The contrasting tale of two Australian steel companies
BHP spun out two steel companies when it merged with Billiton and focused on mining. At the end of 2016, one is booming, the other is bust. James Perkins looks at why.
It’s the tale of two steelmakers in Australia. BlueScope Steel trades at multi-year highs on the local stock market, becoming a darling for investors, while its rival Arrium, under administration, is put to the guillotine, torn up and its parts sold to the highest bidder to pay back around AU$4 billion in debt. How did these two ASX-listed companies, one based in Sydney, the other in Melbourne, and both spun out of BHP in the early 2000s, reach such different fates?
To get to the bottom of this disparate turn of events, we must look back to the early 21th Century, when BHP decided to spin off its steelmaking operations to focus on mining alongside Billiton.
A turning point for BlueScope
In June 2015, at the height of the commodities crisis, BlueScope Steel put two options to its 5,000-strong Port Kembla workforce – accept 500 job losses and reduced employment conditions, or close the steelworks. Despite labelling it a “filthy rotten package”, the BlueScope staff, through the Australian Workers Union, chose option A – keep the plant, located on the Illawarra Coast south of Sydney, open. BlueScope Chairman, John Bevan says, ‘It was a 50-50 decision, and a very tense time’, but the company says it was an essential decision, as part of the relentless cost cutting required to keep the company afloat. In fiscal year 2016 (FY16), BlueScope achieved AU$235m in operational savings and is targeting AU$280m more in FY17.
Of those savings, 30% came from labour, 20% from raw materials and manufacturing, 15% from production efficiencies and 15% from overheads. The Australian plant achieved savings through initiatives such as:
Yield, flux and energy benefits through safely retaining a portion of the slag/metal mixture in the basic oxygen steelmaking furnace at the end of each time, which was previously tipped out every heat. This provided an earnings benefit of AU$11m in FY2016.
Robots were installed on the metal coating lines to move the steel strip at a critical point in the line operation. It is expected these robots will only take three months to pay back the investment cost.
The company also expects it can save around AU$50 million each year by installing automated cranes in its slab making department – a project it plans to undertake over the next two-to-three years.
Even with these savings, however, the chairman says the Port Kembla operations will continue only “for now”. ‘We need to deliver returns necessary to support a decision in 10–15 years, to reline the blast furnace at Port Kembla […] What we have made in the last year are essential steps toward being the competitive and profitable producer needed to support this future reinvestment opportunity,’ said Bevan.
So far, it is looking good for the future of the Port Kembla plant. Since the staff at Port Kembla steelworks, which makes around 5,000 tonnes of flat products per year, made that decision, ASX-listed BlueScope has shot up in value. It has almost tripled its share price in 12 months, from a low of AU$3.69 in January to AU$9.58 in late November. There are doubts about the sustainability of this run – Morningstar analysts have put a heavy ‘sell’ recommendation on the company, with ‘fair value’ of around AU$3.90 per share.
Matthew Hodge, Lead Analyst at Morningstar, says the company is on a firm footing compared to its ‘horrendous’ performance from 2009–13, but it lacks meaningful cost advantage and its patented coated flat steel products, such as the popular roofing product Colorbond, are not ‘moat worthy.’ Nevertheless, it is a remarkable turnaround and the company’s future is secure for the medium term.
Bevan lauds the ‘outstanding results’ achieved because of its cost cutting at Port Kembla, in addition to the strong performance of the newly-acquired North Star electric arc furnace at Ohio, which is rated one of the most productive in the USA. This culminated in a net profit after tax of AU$353.8m up from AU$136.3m the previous year. A strong increase in earnings allowed BlueScope to reduce its debt by AU$595.4 million to AU$779 million. It is expecting earnings before interest and tax in the first half of the 2017 financial year to be around 50% higher compared with the previous period – at least AU$510 milllion.
Looking ahead, the company has growth potential through the planned rollout of its proprietary branded steel products in Asia. Its North Star plant, which could be boosted by “Trumponomics” already engaged in paying back its debts – the day after Donald Trump’s election, BlueScope surged 16% in value. While BlueScope has been able to trade its way out of tough conditions amplified by poor management decisions through a series of capital raising ventures, cost cutting, a strong Australian construction industry, plus a smart purchase in America, Arrium was not so lucky.
The demise of Arrium
Arrium differs from BlueScope, in that it has iron ore mining and export operations, and its Whyalla steelworks produces long products, rather than flat. Just a few short years ago, Arrium, formerly OneSteel, benefited from having a mining division and invested to increase its output to 12 million tonnes per annum.
