Tough, ore what?
Tricky times while ironing out resource’s demand trends
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