Annual Report 2013

Principal Risks And Uncertainties

The Group’s business may be affected by risks similar to those faced by many companies in the mining industry. There are a number of potential risks and uncertainties that could have a material impact on the Group’s performance and could cause actual results to differ materially from expected results. These risks are outlined below.

Market risks +-

The Group’s revenue and earnings depend upon the demand for and prevailing prices of ilmenite, zircon and rutile. Such prices are based on world supply and demand and are subject to large fluctuations in response to changes in the demand for such products, whether as a result of uncertainty or a variety of additional factors also beyond the Group’s control, as well as changes in supply, whether as a result of new heavy mineral sands projects commencing production or closure of existing operations. Demand for our products may be reduced by thrifting or substitution by users of our products. High prices for zircon resulted in some thrifting and substitution of zircon in ceramic tile production, although lower zircon prices are reversing some of the thrifting and substitution. The Group’s revenue generation, results of operations and financial condition may be significantly and adversely affected by declines in the demand for and prices of ilmenite, zircon and rutile.

Concentration and counterparty risk +-

A small number of customers account for a significant proportion of the Group’s revenue. If any of its major customers ceased dealing with the Group and the Group was unable to sell the product in the market on comparable or superior terms, this would have an adverse impact on the Group’s financial condition and results of operations.

Under a number of the Group’s contracts, customers take delivery of product prior to the due date for payment. If any of the customers under such contracts failed to pay for such products, this would have an adverse impact on the Group’s revenue generation, result of operations or financial condition.

Competition risk +-

The Group faces strong competition from other mining companies presently active in the production and sale of titanium minerals and zircon. In addition, a number of new heavy mineral sands projects have commenced or are expected to commence production, which may add to competitive pressures. There can be no assurance that the Group could be able to successfully respond to such competitive pressure or the competitive activities of other producers.

Expansion ramp-up risk +-

A failure to achieve and maintain post-Phase II Expansion production targets on a timely basis could have a material adverse effect on the Group’s production. There is no guarantee that the expanded operations will maintain the anticipated production volumes on a consistent basis, or that post-expansion operating costs will be in line with those anticipated. Failure to implement the Phase II Expansion as planned may have a material adverse effect on the Group’s financial condition and the results of operations, and the Group may be unable to capitalise to the maximum extent on any increase in demand or prices of our products.

Operational risks +-

The Group’s financial condition and results of operations are dependent on the success of our operation of the Mine. Any event that materially interferes with our ability to conduct operations at the Mine could have a materially adverse effect on the Group’s financial condition and results of operations.

Mining operations are vulnerable to natural events, including drought, floods, fire, storms and the possible effects of climate change. Operating difficulties could be experienced as a result of unexpected geological variations. Mineral sands dredge mining involves considerable berm construction and geotechnical management. An accident or a breach of operating standards could result in a significant incident which would affect the Group’s reputation, and the costs of its operations for indeterminate periods.

The Mine requires reliable roads, ports, power sources and power transmission facilities, and water supplies to conduct its business. The availability and cost of infrastructure affects capital and operating costs, production and sales. In particular, the Mine is dependent on the electricity generation and transmission system in northern Mozambique, and a single 170 km transmission line to the Moma Mine from the Nampula substation and has experienced episodes of power instability, partly as a result of an increase in the load on the transmission system that had not been anticipated by the state power transmission utility, EdM. Although the Group has taken a number of initiatives to minimise interruptions to operations caused by power interruptions and has been working with EdM to improve the stability of the electricity supply to the Moma Mine, there is no certainty that it will succeed in minimising or eliminating power instability, which could adversely affect production. If either the power station at Cahora Basa or the power transmission line to the Moma Mine were to experience prolonged or repeated disruptions or instability, production of ilmenite, rutile and zircon would be reduced, which would reduce cash flow, may impact customer relationships, and have an adverse impact on the Group’s results of operations and trading and financial position.

Furthermore, the Mine is reliant on the marine terminal for the shipment of products. Adverse weather conditions can limit the amount of shipments. Extreme weather conditions or accident could result in damage to the marine terminal, rendering the Mine unable to ship its products pending repair. In these situations, the Mine may be unable to meet its commitments to customers to a lesser or greater degree, resulting in reduced revenues, ocean freight penalties and reduced cashflow, with an adverse impact on customer relationships, results of operations and trading and financial condition.

