Cliffs Natural Resources (NYSE:CLF) is set to announce its fourth quarter earnings on Tuesday, February 12. We are expecting the company to post a decline in net income on a year-over-year basis mainly due to the $2 billion impairment charges announced last month.
Barring the fourth quarter, iron ore prices were low for the rest of 2012 as demand came crashing down due to weak economic conditions worldwide. Therefore, Cliffs is likely to report lower year-over-year revenues and profits even if the effect of impairments is not taken into account. Its net income for 2011 was $1.6 billion, which was a year of high iron ore prices. Considering that, we expect losses to be considerable for 2012. Also it doesn’t help that Cliffs’ revenues are overwhelmingly dependent on iron ore. ((2011 10-K Filing, SEC))
Iron ore prices surged in the fourth quarter, so sequential revenues and core profits are expected to improve. However, we don’t expect the price surge to persist in 2013 as it was caused mainly by restocking of iron ore by Chinese steel mills in anticipation of future demand.
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.
Of the total expected impairment, $1 billion will be taken as goodwill impairment related to Cliffs’ 2011 acquisition of Consolidated Thompson Iron Mines Limited. It will be recorded as a non-cash expense. The impairment is primarily driven by the project’s anticipated lower long-term volumes and higher capital and operating costs. The previously announced delay of the Phase II expansion of the Bloom Lake mine also contributed to the impairment. The company also indicated that it expects to incur other charges to the tune of $100-150 million related to its Eastern Canadian Iron Ore business segment.
In addition, Cliffs will record $542 million in non-cash valuation allowances related to two of its deferred tax assets: Mineral Resources Rent Tax (Australia) and Alternative Minimum Tax (United States) carryforwards. The reason for these allowances is basically a revised lower long-term iron ore pricing expectation, which will impact future profitability and hence future tax payments. This isn’t surprising given that iron prices have slumped phenomenally from last year. Although they have been on an upswing for the last couple of months, going forward we don’t expect them to average as high as before.
Finally, Cliffs will record an amount of $365 million as non-cash pre-tax impairment charge. The company is selling its 30% stake in the Amapa iron ore mine in Brazil and based on the pending terms of the sale, this impairment is being recorded. 
Too Dependent On Iron Ore
Cliffs Natural is heavily dependent on the iron ore business. Unlike companies like Rio Tinto, BHP Billiton and Vale, it is not a diversified mining company. Also, since it doesn’t enjoy the economies of scale like these companies do, its cost of production is higher. Tumbling iron prices thus affect it much more than larger, diversified players. Had the iron ore pricing scenario been better, Cliffs wouldn’t have had to take non-cash charges on deferred tax assets and the Amapa iron ore project.
While Cliffs has been trying to diversify away from iron ore, its efforts to generate alternative streams of revenue have been pushed back. It has a world-class chromite asset in the form of Black Thor in Canada which is expected to produce 600,000 tonnes of ferrochrome once production begins. Ferrochrome is used mostly in the production of stainless steel and there are very few mines in the world with large deposits of chromite from which it is made. Production was supposed to start in the last quarter of 2016 after being delayed already but might have to be pushed back even further. You can read about it here.
Cliffs’ North American iron ore and coal businesses constitute nearly 70% of its Trefis price estimate.
Our price estimate for Cliffs Natural Resources is $46, which we will revise once the fourth quarter earnings results are out.Notes: