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

[Snoopy]

Here is what has happened, in $A terms, over the last three six monthly reporting periods.

	1HY2015	2HY2015	1HY2016
Export Tonnage	6.58MT	5.90MT	4.21MT
Exchange Rate AUD/USD	0.8947	0.7778	0.7241
Price Received /dmt	$US68	$US49	$US42
Price Received /dmt (A)	$A76	$A63	$A58
Cash Cost CFR China /dmt (B)	$A72.9	$A60.9	$A57.6
Net Cash Received /dmt {(A)-(B)}	$A3.1	$A2.1	$A0.4
Cash Cost Shipboard Aus /dmt (*) (C)	$A47.6	$A47.8	$A37.1
Implied Cartage Aus-China /dmt {(B)-(C)}	$A25.3	$A13.1	$A20.5

(*) Cash costs for ore as loaded in Australia per 'wet metric tonne' (wmt) have been increased by $2 to convert these to 'loaded costs' per (dmt)

'Cash Costs' delivered to China include:

1/ mining,
2/ crushing,
3/ beneficiation (blending to a specified grade),
4/ road haulage and
5/ transshipping costs.

BUT the cash costs exclude
6/ capitalised costs (infrastructure, pre-stripping and mining licences) (capitalised Cost was estimated at $US4t ($A6t) in the September 2015 Quarterly Mining Report) and
7/ depreciation, amortisation charges in respect of those costs,
8/ royalties,
9/ sales and marketing
10/ corporate overhead costs

Leaving out those "excluded costs" can really only be justified if the mining operation is not regarded as a going concern longer term.

We have identified overall company debt as the big issue. We have also seen that the potential closure of Whyalla triggers site remediation provisions which amount to hidden off balance sheet debt. Now let's combine this off balance sheet debt with the declared debt position as at EOHY2016 and see what happens to the gearing.

Not doing this calculation before was my mistake. Being a 'glass half full' kind of mutt, I did not consider any remediation costs should Whyalla and Middleback Ridge be completely shut down. I should have checked out this 'worst case' scenario :-(

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

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

Interest bearing liabilities = $20.2m + $2,359.3m +$145.0m = $2524.5m
Cash is $303.6m
Total Equity = $2,328.6m
Total Assets = $6,196.9m

then I get the following:

'Gearing' = ($2,524.5-$303.6) / ( ($2,524.5-$303.6) + $2,328.6) = 48.8%

That is creeping towards that critical 50%, yet still just within banking covenants. But have negative earnings over the second quarter for FY2016 pushed things over the edge? Our next point for investigation!

I want to take shareholders back to the period before the last half year reporting period results were declared, but after the half year mining reports were out.

The Question: If I had been a bit more meticulous with my figures, could I have predicted the voluntary administration? Let's see. I will focus on excluded cost 6 (see first quoted section) of the cash costs. There is no easy way to forecast what the other excluded cash costs (7,8,9,10) were. But I believe (6) to be the most significant.

Both the September and December Quarter Mining reports talked about CAPEX costs for mining of $A6/t

So knowing the 'cash cost profit margin' and the volume of iron ore sold as quoted in the quarterly mining reports, we can estimate the balance sheet damage caused by selling iron ore at a profit (positive figure) or loss (neagative figure) for the two quarters.

Q1

$A(8.6 -6)/t x 2.194Mt = +$5.7m

Q2

$A(-6.8 -6)/t x 2.126Mt = -$27.2m

So, Overall balance sheet damage estimated at:

+$5.7m -$27.2m = -$21.5m

Now we need to add this damage (now being used as a a forecast of what might happen over Q3 and Q4) back into our earlier balance sheet calculation (the second quoted block).

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

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

Interest bearing liabilities = $20.2m + $2,359.3m +$145.0m = $2524.5m
Cash is $303.6m -$21.5m = $282.1m
Total Equity = $2,328.6m
Total Assets = $6,196.9m

then I get the following:

'Gearing' = ($2,524.5-$282.1) / ( ($2,524.5-$282.1) + $2,328.6) = 49.1%

Really getting close to that 50% figure now. But still within banking covenants! So even if I had done these calculations at the time, it looks like I would not have predicted the Voluntary Administration :-(.

