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

[Snoopy]

At the end of this just completed capital raising, the 1,366.2 million shares on issue before were joined by another 1,366.2 million shares and 204.9m place shares. So total ARI shares on issue are now 2,937.3m.

I estimate NPAT from normal operations (not including one off writedowns) for FY2015 will be $36.6m or:

$36.6m / 2,937m = 1.25cps

So at 29.5c, Arrium is trading on a PE of:

29.5/1.25 = 23.6

Still very high. Ouch!

I have decided my enthusiasm for the growth of the mining consumables business has been premature.

My new profitability assessment for Arrium for FY2015, with corporate overheads and interest allocated by revenues with tax paid at 30% is as follows.

Division	Net Profit After Tax (FY2015 (Est))
Mining Consumables	$91.7m
Iron Ore	$75.1m
Recyclables	-$29.1m
Steel	-$117.6m
Total	$27.4m

This increaseses the forecast PE for 2015 to 31.5

SNOOPY

[Stranger_Danger]

Bought my first parcel today.

*Sits with Snoopy in the "short term losses" corner*

Clearly the P/E will be ugly high or negative, but such is the nature of cyclical plays.

[Snoopy]

Bought my first parcel today.

*Sits with Snoopy in the "short term losses" corner*

Clearly the P/E will be ugly high or negative, but such is the nature of cyclical plays.

As I write this the share price is 24.7c.

So my estimated PE for FY2015 has been reduced to (24.7/29.5)*31.5 = 26.3

As Stranger Danger has said, this isn't about PE though. The mining consumables business is the key to Arrium surviving. Despite some shareholder criticisim at the AGM about the bank debt taken out to buy Moly Cop, the truth is Arrium would probably be in the hands of receivers now if it had not done so.

With projected earnings of just:

$27.7m / 2,937m = 0.94cps

there isn't much scope to get rich from dividends in the next twelve months.

To a very large extent what happens in the next twelve months depends on iron ore prices. But to a large extent the iron ore troubles are already built into the share price. Those waiting for the iron ore price to rise before investing will gain certainty, but lose - a lot- of potential capital gain. IMO waiting for the iron ore price to rise from here will probbaly see a potentail Arrium investor pay too much, especially as the iron ore price could easily fall back again.

Investing in Arrium at these prices is not without risk. But it is a calculated risk that I am prepared to take.

SNOOPY

[Stranger_Danger]

Agreed, definitely not without risk. Those looking for less financial risk with their iron ore should probably go MGX with it's cash mountain. The risk there is the Chinese holders act in concert to take it out cheaply.

[h2so4]

To a very large extent what happens in the next twelve months depends on iron ore prices. But to a large extent the iron ore troubles are already built into the share price. Those waiting for the iron ore price to rise before investing will gain certainty, but lose - a lot- of potential capital gain. IMO waiting for the iron ore price to rise from here will probbaly see a potentail Arrium investor pay too much, especially as the iron ore price could easily fall back again.

Investing in Arrium at these prices is not without risk. But it is a calculated risk that I am prepared to take.

SNOOPY

Wow!
There is GREAT! risk here. A further fall in iron ore prices, reduced demand or a strengthening $A will compound ARIs problems. If iron ore prices remained low for a number of years they will need more than a few hedging contracts to pay off their debts. They owe tons of money and more is needed for their planned Capital Expenditure.( plant and equipment) Did I mention a further contraction to world economies? Yes that to.
Potential investors may only be waiting for iron ore prices to level out, whatever their strategy they do do so at reducing RISK!
DYOR fellow STs.

[Corporate]

Snoopy I'd be really keen to understand how you've come to $75m profit for the iron ore business?

I have decided my enthusiasm for the growth of the mining consumables business has been premature.

My new profitability assessment for Arrium for FY2015, with corporate overheads and interest allocated by revenues with tax paid at 30% is as follows.

