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

[Snoopy]

Another substantial shareholder on the move (11th March). The Singaporean government controlled GIC Private Limited held 7.08% of the voting power on 1st November 2012. That stake has now increased to 8.21%. The shares were acquired between November 2012 and November 2014 at prices between 24c and $1.64.

In addition Director Brian Davis has been increasing his holding.

More buying from the big boys. Allan Gray now sitting at just under 15% of the company, as announced yesterday.

SNOOPY

[Snoopy]

Been great to watch you ignore the noise generated and stick to your reasoning Snoopy, I hope it pays off for you.
I am sure you would be looking to buy something deeply unloved that the brokers have unanimous sells on good to see the deep value investors like Allan Gray backing up your judgement on this one.

I think with hindsight, my first purchase of ARI shares on the ASX at 37c was premature. At that stage I was simply working on the huge discount to net asset backing, and my underlying liking for mining businesses that 'sell shovels to miners' rather than do the digging themselves. In making this comment I am referring to the mining consumables side of the business. I am aware that with iron ore, Arrium itself is doing the digging! I hadn't done more detailed homework at that time. However ,my 'margin of safety' has come into play here. Even after the subsequent billion dollar asset write downs, even that first purchase is still below asset backing! Feeling reasonably comfortable with my average entry price of 25c. But if I had differently timed that first purchase, then I could have done better overall.

It is a little too complex for me but as you only need things to go from dire to terrible to make lots of money I reckon your odds are good over the long term.

Yes with the four divisions (iron ore, mining consumables, steel and recycling) Arrium is complex. But that in itself has created the opportunity. Some think it is only an iron ore play,and don't bother to look further.

I would like to get BHP if it gets to the point where the market hates it as they have the lowest cost iron ore reserves and they split out their steel operations for a good reason it seems.
It seems likely that that won't happen and I will miss the opportunity with ARI.
My only exposure to resources is CDD as I get a dividend while I wait for the recovery, WOR and STO as no-one seems to think we will need oil (or steel).

I do own BHP. Average buy price around $12 I think, which gives you some idea of how long it has been floating around in my bottom drawer! But BHP and ARI are my only two in the mining sector.

Maybe these forums are only useful for speculators who think they can make money doing what everyone else is doing, day trading going short then long and making brokers rich. Seems like you get a lot of noise rather than useful information on this thread.

Personally I find the views of traders very useful in a contrarian way. The smell of trading fear can turn up gems!

SNOOPY

[Snoopy]

Time to rerun this table using my alternative method EBITDA estimate for iron ore.

FY2015 (forecast)	Iron Ore	Mining Consumables	Recyclables	Steel	Total
EBIT	-$5.0m	$140.0m	$1.3m	$-52.8m
EBIT (corporate)	-$15.9m	-$11.1m	-$11.0m	$-27.4m	$18.1m
D & A	$204.6m	$47.3m	$10.8m	$103.6m	$366.3m
EBITDA	$183.7m	$176.2m	$1.1m	$23.4m	$384.4m
Net Interest Bill	-$23.6m	-$21.6m	-$12.2m	-$37.4m	-$94.8m
EBITDA/Interest	7.8	8.2	0.09	0.63	4.1
Tax Payable					-$39.3m
Net Interest Bill					-$94.8m
EBDA					$250.3m

The key figure (in the box) of 4.1 is in excess of the 3.0 to 3.5 covenant range. On these figures, the EBITDA to interest bill ratio covenant is (still) unlikely to be an issue. However, this is based on an iron ore price averaged over the year of $83/tonne (maybe too high?) with no further reduction in input costs (not true as some further cost savings have been already found) and no depreciation of the exchange rate from $US1= $A0.9121 (not a reflection of what has happened since). All of those assumptions are fair game to challenge.

Time to update my projected full year EBITDA results, based on the information released in the HY2015 results for the period ending 31st December 2014.

