Arrium Steel potential

I have been spending a bit of the downtime over Xmas going back through ARI's reports and trying to work out how the Steel business could look like in the coming years (given once we sell Mining Consumables and close Iron Ore it is all we have left). By the way I still believe we will generate a price for Moly Cop that will allow us to clear the debt (as otherwise why would the Board have approved continuing with the sale process once they saw the indicative bids in October). It is a quality global leading business with excellent growth prospects so in my view will definitely trade above 7x EBITDA and hopefully a lot more.

Anyway back to steel which has clearly turned a corner after a horror few years. EBITDA in H2 2015 was $46m with the statement made that it was "significantly weighted towards Q4". I take that as a minimum $30m in Q4 giving a rough run rate EBITDA of $120m p.a. Off the back of the infrastructure boom led largely by NSW the market for domestic steel is projected to grow by 5% p.a between FY16 to FY18. Arrium has said on several occasions that "on FY15 margins a 5% growth in steel volume drops $50m of EBITDA to the bottom line due to high amount of fixed costs inherent in the steel business. A lot of this growth is baked in given the long lead times of Infra projects. So that means if ARI can just keep market share then this would give us a rough EBITDA of $170m p.a. From steel in FY16 and a $270m p.a. By FY18.

Now where it gets interesting is the following. Arrium's margins on steel have been so thin the past few years that a little margin positive change goes a long way when you have $2.8bnnof revenue from Steel! So if either the $100m of additional savings comes through or the fact there have just been a heap of anti-dumping penalties ranging from 9% to 30% put on their Chinese competition gives us some more pricing power and we will start to see the real benefit of bottom line savings coming through.

I always remember Allan Gray saying they bought into ARI because of the steel business so maybe they see some of this too.

So where does this leave us and why do I hold (and actually averaged down last week). Because if my base case happens and we sell Moly at a price in February to clear the debt and cover costs. We either get Iron Ore to break even or shut it down. And we are left with a debt free business that earns from Steel alone $170m in FY16 (which by way is pretty much our entire market cap!) with visible growth out to $270m EBITDA in the new two years! Bluescope would pounce within weeks I suspect once Moly is gone.

Happy new year to all holders!