Chairman's Letter to Shareholders

Dear Shareholders,

Those of you who have owned our company’s stock for some time must have noticed a common theme in my annual letter as I review the business and assess progress made during the year. This is not surprising as our team is performing the same fundamental tasks every year – building and developing our businesses the best they can in their respective fields, and serving our customers, whether supplying them with steel products or selling a beautiful sea view unit to a property buyer. All these activities are driven by one goal – to create long-term value for you.

2013 was a particularly memorable year as we celebrated the first shipment of iron ore concentrate from our Sino Iron project in Western Australia.

In this year’s annual letter, I will begin with a summary of the company’s financial performance, then move on to reflect upon the significance of Sino Iron’s first export and the lessons we have learned along the way. Finally, I will outline how we see the future and also demonstrate to you how strategic value has been created in both measurable and intangible ways. As always, our eye is on the long-term, and we ask our shareholders to share that long-term point of view.

2013 Financial Results

Profit attributable to ordinary shareholders was HK$7,588 million, 9% more than 2012. Profit from our underlying business operations increased 42% underpinned by the solid performance of our special steel and energy businesses. As China’s largest dedicated manufacturer of special steel, we gain stability and focus from this business and are well placed to meet future challenges and opportunities.

Earnings from mainland property rose as we sold a commercial building in Shanghai. Most of our residential projects are in the development phase with limited finished units for delivery. However, pre-sales of residential units in 2013 were at a record high, but the bookings from them will not be recognised until the units are completed and delivered to buyers. Our other businesses continued to contribute toward our profit and cash flow.

Our single biggest investment – Sino Iron – is now exporting product. However, interest expenses can no longer be capitalised, and we’ve begun recording depreciation, which resulted in a substantial loss for the year 2013.

Turning to our finances, during the year we raised over HK$42 billion of funds from banks and the financial markets. At the end of 2013, we had more than HK$48 billion in cash and available committed facilities, which gave us the financial flexibility to execute our investment plans and pay a dividend to our shareholders.

Our board is resolved to pay a final dividend of HK$0.25 per share, giving our shareholders a total of HK$0.35 per share for the year 2013.

Reflections on Sino Iron and the Wider Implications for Our Business

Sino Iron is a 30-plus year investment, and the dip in 2013 results can only be understood in a longer-term context. Let me share with you my thoughts about where we are, where we have been and where we are going.

On 2 December, our first ship loaded with iron ore concentrate left Cape Preston to arrive in Jiangsu province in China a week later. As you know, this project has been a top priority for CITIC Pacific management in the last few years and will continue to be until all six production lines are up and running.

Sino Iron is much more than a standalone project to us. What we have gained from this valuable experience is also applicable to the management of our other businesses and our company as a whole.

Sino Iron is China’s largest single investment ever made in Australia and is also China’s largest resources investment globally. It now constitutes over 30% of our company’s assets. Over the last decade, commodity prices, the global economy and capital markets have moved up and down. Our shareholder makeup has changed as well. Certainly the world has not stood still while we built this mine.

Through successes and setbacks, the one thing that has remained constant is our perseverance and determination. This is a story of a company setting a goal, staying focused on priorities, learning lessons, celebrating milestones along the way, and seeing light at the end of the tunnel. That light is the long-term value this mine will bring to our company, and that light illuminates our emergence as a major player in a new industry.

CITIC Pacific has been closely watched as an example of how a Chinese company can perform on a world stage. Looking back, we could hardly have chosen a more ambitious test of our resolve. Entering a new industry, embarking upon a greenfield project of massive scale and complexity, and doing so in a developed country with very high standards were all major challenges. Not everyone shared our long-term investment thesis. Some frequently pointed out setbacks experienced along the way and said that this project could never be done, the ore would stay in the ground and the project would fall away. But now the project is taking shape right before our eyes.

Valuable lessons

We have learned and gained so much in knowledge, experience and expertise.

