Trends Driving Our $4 Price Estimate For Cliffs Natural Resources

The prevailing environment of weak iron ore prices has taken its toll on the business prospects of Cliffs Natural Resources (NYSE:CLF). Oversupplied global iron ore markets have driven down realized prices and margins for the company. In addition, the company has also been negatively impacted by the sharp increase in steel imports into the U.S., which has negatively impacted the domestic iron and steel industry.

In light of the adverse business conditions facing Cliffs, we have revised down our price estimate to $3.74. In this article we will look at the trends driving Cliffs’ business prospects and our valuation of the company’s stock.

See our complete analysis for Cliffs Natural Resources

Iron Ore Prices

Iron ore is the chief raw material for the steel industry. Thus, demand for this commodity by the steel industry plays a major role in determining its 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. ^[1] Chinese steel demand is expected to decline by 0.5% in 2015, following on from a 3.3% decline in 2014.  ((Short Range Outlook for Apparent Steel Use 2014-2016, World Steel Association)) 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. 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. ^[2] Iron ore spot prices stood at $63 per dry metric ton (dmt) at the end of June, around 33% lower year-over-year. ^[3]

Iron Ore Prices, Source: Y Charts

In view of the persisting oversupply situation, iron ore prices are expected to remain subdued in the near term. In addition to the subdued iron ore pricing environment, rising steel imports to the U.S. have also negatively impacted Cliffs’ fortunes.

Rising Steel Imports

Steel imports into the U.S. have risen sharply over the course of the last year. This has negatively impacted the fortunes of the U.S. steel industry, with competition from steel imports negatively impacting both realized prices and shipment volumes. Steel sheet imports to the U.S. accounted for 22% of the domestic market in 2014, up sharply from 15% of the domestic market in 2013. ^[4] The adverse business environment for the U.S. steel industry has also impacted the fortunes of iron ore producers such as Cliffs, since iron ore is the primary raw material for steelmaking. As a result of the adverse business conditions impacting the U.S. steel industry, Cliffs has had to lower production volumes in response to the changing market conditions. The company revised downward its shipment guidance for its U.S. Iron Ore division for 2015 to 20.5 million tons, from its previous guidance of 22 million tons. ^[5]

Thus, a combination of subdued iron ore prices and rising steel imports are negatively impacting the business prospects of the company.

Trefis Estimate

In view of the prevailing business environment for Cliffs, we have revised downward various estimates in our model. This has led to a revision in our price estimate for the company from $5.74 to $3.74. With the prevailing subdued iron ore pricing environment expected to persist in the near term, prospects look quite lackluster for Cliffs.

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More Trefis Research

1. China Ore Stockpiles Rise to Record on Financing Deals, Bloomberg [↩]
2. Iron Ore Price Forecast Cut by Morgan Stanley on Supply, Bloomberg [↩]
3. Iron Ore Spot Prices, Y Charts [↩]
4. U.S. Steel’s Q1 2015 10-Q, SEC [↩]
5. Cliffs Natural Resources Q1 2015 Earnings Call Transcript, Seeking Alpha [↩]