Cliffs Natural Resources (NYSE:CLF) announced its third quarter earnings on Wednesday, October 24. It reported revenues of $1.5 billion, a 26% year-over-year decrease from $2.1 billion. This was primarily driven by a 36% decrease in year-over-year pricing for seaborne iron ore. Reduced revenues along with increased labor, mining, and maintenance expenses resulted in a 76% decrease in consolidated sales margin to $198 million, compared with the third quarter of 2011. Net income was down to $85 million from $601 million year-over-year. This was attributed primarily to lower pricing of iron ore. 
Cliffs expects the U.S. economy to stay stable for the remainder of the year. It expects moderate volatility in the pricing for seaborne iron ore and metallurgical coal products driven by Asian and European end markets. However, the company has lowered its full-year expectation for Chinese crude steel production to approximately 715 million tonnes from its previous expectation of 730 million tonnes. Cliffs has also decreased its average full-year 2012 seaborne iron ore spot price expectation to approximately $128 per tonne from its previous expectation of $145 per tonne. This is in view of the year-to-date realized average spot price for 62% Fe seaborne iron ore of $133 per tonne. As a result of economic conditions in the Eurozone and a slowdown in demand from China, iron ore is trading at significantly lower prices in the international markets than in the corresponding quarter last year. 
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. It operates iron ore and coal mines in North America and two iron ore mining complexes in Western Australia. In addition, Cliffs has a major chromite project, in the feasibility stage of development, located in Ontario, Canada.
Iron ore is used in blast furnaces as part of the steel-manufacturing process. The fall in iron ore prices has been driven by tepid demand and plentiful supplies for steel.  Cliffs has also reduced its U.S. iron ore sales volume expectation to 22 million tonnes from its previous expectation of 23 million tonnes. This is in view of lower expected average prices for seaborne iron ore during the second half of 2012, which reduces Cliffs’ ability to profitably sell the ore in the seaborne market from the lower Great Lakes. However, Cliffs is still maintaining its full-year iron ore production volume expectation of approximately 22 million tons. It has also opted to maintain its previously disclosed 2012 capital expenditure budget of approximately $1 billion, comprised of approximately $300 million in sustaining capital and $700 million in growth and productivity-improvement capital. Keeping in mind the volatile pricing environment, management wants to focus on executing the Phase II expansion at Bloom Lake and maintaining its cash dividend and investment-grade rating
Long Term Outlook
Cliffs sees economic growth in developing countries as the driving force for its future business. The company is eying the Asia-Pacific region to tap into continued strong demand. In 2012, the company expects to sell nearly half of its 45+ million tonnes of expected global iron ore sales to seaborne customers in the Asia Pacific region, with the remainder expected to be sold to North American customers. However, sustained weak iron ore prices could dampen the mood.
Barriers to entry in mining are rising due to increasing costs and technological challenges associated with bringing new supplies to the market. This places incumbent players like Cliffs in an advantageous position. With an established track-record and a strong balance sheet, Cliffs will find it easier to tap into scarce capital from the markets in order to invest in future production sources. ((Investor Presentation, Cliffs Website))
Our primary concern stems from the fact that the North American iron ore and coal divisions’ revenues are highly dependent on a few customers. ArcelorMittal, Algoma and Severstal together constitute about 35% of Cliffs’ total revenues. A loss of sales to any of these existing customers could have a substantial adverse impact on the company’s revenues and profitability.
Our price estimate for Cliffs Natural Resources is $48, which will be revised in view of the latest earnings report.Notes:
- Cliffs Natural Resources Q3 Profit Down – Quick Facts, RTT News [↩]
- Cliffs Natural Resources Inc. Reports Third-Quarter 2012 Results, Cliffs Investor Relations [↩]
- Cliffs Q3 Net Income Down 86 Percent, The Street [↩]