financial review

Basis of presentation of financial information

The financial information is presented in accordance with UK generally accepted accounting principles (UK GAAP). The reporting currency of Xstrata is US dollars. Financial statements of subsidiaries are maintained in their functional local currencies and converted to US dollars on consolidation of Group results.

The financial information for the year ended 31 December 2003 includes both UK GAAP statutory and pro forma figures (assuming the results of the MIM Group had been taken through the income statement from 1 January 2003). Xstrata assumed control of the MIM Group at the end of June 2003.

Unless indicated to the contrary, all data and commentary in this report relates to the statutory results for the year ended 31 December 2004 and pro forma results for the year ended 31 December 2003. All pro forma and statutory operational results in the Chief Executive's Report and the Operating and Financial Review exclude the discontinued operations (Avonmouth, Forestry and Magnesium) for both 2004 and 2003.

Transition to International Financial Reporting Standards ("IFRS")

To comply with European Union (EU) legislation, all EU listed companies will be required to present financial accounts for accounting periods from 1 January 2005 in accordance with IFRS. Xstrata's interim results for the period 1 January to 30 June 2005 will be the first report prepared under IFRS. Comparative IFRS figures for the 2004 interim and full year periods will be provided for the 2005 interim and full year financial results. Xstrata will publish the IFRS financial statements for the year ended 31 December 2004 during 2005. A full explanation of the impacts of adopting IFRS was outlined in the press release issued on 16 December 2004, available from our website at www.xstrata.com.

A high-level Steering Committee oversaw the preparation of a Group-wide review of the potential impact of IFRS both on the Group's results and on the procedures and systems currently in place. Xstrata has prepared IFRS accounting policies and Treasury policies and procedures in accordance with IFRS principles. The Group's conversion to IFRS is now substantially complete.

A reconciliation of basic EPS under UK GAAP to IFRS, and a reconciliation of total equity under UK GAAP to IFRS is provided in the unaudited supplementary information following the financial statements.

Summary: consolidated operational results

On the back of strong demand-led price increases across all of Xstrata's commodities in 2004, Group turnover from continuing operations increased by 47% on a pro forma basis to $6,462 million. The most significant contributions to the increase came from Xstrata's coal and copper businesses, which accounted for approximately two thirds of Group turnover, where higher received prices boosted turnover by 45% and 51% respectively on a pro forma basis. Turnover from Xstrata Alloys was also exceptionally strong, up by 76% compared to 2003, despite decreased production from the vanadium business following the suspension of production at the Vantech operation in early 2004. Higher zinc and lead prices increased turnover from Xstrata Zinc by 27%.

Group EBITDA for the year ended 31 December 2004 increased by 117% on a pro forma basis to $2,075 million. Group EBIT increased by 248% on a pro forma basis to $1,503 million. The substantial increase in Group EBIT was recorded despite a weak US dollar, with commodity price increases substantially outstripping the impact of stronger local currencies.

On a statutory basis, Group turnover from continuing operations increased by 86% from $3,476 million in 2003 to $6,462 million in 2004. As a consequence of the MIM Group acquisition mid-way through 2003, the increase in turnover for Xstrata's businesses was 188% for copper, 69% for coal and 53% for zinc. On a statutory basis, Group EBITDA increased 197% from $700 million to $2,075 million and Group EBIT increased 368% from $321 million to $1,503 million.

The unfavourable foreign exchange unit cost variance of $468 million was due to the weaker average US dollar in 2004 against all Xstrata's local currencies compared to 2003. During the year, the South African rand strengthened 15%, the Australian dollar strengthened 13%, and the Euro was 10% stronger. The stronger Australian dollar and South African rand had the greatest impact on Group EBIT, resulting in a negative variance of $274 million and $167 million respectively. The impact of negative foreign exchange variances was partially offset through currency hedging which contributed an additional gain of $55 million versus the previous year.

The partial sell-down in the Queensland coal assets acquired with the MIM Group in November 2003 negatively impacted EBIT by $72 million versus 2003.

Depreciation and amortisation charges increased due to higher production levels, after allowing for the impact of foreign exchange. Other income and expenses includes closure costs associated with the Vantech and Windimurra vanadium operations.

