Operating and Financial Review | Business Overview & Strategy

From its position at the start of 2002 as a small, Swiss-listed company capitalised at around $800 million, with only two businesses (ferroalloys in South Africa and zinc in Spain), Xstrata has grown rapidly to become a major, diversified metals and mining group with a market capitalisation of around $18 billion, a meaningful position in six major commodity markets and operations and projects in eight countries.

Our strategy was put in place shortly before the inception of Xstrata plc, through its initial public offering on the London Stock Exchange in March 2002, and continues to guide our corporate activity today. We aim to grow a diversified portfolio of metals and mining businesses, creating shareholder value at each stage of our growth. Our Mission recognises that, to continue to grow and create value over the long term, we must operate in an ethical and transparent way, through mutually beneficial partnerships with our stakeholders.

We pursue growth and value creation through identifying opportunities for organic growth from our portfolio; through incremental, bolt-on acquisitions; and through identifying and completing larger, company-transforming transactions.

Our growth is guided by the following strategic objectives:

• to manage a portfolio of assets diversified by commodity and by geography, with a balanced spread between commodities where prices are negotiated between customer and supplier, and commodities where prices are set by terminal markets such as the London Metal Exchange;
• to create further value and further optimisation of the portfolio by delivering capital and operational efficiencies and real reductions in costs across our businesses;
• to achieve the highest standards of health, safety and environmental performance at our operations, and to work in partnership with local communities for mutual benefits, supporting the principles of sustainable development;
• to foster a high performance and entrepreneurial culture across the Group through a highly devolved structure, to empower management teams in our commodity businesses and to minimise the burden of overheads;
• to uphold a rigorous and unwavering focus on value, internally and externally;
• to conduct our business activities ethically and with the maximum transparency that is commercially possible; and
• to maintain the capacity to act decisively, to support rational risk-taking and to identify and secure opportunities for value creation.

Group structure and management philosophy

Xstrata's activities are organised into four global commodity businesses: Xstrata Alloys; Xstrata Coal; Xstrata Copper; and Xstrata Zinc. Each commodity business operates with a high degree of autonomy, within the structure of Xstrata's global policies and standards.

Xstrata differentiates itself from its industry peers in our management philosophy that maximum responsibility and authority should be devolved to our operating businesses. We believe this directly benefits our operations by creating a strong sense of local ownership, where entrepreneurial managers are empowered and incentivised to address site-specific challenges and seize opportunities.

In addition to our four major commodity businesses, Xstrata also owns Xstrata Technology, a minerals processing technology business, which successfully markets its products to metals and mining companies worldwide.

Xstrata's global businesses are supported in certain key corporate functions by a head office of around 18 people based in Zug, Switzerland, complemented by a further small corporate office in London, UK.

Each of Xstrata's commodity businesses has the critical mass and scale within its respective commodity markets to compete on an integrated, global basis. When we enter new commodity markets, we generally seek to gain a significant market position. However, we remain open to smaller opportunities where these arise, as with our entry into the platinum market in 2005, through Project Mototolo, a joint venture with Anglo Platinum, to build a platinum mine and concentrator in South Africa.

A balanced, diversified portfolio

The portfolio of commodities produced by the Group is split evenly between terminal-traded commodities such as copper, zinc and lead, and commodities sold through negotiated customer-supplier contracts, such as ferrochrome and thermal and coking coal.

We believe that a portfolio diversified by commodity and by geography balances the risks associated with specific commodity price cycles and operating locations, thus providing investors with more reliable and stable cash flows. Diversification also engenders a healthy competition for capital between Xstrata's commodity businesses; through which only the most attractive projects or acquisitions are approved and allocated capital.

Leaders in operational excellence

We aim to hire and retain the best people at every level of our businesses and to provide them with the resources they require to achieve and maintain our industry-leading operational excellence. We prefer to own a significant stake in our operations and joint ventures and take management control of operations wherever possible. At the end of 2005, Xstrata operated every operation in which it has an interest, with the exception of two thermal coal mines through the Douglas-Tavistock Joint Venture in South Africa.

We aim to operate a fatality, injury and illness-free business and believe that work-related incidents, illnesses and injuries are preventable. Safety is an ongoing, major focus for the Group, as we strive to eliminate fatal and high potential incidents from every aspect of our operations. We expect the leadership, intensive training and investment in this area over the last 18 months, particularly in South Africa, to bring about sustainable improvements in fatality prevention and continue our reduction in injury rates.

Our businesses are mandated to reduce real costs on a continuous and sustainable basis. Cost reduction is an important driver of value creation and a measure of the quality of our operational management and our stewardship of the assets of our owners. In each of the last four years, Xstrata has outperformed its FTSE100 mining industry peers in reducing the operating cost base every year and, in 2005, reduced costs by $19 million, despite steep rises in the prices of key inputs for the mining sector as a whole.

Focus on value creation and growth

Our imperative to grow the business is underpinned by an unwavering focus on value creation. This rigorous assessment of value applies equally to growth initiatives from within our portfolio as it does to the acquisitions of projects or other assets. Since its London listing, Xstrata has completed two company-transforming acquisitions and a number of incremental acquisitions, and has initiated major growth projects in each of its commodity businesses. Two of these, the Black-Star zinc-lead mine at Mount Isa, and the Rolleston thermal coal mine, also in Queensland, began production in 2005 and are already enhancing the production and cost profile of our zinc and coal businesses respectively. A third, the Lion Project in South Africa, will come on stream in 2006, with operating costs expected to be significantly lower than the industry average. Any future funding decisions will continue to be based, as those to date have been, on a dispassionate view of each project's potential to create value in its own right, irrespective of the prevailing commodity price environment.

While value creation remains at the heart of our acquisition strategy, we do not limit our sights to 'tier one' long-life, low-cost operations in low-risk geographies. These assets are undeniably attractive, although increasingly scarce; however our strategy recognises that more challenging assets or more risky locations also offer the opportunity for value creation, through enhanced operational management and judicious capital investment, provided that the price paid reflects the quality of the assets, the risks can be identified and managed appropriately and that upside can be secured following acquisition. In addition to our focus on growth, we maintain a progressive dividend policy, in line with Xstrata's profitability, and make appropriate returns of capital to shareholders, where cash generated exceeds our requirements for investment or further growth opportunities.

Exploring for further growth

Xstrata's commodity businesses are responsible for undertaking near-mine exploration around existing operations or in nearby regions, with the objective of adding resources to the Group's resource base and extending the lives of our operations. This strategy has been successful to date, particularly in Xstrata Copper, at Mount Isa, where an additional 16 million tonnes or a further two years of underground ore reserves has been added and at Alumbrera, where near-mine exploration has yielded 120 million additional tonnes of reserves added over the past two years, with further scope for additions to the reserve base in both cases.

For greenfield exploration in less familiar territories, Xstrata is pursuing a successful strategy of partnering with junior exploration companies, allowing us to leverage each partner's strengths for mutual benefit. This strategy is already bearing fruit at the Tampakan project in the Philippines, where Xstrata is working with Indophil Resources to progress pre-feasibility studies and how an option to take up a 62.5% interest in the project in September of this year. Additional opportunities are being assessed through our partnership with Universal Resources in Australia and Erdene Gold in Mongolia.

Commodity business strategies