani Iron Ore Mine which is located near Kathu and at the Beeshoek Iron Ore Mine which is located outside Postmasburg. Assmang’s iron ore export sales for the year were 5% higher at 14 million tons and local sales increased by 50% to approximately 2 million tons with total sales amounting to a record of 16,1 million tons (2012: 14,8 million tons), an increase of 9% over the previous year.

The majority (68% (2012: 70%)) of sales were made into Asia. However, with sales into India increasing by 61% over the previous financial year, due to regulatory issues in its iron ore mining industry. The sales strategy of the group remains to expand into new markets to ensure as much regional diversification as possible, to ensure effective risk management and to deliver optimal returns.

The iron ore price has seen considerable volatility over the year, driven mostly by stock cycles, sentiment and speculation, as well as the emerging trend of trading in the iron ore market by means of financial instruments. For the year under review, index prices for iron ore with 62% iron content averaged US$127 per ton on a delivered basis to China, down 16% on the previous year’s average of US$151 per ton. For the first quarter of the financial year, the index price declined to below US$90 per ton, as a result of weaker demand from Chinese steel mills. However, a lack of supply and weather disruptions during the second and third quarters, resulted in prices recovering to US$160 per ton in February 2013, before dropping to US$116 per ton by year-end, fuelled by a negative view of Chinese growth prospects and subsequent destocking by Chinese steel mills. The outlook for the next year remains mixed. However, support based on the local Chinese production cost remains for iron ore in the range of US$110 to 115 per ton for the medium term until new lower cost capacity comes into production.

Pricing models for iron ore continue to evolve. For more established and long-term customers, pricing is generally calculated on a synchronised quarterly average, based on an average of iron ore indices, while in China, prices are determined on the average index in the month of delivery.

During the course of the last financial year, the group has strategically placed more shipments on the spot market than in the previous financial year. The pricing models for these shipments have varied between floating and fixed prices. As the market matures, so have the pricing models, with customers continuously looking for shorter pricing periods based around port of discharge arrival dates.

Improvement in the global economic forecast in the short term is expected to have a positive impact on steel, and consequently iron ore demand going forward. However, seaborne iron ore supply growth, particularly from new and established Australian producers, may lead to prices softening in the next financial year. Sales volumes for the next financial year are expected to remain at similar levels in line with the group’s current allocation on the dedicated iron ore rail line to Saldanha Bay.

The contribution to Assore’s headline earnings by Assmang’s Iron Ore division decreased by 7% to R2 766 million (2012: R2 968 million). The distribution of iron ore sales on a per-region basis for the current and previous financial year is illustrated as follows:

Capital expenditure during the year in Assmang’s Iron Ore division amounted to R2,7 billion (2012: R3,7 billion) of which R2,2 billion was spent at the Khumani Iron Ore Mine, with R553 million spent on the Wet High Intensity Magnetic Separation (WHIMS) plant designed to increase yields on low-grade ore, R223 million on the Khumani Optimisation Project (KOP), aimed at plant debottlenecking and R185 million spent on deviating the rail line to enable expansion of the King Pit. A further R362 million was spent at Beeshoek Iron Ore Mine on waste-stripping.

Manganese ore and alloys

Manganese ore is mined by Assmang in the Black Rock area of the Northern Cape province and manganese alloys are produced at the Cato Ridge and Machadodorp Works. Cato Ridge Alloys Proprietary Limited, a joint venture between Assmang, Mizushima Ferroalloys Company and Sumitomo Corporation (both of Japan), produces refined ferromanganese by “blowing” oxygen through a lance into a converter which contains molten metal supplied by Cato Ridge Works, producing a product with a reduced carbon content. Ore-feed for the works is almost exclusively sourced from Assmang’s manganese mines and the bulk of both ore and alloy production is exported. Manganese alloys are used in varying quantities in the production of steel, providing it with strength and a degree of malleability. High-carbon ferromanganese is produced from furnaces 1, 2 and 5 at Cato Ridge Works and from furnace 3 at Machadodorp Works, while refined ferromanganese is produced from hot metal sourced from furnace 5 and from furnace 6 at Cato Ridge Works.

