Merafe Resources Limited (RZT.F) Earnings Call Transcript & Summary

Good day, ladies and gentlemen, and welcome to the Merafe Resources Limited Interim Results. [Operator Instructions] Please also note that this call is being recorded. I would now like to turn the conference over to Zanele Matlala. Please go ahead.

Good morning. Welcome to the Merafe Interim Results Presentation. Ditabe and I will take you through the presentation and Japie Fullard, CEO of Glencore Alloys, is also on the line and will be available for questions at the end of the presentation. Now On Slide 5, we give the key features of the results. COVID-19 is not only a health crisis, but also an economic one. It has impacted our business, communities and our employees. Our response to the pandemic was to adopt new operating protocols, which included screening and testing of employees, monetization and social distancing in order to protect the health of our employees. The Venture also embarked on various programs to assist communities. These included food cattle's distribution, donations of medical equipment, and provision of water tanks. Ferrochrome and chrome ore production decreased significantly period-on-period, this was mainly as a result of COVID-19 lockdown and subdued demand. Production costs continued to increase, especially electricity prices. The global economy contracted in the first half and is expected to contract further for the full year. As expected, industrial production's demand decreased. Ferrochrome and chrome ore demand followed a similar trend and prices were under pressure and continue to be under pressure. The revenues decreased by 16% period-on-period, mainly as a result of lower prices and volumes. Headline earnings of ZAR 0.011 per share were realized, no interim dividend has been declared. For the market on Slide 7 to Slide 10. Chrome ore prices continue to be under pressure, as I mentioned earlier, with UG2 prices hovering below USD 120 per tonne. There was some recovery in Q2 as a result of supply consent and that was short-lived. Once the lockdown restrictions were eased and production resumed prices started declining. Ferrochrome, CIF prices followed a similar patterns with prices hovering around USD 0.71 per pound, and seamless steel production declined by 11.5% from previous 26.2 million to 23.5 million tonnes. China accounted for about 57% of the global stainless steel production and fencing its dominant position. Global ferrochrome demand declined by 15% from 7 million to 6.1 million tonnes with China accounting for about 65% of demand. Global ferrochrome production for the full year is expected to respond to weaker demand and declined by 10% from 14 million to 12.7 million tonnes. China continues to be the largest ferrochrome producer equity 6% of global production, followed by South Africa at 20%, which is a far cry from the once dominant position South Africa had a few years ago. Chrome ore imports into China also decreased by 28% from 8.5 million to 6.1 million tonnes, as a result of COVID related to CapEx. The 5% of import into China in terms of chrome ore was from South Africa. Move to Slide 12, on the impact of COVID-19. As I said earlier, COVID-19 had a negative impact on various aspects of our business. Negative growth in demand of stainless steel impacted this demand of ferrochrome, also negatively impacting prices and volumes sold. Production has been scaled down significantly with only Lion smelter, Eastern chrome mines and UG2 plant operating after lockdown restrictions were eased. The rest of the operations were placed on care and maintenance and have only resumed operating this month and that is in the summer months, except for Lydenburg, which remains on care and maintenance indefinitely. Higher standing charges were in cash due to lower volumes produced. It's important to note that we continue to care our employees during lockdown. As mentioned earlier, we adopted new operating protocols to prevent the spread of COVID-19. A key focus area is cash preservation with CapEx for 2020 being revised down. Reduction of inventory in H1 was achieved and further brought down as anticipated in H2 and Ditabe will elaborate more in terms of those volumes. We'll continue to review our operations to improve operational and cost efficiencies. Regrettably, 4 of our colleagues have succumbed to COVID-19. Move to Slide 13. The safety of our employees remains a critical focus area with the goal of being to achieve zero harm. Safety campaigns and programs continued during the period. Despite our efforts, our Total Recordable Injury Frequency Rate deteriorated from 2.56 in December 2019 to 3.57 for the period under review. There were no fatalities during the period. On Slide 14. Ferrochrome production volumes reduced by 42% from 206,000 tonnes to 120,000 tonnes. We expect the production for the full year to be between 50% and 50% of installed capacity. The CapEx were mainly as a result of the lockdown but also in response to the weaker demand of ferrochrome. On Slide 15, total production costs increased by 8.4% from December 2019. The key contributors to the increase were electricity prices increase effective April 2020, lower production volumes, therefore, higher allocation rate of fixed cost on standing charges, there was some reprieve from lower reductant and oil prices. Electricity supply, and cycles remain a key risk for our business. The recent court victory by Eskom with regard to the tariff determination is a key content for us. At this point, I'll hand over to Ditabe to take you through the finances.

