Arrium's profit proves bid snub has paid off
At the end of September, Posco and Noble proposed a 75¢ a share cash takeover of Arrium, the group that was spun out of BHP in 2000 as OneSteel.
Arrium's shares had been as low as 50¢ a couple of weeks before as a dive in the iron ore price to a low of $US86.70 a tonne posed questions about the wisdom of its decision to effectively recreate the old BHP structure by developing a substantial iron ore mining operation alongside its steel and steel-related businesses.
Boards have an obligation to get the best return for their shareholders. When someone knocks on the door, they need to have good reasons not to engage, and Posco and Noble were offering 50 per cent more than the shares were selling for a fortnight earlier. After consulting with their advisers, UBS, Arrium's board nevertheless announced that the $1 billion bid was unsolicited, opportunistic, highly conditional, short of fair value, and would be ignored.
A bounce in the iron price from its $US86.70 a tonne low on September 5 to just over $US100 a tonne by the time Posco and Noble appeared with their offer had strengthened the board's resolve, and when Posco and Noble bumped their offer to 88¢ a share a month later the iron ore price was about $US120 a tonne: Arrium snubbed its suitors even more definitively, saying the new bid wasn't even close.
Arrium's shares fell by almost 13 per cent from 78.5¢ to 68.5¢ on the news, but as iron ore prices continued to rise they recovered, and began to make the takeover offer look like what Arrium said it was - a highly opportunistic asset-grab. They jumped from 93.5¢ on February 5 to $1.26 the day before Tuesday's profit announcement, and although they eased to $1.235 as the numbers were digested, there was enough in them to confirm the calls that the board made in September and October.
You need to be an optimist to believe that iron ore will hold all of its price rebound. Prices fell last year as the Chinese economy slowed and Chinese steel mills ran down their stocks of raw materials including iron ore. The recovery partly reflects the rebuilding of stocks that is nearly complete, and when it is, underlying demand will be tested.
Reserve Bank board members heard much the same thing when they met and kept the cash rate unchanged at 3 per cent on February 5: minutes of the meeting released on Tuesday record that they were told that while the jump in iron ore prices in the previous two months reflected both stronger demand for steel in China and the rebuilding of depleted Chinese steel mill inventories, iron ore prices had run well ahead of Chinese steel prices in recent months, "and it was widely expected that iron ore prices would not be sustained at these high levels".
Arrium's steel businesses struggled to break even in the December half, and generated goodwill write-downs of $470 million including a $431 million write-down of the Tubemakers business that was taken over by BHP in a $1.1 billion deal in 1996, and spun out in 2000 inside OneSteel.
It is becoming less important as Arrium's other businesses grow, however, and is not in the Dutch Disease ward alongside industrial companies that have been terminally damaged by the resources boom and its companion, a super-charged Australian dollar: rationalisation including the planned sale of Tubemakers gives it a fighting chance of a decent earnings recovery when the $A falls and Australian domestic demand picks up.
What Arrium prosaically calls its "mining consumables business" meanwhile lifted earnings before interest and tax by 23 per cent to $80 million in the half, almost double the $43 million it contributed in the second half of 2010-11. It supplies grinding materials including grinding balls to miners, which means that its profits are tied to mining activity, but appears to be justifying Arrium's decision to expand with a $932 million takeover of assets owned by Anglo American in 2010.
Imminent expansion of iron ore production is the key to Arrium's share price rally since Posco and Noble were sent packing, however.
Iron ore mining earnings before interest and tax fell by 48 per cent to $88 million in the December half as the iron ore spot price fell from an average of $US160 a tonne in the December half to $US118 a tonne, but that was on production of only 3.4 million tonnes, including just 126,000 tonnes from Arrium's new iron ore business, Southern Iron, which began shipping ore in October.
The stronger iron ore price is good if it lasts, but the real earnings driver is the production ramp-up at Southern Iron that is under way. It should see the group shipping at an annual rate of 11 million tonnes by June this year, and 13 million tonnes by August, on an average cash cost of about $US50 a tonne.
mmaiden@fairfaxmedia.com.au
Frequently Asked Questions about this Article…
Arrium's December-half result wasn't spectacular, but it was strong enough to support the board's decision to reject the Posco/Noble bid. The results helped confirm chairman Peter Smedley's call (after advice from UBS) that the unsolicited offers were opportunistic and short of fair value. The shares had rallied into the profit release, backing the view that walking away from the offers was justified.
Posco and Noble first proposed a 75¢ per share cash takeover (later bumped to 88¢). Arrium's board, advised by UBS, called the $1 billion bid unsolicited, opportunistic, highly conditional and short of fair value, so they chose to ignore it. A rebound in iron ore prices also strengthened the board's resolve to stay independent.
Iron ore fell to about US$86.70/tonne in early September, then climbed to just over US$100 when the offer first appeared and to roughly US$120 when the offer was increased. Those price moves influenced investor sentiment: Arrium shares fell almost 13% on the initial takeover news but later recovered, rising from about 93.5¢ on Feb 5 to $1.26 the day before the profit announcement as iron ore and production expectations improved.
Southern Iron is Arrium's new iron ore business that began shipping in October. It contributed just 126,000 tonnes in the December half, but the planned ramp-up is key: Arrium expects to be shipping at an annual rate of 11 million tonnes by June and 13 million tonnes by August, at an average cash cost of about US$50/tonne. That production increase is the main earnings driver if the volume ramp-up and favourable prices hold.
Arrium's mining consumables business lifted earnings before interest and tax by 23% to $80 million in the half, up from $43 million previously. It supplies grinding materials (including grinding balls) to miners, so its profits track mining activity and help justify Arrium's expansion moves, such as the $932 million 2010 takeover of Anglo American assets.
Yes. Arrium's steel businesses struggled to break even and the group took $470 million of goodwill write-downs, including a $431 million write-down on the Tubemakers business. Management is pursuing rationalisation, including the planned sale of Tubemakers, to support an earnings recovery.
The article cautions that sustaining the iron ore price rebound isn't guaranteed. The recovery partly reflected Chinese mills rebuilding depleted inventories, which may soon be complete and then underlying demand will be tested. Reserve Bank minutes noted iron ore prices had run ahead of steel prices and were widely expected not to be sustained at very high levels—so sustainability depends on both price trends and Southern Iron's production ramp-up.
Based on the article, investors should watch: iron ore price trends (and whether the recent rebound holds), Southern Iron's production ramp-up to 11–13 Mtpa and actual shipment figures, mining consumables earnings (which track mining activity), progress on Tubemakers rationalisation or sale, and overall steel business performance. These factors will drive Arrium’s earnings and share performance.
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