Tongaat-Hulett experienced a year dominated by a number of external developments that had a significant detrimental impact on the earnings performance of African Products, Tongaat-Hulett Sugar and Hulett Aluminium. This led to unsatisfactory results for the Group, notwithstanding considerable achievements in these operations and Moreland’s record-breaking year.
The year highlighted the importance of having the ability to draw on expertise on a group wide basis. The prevailing conditions acted as a catalyst to focus our efforts and energies on those actions that will best unlock future earnings from the considerable number of opportunities available, thereby driving recovery and growth.
Tongaat-Hulett enjoys an impressive asset and business base. Over the years, we have made substantial investments in facilities and people. This has provided a solid platform from which we are now moving forward.
We had previously strengthened the cohesion of top management and emphasised the leadership roles of key individuals throughout the Group towards being more proactive, participative and action orientated. This was a source of strength during 2003.
Our actions will result in a future earnings stream for the Group that will be impressive, particularly when external conditions turn in our favour.
REVIEW OF OPERATIONS
“The 2003 financial year has been dominated by the rapid strengthening of the Rand and an equally rapid drop in the South African maize price. These twin developments were compounded by a growing threat of low priced imports.”
Maize Position and its Impact on Profitability
During the planting season of 2002, African Products followed its long established practice of securing the bulk of its customers’ maize requirements for the 2003/4 seasons with a focus on price stability, genetically modified free status of maize, locality and other quality issues. That maize was purchased from various sources, including direct purchases from farmers, contracts with traders and the use of the futures market. An element of this procurement was a hedging strategy that reduced the impact when maize prices rise while keeping the maize price stable into a second season if the market price falls.
The South African maize market experienced a period of extreme volatility, with prices falling from nearly R2 000 per ton late in 2002 to below R800 per ton at one point in 2003. In the second half of 2003 prices have stabilised to an extent, although a relatively sharp rise was experienced late in 2003 to levels of above R1 100 per ton for the July 2004 position.
The aforementioned procurement strategy and price volatility resulted in African Products having a long maize position and incurring valuation losses on certain procurement contracts. The Safex futures position was 412 000 tons at June 2003 and has been reduced to 169 000 tons at the end of December 2003 as futures contracts were sold and replaced by contracts for physical delivery in 2004.
The impact of the high volatility in the maize price as well as new customer pricing expectations have resulted in African Products changing its business model with respect to future maize procurement and product pricing. African Products will move towards this model once the current long maize position is utilised in 2004.
The strong growth trend of the last few years continued in the first half of 2003 with volumes for the six months up by 5,3 percent against the previous year. In the second half, the impact of imports, both in the direct form of imported starch and glucose and in the indirect form of imported finished goods, resulted in declining volumes.
The second half of 2003 saw volumes 7,9 percent below the second half of 2002, resulting in overall local volumes being 1,5 percent below 2002 for the year as a whole. The underlying demand for starch and glucose in South Africa grew by an estimated 1,5 percent in 2003.
Export contributions were considerably reduced as a result of the currency impact on realised prices. African Products maintained its presence in all export markets and grew its export volumes of 65 000 tons by 3,5 percent over the previous year. It will continue to explore export opportunities that offer meaningful contribution, while maintaining its presence in low contribution markets in order to capitalise on future opportunities.
International Trends in Starch and Glucose
The year 2003 was characterised by a significant movement of starch and glucose products around the world. In particular, the weakening of the US dollar has prompted China and the US to increase exports, while strong currency countries such as Australia and South Africa became more attractive target markets.
Starch and glucose prices started to increase towards the end of 2003, partly driven by rising freight rates and a firming world corn price.
“Rolled Products, our major manufacturing operation, increased sales volumes by 24 percent to 130 000 tons in 2003, growing sales in an international market that showed little signs of recovery, while holding manufacturing conversion cost increases to two percent. Sales volumes of exported products grew by 37 percent enabled by increased manufacturing plant performance in Rolled Products. In December 2003 a record rolled products production level of over 150 000 tons annualised was achieved.”
The impact on the 2003 results of the currency movement and time lags in raw material costs have masked the approximate R300 million benefit that was gained from improved capacity utilisation, more profitable sales mix and cost performance.
Growing Market Share
Hulett Aluminium continued to grow overall sales volumes, particularly in higher margin and more technically demanding products, in a lacklustre international market.
