Higher Iron Ore Prices Will Boost Cliffs Natural’s Revenues

Cliffs Natural Resources (NYSE:CLF) will announce its third quarter results on October 24, 2013. Given the higher iron ore prices this year compared to levels in 2012, we expect the company to post higher year-over-year revenues and profits. ^[1]

Iron ore prices were surprisingly higher in the third quarter as China defied slowdown expectations. However, a lot of new supply is set to hit the market in the next few years. Large players such as BHP, Rio Tinto and Vale are going ahead with their expansion plans almost simultaneously. This will push down prices and put pressure on margins of higher cost producers like Cliffs. Prices have already started going down with new supply entering the market from Australia. ^[2]

In September, Cliffs was dealt a big setback when its application for permission to build a road to the Black Thor chromite deposit was rejected by the land and mining commissioner of Ontario. This has put the project in jeopardy. While Cliffs has appealed against the decision in the Superior Court of Justice, it is not very hopeful of a resolution any time soon as the litigation process there takes years.

Our price estimate for Cliffs Natural Resources is $30, which represents a 40% upside to the current market price. It will be revised once the third quarter earnings results are out.

See Full Analysis for Cliffs Natural Resources Here

Iron Ore Prices

Although the majority of Cliffs’ revenues come from its North American iron ore business, which sells primarily to U.S. customers, sales prices are nevertheless benchmarked to global prices, which are influenced to a large extent by the Chinese demand.

Iron ore prices in the third quarter were higher than expected because the sentiment about China’s economy was buoyant, defying previous expectations. The production of steel surged due to the stimulus aimed at stabilizing the country’s economy. Since inventories of iron ore were low, increased demand from the steel industry triggered a rise in demand for iron ore.

However, once the stocking cycle is over and more supplies of iron ore hit the market, prices are likely to go down. According to the Bureau for Resources and Energy Economics, the official Australian commodities forecasting agency, iron ore exports from Australia are expected to grow at an annual rate of 8% between 2014-2018. The rise in demand is not expected to commensurate with the rise in supply. ^[3]. Therefore, Cliffs will face more challenging times than its bigger rivals such as Vale, Rio Tinto and BHP Billiton who have much lower cash costs per ton of iron ore and coal. While Rio, BHP and Vale are estimated to have a production cost of around $50 per tonne, Cliffs has a cash cost of production in the range of $65-70 per tonne. ((Cliffs Q2 2013 10-Q, SEC))

In fact, it is their low operating costs which are likely responsible for the mining giants’ decision to go ahead with a production surge despite the inevitable fall in prices they would have to face. They may be banking on pushing the high cost miners out of the market in an environment of falling prices and capturing their business. ^[4]

Setback At The Black Thor Chromite Project

Last month, the land and mining commissioner of Ontario (Canada) had dismissed Cliffs’ application for permission to build a road to its deposits at Black Thor. This road was proposed to pass through a region claimed by rival miner KWG, which wants to build a railroad instead. The region is too fragile to support two heavy ore transportation systems. While Cliffs proposed a $600 million road, KWG has proposed a $1.6 billion railroad. The province of Ontario was expected to share half the cost of building Cliffs’ proposed road, however the tribunal objected to the province paying for a private road that would bring no benefits to the general public. ^[5]

The company has claimed in the past that building an all-weather surface road is the only way to make its $3.3 billion project viable. Due to uncertainty over granting surface rights, it had put the project on hold in June earlier this year. The litigation process against the commissioner’s ruling may now take years, but Cliffs is unlikely to wait that long before deciding whether to go ahead with the pr0ject.

The Ring of Fire region is thought to hold up to $50 billion worth of minerals and is going to be North America’s first major source of chromite. Black Thor alone is expected to produce 600,000 tonnes of ferrochrome, if and when production begins. Cliffs has a capital expenditure budget of close to $3.3 billion for this project and had already spent around $500 million at the end of 2012. 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. In addition, Canada is the only potential large scale supplier which is politically stable, doesn’t need chromite for its own consumption and can produce it at low costs. ^[6]

In the third quarter earnings conference call, we will watch out for the management’s comments on the Black Thor issue. We are also keen to know Cliffs’ plan to deal with an environment of low iron ore prices.

Understand How a Company’s Products Impact its Stock at Trefis

1. Iron Ore Spot Price Chart, YCharts [↩]
2. Iron ore seen sliding as new supplies hit, Financial Times [↩]
3. Australia raises China iron ore import forecast, Financial Times [↩]
4. BHP, Rio gamble with stacked iron ore deck – Russell, MineWeb [↩]
5. Road to Ring of Fire nixed, The Chronicle Journal [↩]
6. GUEST OPINION: Ring of Fire: Strategic Chromite and the Commodity Supercycle, Canadian Mining Journal [↩]