- Operating profit 13% lower at R538 million, but up 27% on a comparable currency-adjusted basis
- Strong operating performance and metal price lag gain mitigates against the negative R267 million EBIT impact of the stronger currency during the year
- Cost reduction targets achieved R117 million net cost out
- Headline earnings per share down 13% to 104 cents
- Return on capital employed down from 9,2% to 7,8%
- Cash-generation before financing activities (free cash flow) of R296 million, supported by working capital efficiency improvements and capital discipline
- Stronger balance sheet, with net borrowings reducing to R317 million (2016: R577 million)
- Dividend of 15 cents per share (cps) declared (2016: 15 cps)
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 2017 and should be read in conjunction with the annual financial statements presented here.
Despite the achievement of record group sales volumes of 233 000 tons, strong delivery in relation to Hulamin’s cost management programme and a metal price lag gain resulting from the rising aluminium price, a stronger Rand resulted in an 13% decline in Hulamin’s headline and normalised earnings per share to 104 cps from the 119 cps achieved in the previous year.
Notwithstanding a 12-day planned integrated plant shut in the third quarter to attend to major plant maintenance and improvements, a strong manufacturing performance supported the attainment of a record Rolled Products sales volume of 215 000 tons in 2017, resulting in group sales of 233 000 tons.
The Rand averaged R13,32 to the US Dollar during 2017, 10% stronger than the R14,73 average recorded in 2016. This had a R267 million negative impact on Hulamin’s operating profits.
The London Metals Exchange (LME) price of aluminium improved to $2 242 per ton at 31 December 2017, up from the $1 713 per ton recorded a year earlier. This resulted in a R150 million metal price lag gain in 2017, up R100 million from the R50 million gain recorded in 2015.
Conversion margins were in line with those achieved in 2016, however, manufacturing costs were down 4% on a per unit basis.
Group earnings before interest, tax, depreciation and amortisation (EBITDA) declined 7% to R754 million (20% decline before metal price lag).
Improved working capital efficiencies, together with lower levels of capital expenditure resulted in cash inflow before financing activities (free cash flow) of R296 million which enabled the group to reduce its borrowings to R317 million from R577 million a year earlier.
A final dividend of 15 cps was declared for the 2017 financial year, in line with the dividend of 15 cps declared in 2016.
In response to indications of slowing economic growth, the central government of China instituted a fiscal stimulus targeting the infrastructure sector during the 2016 calendar year. The stimulus continued to drive growth in the region, with the Chinese economy growing at 6,9% for the 2017 calendar year. Strong growth prospects in China, which is the world’s largest producer and consumer of aluminium, laid the foundation for a continued strengthening of aluminium prices.
However, it has been the constraint placed on aluminium supply growth by the Chinese government that has had the largest impact on aluminium prices. The China’s Central Government’s Supply Side Reform Policy has resulted in the closure of unlicensed and illegal smelting capacity and has also required dozens of aluminium producers to shut during the winter season to reduce air pollution.
Smelters in China remain largely unprofitable, with significant taxes placed on export of primary aluminium, increased scrutiny of Chinese origin material in Europe and the US and higher input costs, particularly alumina, energy and carbon.
It is likely therefore that the current high inventory levels of aluminium in China will decline, lending support to higher levels in the Shanghai Futures Exchange (SHFE) price of aluminium.
Supply tightness increased in the rest of the world, with London Metals Exchange (LME) inventories at record low levels, supporting the increase in the LME price of aluminium from $1 714/ton at the end of 2016 to $2 242/ton at the end of 2017.
The group’s profit and loss benefited from this continued strengthening in aluminium prices resulting in a metal price lag benefit of R149,6 million in the past financial year (2016:
R50,0 million benefit), although it had a negative impact on cash flow of R145,0 million.
The Rand experienced continued volatility to the US Dollar during the current financial year albeit at levels stronger than in 2016.
The US Dollar came under pressure in the first quarter as the market lost confidence in President Trump’s ability to deliver on his economic agenda, and as improved certainty around the future of the European Union (EU) on the back of elections results in the Netherlands, France and Germany improved the outlook for global trade, supporting emerging market currencies.
The latter half of the financial year saw the Rand losing value against the US Dollar as ratings agencies indicated the possibility of further ratings downgrades which ultimately materialised on 24 November 2017, resulting in the currency trading at R13,93 to the US Dollar on that date.
Following the election of Cyril Ramaphosa as the new president of the ANC, on 18 December 2017, the Rand strengthened sharply to end the year at R12,38 to the US Dollar.
During the financial year, the Rand traded between R14,49 and R12,27 to the US Dollar, at an average of R13,32, 10% stronger than the prior financial year.
The Rand was also, on average, stronger against the Euro for the 2017 financial year, recording an improvement of 8% on the average of the previous year.
Domestically, inflationary pressure eased, assisted by lower food inflation as one of South Africa’s worst droughts came to an end. Consumer price inflation has declined below the Reserve Bank’s top-end target of 6,0% hovering closer to 4,7% at year-end. South Africa’s GDP growth for the 2017 calendar year was 0,8% with projections for the 2018 calendar year, more optimistic since the ANC elective conference, now ranging up to 2,0%.
