Cliffs Focuses on Growing Asia Business

Cliffs Natural Resources (NYSE:CLF) recently announced its decision to shift its focus away from North America to Asia. ^[1] Cliffs 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 and competes primarily with Vale (NYSE:VALE), BHP Billiton (NYSE:BBL) and the Rio Tinto group.

We currently have a Trefis price estimate of $103 for Cliffs Natural Resources’s stock, about 5% above the current market price.

China moves the iron ore market

Iron ore is the principal raw material in the steel manufacturing process with 98% of all iron ore mined used to make steel and China contributes to almost half of the world’s total iron ore production. In spite of this, it is also the biggest importer of iron ore in the world due to the country’s rapid economic development necessitates a substantial increase in its steel production.

Consequently, China has also been one of the biggest factors influencing global iron ore prices in recent years.

… and Cliffs is making moves to address this

Earlier this year, Cliffs had announced its intention to buy its Canadian rival Consolidated Thompson Iron Mines in an all cash deal. We had analyzed the possible rationales and benefits of this deal in our article, Cliffs Acquisition Aimed at Growth, Foothold in Asia. The deal, which was recently approved by Consolidated Thompson shareholders, would make Wuhan Iron and Steel – one of China’s biggest steel manufacturers – its customer.

But will the move add value to Cliffs?

Cliffs iron ore demand in North America has remained more or less stable in the past, limiting growth opportunities in the region. The long-term supply contracts also limit the revenues for Cliffs as agreements with large customers like ArcelorMittal (NYSE:MT), Severstal and Algoma are at discounted prices to existing iron-ore spot prices.

On the other hand, most of the iron ore sold in the Chinese market is at spot prices allowing for higher profit margins considering the steady rise in iron ore prices in the last few years. ^[2]

To get an idea of the impact of an increasing profit margin on Cliffs’ share price, if the company’s Asia Pacific iron ore division can maintain the 50% gross margin it achieved in 2010 for the years to come, this would add around 6% upside for the company’s stock at around $109.

See our full analysis for the Cliffs Natural Resources stock here.

1. Cliffs sees strong demand from Asia, Reuters, March 24 2011 [↩]
2. Northland Ore Heads to China, WDIO, March 30 2011 [↩]