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

[Snoopy]

Over at macrobusiness.com.au they refer to Arrium as the "iron ore zombie" - ie. its a dead man walking. I guess they, and the market, believe that Arrium will be bust before long, and it will be one of the first significant mine shutdowns as high cost producers are forced out of the market by BHP and RIO.

I found an article at "macrobusiness.com.au" titled:

"Thinking Iron ore miners? Think dot bomb stocks!"

This comes up on the site with today's date (October 6th). However, a web search on that header reveals the article was written back in July 2014.

http://sentirate.com/?p=30850

Furthermore it was written when the iron ore price was $97.17 for 62% FE futures. You'd have to give the authors kudos for predicting the subsequent decline of iron ore prices. But the rapid decline in iron ore price was what precipitated the Arrium recapitalisation. IOW the recapitalisation was designed with iron ore prices of $50, $60 in mind.

To use the 'macrobusiness' analogy KW, this is the view before the ambulance arrived. The 'dead man' (ARI) has received CPR from the emergency paramedics (the banks) and is now walking around again. Of course he is still fragile from his near death experience. But the correct treatament from here, IMO, is to watch him closely. Not knock up a coffin.

SNOOPY

[Snoopy]

This 'shortman' website is getting addictive.

http://www.shortman.com.au/

Yesterday at around 4pm NZ time, 9.19% of ARI shares were 'short sold'. Today it is down to just 3.46%. Obviously someone is buying up big to close out their shorts! Yet the actual head share price is still falling, down 0.3c to 35.7c from yesterday's close. I get the feeling it is close to bottoming out. But next week is a whole new week!

Monday's installment from 'Short man'. The biggest weekly move is Arrium. One week ago it was 10.78% shorted. Now the shorting is only 1.89%, down from 3.46% on Friday. All those shorters are rapidly closing out their positions!

The head share price is down again today by 0.8c to 34.7c, which is a bit strange given the collapse in the short position. Maybe the longs are getting out and overwhelming the buying from the shorts? Is this short man stuff really useful?

SNOOPY

[Snoopy]

The current value of the iron ore mines on their books are worth nowhere near what they could sell them on the open market for (who wants to buy an unprofitable mine now?), so that NTA per share is totally bogus. I would be expecting asset writedowns as well as negative earnings. And as soon as the asset writedowns hit the books, and the earnings interest cover falls, the miners are in breach of their banking covenants.

All the above is true, which is the reason for the soon to be completed recapitalisation of ARI.

The post recapitalisation net asset position for ARI is as follows:

($3,730.9m+$754.1m)/(1,366.2*2+204.9) = $1.53

Now I don't believe that asset value figure for a minute. I am expecting a huge loss of at least $2 billion for ARI this year as all the goodwill is written off. But guess what? Even with that huge loss booked my buy in position was still less than half of the net tangible asset position of ARI. So a loss of $2billion plus for ARI will still leave me in a very favourable position.

The net tangible asst value position, post recapitalisation, is as follows:

($1,766.8m+$754.1m)/(1,366.2*2+204.9) = $0.858

Now maybe even this is over inflated, and a further billion will have to be written off. But I will still be ahead, in surviving asset terms, even with this scenario. That is how cheap ARI is on the market at the moment. This is what buying with a margin of safety is all about.

And we all know how quick the banks are to shoot their dogs.

I have never met a banker who's secret dream is to become an iron ore miner. If the market goes down and you owe the bank $1m, then you have got a problem. If the market goes down and the company owes the bank $100m, then it is the bank that has a problem.

SNOOPY

[Stranger_Danger]

> PS. Maybe the looming capital losses on mining company loans are the reason the banks are being sold down the river too?

Or maybe the mining and associated problems will lead to redundancies and mortgagee sales, shining a torch at the "enchanted" property market, and that is why the bank shares are being sold down the river?

Gosh. You mean Australia doesn't walk on water, perfect and oblivious, permanently? Whowouldathunkit, huh.

Re ARI, still haven't bought. Itchy trigger finger. Not yet.

[percy]

Don't know what affect this will have,but BHP says it will now be able to produce iron ore ,excluding the cost of shipping and Govt royalties for less the $US 20 [A$21.64] per tonne in the medium term,after spending $25 billion on its supply chain over the past decade.

[Snoopy]

I found an article at "macrobusiness.com.au" titled:

"Thinking Iron ore miners? Think dot bomb stocks!"

