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CHIEF EXECUTIVE OFFICER’S REVIEW

REVISION TO HULAMIN STRATEGIC GOALS AND BUSINESS PLAN

Hulamin’s business plan was birthed in the early 1990s when the first major Rolled Products capacity expansion was conceived. With almost all top tier aluminium rolling plants in the world situated in high-cost first-world countries and with Hulamin’s enviable Alcan-based technology competence and relatively low-cost environment in South Africa, a major $550 million quadrupling of capacity was approved in 1996. Based on a fledgling and growing local all-aluminium can market, a growing local economy and South Africa’s welcome as the world’s most recent and successful democracy, Hulamin embarked on a new and ambitious business plan as the preferred supplier in a small and rapidly growing local market and as a major, competitive-cost producer of high value products to be exported to large global markets.

Sales grew strongly through the early 2000s, as did Hulamin profits. As the South African Rand began to strengthen against a weakening Dollar, and as rising costs and risk in South Africa became ever more dominant, the local economy started to stagnate. The all-aluminium can in South Africa was still-born and China rose to dominate global manufacturing, including aluminium rolling, and the electricity crisis and its effect on aluminium in the region became a national debating point. The need to refocus the business and find a new business plan had become pressing.

Over the past three years, we have strategically examined the role for aluminium in Southern Africa and particularly the role for Hulamin, resulting in a revision of our business plan to deliver improved results in a shorter time horizon. This has resulted in a refocused Hulamin business plan to capture the following five goals:

1. Meeting operational performance benchmarks

The first priority for achieving success remains the performance of the operations. These include increasing sales volumes towards full capacity and achieving the other key performance benchmarks, which include rolling margins, product yields, unit costs and customer quality returns. Regardless of the other strategic goals, at the core of our success must be a well-run, competitive manufacturing operation.

2. Achieving global cost competitiveness

Part of our cost competitiveness results from efficiencies and operational performance (which is covered in the first strategic pillar). This second pillar covers the need to secure globally competitive prices for our manufacturing inputs. These include power (electricity and gas), metal (the price we pay for primary aluminium and scrap), employment, logistics and coatings.

3. Growing local and regional sales

The rapid GDP growth forecast in the sub-Saharan African region, the growth of the beverage can industry specifically and Hulamin’s regional competitiveness provide the rationale to increase our focus on growing local and regional sales. Hulamin aims to more than double its sales into Southern Africa by 2020.

4. Secure, competitive aluminium supply

As the largest manufacturer of aluminium products in a region where there is both large-scale aluminium smelting and a current shortage of electricity, it is appropriate for Hulamin to play a key role in securing the long-term sustainability of the aluminium smelters. There is an additional opportunity to reduce input cost in the form of scrap aluminium that will become available from the manufacture and post-consumer collection of aluminium beverage cans.

5. Supportive regulatory environment

The fifth pillar of the revised strategic vision is to work with government and other stakeholders in the creation of a competitive and supportive regulatory environment.

Restructuring the Hulamin Balance Sheet

In ensuring that Hulamin has the appropriate balance sheet to deliver on its strategic vision, a number of changes became pressing in the years immediately leading up to 2013. Two major issues required specific attention: the constraints posed by the historical debt package and the valuation of fixed assets.

New debt package

At the time of the last capital raising, the R750 million rights offer in 2010, Hulamin secured a term loan of R630 million, a R550 million 360-day notice facility and a R250 million Forward Exchange Contract facility to cover hedging requirements. There were several shortcomings with this package that required a more appropriate long-term debt structure. These mismatches included the fixed nature of the facilities that was effectively financing working capital whose value is volatile and is driven by the exchange rate and US Dollar aluminium price, and the stringent cash flow and profit-driven covenants that posed ongoing default risk.

Hulamin began exploring various options during 2012 and 2013 to secure more appropriately structured working capital facilities. Through a rigorous selection process, it became clear that the preferred option was a fully underwritten package from Nedbank that included a R1,2 billion three-year Metal Inventory and Receivables Facility, a R250 million general banking facility and a R200 million forward currency facility. Agreements were signed in September and a successful transition commenced immediately. The new debt package has two covenants including a minimum 1,5 times current ratio and minimum 0,5 times debt/equity ratio, posing little risk of impacting ongoing operations or default.