Ongoing efficiency programmes across the Group achieved cash savings of $191 million in 2004. Almost half of these real cost savings were delivered from Xstrata Coal. The significant transformation programme implemented in 2004 to improve efficiency and productivity at the former MIM-owned North Queensland operations had considerable success, stripping out over $52 million of operating costs in real terms during the year. Throughput at the copper concentrating facilities at Mount Isa increased significantly as a result of the transformation programme, and ore treatment rates also improved at Alumbrera in South America, due to the commissioning of a third flotation circuit. Higher costs associated with the accelerated underground development work at Mount Isa were more than offset by the productivity and efficiency gains that resulted in the second half. Alumbrera continued to benefit from low operating costs net of gold credits, although costs were impacted during 2004 by budgeted falling head grades together with increased power and freight costs.

Productivity improvements and cost saving programmes at Xstrata Zinc led to record production at both European zinc smelters during 2004 and further efficiency gains across the operations. The transformation programme underway at Mount Isa also delivered productivity improvements in 2004 which were partially offset by increased freight and other costs in Australia.

Operating costs at Xstrata Alloys came under pressure from power interruptions and the steep increase in reductant costs, particularly metallurgical coke, required in the ferrochrome process. These increases were partially offset by the success of Xstrata Alloys' coke reduction programme which reduced costs by over $11 million. Further cost benefits are expected from the acquisition in January 2005 of the African Carbon Group, a local char producer.

Earnings

On 4 November Xstrata announced the permanent closure of its Vantech vanadium operation in Mpumalanga, South Africa. The Vantech operation was put into care and maintenance in early 2004 and production was suspended following the depletion of the Kennedy Vale ore deposit in December 2003. The decision to close Vantech follows a thorough assessment of the operation's future prospects including the financial viability of opening a new mining area at the site. The closure resulted in an impairment charge of almost $7 million.

The integration of the former MIM Group was completed during 2004 incurring a charge of $8 million. In 2004, the acquisition of MIM contributed $2,684 million towards Group turnover and $875 million to Group EBIT in 2004 , over half of the Group total.

Net interest and similar items decreased by $37 million from 2003 on a pro forma basis before exceptionals to $92 million due to the reduction of net debt from strong operating Group cash flows during 2004. On a statutory basis before exceptionals, net interest and similar items increased by $14 million due to the higher borrowings following the acquisition of the MIM Group mid-way through 2003.

The amended syndicated loan was refinanced in May 2004. Capitalised debt arrangement fees in relation to the facility were written-off.

The statutory pre-exceptionals tax charge is $182 million and represents an effective rate of 12.9% against 20% for 2003. The low tax rate in 2004 is mainly due to the utilisation and recognition of previously unrecognised tax losses as a result of substantially increased earnings in 2004. On a post-exceptionals basis, the tax charge of $177.1 million represents an effective tax rate of 12.9% in 2004. This compares to 13.1% in 2003.

The increase in the minority interest share of profits results principally from improved earnings at the 50% owned Alumbrera operation.

Attributable profit (pre-exceptionals) increased almost seven-fold to $1,088 million from $162 million on a statutory basis and $164 million on a pro forma basis. Pre-exceptional attributable earnings per share of 174USÊ were 370% higher on a statutory basis and 569% higher on a pro forma basis. On a post-exceptionals basis, attributable profit increased almost four-fold to $1,053 million from $277 million on a statutory basis and $279 million on a pro forma basis. Basic attributable earnings per share of 168USÊ were 273% higher on a pro forma basis.

Cash flow, net debt and financing summary

Due to the strong operating cash flows being generated at Minera Alumbrera Limited, a return of capital of $162 million was made to shareholders in May 2004 in accordance with the shareholders' agreement. The repayment of the minorities' share of $81 million is recorded in the cash flow statement.

On 28 May 2004, the Group successfully refinanced its existing syndicated loan. The facility remains at $1.4 billion, however interest margin and commitment fees are substantially lower than those of the previous facility. The Group expensed capitalised loan arrangement fees associated with the old facility of $35 million in 2004.

Plant and equipment purchased under finance lease arrangements are excluded from capital expenditure in the cash flow. New finance leases are reported separately in the cash flow summary.

Statutory cash flow includes the MIM Group from the date of acquisition. Pro forma cash flow includes the MIM Group from 1 January 2003. Consequently, additional cash inflow, debt acquired and other cash flow items reflect the activities of the MIM Group in the first six months of 2003 and have been adjusted to include the estimated position at 1 January 2003.