FY2015 (forecast)	Iron Ore	Mining Consumables	Recyclables	Steel	Total
EBIT	-$5.0m	$140.5m	$7.7m	$-66.6m
EBIT (corporate)	-$5.1m	-$6.1m	-$4.8m	$-11.9m	$48.7m
D & A	$191.2m	$47.0m	$10.0m	$102.0m	$350.2m
EBITDA	$181.1m	$181.4m	$12.9m	$23.5m	$398.9m
Net Interest Bill	-$21.8m	-$23.3m	-$9.9m	-$34.3m	-$89.2m
EBITDA/Interest	8.3	7.8	1.3	0.69	4.5
Tax Payable					-$33.8m
Net Interest Bill					-$89.2m
EBDA					$275.9m

Further working on these figures (not shown in table) leads me to a NPAT projected figure of -$74.4m (based on normalised earnings excluding one off adjustments) for this scenario.


SNOOPY

[Snoopy]

Let's take another look at the iron ore profitability

Let's take another look at the iron ore profitability

Current 62% fines price USD 68.70 wmt
Less discount for lower quality USD 12.37*
Realised price USD 56.33 wmt
Less Conversion to dmt USD 2.82**
Realised price USD 53.51 dmt
Realised price AUD 64.70 dmt***

Less total cash cost AUD 68.4* dmt

Equals negative AUD 3.7 dmt

At at 13mtpa run rate that is a cash loss of AUD 48.1m.

Sources:
* calc from the latest quarterly report (October 2014)
** 5% used, could be slightly higher
*** using 0.8270

Time to try my slightly different way of estimating EBITDA

I shall assume that EBITDA is proportional to the difference between the cost of supplying ore and the price obtained by selling that ore.

1/Supply costs are in Australian dollars.
2/Sold costs are in US dollars.

For comparative purposes in my adjustment ratio, I have converted AUD costs to USD at the rate of 0.9121.

EBITDA for FY2014 was based on average iron ore earnings of $US123m per dry metric tonne.

I am proposing to use an average EBITDA using average iron ore earnings of $US83m per dry metric tonne. This was the spot price at the time of the capital raising. This is higher than the current spot price. But only 25% of the iron ore earnings are tied to current spot prices.

I have assumed that
1/ extraction costs do not change between FY2014 and FY2015.
2/ I also assume a constant AUD/USD exchange rate
3/ Steel prices are based on the Platts 62% Fe Index price in USD
4/ The same tonnage of ore is shipped out in FY2014 as FY2015 (12.5Mt)

EBITDA(2015)= $685.9m x [($83m - ($73m x 0.9121)]/[($123m - ($73m x 0.9121)]

= $685.9m x 0.291 = $199.6m

I assume that depreciation and amortization will not change substantially from FY2014 ($204.6m).

EBIT(2015) = $199.6m - $204.6m = -$5.0m

For those interested I have rerun the same calculation based on a market steel price of $65/dmt

EBITDA(2015)= $685.9m x [($65m - ($73m x 0.9121)]/[($123m - ($73m x 0.9121)]

= $685.9m x -0.0281 = -$19.3m


In this case EBIT(2015) for the iron ore division is

EBIT(2015) = -$19.3m - $205m = -$224m

Because there is more than one view of the future, I have decided to put "Corporate's" assumptions through my model to see what numbers come out.

Corporate has assumed that:
1/ extraction costs are $A68.40 for FY2015.
2/ The AUD/USD exchange rate changes from $A1 = $US0.9121 for FY2014 to $A1 = $US0.8270 for FY2015.
3/ The realised steel price, accounting for the lower quality ore being mined is USD 56.33 /wmt. Note that no allowance is required to convert to dry metric tonnes, because the comparative figures are also in wet metric tonnes.
4/ The tonnage of ore is shipped out in FY2014 (12.5Mt) rises to (13.0Mt) as FY2015

EBITDA(2015)= $A685.9m x [($US56.33m - ($A68.40m x 0.8270)]/[($US123m - ($A73m x 0.9121)] x [13/12.5]

= $A685.9m x -0.00437 = -$A3m

I assume that depreciation and amortization will not change substantially from FY2014 ($204.6m).