Thank you, Zanele, and good morning all. 2020 has been a difficult year so far, and our results reflect that revenue of ZAR 2.3 billion was realized and this is down by 16% period-on-period. With ferrochrome revenue and chrome ore revenue decreased by 16%. The decrease was primarily due to lower volumes sold and lower prices achieved for both products. Product movement was negatively impacted by third party logistics challenges, especially over the initial COVID-19 lockdown period. Rand's weakness over the period has been a boom and supported our revenue. Moving to the next slide. On earnings, as guided in our trading statement for the 6 months, we are reporting a loss of FX. Lower prices achieved have squeezed margins and lower volumes produced and sold reduced our operating leverage. IAS 36, which yielded the impairment of assets, requires one to make an assessment each time that indications of impairment exist. We delayed the release of results due to an extensive exercise that we undertook to review the models used for deposits of assessing our recoverable amount. After this assessment, we decided to raise an impairment loss of ZAR 1.3 billion over the 6 months to June 2020 reported. The slide shows the impact of impairment losses raised in 2019 and 2020 on basic earnings. All these factors have contributed to a basic loss of 38.3% and headline earnings of ZAR 0.011 per share for the period. The next slide provides some color to our earnings. On this slide, we detail a reconciliation of the H1 2019 EBITDA with the H1 2020 figure. Please note that the slide shows the percentage impact of the various factors relative to the H1 2019 EBITDA. EBITDA from the Venture was ZAR 171 million. This is 62% down from the prior year. The following has continued to this variance. Starting with negative contributors, lower volumes of ferrochrome and chrome ore sold were the biggest sectors impacting revenue. Lower commodity prices achieved have added to this negative impact. Inflation, although managed with chrome ore, Eskom and reductants and BNP factors that influence the results as the increase rather. Due to production stoppages, higher spending charges weighted on earnings. Higher interest on net facilities used over the period to resulted in an increase in net interest rate. And lastly various other factors contributed marginally to the variance. On the positive side, we have the following impact at earnings. Although lower volumes sold impacted revenue negatively, there obviously would have been a positive effect on costs. Zanele touched on the positive impact the rand has had on results and the cap illustrates this benefit. And finally, there was marginal contribution from Head office costs. The next slide provides reconciliation of EBITDA from the PSV reported loss. Depreciation and impairments wipe out earnings for the period. Depreciation for the 6 months is much lower than what we would have charged ordinarily, and this is due to the impairment loss recognized in 2019. Because the remaining useful life remains largely the same, the consequences are lower depreciation charge. The deferred tax credit arises from the impairment charge. Corporate costs and current tax were charges against earnings and net interest income contributed to earnings. The result is a net loss of ZAR 961 million. On the next slide provides a bit of details in terms of the income statement. And it's essentially what we have discussed in the form of an income statement. I will briefly go over these items, some of which we have already discussed. We have touched on the revenue line. So I won't go into much detail there. The foreign exchange gain shows the benefit of the weaker end. There was an NRV adjustment rate in 2019. And this was a benefit in terms of the cost of sales of that inventory in the current financial period. Inflationary increases led to the production cost per tonne increasing by 8% from December 2019. Key items that led to this increase is higher standing charges as well as higher labor cost and electricity prices. The relative cost of reductants reduced over the period through lower imports over the period and lower oil prices also benefited us positively, as Zanele indicated. Merafe's corporate costs were lower than in the prior year, mainly due to a reversal of short-term incentives, a provision as well as lower or delayed costs. Moving on to the balance sheet and starting with inventory. One of the positive things we come out of COVID-19 for our business has been the release of inventory over the period. Closing inventory volumes of 99,000 tonnes represent a 24% drop from the year-end levels. These volumes represent straight performance of sales. Trade and other receivables increased due to weaker closing rand as well as the timing of sales and payments for such sales made. Cash decreased mainly due to lower earnings. Payment of the financial dividend -- of the final dividend rather for 2019 and acquisition of a unicorn chrome investment. Noncurrent assets reduced due to the impairment of property, plant and equipment as well as intangible assets. Moving to Slide 23, the cash reconciliation. We opened 2019 with net cash of ZAR 354 million. Cash from operating activities are at ZAR 164 million to this cash balance. This includes a reduction in inventory levels, which led to release of more than ZAR 300 million in working capital. However, the increase in trade receivables, tied up the bulk of this cash. Remaining cash was used to fund the following: capital expenditures of ZAR 102 million. Zanele touched on cash preservation measures and this has been a key focus area for our business, especially after the onset of COVID-19 and has led to a reduction in CapEx over the period. Cash was also used to fund the 2019 final dividend of ZAR 100 million. So ZAR 35 million that was used to fund the Unicorn Chrome investment. And finally, repayment of IFRS 16 loans well as realized foreign exchange effects contributed to the [indiscernible] movement. We closed 2019 with a net closing cash balance of ZAR 263 million. This includes ZAR 2 million being our share of the Venture's overdraft as well as some ZAR 1 million being our share of -- and cash from Unicorn Chrome. Debt facility. On the next slide, deals with headroom that Merafe has. Merafe was un-debt to an extent. And in terms of its headroom, it consists of facilities in case as a PSV to fund operational departments and ZAR 300 million revolving credit facility with Absa. We are of the view that the current facilities provide the business with sufficient liquidity to ride out the difficult period ahead in the short-to-medium term. Slide 26. Talked about the dividend for the period. Our Board has decided not to declare an interim dividend due to the market uncertainty. We will continue to evaluate the position at year-end and foresee the final dividend based on the year-end results and market on this at a later stage. Thank you for your attention. I now hand you back to Zanele for concluding remarks.

