Seeing past the dross at a newly forged Arrium

Geoff Plummer's turnaround strategy for Arrium is strong, and if it wasn't for last year's unfortunate slump in the iron ore price and persistently high dollar, the headline numbers would look a lot better.

Headline numbers can be misleading. Despite a statutory loss of nearly $450 million, Arrium's Geoff Plummer will feel that he has largely completed the challenging task he originally set himself when he hands over the helm of the former OneSteel group to Andrew Roberts later this year.

Even Arrium’s underlying numbers, which show a fall in earnings from $77 million to $51 million, don’t reflect the underlying position of the group because the December half was a period where Arrium was caught in the final phase of its transition from what it was to what it is while being hit by factors beyond anyone’s control.

The stock market obviously now gets the difference between OneSteel and Arrium because the group’s share price, which had already bounced strongly off its lows of around 50 cents last year, when it was being pursued by the Steelmakers Australia consortium, held its ground around the $1.20 a share level in response to today’s result.

Plummer’s strategy for avoiding the fate that almost overwhelmed OneSteel’s former BHP Steel sibling, BlueScope, has been to diversify away from steel manufacturing and distribution into iron ore mining and mining consumables.

The financial and social cost of exiting steel making and shutting down the Whyalla blast furnace and steel-making facilities (and remediating the site) was too prohibitive, so Plummer’s ambition there was to at least get the cost bases in those businesses down to the point where they were cash positive.

Had it not been for the plunge in iron ore prices last September to $US87 a tonne just as Arrium was ramping up its iron ore production and shipments, and the continuing strength of the Australian dollar, the results of that strategy and the quality of its execution would have been far more evident.

The plunge in the iron ore price (which has since rebounded to around $US157 a tonne) cost the group at least $110 million to $120 million of earnings before interest and tax in the half while every one cent movement in the Australian dollar relative to the US dollar impacts the group’s EBIT by more than $10 million a year.

The combination of Arrium’s "old" businesses – its steel manufacturing and distribution businesses – lost money in the half, with manufacturing improving its loss at the EBIT level from $94 million to $27 million, although distribution generated positive EBIT of $1 million against a loss of $10 million previously. Arrium’s recycling business lost $8 million at the EBIT level against a $2 million profit previously.

At the earnings before interest, tax, depreciation and amortisation level, however, manufacturing and distribution produced positive EBITDA of $35 million, a $78 million improvement on the same period previously. Plummer’s goal was to get those businesses into positive cash-positive territory and he achieved it despite the impact of the Australian dollar and soft domestic demand.

The performance of the newer ‘’growth’’ businesses – iron ore and mining consumables – was impacted by that abrupt and relatively short-lived fall in the iron ore price.

The mining business, despite lifting sales volumes by 9 per cent, experienced a 48 per cent fall in EBIT from $171 million to $118 million. The mining consumables business (which Roberts leads) however, lifted its EBIT 23 per cent from $65 million to $80 million.

The big recovery in the iron ore price and the continuing ramp-up of iron ore production ought to flow through to a much stronger second-half performance even if the price falls back from its current levels.

The mining consumables business (where Arrium has global industry leadership) has demonstrated that it has both solid growth potential and resilience and Arrium remains very enthusiastic about its prospects.

The environment for steel remains difficult, with the dollar’s abnormal behaviour in not moving in tandem with commodity prices meaning that the business, and indeed the wider group, has lost a natural hedge.

The quality of the work Plummer has done on its cost base was tested during the December half and stood up, however, and provided it continues to be cash positive as a minimum, Arrium’s other business can continue to carry it.

With hindsight, the Steelmakers Australia consortium – Hong Kong commodities trader, the Noble Group, South Korea’s POSCO and some Korean pension funds – timed their run at Arrium (originally at 75 cents a share) near-perfectly.

Also with hindsight, however, their approach and the subsequent return at 88 cents which were instantly dismissed by the Arrium board did help the market focus on the profound differences between the OneSteel Plummer inherited and the Arrium that he will soon hand over to Roberts.