Higher Iron Ore Prices And Lower Costs Boost Cliff Natural’s Profits

February 18th, 2014 by Trefis Team
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Cliffs Natural Resources (NYSE:CLF) announced its fourth quarter earnings for 2013 on February 13 and conducted a conference call with analysts on February 14. It reported revenues of $1.515 billion, a slight decrease year-over-year. In Q4 2012, the revenues were $1.536 billion. The lower revenues were driven by lower market prices and sales volumes for metallurgical coal. This decrease was partially offset by a 10% increase in global seaborne iron ore prices to an average of $135 per tonne for a 62% Fe fines product (C.F.R. China). Net income stood at $31 million compared to a loss of $1.6 billion in Q4 2012. The loss last year was mostly due to special one-off items. ((Iron Ore Spot Price Chart, YCharts))

Cost of goods sold and operating expenses decreased by 6% to $1.2 billion, primarily driven by favorable foreign exchange rates, lower costs at Wabush Mine and lower cost rates for Cliffs’ North American Coal business. The company also took steps to reduce exploration spending, as well as to scale back spending on chromite project development. Cliffs announced that it was indefinitely suspending major components of its chromite Project in Northern Ontario given the uncertain timeline and risks associated with the development of necessary infrastructure to bring this project online. We believe that this project is unlikely to see the light of day for years now.

See Full Analysis for Cliffs Natural Resources Here

Iron Ore Prices

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China is the world’s biggest consumer of iron ore and its surprisingly robust economic growth rate in face of slowdown expectations drove prices higher in the fourth quarter. The country is in the process of reorienting its economy away from investment in capital assets and towards greater domestic consumption, but the government chose to provide a monetary stimulus to sustain the growth rate. Inventories of iron ore were also low, which led to a higher demand from the steel sector.

We think that there are two factors which will influence prices going ahead. The first is the Chinese central government crackdown on polluting steel plants which use cheaper iron ore fines than pellets or lumps. The shutdown of these units might lower overall iron ore prices but provide a boost to pellet prices. The net effect remains to be seen and will depend on whether the central government will also force the closure of plants that are losing money, but continue to function due to subsidies provided by local governments. The other factor that will influence iron ore prices is the supply scenario. About 90 million tonnes of new supply is likely to hit the global iron ore market in 2014. If all of this new supply materializes, the increase in demand will not be enough to absorb the new supply and prices will go down.

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. In accordance with these trends, the pricing agency Platts reported an iron ore price of $135/tonne for the quarter, 10% higher than Q4 2012. [1]

Performance Of Various Business Segments In Q4

The U.S. Iron Ore business sales volumes of 6.2 million tonnes was relatively flat as compared to last year. While there was increased domestic demand and a catch-up in supply resulting from the lifting of the force majeure customer, this increase was offset by lower sales volume from the expiration of a customer contract. Despite a 1% increase in revenue per tonne, total segment revenues decreased slightly year-over-year from $780.6 million to $773.7 million due to slightly lower volumes.

The Eastern Canadian Iron Ore business sold 2.2 million tonnes, a decrease of 6% from 2.3 million tonnes sold in the fourth quarter last year. The decrease was driven by a logistical issue. December’s extremely cold weather limited the loading of ships at the Pointe Noire port. Year-over-year revenues increased from $231.1 million in Q4 2012 to $235.3 million despite lower volumes because the revenue per tonne of iron ore rose by 8%.

The Asia-Pacific Iron Ore division reported sales volumes of 3 million tonnes, up 5% from 2.8 million tonnes last year. Revenues rose from $284 million in Q4 2012 to $324.8 million due to higher volumes and a 9% rise in iron ore prices.

The North American Coal business recorded revenue of $183.4 million, a decrease from $240.2 million in Q4 2012. This was due to a steep fall in coal prices of 19% and lower sales volumes. [2]

Other Business Developments

Cliffs announced in November that it was suspending the $3.3 billion Ring of Fire chromite project indefinitely because it was no longer financially viable after the company was denied 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 proposed a $1.6 billion railroad. The Ontario land and mining commissioner ruled against Cliff’s. While the company says that it will continue to work with all parties over the issue, we think that the project is as good as dead for a long time. [3]

Outlook For 2014

Cliffs expects to sell 22-23 million tonnes from the U.S. Iron Ore operations, 6-7 million tonnes from the Eastern Canadian Iron Ore operations, 10-11 million tonnes from the Asia-Pacific Iron Ore operations and 7-8 million tonnes from the North American Coal operations.
In 2014, SG&A expenses are expected to be approximately $185 million, down from $231.6 million in 2013. The decrease is expected to be driven by reductions in employee-related expenses, outside services and legal settlements.

Capital expenditures for 2014 is expected to come down drastically by about 50% from 2013 levels of $862 million and is expected to range between $375-425 million. This is because the company plans to cut back its Bloom Lake Mine expansion and idle production at its Wabush Mine. These decisions are driven by the intense pressure on the management to focus on shareholder returns and desist from investing in projects where costs are high and returns low. [4]
Our price estimate for Cliffs Natural Resources is $32, which represents 40% upside to the current market price. We will revise this shortly now that the earnings results are out.

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Notes:
  1. Cliffs Natural Q4 2013 Earnings Presentation, Cliffs Website [↩]
  2. Cliffs Natural Q4 2013 8-K, SEC [↩]
  3. Cliffs Natural Suspends Chromite Project Indefinitely, Trefis [↩]
  4. Cliffs Natural Q4 2013 Earnings Conference Call, Seeking Alpha [↩]