  1. Local knowledge and expertise is critical in getting to know the lay of the land

    The way business is done and projects are developed varies by country. Naturally, operating in Australia is different to our previous experiences, particularly in areas such as the regulatory environment, approval processes and local labour practices. Looking back, both we and MCC underestimated the complexity and the amount of work, time and capital needed to build this project. For example, MCC initially anticipated being able to deploy a certain amount of Chinese labour, which later proved to be unrealistic. It became clear that a one-size-fits-all approach would not suffice. As such, we sought the guidance and assistance of highly experienced local professionals to help us navigate the operating environment and provide their considerable Australian construction and operational expertise. We could not have achieved what we did without them.

  2. It is sometimes best to directly manage the critical components

    Like all large-scale industrial projects, the devil lies in the details of project management. CITIC Pacific Mining directly managed the construction of the power station, desalination plant and the port area, which were all ready for commissioning quite some time before the processing area. Our experience with MCC in constructing the first two production lines was not so smooth. In hindsight, a more hands-on approach was required.

    We have applied this learning to the construction of the remaining lines. CITIC Pacific Mining has mobilised an experienced internal team to directly manage the tasks at hand.

  3. Trust bridges cultural differences, opening up a world of opportunities

    The combination of Chinese and Australian management and workers on the project has not only provided a complementary skill-set, it has built cultural understanding. On my visit to celebrate first shipment, I was delighted to see the bonds that had formed between employees from both countries, as they came together to deliver this megaproject. In the years to come, we hope that Sino Iron is seen as a watershed moment in the development of the cultural and economic relationship between Australia and China. That sentiment was certainly expressed by the Premier of Western Australia when he joined us at site for first shipment.

    We could not have gotten to where we are without a strong partnership with both the Western Australian and the Federal government and the people in the community, including the traditional land owners. Our tangible joint accomplishments include the building of Pilbara’s first greenfield port in more than 40 years; creating an eco-system of infrastructure, including roads, where none existed before; a 450 megawatt energy-efficient power plant; and one of the world’s most advanced desalination plants. Close to 70% of the project’s content is sourced locally including the employment of thousands of Australians. For at least the next 30 years, the Western Australian government will also receive a steady stream of royalties from Sino Iron.

  4. It is important that all parties share a joint vision and similar expectations, act responsibly and lead by example

    Our legal disputes with Mineralogy have been well documented in the media. Unfortunately, commercial disputes are commonplace on major mining projects. Usually, they can be resolved through open discussion and good faith negotiations, which will always be CITIC Pacific’s preferred path. The principle we abide by is to remain consistent in our position and not compromise the interests of the company or shareholders.

    Clearly, not every scenario was foreseen in our original agreements and some ambiguities and different views held by the parties have needed determination by an “independent umpire” – in this case, the Australian courts. We have great respect for the judicial process in Australia, and at all times we have complied with Australian law.

    During the past year, Mineralogy has pursued several attempts to have the project suspended or terminated, but all have failed before the courts.

    We will continue to act responsibly and be a good corporate citizen. We encourage other Chinese companies looking to establish overseas operations to do the same.

    Our experience drives home the need to ensure that all parties are aligned in their vision and expectations at the beginning, so they can weather the unexpected together.

  5. Engaging with the public builds understanding

    As Sino Iron has evolved, we have recognised the need to build understanding with key stakeholders. This means taking the time to explain both the opportunities and challenges confronting us. Naturally, there has been elevated community and media interest in this massive investment. As the project neared fruition, we stepped up our efforts to regularly update and disclose to all stakeholders on how the project was developing. These stakeholders range from community members living near the project, to the media, the highest levels of the Australian Government, our shareholders and the public.

    By being a responsible developer/operator and explaining the socio-economic benefits we are delivering, our project now enjoys strong support from community leaders. The positive relationship that is developing has greatly assisted our efforts to move the project into production.

  6. Risk management is critical

    Careful management of the direct and indirect risks confronting our businesses is crucial to our long-term success, something we have always recognised but which we have also learned on the job. The types of risk vary among businesses and range from financial to operational and legal. For example, the competitive market for special steel means that we need to ensure we can deliver the right amount of the right product at the right price. We do this by understanding our customers’ needs and demand trends in the sector. This is a way of managing commercial risk.

