RELIANCE ON KEY CAPITALS
GOVERNANCE AND LEADERSHIP
Operating profit 110% higher at R622 million, underpinned by record sales volumes of 232 000 tons
Headline earnings per share up 222% to 119 cents
Return on capital employed up from 4,7% to 9,2%
Cash generation of R415 million, supported by working capital efficiency improvements and capital discipline
Stronger balance sheet, with net borrowings reducing to
R577 million (2015: R975 million)
Dividend of 15 cents per share (cps) declared (2015: 8cps)
The purpose of this review is to provide insight into the financial performance and financial position of the group for the year ended 31 December 2016 and should be read in conjunction with the annual financial statements presented here.
Following a difficult year in 2015, strong manufacturing performance and a favourable rand supported a 116% increase in normalised earnings per share to 119cps in 2016 from the 55cps achieved in the previous year. Headline earnings per share rose 222% from 37cps in 2015 to 119cps.
Improved risk management and mitigation measures promoted stable manufacturing conditions, upon which production performance improvements supported the attainment of record Rolled Products sales volumes of 214 000 tons, with group sales of 232 000 tons achieved.
The external environment provided support to Hulamin’s financial performance with the Rand averaging R14,73 to the US Dollar during 2016, 15% weaker than in 2015.
The London Metals Exchange (LME) price of aluminium improved to $1 713 per ton at 31 December 2016, up from the
Rolling margins were weaker in 2016, however manufacturing costs were lower by 4% on a per unit basis, reflecting the impact of improved production on a largely fixed cost operation.
Group operating profit improved 110% to R622 million, and was up 20% on a comparable basis before metal price lag.
Improved working capital efficiencies, particularly in inventory, together with lower levels of capital expenditure resulted in cash inflow before financing activities of R415 million which enabled the group to reduce its borrowings to R577 million from R975 million a year earlier.
KEY FINANCIAL RISKS AND RELATED HEDGING ACTIVITIES
Hulamin purchases primary aluminium and converts this into rolled or extruded aluminium products. It sells the aluminium component in its products to its customers and, in addition, earns a conversion margin as compensation for its costs of casting, rolling, extruding and finishing its various products.
Conversion margins and costs (currency risk)
Hulamin’s conversion margins, particularly in its rolling business, are largely denominated in US Dollars and Euros. Certain of its manufacturing and distribution costs are also foreign currency denominated.
Hulamin does not hedge these exposures and its profits are therefore impacted by currency levels on its conversion margins net of foreign denominated costs. The currency weakened from R12,76 on average in the 2015 financial year to R14,73 on average for 2016, providing a significant support to earnings.
Aluminium purchases and sales (metal price and currency risk)
The price of aluminium purchased by Hulamin and sold to its customers is typically based on the monthly average US Dollar LME price in the month prior to the month of delivery. It usually takes about three months to produce and invoice the semi-fabricated products sold to customers and during this period the quoted LME price may increase or decrease. Similarly, the Rand fluctuates against the US Dollar during this period, resulting in the purchase price of aluminium in Rand differing from the price realised upon sale.
Hulamin uses derivative instruments, forwards and swaps, to reduce these exposures. Hulamin has, since listing in 2007, followed a policy of hedging 50% of its US Dollar aluminium price lag risk exposure and 100% of its currency risk exposure on the metal lag. Eliminating 100% of the US Dollar aluminium price lag risk with derivatives would create a cash flow risk if the price of metal were to rise strongly since new inventory would have to be purchased at a higher price than the proceeds received net of derivative settlements, hence the 50% policy on the US Dollar aluminium price lag.
The unhedged fluctuation in the US Dollar aluminium price from the date of purchase of aluminium to the date of sale results in a metal price lag impact on profits. In the 2015 financial year, Hulamin made a pre-tax loss of R161 million from metal price lag. In the current year a pre-tax gain of R50 million was recorded following a moderate rise in the LME price of aluminium during the year. This net gain was made up of dollar denominated gains on the purchase and subsequent sale of metal offset by losses on derivative instruments. The related currency gains, arising from the weaker Rand /Dollar exchange rate, on the aluminium price lag were fully hedged out in accordance with Hulamin’s policy.
