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

[Snoopy]

Hi Snoopy

I will assume that the $2,356M is AUD and that is equivalent to $1,758M USD.

So apart from the $252M total you list then there is another $1,506M. If it has an average rate of 3.54% then this will give an overall average of

Taa dah!

4% on the $1,758M.



E&OE, All averages are $ weighted.

Your solution is a possible one PT. But 3.54% on a loan with no security on any company assets -(sorry, I didn't mention that last bit before)-? Find that banker! I want him to write me a loan! Or perhaps he has already moved on to an exciting new unskilled mop pushing career?

The bit that caught my eye in the quote was the bit I have just emboldened in brackets

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Finance Costs: ~4% average interest rate on 1HY2016 average net debt of $2,356m (less unwind of interest rate swaps)."

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Could the interest rate being paid by Arrium today have been effectively reduced by some clever historical interest rate swap contracts, with the actual interest rate being much higher if those swap contracts were to be unwound?

SNOOPY

[cammo]

Price of iron ore on the run up. Having not seen this type of situation before, do you think a buy in now is a good idea to double down before government bailout? Or wait for the possible c.r coming? My buy is 20c keen to drop it into the single digits ... But if the return is a very long haul is it worth even contemplating? Your thoughts Snoopy please.

[Snoopy]

Price of iron ore on the run up. Having not seen this type of situation before, do you think a buy in now is a good idea to double down before government bailout? Or wait for the possible c.r coming? My buy is 20c keen to drop it into the single digits ... But if the return is a very long haul is it worth even contemplating? Your thoughts Snoopy please.

I am in a similar position purchase price wise, to you Cammo. Lots of unknowns looking out to the future regarding the capital structure of Arrium going forwards. But even if the GSO recapitalisation turns out to be an opening gambit to get a better deal with local banks, what we do know is this:

1/ Arrium want half their bank debt written off.
2/ Arrium want $US262m ($A350m)of new capital.

The bank debt write off could; include new shares issued in lieu of debt. So we existing shareholders could be faced with massive dilution, leaving the 'valuation' of current ARI shares a difficult exercise. With he current market cap at $A70m, Arrium could be after 5x the value of your current shareholding in new shares. So plenty of 'averaging down' to come, without you purchasing more now :-(

SNOOPY

[Snoopy]

I am wondering if (the GSO offer) is all part of a negotiating process, and the Aussie banks might come back with their own debt forgiveness proposal?

Back to Matthew Steven's article in the AFR dated 23rd February 2016. From p34 of the print edition:

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The litmus test for of negotiations ahead will be Australia's big four banks. Collectively they are the biggest lender to Arrium. And on Monday (22nd February 2016) each was delivered with an Arrium work out plan. We hear that the banks have been given until April (5th) to decide just how much they might concede.

One lever Arrium offered was debt to equity. But given the pressures on the capital side of Australian bank balance sheets, this is just not an option for anyone. So negotiations ahead will focus firmly on the size of the debt foregiveness and the capital haircut the banks are going to have to take.

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Now I agree with Matthew Stevens in the sense that no banker wants to be a shareholder in a steel business. But I am not sure about the emboldened bit. Granted, the big four Aussie banks have raised capital over the last year to shore up their balance sheets. And that was primarily becasue the RBA wanted to 'stress test' the banks using an assumption that the Aussie housing market could tank.

However, surely when faced with a choice of:

(1)/ writing off debt completely, verses
(2)/ transferring that same potentially 'written off debt' to equity (albeit dodgy equity)

the choice of (2) will leave the bank in a potentially better position? Why would Matthew Stevens so adamently dismiss option (2)?

SNOOPY

P.S. Later in the article Matthew Stevens is very adament that the Whyalla Steel works and Iron Ore mining operation should be permanently shut down, while managment want to have the flexibility to ramp up iron ore production should prices improve (if they can lower the cost structure). So perhaps Stevens is just commenting from his own ideologocal perspective?

[Snoopy]

Dilution and large loan fees as well.

On the subject of dilution, I note the ASX has the same 90% 'takeover threshold' as regards a compulsory delisting of a listed share as the NZX. So this means that GSO:

1/ Should they succeed in their recapitalisation plan for Arrium,
2/ Must retain a residual (existing) shareholder base going forwards equating to at least 10% of shares after recapitalisation. (GSO will pick up shares offered to exising shareholders but not taken up, as part of their commitment to underwriting the share issue offer).

