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Here’s why Arrium Ltd popped 9% today

What: Shares in steelmaker and iron ore miner Arrium Ltd (ASX: ARI) (formally OneSteel) today jumped by as much as 10% on the back of a strong full-year report which included an 83% jump in underlying net profit after tax to $296 million. The swing to profit was largely a result of an expansion at Whyalla Port which enabled the Mining division to report a 51% increase of hematite sales and drive EBITDA to $686 million, up 86%, year-on-year.

Arrium achieved strong results despite a struggling Steel business, falling iron ore prices and, importantly for the Consumables division, depressed gold and falling copper prices. However, Arrium expects a 7% compound annual growth rate in demand for its products from North and South American markets until FY19.

So what: The market obviously wasn’t expecting much from Arrium today. But in addition to its big profit surprise it also announced increased cash flows, enabling it to declare a four cent increase in the full-year dividend payout (taking its yearly total to nine cents per share) and pay off around $400 million in debt.

Now what: The market was right to be sceptical of Arrium’s ability to grow profits. It has a cash cost of $48 per wet metric tonne of iron ore produced but its all-in-sustaining cost would likely be significantly higher than this figure. Couple that with a falling iron ore price and the miner’s margins are likely to continue to come under further pressure in the future.

With over $1.7 billion in debt, EBITDA interest cover of only 7.4 times (remember interest rates are low), sales margins of 9% and a return on equity of 8%, I think an investment in Arrium would be a risky one to say the least. In my opinion, if you want exposure to an expanding low-cost iron ore producer, buy Rio Tinto Limited (ASX: RIO) instead. Or if you want better high-risk/high-reward resources stocks, see below!

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Motley Fool Contributor Owen Raszkiewicz owns shares is long $47.53 Dec 2017 Warrants in Rio Tinto. To learn more about warrants, click here

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