Thanks, Ditabe. COVID-19 was definitely disruptive for our business. We continue to focus on health and safety of our employees. There are some signs of recovery but we expect the recovery to be slow. So for the short term, we'll focus on efficient operations, cash generation and cost efficiency amongst others. We remain positive about the future growth of our business. We will now take questions. Please identify yourself before asking a question.

[Operator Instructions] We do have a question from Tim Clark from SBG Securities.

I've got several questions. But perhaps I'll ask a few and then I'll go back in the queue if there aren't other questions. Just to start with, could we please talk about the impairment assumptions that you've made? It looks like you've virtually wiped out all PPE on your balance sheet. And then once you've spoken about the underlying assumptions of the model that you've made because it would be quite concerning to shareholders to see such a low level of PPE. Also to describe to us just what you see the outlook in a normal productive, normal capacity year for depreciation to be because presumably, you've got no more assets to depreciate. So that indicates probably a strong depreciation outlook -- a very low depreciation charge. My second question is just on the Section 189 process in Rustenburg, and then the broader Section 189 process. And I guess that I'm just asking for a bit of an update on timing and perhaps the potential cost of this. It looks like you're going to get about ZAR 300 million from receivables release in the second half, but how much of that is going to be necessary to offset through your restructuring charges? And then if you could, please, just give us some kind of an indication of what you think the standing charges in the second half are likely to be? That would be helpful. Just given your expectation of capacity utilization rates for the year from, say, at the midpoint or something like that. What do you think the standing charge number will be?

Thanks, Tim. I think the question on the assumptions on the model, I'll leave for Ditabe to answer. And then on the Section 189 and the progress we've made, I'll ask Japie to pick up that one. And then we can deal with the pending charges.