Division	Net Profit After Tax (FY2015 (Est))
Mining Consumables	$91.7m
Iron Ore	$75.1m
Recyclables	-$29.1m
Steel	-$117.6m
Total	$27.4m

This increaseses the forecast PE for 2015 to 31.5

SNOOPY

[Snoopy]

Wow!
There is GREAT! risk here. A further fall in iron ore prices, reduced demand or a strengthening $A will compound ARIs problems. If iron ore prices remained low for a number of years they will need more than a few hedging contracts to pay off their debts. They owe tons of money and more is needed for their planned Capital Expenditure (plant and equipment) Did I mention a further contraction to world economies? Yes that to.

Whoa Sulphur Sugar Daddy has a Rotorua moment! All of what you say is possible SSD (except for the bit about debts of which more later) , but I would say it is an apocalyptic viewpoint.

Iron ore is just about as important for Australia as Milk is for New Zealand. Just as a weakening milk price is (usually) enough to send the NZD down, a weakening Iron Ore price (usually) sends the Australian dollar down. Currency concerns IMO are not a big deal here.

The reason for the fall in Iron Ore price is supply lead, not demand lead. Iron ore and the downstream product steel are not luxury items. They will have ongoing use in society, whether a recession hits or not. A contraction of world economies often means goverenments ramp up spending on infrastructure projects (reinforcing steel).

As for iron or prices being low for years to come, that is similar to saying milk prices could be low for years to come, so no-one should go dairy farming. Both might happen. But I believe the underlying demand for both commodities means that it won't in both cases.

Your premise that if all things turn against the company then Arrium (as per this example) will be in real trouble is correct. But you could say the same about any company in any market sector. I don't think focussing only on the worst possible long term market is a satisfactory way to evaluate the potential of any investment.

SNOOPY

[Snoopy]

If iron ore prices remained low for a number of years they will need more than a few hedging contracts to pay off their debts. They owe tons of money and more is needed for their planned Capital Expenditure. (plant and equipment)

SSD raises a legitimate issue more existing and potential Arrium investors. So what really is the debt position for Arrium in the eyes of the banks?

There are two banking covenants, as outlined in slide 29 of the capital raising presentation:

1/ Gearing ratio must be less than 50%.
2/ EBITDA/(Net interest Bill) > 3.0 to 3.5

I will deal with each of these separately.

SNOOPY

[Snoopy]

1/ Gearing ratio must be less than 50%.

Slide 28 of the capital raising document shows a Pro-Forma balance Sheet.

Net Assets: $4,470m
Net Debt: $976m

So net assets would have to decrease by:

$4,470m - $976m = $3,494m for this covenant to be breached.

Now I for one am expecting one off writedowns of up to 2 billion dollars in written off assets (tangible and intangible) over the next couple of years. But even with write offs of that magnitude, the balance sheet will be secure from a banks prespective. So this first covenant is safe.

SNOOPY

[Snoopy]

2/ EBITDA/(Net interest Bill) > 3.0 to 3.5

Please forgive me the following data deluge, regarding forecast FY2015 EBITDA cover both divisionally and as a whole.

FY2015 (forecast)	Iron Ore	Mining Consumables	Recyclables	Steel	Total
EBIT	$170.6m	$140.0m	$1.3m	$-52.8m
EBIT (corporate)	-$15.9m	-$11.1m	-$11.0m	$-27.4m	$189.7m
D & A	$204.6m	$47.3m	$10.8m	$103.6m	$366.3m
EBITDA	$359.3m	$176.2m	$1.1m	$23.4m	$560.0m
Net Interest Bill	$23.6m	$21.6m	$12.2m	$37.4m	$94.8m
EBITDA/Interest	15.2	8.2	0.09	0.63	5.8
Tax Payable					$71.5m
Net Interest Bill					$94.8m
EBDA					$394m

The key figure (in the box) of 5.8 is very healthily in excess of the 3.0 to 3.5 covenant range. So I can say with confidence that this covenant is unlikely to be an issue either.

On an individual divisional basis, the EBITDA covenant is an issue, in Recycling and Steel. But Arrium is assessed by the banks in its entirety, not as divisions.

Finally EBDA is EBITDA with interest and tax removed. This is a proxy for free cashflow (before incremental capex), which to me looks healthy.

SNOOPY