Global demand for manganese ore continues to be driven by Chinese steel production, where another record for crude steel production was reported. For the year under review, Chinese crude steel production increased to 742 million tons from 690 million tons in 2012. Prices for manganese ore stabilised for the first half of the financial year at US$5,00 per metric ton unit (mtu) and gained further upward momentum during the second half of the year to reach a high of US$5,70 per mtu. At these higher price levels, additional supply was attracted to the market and together with the increased supply from new South African mines has resulted in downward pressure on manganese ore prices towards the year-end.

Sales volumes for the year were similar to the previous year. On a per region basis, sales for the year and the previous financial year is illustrated as follows:

The group’s two major markets for manganese alloys, Europe and North America, reported negative growth for crude steel production causing lower demand for manganese alloys, resulting in lower prices for the first half of the year under review. Global supply of high-carbon ferromanganese is flexible and the market continued to be oversupplied, driving the price level down by more than US$120 per metric ton for the year under review, to close at approximately US$1 045 per metric ton on a delivered basis. Prices for medium carbon ferromanganese recovered during the second half of the year. However, following the decision by a major producer to bring forward a maintenance shut early in 2013, as a result of poor market conditions. The decline in these prices over the year was not as marked, therefore, and amounted to approximately US$30 to close at approximately US$1 510 per metric ton.

Sales volumes of manganese alloys for the year were similar to the previous year and remain in line with the production from the group’s ferromanganese facilities.

The distribution of ferromanganese sales on a per region basis for the current and previous financial year is illustrated as follows:

The contribution to Assore’s headline earnings from the Manganese division declined by 23% to R470 million for the current year (2012: R611 million). This was mainly due to lower prices for manganese alloys and higher cost of production of manganese ore. Capital expenditure during the year in Assmang’s Manganese division amounted to R1,2 billion (2012: R886 million). The bulk of this expenditure was on replacement capital and included an amount of R339 million was spent on sustaining the manganese mines as well as on feasibility studies and early establishment costs to expand the capacity of the mines to at least 4 million tons per annum.

The boards of Assmang and Assore have granted conditional approval for the construction by a joint venture comprising Assmang, Sumitomo Corporation and China Steel Corporation of a manganese alloy smelting facility in Sarawak State, Malaysia to be known as Sakura Ferroalloys Sdn.Bhd (Sakura). Sakura is a greenfields project and the facility will be constructed in the Samalaju Industrial Park, in Sarawak. Sakura will initially consist of two 81 MVA furnaces, complete with related infrastructure, equipment and services to allow for the production of both high-carbon ferromanganese and silicon-manganese alloys. The combined anticipated production output is approximately 170 000 metric tons per annum. Besides being the majority shareholder, Assmang will provide marketing consulting and technical services to Sakura. The total project value is set at US$328 million and construction is due to start in early 2014.

Chrome ore and charge chrome

Chrome ore is mined at Assmang’s Dwarsrivier Mine near Lydenburg in the Mpumalanga province. The group also mines chrome ore near Rustenburg (Rustenburg Minerals) from established open-cast and underground operations. In addition, the group is reprocessing tailings at Zeerust Chrome Mines Limited (Zeerust), which is located about 70 km north of Zeerust in the North West province.Rustenburg Minerals is 44% held by a black economic empowerment BEE) partner, Mampa Investment Holdings (refer “Black economic empowerment status report”). Production from Rustenburg Minerals is supplied mainly to the local market. Zeerust is 100% owned by Assore with all production currently being sold into the local market.

The bulk of chrome ore mined worldwide is converted to ferrochrome and utilised in the production of stainless steel. Since the world economic turmoil in 2008 and the strong recovery of stainless steel production in subsequent years, the world production of stainless steel continued to grow in 2012 at a rate of 3% year-on-year. The stainless steel market though remains split into two geographic areas, each with very different dynamics. During the 2012 calendar year, Chinese production was approximately 16 million tons up 14% year-on-year and accounted for approximately 45% of total world stainless steel production. Conversely, both the United States and Europe continue to lag the Chinese market, with production in the USA reducing 4,6% year-on-year and European production reducing 1,8% year-on-year.