During 2004, strong operational cash flows further strengthened the balance sheet. Net debt reduced by $767 million during the year including the repayment during the period of the non-recourse project financing in Alumbrera, with a consequent reduction in the net debt to equity ratio to 16.8% at 31 December 2004.

Working capital

The differences between working capital movements and those shown in the EBITDA cash flow reconciliation are due to non-cash items such as exchange rate movements and the transfer of working capital into the Alloys Pooling and Sharing Venture (PSV).

Under UK GAAP, this Pooling and Sharing Venture is treated as a joint venture where Xstrata's interest in the assets and liabilities is included within Investments in the balance sheet and Xstrata Alloys' share of earnings is separately disclosed in one line in the profit and loss account. This Pooling and Sharing Venture will be proportionally consolidated under IFRS.

The decrease in stocks reflects the transfer of inventories into the PSV and a reduction in European zinc smelter feedstock, partially offset by a rebuilding of adequate coal stocks to avoid supply constraints and higher lead stocks in Europe and copper stocks at Alumbrera due to the timing of shipments over the year end.

The increase in debtors is primarily due to higher sales prices across all Xstrata's commodity businesses, stronger local currencies against the US dollar and lower than normal trade receivables at the end of 2003 due to delayed shipments at Alumbrera and a roof fall at Oaky Creek.

Creditors have increased principally due to higher tax payable balances as a result of improved earnings across the Group. The balance of the increase includes higher coal royalties payable, and the impact of stronger local currencies against the US dollar.

Treasury management and financial instruments

Group Treasury has responsibility for strategic planning of the Group's treasury activities. Its responsibilities include management of the Group's cash resources and debt funding programmes; funding acquisitions and investments; management of interest rate and foreign exchange exposures; and co-ordinating effectively relationships with banks, rating agencies and other financial institutions.

The Group is exposed to US dollars through its revenue stream. The Group will seek to source debt capital in US dollars directly or by borrowing in other currencies and swapping them into US dollars, thus matching the negative exposure of our debt service obligations.

Currency hedging

Currency hedging may be used to reduce the Group's short-term exposure to fluctuations in the Australian dollar, Euro and Sterling exchange rates to the US dollar. The Australian dollar hedging gains reflected in the profit and loss account for the year ended 31 December 2004 amounted to $218 million compared to $163 million for the corresponding period in 2003. The unrealised mark-to-market gain on currency hedging in place at 31 December 2004 was $76 million.

Commodity hedging

The Group is exposed to fluctuations in commodity prices, with the commodity mix spread fairly evenly between those which are priced by reference to prevailing market prices on terminal markets and those that are set on a contract basis with customers, generally on an annual basis. Commodity hedging relates to forward and option contracts covering a portion of planned attributable gold, copper, coal, zinc and lead production. The commodity hedging losses reflected in the profit and loss account for the year ended 31 December 2004 amounted to $115 million.

The unrealised mark-to-market loss on commodity hedging in place at 31 December 2004 was $12 million.

Interest rate hedging

The Group normally borrows and invests at floating rates of interest. A limited amount of fixed rate hedging can be undertaken during periods where the Group's exposure to movements in short term interest rates is more significant. The 2010 guaranteed convertible bonds were initially swapped to a floating rate of interest, but the first 2 years of floating rate payments were subsequently swapped back to a fixed interest rate. The unrealised mark-to-market gain on interest rate hedging in place at 31 December 2004 was $13 million.

Consolidated capital expenditure

Capital expenditure increased in 2004 as a number of areas of historic underinvestment at the former MIM operations were addressed and major new projects were initiated. Overall, capital expenditure across the Group increased by $132 million, or 32%, to $550 million. Sustaining capital expenditure increased by $83 million and expansionary capital expenditure increased by $49 million.

Sustaining capital expenditure of $306 million included:

• $40 million at Xstrata Coal, relating to fleet replacements at Bulga, the acquisition of continuous miners at South Witbank and Tavistock, mine development at WitCons, a drift conveyor and the first stage of the installation of a new longwall at Ulan; and
• $50 million at Xstrata Copper for mobile equipment replacements to mine at greater depth at both Alumbrera and Ernest Henry, together with mine development at Mount Isa.

While the expenditure above is generally sustaining in nature, the investment in new modern equipment and technologies will also increase efficiencies and expand throughput.

