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Who on earth is buying Arrium shares at this price?

Arrium Ltd (ASX: ARI) saw its share price rise 11.3% to 6.9 cents today, after iron ore stage a brief rise.

Overnight, spot iron ore prices rose 1.1% to trade at US$39.08 a tonne.

But bargain hunters are likely to have swallowed a bee rather than a bargain. Back in April 2015, investment bank UBS estimated Arrium’s breakeven iron ore price at US$46 a tonne.

In the last quarter, Arrium reported total cash costs of A$57.40 a tonne, roughly US$40 a tonne, and said it was targeting an average breakeven price of US$47 a tonne.

But the problem Arrium faces, like many others, is that its ore is lower grade, so it only received 87% of the benchmark price – roughly US$34 a tonne these days. In simple terms, Arrium is making a loss on its iron ore operations.

We’ve already seen BC Iron Limited (ASX: BCI) put its shares into a trading halt today until it decides what to do with its Nullagine joint venture with Fortescue Metals Group Limited (ASX: FMG). UBS had estimated BC Iron’s breakeven price at US$59 a tonne, so it obviously has much higher production costs than Arrium.

Arrium also has another couple of problems. There’s a global steel glut going on, which is likely pushing down prices for the steel that Arrium produces. The company itself says that Asian steel prices and margins are at 10-year lows, and most steel mills in China and South-East Asia are running at a loss.

Arrium also makes mining consumables including grinding media for mining operations. But as commodities prices continue to fall, it won’t be long before a number of mines are shut down. That will reduce the market for its mining consumables.

And then there’s Arrium’s $1.75 billion of net debt, which the company shows little sign of being able to repay.

The company announced it was undertaking a strategic review of its operations in June this year, which is yet to be completed. A sale of the mining consumables business was mooted, but again, nothing has been announced as yet, and would buyers still be interested in this environment?

Foolish takeaway

Back in February 2012, when Arrium was trading as OneSteel, I wrote that the company was jumping out of the frying pan and into the fire when it announced it was entering the iron ore mining sector. At the time, Arrium’s share price was 89 cents.

All I can say again is look out below.

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Motley Fool writer/analyst Mike King doesn't own shares in any companies mentioned. You can follow Mike on Twitter @TMFKinga

Unless otherwise noted, the author does not have a position in any stocks mentioned by the author in the comments below. 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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