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• Chairman's statement
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• Managing Director's review
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• Commercial Director's review
• World of sugar

Financial director’s review

“A robust balance sheet and strong cash generation remain a key feature of the group during challenging economic conditions”

Revenue (Rm)	Operating profit (Rm)	Headline earnings per share (cents)
Net borrowings/cash (Rm)	Distribution per share (Rm)	Return on shareholders’ equity (Rm)

Purpose

The purpose of this review is to provide insight into the financial performance and financial position of the group and should be read in conjunction with the summary financial statements presented here, together with the notes to the financial statements which can be found on our website at www.illovosugar.com.

Key financial risks

Exchange rates

As the group enters into purchase and sale transactions denominated in foreign currencies, it is subject to transactional exposure from fluctuating foreign currency exchange rates. To protect the business from the effects of transactional exchange rate volatility, forward exchange contracts are utilised, enabling more effective management of export realisations and cash flows. All forward exchange contracts are entered into in accordance with the Group Treasury Policy and individual contracts are approved by the Treasury Committee.

The group is further exposed to currency fluctuations with respect to the translation of profits into Rand, with 87% of the group’s operating profit being derived from operations outside South Africa. During the current year, the Malawian Kwacha was stable against the Rand with year-on-year devaluation of only 2% despite underlying Malawian inflation of 22%. The benefit of Rand weakness against the Tanzanian Shilling and Mozambique Metical only slightly mitigated the adverse impact of the weaker Zambian Kwacha. The table below summarises the average translation exchange rates for the relevant currencies:

Average translation exchange rates	2015	2014
Rand/Euro	13.99	13.58
Rand/US Dollar	11.06	10.12
Malawian Kwacha/Rand	38.42	37.52
Zambian Kwacha/Rand	0.581	0.544
Tanzanian Shilling/Rand	154.67	160.41
Mozambican Metical/Rand	2.89	3.01

Export market prices

The world sugar price came under significant pressure during the 2014/15 season, falling from US17.5 cents/lb a year ago to current price levels of around US13.0 cents/lb. The weakening of the Brazilian Real has played a significant role in this deterioration, compounded by multiple years of surpluses in the world sugar market.

The South African business is the only operation that exports sugar to the world market and is therefore directly exposed to the world sugar price. This direct exposure was significantly reduced during 2014/15 as export volumes declined with the introduction of an effective import tariff reducing imports and the lower industry production resulting from adverse weather conditions. World sugar exports, together with the related hedging activities, are undertaken on behalf of the sugar milling companies by the South African Sugar Association (SASA). The company participates in all decisions made by SASA relative to its pricing and hedging activities.

European prices have also declined significantly. This reduction in pricing has occurred as European producers reposition themselves ahead of the structural reforms due in 2017. Realisations from European sales have also been adversely impacted by the notable weakening of the Euro, with the average US Dollar/Euro rate declining from 1.34 in 2014 to 1.26 in 2015.

While high inland transport costs continue to protect pricing in certain of the group’s regional markets, the impact of the low world sugar price was felt in certain regional markets, particularly those such as Tanzania and Mozambique where low import duties were in effect.

The impact of inflation and cost containment

Inflation in most countries in which the group operates has been relatively stable in the past year, except in Malawi where inflation averaged 22%, albeit lower than the 27% in the prior year, and continued to have a substantial impact on input costs. The impact of high Malawian interest rates and weak economic growth on consumer demand made it difficult to mitigate this high inflation through domestic price increases, resulting in a reduction in operating margins.

Illovo continued to generate substantial benefits through its continuous improvement programme, which reduced costs through efficiency and productivity improvements.

Interest rate risk management

The group is exposed to interest rate risk with respect to variable rate loans and overdraft facilities. In the prior year, the external debt in Zambia was refinanced using internal funding to maximise the group’s arbitrage opportunity of funding operations in high-interest rate environments from low-interest rate jurisdictions. While an interest saving was realised in the prior year, the full benefit was realised in the current year. Working capital and operating expenditure are tightly controlled so as to maximise cash flow and minimise finance charges. The table below summarises average interest rates across the countries where we operate:

Average interest rates	2015
Malawi	31.4%
Mozambique	5.7%
South Africa	6.4%
Swaziland	9.1%
Tanzania	12.7%
Zambia	15.9%

Accounting policies

The financial statements are prepared in accordance with International Financial Reporting Standards and the requirements of the Companies Act of South Africa. During the year, the group adopted the amendments to IFRS 10 Consolidated Financial Statements, IFRS 12 Disclosure of Interests in Other Entities, IAS 32/39 Financial Instruments and IAS 36 Impairment of Assets. The adoption of these standards has resulted in additional disclosures.

The group is currently assessing the impact of a change to IAS 41 Agriculture which will require cane root assets to be measured at depreciated historical costs and no longer at fair value. The change will come into effect for the year ending 31 March 2017.

Acquisitions, disposals and investments

Effective 26 September 2014, 5.1% of the Zambia Sugar Plc shares owned by Illovo were sold to local Zambian institutional investors for a consideration of R189 million. A further 1.5% is still to be sold in order to achieve compliance with the Lusaka Stock Exchange Listings Requirements, in terms of which all listed companies are required to have a minimum of 25% of their shares held by the public. A gain on the transaction of R93 million has been recognised directly in the group’s reserves.

