Atlas Iron Limited: flogging a dead horse?

Are shareholders throwing good money after bad with Atlas Iron Limited’s (ASX:AGO) capital raising?

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Junior iron ore miner Atlas Iron Limited (ASX: AGO) appears confident that it can survive and prosper, even if iron ore prices retreat back to 10-year lows of US$46 per tonne.

CEO David Flanagan recently told reporters that the company is selling ore and making money today, and had locked in some cargoes of iron ore as far forward as December at US$57 per tonne, above the company’s current breakeven full cash costs of around US$50 per tonne.

Not that Mr Flanagan is too concerned with the commodity price falling. He’s predicted iron ore will trade between US$50 and US$70 per tonne over the next few years. That may be optimistic, given the wall of iron ore supply coming on-stream in that period.

Contractors kick in

But he may be taking a number of things for granted. The company has received royalty tax relief from the West Australian state government, and currently has profit sharing agreements in place with some of its key contractors including transport contractor McAleese Ltd (ASX: MCS), mining operator MACA Ltd (ASX: MLD) and ports operator Qube Holdings Limited (ASX: QUB).

In return for lower contracting base rates, the contractors expect to receive a profit share based on the Australian dollar iron ore price. 25% of positive operating cashflow will be paid to the collaborating contractors.

McAleese also says it has committed to buying up to $14 million worth of Atlas shares in the latter’s capital raising.

Atlas has also signed a royalty relief deed with the state government that provides for 50% cash deferral of iron ore royalties and is expect to provide a total cash flow benefit of around $23 million over the period from October 2014 through to September 2015. Atlas is required to pay back the relief from 31 March 2016 in several quarterly instalments, but will have issues doing that, particularly if the iron ore price is back under US$50 per tonne.

Capital raising

But it’s the company’s capital raising that could see investors throwing good money after bad, with Atlas seeking to raise $180 million at 5 cents per share. Shares last traded at 12 cents, so it’s a hefty discount – but it needs to be to entice shareholders to participate. Attached to each share is one free option exercisable at 7.5 cents up until 30 June 2017.

Apart from McAleese, other contractors are reported to have committed to invest a further $30 million in Atlas – clearly tying them closer to Atlas, and giving them a stake – if the company has a future, of course.

Mr Flanagan says that if the $180 million capital raising is successful, the company could raise up to $270 million in addition, if options are taken up by some of the company’s shareholders.

That appears to be a likely prospect. Atlas has announced it will book an impairment charge of between $130 million and $160 million to reflect the carrying value of its assets at the end of June 2015. That comes on the back of an $834 million write-down in the first half.

The company also has $125 million in cash to offset against its $337 million in debt. Capital raised will be used to strengthen the balance sheet i.e. pay off some of its debt. But the problem Atlas still faces is this: the company will face a shortfall between the forecast cash on hand and the amount owing at maturity date, despite the capital raising. It will either need to extend or refinance the debt before it becomes due, or raise more capital from shareholders.

Foolish takeaway

It’s far from a foregone conclusion that Atlas will survive over the next few years, particularly if a few events go against it, such as a low iron ore price or a higher Australian dollar exchange rate. But survival and generating decent shareholder returns are two different things, and I for one, won’t be betting on Atlas.

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Motley Fool contributor Mike King doesn't own shares in any companies mentioned. You can follow Mike on Twitter @TMFKinga The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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