Commentary

Overview

The company's results were negatively impacted in the first half of the year by the weakening South African economy. Business confidence in South Africa declined further as a result of the recession; with a 0.7% decrease in GDP during the first quarter of 2017; the downgrade to sub-investment grade and the highest unemployment rate since 2004.

The domestic and export steel markets in which the company operates are extremely constrained because of minimal local investment and infrastructure spend, high raw material costs and the volatility of the exchange rate. Local apparent steel consumption decreased by 3.8% as a result of subdued economic growth. In addition, South Africa and key African markets continue to import large quantities of steel, especially from China. Despite the import duties and designation of steel, half a million tonnes of steel were still imported into South Africa. To address the surge in imports, safeguards on hot rolled products have been approved by government and the implementation is pending.

ArcelorMittal South Africa's operating and headline losses increased by R714 million and R1 161 million respectively in the first half of the year compared to the same period last year. This is due to the higher imported coking coal and iron ore costs, relatively strong rand/US dollar exchange rate and continued weakening of the South African economy. The company paid a premium for coke that was imported due to the refurbishment of the coke batteries at Newcastle Works. The company has restructured its balance sheet by replacing overnight facilities with a three-year borrowing base facility of R4 500 million.

Safety remains our number one priority and it is with great regret that we report three fatalities at our plants this year, all contractor employees. This is completely unacceptable and we remain committed to achieving zero harm. The lost time injury frequency rate improved from 0.90 to 0.62.

Despite the positive progress on safeguards on flat products, import duties and the designation of local steel for government infrastructure projects, the group and the local steel industry continue to be threatened by imports entering the market, primarily from China. ArcelorMittal South Africa has implemented various initiatives to return the group to profitability and to generate positive cash flows. In order to address the current challenges, the group is in the process of exploring several additional initiatives, including additional cost-saving interventions, assessing the profitability of various product lines and the implementation of structural changes (restructuring) in the next six months. Further information will be provided as soon as the necessary investigations and decisions have been finalised.

Markets

The global steel demand has shown some improvement in H1 2017, mainly attributed to the positive market environment of developed countries. However, China's steel demand has been relatively flat compared to the last half of 2016. Demand improved due to the improvement in finished steel prices in key markets such as China, Europe and particularly in the USA, where imports of steel have increased in recent months after declining in H2 2016. Hot rolled coil (HRC) and rebar prices gained 14% and 18% respectively compared to H2 2016. The cost of iron ore and coking coal increased on average by US$22 (42%) and US$95 (112%) per tonne respectively compared to H1 2016. Due to the lag in the impact of prices, as a result of stockholding, coking coal prices are expected to remain high in Q3 2017.

The overall African markets have remained positive due to the drive towards infrastructure investments in the rail, roads and energy projects, specifically in the west and east sub-Saharan regions. In the southern African region, fiscal concerns and weak commodity prices have hampered investment progress. South African producers lost sales in African markets due to cheap imports into Africa.

Despite the improvements in global steel demand and steel prices, domestically the economy continues to struggle due to a lack of investments, particularly in the construction and manufacturing sectors, and as cheap imports of primary and finished products continue to flood the local steel market.

Financial results

Revenue

Revenue increased by 12.6% to R19 151 million mainly due to an 18.9% increase in average net realised steel prices, from R6 845 per tonne to R8 138 per tonne. This was partly offset by lower sales volumes. In line with expectations, revenue from the Coke and Chemicals business decreased by 9.4% to R735 million due to scheduled but lengthy repairs to coke batteries at Vanderbijlpark and Newcastle Works. This resulted in a decrease in the quantity of coke available to sell and coke had to be imported at higher prices. Commercial coke and tar prices increased by 117.9% and 5.5% respectively.

Total steel sales volumes decreased by 95 000 tonnes. Local sales declined by 9.2% due to the difficult trading conditions. This was partially offset by export sales which improved by 15.9%. The pending implementation of safeguards is expected to improve flat product sales volumes.

Operating expenses

Cash cost per tonne of liquid steel produced increased by 27% to R8 063, raw materials, namely iron ore, coal and scrap, which accounted for 50% of total costs, increased by 43%. Consumables and auxiliaries, which represented approximately 27% of costs, increased by 15%, and fixed costs per tonne increased by 13%.

The high international coal and iron ore prices are the main contributor to the increase in raw material costs. Electricity costs also increased due to annual electricity price increases.

