Chief Financial Officer’s review

		Dear Shareholders, 2011 was indeed a challenging year for ArcelorMittal South Africa. This was due to the reduced performance of most key drivers in the business. Sales and production dropped in the second half of the year due to technical interruptions at three of our major business units. Input costs remained high throughout the year, especially electricity, iron ore, coking coal and transport. Despite the challenges of 2011, we are confident of improved results in 2012 on the back of production stability and higher sales volumes partially offset by lower international steel prices.
Rudolph Torlage

Overview

The company recorded a disappointing financial year due to an increase in selling prices being out-weighed by a substantial increase in costs and a decrease in volumes.

Sales dropped in the second half of the year and production volumes contracted by more than 20% as a result of technical interruptions at three of our major business units. Input costs remained high, especially electricity, iron ore and coking coal. The strong Rand had a negative impact, though it did weaken and improve returns towards the end of the year. Employee salary and wage rate increases averaged above the national rate of inflation. Losses and impairment charges emanating from Coal of Africa Limited (CoAL), of which ArcelorMittal South Africa is a 15.9% shareholder, negatively impacted our results, although CoAL’s prospects improved following an agreement signed with environmental objectors to its Vele Colliery in November 2011. Production of coal from this source will, however, require capital investment and years of development to reach its full delivery potential.

A major negative impact on our financial performance in 2011 was the production interruptions experienced at our Newcastle, Vanderbijlpark and Saldanha Works. The Newcastle Works blast furnace underwent a chilled hearth shutdown between December 2010 and February 2011, and in August 2011 the dust catcher at the blast furnace collapsed and halted steel production there until December 2011. These two incidents resulted in operating losses of R270 million and R865 million, respectively. The total loss resulting from the dust catcher failure is estimated at R1.1 billion, of which R120 million is for plant repairs and the remainder a loss of income due to reduced steel production. This was partially offset by an interim insurance payout of R489 million in the fourth quarter of 2011, after a deductible of R160 million was taken into account. The full dust catcher insurance claim is anticipated to be finalised in the 2012 financial year.

This review should be read in conjunction with the financial statements on pages 18 to 95 of this report.

Vanderbijlpark Works experienced chilled hearth conditions on blast furnace C in February 2011 and on blast furnace D in August 2011. These resulted in a loss of R240 million. At Saldanha Works, a necessary tap-hole repair at the Corex plant during August and September 2011 caused a loss of R230 million. We view the tap-hole repair as being linked to a 2010 insurance claim, and are currently negotiating the reopening of this claim with the insurers.

An industrial strike action which lasted for two weeks impacted negatively on demand from both our flat and long steel customers and resulted in loss sales of approximately 125 000 tonnes and an EBITDA loss of R218 million.

Our 2011 headline loss of R52 million is a sharp drop from the R1 377 million profit recorded in 2010, while profit from operations decreased from R2 151 million to R297 million.

Revenue increased by 4% to R31.5 billion, driven by price increases averaging 12%, but partially offset by 7% lower sales volumes. Domestic sales volumes increased by 3% and exports decreased by 26%. The cash cost of steel sales on a Rand-per-tonne basis increased by 19% over 2010.

Our finance cost of R168 million includes the foreign exchange profit of R123 million incurred on the revaluation of the US Dollar denominated cash, receivables and payables. This resulted from the Rand weakening by 24% at the close of the year. In 2010, the Rand had strengthened by 11%, resulting in a loss of R150 million.

The loss from equity-accounted investments of R34 million was R156 million down from the 2010 profit of R122 million, which was primarily due to our loss of R211 million incurred through CoAL. Income received from the marketing and shipping joint venture, Macsteel International Holdings, decreased by 37% to R177 million.

The effective tax rate (ETR) for the year of 94% was disproportionate to the previous year (27%) due to the drop in pre-tax profit from R1 837 million to R126 million. Factors contributing to the ncrease in ETR are:

• secondary tax on companies on dividends declared during the third quarter of the year (17%);
• non-deductible legal and other expenditure not decreasing in comparison with the decrease in profit (16%);
• losses incurred by offshore subsidiaries not tax deductible in South Africa (11%);
• non-recoverable withholding tax on dividends received from foreign subsidiary (10%);
• effect of consolidated loss from associates and joint ventures (7%);
• income of controlled foreign companies taxable in South Africa (6%).

Cost performance

The production cash cost per tonne of hot-rolled coil and billets increased by 19% and 23%, respectively, while raw materials and consumable costs increased by 17%. Our iron ore costs rose by 17%, mainly due to higher costs emanating from the Thabazimbi mine, operated by Kumba, which sells its entire iron ore production to us. The year-on-year costs of imported coking coal and scrap climbed by 52% and 29%, respectively.

Employee costs expanded by 7% in line with the average salary and wages increase.

Energy costs – comprising gas and electricity – rose a startling 31%, which was on top of a 17% increase in 2010. The price of electricity increased by 28%. Other operating expenses (hired labour, maintenance and transport) grew by 4%.

The company commenced the 2011 financial year with a cash reserve of R3.5 billion, but an outflow of R3.1 billion reduced the cash reserve to R439 million by year-end. Spending from the cash reserve was allocated to:

• Funding an increase in inventory, due to sharply reduced sales in the fourth quarter of 2011 and higher raw material prices
• Increasing the coke inventories at Newcastle Works to protect the batteries during the repair period of the dust catcher
• Importing steel to service our long steel customers during the Newcastle Works production stoppage
• The continued off-take of iron ore, in terms of the interim agreement with SIOC, despite lower production volumes
• Capital expenditure of R1 190 million
• A R135 million participation in a capital raise by CoAL
• Tax payments of R243 million
• Dividend payments of R221 million.