Impairment

Hulamin has invested comprehensively in its fixed assets, particularly since 1996 when the first major US$550 million Rolled Products expansion was approved. Further investment totalling US$120 million (R970 million) was approved in 2006, resulting in the carrying value of Hulamin’s non-current assets totalling some R4,8 billion and total assets of some R7,9 billion on Hulamin’s balance sheet.

Since these investments were made, and particularly the second Rolled Products expansion, the aluminium rolled products world and the Hulamin position in it have changed significantly. The rise of China as a massive global manufacturing base has had a major impact on manufacturing globally, eliminating jobs in high-cost countries, reducing the price of manufactured products, and forcing manufacturers to examine competitive advantage and value propositions. Chinese manufacturing growth has negatively impacted the selling prices (margins) of aluminium rolled products around the world, directly through competition and indirectly through increased protectionist measures in previously open global markets. Possibly the most severely impacted of these markets has been the global aluminium foil market, which is now dominated by Chinese manufacturers. Average international selling prices for thin gauge foil are now in the region of US$500/ton less (almost 25% lower) than those estimated in 2004 and 2005 when the feasibility study for the second Rolled Products expansion was conducted.

An additional high impact factor that has driven the decision to review Hulamin’s carrying value of its fixed assets is the erosion of the local market to imports (largely from China and other low-cost countries) and the consequent drop in domestic prices, frequently to below other similar countries.

The impact of this declining cost competitiveness and margin pressure, exacerbated by rampant input cost increases, supply disruptions, imported rolled and extruded products in the local market without tariff protection and general weak local demand, has prompted the revalidation of growth assumptions and a resultant revaluation of plant and equipment in terms of accounting standard IAS 36, translating to the net R1,53 billion after tax, once-off non-cash impairment charge.

Employment Environment, Rightsizing and Restructuring

In many respects, 2013 was the continuation of the 2012 domestic labour environment. South African civil society continued to face a period of self-reflection and anger that was sparked by historic events that unfolded in 2012 in Marikana. Throughout 2013, service delivery protests and spontaneous eruptions of worker and community frustration were reported. Striking workers became a regular feature on television screens, aptly illustrated by the violence and anger in the Western Cape agricultural workers minimum wage protests.

Impacting Hulamin, a number of extended strikes occurred in the high profile and fragile automotive sector, resulting in the loss of a significant volume of local brazing sheet sales. Hulamin faced the same and increasingly militant union, NUMSA, who took its cue from other high demand negotiations nationally and raised its wage demands for Hulamin workers, resulting in an extended stand-off negotiating period that lasted from April to October. Fortunately, we reached a reasonable settlement with a three-year agreement lasting until 2016.

Following an extensive review of our manning levels, including a number of international benchmarks, we had come to a conclusion late in 2012 that an employment rationalisation and restructuring exercise was necessary for ongoing competitiveness. Although the process was executed as expeditiously as the Labour Relations Act allowed, the process of consultation and negotiation with employees and their representatives was extended by approximately 60 days. This resulting uncertainty for employees took its toll on production, morale and performance. In addition, a number of skilled employees unaffected by the rightsizing also tendered their resignations during the year.

Operational Performance

Operating performance in Hulamin Rolled Products fell short of targets in 2013. Having completed a comprehensive analysis of contributors and root causes, and while there are multiple issues, a few items stand out.

In the first half, market conditions and particularly soft international plate margins, resulted in an imbalance in the profile of orders available. The effect of this imbalance was an overload on cold rolling capacity and bottlenecks developed in cold rolling as well as other machine centres.

An unusual feature of 2013 was the high frequency of equipment failures that would normally have been prevented or avoided by normal management. Asset management is one of Hulamin’s core operational requirements due to the high capital equipment nature of the business and numerous root cause analyses point to assets being kept in operation longer than would have been ideal over the past four or five years.

However, a further factor that aggravated an already challenging year was the high frequency of human error in process and quality-related problems, where standard practices were not followed, and this was reflected in the 0,8% decline in yield for the year. This can partially be attributed to tougher internal quality controls, but is an important area of focus for the year ahead.

We have concluded from the analysis above, the operational performance in 2013 was negatively impacted by numerous human-related problems and typifies the climate experienced by many employees during the rightsizing that was completed in August and the protracted wage negotiations thereafter, that took almost a full three months longer than usual to settle.

Cost Competitiveness

Hulamin’s second strategic priority for a successful manufacturing business, taking into consideration the need for global and regional competitiveness, is cost. Chinese producers of all types of manufactured goods, including aluminium rolled products, have redefined costs of production, resulting directly in pressure on Hulamin’s operating margins and more indirectly on global selling prices.