Thanks, Tim, for the question. The impairment model is one that unfortunately requires a bit of judgment. The standard does allow several approaches and various models that could be used. Our approach was say the prudent and based on assumptions, which reflect the current market conditions. For the long term, which is from 2025 going out, we've only increased prices by forecast inflation of -- forecast U.S. inflation of 2%. And as you can imagine that in the long term, what would tend to happen is that pricing would tend to consider costs and prices would adjust accordingly. So from a product pricing point of view, we would have looked at the current pricing and projected those on the basis of the current depressed -- currently depressed market up to 2024 and then only inflated by U.S. inflation of 2%. Hopefully, that answers your question.

Yes. That's helpful. So sort of ZAR 0.71 upon China number after 2024 and then inflation at 2% beyond that. So no recovery basically in ferrochrome prices assumed, just assuming the rand offsets your above inflationary cost increases, I suppose?

That's spot on. And contrast with that is that we haven't -- in terms of our normal operating costs, those have been inflated at your -- as a inflation, which is about 5%. And obviously, prices like Eskom would have considered the -- even higher inflation rate. So as you can imagine, there's a squeeze based on pricing assumed for costs relative to pricing assumed for product.

And then Japie, you can deal with the progress.

Can we just run -- just the next leg of that is the depreciation. Just what in a normal year, will your depreciation charge be? Because there's virtually no assets left?

Yes. So the essence of -- what the standard requires as far as depreciation is concerned, is that what net asset value, we are sitting with at the moment, which is about ZAR 140 million, would then be depreciated over the remaining useful life of the asset. And if depreciation for the 6 months amounted to ZAR 101 million. There will be further reversal of depreciation for the next 6 months based on the additional impairment raised. So it's virtually going to reduce to -- I don't have the calculation now, Tim, but it's going to be a very small number coming through relatively.

So average life is what, like 10 years or something because you need to recapitalize, right? So 10 years, maybe ZAR 14 million a year, fair?

I would say that's a reasonable estimate, yes.

Yes. And sorry, just to round off on this whole comment. Presumably, your CapEx plan hasn't changed?

So CapEx for the year has been revised down, as we indicated as part of the cash preservation measure. Our normal guidance around CapEx is the number ZAR 400 million to ZAR 450 million. For the year, we revised that down to about 60% to 70% of normal guidance. And obviously going out into next year, then although similar cash preservation measures will continue what we might end up with some of the CapEx that might have been delayed from this year going out into next year. So you might see a slight increase in CapEx spend next year. But it shouldn't be a materially different number to the guidance that we normally give for our Capex.

And then I know it's not relevant now, but your dividend policy is?

So dividend policy hasn't changed. So it's still a minimum of 30% of deadline earnings. And obviously, to the extent that there is excess cash. The Board would consider paying more than 30%.

And sorry, I know I'm the hogging things, but have you run the numbers to assume a CapEx number of, I don't know, ZAR 400 million versus a depreciation number of [ ZAR 114 million ]. You're going to have a situation where your free cash flow is very materially different to your earnings number, but your dividend is tied to your earnings number. Have you run those numbers? Or is that more for the year-end? So it looks like your policy is going to fail. Sorry.

Well, we'll consider the dividend again at year-end. And to the extent that we need to adjust anything because of the abnormality now. Because, I mean, in the past, you've almost had your depreciation, almost matching you sustaining CapEx, then we would have to adjust for it. But because of particular time, we're not seeing a dividend. We haven't run those calls.

Okay.

Okay. And Japie, can you deal with the progress we've made around the Section 189.

Thank you. Good morning, Tim. Okay. So the Section 189 process has been rolled out through the whole of Glencore Alloys and the PSV. So I mean, obviously, you would have seen that, right in the beginning of the year, we had Rustenburg under Section 189 and that process of Rustenburg is now near completion. We also rolled out Section 189 processes throughout all the smelters and the meter mines. Obviously, during the COVID period, it allowed us the opportunity to reshape our business to be more agile in this regard. And we've identified in the region of close to 1,000 employees contemplating redeployment or replenishment. And because of this process, it was actually right through the whole, you can say, spectrum. And doing this, we also went out on a voluntary process and I'm very glad to say that we've received quite a rich amount of voluntary requirements or applications, which made the whole replenishment process much easier. We would also have seen that we are contemplating closure of the Lydenburg complex. And the reason for that is because of the ranking of all the furnaces. And because of that -- these, there were some 628 employees affected there. We are very close to finalization. We had all our interventions and our meetings with the Unions and the leaderships and stakeholders, and the process will be completed within this month.