So that means the recapitalisation terms may not be so onerous to existing shareholders, as some commentators are assuming?

IOW:
(!) wiping out 95% of shareholder capital would not work. BUT
(2) wiping out 89% of existing shareholder capital, would be (just) OK?

OK neither option is palatable (for those who have Arrium shares now). But maybe a little bit of light is shining here for existing shareholders?

SNOOPY

[Snoopy]

Some history on the purchase of Moly Cop and AltaSteel by Arrium, completed in December 2010.

From the Anglo American Plc annual report 2010 p85:

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Moly-Cop and AltaSteel performed well, assisted by strong demand for grinding media and increased vertical integration with the Canadian rolling mills. Production of steel products at 794,200 tonnes exceeded the prior year, notwithstanding the earthquake in Chile in February 2010 impacting production in Talcahuano.

In November (2010), Anglo American announced the sale of Moly-Cop and AltaSteel to OneSteel. The transaction was completed on 31 December 2010, resulting in a net cash inflow of $US993 million.

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And from p45

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The Group completed the disposal of its 100% interest in Moly-Cop and AltaSteel (Other Mining and Industrial segment), generating a profit on disposal of $US555 million.

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Did Arrium pay too much for Moly Cop as some suggest? On 31st December 2010, $US1 = $A0.9840. So the transaction was almost done on a 1:1 basis.

EBIT was $139.8m for FY2014 and EBITDA was $187.1m and Revenue of $1,538.1m. However, these earnings include some residual Arrium businesses that were combined with Moly Cop after the buy out from Anglo American.

The FY2011 Onesteel (as it was then) annual report gives a comparative measure of the mining consumables business that was rolled into the Moly Cop purchase (AR2011 p76). Putting this information into a table with the above purchase information.

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	Revenue	EBIT	EBITDA
Total Mining Consumables FY2014 (a)	$1,538.1m	$139.8m	$187.1m
Onesteel Mining Consumables FY2011 (b)	$680.1m	$60.5m	$81.4m
Difference (a)-(b)	$858.0m	$79.3m	$105.7m

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We could argue (*) that four years down the track that $933m price gives an EBIT multiple of:

$933m/$79.3m = 11.7

and an EBITDA multiple of

$933m/$105.7m = 8.83

Now, I'm no mining guru. But what do you think people? Do those multiples look OK?

(*) I am making an assumption here that all growth after acquisition has come from the acquired businesses, and none from the original Onesteel business. I am guessing this is not so far from the truth as most of the forecast growth is from the Americas, which was mostly the businesses that were bought.

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.

SNOOPY

[Snoopy]

Time for an update on the NTA of Arrium. The actual half year NTA calculation was a little different to my prediction above. I got the balance between 'intangible' and 'tangible' asset writedowns wrong I think. So I will now be a little more pessimistic in my assumptions going forwards. Figures below are from the actual half year profit release.

Net tangible assets as at 31st December 2015 were ($2,962.2m- $1,789.8m) = $1,172.2m

($2,962.2 - $1,789.8) / (1,366.2*2+204.9) = 39.9c

Income for the half year ended 31-12-2015 was -$1,492.7m including impairment losses. Take out the $1,335m of asset impairments and the loss reduces to:

$1,492.7m -$1,335m = $157.7m

Now assume that level of operationing loss continues for 2HY2015 (a worst case assumption).

The latest announcement on 'impairments' (15th June 2015) is as follows:

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Impairments

The company expects to record a further asset impairment charge of ~A$320 million in its financial statements for the year ending 30 June 2015, primarily related to the impact of forecast lower iron ore prices on its future cash flows

This includes an impairment of ~A$245 million in Mining, ~$45 million related to lower forecast ferrous margins in Recycling and
~$30 million related to Metalcentre, which is part of Steel’s Retail business.

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Assuming all of those new impairment losses are tangible (the worst case), and all asset sales for the year to date were at net asset backing, then the net tangible asset position of Arrium as at 30th June 2015 will be:

[($2,962.2 - $1,789.8) -$320.0- $157.7] / (1,366.2*2+204.9) = 23.7c

We are told the company will be right sized and profit positive for the start of FY2016 (1st July 2015). So this is the worst case new asset base to work from. I had an order in the market for a few days that was triggered yesterday at 15c. My average buy price is now 22.7c. Not sweating, even though it seems I have used up almost all of my safety margin!

