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

[Joshuatree]

Open Briefing

http://www.openbriefing.com/OB/Arrium-Limited/2015/8/19/2H15-Results-Presentation/1870.aspx

[Joshuatree]

This is a risky play . After reading and listening to the open briefing I'm feeling ok about this investment @ my entry point 12.5c.Lots of wiggle room and options and some improvements in the cot cases , well steel anyway.And costs per tonne of Iron ore are there already with maybe a few $ per tonne profit not withstanding a new bottom could still be ahead of us.The Strategic review and decisions down the track re whether to unload the best asset{lots of willing buyers) or lesser ones will hopefully unlock the value stuck in Arrium atm.S/P weak ; lots of manipulation and shorting?
I await the prodigious dot joining of Snoopy.

[Snoopy]

At corporate's request, I have repeated my forecast FY2015 EBITDA cover calculation, assuming a much lower iron ore EBIT. Updating my post in the format of post 120.

FY2015 (forecast)	Iron Ore	Mining Consumables	Recyclables	Steel	Total
EBIT	$19m	$140.0m	$1.3m	$-52.8m
EBIT (corporate)	-$15.9m	-$11.1m	-$11.0m	$-27.4m	$42.1m
D & A	$204.6m	$47.3m	$10.8m	$103.6m	$366.3m
EBITDA	$207.7m	$176.2m	$1.1m	$23.4m	$408.4m
Net Interest Bill	$23.6m	$21.6m	$12.2m	$37.4m	$94.8m
EBITDA/Interest	8.8	8.2	0.09	0.63	4.3
Tax Payable					$33.4m
Net Interest Bill					$94.8m
EBDA					$280.2m

The key figure (in the box) of 4.3 is still 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, even with steel at USD60, and the prevailing exchange rate at AUD1 = USD0.8310.

My main interest in the just released Arrium result is the underlying free cashflow. I measure this by taking the EBITDA figure and subtracting out the 'I' (net interest) and 'T' (current year tax) that has to be paid. Some here may wonder why, when Arrium has declared such a huge loss for the year, do they pay any tax? The reason is the Molycop subsidiary, largely based in the Americas, is highly profitable.

EBIT figures have been adjusted from those published for each division to include unallocated corporate costs (total $54.4m).

FY2015 (actual)	Iron Ore	Mining Consumables	Recyclables	Steel	Total
EBIT	-$97.4m	$153.0m	-$2.4m	$-33.2m
EBIT (corporate)	-$9.1m	-$15.9m	-$11.0m	$-29.4m	-$45.4m
D & A	$187.6m	$57.5m	$10.7m	$95.0m	$350.8m
EBITDA	$81.1m	$194.6m	($2.7m)	$32.4m	$305.4m
Net Interest Bill	$22.1m	$18.1m	$10.9m	$37.4m	$88.5m
EBITDA/Interest	3.7	10.8	NM	0.87	3.5
Tax Payable					$34.5m
Net Interest Bill					$88.5m
EBDA					$182.4m

The critical EBITDA/I figure is still within the acceptable 3.0 to 3.5 guidance band, so banking covenants have not been breached.

Free cash flow was actually around $100m less than I thought. That is quite a large difference. Looking further up the table it looks like it was almost entirely because of the much lower contribution from iron ore. The free cash flow (EBDA) figure that I have calculated above must also fund new capital expenditure. During FY2015, the following capital expenditure was made (listed under the segmented results):

1/ Mining Consumables: $81.2m
2/ Mining: $271.8m
3/ Steel: $61.1m
4/ Recycling $4.7m

Obviously that made quite a hole in the so called 'free cash flow'. But much of this expenditure will have benefits that flow well beyind FY2015.

SNOOPY

[Snoopy]

Free cash flow was actually around $100m less than I thought. That is quite a large difference. Looking further up the table it looks like it was almost entirely because of the much lower contribution from iron ore.

I need to understand what is going on here with my iron ore model. Iron ore earnings were estimated using the method worked through in my post 107 of this thread. So time to review my estimation methods. The basic method is to

--------

A/ Take a known EBIT figure for FY2014

B/ Multiply the known EBIT by a ratio of net profit margin between the two comparative periods.

---------

The data used to do this was as follows:

1/ Divisional EBIT for mining in FY2014 was $A481.3m (AR2014 p83).

2/ I seem to have used the Platts CFR index price, $US123/dmt for FY2014 as a comparative base (AR2014 p12). This is not the average price that Arrium got for the year. That was $US111/dmt. I had assumed that lower cost received was all down to Arrium's grade of iron ore being lower than the Platts CFR index comparative grade. But I suppose it might also be due to timing, with proportionately more ore being sold at lower prices late (after the index value slumped) in the year compared to the 'average' mine across all the industry. IMO the comparative figure being used doesn't really matter, as long as you are consistent between the two comparative periods.