This comes up on the site with today's date (October 6th). However, a web search on that header reveals the article was written back in July 2014.

http://sentirate.com/?p=30850

Furthermore it was written when the iron ore price was $97.17 for 62% FE futures. You'd have to give the authors kudos for predicting the subsequent decline of iron ore prices. But the rapid decline in iron ore price was what precipitated the Arrium recapitalisation. IOW the recapitalisation was designed with iron ore prices of $50, $60 in mind.

The decline in the iron ore spot price is certainly not helping ARI. However, it may not affect them as much as some here think.

ARI do sell on the spot market, but mostly into long term contracts. The contract/spot sales split trend is as follows (source Arrium Mining full explanation section of annual report in respective years):

Year	Contract Sale Percentage	Spot Sale Percentage
2012	65%	35%
2013	70%	30%
2014	75%	25%

It looks to me like Arrium have been busy locking in longer term contacts for some years to guard against just such a spot price iron ore downturn we are now seeing.

SNOOPY

[Snoopy]

And as soon as the asset writedowns hit the books, and the earnings interest cover falls, the miners are in breach of their banking covenants.

Time to investigate exactly what the banking covenants for ARI are.

1/ Gearing ratio > 50%.

Not an issue since the October 2014 recapitalisation.

2/ EBITDA / Debt servicing > 3.0-3.5 (Interest cover)

After recapitalisation the historical interest cover ratio is 5.2.

For FY2014 the EBITDA contributions from the various business units are as follows:

EBITDA Mining	$685.9m
EBITDA Mining Consumables	$187.1m
EBITDA Steel	$50.8m
EBITDA Total	$923.8m

Assuming the other divisions when added hold their own (I believe a realistic scenario) , we can work out how far the EBITDA for mining has to fall before the banking covenants need to be revisited.

$928.3m x (3.5/5.2) = $624.8m

That is a reduction in EBITDA of

$928.3m - $624.8m = $303.5m

Assuming all that comes off the iron ore exporting, our 'danger' EBITDA figure to look out for is anything below:

$685.9m - $303.5m = $382.4m

This is the kind of figure that was achieved by the iron ore mining division in FY2013

SNOOPY

[Snoopy]

Don't know what affect this will have,but BHP says it will now be able to produce iron ore ,excluding the cost of shipping and Govt royalties for less the $US 20 [A$21.64] per tonne in the medium term,after spending $25 billion on its supply chain over the past decade.

For comparison Arrium figures for FY2014 were as follows:

Loaded cash cost	$A48-50 per tonne
Freight	$A15 per tonne
Royalties	$A3 per tonne
Overheads	$A5 per tonne
Wet to Dry	$A2 per tonne
Total Delivered Cash Cost	$A73 per tonne

SNOOPY

[Snoopy]

Is there any visibility into the length of the contracts and when they expire? If they expire quickly then it simply delays the problem. I found this with HDX - half their contracts were due to expire in a period of 12 months, and it was obvious that new contracts were not going to be renegotiated at the same rates (if at all). I believe most "long term" contracts are only 3 months.

http://www.ft.com/cms/s/0/2c49991e-f...#axzz3FWSYcrfo

No mention was made by Arrium of how long a contacted period is. Perhaps that kind of information is commercially sensitive?

Up until 2012, Arrium and BHP were linked selling their iron ore through one agency. I think BHP tends to arrange one year contact deals with their big customers. At a guess I would say that one year deals are likely still. But I don't know for sure.

Secondly, what is stopping customers from defaulting on the contract, and instead buying at the cheaper spot price?

I doubt if even the Chinese could afford to be that blatant in disregarding the law. The purpose of a long term contact is to provide price certainty for both sides who arrange the deal. If the Chinese reneged on such a contract now, not only would they face legal action in Australia. They would probably never to trusted to sign any delivery contacts ever again. I really doubt the Chinese could afford to risk that.

SNOOPY

[Snoopy]

Monday's installment from 'Short man'. The biggest weekly move is Arrium. One week ago it was 10.78% shorted. Now the shorting is only 1.89%, down from 3.46% on Friday. All those shorters are rapidly closing out their positions!

The head share price is down again today by 0.8c to 34.7c, which is a bit strange given the collapse in the short position. Maybe the longs are getting out and overwhelming the buying from the shorts?

A Wednesday update from 'short man'. ARI shorting has now reduced from 1.89% to 1.32%. That is nowhere near the top 100. Looks like the 'big ARI short' is over. Arrium is up on the market today, admittedly by a measly 0.6% or 0.2c to 34.7c as I write this.

SNOOPY