Material items and impairment

There were no material items or impairments during the current year.

Financial performance

The financial performance of the group is measured in terms of various key financial ratios which include the operating margin, headline earnings growth, gearing and cash flow generation, as set out below:

Operating margins (%)	Headline earnings (Rm)	Gearing (%)	Cash generated from operations (Rm)

Operating performance

2015 Operating profit (%)	2014 Operating profit (%)

Revenue and operating profit by country

Revenue was marginally higher than the prior year, with the impact of lower EU price realisations and lower sales volumes offset by an improved sales mix and inflationary domestic price increases in South Africa, Zambia and Swaziland. In Malawi, weakening domestic demand led to both lower sales volumes and increased difficulty in achieving inflationary price increases, although the impact of the stronger Kwacha resulted in translated revenue being level year-on-year. The 11% reduction in South Africa’s sales volumes, due to the lower production impacted by adverse weather conditions, was largely offset by an improved domestic environment supported by improved regulation of imports from world markets along with improved downstream revenue supported by a weaker Rand. Swaziland’s revenue was lower due to lower EU prices and a weaker Euro, while Tanzania benefited from a 15% increase in sales volumes enabled by a stabilisation of domestic market conditions, along with the additional revenue generated from the first full year of operation of the distillery.

Operating profit declined with the impact of the lower production and sales volumes, along with cost inflation in the face of flat revenue, only being partially offset by substantial benefits generated from the continuous improvement programme. The operating margin decreased from 14.3% to 12.5%. The adverse profit impact of the lower EU prices and a weaker Euro were felt most heavily in Swaziland, Zambia and Malawi, although in Zambia this was fully mitigated via a strong 60% increase in regional sales volumes, domestic market growth and record production volumes. The operations in Tanzania achieved a strong improvement in operating profit on the back of improved sales volumes, significant cost savings, and the full-year contribution from the distillery. The co-generation business in Swaziland achieved increased exports to the national grid and energy efficiency improvements, resulting in a 57% increase in operating profit.

The decrease in operating profit over the previous year is graphically depicted in the chart below:

Operating profit (Rm)

Finance costs

	2015  Rm	2014  Rm	Variance
Malawi	(105)	(44)	(61)
Mozambique	(11)	(9)	(2)
South Africa	(102)	(78)	(24)
Swaziland	(83)	(80)	(3)
Tanzania	(81)	(76)	(5)
Zambia	(301)	(255)	(46)
Group operations	295	206	89
Translation	32	n/a	32
Total	(356)	(336)	(20)

Rising interest rates across most emerging economies and the impact of a slower sales profile resulted in finance costs increasing by R20 million compared to 2014. This was most evident in Malawi and Zambia which were impacted by lower export realisations. Malawi was also impacted by dampened domestic demand resulting in the need to finance higher inventory holdings over the course of the year. Higher finance costs in South Africa were also affected by the lower cash from operations resulting from the effect of drought and frost conditions which lowered crop yields. At a group level, finance costs were favourable primarily due to the realisation of the full year benefit of the prior year external debt refinancing in Zambia.

Translation gains arose from the effect of a weaker Zambian Kwacha on the interest expense, and a stronger US dollar on the interest income.

Taxation

The effective tax rate decreased from 31.3% to 29.8% in the current year.

Effective tax rates (%)	2015	2014
Current tax	9.8	13.3
Deferred tax	16.2	14.8
Withholding tax	3.8	3.2
Effective tax rate	29.8	31.3

Headline earnings

Headline earnings decreased by 7.7% to R825 million (2014: R894 million). The weighted average number of shares in issue increased by 107 600 shares to 460.7 million as a result of the final issue of shares in terms of the Illovo Sugar 1992 Share Option Scheme.

Cash flow (Rm)

Operating cash flows declined in line with the lower operating profit, but the cash conversion ratio remained strong at 101% (2014: 102%), as the group continued its focus on operating cash flows with the objective of ensuring that operating profit is largely covered by cash. Working capital increased primarily due to the impact of the slower sales profile on receivables. Management continues to focus on revenue enhancements, cost reductions and continuous improvement initiatives across the group to maximise cash flow generation, optimise working capital requirements and minimise financing costs.

The group invested R334 million in expansion capital projects including the Nakambala refinery expansion, a packed sugar warehouse in Malawi and an energy efficiency project at the Sezela mill in South Africa. In addition to this, R366 million was spent on on-going replacement capital and minor capital projects. The sale of 5.1% of the Zambia Sugar Plc shares owned by the group generated proceeds of R189 million. Distributions to shareholders totalled R576 million (2014: R557 million).

Borrowings

At year-end, the group had banking facilities totalling R5 166 million of which R1 322 million was drawn down. Committed facilities totalled R3 942 million while the group has access to R1 224 million of uncommitted facilities. Cash-on-hand at year-end totalled R477 million, resulting in a net borrowings position of R2 731 million.

