Cliffs Natural Resources (NYSE:CLF) announced its fourth quarter and full year earnings for 2012 on Tuesday, February 12. It reported annual revenues of $5.9 billion, a decrease of 11% year-over-year. The lower revenues were driven by a 23% decrease in year-over-year seaborne iron ore pricing. Reduced revenues along with increased labor, mining, and maintenance expenses resulted in a steep fall in annual consolidated sales margin to $1.2 billion from $2.6 billion in 2011. The formula based long-term contracts in place for the company’s U.S. iron-ore business cushioned the full impact of lower pricing for the major part of the year. On the flip side, we think that this may have deprived it of the opportunity to profit from very high prices in the fourth quarter.
The company reported a net loss of $899 million for 2012 compared to a net profit of $1.6 billion in 2011. This was attributed primarily to non-cash impairments of nearly $2 billion and lower iron ore prices. Excluding impairments, this figure stood at $493 million. For the fourth quarter, after adjusting for non-cash charges, net income attributable to Cliffs’ common shareholders was $89 million as against $213 million in Q4 2011. 
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.
During the fourth quarter of 2012, Cliffs recorded non-cash impairment charges of approximately $1 billion in goodwill related to its 2011 acquisition of Consolidated Thompson Iron Mines Limited as well as $365 million related to the Amapa iron ore project. 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 was recorded. Cliffs also recorded a $50 million non-cash impairment charge related to its Wabush Mine in Eastern Canada. The Wabush Mine asset impairment was the result of a higher book value versus the asset’s fair value.
In addition, Cliffs recorded $541 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. ((Cliffs Natural Resources Inc. Expects to Include Non-cash Impairment Charges within Its Fourth-quarter Results, Cliffs Press Release))
Short Term Outlook
In view of the volatility in iron ore prices witnessed last year, Cliffs is planning temporary production curtailment and slowdown of expansion activities within certain mines in North America in 2013.
The fall in iron ore prices has been driven by tepid demand and plentiful supplies of steel in the U.S., mainly on account of imports. Cliffs has reduced its U.S. iron ore sales volume expectation for 2013 to 20 million tonnes from its 2012 sales volume of 21.6 million tonnes. This is due to lower expected demand for iron ore pellets from steel plants in the Great Lakes area.
Cliffs also aims to reduce its year-over-year SG&A expense by nearly $50 million to approximately $230 million in 2013. It expects to achieve this through a continued focus on reducing company-wide expenses. The company is also decreasing its expected exploration spending by more than half when compared to 2012 to approximately $25 million in 2013.
The major focus, as far as growth is concerned, will be on the Bloom Lake project which the Cliffs management considers the future of the company. By the management’s own admission, the delay being witnessed in expansion will impact profitability in the short term. For 2013, Cliffs expects to produce and sell 9 to 10 million tons from its Eastern Canadian iron ore business segment, comprised of approximately 6.5 to 7 million tons from Bloom Lake, and the remainder from Wabush.
Cliffs has a world-class chromite asset at Black Thor in Canada which moved from the pre-feasibility stage of development to the feasibility stage in 2012. In 2013, the company expects to spend approximately $60 million to complete the feasibility stage of development for this project. 
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.
On the positive side, 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))
On the negative side, 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 same economies of scale like these companies do, its cost of production is higher.
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.
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 will be revised shortly in view of the fourth quarter earnings results.Notes: