Lower Iron Ore, Coal Prices And Shipments Bring Down Cliffs’ Q1 Results

Cliffs Natural Resources (NYSE:CLF) announced its Q1 2014 earnings on April 24 and conducted a conference call with analysts on April 25. As expected, lower iron ore and metallurgical prices, and lower shipment volumes negatively impacted the results. The company reported consolidated quarterly revenues of $940 million as compared to $1.14 billion in the corresponding period last year. A decrease of $173 million in revenues is attributed to lower realized prices of iron ore and metallurgical coal. Lower volumes accounted for an additional $28 million decrease in revenues. The company reported a net loss of $83.1 million for the quarter as compared to a profit of $97.1 million in the corresponding period last year. ^[1]

In view of the adverse pricing environment and demand scenario for both iron ore and metallurgical coal, the company focused on cost cutting and discipline in capital allocation. Cliffs announced that quarterly capital expenditures were lower 55% year-over-year. In addition quarterly SG&A and exploration expenses, excluding severance costs decreased 30% year-over-year.

The company maintained its outlook on shipment volumes for each of its business divisions for 2014. The company also gave its outlook on the segment-wise revenue per tonne for the whole year. Furthermore, the company maintained its forecast for capital expenditure and SG&A expenses for 2014. ^[2]

Iron Ore And Metallurgical Coal Prices

Though a majority of Cliffs’ iron ore sales are to the North American steel industry, sales agreements are benchmarked to international iron ore prices. Thus, global demand for iron ore plays a major role in influencing Cliffs’ average realized prices. International iron ore prices are largely determined by China, which is the largest consumer of iron ore in the world. Flagging demand for iron ore from China in the wake of an economic slowdown has put downward pressure on iron ore prices. According to data from China’s National Bureau of Statistics, growth in investment, factory output and retail sales has slowed to multi-year lows in the first two months of the year. A Chinese government crackdown on polluting steel plants has forced many of them to shut down. In addition, tightening of credit by Chinese banks to steel plants that are not performing well will affect their ability to purchase iron ore, and thus the overall demand for it. This has resulted in an inventory build-up at Chinese ports which will further curtail imports. Further, the Chinese leadership has proposed structural reforms for the economy, shifting the emphasis from an investment and export driven growth to services and consumption led growth. Such a transformation of the Chinese economy may negatively impact Chinese demand for iron ore in the long run. ^[3]

On the supply side, iron ore majors such as Rio Tinto, BHP Billiton have expanded production. These companies are banking on higher volumes to compensate for lower prices and drive profits given their low costs of production. These companies are betting on continued strength in iron ore demand over the long term. The main drivers of such long term demand are increasing levels of urbanization, and industrialization in developing and emerging economies, particularly China and India. However, given the weak demand scenario at least in the near term, expanded production by iron ore majors has resulted in an oversupply situation which is expected to keep prices subdued in the near term. Lower iron ore prices will impact Cliffs much more than other major mining companies due to it’s higher cash costs per tonne of around $65-70, as compared to less than $50 for Rio Tinto and BHP. ^[4]

China is also the largest consumer of metallurgical coal in the world. There has been falling demand for the commodity by the Chinese steelmaking industry along with lower demand from other major consumers such as Japan and the EU. Falling demand coupled with an oversupply situation due to expansion in production by major mining companies has resulted in plummeting coal prices. This will have a negative impact on Cliffs’ North American coal business which primarily sells metallurgical coal, prices for which are linked to prices of Australian metallurgical coal. ^[5]

Segment-wise Performance

Quarterly revenues at Cliffs’ U.S. iron ore operations fell to $361.3 million as compared to $410.1 million year-over-year. First quarter shipment volumes in Cliffs’ North American operations are affected by frozen conditions on the Great Lakes, which are a significant transportation route. Extreme weather conditions and extended freeze on the Great Lakes this quarter has led to quarterly shipments of 2.8 million tonnes versus 3.1 million tonnes year-over-year. The realized product revenue per tonne fell to $109.02 as compared to $119.82 in the corresponding period last year. Thus, a combination of lower shipments and realized prices led to lower revenues year-over-year.