    At Sino Iron, we’ve learned that an allencompassing risk management programme underpins our social licence to operate in Australia. This is why we strive to meet or exceed the health, safety and environmental standards in Australia, often going beyond the efforts of our local peers.

    The potential hazards posed by a harsh environment, big equipment and complex processes means that the health and safety of our employees has to be the number one priority at Sino Iron. Our safety vision, “incident-free through the way we think and act,” drives the behaviour of staff, contractors and visitors.

    We also have a strong commitment to sustainable mining practices that minimise our impact on the natural environment.

  7. Meeting global standards inspires pride

    At the end of the day, meeting global standards inspires real pride in this Chinese company, and this is the most positive lesson of all, for all of us.

    Our investment in Australia has raised the bar in terms of our overall approach to project development, people management, risk mitigation, and corporate social responsibility. The lessons learned from Sino Iron will guide our future management of this project as well as our other businesses.

    In fact, this understanding of the importance of meeting global standards is already permeating our other businesses such as special steel. Last year, we took time to examine our market position in the overseas special steel market and made a plan to ensure our products align with international quality benchmarks. This not only ensures we maintain a competitive edge; it motivates our workforce and business units to be the best in their respective fields.

Sino Iron – The Next Chapter

We believe that, despite any shortcomings, we have been good partners to government entities, private companies, global suppliers and our multinational workforce. This project is a very important moment in the evolution of CITIC Pacific as a 21st century company with international capability and aspirations.

Sino Iron’s first shipment is by no means the end of the road. In fact, it is the beginning of our future as we are now shipping regularly. The situation is best portrayed in a quote by Winston Churchill after allied forces had won a momentous battle during World War II: “Now this is not the end. It is not even the beginning of the end, but it is, perhaps, the end of the beginning.”

You have all heard the phrase “no pain, no gain.” Nothing more succinctly describes our situation than this phrase. Now that the mine is in operation and generating revenue, a whole host of costs will begin to migrate from our balance sheet to the income statement. You will see depreciation start, and interest expenses – already hitting our accounting bottom line – rise significantly in 2014. We may also face impairment pressure in the coming years. So the ironic fact is that in meeting the major milestone of first export shipment our company’s financial results will suffer in the short-term. I want to prepare you for these realities.

The only remedy for this effect is to scale up production. However, this will not happen immediately. We ask for your patience as we finish installing and commissioning lines three to six and build up our designed capacity of 24 million tonnes a year. Only then can we achieve economies of scale. In the meantime, for this year and next, our production cost per tonne will be high. However, it is important to note and remember that production and export activities bring significant cash flow, which is ultimately what matters as the key measurement of the financial health and strength of a company.

I still get asked if I ever thought about pulling back on the project when I came on board CITIC Pacific a few years back. My answer back then, and remains today, was that Sino Iron is an attractive long-term investment, supported by China’s appetite for iron ore as the country continues to develop. My optimism in the value we will be bringing to our shareholders has never wavered. Our shareholders should also appreciate the types of strategic value that have been and are still being created. Among these are the values of:

  • Vertical integration and a stable supply of ore to our steel plants
  • Hard-won global operating experience
  • Accumulated increases in our skills base

What we are doing is much more than just a dig-it-up and ship-it-out operation. Our project involves significant downstream processing. We are using technical know-how to create a high-value product out of something which, in its raw state, has almost no commercial value. And frankly, any one of the single components of infrastructure we designed and built to make mining and processing possible would be considered a major achievement in itself. Bringing all these together, we have a megaproject.

When I celebrated Christmas with our workers and contractors on site in Australia, I said to all that the development of this project had been a long and challenging journey and now the day is upon us as we enter a new phase – production and export. Continuity in strategy and purpose enabled us to weather changes in management, shareholding and the global operating environment, and will continue to guide us through uncertain times.

In closing, I want to acknowledge and thank our shareholders, investors and lenders for supporting and trusting us. To our employees across the company, I want to say that I am most grateful for your loyalty and dedication. Together, let’s continue to write our China story.

Chang Zhenming
Hong Kong, 20 February 2014

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