REVIEW OF OPERATIONS: CHEMICAL SERVICES LIMITED

Chemical Services Limited (Chemserve) is the specialty chemicals arm of AECI and manages a portfolio of 20 businesses, each focused on specific markets with common values of innovative customer service and bottom line delivery. Historically, the Chemserve group has grown by acquisition and by organic growth. In 2009 Chemserve mechanically completed the major capital investment programme which commenced in 2007.

Each Chemserve business aspires to be the supplier of choice for customers in its markets, supported by the best technology available, a carefully designed service package, and with the lowest possible cost base. Technology is sourced from international partners and is also developed in-house. Full service package business models provide customers with innovative solutions to their chemistry-driven requirements and differentiate Chemserve from competitors in terms of skills, competencies and value-add for their customers.

Chemserve's strategy is to:

• expand its mining chemicals product and service offering in South Africa, the rest of Africa, and in other geographical areas where the full service model is valued and the mining profile fits the company's capabilities. Senmin, Chemical Initiatives (CI) and ImproChem are driving this strategic thrust;
• expand its water-, oil-, gas- and energy-related product and service offering from Southern Africa to the rest of Africa, and to other geographical areas where the full service model is valued. ImproChem will be the vehicle for the push out of Southern Africa;
• explore the opportunities for sales of specialist products and services offered by the global focus on food production and preservation,
  and agriculture;
• grow its joint venture business in Brazil, based on oleochemical expertise it shares with its partner, move into other sectors where the partnership has appropriate expertise, and seek other appropriate investment opportunities;
• manage and grow its South African portfolio; and
• expand businesses in its portfolio into Africa, and into other territories where suitable markets exist.

BUSINESS ENVIRONMENT

The start to 2009 was particularly difficult with mines closed or on reduced rates and large manufacturing operations and paper mills on short time or care and maintenance. In the year to October, South African volumes were down 13% overall in manufacturing where capacity utilisation dropped to 79%. The food and beverage sector grew by 2%. General manufacturing declined by 13%, motor vehicles production by 36%, paper and paper products by 13%, petroleum, chemicals and plastics by 10%, and the value of building plans passed fell by 21% (40% from 2007's peak). Mining production volumes dropped 7% from 2008's levels, and 15% from the peak in 2007.

The rand started the year weak at R/US$9,37, weakened further, and then strengthened, closing the year at R/U$7,37. This caused additional net realisable value write-downs of inventory and uncovered export debtors. Fortunately the oil price increased early in 2009 and remained firm, keeping base chemical prices up despite a worldwide reduction in demand.

PERFORMANCE

Financial performance: Chemical Services Limited (Rm)

The slowdown in performance experienced by Chemserve in the first half-year continued into the second six months, exacerbated by the currency strength and worsened by a bad debt with a Zambian sulphur distributor which came to light in the latter part of 2009.

Revenue decreased by 23% to R6 524 million (2008: R8 434 million) and trading profit decreased by 43% to R483 million (2008: R851 million), after provision for the bad debt of R163 million and restructuring costs of R39 million. The trading margin decreased to 7,4% from 10,1% in 2008 (10,5% if the bad debt and restructuring costs are excluded) on volumes which were 27% lower than in the previous year.

Prices held firm for the first half of the year but came under pressure in the second half. Nonetheless, overall prices increased by 5,6%. Given the business environment in 2009, with the mining and manufacturing sectors severely affected by the global economic crisis, Chemserve's businesses did well to limit the decrease in trading profit on dramatically reduced volumes.

On the positive side, significant growth was achieved by Chemserve Perlite (Perlite), Crest Chemicals (Crest), Industrial Oleochemical Products (IOP), Lake International (Lake) and Specialty Minerals SA (SMSA).

Perlite recorded good sales into the glucose and wine industry. Crest maintained its effective distribution model and benefited from the integration of CH Chemicals.IOP enjoyed high demand for phosphate recovery reagents and its plant ran at reasonable rates. Lake benefited from modest growth in the food and beverage industry, the acquisition of Cobito which outperformed expectations, and the pull through of demand from AEL. SMSA's low cost base, good purchasing and high efficiencies resulted in a good performance despite the volume decline in the paper industry.