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 in further detail.
Rolled Products built on the strong manufacturing performance delivered in 2016 and increased production levels by 1 000 tons to 215 000 tons in 2017. The plant undertook a 12-day integrated shut in the third quarter to attend to major maintenance and improvements. Risk mitigation systems continue to be effective and plant reliability is stable. This led to an improvement in sales volumes to a record 215 000 tons (group volumes improved to a record 233 000 tons).
Overall, average unit US Dollar rolling margins achieved in 2017 were in line with the prior year. Trading conditions in Hulamin’s export markets remained difficult during 2017. This was offset by the continued growth of Rolled Products’ local market sales, driven by increased sales of can stock, which now represents 40% of total domestic sales, up from 33% level achieved in the prior year. The increase in can stock sales permitted an increase in the recycling of market scrap by 40% over the previous year.
Material costs, packaging and gas costs were impacted by higher commodity and crude oil prices, the weaker local currency and increased volumes. Electricity prices, on average, and salary and wage increases in 2017 were above the official consumer price inflation level, although there was a welcome reduction in the rate of increase in electricity prices approved by NERSA for the period 1 July 2017 to June 2018 to 2,2%. However, due to the poor financial state of Eskom, the risk remains that electricity prices will increase significantly going forward.
Excellent progress was made during the current financial year both in terms of the delivery of significant cost reduction against target and the development and the roll out of Hulamin’s cost optimisation programme. This, together with the strong production performance, mitigated the impact of inflation and commodity price increases, and resulted in a 6% improvement in unit manufacturing costs at Rolled Products.
Hulamin’s cost optimisation programme, which was rolled out at the beginning of 2017, aims to deliver further measurable, sustainable cost reduction of R300 million (12% of addressable manufacturing costs) over the next five years.
In the current year, Hulamin delivered cost reductions in the manpower, contractor and operating supplies categories through the deployment of lean methodology, supported by improved cost management systems. Procurement and supply chain improvements resulted in reductions in certain material and packaging costs. Baseline gas costs improved as Rolled Products converted a further 35% of its gas supply to compressed natural gas, which now stands at 45% of its total supply. The remelt and casting operation remains fully supplied by liquid petroleum gas, whilst Hulamin continues to seek a long-term solution to securing piped gas into the region.
The Rand averaged R13,32/USD for the 2017 financial year, 10% stronger than the previous year’s average of R14,73/USD. This had a significant negative impact on the current year’s operating profit of R267 million as Hulamin’s conversion margins are predominantly foreign-currency denominated.
The Rolled Products segment recorded operating profits of R523 million, a decrease of 11% over the prior year, and Hulamin Extrusions’ operating profits were lower by 55% to R15 million. Note 2.1 of the group financial statements discloses more information on our operating segments contribution.
Total interest paid remained comparable with prior years, decreasing by 3% to R99 million as a result of marginally lower average borrowings during the current financial year, despite the impact of the rising LME price of aluminium.
Net finance cost decreased by 10% to R78 million due to a higher proportion of borrowing costs capitalised to plant and equipment in the current financial year.
The effective tax rate decreased from 28,0% to 27,8% in the current year.
Headline and normalised earnings
Basic headline earnings and normalised earnings for the group decreased by 12% to R333 million in 2017 from R380 million in the previous year.
A strong operational performance and working capital management, together with controlled capital expenditure, resulted in the group generating cash flow before financing activities (free cash flow) of R296 million (2016: R415 million), despite the negative impact of the weaker average currency on conversion prices and the impact of the strengthening of the aluminium price on derivative cash flows.
Operating cash flows
The group generated positive cash flow before working capital changes of R716 million in 2017, a 4% decrease on the previous year.
Working capital management
Improvements in the management of working capital resulted in a release of cash of R68 million in the 2017 financial year, despite a significant negative impact due to the increase in the LME price of aluminium.
After achieving a significant improvement in inventory efficiencies in 2016 to average 85 days (2015: 115 days; 2014: 103 days and 2013: 119 days), Rolled Products maintained these levels in 2017 despite a build-up of inventory in the first quarter due to operational challenges in the Pietermaritzburg remelt operation and higher inventory levels in the third quarter as a result of the integrated plant shut. The Rand value of inventory nevertheless increased by 18% mainly due to the increase in the aluminium price.
Rand receivables decreased by 18% over 2016, despite comparable sales volumes, mainly due to a sustainable reduction in the cash cycle arising from increased sales into the local market and credit term improvements. Foreign receivables were further impacted lower by the stronger currency towards the 2017 year-end, which closed at R12,38, down 9% from the rate of R13,61 recorded at the end of 2016. Almost all receivables are insured, with a 10% deductible, and the quality of the book remains excellent.
Trade payables increased by 11% on the prior year, mainly as result of the impact of the 23% increase in the Rand aluminium price on metal creditors.