Following the profit performance of 2011 and 2012, management undertook a critical assessment of the cost competitiveness of the business and concluded that there are three major opportunities to immediately address Hulamin’s cost competitiveness. These are the cost of employment, the price of energy and particularly gas and thirdly the price of aluminium.

The exercise to rightsize the employment complement was concluded early in the third quarter of 2013, resulting in the redundancy of 159 jobs, representing an annual saving of R59 million at a once-off cost of R25,6 million. Included in the number of departing employees were approximately 70 resignations, which significantly contributed to mitigating the negative impact of a forced retrenchment. However, the unplanned resignation of an additional 52 people whose skills were recognised as being important for the company and whose jobs were not at risk had a significant and adverse impact on the business. These employees are being replaced, with a number of new employees already having joined the company.

The second cost focus is to address gas energy. Hulamin uses Liquid Petroleum Gas (LPG) as its primary energy source, with approximately 70% of its energy cost spent on LPG, which is a measurably higher cost per energy unit than natural or methane-rich gas. LPG is produced as a by-product of crude oil refining and Hulamin thus procures its supply from various oil refineries in South Africa (largely the SAPREF refinery in Durban), whose supply has been disrupted on a number of occasions since the mid-2000s. Hulamin has thus commenced a feasibility study into natural or methane-rich gas supply to its Pietermaritzburg operations.

The third early focus to improve competitiveness is metal cost. Hulamin sources primary melting ingot aluminium from BHP Billiton’s Hillside smelter, rolling slab from BHP Billiton’s Bayside smelter, extrusion billet from a number of international aluminium smelters, hardeners such as magnesium, manganese, iron, silicon, copper and zinc from a range of local and international sources and also procures aluminium scrap locally.

The pricing of aluminium is linked to the ruling LME Aluminium price and Rand/US Dollar exchange rate as well as ruling geographic, format and other premiums and discounts at the time of purchase. Due to the value of metal purchases, the impact of relatively small beneficial or prejudicial unit variances can have a major impact. Hulamin’s existing melting ingot supply agreement with BHP Billiton will terminate at the end of 2015, while the supply and pricing of rolling slab have been agreed until the end of December 2014.

The conversion of the South African beverage can market to all-aluminium cans provides a new and alternative source of aluminium. Both the increased volume of can makers’ process scrap and post-consumer scrap are large volume opportunities to source metal at a net (after processing) cost that is lower than what is available from BHP Billiton. To this end we are pleased that the Hulamin board has approved the R300 million capital investment in state-of-the-art recycling equipment.

Growth in regional sales

Our customers remain central to our business model of differentiation and value creation and we will remain focused on continually improving service offerings. In comparison to other international suppliers, Hulamin has limited advantages we can offer to international customers, especially when compared to their local suppliers. To provide these customers the lead times, product range, pricing and service necessary in today’s competitive world is proving increasingly challenging.

Hulamin has an emerging and significant competitive advantage, being located in a rapidly developing region, where aluminium consumption is lower than international comparisons and per capita wealth is increasing.

Between Hulamin Rolled Products and Hulamin Extrusions, we currently sell approximately 75 000 tons per year in South Africa, of which over 50% is sold into the combined packaging and automotive industries. These industries are already proving to be the growth drivers of aluminium consumption and show clear potential for considerable further growth. The all-aluminium can alone offers a potential market of in excess of 100 000 tons by 2020. Increasing aluminium usage in automotive applications has already sparked a number of large potential local opportunities.

As part of the restructuring completed in 2013, Hulamin has increased its high level sales and market development resources with the addition of two experienced executives to its local sales and market development team.

The all-aluminium beverage can in Southern Africa

Since 2010, Hulamin has remained focused on working with the other key stakeholders to convert manufacture of the body of the beverage can from steel to aluminium. This provides many advantages to the industry, including lower cost, improved carbon footprint, job creation potential, quicker cooling and a more attractive container.

We are particularly encouraged that the industry has chosen to switch to the all-aluminium can and Nampak’s decision to award Hulamin with part supply of its 2013 to 2015 can body stock requirements. This increase in local sales has been further enhanced by a further announcement late in 2013 that Nampak has bought an aluminium can manufacturer in Nigeria, will be installing a second and all-aluminium line and converting its first can line at its Angolata operations in Angola to aluminium and will install a new all-aluminium can line at its Rosslyn beverage can operation. In addition to the increased regional demand for aluminium can body stock, the substantial increase in the number of cans to be produced will increase the requirement for can-ends, potentially doubling the local requirement for can-end and tab stock.