Dividend

An interim dividend of 55 cents per share was declared and paid during 2011. Following the headline loss of R720 million recorded in the second half of 2011, no final dividend was declared.

Share performance

Over a five-year period, the share price has decreased by an average of 8.8% per annum, compared to the 5.2% per annum rise of the All Share Index over the same period.

Up until the end of 2008, our share price outperformed the All Share Index. It has underperformed since the commencement of the global financial crisis, but moved in line with global industry peers. In 2010 our share price performance was negatively impacted when the dispute with SIOC was announced.

Currency, commodity and credit risk management

We are exposed to financial risks due to our exposure to foreign exchange rates, commodity price movements and counterparty credit risk. These risks are managed within the framework of our treasury and financial risk management policy, which is regularly reviewed and approved by the Board. Exposures and our management thereof are reported each quarter to the Executive Committee and Audit and Risk Committee.

Currency risk

As we undertake transactions in currencies other than the South African Rand, we are exposed to transactional currency risk. Export revenue received in US Dollars acts as a natural hedge for US Dollar imports. Capital expenditure and firm import commitments in currencies other than the US Dollar are hedged using forward exchange contracts. Surplus US Dollar cash is sold on a short-term rolling forward basis to reduce any short-term Rand borrowings.

Commodity risk

We have not undertaken any economic hedging of commodities since mid-2008. We continually monitor the markets to determine the most opportune time to commence hedging. We did, however, hedge to reduce the currency volatility risk when we imported steel for domestic customers during the Newcastle Works production outage.

Credit risk management

Our counterparty credit risk arises mainly from exposure to customers and financial institutions. There is some concentration of credit risk with respect to trade receivables, as three main customers account for approximately a third of the receivables balance. Third-party trade receivables are covered by credit insurance placed with the Coface Group.

Exposure to counterparty financial institutions arising from deposits, derivatives and foreign exchange settlements is managed according to predetermined limits approved by the Board. These limits are determined in accordance with various rating indicators by Fitch Ratings, and are continuously reassessed according to the latest information in the financial markets.

Capital commitments and contingencies

Capital investments

Projects requiring development capital have been identified for 2012 in terms of a longer-term infrastructure development strategy, but are subject to more clarity on outcomes of the fragile economic situations in Europe and the USA.

Contingent liabilities

The case brought before the Competition Tribunal by Barnes Fencing Industries Limited, relating to alleged price and exclusionary conduct on the sale of wire rod, is continuing in accordance with tribunal procedures. A date for the hearing has not been set and an amount has not yet been provided.

The Competition Commission has referred ArcelorMittal South Africa and three other primary steel producers in South Africa to the tribunal for alleged price fixing and market division, in respect of certain longsteel products. The commission has recommended the imposition of a financial penalty of 10% of the company’s 2008 annual turnover. On 3 September 2010, the tribunal refused access to the bulk of the documentation requested by the company, causing us to file a notice of appeal with the Competition Appeal Court (CAC) to review the tribunal’s decision. The company also requested the CAC to suspend the tribunal’s order that we should file its answering affidavit, pending the outcome of the appeal. An appeal and review hearing was heard on 2 December 2011. The decision is still outstanding, and is not expected before the second quarter of 2012. The company has also filed an application challenging the validity of the referral of this matter to the tribunal. No date has been set as yet for the hearing of this application.

During the fourth quarter of 2011, South African Revenue Service (SARS) issued a letter of assessment relating to the erroneous claiming of customs value added tax (VAT) by the company for the period 2005 to 2008, relating to the wholly owned subsidiary Saldanha Steel (Proprietary) Limited. The VAT was unintentionally reclaimed in error by us, as the parent company. In this letter, SARS demands that a principal amount of R249 million should be repaid by the company and that SARS may consider imposing interest and penalties thereon, though no amount was quantified. We issued a letter of objection to this, as SARS was not in any manner disadvantaged by the company claiming the VAT in the place of Saldanha Steel. We have requested for this dispute with SARS to be advanced to a formal alternative dispute resolution process (ADR). The ADR was held on 20 February 2012 and a ruling is outstanding. Only R1 million has been provided for.

Competition Commission investigations

The commission is formally investigating five complaints against the company, as detailed in the Integrated annual report. The company is cooperating fully with the commission in these investigations, and has delivered all requested documentation to the authorities.

Dispute with Sishen Iron Ore Company (Proprietary) Limited (SIOC)

A judgment favourable to ArcelorMittal South Africa was released on 15 December 2011 by the North Gauteng High Court in the review application brought by SIOC against the Department of Mineral Resources (DMR) and Imperial Crown Trading 289 (Proprietary) Limited (ICT). Once this case is finalised, we are confident that the arbitration process will rule in our favour on the supply agreement with SIOC.

Acquisition

The due diligence on the Northern Cape Iron Ore mining project is complete, except for the final approval of the transaction by the Minister in terms of the Minerals and Petroleum Resources Development Act No 28 of 2002. The proposed transaction outlines terms to acquire certain Northern Cape prospecting rights, which were renewed during the due diligence process. We hope to soon be in a position to commence early stage exploration.

Basis of preparation

The group financial results have been prepared on the historical cost basis, except for the revaluation of financial instruments. We have adopted all of the new and revised standards, amendments and interpretations issued by the International Accounting Standards Board (IASB) and the International Financial Reporting Interpretations Committee (IFRIC) of the IASB that are relevant to our operations and effective from 1 January 2011.

The principal accounting policies and methods of calculation are consistent with those applied in 2010, except for the early adoption of amended standards and interpretations as set out in our accounting policies. The amended statements and interpretations did not have a significant impact on our financial results.

Outlook

We expect improved results for 2012 on the back of higher sales driven by improved production stability, efficiency initiatives and the easing in the price of coal, which should more than offset electricity, wage and general inflationary cost increases.