Foreign denominated receivables, payables and import transactions (currency risk)
Hulamin hedges its currency exposures on foreign denominated receivables and payables from invoice date to expected receipt or payment date and on import transactions from the date of commitment.
Interest rate risk
The group is exposed to interest rate risk with respect to its borrowings which carry variable rates. Interest payments of R102 million were some 17% higher than in the prior year (including interest capitalised of R15 million) due to higher average borrowings and higher prevailing interest rates in 2016. However, a strong operating performance in the second half, with improvements in working capital efficiencies, led to a sharp reduction in net borrowings to R577 million at 31 December 2016.
Cost inflation in large cost categories such as energy and manpower costs have continued to outpace official measures of inflation, however Hulamin, as a largely fixed cost operation, benefited from significantly improved volumes, resulting in a 4% improvement in unit conversion costs in nominal terms. The weaker currency further improved Hulamin’s Dollar cost competitiveness resulting in a 17% improvement in Dollar unit manufacturing costs.
The group financial statements have been prepared in accordance with International Financial Reporting Standards (IFRS), IFRIC interpretations, SAICA Financial Reporting guides, the requirements of the Companies Act, No 71 of 2008, as amended, and the Listings Requirements of the JSE Limited.
During the year, the group adopted the amendments to IAS 1 “Presentation of financial statements”. The adoption of this standard has impacted certain disclosures and the presentation of the Hulamin company financial statements.
The group is currently assessing the impact on hedge accounting of the introduction of IFRS 9 “Financial instruments”, which will come into effect for the year ending 31 December 2018.
Impairment assessment of Rolled Products assets
International Accounting Standard (IAS) 36 requires that management assess the carrying value of assets at every reporting date for possible impairment in value. Where the share price of a listed entity trades at a discount to its underlying net asset value, as is the case at Hulamin, management are obliged to determine the value in use of the assets and should this be below their carrying value, make an appropriate adjustment.
A full value in use computation was performed at the balance sheet date and no adjustment to the carrying value of assets was indicated. Full details are provided in note 20 to the financial statements and the determination was reviewed by the company’s external auditors. Key sensitivities are explained in the note and the Rand/US Dollar exchange rate assumed is a key determinate of the value in use of the assets due to the impact of the exchange rate on profitability. The valuation assumed a rise in the average Rand/US Dollar exchange rate from R13,98 in 2017 to R14,87 in 2021.
The financial performance of the group is measured in terms of various key financial measures which include operating profit, headline and normalised earnings, return on capital employed, cash flow generation, gearing and liquidity, as set out below:
A strong manufacturing performance in Rolled Products, supported by improved risk mitigation and plant reliability as well as productivity and yield improvements, led to sales volumes increasing by 19% to a record 214,000 tons (group volumes were up 17% to 232,000 tons).
Average unit US Dollar rolling margins were some 16% weaker in 2016, largely due to a weaker product mix (the low sales volumes in 2015 had a higher concentration of high value products), the weakness of the Euro which impacted rolling margins in US Dollar terms on Hulamin’s sales to its European customers and the weaker average geographic premiums year-on-year. Although regional premiums softened in 2016, they fell far less dramatically than during 2015 and have demonstrated relative stability in the second half of 2016, following the LME’s implementation of more stringent warehouse controls.
The strong volume improvement contributed to a 4% improvement in unit manufacturing costs in nominal terms. Total conversion costs, adjusted for volume and currency impacts, were in line with price inflation.
Material costs, alloying elements, packaging and gas costs were impacted by stronger commodity and crude oil prices, the weaker local currency and increased volumes. Electricity costs and manpower continue to increase above the official consumer price inflation levels. Following the disruptions to local refinery liquid petroleum gas (LPG) supply in 2015, a higher proportion of imported LPG was contracted in 2016 at higher costs but this contributed to increased production stability. Hulamin made progress in 2016 in converting around 10% of its gas supply to compressed natural gas while it continues to seek a long term solution to securing piped gas into the region.
The weakening of the Rand by 15% to an average of R14,73/USD for the year(2015: R12,76/USD), protected Rand revenues and mitigated the effects of declining rolling margins and domestic cost inflation. The Rand was particularly weak in the first half, averaging R15,46/USD whilst it was significantly stronger in the second half, averaging R14,00/USD.