SNOOPY

[Snoopy]

Tiny bubbles at Hope Springs

http://www.abc.net.au/news/2016-05-03/arrium-administrator-whyalla-talks-with-jay-weatherill/7377800

Oz Federal budget tonight Joshuatree. Let's see what that serves up for Arrium!

SNOOPY

[Snoopy]

From my wider reading on Whyalla's problems, I think the most pressing issue is input costs. I have read that the historically struck internal deal that Arrium's Whyalla has made with Arrium's company owned iron ore mining division means that currently Whyalla is paying way above market price for iron ore. IOW there is transfer pricing going on between Arrium's Mining division and Arrium's Whyalla Steel manufacturing plant. It is possible that if this transfer pricing was removed, Whyalla would suddenly become profitable!

More info on the above from the AFR dated 13th April 2006, p30.

"Our sources say that Whyalla pays about $100/tonne for a magnetite feed that makes up about 70-80 percent of the feed for iron making. But the standing market price for magnetite is said to be $70 a tonne."

"The theory goes that the embrace of market pricing would reduce Whyalla's costs by maybe $70m per year. Now to be fair Arrium's people say these numbers are inflated and that Whyalla's cost profile been a matter of consitant very deep internal analysis. Nonetheless it has been confirmed that Whyalla pays pays cost rather than market pricing. It is also confirmed that Whyalla's existing blast furnance technology could be flipped to take more (Snoopy comment: cheaper?) hamatite that magnetite."

I don't fully understand the above quote. When 'Project Magnet Part 1' was mooted as a way to introduce the otherwise unused magnetite reserves into the Whyalla blast furnace, shareholders were told operating costs at Whyalla could drop 5%. Has the price of hematite falllen faster than magnetite to the extent it will pay to switch back? Or does the chemical composition of the magnetite ore and the associated wet rather than dry extraction process mean that it is less polluting and/or energy intensive to extract ore from magnetite?

SNOOPY

[Snoopy]

From the Australian, 4th May 2016 (my bolding)

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One of New Zealand’s largest and most successful companies, Todd Corporation, is believed to be circling troubled iron ore miner and steelmaker Arrium, currently in the hands of voluntary administrators KordaMentha.

Sources said yesterday that Todd Corp’s interest extends to buying all of the company, with some tipping that its strategy may involve a breakup scenario where various parts of the operation are sold off to Chinese entities.

The family-owned corporation describes itself as one of New Zealand’s largest and most successful companies, with interests in oil and gas exploration and production, electricity generation, energy retailing, property development, healthcare, minerals, technology and wine.

Todd Corp’s vice-president of minerals, Michael Wolley, is the former president of BlueScope Steel China, which means the company may possess the expertise needed to address the challenges with respect to Arrium’s steel operations.

While speculation suggests KordaMentha may run another sales process for Arrium’s highly attractive $1.5 billion-plus grinding media business Moly-Cop, others say that any revised process will be some way down the track.

One view is that the South Australian government, which has a seat at the table on the creditors committee, would favour a deal involving a commitment to Arrium’s steel division.

It is also thought that the government would be eager to ensure that Whyalla did not shut ahead of the election and may provide some sort of funding or deal to ensure that the steelworks remained in operation. Arrium’s steel division is currently profitable, but the widely held view among deal makers in the market is that turning around Arrium’s steelworks at Whyalla is a near- impossible task.

Whyalla steelworks is an integrated steel mill, which is suited to large manufacturing volumes and needs to be kept running constantly, making such an operation costly.

Arrium’s other steelmaking operations are electric arc furnaces that use scrap metal for manufacturing. They are seen as more economical because they can be turned off and on.

Todd Corp declined to comment yesterday.

