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COMMENTARY

Basis of preparation

On 6 March 2014, the board of directors (the board) of Merafe Resources Limited (the Company) approved the audited consolidated annual financial statements of the Merafe Group (Group) and the Company for the year ended 31 December 2013.

These summarised consolidated financial statements have been prepared in accordance with the framework concepts, the measurement and recognition requirements of International Financial Reporting Standards (IFRS), the requirements of the Companies Act 71 of 2008, as amended, the SAICA Financial Reporting Guides as issued by the Accounting Practices Committee, the Financial Pronouncements as issued by Financial Reporting Standards Council and the presentation and disclosure requirements of IAS 34 Interim Financial Reporting.

The accounting policies applied in the preparation of the audited consolidated annual financial statements from which the summarised consolidated financial statements were derived are in terms of IFRS and are consistent with those accounting policies applied in the preparation of the previous audited consolidated annual financial statements, except as disclosed below:

New standards and amendments to published standards

The following standards and amendments to published standards which became effective for the year commencing on 1 January 2013 were adopted by the group:

IFRS 10 Consolidated Financial Statements
IAS 27 Separate Financial Statements
IFRS 11 Joint Arrangements
IAS 28 Investments in Associates and Joint Ventures
IFRS 12 Disclosures of Interests in Other Entitie

In management’s view, the Glencore-Merafe Chrome Venture (the Venture) is a joint arrangement which constitutes joint control, as defined in IFRS 11. The adoption of these standards have not resulted in any changes in the measurement and recognition of assets, liabilities or equity in the audited consolidated annual financial statements. Additional disclosures were included in the audited consolidated annual financial statements, as a result of adoption of these standards.

In 2013 the Group did not early adopt any new, revised or amended accounting standards or interpretations. The accounting standards, amendments to issued accounting standards and interpretations which are relevant to the Group but not yet effective at 31 December 2013 are being evaluated for the impact of these pronouncements.

Auditors report

The Group annual financial statements from which the summarised consolidated financial statements were derived have been audited by the Group’s auditors, KPMG Inc. The auditors have expressed an unqualified audit opinion. The audit report is available for inspection at the Company’s registered office.

The summarised consolidated financial statements is extracted from the audited consolidated annual financial statements, but is not itself audited. The board takes full responsibility for the preparation of the summarised consolidated financial statements and the financial information has been correctly extracted from the underlying audited consolidated annual financial statements, which is available at the Company’s registered office on request.

Review of results

Merafe’s revenue and operating income is primarily generated from the Venture, previously known as the Xstrata-Merafe Chrome Venture, which is one of the global market leaders in ferrochrome production, with a total installed capacity of 1.98m tonnes of ferrochrome per annum. Merafe shares in 20.5% of the earnings before interest, taxation, depreciation and amortisation (EBITDA) from the Venture.

Merafe’s revenue from the Venture increased by 38% from the prior year primarily as a result of a 23% increase in ferrochrome sales to 314kt (2012: 255kt) and a 17% weaker Rand/Dollar exchange rate which were partially offset by a 4% decrease in the average European benchmark ferrochrome price to 116USc/lb (2012: 121USc/lb). Chrome ore revenue as a percentage of total revenue increased from 13% in 2012 to 14% in 2013.

Merafe’s share of EBITDA from the Venture for the 2013 year was R583.5m which was 67% higher than the R349,4m EBITDA from the 2012 comparative year. The EBITDA for 2013 includes a foreign exchange loss of R21.3m (2012: R3.9m), which increased from the comparative year primarily as a result of the utilisation of the Venture’s US Dollar overdraft and short-term inventory facility as well as the realised losses on the Venture’s foreign exchange contract hedge that was entered into in the first half of 2013.

The EBITDA also includes Merafe’s attributable share of standing charges of R63.9m (2012: R151.8m). After accounting for corporate costs of R19.7m (2012: R33.6m) and a share-based payment expense of R6.2m (2012: R2.1m), Merafe’s EBITDA was R557.6m (2012: R313.7m). Corporate costs decreased year-on-year primarily as a result of a write-back of a R22.0m provision for VAT.

