Cost Rationalization Efforts Partially Offset Impact Of Low Commodity Prices On Cliffs’ Q4 Results

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Cliffs Natural Resources (NYSE:CLF) released its fourth quarter results on February 2 and conducted a conference call with analysts the next day. As expected, the company’s results were negatively impacted by lower realized iron ore and coal prices. However, Cliffs’  cost rationalization efforts helped offset some of the negative effects of a weak commodities pricing environment on the company’s results. Cliffs’ adjusted EBITDA figure, which excludes the impact of one-time and non-cash items on the company’s profits, stood at $297 million in Q4 2014, as compared to $437 million in the corresponding period of 2013. [1] The company’s revenues in Q4 2014 stood at $1.16 billion, around 18% lower than in the corresponding period a year ago. [1] The decline in revenues was primarily due to a reduction in market pricing for iron ore, partially offset by higher shipment volumes from the company’s U.S. Iron Ore operations. [1]

In addition, the management announced that the Bloom Lake Group, the legal entity operating Cliffs’ Bloom Lake iron ore mine in Canada, commenced restructuring activities under Canada’s Companies’ Creditors Arrangement Act. [1] Commencement of restructuring activities at the loss-making Bloom Lake mine is consistent with the company’s previously stated policy of focusing on its profitable U.S. Iron Ore division and selectively idling or selling off its loss-making assets.

See our complete analysis for Cliffs Natural Resources

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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 2.7% in 2015, from 6.1% and 3% in 2013 and 2014, respectively. [3] 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. [4] 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. [5] 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. [6] [7] In view of the persisting oversupply situation, iron ore prices will remain subdued in the near term.

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. [8] 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. [9] In view of the oversupply situation, metallurgical coal pricing is expected to remain subdued in the near term.

Segment-wise Performance

Shipments for the U.S. Iron Ore operations rose sharply from 6.20 million tons in Q4 2013 to 7.82 million tons in Q4 2014, primarily driven by an additional supply contract in 2014 and the shipments of stockpiled ore to customers that had been affected by the freeze on the Great Lakes in Q1. [1] The sales margin, a measure of segment operating income reported by the company, fell from $41.06 per ton in Q4 2013 to $31.82 per ton in Q4 2014 for the U.S. Iron Ore operations. [1] This was primarily because of a fall in realized prices from $112.70 per ton in Q4 2013 to $98.93 per ton in Q4 2014. [1] The fall in realized prices for the company’s U.S. Iron Ore operations was lesser than the corresponding fall in spot prices. This is because contracts for this division are mostly structured on 12-month averages and the company sells iron ore pellets in the U.S., a value-added product, as opposed to iron ore fines sold by the company’s other iron ore operations. [10]

Shipments for the Eastern Canadian Iron Ore operations fell from 2.16 million tons in Q4 2013 to 1.36 million tons in Q4 2014, primarily due to the idling of the Wabush mine at the end of Q1. [1] Sales margin for the segment fell from a loss of $14.57 per ton in Q4 2013 to a loss of $54.97 per ton in Q4 2014. [1] This was primarily because of a fall in realized prices from $104.39 per ton in Q4 2013 to $62.55 per ton in Q4 2014. [1]

Shipments for the Asia Pacific Iron Ore operations fell marginally from 2.98 million tons in Q4 2013 to 2.92 million tons in Q4 2014, primarily due to port maintenance activity affecting the timing of shipments. [1] Sales margin for the segment fell from $37.54 per ton in Q4 2013 to $3.54 per ton in Q4 2014. [1] The division’s realized price fell sharply from $109.07 per ton in Q4 2013 to $54.96 per ton in Q4 2014. [1] Cliffs’ efforts to boost the efficiency of its operations and favorable currency movements helped the division lower its unit cash production costs by nearly 25% year-over-year. [1] This partially offset the impact of a fall in iron ore prices on the division’s sales margin.

Shipments for the North American Coal operations rose from 1.78 million tons in Q4 2013 to 1.93 million tons in Q4 2014, due to higher export sales and additional sales from the signing of a new supply contract. [1] Sales margin for the segment increased from a loss of $11.87 per ton in Q4 2013 to a loss of $5.38 per ton in Q4 2014. [1] This was despite a fall in realized prices from 101.57 per ton to 79.90 per ton between the two periods, as the company’s efforts to increase the efficiency of its operations and higher production volumes lowered average costs of production in Q4 2014. [1]

Outlook

During the earnings conference call, the company management reiterated its previously stated strategy of focusing on its U.S. Iron Ore operations in order to operate competitively in  a subdued commodity pricing environment. The company intends to exit its other mining operations in the coming years, which are considerably less profitable than its U.S. Iron Ore operations. With Cliffs’ loss-making Bloom Lake operations undergoing restructuring under bankruptcy protection, these operations will be deconsolidated from the company’s financial statements in 2015. The removal of these loss-making operations from Cliffs’ financial statements will boost the company’s profitability going forward. In addition, the company intends to scale down its capital spending next year, in order to conserve cash and improve its financial flexibility. With a subdued demand and commodity pricing environment expected to persist in the near term, we feel that Cliffs’ management is taking the right steps to boost the company’s prospects.

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Notes:
  1. Cliffs Natural Resources Q4 2014 Earnings Release, 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. Iron Ore Spot Prices, Y Charts []
  6. Iron Ore Price Forecast Cut by Morgan Stanley on Supply, Bloomberg []
  7. Iron Ore Caps 2014 Loss as Morgan Stanley Says Worst Over, Bloomberg []
  8. Coking coal price crashes through $100, Mining.com []
  9. Metallurgical Coal at 6-Year Low as Chinese Demand Slows, Bloomberg []
  10. Cliffs Natural Resources 2013 10-K, SEC []