So the cash flow or the cash will all flow in the second half?

Definitely, yes. And that's all part of the process.

Can you give us some kind of estimate of the total cash outflow from the process?

Yes. Look, it's in the region of about -- you can say ZAR 400 and ZAR 409 million. That's for the whole PSV. Any more questions in terms of the Section 189?

No. That's very helpful. And so Ditabe, that means -- sorry, I'm hogging everything, but does that mean that the receivables billed, ZAR 300-odd million is going to release into the second half into your cash flow statement? Less your share of the ZAR 409 million and standing charges?

The receivables Tim, is a bit tricky. What tends to happen is it really and truly is a function of the sales made around a period reporting at around the year-end or interim as well as when we receive payments. So what would have happened last year is that because of earlier receipt of some of the use, we had a release of cash from accounts receivable. But that -- although it was positive for last year, impacted us a bit negatively this year in the sense that with increased sales, particularly around -- after the lockdown period, there was cash tied up in the receivables. We expect, obviously, what has been tied up now to release over the next few months. But to a large extent, what happens at the year-end, year-end will depend on the quantum of the sales around the November, December month and when we receive cash for those sales. The intention usually around year-end is to try and get those receipts earlier than we would have received them with the aim of releasing the cash, but we'll see how things transpire at year-end.

But your inventory is now at a relatively normal level. I mean, 3 to 4 months is pretty normal, right?

Inventory, 3 to 4 months is pretty normal, and that's what we aim to sit with from a working capital point of view. And the plan is to sustain that level at year-end.

Yes. Because you generally, you build inventory into the June period. Now this year might have been a little bit different because of COVID. So I would imagine, yes. But so what you're saying is that the full ZAR 300 million receivables release might not be realized, but you do expect some kind of receivable release into the second half in all likelihood? But you can never be 100% sure, but.

Yes, that's correct.

Okay. Okay. And standing charges?

And I think standing charges and maybe Japie can also come in here, Tim. But my sort of guidance would be, to a large extent, obviously, that was a function of the capacity that was idle over the lockdown period. Since first of September, production has opened up at both -- at the mines. As well as the other smelters, you'll remember that only Lion operating over the winter period. And perhaps as guidance, and it's really a matchbox type of county that you -- if you consider the production from Lydenburg, which will not be part of the production going forward. And you consider then that for the period that they are idle until the retrenchments happen that would constitute spending time over a few ones. The retrenchments have happened, then it doesn't form part of the standing charge calculation. That would be possibly the extent of the standing charges for the remaining 6 months, over and above the portion from June to end of September relating to a plant that was idle. So bottom line is, also I don't have a figure Tim, the number should be lower than the ZAR 270-odd million that was recognized standing charges for the first 6 months. But the quantum of the decrease had to pin down, except for the guidance that I've just given now.

We have no further questions on the conference call.

Okay. On the webcast, I see there's question from Gabelo on the Section 189. Gabelo I think that was addressed by Japie because Tim had a similar question. And then the second question is, are there reopened smelters and mine cash flow positive at current prices? The answer to that is yes, they are, even though some of them are just marginal, but they are cash positive. Then I see there is a question from Andrew to say how much ferrochrome was sold over the last 6 months? Ditabe do you have that volume? That should be in the...

Over the 6 months to end of June, we sold 151,000 tonnes.

And then there's a question from David on the Section 189, whether the 1,000 includes Lydenburg or is it 1,000 plus 628? It does include Lydenburg, the 1,000. Japie, I don't know whether you want to add anything to that?

No. No. Thank you, Zanele. That's spot on. In total, it's about 1,000 employees or contemplated. But yes, Lydenburg 658.

Yes. Okay. Thank you for that. It doesn't look like we have any further questions on the webcast. And if there's nothing else on the conference, then maybe that's complete.