Exports of can-end stock, a demanding thin gauge and hard alloy product, have more than doubled in the past year. Growth in other higher value products, such as painted sheet and automotive clad products, has also been robust.
Following concerted efforts to develop the local downstream manufacturing market, particularly in the automotive and transport sectors, a number of customers are advanced in their planning and implementation of downstream investments, which should increase total sales in the local market by 20 percent in the next two years.
Late in 2003, international volumes and rolling margins were starting to respond to an improving world economy and a weaker dollar, both of which will enhance future profitability.
Hulett Aluminium continues to be one of the world’s fastest growing independent aluminium rolled products companies. Alcoa has lodged an anti-dumping petition against a very narrow range of heat treated plate exported by Hulett Aluminium to the USA. Should anti-dumping duties be imposed, they are unlikely to have a significant impact on Hulett Aluminium or on sales to North America. The Group believes the case is without merit. Market response to this action has confirmed our position as a preferred supplier of high quality products to this market.
A Year of Manufacturing Breakthroughs
In November 2000, Hulett Aluminium commissioned the R2,4 billion expansion of its rolled products facility, lifting capacity from 54 000 tons to an estimated maximum in excess of 200 000 tons per annum. The process of ramping up production towards this target is progressing well, with output growing from 105 000 tons in 2002 to 130 000 tons in 2003.
An increase in production yields and other manufacturing achievements in key areas such as the remelt and the coating line are indicative of many start-up complexities and problems being overcome. We are increasingly confident in our ability to produce more high value products.
The manufacturing cost structure of the rolled products operation is largely fixed, and this, coupled with stringent cost containment and a strengthening Rand, led to limited cost increases.
Progress in the Other Aluminium Operations
While much of the recent focus has been on the growth of the rolled products operation, Hulett Aluminium’s other operations are sizable organisations in their own right.
Hulett-Hydro Extrusions has a major share of the market for extrusions in sub-Saharan Africa and achieved improved profits and cash flows during 2003. An expanding domestic architectural and transport sector point to a number of opportunities for future growth in Hulett-Hydro Extrusions.
The Commercial Products business produces a range of downstream products, including rigid foil containers, composite panels, roll formed sheet, and high pressure cylinders. It also includes the Aluminium City distribution operation. Results from these operations in 2003 were mixed and their combined contribution to profits was below 2002. Actions in the second half of 2003 will result in the contribution from rigid foil container sales increasing substantially in 2004, and sales from all manufacturing operations increasing by more than 20 percent.
“The 350 percent increase in operating profit in 2003 confirmed Moreland’s status as one of South Africa’s premier private sector land developers. Taking full advantage of the booming property market, fuelled by reducing interest rates, and its leading-edge investments over the last decade, Moreland posted record earnings performance together with strong cash generation, with improvements in all portfolios.”
A major milestone achieved during the year was the conclusion of an international deal in which we sold a 50 percent interest in our 400-hectare Zimbali Coastal Estate to International Financial Advisers (IFA) Hotels and Resorts, a Kuwaiti company with resort investments in Dubai, Portugal and Zanzibar that will partner Moreland in the further development of the estate and surrounding areas. The project encompasses the realignment of the M4 coastal highway to the west of the resort to create a single coastal-fronting land entity that adds substantial value to existing and future Zimbali properties. These proposals include a commitment by IFA to develop a five star internationally managed hotel on a 100-hectare resort incorporating a planned new 18-hole golf course.
Successful residential sales included the virtual sell out of Mount Edgecombe Country Club Estate Two and the sale of sought-after sea view apartment sites in Ilala Ridge, La Lucia. Sewer capacity constraints in Umhlanga delayed further phases of Ilala Ridge and the launch of Izinga Ridge. A solution has now been developed in conjunction with the eThekwini Municipality that will see the launch of these projects early in 2004.
Several new office buildings were erected by the purchasers of sites in the La Lucia Ridge Office Estate, in the vicinity of Unilever’s award-winning headquarters serving the African continent. A number of retail buildings were commissioned in the Umhlanga Ridge New Town Centre, including the flagship City Lodge Hotel, to complement Old Mutual’s R1,4 billion Gateway Theatre of Shopping complex, bringing total commercial building development on the Ridge to more than 350 000 square metres. The completion of the first residential apartments near Gateway has set the scene for a truly mixed-use urban environment on the Umhlanga Ridge.
