Cliffs’ Earnings Review: Lower Iron Ore Prices Negatively Impact Q2 Results

-0.35%
Downside
20.07
Market
20.00
Trefis
CLF: Cleveland-Cliffs logo
CLF
Cleveland-Cliffs

Cliffs Natural Resources (NYSE:CLF) released its second quarter results and conducted a conference call with analysts on July 29. [1] 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 $65 million in Q2 2015, as compared to $224 million in the corresponding period of 2014. [2] Cliffs changed its reporting structure with effect from Q1 2015. It now reports its North American Coal division separately, since its coal mining operations constitute a part of its non-core operations, which it intends to sell. Excluding the coal mining operations, the company’s revenues in Q2 2015 stood at $498 million, around 33% lower than in the corresponding period a year ago. [2] The decline in revenues was primarily due to a sharp reduction in market pricing for iron ore. In this article, we will take a closer look at the company’s Q2 results.

Iron Ore Prices

Iron ore is the main raw material for the steel industry. Thus, demand for iron ore 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. [3] Chinese steel demand is expected to decline by 0.5% in 2015, following on from a 3.3% decline in 2014. [4] Weak demand for steel has indirectly resulted in weak demand for iron ore.

Relevant Articles
  1. What’s New With Cleveland-Cliffs Stock?
  2. What’s Happening With Cleveland-Cliffs Stock?
  3. Why We Are Raising Our Price Estimate For Cleveland-Cliffs Despite A Weak Q4
  4. With Contracted Prices For 2023 Up, Is Cleveland-Cliffs Stock A Buy?
  5. Company Of The Day: Cleveland-Cliffs
  6. What To Expect From Cleveland-Cliffs Q3 Results?

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

Iron Ore Prices, Source: Y Charts

Segment-wise Performance

Shipments for the U.S. Iron Ore operations fell from 4.34 million tons in Q2 2014 to 4.24 million tons in Q2 2015, primarily due to weaker demand conditions, partially offset by more favorable shipping conditions on the Great Lakes. [2] The sales margin, a measure of segment operating income reported by the company, fell from $33.94 per ton in Q2 2014 to $11.55 per ton in Q2 2015 for the U.S. Iron Ore operations. [2] This was primarily because of a fall in realized prices from $106.80 per ton in Q2 2014 to $78.32 per ton in Q2 2015. [2] The fall in realized prices for the company’s U.S. Iron Ore operations was less severe 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. [7]

Shipments for the Asia Pacific Iron Ore operations fell from 2.9 million tons in Q2 2014 to 2.75 million tons in Q2 2015, as a result of port maintenance activities hampering shipments. [2] Sales margin for the segment fell from $12.41 per ton in Q2 2014 to $3.01 per ton in Q2 2015, primarily due to a fall in realized prices. [2] The division’s realized price fell sharply from $80.38 per ton in Q2 2014 to $44.29 per ton in Q2 2015. [2] Cliffs’ efforts to reduce operating costs and favorable currency movements helped the division lower its unit cash production costs by nearly 33% year-over-year to $34.32 per ton. [2] However, the fall in iron ore prices more than offset the impact of cost reductions 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 is looking to exit its other mining operations in the coming years, which are considerably less profitable than its U.S. Iron Ore operations. Furthermore, the company has lowered its full year production guidance for its U.S. Iron Ore operations to 19 million tons, from its previous guidance of 20.5 million tons. [8] 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.

View Interactive Institutional Research (Powered by Trefis):
Global Large CapU.S. Mid & Small CapEuropean Large & Mid Cap
More Trefis Research

 

 

Notes:
  1. Cliffs Natural Resources Inc. to Announce Second-Quarter 2015 Financial Results July 29, Cliffs Natural Resources News Release []
  2. Cliffs Natural Resources Q2 2015 Earnings Release, SEC [] [] [] [] [] [] [] [] []
  3. China Ore Stockpiles Rise to Record on Financing Deals, Bloomberg []
  4. Short Range Outlook for Apparent Steel Use 2014-2016, World Steel Association []
  5. Iron Ore Price Forecast Cut by Morgan Stanley on Supply, Bloomberg []
  6. Iron Ore Spot Prices, Y Charts []
  7. Cliffs Natural Resources 2013 10-K, SEC []
  8. Cliffs Natural Resources Q2 2015 Earnings Call Transcript, Seeking Alpha []