Tough, ore what?

Tricky times while iron­ing out re­source’s de­mand trends

Finweek English Edition - - Companies & Markets - AL­LAN SEC­COMBE al­lans@fin­

KUMBA IRON ORE is tak­ing a heavy and risky bet on China in a year that man­age­ment will have to pay ex­tremely close at­ten­tion to fos­ter­ing re­la­tions with clients and keep a tight rein on costs and cash man­age­ment. South Africa’s largest iron ore pro­ducer and world num­ber four ex­pects a dif­fi­cult first six months of the year and can’t pre­dict a time when de­mand for the re­source used to make steel is go­ing to pick up.

“It’s go­ing to be quite tough times,” said Kumba CEO Chris Grif­fiths, who has been in the job just seven and a half months and has to deal with mar­kets bat­tered by the worst eco­nomic con­di­tions in decades.

“It’s go­ing to be chal­leng­ing for our man­age­ment team, be­cause noth­ing is go­ing to be sta­ble. We’ll keep on hav­ing to look at our plans on a monthly ba­sis and re­view them,” says Grif­fiths. “It’s go­ing to re­quire con­tin­ual man­age­ment think­ing about whether we’re fol­low­ing the right strate­gies.”

One of the most im­por­tant strate­gies is find­ing non-con­tract cus­tomers in China to take up ore that can’t find a home in Europe or Ja­pan, both hard hit by the world­wide eco­nomic down­turn.

Kumba isn’t alone in see­ing China as the panacea for its dif­fi­cul­ties, which means com­pe­ti­tion for buy­ers in that mar­ket is fierce. Kumba has de­ployed mar­ket­ing teams to China over the past two months to drum up new busi­ness.

But even China’s econ­omy has slowed. Which raises a red flag, says Im­tiaz Ahmed,

of Mac­quarie First South, who says the group’s div­i­dend pay­ment this year will be well be­low the to­tal R21 paid last year.

That point about China is con­ceded by Grif­fiths. “Is China able to pick up the whole world’s iron ore pro­duc­tion? That’s not likely. Are we as Kumba go­ing to see China pick up all our vol­umes not go­ing to Europe or Ja­pan? That’s also un­likely.

“How­ever, we’ve been able to sell quite sub­stan­tially more than our con­trac­tual vol­umes into China – but every­one has the same game. We think we’re do­ing bet­ter than other iron ore pro­duc­ers. We’re get­ting cut back less than the ma­jor­ity of other pro­duc­ers.”

Europe’s steel mills have cut pro­duc­tion by 40% and are de-stock­ing, which means Kumba’s sales to that mar­ket have been sharply cur­tailed. Ja­pan’s econ­omy recorded its big­gest slump since the 1974 oil cri­sis.

At some point this year the world’s steel mills will come to the end of their de-stock­ing process once in­ven­tory lev­els hit new lows, says Shoaib Vayej, head of re­sources at San­lam In­vest­ment Man­age­ment. “Then we’ll get a bet­ter idea of what the un­der­ly­ing de­mand pic­ture looks like. If any­thing, it will have to be bet­ter than where we are cur­rently.”

De­spite the gloom in global steel mar­kets Kumba is talk­ing of ramp­ing up pro­duc­tion by 10% this year. Its key Sishen project lifted pro­duc­tion 15% last year, boost­ing Kumba’s to­tal iron ore out­put to 36,7m t.

Kumba is too small to be a price set­ter like its larger peers – BHP Bil­li­ton, Rio Tinto and Brazil’s Vale. Kumba’s pro­duc­tion is small com­pared to those com­pa­nies, so it would make lit­tle dif­fer­ence to the mar­ket if it held back on ex­pan­sions or cut out­put, says Grif­fiths. “We’d rather of­fer price dis­counts to be able to sell vol­ume than cut pro­duc­tion. We’ve got a re­ally good mar­gin busi­ness (60%) and you’d rather take some off that mar­gin than get noth­ing.”

The big three iron ore pro­duc­ers are in talks with Chi­nese steel mills to set­tle bench­mark con­tract prices for the 2009/2010 year af­ter last year’s talks yielded a 93% price in­crease. Kumba is talk­ing of a 10% to 20% de­cline in prices for this year and mar­ket talk is of prices prob­a­bly com­ing in be­tween 30% to 50% lower.

Kumba is dis­count­ing the price of its lower qual­ity ma­te­rial, while the very high grade ore that can’t be sold at higher con­tract prices is kept to one side un­til the mar­kets turn. Kumba has al­ready stock­piled al­most 4m t of iron ore and can hold at least an­other 7m t be­fore it will con­sider trim­ming pro­duc­tion.

Cur­rently trad­ing around 16 100c/share – an im­prove­ment of lows of around 10 400c/ share in Oc­to­ber last year – the share price still has a long way to go to mir­ror its peak early in 2008. How­ever, an­a­lysts fore­cast at­trac­tive div­i­dend yields of 8% or more.

Of­fer­ing price dis­counts. Chris Grif­fith

26 FE­BRU­ARY 2009

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