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Arrium Ltd: How investors were sold a lemon

From time to time as a stock picker, writer and analyst I read a recommendation that upsets me for the danger it presents readers. It seems that some are happy to encourage investors to buy, but don’t let them know when to sell.

Case in point is the Managing Director of listed investment company Cadence Capital Limited (ASX: CDM), Karl Siegling, who recommended Arrium Ltd (ASX: ARI) in September 2013 and then again in January 2014 when he said: “Iron ore and steel manufacturer Arrium is trading on 5 to 6 times cash flow, which means it is very cheap.”

That’s not correct, in my opinion – and  I said so at the time. The reason is because 5 times cashflow is not cheap for an iron ore miner when the iron ore price is at historic and unsustainable highs. As I said back then, “I’m not willing to risk such exposure to the iron ore price,” not to mention the heavy debt load carried by the company.

Let’s have a look at how the share price has fared since then.

ASX ARI

Whether you blame an increase in supply from the likes of Rio Tinto Limited (ASX: RIO), or weakening demand from a Chinese residential market in which over 20% of homes are apparently vacant, the falling iron ore price has smashed Arrium’s share price – just as I had feared.

What really annoys me is that Karl Siegling’s fund, Cadence Capital was lowering its portfolio’s weighting of Arrium shares even before January. According to Cadence Capital’s monthly investment updates, Arrium shares were 6.3% of the portfolio on November 30th 2013, but only 3.7% of the portfolio by December 31st, 2013. By January 30 2014 Arrium was 3.3% of  the Cadence Portfolio and by March 31 it was 2.1%. By the end of May 2014, it was less than 1%, if it was in the portfolio at all. I would have thought readers might have been interested in this fact.

Karl Siegling was smart enough to sell plenty of Arrium shares above $1, which is just as well (for Cadence) because Arrium has today announced a $754 million capital raising at a minimum share price of 48c per share. It would, however, be most unfortunate for anyone who had followed the “outperform” recommendation in September and held on in January because the company was apparently “cheap.”

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Motley Fool contributor Claude Walker (@claudedwalker) does not own shares in any of  the companies mentioned in this article.

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