The profit and total comprehensive income for the year was R210.6m (2012: R48.9m) after taking into account depreciation of R179.0m (2012: R140.1m), an impairment loss of R74.0m (2012: R77.5m), net financing costs of R17.3m (2012: R19.7m), current tax expense of R18.7m (2012: R0.3m), deferred tax expense of R59.7m (2012: R60.2m) and a R1.7m (2012: R33.0m) write-back arising from prior years’ overprovision of current tax. The balance of unredeemed capital expenditure is estimated to be R553m at 31 December 2013 (2012: R446m). The decrease in the effective rate of tax arose from the SARS assessment of our returns during 2013 which resulted in a prior years’ overprovision. Depreciation increased year-on-year as a result of the re-assessment of useful lives and residual values in accordance with IAS16 Property, Plant and Equipment and the accelerated depreciation recognised on assets scrapped during the year. An impairment loss was recognised on the Horizon mine which was placed on care and maintenance during 2013 as the production from this mine is not viable in the current economic climate. Whilst efforts to sell the Horizon mine are continuing, the requirements were not met to present the mine as held for sale at 31 December 2013 in accordance with IFRS 5 Non-current Assets Held-for-sale.

Property, plant and equipment increased from 31 December 2012 as a result of capital expenditure of which R208m was sustaining and R397m was expansionary. Expansionary capital comprised expenditure primarily on the Venture’s flagship expansion, Project Lion II. Borrowing costs of R23.3m (2012: R8.2m) were capitalised during 2013 and included in expansionary capital expenditure.

Merafe closed the year with a net overdraft balance of R10.7m at 31 December 2013. This comprised of cash in Merafe’s books of R24.9m and Merafe’s share of the net overdraft in the Venture of R35.6m. At 31 December 2013, Merafe had total debt owing to ABSA Capital of R581m and approximately R219m unutilised ABSA long-term debt facilities.

Trade and other payables increased from the prior year primarily as a result of the R194m (2012: nil) utilisation of the short-term inventory facility at 31 December 2013. The provision for closure and restoration costs increased from the prior year primarily as a result of the following: (i) an increase in rehabilitation costs, based on more recent expert rehabilitation assessments, (ii) additional provisions arising from new mines and plants and (iii) the re-assessment of the Horizon mine’s provision taking into consideration the decision to place the mine on care and maintenance. The income statement impact of the increase in the provision for closure and restoration costs was R38m (2012: R9m). Trade and other receivables increased from the prior year primarily as a result of the increase in the ferrochrome and chrome ore sales tonnes, the weaker Rand and the higher European benchmark ferrochrome price in the fourth quarter of 2013 compared to the previous period.

The Merafe board has not declared a dividend for the 2013 financial year.

Review of operations

During 2013, Merafe’s share of ferrochrome production from the Venture was 319kt (2012: 242kt). This represents a 32% increase from the previous year’s production and is primarily as a result of higher demand and improved efficiencies, resulting in increased operating capacity utilisation of 87% (2012: 66%). During 2013 the Venture participated in Eskom’s power buy-back programme at levels similar to those in the comparative year.

In spite of higher electricity tariff increases this year, production cost increases were contained below inflation in the ferrochrome sector of South Africa.

The energy use per tonne of ferrochrome produced by the Venture reduced by 7% to 13.49Gj (2012: 14.50Gj) and the carbon dioxide emissions per tonne of ferrochrome produced by the Venture reduced by 3% from 5.10 in 2012 to 4.95 in 2013.

The Venture’s wage negotiations at its smelters and mines were successfully concluded and no industrial action arose as a result of these negotiations. Unfortunately, the Venture’s eastern and western mining operations were affected by industrial action, which was not wage related. The unprotected strike in the eastern mining operations resulted in the dismissal of more than 1 200 employees. The eastern mining operations were resumed in the second half of the year and the smelters that were supplied by these mines were not significantly impacted due to sufficient stock piles of chrome ore.

