Cliffs Natural Resources Earnings Preview: Lower Iron Ore And Coal Prices To Negatively Impact Q2 Results

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Cliffs Natural Resources (NYSE:CLF) will announce its second quarter results and conduct a conference call with analysts on July 29. [1] We expect lower iron ore and metallurgical coal prices to negatively impact Cliffs’ quarterly results year-over-year. [2] Cliffs has been battling a subdued iron ore and coal pricing environment over the past year or so. In addition, rising U.S. steel imports have also dented the company’s prospects. Poor business conditions have negatively impacted the company’s stock price, which has fallen more than 80% over the last twelve months. [3] In this article, we will take a closer look at what to expect from Cliffs’ Q2 results.

Iron Ore and Coal Prices

Iron ore and metallurgical coal are important raw materials for the steel industry. Thus, demand for these commodities 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 is expected to decline by 0.5% in 2015, following on from a 3.3% decline in 2014. [5] Weak demand for steel has indirectly resulted in weak demand for both iron ore and metallurgical coal.

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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. [6] Iron ore spot prices stood at $63 per dry metric ton (dmt) at the end of June, around 33% lower year-over-year. [7]

Iron Ore Prices, Source: Y Charts

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 an expansion in production by major mining companies, has resulted in plummeting coal prices. [8] This has negatively impacted Cliffs’ North American Coal business, which primarily sells metallurgical coal, the prices of which are linked to the prices of Australian metallurgical coal. Benchmark metallurgical coal prices currently stand at around $90 per ton, nearly 70% off the levels of $300 per ton seen in 2011. [9] In view of the oversupply situation, metallurgical coal pricing is expected to remain subdued in the near term.

Thus, weak iron ore and metallurgical coal prices as a result of oversupplied markets will negatively impact Cliffs’ Q2 results. In addition to a weak commodity 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. [10] 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 the shipment guidance for its U.S. Iron Ore division for 2015 to 20.5 million tons at the time of declaration of its Q1 results, down from its previous guidance of 22 million tons. [11] Thus, rising U.S. steel imports have only added to Cliffs’ woes.

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. The company’s Canadian unit filed for bankruptcy protection earlier on in the year. The company also managed to sell off a part of its coal mining operations earlier in the year, specifically Logan County Coal, a fully-owned Cliffs subsidiary which represents the company’s coal assets in southern West Virginia. [12] In addition, the company had also earlier announced the termination of its quarterly dividend payment policy with effect from Q1 2015. [13]

We would be keenly watching out for any additional announcements from Cliffs’ management in the Q2 earnings call as the company continues to grapple with low commodity prices. Though the steps taken by the management so far have helped make incremental improvements to Cliffs’ operations, the external pricing environment has had an overwhelmingly negative effect upon the company’s business. Thus, the fate of the company remains tied to the externally imposed pricing environment. This has primarily been responsible for the company’s woes, and is unlikely to improve substantially in the near term.

 

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Notes:
  1. Cliffs Natural Resources Inc. to Announce Second-Quarter 2015 Financial Results July 29, Cliffs Natural Resources News Release []
  2. Iron ore spot price chart, Y Charts []
  3. Cliffs Natural Resources Stock Price, Google Finance []
  4. China Ore Stockpiles Rise to Record on Financing Deals, Bloomberg []
  5. Short Range Outlook for Apparent Steel Use 2014-2016, World Steel Association []
  6. Iron Ore Price Forecast Cut by Morgan Stanley on Supply, Bloomberg []
  7. Iron Ore Spot Prices, Y Charts []
  8. Coking coal price crashes through $100, Mining.com []
  9. Coking coal market slumps despite iron ore rebound, Financial Times []
  10. U.S. Steel’s Q1 2015 10-Q, SEC []
  11. Cliffs Natural Resources Q1 2015 Earnings Call Transcript, Seeking Alpha []
  12. Cliffs Natural Resources Inc. Concludes the Sale of Logan County Coal and Provides Update on Bloom Lake, Seeking Alpha []
  13. Cliffs Natural Resources Inc. Announces $400 Million Net Debt Reduction and Elimination of Common Share Dividend, Cliffs Natural Resources News Release []