EBIT(2015) = -$3m + $204.6m = -$201.6m

SNOOPY

[Snoopy]

Because there is more than one view of the future, I have decided to put "Corporate's" assumptions through my model to see what numbers come out.

Corporate has assumed that:
1/ extraction costs are $A68.40 for FY2015.
2/ The AUD/USD exchange rate changes from $A1 = $US0.9121 for FY2014 to $A1 = $US0.8270 for FY2015.
3/ The realised steel price, accounting for the lower quality ore being mined is USD 56.33 /wmt. Note that no allowance is required to convert to dry metric tonnes, because the comparative figures are also in wet metric tonnes.
4/ The tonnage of ore is shipped out in FY2014 (12.5Mt) rises to (13.0Mt) as FY2015

EBITDA(2015)= $A685.9m x [($US56.33m - ($A68.40m x 0.8270)]/[($US123m - ($A73m x 0.9121)] x [13/12.5]

= $A685.9m x -0.00437 = -$A3m

I assume that depreciation and amortization will not change substantially from FY2014 ($204.6m).

EBIT(2015) = -$3m + $204.6m = -$201.6m

The following 'alternative' forecast relates to the financial year 2015, whihc will end on 30th June 2015.
Time to insert the 'Corporate' Iron Ore EBIT figure of -$201.6m into the spreadsheet and see what comes out.

FY2015 (forecast)	Iron Ore	Mining Consumables	Recyclables	Steel	Total
EBIT	-$201.6m	$140.5m	$7.7m	$-66.6m
EBIT (corporate)	-$3.8m	-$6.5m	-$5.1m	$-12.6m	-$148.0m
D & A	$191.2m	$47.0m	$10.0m	$102.0m	$350.2m
EBITDA	-$14.2m	$101.0m	$12.6m	$22.8m	$122.2m
Net Interest Bill	-$21.0m	-$22.4m	-$10.4m	-$35.3m	-$89.1m
EBITDA/Interest	0.68	4.51	1.21	1.49	1.4
Tax Payable					-$33.5m
Net Interest Bill					-$89.1m
EBDA					-$0.4m

The key figure highlighted in this table is the EBITDA to interest rate ratio. At 1.4, this is seriously below banking covenant agreements that say this ratio should be 3 to 3.5 at least. However, CEO Andrew Roberts is already on record as saying that banking covenants will be hurdled over in FY2015, even though he hasn't released any definitive full years earnings guidance. This means we can be fairly sure that this scenario, as painted by Corporate, will not happen. Nevertheless, despite all this scenario gloom net cashflow is within rounding error zero. This means that ARI would not have to increase its borrowings, even with a result as dire as Corporate suggested. That is good news for shareholders, should unexpectedly bad news come to pass.

Further working on these figures (not shown in table) leads me to a NPAT projected figure of -$270m (based on normalised earnings excluding one off adjustments) for this scenario.

SNOOPY

[Snoopy]

More buying from the big boys. Allan Gray now sitting at just under 15% of the company, as announced yesterday.

Here is a quote from an AFR article dated 25th March where Allan Gray outline their thoughts on investing in Arrium:

-------

"At the centre of this thesis is the value of the company's assets. Arrium has three separate businesses: an iron ore mining business, a steel business and a mining consumables business. The iron ore business is possibly the most broken: the company announced it was closing its loss-making mines in South Australia and investors should ascribe no value to this business. But the other two businesses have value: the mining consumables business is the strongest and generates about $150 million worth of earnings before interest and tax (EBIT). Management thinks it can get this figure up to about $200 million."

"The steel division has been hampered by the elevated Australian dollar and a global oversupply of steel. Chief executive Andrew Roberts seized on this last point when he admonished the government for slow progress on its anti-dumping legislation. Last year the business delivered underlying EBIT of just $54 million compared with a longer-term average of closer to $250 million EBIT. Favourable government policy and a lower dollar should help."

