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 Sishen mine (37m tonnes per annum), Thabazimbi (1m tonnes per annum, approaching the end of its life in 2016) and an expansion project which is now fully ramped up, Kolomela (10m tonnes guided by management for 2014).

Kumba exported 89% of its 2013 iron ore production to Asia and Europe, most of which went to China. 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 90-93m tonnes per annum, in consultation with producers that include Kumba.

Kumba is a low-cost producer with cash costs at Kolomela of under $20 per tonne (in the lower quartile of the global cost curve). Given average iron ore prices in 2013 of $116 per tonne, Kumba achieved a group operating profit margin of 52% and cash flow from operations of R29.4bn ($2.8bn) before mineral royalty. Some 60% of Kumba’s production is lump-sized, which has historically attracted a premium price.

Kumba’s dividend cover for 2013 was 1.2, with an historical dividend yield of around 10% – high in the context of a Johannesburg Stock Exchange top-40 dividend yield of around 3%. 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 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 found in favour of Kumba. The company was also subsequently able to resolve an ongoing dispute with AMSA over the pricing arrangements for iron ore. The new pricing agreement, which relates to both Sishen and Thabazimbi mines, came into effect on January 1, 2014 and is based on a cost-plus arrangement following a transitional period. We believe this arrangement is marginally positive for Kumba.

Developmeny Strategy

Kumba experienced operational difficulties at its Sishen mine in late 2012 and 2013 due to the lingering impacts of an unprotected strike in late 2012 and a revision in the grade profile and mine plan. However, in late 2013 Anglo American and Kumba announced a Sishen mine recovery and optimisation plan which aims to drive production from 31m tonnes for 2013 to 35m tonnes in 2014 and 37m tonnes in 2016. The CEO of Anglo American, Mark Cutifani, has confirmed that Sishen’s performance remains challenging but is improving, given the implementation of a revised operating model for waste stripping using lessons learnt from Anglo’s metallurgical coal business. Sishen formally adopted this model in August 14, 2014.

Also key for Kumba will be the normalisation of cost inflation for Sishen unit costs, which were up 35% y-oy in 2013 due to above-PPI inflation increases and additional waste stripping. Kumba is revisiting its expansion strategy in the medium to long term. Its strategy has historically included expansion plans to 70m-90m tonnes per annum both in South Africa and potentially West Africa, in partnership with Anglo American.

In light of the revised Sishen mine plan, as well as the fact that Kolomela’s performance has exceeded the mine’s planned capacity, Kumba is expected to release an updated project plan for expansion, in addition to revised capital expenditure associated with the plan.