Factors driving the mining industry in South Africa
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South Africa is a treasure trove of mineral resources. The country produces and shares a significant amount of the world's minerals. Figure 1 shows that South Africa's riches comprises just under 90% of the platinum metals on Earth, 80% of the manganese, 73% of the chrome, 45% of the vanadium and 41% of the gold.
SA's share of world reserves & production
Having involved in mining since the 1860's when large swathes of diamond-bearing rocks were discovered in Kimberly, South Africa's competitiveness has evolved to include high level technical and production know-how and wide-ranging research and development activities. And, increasingly government is taking an interest in beneficiation to add value to the end product.
Objectives of the Report
The first part of the report gives a snapshot of the macro-economic factors driving the mining industry in South Africa. This is complemented by an in-depth industry analyses. The relevant macro-environment elements and industry-specific factors will assist Merchant Bank and OMC in their investment decision. The macro-environment is crucial in the decision to invest especially in a foreign country, and this will help OMC a great deal.
The choice of company to spend in is also of extreme importance for investors. This report analyses two companies with great potential, and both are registered with the Johannesburg Securities Exchange (JSE). This objective is the third leg of the report and will involve the in-depth scrutiny of AngloGold Ashanti and African Rainbow Minerals (ARM). The report will show that these companies are well managed and growing.
Technical financial analysis and share valuation potentiate the company analyses to give a clearer picture of how the companies perform. This section aims to give Merchant Bank and OMC, before they invest, the general financial position of AngloGold Ashanti and ARM to limit the risk of investing in a failing business. Financial and share analyses will reveal certain trends as well as the financial strengths and weaknesses of both companies.
Based on the analyses the report will make recommendation to Merchant Bank regarding which company OMC must consider for investment. This will include our recommended share value and right price to pay for it. The report will provide financial reasons for our recommendations.
In mining, beneficiation is all the processes designed to separate extracted ore into mineral and something fit for added doling out or direct use (Department of Minerals and Energy). This definition has evolved to mean processes to add economic value on a mineral through cutting and polishing (SACCI, 2010 & Chamber of Mines, 2008). For example, in the diamond sector, those advocating for more beneficiation argues that cutting and polishing processes within the diamond value chain should be done inside the country to fully exploit the local economic contribution (Department of Minerals and Energy).
Sustainable development is a concept that offers an option to the long-established notion of development that looked at business expansion and profiteering as the ultimate goal for business regardless of the means (Khator & Fairchild, 2006:13). The Brundtland report of 1987 paved the way for the modern concept of sustainable development: "development that meets the needs of the present without compromising the ability of future generations to meet their own needs" (Clugston & Calder, 1999:1). A more technical definition is provided by the Organisation for Economic Cooperation and Development's 2001 policy brief: a development path along which the maximisation of human well-being for today's generations does not lead to declines in future well-being.
Yager (2010) estimated that in 2008 South Africa's share of world kyanite and other materials amounted to 55%; rutile, 20%; ilmenite, 19%; fluorspar, 6%; aluminum, 2%; antimony, 2%; iron ore, 2%; nickel, 2%; and phosphate rock, 1%.
According to the Chamber of Mines of South Africa (2008) South Africa is the world's largest producer of alumino-silicates, chrome, ferro-chrome, platinum group metals, vanadium and vermiculite; and a significant supplier of aluminum (world rank 9), antimony (7), coal (6), manganese (2), ferro-manganese (4), gold (2), iron ore (7), nickel (9), phosphate rock (10), silicon (8), titanium minerals (2), uranium (11) and zirconium (2).
Minerals in the National Economy
China usurped South Africa's position as the world's largest gold producer in 2007. But mining continues to be a critical player in South Africa's ever diversifying economy. According to various studies (Annual Financial Statistics, 2008; Yager, 2010 & Chamber of Mines of South Africa, 2010) the output of the mining industry, analysing 2008 figures, accounted for:
9.5% of the gross domestic product;
41% of the value of total exports (crude and processed mineral products);
80% of total value exports processed mineral products;
518 519 of employment;
About 400 000 jobs in supply and services industry related to mining and quarrying;
18% of total investment in the economy;
R1.4 trillion, or 31%, of the value of the Johannesburg Securities Exchange;
17.3% of direct taxes of total company tax.