The following calculation is made using the information in the balance sheet at the latest reporting date and the total number of shares currently on issue. Time to update the NTA of the company:

'Other' Intangible Assets and Goodwill are listed at $1,738.3m. This implies there are intangibles on the balance sheet not listed under the header 'other'. 'Mine development expenditure' ($92m) is the only listing in the asset column that is possibly 'intangible'. I had always considered 'Mine development expenditure' as a capitalised aseet before. But if that is 'intangible' in Arrium account terms them so be it.

NTA @ 31-12-2015 = [$2,328.4m - ($92.0m + $1738.3m)] / 2,937.3m = 17.0c

SNOOPY

[Snoopy]

The following calculation is made using the information in the balance sheet at the latest reporting date and the total number of shares currently on issue. Time to update the NTA of the company:

'Other' Intangible Assets and Goodwill are listed at $1,738.3m. This implies there are intangibles on the balance sheet not listed under the header 'other'. 'Mine development expenditure' ($92m) is the only listing in the asset column that is possibly 'intangible'. I had always considered 'Mine development expenditure' as a capitalised aseet before. But if that is 'intangible' in Arrium account terms them so be it.

NTA @ 31-12-2015 = [$2,328.4m - ($92.0m + $1738.3m)] / 2,937.3m = 17.0c

The question is, if the NTA is 17c, why is the share price stuck around the 2.5c level? The answer is that the market is expecting either

1/ a capital raising OR
2/ a debt to equity conversion OR
3/ a combination of both (1) and (2)

Any of these measures will mean a greater number of shares in on issue, over which the value of the company must be shared. As an indicative example, let's assume the GSO offer goes ahead.

One way of the raising the close to $A350m that the capital raising proposal suggests is needed woudl be to have a 10:1 cash issue at 1.2c. There are currently 2,937,293,755 shares on issue. So the amount raised in such a GSO underwritten rights issue would be:

2,937,293,755 x 10 x $A0.012 = $A352.2m - about right

Post recapitalisation, the net tangible asset backing for each share in the the company would change as follows:

NTA = (17c + 10(1.2c))/ 11 = 2.6c

This is more or less where the share price is trading now. So Mr Market has done his sums correctly, I think.

SNOOPY

[Daytr]

One very simple answer Snoop is the valuation of the assets is unrealistic and there are more write offs to come.
Goodwill? Hmmm unlikely to be much value left in that either.

[Snoopy]

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 probably see a potential Arrium investor pay too much, especially as the iron ore price could easily fall back again.

Investing in Arrium at these prices (24.7c) is not without risk. But it is a calculated risk that I am prepared to take.

I wrote the above on 20th November 2014. So my calculated risk did not pay off :-(. I did subsequently reduce my average price paid to 22.7c. But given the Easter Thursday ARI closing price was just one tenth of this, I can hardly say my risk mitigation strategy was successful. So what did happen to the Arrium iron ore mining profitability, during the period of precipitous iron ore price decline?

We can all choose to get excited by:

1/ daily iron ore price fluctuations, OR
2/ quarterly mining report profitability OR
3/ annual report smoothing and soothing comments

But I will look at none of these. Daily iron ore price fluctuations make little difference when over 70% of your business is on fixed price term contracts (the case for Arrium). The quarterly mining information covers IMO too short a time frame to get an understanding of where a business is going. Management would really struggle to make a meaningful response to market signals in only three months. One year, OTOH is just too long a time frame, when the iron ore price is fluctuating so wildly. So for my comparative periods, I choose six months, corresponding to management's half year update report releases to the markets.

CEO Andrew Roberts is forever stressing that it is the Australian dollar results that matter. So 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)

The non numerical summary of what happened goes like this.

1/ The iron ore price has declined dramatically in USD terms.
2/ The decline in the USD/AUD exchange rate has partially mitigated this decline in AUD terms. BUT
3/ the decline in the AUD price received (-38%) has not been matched by the AUD cost cutting that Andrew Roberts and his team have done over that same period (-24%).

Another point we shareholders have to remember is that these '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 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.

SNOOPY