Zanele, we do have a follow-up question from Tim Clark.

Okay.

Just so I can get my head around your competitive position going forward. You're taking out a whole lot of costs to try and make the operations future-ready and competitive. But you haven't really given us any kind of guidance of how much of a total cost that is that you're taking out? Or what it does to your net cost position or your margin or something that helps us to get an estimate from next year once you've paid all these costs. What it does to your competitive cost position? Obviously, that can get eroded over time. But for now, can you give us some kind of indication of what the benefit is?

Okay. Japie, do you want to take the first stab at the question?

Yes. I'm interested. Thanks, Tim. So look, it's all got to do with supply demand as well. So we know that we've got capacity of, let's say, 2.3 million tonnes of ferrochrome, yes, per year over capacity. But ultimately, there's no supply demand balance. You can then flat the market and then pushes the prices further down. So what we've done is that we've evaluated our supply demand strategy. And obviously, if we go as a Venture, we are forecasting, let's say, about 1.7 million tonnes of ferrochrome production next year. And that will then bring the supply demand into balance that will sustain a ferrochrome price, we will picture that. And because of that, that's the way that we can then say, okay, we've got our operations because we've ramped in according to from #1 to #5. Is the reason for that -- the reason for us to put Lydenburg on a care, in a maintenance, that was the reason for that? So during that balancing, we looking at the long-term pricing going forward, that's the way that we evaluated it. I'm not sure if that's make sense, Tim. Or do you have a follow-up on that?

Japie, it's hard for me to -- I mean, we don't know how much Lydenburg made or lost versus other smelters because we don't have visibility of that at all. So I suppose what I'm trying to understand is there's clearly going to be a benefit. 1,000 people are leaving. Lydenburg is closing down. There must be a big loss there, standing charge, something like that, that in cash flow terms, that must be net beneficial. What I'm struggling to get my hand around is like if you look at next year and you just said I understand your supply demand analysis. It's 100% correct. But that's really managing the price intersect. What I'm trying to understand is that if we ignore the price intersect and just assume spot prices because it's been ZAR 0.71 for a long time now. So spot prices, spot Rand how much benefit will -- I mean, will taking after a Lydenburg, plus the Section 189s due to your net cost position? Will it -- can you give us a number of sense or percentage or sorry, it's just still quite difficult to work out the benefit. I mean, I'd really like to be able to give you the benefit in my analysis. I don't know how to do it.

I understand. Okay. So obviously, as you know, if you just think about the costing side. I mean, you can only -- there are 2 sides of it. Either the prices don't go up or our operating costs must come down. I think that's your question, is that, what did we do to really squeeze down the operating costs. So there's a lot of things that we can talk about that. Is that your question?

I think so. I think so because we don't know what the price will do.

Perfect. So obviously, when we rank our furnaces, we look at operating cost versus selling price. And during that cost curve analysis that we've done, we've got Tier 1 operations, and then we've got operations that's very close to the cost curve on the fourth quarter. So because of that, if you then take out the one, I mean, if you've got a complex that's value destroying. So that means that it doesn't contribute towards the profit, it actually sucks up some of the money. It means that if you then take that out and you only then apply the standing charges, it's -- it is -- it's cost beneficial for us to then close it down because of the fact that the selling price, it is where it is. So by doing that, obviously, there's already a huge -- a saving in terms of the whole Venture in terms of our profit situation. So I mean, I can't, unfortunately, give you all the real costs in terms of where we stand. But I mean it's definitely ZAR 0.03 to ZAR 0.04 difference. If you take it out, I mean, as you would appreciate ZAR 0.03 to ZAR 0.04 in our market makes a huge difference.

That's exactly what I needed. That's exactly the number I needed. Thanks, Japie that's really helpful.

Perfect.

We have no further questions. Zanele, do you have any closing comments?

Yes, I was going to say it doesn't sound like we have any further questions. At this stage, we can conclude. And thank you very much for attending and for all the questions.

Thank you very much. Ladies and gentlemen, that concludes this event, and you may now disconnect your lines.