For a short while, with iron ore prices at record levels, Arrium, which employs around 8,100 people, enjoyed a golden run. It exported 12.5 million tonnes of hematite iron ore in 2013 from its mines in the Middleback Ranges, around 60km from Whyalla, where Arrium has its steelworks and export facilities. Its mining consumables business, Moly-Cop remains a profitable world leader in steel grinding media. In FY14, Peter Smedley, Chaiman of Arrium, said the company had enjoyed ‘strong results from successful strategy execution’, after net profit jumped 83% to AU$296 million on the back of record cash earnings – the mining business doubled earnings in 2013.
But things soon turned sour. In FY15, the mining business suffered an AU$600 million drop in cash generation because of the 40% fall in iron ore prices. The previous year iron ore was a major driver of the business. Chairman Jeremy Maycock, who has since resigned, said in 2015, ‘Prior to my joining the board last August (2014), it was widely regarded that iron ore prices would not fall below US$100 a tonne on a sustained basis. They have, and we had to respond quickly to reset the business.’ Arrium identified that its breakeven price for mining iron ore was US$47/dmt, but that is too high – fellow Australian iron ore miners Fortescue Metals, BHP and Rio Tinto have reportedly hit a breakeven point of around US$30/dmt.
Arrium went on to report a AU$1.9 billion loss in FY15. It was the beginning of the end. In the first half of 2016, the company’s net debt increased to more than AU$2 billion, compared with AU$1.75 billion the previous half. The mining division and the 50-year-old Whyalla Steelworks contributed AU$230 million to the new debt.
The Whyalla Steelworks, which produces around 1.2Mt of long products each year and employs 5,000 people, operated at a AU$43 million loss in the first half of the 2016 financial year. This came despite an increase in earnings and a rise in domestic demand for steel construction product. The Australian Government improved its anti-dumping tariffs in November 2015 and Arrium fought hard through the process to reduce the amount of Asian steel being dumped in Australia, and saw some positive results early in 2016, but the company said, ‘There is more to do.’
It searched for efficiency, but was only able to save AU$200 million over two years – half of what BlueScope has achieved. Arrium collapsed into voluntary administration in April 2016, under the care of Grant Thornton with around AU$2.8 billion in unsecured debt and a total of around AU$4 billion owing to creditors. The only profitable part of the business, Moly-Cop, was sold for US$1.23 billion in November 2016 to American Industrial Partners. Scott Kershaw, partner at KordaMentha, said, ‘The sale of Moly-Cop is the first step in realising value with the sale process for the remainder of the Arrium business ongoing.’ There are understood to be four interested parties in buying the remaining steel and mining assets, including an alliance between Liberty House and SIMEC, and South Korea’s POSCO.
The bidding process for the company is expected to stretch into this year, because of uncertainty regarding the value of the assets because of the rally in iron ore and coal prices. Meanwhile, the staff in Arrium’s mining and steel divisions keep working, and hope they will have a job through 2017.
James Perkins speaks to Roger Leaning, former metallurgist and Director of Corporate Advisory at stockbroker Morgans, in Brisbane, Australia.
Is it the iron ore business that sunk Arrium?
It is the timing of the cycle. When the iron ore price was high, Arrium was flying while BlueScope was hurting. When the iron ore prices dropped, it came down to the competitiveness of the Arrium operations in iron ore and steel and as the price iron ore dropped, Arrium struggled. Arrium’s space in the steel industry is competitive, adding to the challenge. When BHP spun out Arrium, the strategy was to vertically integrate the iron ore and steel businesses and that does have value. But you have to make sure the businesses are competitive and are not wholly reliant on one more than the other. To remain competitive at the various parts of the cost curve and remain cost competitive is a difficult thing to do.
BlueScope’s restructure ended up being a success.
BlueScope had a strategy to make the business cost competitive anyway. A high iron ore price is detrimental to the business, it pushes the costs up because the raw feedstock is at a high price. The strategy was required and necessary to make sure the business was profitable and sustainable when it comes off the cycle, and it is important that it maintains those productivity and efficiency gains.
And North Star has proved a smart buy?
Again, it is all about timing. At one stage BlueScope was criticised and now they are being congratulated – it is all about timing the market.
It seems the businesses are set up to have differing fortunes?
They are entirely different businesses with different products. Albeit they are both steel. They are operating at different parts of the value cycle. Three or four years ago, you could have written a story highlighting the success of Arrium while the opposite was happening at BlueScope. The key takeaway is that for all businesses, regardless of what sector they are in, or product or service they have, is that they need to have a broad, sustainable, long-term strategy.