Lower Commodity Prices and Shipments Weigh on Cliffs’ Q2 Results

Cliffs Natural Resources (NYSE:CLF) released its second quarter earnings on July 23 and conducted a conference call with analysts on July 24. The company’s results were negatively impacted by lower realized iron ore and coal prices, as well as lower shipment volumes from its U.S. iron ore operations, as a result of weather-related operational issues, and the idling of the Wabush Scully mine in Canada in March. The company’s second quarter revenues stood at $1.10 billion, $387.7 million or around 26% lower than the company’s revenue in the corresponding period a year ago, which stood at $1.49 billion. A decrease in market pricing for the company’s products accounted for a $187.1 million decrease in year-over-year revenues, while lower sales volumes at the company’s U.S. Iron Ore operations negatively impacted revenues by $153.5 million. The company reported a net loss of $1.9 million in the second quarter as compared to a net profit of $133.1 million in the corresponding period a year ago. ^[1]

The company maintained its lower capital expenditure guidance for the year, after it had slashed its expected capital expenditure for 2014 in May. The company management also gave its outlook on shipment volumes and price realizations for the year during the conference call. It also gave an update on its proxy contest with Casablanca Capital, an activist hedge fund that holds a 5.2% stake in Cliffs, which will potentially end decisively at Cliffs’ annual meeting of shareholders, scheduled to be held on July 29.

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Iron Ore and Coal Prices

Iron ore and metallurgical coal are important raw materials for the steel industry. Thus, demand for these raw materials by the steel industry plays a major role in determining their 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. International iron ore prices are largely determined by Chinese demand, since China is the largest consumer of iron ore in the world. It accounts for more than 60% of the seaborne iron ore trade. ^[2] Chinese steel demand growth is expected to slow to 3% and 2.7% in 2014 and 2015 respectively, from 6.1% in 2013. ^[3] Weak demand for steel has indirectly resulted in weak demand for iron ore.

On the supply side, expansion in production by majors such as Rio Tinto and BHP Billiton has created an oversupply situation. A combination of weak demand and oversupply is likely to result in lower iron ore prices in the near term. ^[4]

The Platts 62% Fines spot price, which is the most commonly used world market price in Cliffs’ sales contracts, decreased 18.5% year-over-year to an average value of $103 per ton for Q2 2014. ((Cliffs’ Q2 2014 10-Q, SEC))

China is also the largest consumer of metallurgical coal in the world. Demand for the commodity by the Chinese steelmaking industry has been weak, adding to subdued demand from other major consumers such as Japan and the EU. Weak demand coupled with an oversupply situation due to expansion in production by major mining companies, has resulted in plummeting coal prices. ^[5] The quarterly benchmark price for premium low-volatile hard coking coal between Australian metallurgical coal suppliers and Japanese and Korean consumers decreased 30.2% to a second quarter average of $120 per ton in 2014 versus the comparable period in 2013. ((Cliffs’ Q2 2014 10-Q, SEC)) This will negatively impact Cliffs’ North American Coal operations, which primarily sells metallurgical coal, whose prices are linked to prices of Australian metallurgical coal.

Segment-wise Performance

Shipments for the U.S. Iron Ore operations fell from 5.73 million tons in Q2 2013 to 4.34 million tons in Q2 2014, primarily due to reduced shipment vessel availability, as a result of the freeze on the Great Lakes delaying the start of the 2014 shipping season. The realized product revenue rate fell from $110.32 per ton in Q2 2013 to $106.80 per ton in Q2 2014. The fall in realized prices for the company’s U.S. Iron Ore operations was lesser than the corresponding fall in spot prices, as contracts for this division are mostly structured on 12-month averages. A combination of lower prices and shipments resulted in lower divisional revenues of $514.6 million in Q2 2014 versus $701.7 million in the corresponding period a year ago. The cost of goods sold and operating expenses rate dropped marginally to 66.73 per ton in Q2 2014 from 67.59 in Q2 2013. This was primarily due to restarting of two production lines at the  Northshore mine during Q1 2014 that were previously idled in January 2013, and the non-recurrence of the 2013 shutdown of Empire mine. Including depreciation expenses, the segment’s sales margin dropped to $33.94 per ton in Q2 2014 from $37.77 per ton in Q2 2013. ((Cliffs’ Q2 2014 10-Q, SEC))