The first businesses have opened at the RiverHorse Valley Business Estate, a joint venture with the eThekwini Municipality straddling the N2 freeway at Effingham which includes international investment by Total France in a Petroport. The strategic Nandi Drive interchange on the N2 has been completed recently by the City and will establish a road link through to Moreland’s Briardene Industrial Park and into the Durban CBD by the end of 2004.
Moreland is increasingly earning revenue through its expertise in the management of property development. The largely city-funded uShaka Marine World is being project managed by Moreland and is due to open in the first half of 2004. The project is likely to be the catalyst for the renewal of the Durban–Point precinct. Moreland is also project-managing the Point Waterfront development around an ambitious waterway and canal system currently under construction. Following its market launch in April, sales of R60 million were achieved during the year.
Further north, Afrisun KZN’s Sibaya Casino Resort at Umdloti is well under way with a scheduled opening in 2004. The infrastructural development of this node will open up a further 200 hectares for future development in a prime node on the north bank of the Ohlanga River.
The focus on black economic empowerment has seen the proportion of total spend exceed 35 percent in 2003. It is particularly pleasing that we have facilitated the establishment of black property developers into our customer base. With its professional, multi-disciplinary team, supplemented by effective management of outsourced property consultants and contractors, Moreland continues to provide a sound foundation for growth, economic investment and job creation.
“2003 has seen the unleashing of a process that will extensively change the way Tongaat-Hulett Sugar runs its business. It is in this operating company that the external environment has provided the greatest catalyst for change.”
The sugar industry in South Africa is facing one of its most extreme challenges in recent history brought about by a number of factors converging at the same time. The most important factors are the rapid strengthening of the Rand, cost push pressures since 2000 that have rendered the industry less competitive in US dollar terms, the reduction in the domestic market sugar price in 2003 and the “dumped” world market price being at its lowest level in recent years. This environment has been exacerbated in 2003 by poor rainfall in many parts of the cane belt, with some of the worst affected areas reaching full-blown drought status.
Total sugar production in 2003 decreased to 1,1 million tons, 18 percent down on 2002. The total cane crush of 9 million tons in 2003 represents 71 percent of installed capacity compared to 84 percent in the 2002 year.
Sugar production in South Africa of 652 000 tons was 24 percent down on the 860 000 tons produced last year. This decrease is attributable to the poor rainfall in many parts of the cane belt.
In Swaziland, Tambankulu Estates produced the raw sugar equivalent of approximately 54 000 tons, compared to 50 000 tons in the 2002 season. Record sucrose yields as well as additional hectares under cane following the conversion of the citrus orchards to sugar cane were the major drivers behind this eight percent improvement.
The socio-political and economic difficulties of operating in Zimbabwe have continued and Triangle’s sugar production decreased to 264 000 tons, nine percent down on the previous year. The operation has remained profitable and intact.
In Mozambique the rehabilitation of the Mafambisse and Xinavane sugar estates continued in 2003 with sugar production up 15 percent to 82 000 tons compared to 71 000 tons in the 2002 season.
In terms of installed milling capacity, Tongaat-Hulett Sugar is capable of producing 1,5 million tons of sugar per annum compared to the 1,1 million tons produced in 2003.
Export market prices in Rand terms in 2003 were approximately 16 percent below those prevailing in the 2002 year due to the low international prices coupled with the strength of the Rand. Export sales at 344 000 tons show a one percent increase over 2002.
The domestic markets of Mozambique, Zimbabwe and the South African customs Union have been characterised by opportunities and challenges. Tongaat-Hulett Sugar’s brands performed well in 2003 with Huletts® being voted by an independent survey South Africa’s fifth most admired food brand and sixth favourite brand overall measured in terms of awareness as well as trust and confidence.
In South Africa, local market sales at 499 000 tons show an increase of six percent over 2002, although the recent seven percent decrease in the price of sugar in October 2003 has resulted in a reduction in margins.
Good progress has been made by sugar producers in Mozambique to secure the domestic market against imports with year-on-year sales by domestic producers growing by 68 percent.
Statutory price control remains the over-riding feature of the market in Zimbabwe, squeezing both cane growing and sugar milling margins. The sugar industry in Zimbabwe continues, with some success, to make representation to the government for increases in controlled prices.
The Department of Trade and Industry is reviewing the South African sugar industry’s regulatory framework following a notice to this effect in the Government Gazette on 12 January 2001. The review is being undertaken within the accepted framework of the government’s strategies for the sugar sector in the South African Customs Union and the Southern African Development Community, and will be undertaken in consultation with the industry. Changes are not expected before the 2004/5 season.