Capital expenditure and commitments
Cash outflows from investing activities for the year decreased to R261 million from the R264 million net outflow in 2016.
Cash flows from investing activities in the prior year included the receipt of a R57 million government grant under the Manufacturing Competitiveness Enterprise Programme (MCEP), excluding which cash outflows from investing activities decreased by 18%.
An amount of R43 million (2016: R110 million) has been contracted and committed but not spent.
Borrowings and liquidity
Net borrowings closed at R317 million, down R260 million on the prior year closing position. Borrowings comprised the balance of R162 million on an original R270 million term loan (put in place to fund the investment in Hulamin’s recycling facility), a R193 million revolving working capital loan and a R73 million loan from the employer surplus in the pension fund, reduced by cash balances of R111 million. Committed facilities totalled R1 885 million, leaving headroom of R1 568 million at year-end.
Key covenants on the debt package are a current ratio in excess of 1.25 times and a debt-to-equity ratio less than 0.5 times. All covenants have been met with a significant safety margin in the 2017 financial year.
Gearing (net debt to equity) decreased to 7%. 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 decreased from 9,2% to 7,8% year-on-year, mainly due to the negative impact of the stronger local currency on Hulamin’s operating profits.
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 2017 financial year of 15 cps per share has been approved (2016: 15 cps). This represents a distribution which is seven-times covered by headline earnings and is considered appropriate in order to permit a further reduction in the group’s gearing levels.
KEY FINANCIAL RISKS AND RELATED HEDGING ACTIVITIES
Metal price risk and currency risk exposures
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 margin and costs (Currency Risk)
The group’s conversion margins, particularly in its Rolled Products segment, are largely denominated in US dollar and Euro. Certain of its manufacturing and distribution costs are also foreign currency denominated.
The group does not hedge these exposures and its profits are therefore impacted by currency levels on its conversion margins net of foreign denominated costs. Although volatile during the current financial year the Rand traded on average 10% stronger than the previous financial year placing some pressure on converted rand earnings in a market where margins are under pressure.
Aluminium purchases and sales (metal price and currency risk)
The price of aluminium purchased by the group 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.
On an unhedged basis, this can result in a high level of profit and loss volatility as metal pricing in cost of sales, based on an inventory FIFO valuation, is misaligned with metal pricing in sales. However, there is a low level of cash flow volatility as monthly sales and purchases typically align in both pricing and volume.
The group uses derivative instruments, forwards and swaps, to reduce these profit and loss exposures. The group has, since listing in 2007, applied 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 group decided, based on increased market volatility ahead of the ANC elective conference, to reduce its level of hedging of the currency risk exposure on the metal lag to 50%, in order to avoid undue cash flow volatility.
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. During the current financial year the group made a pre-tax gain of R150 million from metal price lag (2016: R50 million). 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 losses, arising from the stronger 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)
The group 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 R99 million were 3% lower than that incurred in the prior year (including interest capitalised of R21 million). Due to some operational disruptions in the Hulamin’s Pietermaritzburg casting operation in the first half, borrowings increased significantly as working capital grew to buffer the rolling operations. This was remedied during the second half which, together with sustainable improvements in Hulamin’s cash conversion cycle, offset the impact of the higher price of aluminium, and led to a sharp reduction in net borrowings in the fourth quarter to R317 million at 31 December 2017.
Cost inflation in large cost categories such as energy and manpower have continued to outpace official measures of inflation, however, Hulamin achieved significant baseline manufacturing cost reductions in the first year of its cost transformation programme. These reductions in cost offset the impact of inflation and resulted in a 4% improvement in the group’s unit conversion costs in nominal terms.
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 an indicator of impairment exists. Where the share price of a listed entity trades at a discount to its underlying net asset value such an indicator is triggered and 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 5.3 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 R12,96 in 2018 to R14,64 in 2022.
The group’s accounting policies are governed by International Financial Reporting Standards (IFRS). Guidance has been obtained from the International Financial Reporting Interpretations Committee (IFRIC) and circulars. The group maintains the view that the standards set the minimum requirements for financial reporting.
During the year, the group adopted the amendments to IAS 7 “Cash flow statements”. The adoption of this standard has impacted certain disclosures. The adoption of amendments to other standards has not had a material impact on the group.
The group has assessed the impact of IFRS 9 “Financial instruments” and IFRS 15 “Revenue from contracts with customers”, which will come into effect for the year ending 31 December 2018. The application of these standards will not have a material impact on Hulamin’s 2018 financial statements.
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.
Notwithstanding the adverse impact of the stronger Rand and the rising LME aluminium price on Hulamin’s cash flows, a record production performance, together with the impact of a focused cost optimisation programme, sustainable working capital improvements and prudent management of capital expenditure, resulted in the generation of R296 million free cash flow in 2017.
This permitted a decrease in Hulamin’s net borrowings to R317 million, representing a gearing level of 7%, which places Hulamin in a strong position from which to execute its medium-term strategic objectives.