Cliffs’ Earnings Preview: Low Iron Ore And Coal Prices To Weigh On Q4 Results

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Cliffs Natural Resources (NYSE:CLF) will announce its fourth quarter results on February 2 and conduct a conference call with analysts the next day. We expect lower iron ore and metallurgical coal prices to negatively impact Cliffs’ quarterly results year-over-year. [1] Cliffs has been battling a subdued iron ore and coal pricing environment over the past year or so. The company’s loss-making Bloom Lake mining operations recently filed for bankruptcy. [2] In addition, the company has announced the termination of its policy of quarterly dividend payments. [3]  These are the latest steps taken by the company as it grapples with poor market conditions for both iron ore and coal.

See our complete analysis for Cliffs Natural Resources

Iron Ore and Coal Prices

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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. [4] Chinese steel demand growth is expected to slow to 2.7% in 2015, from 6.1% and 3% in 2013 and 2014, respectively. [5] Weak demand for steel has indirectly resulted in weak demand for iron ore.

On the supply side, an expansion in production by major iron ore mining companies such as Vale, Rio Tinto, and BHP Billiton has created an oversupply situation. A combination of weak demand and oversupply is likely to result in weak iron ore prices in the near term. [6] Iron ore prices stood at $68 per dry metric ton (dmt) at the end of December 2014, around 50% lower as compared to prices at the end of December 2013. [7] The worldwide surplus of seaborne iron ore supply is expected to rise to 300 million tons in 2017, from an expected surplus of 175 million tons in 2015, and a surplus of 72 million tons and 14 million tons in 2014 and 2013, respectively. [8] [9] In view of the persisting oversupply situation, iron ore prices will remain subdued in the near term. This will negatively impact the company’s fourth quarter results.

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. [10] This will have a negative impact on Cliffs’ North American coal business, which primarily sells metallurgical coal, whose prices are linked to prices of Australian metallurgical coal. The benchmark Australian metallurgical coal price stands at around $119 per ton, around a third of its 2011 peak level of $330 per ton. [11] In view of the oversupply situation, metallurgical coal pricing is expected to remain subdued in the near term. This will negatively impact the company’s fourth quarter results.

Recent Developments

In order to remain competitive in a subdued iron ore and coal pricing environment, Cliffs’ management favors focusing on the company’s profitable U.S. Iron Ore operations and the sale of its other high-cost assets. Earlier this month, the company completed the sale of Logan County Coal, a fully-owned Cliffs subsidiary which represents the company’s coal assets in southern West Virginia, for $175 million in cash. [12] Last month,  Cliffs idled its loss-making Bloom Lake iron ore mining operations in Canada. The Bloom Lake mining operations recently filed for bankruptcy protection and will be deconsolidated from Cliffs ‘ financial statements. [2] In addition, the company has announced the termination of its quarterly dividend payment policy with effect from Q1 2015. [3] The company has prioritized the reduction of its debt over quarterly dividend payments. Using the proceeds from the sale of its Logan County Coal assets and savings from the elimination of its quarterly dividend payments, the company lowered its net debt balance by around $400 million over the last two months. [3] We feel that Cliffs’ decision to prioritize debt reduction over dividend payments is a smart move. It will help boost the company’s cash flows and give it greater financial flexibility to operate effectively in a subdued commodity pricing environment.

Expectations from Conference Call

With the subdued iron ore and coal pricing environment set to continue in the near term, we would like to know whether the company has identified any other opportunities for reductions in operating costs or capital expenditure. We would also like to know if any asset sales, as per its strategy, are on the horizon. More clarity on this front will shed some light on the road ahead for Cliffs.

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Notes:
  1. Iron ore spot price chart, Y Charts []
  2. Cliffs Natural Resources Inc. Announces Decision on Bloom Lake Mine, Cliffs Natural Resources News Release [] []
  3. Cliffs Natural Resources Inc. Announces $400 Million Net Debt Reduction and Elimination of Common Share Dividend, Cliffs Natural Resources News Release [] [] []
  4. China Ore Stockpiles Rise to Record on Financing Deals, Bloomberg []
  5. Short Range Outlook for Apparent Steel Use 2013-2015, World Steel Association []
  6. BHP, Rio Gamble with Stacked Iron Ore Deck, Mineweb []
  7. Iron Ore Spot Prices, Y Charts []
  8. Iron Ore Price Forecast Cut by Morgan Stanley on Supply, Bloomberg []
  9. Iron Ore Caps 2014 Loss as Morgan Stanley Says Worst Over, Bloomberg []
  10. Coking coal price crashes through $100, Mining.com []
  11. Metallurgical Coal at 6-Year Low as Chinese Demand Slows, Bloomberg []
  12. Cliffs Natural Resources Inc. Concludes the Sale of Logan County Coal and Provides Update on Bloom Lake, Seeking Alpha []