Safety and environment

As reported in our interim report, we were saddened by two fatalities during 2013. There were no fatalities in 2012. The safety of our employees remains a priority as evidenced by the Venture’s total recordable injury frequency rate (TRIFR) of 3.84 (2012: 4.05) for 2013 which decreased by 5%. There were no significant adverse environmental incidents in the Venture during the reporting period.

Mineral reserves, mineral resources and mining rights

During 2013, there were no material changes to the mineral reserves, mineral resources and mining rights of the Venture.

Market review

Global stainless steel production reached a record 38.5m* tonnes in 2013, which was 8%* higher than in 2012. Global demand for ferrochrome reached 10.3m* tonnes, driven by stronger stainless steel production as a result of a general improvement in the global economic environment. Globally, stainless steel production growth was driven largely by China and India, which had 17%* and 6%* year-on-year growth rates respectively. European mills’ stainless output declined by 5%* year-on-year, with North America showing a strong performance at 4%* year-on-year growth.

Global ferrochrome production was 10.2m* tonnes in 2013, 8%* higher than 2012’s levels. China continued to dominate global production levels, with its ferrochrome production growing by 13%* year-on-year to 3.8m* tonnes. In 2013, it is estimated that China produced 50%* of the world’s stainless steel and 37%* of the world’s ferrochrome, cementing its position as the world’s leading producer of both stainless steel and ferrochrome. Despite South African ferrochrome producers participating in Eskom’s buyback scheme in the first half of 2013, their ferrochrome output grew by 2%* to 3.2m* tonnes in 2013. South Africa’s market share of ferrochrome production, however, decreased to 32%* from 34%* in 2012. Chrome ore imports into China increased by 30%* year-on-year to 12.1mt*, of which 6.7mt* (2012: 4.5mt*) was from a South African source.

The European benchmark ferrochrome price for the first quarter of 2014 was settled at 118USc/lb, which was 5% higher than the price in the fourth quarter of 2013. This was as a result of improved demand outlook from the European, Japanese and US stainless steel markets.

Project Lion II update

We are pleased to report that commissioning of the Venture’s Lion II smelter commenced in the last quarter of 2013 and will continue into the first half of 2014. This R5bn project involves the construction of a 350 000 tonne per annum capacity smelter. First production of ferrochrome has been slightly delayed mainly due to limited availability of contractors over the December holiday period as well as heavy rainfall and windy conditions in the last quarter of 2013. The overall project remains within budget and was estimated to be 87% complete at 31 December 2013. It is envisaged that the smelter will be fully operational by middle of 2014. The project has a very good safety record with more than 7 million man hours worked without any lost time injury.

The Lion I ferrochrome plant produced excellent volumes during 2013 with its average production volume during the second half of the year exceeding its design capacity by 8%. The cost performance of this plant was 16% below the average of the Venture’s other plants during the same period. Its performance highlights the advantages of the energy efficient Premus technology installed at this plant. We look forward to Lion II’s performance further reducing the Venture’s total ferrochrome cost per tonne.

Outlook

The Venture has performed well through the combination of being the lowest cost producer in South Africa and its ability to negotiate favourable pricing through its partnership with Glencore. While the South African ferrochrome industry faces a number of challenges, including its market share dropping from 51%* in 2003 to 32%* in 2013, demand fundamentals for ferrochrome remain strong. The stainless steel industry is set to maintain a growth rate of more than 4%* per annum and to meet this demand, approximately 2.5Mt** of additional ferrochrome will be required by 2017. The Venture’s investments in energy efficient technology will continue to provide it with a significant advantage in the ferrochrome market. The additional high quality and low cost production the Venture will gain from Lion II will allow it to maintain its position as the lowest cost ferrochrome producer in South Africa and to aggressively target new customers.

Diversification remains a key part of our strategy and with no immediate major expansionary capital investment planned, we look forward to repaying our debt, paying dividends and pursuing value enhancing opportunities for our shareholders.

* Source: Heinz Pariser/January 2014.
** Calculated taking into consideration the average trend in the last five years.

Changes to directorate

Mr Ditabe Chocho was appointed CFO with effect from 2 January 2013.

Sandton
11 March 2014