Cliffs Natural Resources (NYSE:CLF) announced its first quarter earnings for 2013 on April 24. It reported revenues of $1.1 billion, a decrease of 6% year-over-year. The lower revenues were driven by a 10% decrease in year-over-year iron ore sales volume. Net income stood at $97 million compared to $376 million in Q1 2012.
The stark difference in net income is primarily driven by lower income tax benefits this year. The previous year’s first quarter results included a non-cash deferred tax benefit of $213 million, primarily related to the enactment of a new Australian tax. The tax benefit this year was just $6 million. Indeed, the operating income this year was $168 million compared to the 2012 figure of $222 million, which can be explained by lower sales volume. 
Cliffs increased its sales outlook for the U.S. Iron Ore division, but maintained its previous expectations for other divisions. The company didn’t have anything new to report on its chromite projects. The negotiations with various stakeholders are still in progress. With regards to the Wabush iron ore pellet plant, Cliffs said that it would take steps to reduce cash cost per ton to $100. If unsuccessful, it might consider a more “permanent solution”. 
Performance Of Various Business Segments
The U.S. Iron Ore business recorded sales volumes of 3.1 million tons, down from 3.4 million last year due to financial difficulties experienced by a specific customer. Despite 2% growth in revenue per ton, lower sales dragged total segment revenues lower from $442 million to $410 million.
The Eastern Canadian Iron Ore business sold 1.9 million tons, almost the same as last year. Year-over-year revenues increased by $24.6 million to $245 million as revenue per ton rose by $15.5.
The Asia Pacific Iron Ore division reported sales volumes of 2.3 million tons, down 17% from last year. Revenues fell by $89 million to $271 million due to a combination of lower sales and a price drop of $9 per ton. Prices were negatively impacted by lower than expected iron ore grade and penalties resulting from the same.
The North American Coal business recorded revenue of $214 million, an increase of $26 million year-over-year. This was due to increased sales, offset partially by lower prices in line with prevailing market trends.
Other Business Developments
Cliffs will idle its Wabush Pointe Noire iron ore pellet plant in Canada by the end of the second quarter as the current cost structure there is not sustainable. By the end of Q2, existing commitments to pellet customers would have been met. The Wabush facility also has a concentrator and the company will transition to producing only iron ore concentrate from here in the future. However, Cliffs has maintained its 2013 sales and production volume expectations of 9-10 million tons from the Eastern Canada business segment to which Wabush belongs. As a result of idling the pellet plant, 2013 cash cost per ton in the Eastern Canadian Iron Ore segment is expected to be $95-100, down from the company’s previous expectation of $100-105. 
The feasibility study on the Black Thor chromite project is on schedule and is expected to be completed later this year. The company is keen to bring in more partners into the project to share capital costs and risks. Any meaningful discussion is expected to begin once the feasibility of the project is established. Due to the diverse nature of the First Nations communities and wide-ranging concerns, progress has been slow and negotiations complicated. Progress has also been tardy towards signing of a definitive agreement between the company and the Ontario government, without which production cannot begin in 2016.
Outlook For 2013
Cliffs has raised its sales outlook for the U.S. Iron Ore business by 1 million tons to 21 million tons for the full year. This revision was driven by higher iron ore pellet demand from existing customers in the U.S.
For the Eastern Canadian Iron Ore segment, the company maintained its sales and production volumes expectations of 9 million to 10 million tons. This includes 6.5 million to 7 million tons of iron ore from Bloom Lake and the remainder from Wabush.
In the Asia Pacific Iron Ore division, it maintained the sales and production volumes at 11 million tons.
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.
On the negative side, Cliffs 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. 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 $36, which will be revised shortly in view of the first quarter earnings results.Notes: