Diversified JSE Securities Exchange-listed mining company Kumba Resources has been one of the most successful new listings of the last decade. Key to this success was the early use of strategic financial planning, effected through Monte Carlo analysis using Decisioneering`s Crystal Ball software.
"Due to the unbundling from Iscor in 2001, we had no clearly defined strategy as a new business," says Tom de Lange, strategy manager at Kumba Resources.
A strategic workshop was organised in 2003 to define Kumba Resources` path forward and to optimise its growth portfolio. Would the business diversify and if so, to what extent?
The existing portfolio was analysed at a strategic workshop using Monte Carlo analysis and indicators to provide insight on its potential improvement.
These concepts were drawn into a projection model containing the items in the portfolio determining growth, as well as the appropriate key value drivers. Conclusions were drawn by means of a scenario analysis of the impact of key macro-economic factors.
The project kicked off with an internal analysis focusing on three areas: historic portfolio analysis; the impact of business drivers on forecast results; and future portfolio analysis.
"For the portfolio analysis, we followed an efficient investment frontier approach, which involves plotting the risk-return relationship of various portfolio weights," says De Lange.
Kumba Resources used Crystal Ball`s Monte Carlo simulation software to save the team of skilled analysts the money and time required to manually generate thousands of scenarios. Harvey Jones Systems distributes the product in SA and provides local support, training and backup.
"Crystal Ball enhances Excel models by letting users create probability distributions that describe the uncertainty surrounding specific input variables," says Yolanda Smit, Crystal Ball product manager at Harvey Jones Systems. "Thousands of scenarios are simulated for each of the variables, the outcomes are calculated for each scenario and probability factors are graphed."
"In deciding which ratio or return parameter to analyse, we had to contend with the after-effects of Kumba`s unbundling, in which company debt was distributed to the various business units to optimise tax," says De Lange. "This created a skewed picture of the true solvency situation, so we concentrated on return on total assets in our simulations, excluding any debt."
With each iterative simulation, a set of portfolio weights was generated, which had to be normalised to a 100% total weight.
Diversified portfolio
"We needed a record of the generated weights for the chart, so we linked the assumptions to a corresponding set of forecasts. The spreadsheet calculates the mean return of the portfolio and the standard deviation over the appropriate period," says De Lange.
A correlation coefficient matrix was developed.
"It showed us that Kumba has a well diversified portfolio. Disappointing, however, was the high correlation between the two largest businesses - iron ore and heavy minerals," says De Lange.
The key commodities for the business are: iron ore, which accounts for about 49% of revenue; coal, which accounts for 22% of revenue; base metals that accounts for 9% of revenue; and, the newest and growing contributor, heavy minerals, which accounts for 19% of revenue.
De Lange and his team created a frontier map that showed them that iron ore delivers high returns for the business, albeit at greater risk; coal offers low risk with medium to low returns; base metals is a high risk, low return business; and heavy minerals offers medium to low risk with low returns. (Low to negative returns are typically associated with projects in the ramp-up phase, as was the case with the heavy minerals business.)
Executives then had to decide: would they chase profits by investing more in iron ore and coal; or would they divest of iron ore and invest in coal and heavy minerals to steer the business toward mitigating risk?
The final outcome was to:
* Retain the option of being moderately diversified;
* Grow iron ore, heavy minerals and coal;
* Freeze growth plans for zinc business for three years; and
* Divest copper, and investigate manganese
The results from the model generated in 2003 today show that the business has delivered as expected.
"Crystal Ball played a significant part in arriving at these decisions," says De Lange.
"The tool really gives you a method for handling risk and uncertainty, which I have not seen anywhere else."
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Harvey Jones Systems (HJS) is a global award-winning company that was established in SA in 1997 and has grown to become the leading provider of business intelligence, performance management and decision support solutions on the Microsoft platform in Africa. The solution set consists of global best-in-class solutions including ProClarity, Crystal Ball and Corda. The HJS team provides the market with best-practice implementation, training and support.
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