Some also question Todd Corp’s level of competitive advantage in a process that may see either the entire company or only Moly-Cop — one of the world’s largest manufacturers of steel grinding balls that are used in mining — is put up for auction, compared to major global private equity powerhouses such as Cerberus Private Equity, which is teaming with Argand in the hope of buying the business.

Once the starting gun is fired on any revised Arrium sale, it will be interesting to see if KordaMentha brings in a new adviser — likely to be Fort Street — to run the process after UBS and Lazard worked for Arrium’s board last year.

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It was also announced today that the second creditors meeting that will decide the future of Arrium as agoing concern and scheduled for next week, will now be put off until the end of February 2017, with the possibility of a further three month extension beyond that!

Another plan in the mix is for listed OZ minerals to use bothe the Whyalla site and the port for exporting copper from 2019. Lots of possibilities then. There is no quick resolution for Arrium. In the current volatile environment, this is probably a good thing!

SNOOPY

[Snoopy]

Oz Federal budget tonight Joshuatree. Let's see what that serves up for Arrium!

From the Weekly Times May 4, 2016 6:57pm AAP (my embolding)

--------

Embattled steel producer Arrium remains hopeful of federal government support for its Whyalla operations despite being overlooked in the federal budget.

South Australian Treasurer Tom Koutsantonis has criticised the commonwealth for not outlining a plan to co-invest in the steelworks as he scored the budget an "uninspiring" five out of 10.

He said business tax cuts were welcome but the financial blueprint also failed to deliver any new infrastructure projects for SA or reverse previous health and education cuts.

"This budget didn't answer any questions about Arrium and steel manufacturing and didn't answer any questions about infrastructure for our state," Mr Koutsantonis told reporters on Wednesday.

Arrium administrators KordaMentha said they understood that support packages could not be "conjured up overnight" and the budget was probably locked-in soon after the company went into administration in April.

"Just because there's nothing specific in the budget doesn't mean there may not be something down the track," KordaMentha spokesman Mike Smith told AAP.

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SNOOPY

[Joshuatree]

Arrium administrators get long extension as OZ offers hope

22,500 claimant creditors
Complex business structure .94 entities, cross deeds created two pools of companies ...staff employed under business units rather than registered companies, messy!.

[Snoopy]

'Gearing' = ($2,524.5-$282.1) / ( ($2,524.5-$282.1) + $2,328.6) = 49.1%

Really getting close to that 50% figure now. But still within banking covenants! So even if I had done these calculations at the time, it looks like I would not have predicted the Voluntary Administration :-(.

There is one more arm of the avenue to administration to explore. We need to know the book value of Whyalla. We need to know this because if Roberts and his proposed GSO rescue plan cohorts were really intent on shutting all activity at Whyalla, then these 'assets' would have no value. Consequently whatever 'Whyalla' value is recorded needs to be removed from the books. To my knowledge the book value of Whyalla on its own has never been explicitly disclosed.

At the genesis of what was then Onesteel (now Arrium) in 2000, manufacturing assets were listed as being worth $1,704.9m.

On the steel supply side , this figure includes:

1/ Whyalla: iron ore to steel production.
2/ Sydney Steel Mill: steel recycling plant

The production capacity at (1) is roughly three times that of (2).

On the steel processing sde, this figure includes:

3/ Whyalla: Rail and Structural Steel
4/ Newcastle: Rod and Bar Steel (bar production subsequently ceased in 2009)
5/ Newcastle; Pipe & Tube production (subsequently moved to Acacia Ridge in Queensland and Somerton in Vistoria)
6/ Newcastle: Wire Production
7/ Geelong: Wire
8/ Somerton: Wire

Onesteel was designed as a vertically integrated steel company. So as an approximation we can assume that production from 1/ and 2/, is fully taken up by 3/,4/,5/,6/,7/ and 8/. I am therefore going to assume an asset breakdown model that looks like this:

Whyalla (Steel Production)											-37.5%-		Sydney Steel Mill	-12.5%-
Whyalla: Rail, Structural						-20%-	Newcastle: Rod, Bar,Pipe/Tube, Wire					-23%-	Glng: -3.5%-	Smtn: -3.5%-

Adding up the Whyalla Assets, they make up 37.5% + 20% = 57.5% of all book manufacturing assets.