Sustainable and Competitive Aluminium Supply

The production of primary aluminium in Southern Africa dates back to the early 1970s and has grown to be one of the most important regions globally. Due to the electricity-intensive nature of primary aluminium production and the well-publicised current constraints in electricity supply, there is inevitable debate around the allocation of resources and the production of aluminium in the region.

The downstream aluminium industry in Southern Africa is growing rapidly, led by the beverage can conversion to aluminium that, on its own, is likely to double aluminium consumption regionally by 2020. In addition to this packaging-led growth, the use of aluminium in automotive is also expanding rapidly. With its sizeable local automotive industry, aluminium consumption in the manufacture of automotive components has increased its growth rate and there are increasing opportunities in an industry looking for improvements in lightweighting, energy consumption, carbon footprint and recycling. A recently published independent study indicates the opportunity for the aluminium industry to grow by 13 000 jobs to 29 000 and to increase local beneficiation from 178 000 tons per year to 386 000 tons by 2018. Hulamin continues to play a leading role in the development of the downstream industry and contributes to a sustainable aluminium smelting industry.

Hulamin has been in discussions with BHP Billiton on the supply of rolling slab since 2009 when they advised of their plans to cease production of value-added products, which are crucial for downstream beneficiation. These products include rolling slab, extrusion billet, rod (for the wire industry) and other alloys for casting. Discussions have continued without conclusion since 2009, resulting in numerous temporary arrangements. A long-term settlement has proved elusive owing to many associated complexities, contributing to uncertainty over Hulamin’s ability to meet its slab supply requirements for full capacity. During 2013, Hulamin and BHP reached alignment on the strategic rationale for future value-added product manufacture at the Bayside casthouse, while economic pressures of a low aluminium price resulted in BHP commencing consultation with employees over the closure of the pot line and carbon anode plant. While we expect smelting to cease at Bayside during 2014, we are hopeful that a longer-term solution in the interests of all stakeholders will emerge during 2014.

The second and equally important dimension to sustainable aluminium supply is the role of recycling, based on the growing availability of scrap aluminium in the form of both used beverage cans (UBCs) and Class scrap (from can manufacture). The increasing availability of competitively priced and conveniently formatted aluminium scrap provides great opportunities for Hulamin as an additional source of its raw material sourcing over the coming years. The Hulamin board has accordingly approved a R300 million capital investment in beverage can sorting, processing and recycling equipment to be based at its Pietermaritzburg facility. In addition to its state-of-the-art recycling efficiency, this investment also allows for the significant improvement and lowering of cost in existing scrap processing.

A Cooperative Regulatory Environment

Hulamin has specific needs which include controlling the flood of low-priced imports (largely from China), mitigating the impact of Carbon Tax proposals to ensure that the South African manufacturers are not unfairly placed at fatal disadvantage to their international competitors, local content requirements, making infrastructure (such as harbours, pipelines, train services, roads, water and electricity) available at competitive prices and ensuring that aluminium scrap is priced competitively in South Africa.

Hulamin recognises its critical role in assisting government in creating employment and regional stability, sharing technology, bringing competitive advantage and contributing to the reindustrialisation of South Africa and thus the cooperative relationship between Hulamin and government is to the benefit of all South Africans.

Prospects for 2014

With much of the groundwork for the transformation of Hulamin having been completed in 2013 and good progress made in reducing Hulamin’s risk profile, future prospects look encouraging.

Hulamin is a founding member of the Manufacturing Circle and has long supported the importance of a competitive currency to a healthy manufacturing sector. Relative competitiveness between countries and companies can only be compared using the same currency. Thanks to the 17% depreciation in the Rand over the course of 2013, the competitiveness of South African manufacturers and Hulamin in particular has similarly improved and bodes well for the year ahead.

We will intensify our focus on manufacturing performance, cost and efficiency, building on and adding to the capability of our existing, newly restructured management team. We will continue to deliver against the five strategic objectives described above.

I would like to thank all our stakeholders, and in particular our employees, who have supported us through an uncertain and challenging 2013.

 

Progress in Hulamin’s turnaround reached tipping point in 2013 in five major areas. These include structuring the balance sheet, refining the business’ strategic goals, securing long-term metal supply, rightsizing and restructuring the organisation in progressing local and regional can stock market opportunities.