What Would Be The Impact Of A Restart Of Mining Operations At Bloom Lake On Cliffs’ Stock Price ?

Cliffs Natural Resources (NYSE:CLF) has been grappling with an environment of weak iron ore prices for some time now. Iron ore prices have declined sharply over the course of the last year, with weak demand and oversupply resulting in prices declining around 47% year-over-year to $68 per dry metric ton (dmt) at the end of January. ^[1] In response to the weakening pricing environment, the company idled its high-cost Bloom Lake iron ore mine in Canada at the end of December. Though it made sense for the company to idle the Bloom Lake mine, it was an unpopular decision in Quebec, resulting in the loss of around 500 jobs. ^[2] The Government of Quebec was engaged in talks with the company over restarting operations at Bloom Lake in January. ^[3] However, the company stuck to its guns, with operations at Bloom Lake still in the idled state. In addition, the Bloom Lake Group, the legal entity which operates the Bloom Lake mine, recently filed for bankruptcy protection. ^[4]

In this article, we will take a look at why it makes sense for Cliffs to keep operations at Bloom Lake firmly shut. We will look at the impact of a possible restart of the Bloom Lake mine on the stock price and EPS for Cliffs Natural Resources.

See our complete analysis for Cliffs Natural Resources

Iron Ore Prices

Iron ore is an important raw material 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. ^[5] Chinese steel demand growth is expected to slow to 2.7% in 2015, from 6.1% and 3% in 2013 and 2014, respectively. ^[6] 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. ^[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.

The Bloom Lake Mine

Cliffs reports a sales margin figure for each of its iron ore mining segments, which is an indicator of the segment’s operating performance. The sales margin for the Bloom Lake mine stood at a loss of $30.13 per ton of iron ore produced in 2014. ^[10]  This compares unfavorably with the company’s U.S. Iron Ore business segment, which reported a sales margin of $32.53 per ton in 2014. ^[10]

Cliffs’ management had stated that the then ongoing Phase I mining operations at Bloom Lake were not economically viable. ^[11] With the company unable to attract equity investors for further development of Bloom Lake, it decided to idle the mine. Given the prevailing iron ore pricing environment, it was a wise decision as we will show in the following section.

Impact on Cliffs had Bloom Lake been Operational

The Bloom Lake mine is a part of the North American Iron Ore division in our model. Had the loss-making Bloom Lake mine been operational, it would have augmented shipments from the North American Iron Ore division, with Bloom Lake producing around 6 million tons of iron ore concentrate in 2014. ^[10] However, it would have weighed on realized prices and margins for the division. Iron ore concentrate sold by Bloom Lake sells at lower prices as compared to iron ore pellets sold by the company’s US Iron Ore division. Realized prices for Bloom Lake stood at $81.19 per ton, as compared to $102.36 per ton for the US Iron Ore division. ^[10] In addition, the loss-making Bloom Lake mine would have brought down margins for the whole division. In our stock price estimate to factor in the impact of a restart of operations at Bloom Lake, we will keep the company’s capital expenditure at the levels given by the company in its current guidance.

If we factor in these cumulative impacts of the operation of the Bloom Lake mine on our model, our estimate of Cliffs’ stock price declines by around 57% from $7.25 to $3.09. In addition, our estimate of the company’s EPS for 2015 declines to a loss of $0.52 from our current estimate of $0.29, in which we have assumed that Cliffs keeps the Bloom Lake mine in an idled state.

See our analysis of this scenario here

Looking at the drastic impact on the company’s stock price and EPS, Cliffs should certainly keep the Bloom Lake mine shut.

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1. Iron Ore Spot Prices, Y Charts [↩]
2. Rock-bottom prices forcing Cliffs to pull up stakes in Canada, The Globe and Mail [↩]
3. Quebec Says It’s Talking to Cliffs About Reopening Mine, Bloomberg [↩]
4. Cliffs Natural Resources Inc. Announces Decision on Bloom Lake Mine, Cliffs Natural Resources News Release [↩]
5. China Ore Stockpiles Rise to Record on Financing Deals, Bloomberg [↩]
6. Short Range Outlook for Apparent Steel Use 2013-2015, World Steel Association [↩]
7. BHP, Rio Gamble with Stacked Iron Ore Deck, Mineweb [↩]
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. Cliffs Natural Resources 2014 10-K, SEC [↩] [↩] [↩] [↩]
11. Cliffs Natural Resources Q3 2014 Earning Call Transcript, SEC [↩]