Despite the stronger currency in the second half, Hulamin performed significantly better in the second half recording a group EBITDA
The Rolled Products segment recorded operating profits of R588 million, an increase of 108% over the prior year, and Hulamin Extrusions improved operating profits by 172% to R34 million. Note 2 of the group financial statements disclose more information on our operating segments contribution.
Total interest paid increased by 17% to R102 million due to higher average borrowings (albeit significantly reduced in the second half) and higher average interest rates predominating in the year.
Net interest expense increased by 31% to R87 million, with a lower proportion of finance costs capitalised to plant and equipment in the current year.
The effective tax rate decreased from 28,5% to 28,0% in the current year.
Headline and normalised earnings
Basic headline earnings and normalised earnings for the group increased to R380 million, an increase of 218% and 115% respectively. The 2015 headline earnings was impacted by the accounting implications of Hulamin’s investment in Isizinda Aluminium.
The group generated cash flow before financing activities of R415 million in 2016, supported by improved operational performance and working capital management, and lower capital expenditure.
Operating cash flow
The group generated positive cash before working capital changes of R743 million in 2016, a 38% increase on the previous year. EBITDA for the current year of R808 million was 82% up on the R444 million achieved in the prior year. This was offset, however by a loss of R127 million relating to movements in derivative balances (2015: R64 million gain) primarily relating to the translation of derivatives hedging the metal price lag.
Working capital management
Improvements in management of working capital resulted in a release of cash of R166 million in the 2016 financial year.
Significant progress was made during the year in improving inventory efficiencies. Rolled Products inventories averaged 85 days of sales in 2016, 26% below the average of 115 days achieved in 2015 (2014: 103 days and 2013: 119 days).
Rand receivables increased by just 9% over 2016, despite the 17% increase in sales volumes. The Rand aluminium price at the close of the 2016 financial year was fairly consistent with that of the prior year, however foreign receivables were impacted lower by the stronger currency towards the 2016 year end, which closed at R13,61, down 13% from the rate of R15,56 recorded at the end of 2015. Almost all receivables are insured, with a 10% deductible, and the quality of the book remains excellent.
Trade payables increased significantly on the prior year, reflecting higher purchases, particularly in the fourth quarter, in line with increased production volumes.
Capital expenditure and commitments
Cash outflows from investing activities for the year decreased to R264 million, net of a receipt of a R57 million government grant under the Manufacturing Competitiveness Enterprise Programme (MCEP), from the R543 million outflow in 2015.
Cash flows from investing activities in the prior year included Hulamin’s R100 million investment in Isizinda Aluminium.
Stay in business capital expenditure declined by over R100 million, from the R363 million incurred in the prior year, to more sustainable levels.
Borrowings and liquidity
Net borrowings closed at R577 million, down R398 million on the prior year closing position. Borrowings comprised the balance of R216 million on an original R270 million term loan (put in place to fund the investment in Hulamin’s recycling facility), a R363 million revolving working capital loan and a R73 million loan from the employer surplus in the pension fund, reduced by cash balances of R76 million. Committed facilities totalled R1 839 million, leaving headroom of R1 187 million at year end.
New working capital and general banking committed facilities were put in place in October 2016 for a further three-year period, following the maturing of the previous facilities.
Gearing decreased to 13%. The low level of gearing is expected to be further reduced in the short term, however, will increase again over the medium to long term, in anticipation of investment in capital expansion projects.
Return on capital employed
The return on capital employed for the group increased from 4,7% to 9,2% year-on-year. This mainly reflects the substantial increase in operating profit in 2016, the improvements in working capital and the lower level of capital expenditure.
The group amended its policy during the course of the 2016 financial year to pay only a final dividend to shareholders. The group has maintained its policy to target a distribution to shareholders which is three-times covered by headline earnings, after due consideration of current and forecast cash generation, liquidity and gearing levels, and planned capital expenditure. A final dividend for the 2016 financial year of 15 cents per share has been approved. This level of dividend allows the group to focus on further reducing its gearing in the short term. In accordance with International Financial Reporting Standards, no liability has been raised for the final dividend declared. A dividend of 8 cents per share was declared and distributed in the previous year.
GOING CONCERN ASSERTION
The board has formally considered the going-concern assertion for the group and is of the opinion that it is appropriate for the forthcoming year.