3/ I have assumed the same tonneage of Iron Ore was shipped out in FY2015 as FY2014. Actual figures were 12.5Mt for both years, so my assumption was correct.

4/ Indicative AUD to USD exchange rate at the time the capital raising prspectus was signed off (15th September 2014): $US0.9121 = $A1.0000. (Note this is a 'spot' exchange rate. The average exchnage rate throughout the year will in reality be different.) Average over FY2015 was $US0.7721 = $A1.0000 (source Oanda).

5/ Actual calculation using fines cost ratio, using information from Corporate (post 170) was:

EBIT(2015)= $A481.3m x [($US53.5m - ($A68.4m x 0.8270)]/[($US123m - ($A73m x 0.9121)] = -$A26.2m

That is getting closer to the -$97.4m result that actually happened. I will have to do some more fiddling around with exchange rates and prices received to see if I can get closer still.

SNOOPY

[Snoopy]

Snoopy, you bought your shares at 38c - the share price is now 10.5c (after dropping to a low of 9.6c). That is value destruction of an order of magnitude - a 72% loss of capital.

I bought some shares at 38c. However may average buy in price is well below that figure. The average price is what I look at, because once an individual share it bought, it loses all memory of what price it is bought at.

To get back to where you started the ARI share price needs to go up by 365%. What is the likelihood of this happening in the near future?

NTA is in the high 20c. So provided we still have a business generating reasonable income, even 38c is still only a 25% premium to NTA. That still looks achievable at some nebulous point in the future to me. So, I am not too worried about where ARI shares are priced by Mr Market today.

The problem with valuing Arrium is that we have a very large debt that is somewhat matched in value on the other side of the scale by a very large asset, with good prospects (Molycop). The value of the company is largely determined by the difference between two very large numbers. Thus a small increase in the debt, or conversely a small increase in the value of Molycop can bump the value of the ARI share price around a lot, very quickly.

The solution to this dilemma is to better refine my valuation model. A $100m error in part of my EBIT is not normally critical in a company of this size. However, with Arrium my original model is no longer precise enough. Put simply, so far I have been wallowing around in the red mud in my gumboots. I need to trade in those gumboots for a less blunt tool - ballet shoes! With ballet shoes I have to think more whre I put my feet or I will fall over. I need to find firmer ground than the mud I have been slopping around in up to now (hence the need to refine my model). The real question you need to ask is "Can Snoopy dance?" And over the next few months you (we) get to find out!

SNOOPY

[Snoopy]

Not just a hole in the free cash flow, a negative free cash flow when capital expenditure to replace the company's assets is included.
We aren't talking about a hydro dam but big capital intensive holes in the ground and steel making plant?
Stuff what needs replacing.

If Arrium decide to completely run down iron ore then , no, not everything does need replacing. Steel is good for the next five years. Most of the capital expenditure on Molycop is done, while most of the value of that spending is yet to kick in. So I think it is far too soon to write off Arrium yet.

The question is, how much is the 'stay in business' capital expenditure going forwards? If you drill down into the annual result presentation you will see it is far less than those FY2015 figures that I quoted

I was hoping for clarity on the business with this result but we are still none the wiser on the iron ore mines, dragging on the good businesses.
"Instead of a cross, the albatross: about my neck was hung"
Until I know they can get rid of the albatross I have to sit on the sidelines, classic turnaround situation though.

Andrew Roberts knows the score with iron ore (or at least he does now!). Don't get spooked with spot market iron ore figures. Remember 75% of the iron ore produced by Arrium is not priced on spot rates.

SNOOPY

[cammo]

Im sitting on snoopys side of the fence. Unless somebody makes a dive for the molycop part or their supply contracts come up for renegotiation and they get hammered down in price, this is still a good med-long term play here.

[Snoopy]

I need to understand what is going on here with my iron ore model. Iron ore earnings were estimated using the method worked through in my post 107 of this thread. So time to review my estimation methods. The basic method is to

--------

A/ Take a known EBIT figure for FY2014

B/ Multiply the known EBIT by a ratio of net profit margin between the two comparative periods.

---------

The data used to do this was as follows:

1/ Divisional EBIT for mining in FY2014 was $A481.3m (AR2014 p83).