Revenues for the Eastern Canadian Iron Ore operations fell from $213.9 million in Q2 2103 to $174 million in Q2 2014. This was mainly as a result of a lower realized product revenue rate of $87.48 per ton in Q2 2014, as compared to $110.66 per ton in the corresponding period last year. Shipments rose marginally to 1.99 million tons in Q2 2014 from 1.93 million tons in Q2 2013, as higher production from the Bloom Lake mine offset the loss in production due to the idling of the Wabush mine. As a result of the idling of the high-cost Wabush mine, the division’s cost of goods sold and operating expenses rate fell to $106.84 per ton in Q2 2014 from $136.36 per ton in the corresponding period a year ago. Including depreciation expenses, the division’s sales margin improved to a loss of $19.36 per ton in Q2 2014 from a loss of $25.70 per ton in Q2 2013. ((Cliffs’ Q2 2014 10-Q, SEC))

Revenues for the Australia Pacific Iron Ore operations fell from $327 million in Q2 2103 to $233.1 million in Q2 2014. This was mainly as a result of a lower realized product revenue rate of $80.38 per ton in Q2 2014, as compared to $109.36 per ton in the corresponding period last year. Shipments fell marginally to 2.90 million in Q2 2014 from 2.99 million tons in Q2 2013, as a result of unfavorable timing of shipments. The division’s cost of goods sold and operating expenses rate fell to $53.38 per ton in Q2 2014 from $63.65 per ton in Q2 2013, as a result of lower mining contractor and logistics costs resulting from a focus on efficiencies across the operation. Including depreciation expenses, the division’s sales margin fell to $12.41 per ton in Q2 2014 from $31.76 per ton in Q2 2013. ((Cliffs’ Q2 2014 10-Q, SEC))

Lower coal prices impacted the North American Coal division’s quarterly performance. The realized product revenue rate fell to $72.84 per ton in Q2 2014 from $104.89 in Q2 2013. Despite a reduction in the cost of goods sold and operating expenses rate to $83.01 per ton from $88.12 per ton, sales margin for the second quarter fell to a loss of $25.89 per ton, as against a profit of $3.16 per ton in the corresponding period last year. ((Cliffs’ Q2 2014 10-Q, SEC))

Casablanca Capital

In addition to the troubles caused by falling commodity prices, Cliffs’ negotiations with Casablanca Capital have resulted in a stalemate. Casablanca favors strategic focus on Cliffs’ U.S. Iron Ore operations and the sale of its Canadian and Asia-Pacific businesses. Cliffs’ management believes selling off these assets in a low commodity price cycle would destroy shareholder value. ^[6]  Negotiations between Cliffs and Casablanca over the number of Casablanca’s nominees on Cliffs’ board of directors have not resulted in an agreement. Casablanca is seeking election of six of its nominees to Cliffs’ eleven-member board at the company’s annual meeting of shareholders. ^[7] The outcome of this tussle between Cliffs’ management and Casablanca may impact the company’s strategy going forward.

Outlook

In view of the subdued commodity pricing environment, the company lowered its outlook for realized prices for 2014 from its previous guidance at the time of its Q1 results. Cliffs lowered the expected revenue per ton outlook for its Eastern Canadian Iron Ore, Asia-Pacific Iron Ore and North American Coal operations from  $95-100 to $85-90, $95-100 to $85-90 and $80-85 to $75-80 respectively. The company maintained its previous revenue per ton guidance for the U.S. Iron Ore division of $100-105. The company now expects shipments at the the lower end of its previous guidance of 22-23 million tons and 7-8 million tons for the U.S. Iron Ore and North American Coal operations. Shipments for the Asia Pacific and Eastern Canadian Iron Ore operations stand at the higher ends of the previous guidance of 10-11 million tons and 6-7 million tons respectively. ^[8]

The company maintained its guidance for reduced capital expenditure spend of $275-325 million for 2014, which is in line with its announcement in May, when the company cut its capital expenditure expectations by $100 million from its previous guidance. ^[9]  The company may also temporarily idle Phase 1 operations at its Bloom Lake mine, if the iron ore pricing environment deteriorates. ^[1] Thus, the company is sticking to its strategy of disciplined capital allocation, in order to operate competitively in a depressed commodity pricing environment.

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1. Cliffs’ Q2 2014 10-Q, SEC [↩] [↩]
2. China Ore Stockpiles Rise to Record on Financing Deals, Bloomberg [↩]
3. Short Range Outlook for Apparent Steel Use 2013-2015, World Steel Association [↩]
4. BHP, Rio Gamble with Stacked Iron ore Deck, Mineweb [↩]
5. Coking coal price crashes through $100, Mining.com [↩]
6. Cliffs Natural Resources Inc. Mails Open Letter to Shareholders, Cliffs Natural News Release [↩]
7. Casablanca Capital Files Definitive Proxy Statement and Sends Letter to Cliffs’ Shareholders, Wall Street Journal [↩]
8. Cliffs’ Q2 2014 Earnings Presentation, Cliffs’ Website [↩]
9. Cliffs Q2 2014 Earnings Conference Call Transcript, Seeking Alpha [↩]