So $1,704.9m x 0.575 = $980m

SNOOPY

[Snoopy]

Adding up the Whyalla Assets, they make up 37.5% + 20% = 57.5% of all book manufacturing assets.

So $1,704.9m x 0.575 = $980m

Onesteel/Arrium has a policy of depreciating their manufacturing assets 3 to 30 years (p94 AR2015).

IFRS standards were adopted in 2006. IFRS standards are the current system used in FY2015 today.

From p17 of the Onesteel Financial Report for 2006:

-----
OneSteel has elected to use property, plant and equipment carrying values under AGAAP as “deemed cost” under AASB 116 “Property, Plant and Equipment” on transition to AIFRS.
-----

From p19 of the Onesteel Financial Report for 2006:

-----
Impairment of assets

Assets that are subject to depreciation or amortisation are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. An impairment loss is recognised in the Income Statement for the amount by which the asset’s carrying amount exceeds its recoverable amount. The recoverable amount is the higher of an asset’s fair value less costs to sell and value–in–use. This is determined for an individual asset, unless the asset’s value–in–use cannot be estimated to be close to its fair value less costs to sell and it does not generate cash flows that are largely independent of those from other assets or groups of assets, in which case, the recoverable amount is determined for the cash–generating unit to which the asset belongs.

In assessing value–in–use, forecast future cash flows are discounted by the use of a pre–tax rate that reflects current market assessment of the time value of money and the risks specific to the asset or cash–generating unit(s).
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From 2000 up until today there were substantial improvements to the Whyalla assets as follows:

1/ $110m was spent relining the Whyalla Blast Furnance in FY2004
2/ $395m was spent under 'Project Magnet Stage 1' to ready the Whyalla Steel Plant to a different raw iron ore: magnetite instead of hematite.

SNOOPY

[Snoopy]

What follows is a multi year look at the jewel on the crown of Arrium, Moly-Cop from FY2012. FY2012 was the first full year that Moly-Cop became a fully integrated Arrium subsidiary.

Moly-Cop: Operational Performance	FY2012	FY2013	FY2014	FY2015	FY2016(F)
EBITDA ($Am)	171.6	195.3	187.1	210.5	224.5
EBIT ($Am)	135.2	150.7	139.8	159.9	170.9
DA ($Am)	36.4	44.6	47.3	58.6	50.6
NPAT ($Am)(Assuming Stand Alone Business)	66.2	77.8	69.1	86.4	127.6
External Tonnes Dispatched (kT)	1,060	1,140	1,090	1,130	1,090

Before the expansions detailed below, maximum theoretical capacity was 1300kT.

The interesting thing about the table figures is reading them in conjunction with the recent Moly-Cop business expansions:

1/ Kanloops, Canada: Existing Capacity 115kT, about to add 120kT (June 2015)
2/ Cilegon, Indonesia: 30kT, just added 50kT (December 2014)
3/ La Joya, Peru: 0kT (greenfield), about to add 175kT (June 2016)

The FY2015 reporting (most recent) period includes only six month's contribution from the smallest of these new projects. But even that has been affected by Indonesian Goverment tax issues. So on a net basis, I don't think we have any contribution from these projects to date. Yet most of the establishment expenses have been incurred.

My FY2016 projection does not include any significant top line growth. All the projected FY2016 growth is basically from structural wider group cost cutting. My point then is that when these projects start to make a net contribution to the business, the earnings of Moly-Cop could increase substantially. This is why I think it is worth hanging in there through the capital reconstruction if you are an Arrium shareholder.

