Cliffs Upside/Downside Scenarios To $71 Fair Value

CLF: Cleveland-Cliffs logo

Cliffs Natural Resources (NYSE:CLF) is the largest producer of iron ore pellets in North America, a major supplier of direct-shipping lump and fines iron ore out of Australia and also a significant producer of metallurgical coal. According to our analysis, North American iron ore division contributes most, about 60% to our $71 Trefis price estimate for the company’s stock.

One can imagine the sheer size of this division’s operations, which represents a huge 57% share of the U.S. iron ore industry (produced about 54 million ton of iron ore in 2011) with total production of 31 million tons.((Iron Ore Statistics and Information, The U.S. Geological Survey, May 15 2012)) Cliffs competes with other international mining and natural resources companies including Vale (NYSE:VALE), BHP Billiton (NYSE:BHP) and Rio Tinto (NYSE:RIO), and below we take a look at some upside and downside scenarios to our estimates.

Here, we highlight 2 of the most important drivers for Cliffs’ stock and the upside/downside potential.

1. North American Iron Ore Revenue Per Ton: Cliffs iron ore operations in North America realized an average of $148 for each ton of iron ore pellets sold in 2011.

2. North American Iron Ore Gross Profit Margin: The North American iron ore business saw margins of 42.6% in 2011.

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30% Upside Scenario | $93 Trefis Price Estimate

1. Higher Iron Ore Prices  (+20%):

The revenue generated by Cliffs per ton of iron ore sold is directly correlated to the global iron ore prices over a period. As the iron ore pellets produced by the division are used exclusively by steel manufacturers, the demand for steel directly impacts the demand for iron ore and hence the price commanded.

The revenue per ton generated by Cliffs’ North American iron ore division has skyrocketed from $104 in 2008 to $148 in 2011. This can mainly be attributed to the huge Chinese demand for iron ore from all over the globe. Also, a continuous rise of international sea freight pushed up global iron ore prices sharply during this period.

However, the recent Euro Zone woes and China’s lower GDP growth target, we have seen a decline in iron ore prices. Further, China’s push for iron ore self-sufficiency and upcoming additional supply suggest a decline in iron ore prices in the years to come. We factored this in while forecasting the division’s revenues per ton.

We expect iron ore prices to remain substantially low from 2011 prices for our forecast period. If iron ore sees its prices remaining at same levels for Trefis forecast period, this could translate into a share price of $85, an upside of more than 20% to our current price estimate of $71.

2. Stable Margins (+10%):

Nowadays miners are grappling with rising input including fuel and labor costs.  Any miner’s margins are largely affected by the prices of commodity if the mine is already running close to its production capacity.

However, if Cliffs is somehow able to maintain current margins of 42.6% by the end of the Trefis forecast period, this will represent a 10% upside to the Trefis price estimate.

20% Downside Scenario: $58 Trefis Price Estimate

1. Iron Ore Prices Fall More (-10%):

Due to anticipated slowdown in Chinese demand and iron ore over-supply in upcoming years, we currently forecast a decline in global iron ore prices and hence a decline in Cliffs’ revenue per ton of iron ore sold.

But if slowdown and over-supply hits iron ore prices harder than we currently predict and drive down revenue per ton to just about $100 by the end of the Trefis forecast period, instead of the $120 currently estimated. In such a scenario, our price estimate will see a 10% downside.

2. Lower Margins (-10%):

Cliffs’ North American iron ore division’s EBITDA margins were well below 30% prior to 2010. Significant increases in prices in 2010 and 2011 pushed EBITDA margins to 42.6% levels. Improved pricing in its contracts with the some large customers ArcelorMittal, Algoma and Severstal also bolstered the same.

Going forward, declining iron ore prices and soaring input costs will keep margins in check. We expect margins to fall to 36% till the end of our forecast period. However, if the margins decline far more than we anticipate, to about 30% levels seen before 2010, this would represent a 10% downside to our current price estimate of $71.

See more details for our analysis of Cliffs Natural Resources here

Iron Ore
Statistics and Information