ARI (Arrium) : At Rock bottom, ore not?

[Snoopy]

'Gearing' = (Net Debt) / (Net Debt + Equity)

If I use that definition with the data:

Interest bearing liabilities = $1,611.3m
Cash is $181.7m
Total Equity = $2,962.2m
Total Assets = $6,406.0m

then I get the following:

'Gearing' = ($1,611.3-$181.7) / ( ($1,611.3-$181.7) + $2,962.2) = 32.6%

This same percentage is later referred to as 'Statuatory Gearing'.

Throwing a few numbers into the mix here to see what the Arrium balance sheet might look like at the start of FY2017, the year in which the next large tranche of debt rolls over.

I am forecasting a normalised operating loss of -$74.4m for FY2015. Lets say half of that ( $37.2m) happens in 2HY2015. I need to add to that another $70m lost in 2HY2015 because of the close out of the contracting workforce at Peculiar Knob. Then I need to add another $45m of losses for FY2016. That is a total of $152.2m

Depreciation and amortisation of assets on the balance sheet over the next 18months will be approximately 1.5 x the figure on the FY2016 forecast: 1.5 x $350.2m = $525.3m

Now I can modify the data that I was using before:

Interest bearing liabilities = $1,611.3m
Cash is $181.7m
Total Equity = ($2,962.2m-$152.2m-$525.3m)= $2,284.7m
Total Assets = ($6,406.0m-$152.2m -$525.3m)= $5,728.5m


'Gearing' = (Net Debt) / (Net Debt + Equity)
= ($1,611.3-$181.7) / ( ($1,611.3-$181.7) + $2,284.7) = 38.5%

Immediately before the capital raising the gearing was 31.4%, reducing to 17.9% once the money was raised (but before the HY2015 billion dollar writedown). 38.5% is certainly higher than desirable. But if Arrium can pay their interest bill (they can) what are the banks going to do about it? I am not sure how many senior bank executives would have any ambition to run Arrium themselves. How does this potential level of gearing compare to other companies where the banks have stepped in?

SNOOPY

[Snoopy]

Hi Snoopy, I find myself with the same question for CAV on the NZX with 39% gearing at present. I reckon Arrium is larger and more diversified and you are needing a couple of years of poor results to get to that position, who can say what the outlook will be in 2017? Most probably not as bearish as today.
Maybe you won't find the other companies with the banks stepping in overtly but rather behind the scenes. I expect they would pressure management to reduce debt first through inventory or asset sales and finally a capital raising as we have seen with ARI already. Where the shareholders equity is too small relative to total assets and are no longer profitable or making losses then this is when companies go to the wall.

p12 of the half year results is an attachment with print so tiny it begs me not to read it. However near the bottom of that page is a multi half year 12 month rolling analysis apparently based on EBITDA. Bizarrely interest revenue earned is not offset against interest payable. However, given interest earned is generally small the statistic is still useful.

The lowest figure historically for EBITDA/I was 4.0 in June 2009. This was progressively fixed by a capital raising in May 2009. One year on, with the high debt period rolled out of the rolling twelve months, EBITDA/I had improved to 7.4.

My double doom forecast at EOFY2016 will produce an EBITDA/I figure of 3.8. In normal times that might mean a capital raising (may not go down well in current market conditions) or asset sales like the mooted half sell off of the Mining Consumables business. Nevertheless 3.8 is well above the 3.5 to 3.0 target set by the banks.

The funding maturity profile has been updated on slide 30 of the half year presentation. Syndiacted debt of around $350m is due to be repaid in FY2017. There is enough free cashflow being generated by Arrium to cover that. The big debt mountain does not come up until FY2018. So Arrium has time. Still trouble if markets don't turn up by FY2018 of course. But not nearly so much of a gamble as some of those miners out there IMO.

SNOOPY

[Snoopy]

I think your double doom scenario should include iron ore prices falling, in fact I think this should be the base case. They are still high relative to historical averages, as Simon Mawhinney says the iron ore business is worth nothing so the sooner they mothball the iron ore mining section the better.

Assuming no iron ore business in the future, but steel recovering to long term averages ( +$200m of EBITon current cost base) I think we are looking at a total Arrium NPAT of somewhere around $165m at the top of the cycle.

With 2937.3m Arrium shares now on issue this represents eps of 5.6c. At 20c, Arrium is on a potential top of the cycle PE of:

20/5.6 = 3.6

This tells me there is potentially a very high return for investors buying in today. At 40c, Arrium would only be on a forwrad PE of just over 7. Over the medium term, I don't think 40c is an unrealistic target even if all iron ore mining ceases.

SNOOPY

[Joshuatree]

S/P currently 15c/5.6= PE 2.7 !!!. Tough for holders. New low in Iron Ore price has dragged ARI down with the producers unfort.

Do banking covenants etc trigger when s/p mkt cap drops below certain threshold/levels?