In addition, the Group’s customers depend upon ocean freight to transport products purchased from the Group. Disruption of ocean freight as a result of piracy or other events could temporarily impair the Group’s ability to supply its products to its customers and thus could adversely affect the Group’s results of operations and trading and financial condition. The Group has developed a policy to manage the threat of piracy near the marine terminal.

The Group’s insurance does not cover every potential risk associated with its operations. Adequate cover at reasonable rates is not always obtainable. In addition, the Group’s insurance may not fully cover its liability or the consequences of any business interruption such as weather events, equipment failure or labour dispute. The occurrence of a significant event not fully covered by insurance could have an adverse effect on the Group’s business, results of operations and financial condition.

Ore reserve and mineral resources risk +-

The Group’s estimates of ore reserves and mineral resources are subject to a number of assumptions that may be incorrect and may be materially different from mineral quantities that may ultimately be recovered. Actual ore reserves may not conform to geological or other expectations and the volume and grade of ore recovered may be below the estimated level. Changes in the forecast prices of the Group’s products, exchange rates, production costs or recovery rates may result in reserves ceasing to be economically viable and needing to be downgraded or reduced. Moreover, short-term operating factors relating to the reserves, such as the need for sequential development of ore bodies and variations in ore grades, may adversely affect the Group’s production and profitability in any particular accounting period.

Financing and refinancing risks +-

The development of the Mine has been partly financed by the Project Loans. The Group’s ability to meet its debt service obligations under these loans depends on the cash flow generated from operations. The Mine’s cash flow, in turn, depends primarily on the Mine’s ability to achieve production, product sales volumes and pricing and cost targets. Failure to achieve these targets could result in insufficient funds to meet scheduled interest and principal repayments which would result in an event of default. Senior management monitors achievement of targets and cash flow to ensure sufficient funds are available to meet scheduled repayments.

On 16 December 2013, Kenmare and Absa agreed to an extension of the corporate facility provided by Absa in a reduced amount of US$20 million maturing on 31 March 2015, which was fully drawn at year end. Although the Group does not expect to be able to repay this corporate facility from operating cash flows as a result of restrictions under the Project Loans, the Group expects to have cash reserves that it can apply in repayment of the facility; in addition, the corporate facility is capable of being renewed on the written agreement of both Absa and Kenmare. A reduction in cash reserves below that required to repay the corporate facility, coupled with a failure to renew or refinance such facility may result in an event of default under the corporate facility as well as under the Project Loans.

Currency risks +-

The Group’s corporate and Moma project loans are denominated in US Dollars and Euro. At 31 December 2013, the loan balance comprised US$169.1 million denominated in US Dollars and US$186.1 million denominated in Euro. The outstanding loans are due to be repaid in instalments between 2014 and 2019. All the Group’s sales are denominated in US Dollars. Euro-denominated loans expose the Group to currency fluctuations which are realised on payment of interest and principal on Euro-denominated loans.

Senior management regularly monitors and reports to the Board on these currency risks. The Board had determined that the Group’s current policy of not entering into derivative financial instruments to manage the loan-related currency risks continues to be appropriate in light of the length of, and payment profile over, the loan repayment period. In February 2014, the Group entered into a loan amendment with the Project Lenders which provides more certainty on the repayment profile from 1 August 2015 onwards. The policy will be reviewed in light of this amendment.

Group operating and capital costs are denominated in a number of currencies, including US Dollars, South African Rand, Mozambican Metical, Euro, Sterling and Australian Dollars. Fluctuations in these currencies will impact on the Group’s financial results. The operating and expansion capital currency exposure is managed by adjusting the currencies in which the cash used to fund such expenditure is held.

Interest rate risk +-

Interest rates on the Group’s bank loans are both fixed and variable. The variable rates are based on one month and six month US Dollar LIBOR. All the Euro loans are fixed rate. The Group is exposed to movements in interest rates which affect the amount of interest paid on borrowings. As at 31 December 2013, 64% of the Group’s debt (US$226.7 million) was at fixed interest rates and 34% (US$128.5 million) was at variable interest rates. Any increase in the one month and six month US Dollar LIBOR would increase finance costs and therefore have a negative impact on the Group’s profitability. Senior management regularly monitors and reports to the Board on these interest rate risks. The Board has determined that the Group’s current policy of not entering into derivative financial instruments to manage such risks continues to be appropriate in light of the length of the loan repayment period, the payment profile over this period and the mix of fixed and variable rate debt. In February 2014, the Group entered into a loan amendment with the Project Lenders which provides more certainty on the repayment profile from 1 August 2015 onwards. The policy will be reviewed in light of this amendment.