Loss from operations

The loss from operations increased by R714 million to R983 million, primarily due to the higher coal and iron ore prices. Depreciation decreased due to the substantial impairment of the Vanderbijlpark and Saldanha Works' cashgenerating units in 2016.

Loss for the period

The loss for the period increased by R1 773 million. This was largely attributable to the loss from operations which increased by R714 million. Financing costs were R284 million higher, mainly due to the higher debt position, facility cost and exchange rate losses resulting from the volatility of the rand against foreign currencies and discounting rate adjustment on non-current provisions.

An impairment of R600 million was recognised against property, plant and equipment for the long products unit. This was primarily as a result of the strengthening of the rand against the US dollar and loss of volumes due to higher coal prices compared to scrap-based local competitors.

Income from equity-accounted investments decreased by R122 million as a result of reduced profits from joint ventures primarily due to poor economic conditions.

Cash position

The cash position deteriorated from a net cash position of R1 010 million to net borrowing position of R2 577 million, mainly due to lower operating results, higher financing costs and capex spending on the refurbishment of the coke batteries.

Operational

The company's capacity utilisation was 79% compared to 83% the previous year. Liquid steel production for the year was 2.4 million tonnes, a decrease of 146 000 tonnes (5.8%). Production at our long products business was cut back due to the increase in coking coal prices and decrease in scrap prices, making our long products more expensive due to the use of coking coal in the manufacturing process. The long products business was negatively impacted even further by the deteriorating market conditions and higher raw material prices. The restart of the Highveld Steel heavy structural mill contributed 22 000 production tonnes and 6 000 more sales tonnes of heavy sections and rails in Q2.

Flat products' liquid steel production decreased by 83 000 tonnes and plant utilisation decreased to 79% compared to 83% in 2016. This was due to a rupture of the stove at blast furnace C at Vanderbijlpark Works in Q4 2016, and the blast furnace D incident which resulted in a decrease in production of 80 000 tonnes.

The company initiated several initiatives to improve operational efficiencies, increase volumes and/or reduce costs. These initiatives include:

  • The N2 battery refurbishment at Newcastle Works will be completed in Q3 2017. It is expected that the refurbishment will improve the sustainability of the coke batteries and that the batteries' coke-making capability (traditionally a significant EBITDA contributor) will be restored to 381 000 tonnes per year;
  • The boiler project completed at Vanderbijlpark Works in June 2017 will enable optimal use of the power station in generating approximately 10MW additional power per annum – a R60 million annual benefit;
  • Further restructuring, cost-cutting and efficiency measures have been implemented and additional measures will be considered in the next quarter; and
  • The company intends to aggressively pursue the Africa Overland (AOL) market.

Sustainability

A number of steps were taken, all of them likely to have an impact on the company's sustainability and licence to operate. These included:

  • Safeguard duties on hot rolled products have been approved by government and we await implementation;
  • Air emissions are currently a key focus area and significant challenges regarding sinter emissions at Vanderbijlpark and blast furnace emissions at Newcastle Works are being addressed. Our newly installed water treatment facilities at Newcastle Works are performing as per our expectations;
  • ArcelorMittal South Africa is a level 3 B-BBEE contributor compared to level 4 in 2016;
  • Fair pricing model for flat steel products has been approved by government and continues to be monitored; and
  • The company has restructured its balance sheet by replacing overnight facilities with a three-year borrowing base facility of R4 500 million. Eligible inventories and receivables are provided as security for the borrowing base facility to the extent of the draw down.

Changes to the board of directors

Mr LP Mondi resigned as non-executive director with effect from 24 May 2017.

Ms KM Musonda appointed as independent non-executive director with effect from 12 June 2017.

Dividends

No dividends declared for the six months ended 30 June 2017.

Outlook for H2 2017

Volatility in the rand/US dollar exchange rate will continue to have a material impact on our financial results. ArcelorMittal South Africa has implemented various initiatives to return the group to profitability and to generate positive cash flows. As already indicated, the company will also be looking to implement a number of interventions to address the challenges that it faces.

In the second half of the year, domestic steel demand is expected to remain subdued due to low economic growth and lack of infrastructure spend. The flat steel business will benefit from the implementation of safeguard duties in the second half of the year. The long products business could improve depending on coal and scrap prices and as the full benefit of the heavy sections and rail volumes is realised. Export markets are likely to be more resilient; however, projections are that Africa will experience a growth in demand in the order of 2.3%.

On behalf of the board of directors

WA de Klerk D Subramanian
Chief executive officer Chief financial officer

25 July 2017