Arrium - So Where are we at?

Given the recent serious FX fluctuations & patchy conflicting & press going around value of Molycorp – thought it was time for a little stock take on where any of us remaining weary shareholders in Arrium’s are at. So – what do we know:   

Arrium has too much debt – undergoing strategic review at moment to sell significant assets to address this. Given current I/O & Steel backdrop – they will obviously need to sell all (or part) of Moly Cop. It is a highly prized business – number 1 & 2 in all its markets – and there is a significant line up PE & trade buyers interested. Data packs to interested bidders went out Friday before last I believe, and indicative bids are due by next Friday 18^th September.

A lot of conflicting press doing the rounds on value of Moly Cop (some of this could be quite deliberate – talk down the target), the most credible sources put forth following range of values:
- 11.2 x EBITDA (Average multiple achieved on comparable businesses over last 5 years, source AFR Street Talk 3^rd Sep).
- 9.3 x EBITDA (The multiple Arrium paid for Moly Cop back in 2010 - AFR 3^rd Sep).
- 9 x EBITDA (AFR Street Talk 20^th Aug - Citi analysts’ opinion).
- 8 x EBITDA (AFR Street Talk 20^th Aug - UBS opinion... once bitten twice shy??!)

http://www.copyright link/street-talk/arriums-molycop-grinding-out-strong-growth-20150902-gjd8ow

To get clearest picture of ongoing Moly Cop business (excludes divested wires & ropes business) see p86 of Annual results presentation. Also need to factor in fact that Moly Cop just coming to end of a significant cap-ex program to ramp up capacity, new facilities & next generation products – so significant uplift in FY16 projected sales versus FY15 actuals (USD 190M v USD 155.3M in FY15).

Given these sales are already evident YTD & no reason they won’t be sustained, plus ongoing projected 7% p.a. growth to 2020 - bidders should be very comfortable with strong revenue uplift & using FY16 projected EBITDA (rather than FY15 EBITDA numbers) to prepare bids.

Applying multiples talked about before to US190M, one gets a value range of USD 1.52 – 2.13 Bn. In interests of staying conservative, let’s stick with middle of road number of about 9.15 x EBITDA = USD$1.7385 Bn = AUD$2.51 Bn at yesterday’s exchange rate of about 0.693.

Before anyone gets too excited, have to remember that nasty debt pile, which has been quietly growing as the AUD exchange rate has fallen away. However thankfully only a portion of debt in USD, so net translation effect of Moly sale in USD outweighs damage of rising USD debt in AUD.

So how much do we owe?

First last published figure was Net Debt of 1.75Bn AUD as at 30 June reporting date, and can glean breakdown of this on p93 of Annual Results (1233M USD loans, 312M CAD = 1.934M AUD at prevailing exchange rates at reporting date (AUD:USD 0.7679 & AUD:CAD 0.9524) plus Finance Lease 10.7M = 1,945M AUD loans less Cash/Cash Equivalents 195M = 1.75Bn Net Debt.

	Column 1	Column 2	Column 3	Column 4	Column 5	Column 6
0	Actual Drawn Facillities - from p80 of Accounts​
1	Drawn Facilities at 30 June -	USD​	CAD ​	AUD​
2		Notes, Bilat	981.3​	312.4​
3		& Synd loans	252​
4		USD/CAD:	$ 1,233	$   312
5		AUD:	$ 1,606	$   328	$ 1,934
6			Finance Lease	10.7​
7					$ 1,945
8			less: Cash/Cash Equivalents	$ 195
9				Net Debt	$ 1,750

HOWEVER with pronounced slide in AUD then by my calculations we’re now looking at more like 1.935Bn Net Debt (using same liabilities & current (yest’s) exchange rates of 0.693 & 0.92 AUD/CAD)

	Column 1	Column 2	Column 3	Column 4	Column 5	Column 6
0	Actual Drawn Facillities - from p80 of Accounts​
1	Drawn Facilities at 30 June -	USD​	CAD ​	AUD​
2		Notes, Bilat	981.3​	312.4​
3		& Synd loans	252​
4		USD/CAD:	$    1,233	$ 312
5		AUD:	$ 1,779.91	$  339.57	$ 2,119
6			Finance Lease	10.7​
7					$ 2,130
8			less: Cash/Cash Equivalents	$ 195
9				Net Debt	$ 1,935

So, assuming Moly is sold in its entirety, & all debt retired, we should be looking at a surplus cash injection of about 575M (about 19.5 cps) less some transaction costs.

Now I know Iron Ore & Steel are hardly in vogue at the moment, and the outlook for both remain challenging, but keep in mind Arrium has already done most of the heavy lifting with respect to closing their high cost SI mine, redundancies, cost cutting in both Iron Ore & Steel and are now acutely focused on running both as efficiently as possible. Arrium has flagged 85M in additional redundancy/restructuring costs for FY16 (-2.9cps to 16.6cps cash), but could be little higher (July UBS analyst allowed for 105M to be safe = -3.5c to 16c cash & debt free). I imagine management have used the window of opportunity of capital raising & Moly’s strong revenue to take the hit from all these substantial one-off costs, so the streamlining of the remaining businesses should pretty much be done (cost outs have actually been impressive – see Pres).

So after 1H16, we will likely be the owners of a vertically integrated steel & iron-ore business, should finally be looking at better days ahead with significantly lower AUD, long overdue strengthening anti-dumping regime covering much of Arrium Steel’s import competition (see pp22 & 67 of results presentation on dumping measures/progress) and significant domestic construction & planned infrastructure activity.

So – the million dollar question is what’s the remaining business worth? Would welcome others input here, but few back of the envelope numbers to start:

Iron Ore – again lets be conservative. Put this one down to charity – run at average of breakeven for next few years. Ascribe zero value for now (but medium term should have reasonable value, especially with 85% of ore sales with contract customers p53).

Steel - FY15 EBITDA 61.8M & Recycling FY15 EBITDA 8.3M = Total say 70M EBITDA ongoing (actually with lower AUD , robust construction activity & ongoing significant cost cutting measures of past 12 months should be higher & good outlook at last).

So 70M bare minimum EBITDA = about 2.4cps annual earnings (not to mention Interest income on cash of c0.6cps p.a. at 3.5% rate), with zero interest & tax expense for the foreseeable future (& DA non-cash & likely disciplined & restrained cap-ex outlook for some time). So if put on an extremely conservative EV of 4.5 x EBITDA for these = bare minimum 13.5c EV. Add back on the 16c +/- surplus cash from Moly & pretty quickly looking at 30c+/- on very harshest FY15 earnings case, with significant upside potential and leverage to lower AUD at last & medium term improved international steel prices.

So anyway you cut it, given the significant buyer interest in Moly Cop then on very conservative valuation should see 30c in 12-18 months, even if ascribe zero value to Iron Ore operations. I’d like to think we’ll actually see 15-25c within 3-8 weeks, soon as Moly sale realisation announced & market removes going concern discount that has overhung the stock for past 12 months).

I suspect this is the kind of embedded value that Allan Gray saw when they got involved, although with harry hindsight we now know they could have got on board a lot cheaper (applies for most of us I’d say!).

Time will tell – but I believe Arrium has been heavily discounted for possible failure by the market, and steered clear of by the institutional shareholder base that management did such a good job alienating last year. A very understandable wait-and-see approach before non-holders consider getting involved again - but therein lies the opportunity for those who are game?

Would welcome anyone else’s meaningful contributions/insights…