2/ I seem to have used the Platts CFR index price, $US123/dmt for FY2014 as a comparative base (AR2014 p12). This is not the average price that Arrium got for the year. That was $US111/dmt. I had assumed that lower cost received was all down to Arrium's grade of iron ore being lower than the Platts CFR index comparative grade. But I suppose it might also be due to timing, with proportionately more ore being sold at lower prices late (after the index value slumped) in the year compared to the 'average' mine across all the industry. IMO the comparative figure being used doesn't really matter, as long as you are consistent between the two comparative periods.

3/ I have assumed the same tonneage of Iron Ore was shipped out in FY2015 as FY2014. Actual figures were 12.5Mt for both years, so my assumption was correct.

4/ Indicative AUD to USD exchange rate at the time the capital raising prspectus was signed off (15th September 2014): $US0.9121 = $A1.0000. (Note this is a 'spot' exchange rate. The average exchnage rate throughout the year will in reality be different.) Average over FY2015 was $US0.7721 = $A1.0000 (source Oanda).

5/ Actual calculation using fines cost ratio, using information from Corporate (post 170) was:

EBIT(2015)= $A481.3m x [($US53.5m - ($A68.4m x 0.8270)]/[($US123m - ($A73m x 0.9121)] = -$A26.2m

That is getting closer to the -$97.4m result that actually happened. I will have to do some more fiddling around with exchange rates and prices received to see if I can get closer still.

A slightly different point of view on the same strategy. I am now going to use the actual prices received plus the actual costs incurred by Arrium. The FY2015 figures are from the operating and financial review (p4) which form part of the FY2015 annual results increase.

"Arrium’s average price for the year was US$59/dmt CFR, down 47% from US$111/dmt for the prior year. In Australian dollars, the average price for the year was $70/dmt. The average loaded cash cost for the year was A$45.7/wmt, down from A$48.2/wmt."

For those who don't know 'Cost and Freight - CFR' is trade term requiring the seller to arrange for the carriage of goods by sea to a port of destination. IOW the cost of freight from Australia to China must be added on. The 2015 results presentation targets this cost to be $US12/t, so this is the figure I have used, being unable to locate the equivalent figure for FY2015 or FY2014. I have added that figure to teh loaded cash cost. From the same reference I have added $1/t for 'Royalties' and $2/t for the wet to dry conversion and $3/t for 'local' overheads (crushing, benefication, road haulage and transhipping), but not corporate head office costs. (Corporate costs are treated separately in the segmented annualised results.)

For exchange rates, the Oanda website gives the following annual averages for the 1st July to 30th June financial years:

FY2014: AUD1 = USD0.9403
FY2015: AUD1 = USD0.7721

However, Arrium has a hedging policy for their overseas currency transcations as outlined in AR2014 sections 8e and 8f

"The options are being used to to hedge the foreign currency translation risk associated with highly probable sales of iron ore and scrap mertal in USD against fluctuations in AUD/USD exchange rate."

The overwhelming amount in this trade referred to in FY2014 was in iron ore, not recycling. So I have used the hedged currency figures that in both FY2014 (USD1 = AUD0.9800) and FY2015 (USD1=AUD0.8700) were less favourable to Arrium than the actual average year currency figures.

EBIT(2015)= $A481.3m x [($US59m - ($A45.7m+$A18m)x 0.8700)]/[($US111m - ($A48.2m+$A18m)x 0.9800)] =

= $A481.3m x [($US3.581)]/[($US46.1m] = +$A7.7m

Considering I am traying to estimate the actual FY2015 EBIT divisional result of -$A97.4m, this is an unacceptable estimate. I will only get a loss EBIT figure if the price received for the iron ore is less than the cost of extraction and transportation. Even with the 'worst case' figures' I have used I am nowhere near seeing that. So I am no nearer figuring out how Arrium made an EBIT loss on iron ore in FY2015. As Charlie Brown would say: Arrrrgh!

SNOOPY

[Snoopy]

This seems like an awful lot of work to do in return for the possibility of a return in the future. It would have been far easier to have purchased a company whose stock was in an uptrend and made 50% or more already, without any of the stress or worry

So every uptrend makes 50%? Or the average of all your uptrends is 50%?

The problem with this kind of overall trend approach is that Arrium is quite a complex little beast. The divisions are not all trending the same way, so you will never gain an understanding as to what will ultimately drive the share price by looking at any 'big picture' as reflected in today's share price. My stress (sic) can only be relieved by finding out what is going on inside a company that is driving the share price movements we observe. Half of the shareprice movements on the last few months have been market related as all sector shares in the resource sector have been hit. I am most interested in the Arrium specific proce driving factors.

SNOOPY

[Joshuatree]

prospective bidders lining up for molycorp

http://www.theaustralian.com.au/busi...-1227498808672

If you can't get past paywall , google it. $1.5 to $1.8 bill suggested.Shareholder approval not needed either?.