Commodity risk +-

Certain of the Group’s operations and facilities at the Mine are intensive users of diesel fuel and, to the extent that diesel-powered generators are used to supplement power supplied by EdM, the Group’s consumption of diesel fuel will increase. Factors beyond the Group’s control may put upward pressure on the price paid by the Group for diesel fuel.

Health and safety risks +-

The Group is committed to conducting its business in a manner that minimises the exposure of its employees, contractors and the general public to health and safety risks arising from its operations. An accident or a breach of operating standards could result in a significant incident which would affect the community, employees, the Group’s reputation, and the costs and viability of its operations for an indeterminate period. The Group’s operations worked 5.9 million hours in the twelve months to 31 December 2013 (2012: 5.5 million hours), with 17 lost-time injuries to employees and contractors (2012: 9 lost-time injuries). Malaria is a key risk at the Mine and the Group continues to develop and implement programmes to minimise its impact on personnel at the Mine. The Group will also continue to ensure that appropriate health and safety standards are maintained across all its activities.

Human resources risks +-

The Group’s success depends upon the expertise and continued service of certain key executives and technical personnel, including the Executive Directors. The loss of the services of certain key employees, including to competitors, could have a material adverse effect on the results of operations and financial condition of the Group. In addition, as the Group’s business develops and expands, the Group’s future success will depend on its ability to attract and retain highly skilled and qualified personnel, which is not guaranteed. Due to the increased mining activity in Mozambique and new projects in the heavy mineral sands industry in recent years, the Group has encountered increasing competition in attracting and retaining experienced mining professionals. Should key personnel leave or should the Group be unable to attract and retain qualified personnel, the Group’s business, its results of operations and financial condition may be adversely affected.

Certain employees are represented by a union under a collective agreement. The Group may not be able to satisfactorily renegotiate labour agreements when they expire and may face higher wage demands. In addition, existing labour agreements may not prevent a strike or work stoppage, which could have an adverse effect on the Group’s results of operation, financial condition and reputation.

Litigation risks +-

The Group is a party to a number of disputes that are subject to resolution through court or arbitral proceedings and may from time to time face the risk of other litigation in connection with its business and/or other activities. Recovery may be sought against the Group for large and/or indeterminate amounts and the existence and scope of liabilities may remain unknown for substantial periods of time. Of the two current material claims against the Group, the estimated defence costs of one have been provided for under legal provisions, and the value of the other is included in the Group’s current liabilities although the Group is disputing the claim in full and has raised a counter-claim. A substantial legal liability and/or an adverse ruling could have a material adverse effect on the Group’s business, results of operation and financial condition.

Political risk +-

The Mine is located in Mozambique, which has been politically stable for almost two decades. The Group has operated in Mozambique since 1987, and has executed a Mineral Licensing Contract and an Implementation Agreement which each contain certain protections against adverse changes in Mozambican law. The Group’s operations in Mozambique may, however, become subject to risks similar to those which are prevalent in many developing countries, including extensive political or economic instability, changes in fiscal policy (including increased taxes or royalty rates), nationalisation, inflation, and currency restrictions, as well as renegotiation, nullification, termination or rescission of existing concessions or of licenses, permits, approvals and contracts. In addition, there may be an increase in, and tightening of, the regulatory requirements (including, for example, in relation to employee health and safety, permitting and licensing, planning and development and environmental compliance). The occurrence of these events could adversely affect the economics of the Mine and could have a material adverse effect on the results of operations and financial condition of the Group.

Regulatory risk +-

The Group’s operations are extensively regulated by national authorities in Mozambique. Regulations govern matters including, but not limited to, employee health and safety, permitting and licensing requirements, planning and development and environmental compliance. Although the Mineral Licensing Contract and Implementation Contract contain certain protections against adverse changes in Mozambican law, non-compliance with current or future regulations may result in financial penalties, the curtailment or cessation of operations, orders to pay compensation, orders to remedy the effects of non-compliance and orders to take preventative steps against possible future non-compliance. In addition, a violation of environmental or health and safety laws or permits or a failure to comply with the instructions of the relevant environmental or health and safety authorities could lead to, among other things, a temporary shutdown of all or a portion of the Mine, a loss of the right to mine or to continue with production or the imposition of costly compliance procedures, fines and penalties, liability for clean-up costs or damages. Any such measures could have a material adverse effect on the Group’s results of operations and financial condition.