Tongaat-Hulett Sugar’s molasses and bagasse-based animal feeds operation, Voermol Feeds, again experienced significantly improved trading conditions. Its contribution to Tongaat-Hulett Sugar’s earnings in 2003 was more than double that of the previous year.
TAKING THE GROUP FORWARD
The Group’s earnings profile remains sensitive to exchange rate movements. The strengthening rand and external developments such as the movements in the maize price have impacted our 2003 results. These developments have acted as a major stimulus to further energise and focus our efforts on all opportunities to improve earnings going forward, whatever the external conditions.
Actions to address the current challenges have been initiated and the road ahead is clear. Each operating company has a different profile of future earnings enhancing opportunities, the most important ones being:
Nowhere have the developments in 2003 had a bigger impact than in our sugar business, where a course of action has been unleashed that will result in a century old company changing dramatically to ensure its future success.
Tongaat-Hulett Sugar is moving to a leaner and flatter structure and a more decentralised management approach. People at operating centres will assume greater responsibility and accountability for overall performance. Senior management are becoming increasingly mobile and more hands-on. The closure of the 180 people head office in La Lucia will see the small leadership team joining our offices at Amanzimnyama in Tongaat. Management changes have already resulted in the Tongaat-Hulett Sugar board halving in number and two regional operations managers have replaced the five mill general managers. The behavioural change that is emerging from this process will allow us to best tackle the challenges that we currently face and to take advantage of the opportunities that exist.
The focus in the South African operations is on lowering overhead costs, optimising milling capacity utilisation and improving the profitability of agricultural activities. The actions to reduce head office overheads by 50 percent include the closure of the La Lucia office and the downsizing and re-positioning of centralised services. Milling and refining costs are targeted to reduce by 10 and 30 percent respectively. The shutting down of the Entumeni sugar mill will further reduce the cost base and the additional available cane supplies, together with other cane procurement initiatives, will increase the capacity utilisation at the other mills. All of these actions will substantially improve our competitiveness.
Triangle Sugar in Zimbabwe is well placed to continue to assess the socio-political environment and to proactively manage it, where possible. It is ably positioned to determine the optimum timing to act on the growth opportunities that are currently on hold. The remittance of dividends from Zimbabwe remains an issue on which we maintain focus. We have received US $2 million in dividends since the beginning on 2004.
Mozambique provides us with an immense opportunity for earnings improvement. Actions are under way at Mafambisse and Xinavane to continue to increase cane and sugar production towards full capacity of 156 000 tons per annum together with growing domestic market sales. We will benefit further from Mozambique’s Least Developed Country status, which will enhance export revenue through improved access to preferential markets.
We are committed to the journey underway in Tongaat-Hulett Sugar and breakthroughs are being achieved on a weekly basis. We believe that the benefit of all these actions is likely to exceed R150 million per annum within the next three years.
The events over the last two years have clearly confirmed the need to change the business model as far as the local market interface and maize procurement is concerned. The local customer base has generally shifted from the need to have a stable inflation related price to one that has to compete internationally with the emphasis on currency and international starch prices. This is similar to Hulett Aluminium’s experiences in the early 1990’s.
The most appropriate maize procurement strategy, for African Products to match this development, is being implemented. In future, the bulk of its maize pricing will be done on a back-to-back basis when product prices are agreed with customers. Physical procurement will still largely occur during the planting season as quality, locality and genetic modification status need to be ensured. This will mean that African Products’ future earnings will be influenced by the extent to which the local maize price varies between export and import parity. At the same time the volatility arising from major valuation adjustments such as those that occurred in 2003 will be substantially reduced.
The emphasis on reducing the cost of running the business is encouraging. The cost reduction initiatives focus on lowering fixed overheads, improving procurement practices and further increasing plant efficiencies.
The year ahead will see continued progress in our many new business development initiatives, both in the local and export markets. These include new applications for existing products and the formulation of new products to be manufactured at existing plants. This should happen in concert with us regaining our position over imports in the local market. Underlying domestic demand for starch and glucose is expected to remain strong and grow over the next few years.
We expect to earn an attractive return on capital by 2005 following the implementation of the new approach to maize procurement with its link to the local customer base, combined with the impact of further cost reductions and market development initiatives, with the main uncertainty being whether the local maize price is closer to import or export parity.