Significant expansionary capital in 2004 related to the initiation of Xstrata's growth projects. The development of the Rolleston coal project incurred expenditure of $122 million. Despite cost increases in a number of key inputs this project remains on track and on budget for production in late 2005. An initial $15 million was spent in 2004 as construction of phase one of the Project Lion ferrochrome smelter and related mine commenced. The development of the Black Star zinc-lead open pit at Mount Isa incurred $18 million of capital expenditure.

Consistent with trends across the industry, rising input costs, in particular raw materials and labour, are expected to contribute to a rise in sustaining capital spend in 2005 from 2004 levels. Xstrata Coal will spend around $55 million in 2005 to complete the installation of the Ulan longwall, which will see the existing 250 metre longwall replaced by a longwall of some 400 metres, the widest in Australia. This project will not only substantially increase production, but is expected to lead to a significant improvement in unit costs. In South Africa, the ongoing modernisation and mechanisation programme in the coal operations will involve expenditure during the year of around $20 million.

Following the capital enhancement programme implemented across the Mount Isa copper operations in 2004, increased sustaining expenditure in 2005 will be directed to the zinc operations at Mount Isa to significantly improve productivity and costs. Around $40 million of additional expenditure will be incurred relating to mine development and mobile equipment at George Fisher, together with the installation of a zinc filter plant at the Mount Isa concentrating facilities.

In addition to these specific projects, further sustaining capital of approximately $200 million is expected to be incurred across the Group.

Expansionary capital is also set to rise versus 2004 levels. In addition to a number of smaller growth projects across the Group, totalling some $200 million, major project-related items of expansionary capital expenditure include:

• $30 million to expand throughput at the Mount Isa copper smelter to 280,000 tonnes per annum, an increase of 40,000 tonnes over current capacity. The project comprises the installation of a second rotary holding furnace to remove a current bottleneck in the flowsheet. This high-return expansion implies a capital cost of only $750 per tonne of incremental anode capacity, which compares favourably against other brownfield copper smelter expansions;
• $25 million to develop the Northern 3500 underground copper orebody at Mount Isa, which will provide an additional high-grade mining zone in the Enterprise underground copper mine. The development enables improved utilisation of the existing hoisting and concentrating facilities and allows the mine to achieve its rated capacity of 3.5 million tonnes per annum;
• $30 million (Xstrata's share) to upgrade the coal flotation plants at both Collinsville and Newlands. Since the acquisition of MIM, detailed planning by Xstrata has determined that by installing a new coal handling and preparation technology, a Dense Medium Cyclone (DMC) plant, production of substantial quantities of coking coal can be achieved. Cash payback for both wash plant upgrades is less than one year, with commensurate internal rates of return. In addition, the Newlands plant provides additional capacity to coincide with the development of the Northern Underground mine, which will replace production from the existing Southern Underground mine. The Northern Underground mine will be completed in late 2005 after remaining expenditure of approximately $25 million (Xstrata's share); and
• $20 million for the initial phase of the development of the Goedgevonden colliery in South Africa. Once complete, total annual production from Goedgevonden is anticipated to reach 3 million tonnes of export thermal coal and 2 million tonnes of domestic power station feedstock.

In addition, development of two of Xstrata's key growth projects, namely the Rolleston coal project and Project Lion, will continue in 2005, with capital expenditure of approximately $110 million and $190 million respectively anticipated during the year.

Acquisitions

On 31 August 2004, the Group acquired the Las Bambas copper project in the Cotabambas province, Peru for $91 million. A further $30 million is payable to a community trust during the development and construction phases of the project. This amount reduces to $4 million should the project not proceed to development. The Las Bambas copper project is within the Southern Peru copper belt, which hosts a series of major copper operations including Toquepala and Cuajone (SPCC), Tintaya (BHP Billiton) and Cerro Verde (Phelps Dodge). A comprehensive drilling programme, at a cost of some $10 million in 2005, has recently commenced in March 2005.

In April 2004, Xstrata Coal purchased a further 45% of Cook Colliery from Centennial Coal Company Limited for $6 million to take its shareholding to 95%. Xstrata has assumed operating management of the mine.

In January 2005, Xstrata Alloys acquired a controlling stake in the African Carbon Group ("ACG"), a char producer situated in the Mpumalanga province, South Africa for $63 million. The acquisition of ACG extends Xstrata Alloys' strategy to secure its own supply of reductants, a key input cost into the ferrochrome manufacturing process.

