Cliffs Wraps Up 2010; Encouraging Outlook for North American Iron Ore

Cliffs Natural Resources (NYSE:CLF) is an international mining and natural resources company. It is the largest producer of iron ore pellets in North America and a major supplier of direct-shipping lump and fines iron ore out of Australia. It is also a significant producer of metallurgical coal. Competitors include Vale (NYSE:VALE), BHP Billiton (NYSE:BBL) and the Rio Tinto group.

Earnings Show Unprecedented Growth and Profitability for Cliffs in 2010

Cliffs recently released earnings for the last quarter of 2010, marking the end of an extremely profitable and eventful year for the company. Cliffs reported total revenues of $4.7 billion in 2010, more than double its $2.3 billion in 2009. This had a significant impact on the company’s net income, which saw a five-fold increase from $205 million in 2009 to more than $1 billion in 2010.

We have updated our price estimate for Cliffs to $103 following the earnings release. This represents a premium of roughly 5% to market price. We primarily attribute this premium to our estimated impact of the recently acquired Consolidated Thompson Iron Mines on Cliffs’ North American iron ore division.

Understanding the Value Unlocked by the Acquisition

In a recent article, we had enumerated the advantages to Cliffs once the integration of Consolidated Thompson is completed (Cliffs Acquisition Aimed at Growth, Foothold in Asia). As we had mentioned then, the most significant advantage to Cliffs from the acquisition is the increase in its North American iron ore production capacity.

The newly acquired mines are ramping up to their full production capacity of 8 million tons of iron ore. There is also an increase in capacity to 16 million tons expected towards the end of 2012. This would, hence, increase Cliffs’ iron ore production capacity in North America from around 25.6 million tons to more than 40 million tons in a few years.

This would likely translate to a corresponding increase in iron ore pellets sales for the division. With the amount of iron ore pellets sold to the 3 biggest customers (ArcelorMittal, Algoma and Severstal) expected to remain more or less constant, this increase in sales would be captured in our forecast for sales to other smaller Cliffs’ customers.

See our full analysis and $103 price estimate for Cliffs Natural Resources

With gross margins for the North American iron ore division expected to stabilize around 36%, and with an expected revenue of more than $100 per ton of iron ore, this increase in sales would lift the value of this division, and hence, the value of the company.