Total world production of stainless steel for the 2013 calendar year is expected to be approximately 5% higher than 2012, at approximately 37,3 million tons (2012: 35,5 million tons). Chrome ore sales on a per region basis for the current and previous financial years are illustrated as follows:

Ferrochrome demand and pricing has remained under pressure during the year under review. South African producers continued to act as swing producers, operating their furnaces to suit market conditions. This was exacerbated by the power buy-back offers from Eskom, resulting in lower South African production and allowing China to assume the majority market share of ferrochrome production. South African ferrochrome production reduced by 12,5% in 2012 calendar year, while China increased production by 13,5% and increased their market share to 35% of global production. Assmang’s remaining ferrochrome furnace (furnace 1) at Machadodorp Works has remained idle throughout the period under review, due to the continued pressure on ferrochrome prices and the increased cost of electricity. The group’s ferrochrome sales have been made out of its existing inventories.

The distribution of ferrochrome on a per-region basis for the current and previous financial years are illustrated as follows:

Rustenburg Minerals produced and sold approximately 163 000 tons (2012: 201 000 tons) run-of-mine (ROM), lumpy and concentrate grades and Zeerust produced and sold approximately 37 000 tons (2012: 60 000 tons). Stoping of ROM material has commenced from the Groenfontein underground mine at Rustenburg which is expected to reach full production capacity of 12 000 tons per month in the third quarter of 2014. Development expenditure on the Zandspruit underground shaft continues, and R36 million (2012: R41 million) was spent across both shafts.

Wonderstone

Market conditions for all of the Wonderstone ceramics divisions (Wonderstone, Ceramox and Group Line Projects) have been difficult and challenging over the past year, due both to the closure of a significant portion of the traditional Western markets for Wonderstone products as well as delays in the awarding of capital projects for which tenders have been lodged.

Since 1937, the group has mined a type of pyrophyllite which, for trade purposes, is referred to as Wonderstone. The deposit, which is located outside Ottosdal approximately 300 kilometres west of Johannesburg, is volcanic in origin and displays unique corrosion, heat and abrasion-resistant, as well as good filtration properties. The bulk of the material mined is beneficiated and reworked into components for export to the USA, the United Kingdom and the Far East. The components are utilised in various high-tech industrial applications, including the manufacture of synthetic diamonds and consumable products for the welding and electronics industries, and are sold as ceramic products. The most significant market for Wonderstone products, to date, has been its use in the manufacture of polycrystalline diamond (PCD) cutters for the oil well bit and drilling industries. Wonderstone off-take used to be reasonably well correlated with drill rig activity. However, this relationship has become more complex over the past two to three years with indications that GDP is a more important factor affecting short-term demand for both oil and energy products. Other factors affecting demand include improvements in drilling efficiency as well as market and political uncertainties. While a short-term reduction in oil demand in the United States and Europe is apparent, demand is growing in China, India, Brazil and other emerging markets.

Alumina wear-resistant tiles are produced by the Ceramox division of Wonderstone (Ceramox), most of which are supplied to the local tile installation market, which has shown significant sales growth over the recent past. Wonderstone, through its division, Group Line Projects (Groupline), specifies, selects and installs a range of lining products, including Ceramox alumina tiles, to assist in solving a wide range of industrial wear and flow problems.

Wonderstone, in conjunction with a minority shareholder, has established a company, iCerMax Proprietary Limited (iCerMax) to exploit the unique properties of Wonderstone’s pyrophyllite to manufacture ceramic filters. These can be tailor made to service a wide range of applications, especially in the harsh African conditions. While these applications can be multi-functional for a variety of mediums (air, gas, liquids or acids), the initial focus is on fuels, oils and hydrocarbons. Plans to expand the business have been formulated and include a customer prospecting pipeline, for both direct and distributor sales, as well as performance testing of Wonderstone filter cartridges and equipment at a number of potential customer sites to demonstrate their capability.