Quarterly revenues at Cliffs’ Eastern Canadian iron ore operations fell to $158.3 million as compared to $245.3 million year-over-year. Quarterly shipments fell to 1.6 million tonnes versus 1.9 million tonnes. This was mainly due to idling of the Wabush mine and delays in shipments due to adverse weather conditions, offset by higher production at the company’s Bloom Lake operations. The realized product revenue per tonne fell to $98.45 as compared to $131.95 in the corresponding period last year. Thus, a combination of lower shipments and realized prices led to lower revenues year-over-year.

Quarterly revenues at Cliffs’ Asia-Pacific iron ore operations fell to $254.2 million as compared to $270.8 million year-over-year despite higher shipment volumes. Shipment volumes rose to 2.6 million tonnes from 2.3 million tonnes year-over-year, driven by favorable timing of vessel shipments. However, realized product revenue per tonne fell to $96.25 as compared to $117.48 in the corresponding period last year due to an adverse pricing environment. Lower realized prices translated into lower year-over-year revenues.

Quarterly revenues at Cliffs’ North American Coal operations fell to $166.2 million as compared to $214.3 million year-over-year. Quarterly shipments fell to 1.6 million tonnes versus 1.8 million tonnes due to extended price negotiations with a customer in view of lower coal prices and adverse weather conditions. The realized product revenue per tonne fell to $88.61 as compared to $110.35 in the corresponding period last year due to an adverse pricing environment. Thus, a combination of lower shipments and realized prices led to lower revenues year-over-year.

Other Developments

The company’s management was tight-lipped about its negotiations with Casablanca Capital, a hedge fund that has a 5.2% shareholding in Cliffs. Casablanca favors separating Cliffs’ U.S. and international operations, by bundling its Canadian and Asia-Pacific businesses into a separate entity. Negotiation between Casablanca and the company regarding the number of Casablanca’s nominees on Cliffs’ board did not result in an agreement. However, in order to reach a settlement, Cliff had agreed to postpone its annual meeting of shareholders as per Casablanca’s request. Along with its quarterly results the company announced the new date for its annual meeting of shareholders.(( Cliffs Natural Resources Inc. Announces 2014 Annual Meeting of Shareholders, Cliffs Natural Resources News Release))

Outlook

The company maintained its guidance regarding sales volumes but lowered its forecast for 2014 realized prices. Cliffs maintained expected sales volumes at its U.S. iron ore, Eastern Canadian iron ore, Asia-Pacific iron ore and North American coal operations at 22-23 million tonnes, 6-7 million tonnes, 10-11 million tonnes and 7-8 million tonnes respectively. In view of the subdued pricing environment, the company lowered its revenue per tonne outlook for its U.S. iron ore, Asia-Pacific iron ore and North American coal operations from $105-110 to $100-105, $100-105 to $95-100 and $85-90 to $80-85 respectively. Cliffs maintained revenue per tonne guidance for its Eastern Canadian iron ore operations at $95-100.

The company maintained its forecasts on capital expenditure of $375-425 million and SG&A and exploration of $200 million. The management reaffirmed its commitment to cost-cutting and discipline in capital allocation.

Our price estimate for Cliffs Natural Resources is $24.67, which represents 37% upside to the current market price. We will revise this shortly now that the earnings results are out.

1. Cliffs Natural Resources 10-Q, SEC [↩]
2. Cliffs Natural Resources Q1 2014 Earnings Conference call Transcript, Seeking Alpha [↩]
3. The Latest Iron Ore Price Slump: Causes and Effects, Forbes [↩]
4. BHP, Rio Gamble With A Stacked Iron Ore Deck, Mineweb [↩]
5. Coking coal price crashes through $100, Mining.com [↩]