Chemfit's performance was robust, matching its 2008 earnings despite lower volumes, and considerable efforts to reduce costs and improve margins yielded results. Senmin maintained its revenue and profitability despite the considerable drop in volumes in the first quarter, pressure in the mining industry to reduce chemical consumption, and pricing challenges due to the strong currency and falling commodity prices.

Akulu Marchon (Akulu), Chemserve Systems (Systems), Chemiphos, ImproChem, Plaaskem, Resinkem and SA Paper Chemicals (SAPCO) were all affected by lower demand from customers and considerable price pressures aggravated by the rand strength.

Akulu noted improved conditions in the last quarter. ImproChem controlled costs and retained market share but volumes, especially toll volumes, dropped significantly and the strong rand impacted on margins and foreign earnings. Resinkem's very low cost base and high efficiencies assisted the business through a period of reduced prices and volumes which were lower, in line with the chipboard industry's performance. SAPCO had to contend with reduced volumes due to mill shutdowns and commercial down time, pricing pressures from a strong rand and global purchasing arrangements, and the disruption caused by the BASF purchase of Ciba.

Simitri, which serves the leather industry, was divisionalised into SAPCO to reduce its overhead costs and its production facility was closed. Leather volumes locally were negatively impacted by the reduction in automotive upholstery demand.

Resitec had a mixed year with a very strong Brazilian real, but demand returned from the synthetic rubber industry in the last quarter to provide a base load with improved prices. The fractionation column looks promising now that operational issues affecting product quality are being resolved. The business has written-down inventory and impaired assets relating to a discontinued food business.

Particularly hard hit in the year were Plastamid and Duco Speciality Coatings (Duco), both of which are exposed to the automotive and railway industries. Industrial Urethanes was also severely affected, owing to demand from the white goods market being at its lowest in many years. Plastamid was impacted further by the loss of SANS Fibres' textile fibre waste which was a very important low cost raw material for its in-house products. Plastamid has been restructured to eliminate as much cost as possible and Duco has been re-engineered to become a logistics and services company with no in-house manufacturing. The company's Struandale site, in Port Elizabeth, has been sold.

DEBT WRITE-OFF

CI exported large quantities of raw sulphur to a distributor in Zambia in 2008, at the peak of the commodity boom. The sulphur sold to the distributor was procured by mines in the copper belt region.

During the latter part of 2008 the price of sulphur declined rapidly and severely. Despite this, the customer continued to make regular payments during the first half of 2009. In the latter part of the year, however, it became apparent to management that the balance of the receivable outstanding could not be recovered from the distributor.

Accordingly, management has provided R125 million in respect of the probable bad debt and has further processed adjustments in respect of pricing adjustments, foreign exchange revaluations and net realisable inventory adjustments of R38 million.

COSTS, MARGINS AND GROWTH

All businesses, including those which performed well in 2009, reduced their costs by reviewing expenditure and by bottom slicing to reduce the effort and resources allocated to less profitable products and markets. The focus on maintaining and improving margins resulted in better purchasing, inventory management and pricing.

Growth was difficult to achieve outside of the acquisitions, but most Chemserve businesses held their market share or improved it as a consequence of maintaining and enhancing service levels.

CASH

It was most pleasing that strict working capital management released over R1 billion in cash.

STRATEGY IMPLEMENTATION

Chemserve has made substantial investments in mining chemicals production capacity to service local and international markets, and on infrastructure at mines to supply the services required. Senmin has built an impressive team of qualified and experienced people to meet the mining industry's needs, including team members based at mining extraction sites. A mining chemicals strategy update follows in this operational review.

ImproChem is no longer restricted geographically by technology agreements and is engaged in expanding its operations beyond Southern Africa. This business will be the main vehicle for implementing Chemserve's water, oil, gas and energy strategy.

Through Lake and Plaaskem, in particular, Chemserve is exploring medium-term opportunities in the food and agricultural chemicals markets in order to focus on the most promising areas.

In Brazil, the focus will be on commercialising Resitec's expanded oleochemical facilities that were brought on line in 2009. Acquisition opportunities have started to reappear in Brazil and will receive attention in 2010.