"Accounting for its debt load, the market currently values Arrium at about $1.2 billion. "That is a very conservative valuation, especially if you think Arrium's steel business can normalise its earnings," says Simon Mawhinney, a portfolio manager with turnaround specialist Allan Gray. The funds manager is betting on an Arrium turnaround and owns 13.4(*) per cent of the company. "You don't need the future to be bright to justify investing in this company," Mawhinney says."

--------

(*) Note Allan Gray Arrium stake increased to 14.56% from purchasing on 18th March since this interview was done.

This confirms my own view that the much talked about iron ore mining division is essentially no longer relevant for company valuation purposes going forwards. Nevertheless, any unexpected pick up in the iron ore margin is still the potential free lotto ticket that new shareholders should get when buying into Arrium in the sub 20c range.

SNOOPY

[Snoopy]

We can be fairly sure that this scenario, as painted by Corporate, will not happen. Nevertheless, despite all this scenario gloom net cashflow is within rounding error zero. This means that ARI would not have to increase its borrowings, even with a result as dire as Corporate suggested. That is good news for shareholders, should unexpectedly bad news come to pass.

Further working on these figures (not shown in table) leads me to a NPAT projected figure of -$270m (based on normalised earnings excluding one off adjustments) for this scenario.

Digging through the half-year result, there are more one off bitter pills to take before FY2015 is done with. Slide 52 in the HY2015 presentation suggests break fees due to Southern Iron contactors will result in a one off payment of $70m, based on contractors reducing their work force by 380 people.

'Statuatory Gearing' at 31st December 2014 (HY2015 balance date) is reputedly 32.6% (slide 68).

According to 'investorwords' gearing is the ratio of a company's long-term funds with fixed interest to its total capital.

(Read more: http://www.investorwords.com/2156/ge...#ixzz3VSKRrwm7)

From the same page:

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

More information is in the Consolidated balance Sheet:

Current Interest Bearing liabilities = $161.2m
Non-Current Interest Bearing liabilities = $1450.1m

Now,

(Net Interest Bearing Liabilities)/(Total Equity)
($1,611.3m - $181.7m) / $2,962.2m = 48.26%

(Long Term Interest Bearing Liabilities)/(Total Equity)
$1450.1m / $2,962.2m = 49.0%

Nowhere near the quoted figure. Can anyone help out here?

SNOOPY

[Snoopy]

'Statuatory Gearing' at 31st December 2014 (HY2015 balance date) is reputedly 32.6% (slide 68).

According to 'investorwords' gearing is the ratio of a company's long-term funds with fixed interest to its total capital.

(Read more: http://www.investorwords.com/2156/ge...#ixzz3VSKRrwm7)

From the same page:

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

More information is in the Consolidated balance Sheet:

Current Interest Bearing liabilities = $161.2m
Non-Current Interest Bearing liabilities = $1450.1m

Now,

(Net Interest Bearing Liabilities)/(Total Equity)
($1,611.3m - $181.7m) / $2,962.2m = 48.26%

(Long Term Interest Bearing Liabilities)/(Total Equity)
$1450.1m / $2,962.2m = 49.0%

Nowhere near the quoted figure. Can anyone help out here?

I must say, I do find it annoying that there are seemingly several legitimate ways to calculate 'gearing'. And due to rather lax nomenclature there is no real way to know what measure is being used in any particular case.

To answer my own question.

Slide 8 of the Capital Raising presentation says that:

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

If I use that definition with the data that I used in the previous post:

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', although the statute it is apparently linked to is not defined. Annoyingly this methodology does not agree with the investorwords (admittedly an American site) definition of gearing.

Now this is sorted out, I can start working on some forecast comparative figures.

SNOOPY

[Snoopy]

I would be more worried about the debt refinancing. How long before ARI has to sell off its profitable businesses in order to bail out its loss making ones?