Gold, one time foundation of the South African economy, has budged over time to Platinum. In 2008, exports of Platinum Group Metals (PGM) amounted to $9.43 billion; gold, $5.32 billion; coal, $5.13 billion; iron ore, $2.45 billion; manganese ore, $1.89 billion; nickel, $497 million; copper, $183 million; chromite, $154 million; and other crude mineral products, which included diamond, ilmenite, rutile, and zircon, $1.33 billion (Yager, 2010). All these accounted for over 25% of the country's turnover (Statistics South Africa, 2008).
South African Mining Industry
As a major mining country, South Africa's competitiveness includes a high level of technical and production know-how and world-class research and development activities (Zieleniewski, 2008). Recently South Africa featured prominently in the rescue mission of the 32 Chilean miners that were trapped in a mine.
South Africa boasts world-class processing facilities covering carbon steel, stainless steel and aluminium as well as gold and platinum. It is also an innovative leader coming with ground-breaking processes that converts low-grade superfine iron ore into high-quality iron units (Zieleniewski, 2008). Although at a lower level this value adding process to raw minerals before export, has been identified by the Accelerated and Shared Growth Initiative for South Africa as a major growth area (Mlambo-Ngcuka, 2006).
According to the Chamber of Mines of SA (2009) the past 12 months has been a very difficult period for the mining sector, with mining's real GDP shrinking by 32,8% in the first quarter of 2009.
The Mining Charter
Transformation is a key issue facing South Africa's mining sector. Fair access to mineral resources and opportunities has been legislated (Minerals and Petroleum Resources Development Act of 2002). The spirit of the legislation is to be fully inclusive with meaningful involvement of historically disadvantaged individuals, the subject of the industry's mining charter, in ownership, management, and access. The industry have little choice but to comply as the Minerals and Petroleum Resources Development Act of 2002 recognises the state's custodianship over the country's mineral resources.
In a response to the country's skewed ownership, management and control of mining, the industry put together a transformation charter, in 2004, committing to sell 15% of their South African assets to black investors by the end of 2009, and 26% by 2014. Recent actions to increase black ownership included the purchase of 20% of Gold Fields Ltd. by black-owned Mvelaphanda Resources Ltd. by 2009, the transfer of mines held by AngloGold Ashanti Ltd. to black-owned African Rainbow Minerals Ltd., and the acquisition of 30% of Sallies Ltd. by African Renaissance Investments (Pty.) Ltd. (Mining Journal, 2005).
Nonetheless, these high profile empowerment deals are too little. Mining assets ownership remains relatively unchanged, with only 8, 9% falling under black ownership. The charter has been reviewed and is expected to be released in the last quarter of 2010 (Ryan, 2010).
The charter seeks to correct the present anomaly where more than 70% of the mining industry's labour force is black, but less than 5% of managerial positions are held by black people (Stats, SA). The reviewed charter is expected to stick to the 2004 targets envisaging that, by 2014, all mining companies will have 40% of leadership positions in black hands (Ryan, 2010).
Though South Africa is one of the largest producers of diamond, the country currently beneficiates a paltry 5% (Mining Review, 2008) of its diamond production despite cutting and polishing of these precious stones adding 50% to their value (SACCI, 2010). To stimulate the cutting and polishing of diamonds the South African government enacted the Diamonds Act of 2005 in early 2006. Two years later the State Diamond Trader was established with a mandate to purchase 10% of South Africa's rough diamond production for use in domestic cutting and polishing plants (Mining Review Africa, 2008) and the Accelerated and Shared Growth Initiative for South Africa, launched in 2006 as an economic growth strategy, identifies the beneficiation of diamond and jewellery making as one of the key sectors of growth (Mlambo-Ngcuka, 2006).