Revelations published in "The Australian"
http://www.theaustralian.com.au/busi...8dd55b98e0075c

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"Arrium’s board was becoming concerned about its liquidity levels in February, despite not being at risk of breaching its debt covenants at a time Moly-Cop’s earnings were falling due to a shift in the price of copper."
(Note: this is due to key Molycop customers being miners of copper)

<snip>

"Meanwhile, some believe that the value of Moly-Cop may fall further, with customers potentially shying away from the business at a time it faces an uncertain future. Arrium’s creditors will next meet at the end of February next year after winning an extension from the Federal Court. Administrators are scheduled to hold a meeting on May 13."

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That last paragraph is pure speculation. But maybe there is an ounce of truth at the bottom of that speculation?

SNOOPY

[Snoopy]

At the genesis of what was then Onesteel (now Arrium) in 2000, manufacturing assets were listed as being worth $1,704.9m.

On the steel supply side , this figure includes:

1/ Whyalla: iron ore to steel production.
2/ Sydney Steel Mill: steel recycling plant

The production capacity at (1) is roughly three times that of (2).

On the steel processing sde, this figure includes:

3/ Whyalla: Rail and Structural Steel
4/ Newcastle: Rod and Bar Steel (bar production subsequently ceased in 2009)
5/ Newcastle; Pipe & Tube production (subsequently moved to Acacia Ridge in Queensland and Somerton in Vistoria)
6/ Newcastle: Wire Production
7/ Geelong: Wire
8/ Somerton: Wire

Onesteel was designed as a vertically integrated steel company. So as an approximation we can assume that production from 1/ and 2/, is fully taken up by 3/,4/,5/,6/,7/ and 8/. I am therefore going to assume an asset breakdown model that looks like this:

Whyalla (Steel Production)											-37.5%-		Sydney Steel Mill	-12.5%-
Whyalla: Rail, Structural						-20%-	Newcastle: Rod, Bar,Pipe/Tube, Wire					-23%-	Glng: -3.5%-	Smtn: -3.5%-

Just in case I fall under a bus tomorrow, I had better make some public notes on how I allocated the total plant and equipment assets amongst the list of worksites declared.. It is a little flakey compared to some of the work I do here. But if I have nothing more definite to work with, a little flakeyness based around general knowledge of the industry I think is OK.

Arrium Steel Division make loud of the fact they are an 'integrated supplier' of steel product, along the following lines:

A/ Supply raw material
B/ Make raw material into steel.
C/ Make steel into useful steel sections
D/ Sell to Customer through company owned Retail Chain.

Of most interest here is the Property Plant and Equipment used in steps B/ and C/, which the casual observer would identify as 'manufacturing plant'.

Level B

The plant at level B/ tends to be 'bigger' and 'dirtier'. At Whyalla, for example, 2 MT of input iron ore is needed to produce 1.2MT of useable steel billet. So storage yards for process input tend to be bigger. Heat requirements of the process are overall greater. And more of a buffer zone of land to neighbouring businesses is needed. So I do not shy from allocating 50% of plant and equipment assets to 'stage B'. Despite both steel creating facilities at Whyalla and Sydney being different technologies I am allocating level B costs strictly on production capacity. The throughput of Whyalla is roughly three times that of Sydney.

Level C

Ultimately all this output from level B/ is ditributed to level C/. Wire is a relatively small compact product to form. Rod, Bar Steel and Pipe (medium size extrusion) are significanmtly larger cross sections. Whereas Structural Steel (large size extrusion) , the type you might see going into building frames, is that much larger again. After production the larger product will require a larger storage area before it is transhipped too.

So:

i/ For each 'wire plant' I have assigning a 'size factor' of '1'.
ii/ For each 'medium size extrusion plant' I have assigning a 'size factor' of '2'.
ii/ For each 'large size extrusion plant' I have assigning a 'size factor' of '4'.

Thus, for example, Whyalla Type C has a Structural Steel Plant (size 4) and a rail sleeper plant (size 2), giving a total proportional size of '6' for all Whyalla 'category C' sites. The total I have used for Newcastle based on three 'medium size extrusion plants' (size 2) and one wire extrusion plant (size 1) is '7'. The wire plants at Geelong and Somerton are both stand alone 'size 1'.

SNOOPY