A lot of these debt loaded miners are going to go to the wall as a result of bankers forcing asset sales in order to get their money back. The market will not wear multi-billion dollar capital raisings in such a perilous commodity climate, so the companies are F***d. Place your bets as to who will be the first to fold.

PS. ARI next significant debt maturity is 2H 2016 so they have only a year to find the money.

KW you are one step ahead of me. I am presently working through just how Arrium can address its debt repayment schedule. Unlike other 'miners' (although I think it is not accurate to put Arrium in the miners basket, because most of their divisions are not mining divisions in that sense).

I draw your attention to slide 29 of the capital raising presentation. Debt repayment profile post equity raising shows less than $200m of debt maturing in FY2016. Now refer to my post 255 on this thread, and look at the EBDA figure right at the bottom. This is also the base for calculating potential free cashflow for FY2016. This figure, $275.6m, will more than cover the maturing debt.

I do agree though that FY2017 may be a challenge for repaying debt. This is what I am concerned about and am currently investigating.

SNOOPY

[Snoopy]

Time to update my projected full year EBITDA results, based on the information released in the HY2015 results for the period ending 31st December 2014.

FY2015 (forecast)	Iron Ore	Mining Consumables	Recyclables	Steel	Total
EBIT	-$5.0m	$140.5m	$7.7m	$-66.6m
EBIT (corporate)	-$5.1m	-$6.1m	-$4.8m	$-11.9m	$48.7m
D & A	$191.2m	$47.0m	$10.0m	$102.0m	$350.2m
EBITDA	$181.1m	$181.4m	$12.9m	$23.5m	$398.9m
Net Interest Bill	-$21.8m	-$23.3m	-$9.9m	-$34.3m	-$89.2m
EBITDA/Interest	8.3	7.8	1.3	0.69	4.5
Tax Payable					-$33.8m
Net Interest Bill					-$89.2m
EBDA					$275.9m

Further working on these figures (not shown in table) leads me to a NPAT projected figure of -$74.4m (based on normalised earnings excluding one off adjustments) for this scenario.

Time now to put on my hat of gloom. We all know that if the iron ore and steel markets recover, then owning shares in Arrium is 'money for jam'. What is of more interest to me is what happens if the iron ore market just bobs along at current market prices, and the steel market doesn't recover? Will shareholders be required to put in more share capital under that 'double doom' scenario?

The table below I have titled 'FY2016 forecast'. But it is simply a repeat of my FY2015 forecast, with an adjustment made to the iron ore division to reflect the decrease in sale volumes to 9Mt per year at much lower (current) market prices.

FY2016 (forecast)	Iron Ore	Mining Consumables	Recyclables	Steel	Total
EBIT	$26.4m	$140.5m	$7.7m	$-66.6m
EBIT (corporate)	-$2.9m	-$6.7m	-$5.3m	$-13.1m	$80.0m
D & A	$100.0m	$47.0m	$10.0m	$102.0m	$350.2m
EBITDA	$123.5m	$188.8m	$12.4m	$22.3m	$347.0m
Net Interest Bill	-$19.5m	-$22.8m	-$10.7m	-$36.2m	-$89.2m
EBITDA/Interest	6.3	8.3	1.2	0.61	3.8
Tax Payable					-$34.5m
Net Interest Bill					-$89.2m
EBDA					$223.3m

Despite being cashflow positive (see the EBDA figure), we are still looking at a negative NPAT with this double gloom scenario: A loss of -$45m.

Nevertheless, the key figure here is the overall EBITDA/Interest Rate ratio of 3.8 (highlighted). The banks have asked for this figure to be above 3.5. So all still looks OK. No reason for the banks to not grant renewal of any loans with this kind of cashflow coming through. CEO Andrew Roberts would be horrified to see my FY2016 forecast as above. But he would be pleased to see that even if the recovery in the steel industry doesn't pan out in the timely manner he expects, then shareholders should not need to tip in more funds.

SNOOPY