Table 1 adapted from Chamber of Mines of SA (2009) shows how little went to local beneficiation in 2008 as compared to production and exports.
South African mining industry is largely privately owned with few dominant players. For instance, in 2008 the leading producer of diamond accounted for 93% of national production; iron ore, 69%; manganese ore, 51%; chromite, 43%; and coal, 24% (Yager, 2010). Government is looking to join in the fray to mitigate the dominance of mining by few big corporations. In October 2010 the state-owned mining company African Exploration Mining and Finance Corporation became the second state-owned mining company, after diamond producer Alexkor Limited, to be granted a mining right (Mining review, 2010).
Two of the world's biggest mining companies originate in South Africa. BHP Billiton, the world's largest mining company, came after a merger between South African company Billiton and Australian firm BHP. Anglo American Plc, which has its primary listing in London and its secondary listing in Johannesburg, owns many major subsidiaries operating in South Africa, such as Anglo Platinum, Anglo Coal, Impala Platinum, Kumba Iron Ore and De Beers. De Beers is the biggest diamond miner in the world and has mines in South Africa an Botswana (Yager, 2010).
Mining is exposed to various legal issues related to the environment, now and then, due to the nature of its operations. Again, the world is fast becoming green, and in South Africa environment management is taking centre stage. The Chamber of Mines of South Africa (2010:56) is worried about continuous adverse media reports on the environmental legacies of the past noting that such reports are "resuscitating a tendency among non-governmental environmental organisations to measure the commitment of current and future mining operations in terms of these legacies".
Mining companies must incorporate environmental management and rehabilitation into their business in "a cradle to grave" kind of approach (Baillie, 2009). Furthermore, Baillie (2009) laments the fact that there is no clear guidelines for the gold mining sector, in particular, to follow in complying with the minefield of legislation and regulations designed to protect the environment. This is a necessary costs as the South African laws have adopted the "polluter pays" principle (Mineral and Petroleum Resource Development Act of 2002 & National Environmental Management Act, 1998).
Cronje´ and Chenga (2009) report that the mining communities have severe social problems, exposed to toxic waste, and that they perceive most problems as being caused by the mine and its operations. Therefore the solutions, they say, are the responsibility of the mine, which may be an input cost for the mine. It will be wise to look at taking care of the environment as part of input costs to the company.
South Africa experienced power outages in 2008. Rooted on a "business as usual" scenario, and not including any mitigation measures, production of PGMs could be 19 150 oz lower in 2011 and as much as 197 419 oz lower in 2013, as a result of power supply shortfalls, according to RBC Capital Markets analyst Leon Esterhuizen (Hill, 2010). Electricity is likely to be a big blow to the industry if Eskom does not complete its planned power generating plants in time. In the offing production of PGMs has been waning, as producers combat rising costs and unpredictable prices (Hill, 2010). Nonetheless, Eskom appears set to meet its targets and plans are afoot to develop nuclear-driven power stations (Etzinger, 2010). According to the Chamber of Mines of South Africa (2010) there was no need to implement energy reduction measures in 2009.
Investors thrive on certainty. Nationalisation jitters continues to bedevil investors amid calls by mainly the African National Congress Youth League (Nevin, 2010) despite nationalisation not being the government policy. The article looks at the new mineral regulatory regime of South Africa in 2008. Instead government has enacted the Mineral and Petroleum Resources Development Act (MPRDA), which came into act in 2004.
The MPRDA acknowledges that the country's mineral and petroleum resources belong to the nation, whose custodian is the state, but seeks to attract foreign investors by making new areas available for exploration and exploitation. However, this also causes jitters as the regulations to the law are unclear as it is seen in the Sishen Mine saga involving ArcelorMittal.
Another novelty that the industry has to deal with is the Mineral and Petroleum Resources Royalty Act (2008) implemented in 2010. It is expected to cost the industry about R1.8 billion per annum (Antonioli, 2010).
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