Resourceful Arrium's future opens up

You’ve got to love it when a plan finally starts to come together and the plan that former chief executive Geoff Plummer devised for Arrium is finally starting to produce the outcomes envisaged.

Plummer, who retired earlier this year to be succeeded by Andrew Roberts, initially decided to integrate backwards from the former OneSteel’s steelmaking business into iron ore. Then as iron ore prices took off, he decided to greatly expand that business into an export operation. He also made a major expansion into mining consumables.

When – in the post-financial crisis period – domestic demand plummeted, the dollar spiked and iron ore prices soared, creating a crisis for the domestic steelmakers, the strategy Plummer had embarked on saved OneSteel and transformed it into something quite different. The change of name was designed to provide a punctuation point for the group’s new reality.

In the first half of the 2012-13 financial year the extent of the transformation in Arrium’s profile wasn’t particularly evident. Its numbers were swamped by massive writeoffs while the iron ore business, which was in a ramp-up phase that would double its production, was hit by the steep plunge in iron ore prices last September. The steel businesses lost money.

It didn’t help that, until relatively recently, the Australian dollar had remained stubbornly high despite the plunge in commodity prices.

A strand of the Arrium strategy was to create a natural hedge. If iron ore prices and consequently the Australian dollar were high, the adverse impact on the steel business from higher raw material costs and increased competition would be offset. If the iron ore price fell, so should have the dollar, benefiting the steel business.

For a while the dollar didn’t behave as it historically has.

Today Roberts unveiled an underlying profit for the year of $168 million. While that was lower than the $195 million the group generated in 2011-12, Arrium earned $117 million of it in the second half.

With the iron ore expansion, which has doubled the group’s production, finally hitting its sales run rate of 12 million tonnes a year in June and iron ore prices rebounding Arrium is finally in a position to properly benefit from the strategy it has been pursuing. The mining business generated earnings before interest, tax, depreciation and amortisation of $340 million in the year to June.

The combination of a lower Australian dollar, the higher iron ore prices and the increased output ought to be strongly positive for the mining operation’s profitability in the first part of this financial year. A one cent movement in the Australian dollar relative to its US counterpart impacts Arrium’s earnings before interest and tax by about $10-$12 million.

Plummer’s goal for the steel-making business was to run it for cash. He would have shut it down if he could but the prohibitive financial and social costs of closing the facilities and remediating the site at Whyalla made that unpalatable, so the goal was to stop it devouring cash.

The steel business generated positive EBITDA of $76 million, up 15 per cent, in the year to June, although it lost $43 million at an EBIT level ($56 million previously). Roberts has embarked on a further divestment and cost-cutting program and is combining his steel manufacturing and distribution businesses in a move expected to save about $40 million a year.

While it is probably unlikely to return to being a major profit centre for Arrium the lower dollar will benefit it and it would be highly leveraged to an improvement in domestic demand.

The mining consumables business contributed EBITDA of $197 million, up 15 per cent, and continues to prove itself as a reliable and growing source of earnings.

What would particularly please Roberts is that the group’s cash flow soared 26 per cent to $596 million.

Arrium is still carrying $2 billion of debt and while that will leverage the underlying momentum in the group’s performance while the current external settings remain in place there is little doubt he would prefer to reduce that debt and lower the inherent risk in his balance sheet. Assets sales from within the steel business that are expected to yield at least $200-$250 million will help.

This financial year will, if iron ore prices hold up and the dollar doesn’t surge again, provide a better sense of the potential of the new Arrium now that that the iron ore leg of the strategy is fully in place and the steel business is quite stable in cash terms.

The very positive sharemarket response to the result suggests it is confident that the strategy the group has been pursuing is beginning to produce, or at least produce more clearly, the desired outcomes.