[Snoopy]

S/P currently 15c/5.6= PE 2.7 !!!. Tough for holders. New low in Iron Ore price has dragged ARI down with the producers unfort.

A clarification here. My 5.6c/share eps estimate was a top of the cycle estimate. This assumes that the steel division recovers to historical profitability levels of 4-5 years ago. It also assumes the grinding ball business continues to grow steadily. I am also assuming no earnings at all from iron ore exports going forwards, even as iron ore exporting remains cashflow positive. IOW that 5.6c assumes alignment of the ducks. Nevertheless nothing can hide the fact that ARI is looking extremely cheap going on next years profitability, given even a minor revial of the non-iron ore divisions.

Do banking covenants etc trigger when s/p mkt cap drops below certain threshold/levels?

During the capital raising, mention was made of EBITDA to Net interest covenants. That ratio should be 3 to 3.5. In the most recent update to the market, CEO Andrew Roberts said ARI are on course to be well clear of this covenant. No mention was made of any market cap covenants. The share price would be of interest if Arrium was on the point of raising new capital. But Arrium doesn't need to raise any new capital, even with iron ore prices at current levels. Not until FY2018 anyway, when the next big tranche of debt is due to roll over. And who knows where the market will be then?

SNOOPY

discl: Holder, and busy arranging to shuffle off some more cash to Oz to buy more, taking advantage of the current exchange rates.

[Snoopy]

How much of their mining consumerables business will be left after their customers close their mines?

The mining consumables business largely sells to copper and gold miners in both North and South America. These mines are not closing. They are expanding, and Arrium has been investing flat out to meet increasing sales.

Mining consumable sales are projected to grow 7% per year for several years at the mining consumables business. Arrium are the world's largest supplier of these grinding products. The worse the quality of the ore deposit, the more sales for Arrium mining consumables. And globally the quality of ore being mined is on the decline.

More grinding material is required to get through lower quality of ore to obtain the equivalent volume of output compared to higher quality deposits.

SNOOPY

[Snoopy]

I am also assuming no earnings at all from iron ore exports going forwards,

Update on Arrium's position in the AFR

http://www.afr.com/business/mining/a...0150407-1mg071

Simon Mawhinney from largest shareholder Allan Gray had this to say:

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"It [Arrium mining] is not a good business, it is a product of the boom. There is no change to our view that we ascribe very little value or no value to their iron ore business," he said.

Allan Gray is Arrium's biggest shareholder with 14.5 per cent of the stock. Mr Mawhinney took the position based on the value he sees in Arrium's mining consumables and steel businesses.

He said the important question for the iron ore business is how big a liability it could be in the event it is closed: "It is probably not insignificant, but we don't think it will be financially crippling."

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I see he agrees with me that Arrium's Iron Ore business has little value.

Meanwhile Arrium itself is a little more upbeat on Iron Ore

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Indebted mining and steel group Arrium says it can "further optimise" its mining operations to cut costs if necessary as the iron ore price dive threatens the viability of smaller miners.

Based on Tuesday's benchmark spot price of $US47 a tonne, an Australian dollar fetching US77¢, and the fact Arrium's lower grade ores attract a discount to the benchmark price, Arrium Mining is likely to be losing cash.

"Arrium have a plan to transform their business to get their total cash cost down to $57 a tonne by 2015-16, so that's a big drop in cost that at current spot iron ore prices would be needed in a shorter period of time," Citi analyst Simon Thackray said.

"It is now hypothetically costing them money to produce."

An Arrium spokeswoman said the company was in a transition phase as it mothballs Southern Iron,

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Thackery is just highlighting that as Arrium moves to a lower cost base for iron ore, there will be a transition period where Arrium is burning cash. A fair point. But Arrium is ahead of their targets in their asset sales program. So I think they have the cash to bridge this gap.

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"The company releases its third-quarter mining report on April 20."

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The market will be expecting a bad result. Hopefully I will have my cash in place to buy some more shares before that date!

SNOOPY

[Corporate]

It looks like Atlas (AGO) is in big trouble. BCI is next by the looks of it.

[Snoopy]

http://www.reuters.com/article/2014/...A1N06Y20140224


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Many mills are already near bankruptcy because of slowing demand, plunging steel prices and a liquidity crisis that would have forced them to shut anyway, experts said.

…On the outskirts of Tangshan, a city of 7 million people that makes more steel a year than the whole of the United States, the hulking cranes and chimneys at the Qingquan Steel mill are frozen in inactivity. Workers unpaid for six months went on strike in October and haven’t returned.

Qingquan Steel is one of dozens of so-called zombie mills in Tangshan, where authorities have been ordered by the provincial government to draw up a list of plants to close so output can be cut by 10.8 million metric tons this year.

