Cliffs’ Earnings Review: Lower Iron Ore Prices Negatively Impact Q1 Results

Cliffs Natural Resources (NYSE:CLF) released its first quarter results on April 28 and conducted a conference call with analysts the next day. As expected, the company’s results were negatively impacted by lower realized iron ore 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 $94.4 million in Q1 2015, as compared to $208.6 million in the corresponding period of 2014. ^[1] Cliffs has made a slight change to its reporting structure. It now reports its North American Coal division separately, since its coal mining operations constitutes a part of its non-core operations, which it intends to sell. Excluding the coal mining operations, the company’s revenues in Q1 2015 stood at $446 million, around 28% 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. ^[2]

In order to operate competitively in the prevailing environment of subdued iron ore prices, the company management reiterated its previously stated policy of focusing on its profitable U.S. Iron Ore division and selectively idling or selling off its loss-making assets. ^[3] In addition, the management announced plans to further reduce its capital spending in 2015, as it looks to better align Cliffs’ business with the prevailing market conditions.

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Iron Ore Prices

Iron ore is the chief raw material for the steel industry. Thus, demand for iron ore by the steel industry plays a major role in determining its price. 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 decline by 0.5% in 2015, following on from a similar decline in 2014. ^[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 $58 per dry metric ton (dmt) at the end of March 2015, around 48% lower as compared to prices at the end of March 2014. ^[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 results going forward.

Segment-wise Performance

Shipments for the U.S. Iron Ore operations rose from 2.84 million tons in Q1 2014 to 2.95 million tons in Q1 2015, primarily due to more favorable shipping conditions on the Great Lakes in Q1 2015, as compared to the corresponding period in the previous year. ^[1] The sales margin, a measure of segment operating income reported by the company, fell from $33.48 per ton in Q1 2014 to $27.15 per ton in Q1 2015 for the U.S. Iron Ore operations. ^[1] This was primarily because of a fall in realized prices from $109.02 per ton in Q1 2014 to $92.70 per ton in Q1 2015. ^[1] The fall in realized prices for the company’s U.S. Iron Ore operations was less than the corresponding fall in spot prices. This is because contracts for this division are mostly structured on long-term contracts 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 Asia Pacific Iron Ore operations rose from 2.64 million tons in Q1 2014 to 3.03 million tons in Q1 2015, primarily due to the favorable timing of shipments of stockpiled ore. ^[1] Sales margin for the segment fell from $25.11 per ton in Q1 2014 to $0.26 per ton in Q1 2015, primarily due to a fall in realized prices. ^[1] The division’s realized price fell sharply from $96.25 per ton in Q1 2014 to $42.81 per ton in Q1 2015. ^[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 28% year-over-year to $36.77 per ton. ^[1] The reduction in production costs was offset by the impact of a fall in iron ore prices on the division’s sales margin.

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. The company is in talks with various potential buyers for its North American Coal business, though a deal has not been finalized yet. In addition, the company has announced cuts to its capital expenditure budget for 2015 to $100-125 million, from its previous estimate of $125-150 million. ^[3] Furthermore, the company has lowered its full year production guidance for its U.S. Iron Ore operations to 20.5 million tons, from its previous guidance of 22 million tons. ^[1] This decision was taken to more closely align production with demand from the North American steel industry, which is operating at lower capacity utilization rates, as a result of competition from steel imports. 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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1. Cliffs Natural Resources Q1 2015 10-Q, SEC [↩] [↩] [↩] [↩] [↩] [↩] [↩] [↩] [↩] [↩]
2. Cliffs Natural Resources Q4 2014 Earnings Release, SEC [↩]
3. Cliffs Natural Resources Q1 2015 Earnings Conference Call Transcript, Seeking Alpha [↩] [↩]
4. China Ore Stockpiles Rise to Record on Financing Deals, Bloomberg [↩]
5. Short Range Outlook 2015-2016, 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. Cliffs Natural Resources 2013 10-K, SEC [↩]