Disposals and other changes to group companies

Xstrata assumed ownership of the Ravenswood gold mine, located in Queensland Australia, with the acquisition of the MIM Group in June 2003. The mine was identified as non-core at the time of acquisition and in February 2004, the Ravenswood mine was sold for $44 million after selling costs but before the loss on disposal of the associated gold hedge book to Resolute Mining Limited. There was no gain or loss on disposal under UK GAAP.

On 1 July 2004, Xstrata Alloys established a Pooling and Sharing Venture with Merafe Resources Ltd (formerly SA Chrome & Alloys Limited). Xstrata Alloys and Merafe Resources Ltd ("Merafe") will retain legal ownership of their respective assets, mining rights and land, with both parties undertaking to contribute to the Venture the right to use all such assets in the ratio 82.5%/17.5%, in exchange for participations in the pooled EBITDA as follows:

Merafe has an option, exercisable for one year, to acquire an additional 2.5% in the venture at a value of $11 million per percentage point. This arrangement will enable both parties to realise operational efficiencies and will fulfil a key requirement of the new Mineral and Petroleum Resources Development Act in South Africa.

In January 2005, Xstrata sold its wholly owned forestry operation in Chile, Forestal Los Lagos SA ("FLL"). The majority (89%) of the operation has been purchased by Forestal Valdivia SA, a subsidiary of Forestal Arauco, an integrated private Chilean forestry company. The remaining 11% was purchased by Forestal del Sur SA, a privately-held forestry trading company. The disposal proceeds amount to $24 million. As a result of the sale, Xstrata will be released from all its obligations with respect to the $12 million project debt related to FLL. There is no material gain or loss arising on this disposal under UK GAAP.

Dividends

The Directors have declared a dividend of 16USÊ per share amounting to $100 million, which represents two thirds of the full year dividend. The total 2004 dividend is $150 million or 24USÊ per share (2003 $126 million or 20USÊ per share).

As Xstrata plc is a Swiss tax resident company, the dividend payment will be taxed at source in Switzerland at the rate of 35%. A full or partial refund of this tax may be available in certain circumstances.

The dividend is declared and will be paid in US dollars. Shareholders may elect to receive this dividend in Sterling, Euros or Swiss francs. The Sterling, Euro or Swiss franc amount payable will be determined by reference to the exchange rates applicable to the US dollar seven days prior to the dividend payment date. Dividends can be paid directly into a UK bank or building society account to shareholders who elect for their dividend to be paid in Sterling.

Further details regarding tax refunds on dividend payment, together with currency election and dividend mandate forms, are available from Xstrata's website (www.xstrata.com) or from the Company's Registrars.

Share data

Under UK GAAP, own shares (treasury stock) are deducted from the total issued share capital when calculating earnings per share.

Equity capital management programme

Under the equity capital management programme (ECMP), up to 10% of the issued share capital of Xstrata plc can be purchased in the market by Batiss Investments (Batiss), a Guernsey-registered entity owned by a charitable trust and independent of the Xstrata Group. During 2004, 3.4 million shares (0.5% of ordinary share capital) were purchased under the ECMP for $51 million. No shares were sold under the ECMP during 2004.

Future Application of Xstrata Shares Held by Batiss

Xstrata Capital intends that the shares held by Batiss will either be used by the Group as a source of financing for future acquisitions, in keeping with the Group's growth strategy, or placed in the market.

The decision when to place the shares in the market, use the shares to assist the Group in facilitating future transactions, or to repurchase shares for cancellation, will be considered in light of the Group's funding requirements and capital structure at the time.

Accounting Treatment

For so long as the shares continue to be held by Batiss they are disregarded for the purposes of calculating the earnings per share of Xstrata plc. Batiss will be consolidated by Xstrata as a quasi-subsidiary, and the shares held by it will be accounted for as a deduction from shareholders funds in the consolidated balance sheet of the Group.

If Xstrata shares held by Batiss are subsequently disposed of by way of a placing or as consideration for an acquisition by the Group, any gain or loss will be taken directly to the Group's reserves to the extent that the market value of the shares so disposed is above or below the cost of those shares. No gain or loss would be recognised in the consolidated profit and loss account of the Group.