“In Tangshan and other parts of Hebei, the private mills are facing the most difficult time in their history,” said Xu. “Profits are poor and producers are all losing money – this has nothing to do with environmental measures: it is the economy.”
”There are many others that have closed even though they haven’t declared bankruptcy. They aren’t formally shut because of the financial implications – they might be in debt and the banks would close in,” said a senior iron ore trader based in Tangshan.

From the SMH, 9th April

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China has sent a blunt warning to governments in Australia that it will strive to keep its domestic iron ore miners afloat by announcing a new round of tax cuts for the embattled industry.

Just days after the Western Australian Government started giving royalty relief to junior miners like BC Iron, China's State Council announced that Chinese iron ore miners would receive a 6 yuan ($1.27) tax cut on each tonne of iron ore produced.


The introduction of a subsidy by the world's largest steelmaker may further hurt iron ore prices which fell to a 10-year of $US47.08 per tonne last week, and is bad news for Australian miners hoping to survive long enough to succeed the Chinese domestic miners.

The Australian iron ore industry has long expected to replace Chinese miners as the main suppliers of iron ore to Chinese steel mills, because the costs of production were typically lower in the Pilbara than in China.

But the dramatic slide in the iron ore price has challenged that notion, which was supposed to keep iron ore prices around $US110 per tonne in the long term.

"The subsidies, if implemented, will sustain domestic production, increase the global supply of iron ore and result in prices slumping further," said Shenhua Futures analyst Wu Zhili on Wednesday.

Iron ore miners in both countries have worked hard to lower their costs of production over the past year, but huge amounts of extra supply have continued to erode margins, and recent support measures by governments in both nations suggests the iron ore fight has progressed to a higher level.

Aside from rescinding the minerals resource rent tax, the carbon tax and Western Australia offering royalty relief, the Reserve Bank of Australia has also been accused by foreign miners of trying to save Australian miners by cutting interest rates in a bid to devalue the local currency.

Despite those measures, Australian microcaps like Western Desert Resources have gone into receivership, while bigger players like Atlas Iron have ceased trading on the ASX while they try to work out whether they have a viable future at current iron ore prices.

BHP and Rio Tinto are believed to be the only Australian miners making a profit at the current iron ore price.

The Chinese tax cut will further stoke speculation that Australian miners, rather than Chinese, will be the victims of the iron ore price slump.

Former BHP Billiton executive, and now Orica boss Alberto Calderon speculated as much during a speech in Melbourne late last year.

"The conventional wisdom was that the production tonnes that would be displaced through mines closing would be in China; this is probably not true," he said at the time.

"China's iron ore production will remain around 400 million tonnes. Maybe it will drop to about 360 million tonnes, but it should orbit at around those levels during the next few years.

"Yes there will be closures but new and more efficient mines are being built. China will repeat what it has done already in aluminium and thermal coal: create an oversupply of iron ore that will benefit them as a consumer country."

Mr Calderon said China had saved itself about $US250 billion over recent years by flooding the aluminium market with supply and duly dragging down prices for the lightweight metal.

That process forced many marginal aluminium smelters around the world, including in Australia, to be closed, and Mr Calderon said Australia's iron ore sector could endure a similar experience.

"The bulk of the reduction in iron ore supply will not come from China. A significant part of the excess tonnes may come from Australia. What we can guess with some certainty is that prices will revert to marginal cost, even under-shooting into the low $70s (per tonne of iron ore) for some years," he said.

"Some iron ore producers, or many, will experience what their colleagues in aluminium and nickel have lived through over the past few years."

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This kind of thing is always a risk with China as they are rich enough not to bother with conventional economic rules if they make that choice. No Chinese government wants to deal with restless ex iron workers making trouble in the provinces. So better to subsidise them and keep them slaving away. If a few Chinese workers get killed due to non-existant OSH practices, this is beneficial long term in reducing the number of biological economic units that are not longer required.

However, I do wonder if the reporters have got the wrong end of this story. A $1.27 tax cut per tonne is hardly going to influence things when prices have fallen about thirty times that amount over the last year, is it? I also believe the Arrium cost structure, while not matching Rio or BHP, is on par or a bit less than Vale of South America. So maybe a big upheaval in Brazil is the next part in this play to act out?

SNOOPY

[Joshuatree]

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During the capital raising, mention was made of EBITDA to Net interest covenants. That ratio should be 3 to 3.5. In the most recent update to the market, CEO Andrew Roberts said ARI are on course to be well clear of this covenant. No mention was made of any market cap covenants. The share price would be of interest if Arrium was on the point of raising new capital. But Arrium doesn't need to raise any new capital, even with iron ore prices at current levels. Not until FY2018 anyway, when the next big tranche of debt is due to roll over. And who knows where the market will be then?

SNOOPY

http://www.theaustralian.com.au/bus...h-debt-covenants/story-e6frg90f-1227303904164

Footnote: Credit suisse are pretty negative here snoopy.Whats your opinion. cheers JT
Next to your research it looks pretty clueless actually.