The Wonderstone Mine and Machining division recorded a lower net profit of R2,6 million (2012: R8,9 million), due mostly to reduced demand from the markets in the United States and the United Kingdom. It has become apparent that there has been a change in the global demand for Wonderstone products from synthetic diamond customers. Some customers in the West have stopped producing PCD cutters and are selling their presses. Other customers have reduced their Wonderstone demand for their manufacturing and are purchasing third-party PCD cutters instead. The increased demand from markets in the Far East is encouraging, with a number of potential new customers having successfully tested Wonderstone products and placing orders for machined products.

The demand for Ceramox alumina tiles has been depressed over the year, due to delays in projects caused by global and local economic uncertainties, labour unrest, infrastructure bottlenecks, tender irregularities and logistical problems. While a positive gross contribution margin across the Ceramox and Groupline divisions has been maintained, allocated overheads have resulted in net losses being recorded in both divisions. The product focus and cost structure of these businesses is being reviewed and staffing at a senior level has already been addressed in this regard.

Groupline currently has over R90 million worth of open tenders and has recently established a branch in Richards Bay. Plans are under way to establish a branch in the Northern Cape, from which it plans to perform project and maintenance work at the Assmang mines in that area. Actions to secure maintenance contracts at Eskom power stations are also progressing.

Wonderstone recorded a net loss of R12,3 million (2012: net loss of R8,9 million) for the year. The proportion of sales of Wonderstone’s division for the current and previous financial years are illustrated as follows:

Capital expenditure for the year amounted to R7,9 million (2012: R5,5 million), which included R5,3 million (2012: R1,0 million) being spent on refurbishing the recently acquired new business premises.

Marketing and shipping

Wholly owned subsidiary, Ore & Metal Company Limited, is responsible for the marketing and shipping of all the group’s products, including those produced by the three divisions of Assmang. Strong relationships have been established with customers in Europe, North America, South America, Africa, India and the Far East, and products with a market value of approximately R25,0 billion (2012: R23,7 billion) were marketed and distributed in these regions during the year. The company is an established supplier to steel and allied industries worldwide and has operated effectively in these markets for over 70 years. Commission income is based on the value of sales negotiated during the year and, due mainly to increased sales volumes of iron and chrome ores throughout the year, trading profit after taxation increased to R275,9 million (2012: R254,6 million) for the year under review.

Minerais U.S. LLC

The group holds a 51% share in Minerais U.S. LLC (Minerais) which is a limited liability company registered in the state of New Jersey in the United States of America (USA). Minerais is responsible for marketing and sales administration of the group’s products in the USA, in particular manganese alloys, and trades in other commodities related to the steelmaking industry. Trading levels for the year under review were similar to those of 2012, and the contribution by the company to the group’s attributable profit amounted to R5,6 million (2012: R5,9 million).

Technical and operational management

As technical adviser to Assmang and other group companies, African Mining and Trust Company Limited provides operational management services to the group’s mines and plants. For these services it receives fee income based on turnover and commodity prices, with trading net profit after taxation for the year declining modestly to R139,1 million (2012: R147,6 million) for the year under review.

Investments

The group maintains a limited portfolio of listed shares which are selected and held in accordance with long-term investment criteria. Certain shares, the cost of which was R9,1 million were sold, realising R37,0 million, resulting in a profit of R22,7 million net of capital gains tax for the group. In accordance with IFRS, the portfolio is valued in the financial statements at market value and the difference between cost and market value is transferred to other reserves net of any capital gains tax which would arise on eventual disposal. At year-end the market value of the portfolio was R178,4 million (2012: R239,3 million) based on a cost of R157,8 million (2012: R167,0 million). Other income includes interest received of R219,0 million (2012: R183,3 million) generated on cash in excess of current requirements which was invested on a short-term basis in the money market. The increased level of interest received is due to the strong cash generation by the group during the financial year, mainly as a result of its increased sales volumes of iron ore.