The progress in Hulett Aluminium is expected to continue as the growth in manufacturing output is maintained.
Hulett Aluminium plans to grow output of rolled products by 50 percent over a two-year period by the end of 2004, towards a target of 185 000 tons within the next three years.
The majority of the costs in the business are already being incurred and manufacturing conversion costs should largely remain fixed as volumes grow. Important breakthroughs in energy and recycling costs, together with further cost saving opportunities, are expected to exceed R75 million per annum. This will yield a significant reduction in manufacturing costs per ton.
The prime opportunity to grow earnings is through the enhancement of the sales mix, as evidenced by the 60 US dollar per ton increase in average export margin in 2003 in a tough global market. It is encouraging that dollar rolling margins are increasing in sympathy with the weakening US dollar and improvements in commodity prices. Special emphasis will be placed on increasing the production of technically challenging and hence higher margin products. Exports of can-end stock should double again over the next two years. A 50 percent increase in painted coil exports is expected in 2004, with clad products well set for dramatic growth. These products will continue to push Hulett Aluminium’s average dollar margin upwards.
The local market remains an important aspect of the business and some major growth initiatives are encouraging. This is particularly the case in the automotive sector, in spite of the relative strength of the Rand.
Hulett Aluminium should use 70 percent of the incremental capacity from its expansion during 2004, with a target volume above 200 000 tons beyond 2006. This, together with an enhanced sales mix and substantial unit manufacturing cost reduction, will see a significant improvement in profitability, even in a strong rand scenario.
There is general acknowledgement that Moreland’s development initiatives north of Durban over the past decade have created one of the country’s leading property growth nodes and a solid platform for unlocking the value of the prime land in the area. With the substantial investment in infrastructure and new capital investment into the area over a ten-year development horizon, Moreland has established a sound base to accelerate further unlocking of land values and for future earnings growth. The present assessment of the current value of our prime land, which is under pressure from urban expansion and potentially surplus to the operational requirements of the Group, once developed by Moreland exceeds R1,5 billion.
Joint ventures with international investors, particularly those with access to international customers, such as IFA, provide exciting initiatives for accelerated growth in earnings. Moreland’s reputation as a property developer, in concert with the provision of infrastructure and sensitivity about the environment, has been firmly established as a leading South African brand, supported by the strong brands of individual projects.
The full benefits of Moreland’s joint venture with IFA at Zimbali are still to be realised, including the anticipated positive impact on the value of the adjacent properties. Sales are exceeding expectations and are an acknowledgement of the prime international quality of our land holdings.
Moreland has earnings growth opportunities in other areas of Greater Durban. The scheduled opening of the Sibaya Casino Resort during 2004 will see the further development of 200 hectares of coastal property adjacent to Umdloti to the north of Durban. Residential property sales, particularly along the established La Lucia Ridge with its expansive sea and city views, are expected to remain buoyant. The extension of the Umhlanga Ridge New Town Centre surrounding Gateway will provide further commercial, retail and residential development. The completion of major infrastructural work by the City along the N2 freeway at RiverHorse Valley Business Estate will open up further industrial project opportunities. To the west of Durban, we are planning how to best realise the development of over 2 000 hectares at Shongweni.
In addition to earnings escalation over the next few years from Moreland’s project pipeline, interesting opportunities are being explored in expanding our business model beyond land development. For example, in the joint venture with IFA, we have secured the option of joining them in any downstream income earning opportunities in their resort development activities.
The developments impacting on Tongaat-Hulett’s results for the past year have acted as a catalyst to accelerate management actions to improve profitability. Group-wide initiatives to reduce the cost base, increase sales volumes and optimise capacity utilisation will provide benefits as the year progresses.
The Group’s results will continue to be impacted by the size of the sugar crop, commodity prices and fluctuating exchange rates.
The results for the first half of 2004 will be affected by restructuring costs as well as by the size of last year’s sugar crop in South Africa. The size of the 2004 sugar crop in the non-irrigated areas will depend on good rains in the rest of the summer growing season. The soaking rain experienced early in the year is encouraging.
There are signs of international starch and glucose prices rising and the same applies to US dollar aluminium rolling margins. World sugar prices are presently at their lowest levels in recent years. The property market in which Moreland operates remains strong, with growing national and international interest.
The Group expects to record a substantial headline earnings recovery in 2004. Its asset and business base remains sound, with considerable opportunities for sustained earnings growth.
Chief Executive Officer
20 February 2004