Arrium's plum mining move

Geoff Plummer's decision to take manufacturer OneSteel into the mining and mining consumables businesses – and in the process rename the group Arrium – has provided a sturdy framework for the future.

Was Geoff Plummer a little premature in changing the name of OneSteel to Arrium earlier this year to reflect its transformation into a mining and mining-related business just as iron prices started to dive? It is improbable he’s had any second thought.

Arrium’s underlying results for the year to June that were released today may have been down 17 per cent and the earnings before interest and tax flowing from its mining operations may have been down from $524 million to $303 million but the results still validate Plummer’s strategy of transforming the old OneSteel from a steelmaking business into a group whose operations, and earnings, are now dominated by its mining and mining consumables business.

Like its former BHP sibling, BlueScope, Arrium has had to painfully and radically remake its former core as demand plunged after the financial crisis erupted and the strong Australian dollar and global steel mill over-capacity undermined its competitiveness. Unlike BlueScope, Arrium had created some natural hedges against the forces that destabilised its steelmaking activities.

The sharp fall in iron ore prices that accelerated through the June half may have impacted the contribution from Arrium Mining but it did provided a solid foundation for the group result and with production from Arrium’s new mine running on time and on budget its iron ore output will almost double once the mine is in full production. First sales from the expansion project are due in December this year.

That will generate extra export volumes to offset the lower prices that have emerged as China’s economy has slowed and its steel mills have started lowering production and their demand for ore.

Plummer’s strategy was further vindicated by the "other" diversification he made into mining, the building of Arrium’s mining consumables business into a world-leading business. It contributed $135 million of EBIT, up 107 per cent on the previous year.

While also exposed to the overall state of the global mining sector the economics of Arrium Mining Consumables are driven by volume rather than price and there are still a lot of new committed mining projects and expansions in the pipeline to underwrite its continuing growth.

Where only a few years ago OneSteel was almost entirely a steel company, today its traditional operations are a rapidly diminishing proportion of the Arrium group as the mining and mining consumable divisions continue to grow.

That’s not to say that they are or will be irrelevant within Arrium’s future.

Arrium delivered on its guidance that the OneSteel and recycling businesses would have positive earnings before interest, tax, depreciation and amortisation in the second half of the year. In the steel manufacturing business EBITDA for the year was a loss of $19 million – which was also the level of positive EBITDA in the second half as the group’s continuing cost reductions and a modest improvement in volumes were reflected in its performance.

At an EBIT level the business reduced its loss for the year from $185 million to $50 million. Given the prohibitive closure and remediation costs that would have been incurred if Plummer had decided to exit the sector an acceptable outcome for the steelmaking division would be if it does generate positive EBITDA. Plummer believes it can do better than that, particularly if the dollar were to weaken.

The OneSteel distribution business lost $10 million at the EBIT level while the recycling business experienced a fall in EBIT from $21 million to $7 million.

With continuing weak markets and an Australian dollar that hasn’t performed in line with its history, remaining stubbornly high even as commodity prices have fallen significantly, there will be continuing pressure on those businesses but the full benefit of the restructuring Arrium has done hasn’t yet fully flowed through.

Had the dollar performed normally, the manufacturing, recycling and distribution businesses would have provided something of a natural hedge against the lower iron ore prices.

Longer term that might still occur, particularly if domestic demand strengthens, although the dramatic shift in the nature of the group means its fortunes are now increasingly leveraged to the state of China’s economy and its demand for commodities.

Arrium is, because of the nature of the mining consumables business and the efficiency gains it will get from the big ramp up in its iron ore production and export capacity, less vulnerable than most resources groups to the shift in the sector’s emphasis from price to volume.

If the stabilisation and improvement in its manufacturing businesses remains on track there will be no reason to second-guess Plummer’s strategy or the name change it led to.