Here’s Why We Think Cliffs Natural Is Fairly Valued At $24

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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))

Following the release of fourth quarter and full year results, we have modified our price estimate for Cliffs to $24.67 from $32.72. This takes into account the global economic outlook, the iron ore market outlook and company-specific factors. Below we outline the case for our price revision.

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See Full Analysis for Cliffs Natural Resources Here

Factors Which Impacted Our Revision

1) Pessimistic Iron Ore Price Outlook

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. About 25% of China’s steelmaking capacity is located in the Hebei province and the level of pollution there has forced the government’s hand. Shutting down of steel units will result in a dip in iron ore demand and drive down prices.

Right now, there is another factor reinforcing the bearish case for iron ore prices. Chinese state-owned banks are no longer lending freely to steel mills which are not in good financial shape to purchase iron ore. The credit squeeze is causing a dip in demand and thus in prices. Whether a tight credit situation persists going forward will depend on policy decisions of the government. [1]

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. We believe that this is the likely scenario and expect iron ore prices to show a declining trend for the next 3 years.

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.

2) Bloom Lake Expansion Suspended

Cliffs Natural has put the Phase II expansion of Bloom Lake mine in Canada on hold for an indefinite period. The cost of production at this mine has been higher than expected and this is unlikely to change going forward. In an environment of declining iron ore prices and negative outlook for the same, the company is no longer confident of the mine’s prospects. In fact, it went to the extent of saying that it would put the ongoing Phase I of Bloom Lake expansion on hold if prices kept decreasing for a significant period of time. Consistent with our outlook on iron ore prices going forward, we have concluded that the surge in production and shipments as a result of the planned expansion will not materialize any time soon. Accordingly, we have revised shipment figure estimates downwards in our valuation. [2]

3) Wabush Mine Will Be Idled At The End Of Q1 2014

Cliffs Natural will idle the Wabush iron ore mine in Canada at the end of the first quarter in 2014. The costs here are astronomically high and even the most bullish case for iron ore prices will not justify running this mine going ahead. In Q4 2013, the cash cost per ton of iron ore was $143 which was much lower than the average realized revenue of $108.73 per tonne from Eastern Canada operations in Q4. The company has already idled the Pointe Noire pellet plant at Wabush in June 2013. [3]

Idling this mine will result in a further loss of future production while the capital already sunk into the project has been wasted.

Given the twin blows of reduced production expectations and a disappointing iron ore pricing scenario, we have revised our model and valuation for Cliffs accordingly.

Our price estimate for Cliffs Natural Resources is $24.67 after the latest results.

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Notes:
  1. The Latest Iron Ore Price Slump: Causes And Effects, Trefis []
  2. Cliffs Natural Resources Inc. Announces Significant Reduction in 2014 Capital Expenditures, Cliffs News Release []
  3. Cliffs Natural 2013 10-K, SEC []