Two very successful acquisitions were made in 2009: 80% of the shares in Cobito, which services the poultry industry, were purchased. The business was integrated into Lake and the business of CH Chemicals was bought and integrated into Crest. Both acquisitions are operating well.

More Chemserve companies are expanding their footprints in Africa. As expected, the lead has been taken by the businesses involved in mining chemicals and water treatment, but others are also identifying opportunities.

MINING CHEMICALS STRATEGY UPDATE

The global economic crisis had a major negative impact on the mining industry in 2009, especially in the first half when diamond and copper mines in Southern Africa ceased operations abruptly. Closures, care and maintenance programmes and chemical cuts had a significant impact on volumes sold into this sector. In addition commodity chemical prices fell to record lows. Chemserve's sales to the mining sector were R1 679 million, 35% less than comparative 2008 sales revenues.

The sulphur trading business was hard hit, with sales into the mining sector at R184 million compared to almost R1 200 million in 2008. The outlook for 2010 is optimistic with copper and diamond mines re-opening and commodity prices strengthening. Some large capital projects are coming on line and these are expected to have a significant impact on volumes and margins over the next 12 months.

The continued focus on mining chemicals is critical to Chemserve's long-term growth. The group's vendor service model is unique and innovative and its value at mines in South Africa and Africa continues to gain acceptance. Akulu, CI, ImproChem, IOP, Senmin and Systems provide customers with tailored account management solutions which include on-site production and process management, dosing control, storage, logistics, maintenance, training and environmental compliance. Together with proven expertise in ore beneficiation, this model has resulted in improved yields, more effective use of scarce water resources and the streamlined use of systems that improve customers' profits.

Offices and storage facilities have been opened in Botswana, Kenya, Mozambique and Zambia and new facilities are planned for Namibia and Tanzania later in 2010. As Chemserve's new production facilities ramp-up production, opportunities are being explored for exports to regions in Australasia and South America.

As mining projects in Southern and Central Africa come on line, opportunities in these territories will continue to be pursued.

CAPITAL PROGRAMME

By the end of 2009, Chemserve's R1 200 million major capital programme was drawing to an end. Projects included a fractionation plant at Resitec, Akulu's sulphonation plant, additional capacity for Senmin's guar plant, and Senmin's pelletised xanthate plant, carbon disulphide (CS₂) plant and its acrylamide and polyacrylamide plants.

All projects are mechanically complete and commissioned with the exception of the acrylamide and polyacrylamide plants. Their three-stage commissioning process commenced in January 2010 and will be concluded in the second quarter.

Resitec's fractionation plant experienced some quality issues which are being resolved with the assistance of IOP and MeadWestvaco, the joint venture partner in Resitec. The plant is operating well at current market rates.

The guar plant runs well and has capacity to meet growing demand in Southern Africa. The xanthate reactors have been commissioned and are operating at design capacity. Production of pelletised product is being hampered by performance of a dryer downstream of the reactors. The resolution of this issue is receiving focused attention. The CS₂ plant has been run at design capacity. This project will have a significant impact on Senmin's profitability due to its considerably reduced cost base compared to that of the old plant and imports.

SAFETY

Chemserve achieved its safety targets, with a Total Recordable Injury Rate (TRIR) for employees of 0,96. This reflects the continued focus by executive and senior management on safety systems, structures and training. Most importantly, there is increased safety awareness among employees and a commitment from them to take responsibility for their own and others' safety.

The focus on safety will continue in 2010 and will be steered by the outcome of a safety attitude survey among 1 500 employees.

OUTLOOK

The outlook for 2010 and beyond is underpinned by the strength of the rand, the recovery of the South African economy, and the resurgence of the African mining industry which seems well underway.

The capital programme, which has required considerable resource for two years, is close to completion and all indications are that the markets served by the investments in oleochemicals, surfactants and mining have recovered sufficiently to load the plants adequately.

Akulu, Resitec and Senmin will focus on growth on the back of their new capacities and improved efficiencies. The other Chemserve companies have trimmed costs and shed unprofitable business in 2009, and they are well set up to take advantage of any upturn.

Fractionation column at Resitec, in Brazil.

Carbon disulphide plant, at Senmin.

CHEMSERVE'S BUSINESSES