The net borrowings position at year-end was made up as follows:

Rm	2015	2014
Long-term borrowings	2 043	1 825
Current portion of long-term borrowings	100	151
Short-term borrowings	615	297
Bank overdraft	450	410
Total borrowings	3 208	2 683
Less: Cash and cash equivalents	(477)	(597)
Net borrowings	2 731	2 086
Increase in funding	645	213

Net borrowings increased from the prior year and included a R329 million loss that arose largely on translation of US Dollar obligations into Rands. Excluding translation losses, this results in an increase of net borrowings of R316 million which is attributable to the impact on cash from the lower cash operating profit. This increase in net borrowings is after a R189 million cash inflow resulting from the disposal of a 5.1% interest in Zambia Sugar Plc.

The borrowings profile is largely long-term in nature which reflects both the capital investment programme and working capital requirements of the business. Capital projects are largely funded by each of the individual businesses, primarily in the currency of that business’ operations. Any residual funding is financed through group treasury which in turn is financed by the local debt markets. Capital expansion projects are financed by floating rate long-term debt and are repaid from project cash flows.

The external borrowings exposure at 31 March is analysed by currency:

Rm	2015	%	2014	%
Rand	43	1	24	1
US Dollar	2 253	70	1 959	73
Euro	204	6	–	–
Malawian Kwacha	115	4	–	–
Zambian Kwacha	8	1	20	1
Tanzanian Shilling	561	17	656	24
Mozambican Metical	24	1	24	1
Total borrowings	3 208	100	2 683	100
Translational exposure	3 165	99	2 659	99
Transactional exposure	–	–	–	–
No currency exposure	43	1	24	1

The group manages transactional exposure on external borrowings by ensuring that the businesses borrow in their local currency. The group’s treasury operation may borrow in a currency other than its local currency, provided the exchange exposure is appropriately hedged. Where internal financing is utilised for long-term funding and is designated as part of the investment in the operation, foreign exchange gains and losses are recorded directly in reserves.

Gearing increased to 26% which is within the group’s objective limit of 40%. The low level of gearing is expected to be maintained in the short term, however, over the medium to long term, in anticipation of large capital expansion projects, this gearing level is expected to reach the objective limit.

Shareholding and return

Trading activity by volume of shares traded on the JSE decreased by 11% year-on-year, following a 47% increase in the prior year. The share price decreased by 15% from 2 801 cents to 2 378 cents at year-end.

The group has maintained its policy to pay a distribution to shareholders twice a year (interim and final), in aggregate twice-covered by headline earnings after due consideration of current and forecast cash generation, planned capital expenditure and gearing levels.

An interim capital distribution, in lieu of a dividend, of 37 cents per share was paid and a final capital distribution, in lieu of a dividend, of 53 cents per share has been approved. The total distribution of 90 cents per share is lower than the 97 cents per share distributed in 2014 in line with the lower headline earnings. In accordance with International Financial Reporting Standards, no liability has been raised for the final distribution. As the source of the distribution is a reduction of contributed tax capital, the cost of the final distribution of R244 million has been transferred from share premium to a separate distribution reserve.

Return on net assets

The return on net assets for the group decreased from 16.1% to 13.1% year-on-year. This mainly reflects the decrease in operating profit and the increase in working capital resulting from the challenging commercial environment. A currency loss of R405 million arose on the translation of the group’s foreign currency denominated net assets into Rand.

Capital expenditure and commitments

A summary of the group’s capital expenditure and approved capital commitments as at 31 March is set out below:

Rm	Capital expenditure			Capital commitments
	2015			2016
	Expansion	Ongoing	Total	Expansion	Ongoing	Total
South Africa	100	87	187	161	108	269
Malawi	73	88	161	57	97	154
Zambia	65	68	133	909	102	1 011
Swaziland	16	36	52	75	42	117
Tanzania	1	23	24	12	49	61
Mozambique	5	28	33	10	31	41
Group	74	36	110	198	17	215
Total	334	366	700	1 422	446	1 868

The group continued to apply the following hurdle rates to new expansion capital projects:

Internal rate of return	> 20%
EBIT/capital at steady state	> 20 %
Payback	< 7 years

The hurdle rates ensure that capital is applied to expansion projects that give the best return on investment. However, these hurdle rates do not apply to ongoing replacement capital and environmental capital where it is not always possible to demonstrate the financial returns. Equity injections into the operating subsidiaries are considered from time to time, as appropriate, in order to maximise shareholders’ returns.

Financial controls and risk management

The internal control systems are designed to provide reasonable assurance against material losses and misstatement of financial results, and are intended to manage all significant risks. The safeguarding and prevention of misuse of assets is an important aspect of internal control. An internal financial control framework has been developed, in line with King III, to improve the identification of financial reporting risks and to provide additional assurance that controls are adequate to address the risk of material misstatements of financial results. During 2015, internal control frameworks were tested by the internal audit division at numerous locations. Areas of non-compliance were reported and discussed with management, following which action plans were implemented to address the risk of material misstatement of financial results.

Going concern assertion

The board has formally considered the going concern assertion for the Illovo group and is of the opinion that it is appropriate for the forthcoming year.

Mohammed Abdool-Samad
Financial Director