Cliffs’ Q3 Earnings Preview: Weak Iron Ore Prices To Negatively Impact Results

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Cliffs Natural Resources (NYSE:CLF) will announce its third quarter results and conduct a conference call with analysts on October 29. [1] We expect the sharp decline in iron ore prices over the past twelve months to negatively impact the company’s revenues and profitability. [2] Cliffs has been grappling with a subdued iron ore pricing environment over the past year or so. In addition, cheap steel imports have negatively impacted the U.S. steel industry and dented the company’s prospects. In this article, we will take a closer look at what to expect from Cliffs’ Q3 results.

Iron Ore Prices

 

Iron Ore Prices, Source: Y Charts

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Iron ore prices have declined sharply over the past twelve months, as illustrated by the chart shown above. Iron ore, the sales of which account for most of Cliffs’ revenues, is the main raw material for the steel industry. Thus, demand for iron ore by the global steel industry plays a major role in determining prices of the commodity. 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 primarily determined by Chinese demand, since Chinese steel mills account for the purchase of nearly two-thirds of the world’s seaborne iron ore supply. [3] Chinese steel demand has declined over the past couple of years, with the World Steel Association estimating that Chinese steel demand will decline by 0.5% in 2015, following on from a 3.3% decline in 2014, as a result of slowing economic growth in China. [4] Weak demand for steel has translated into weak demand for iron ore.

On the supply side, rising iron ore production by major iron ore mining companies such as Vale, Rio Tinto, and BHP Billiton has created an oversupply situation. [5] Rising production in the backdrop of weak demand is expected to widen the worldwide surplus of seaborne iron ore supply to 437 million tons in 2018, from an expected surplus of 184 million tons in 2015. [6] As a result of the prevailing oversupply situation, iron ore prices are unlikely to increase significantly in the near term.

Rising Steel Imports

Steel imports into the U.S. have risen sharply over the course of the last year, which has negatively impacted the prospects of the U.S. steel industry. Competition from cheap steel imports has negatively impacted both realized prices and shipment volumes for the domestic steel industry. The market share of steel sheet imports in the domestic U.S. market rose sharply to 22% in 2014 from 15% in 2013, and is expected to rise further in 2015. [7] Rising steel imports have adversely impacted domestic steel production and consequently, the demand for iron ore. Earlier on in the year, Cliffs revised down its shipment guidance for its U.S. Iron Ore division for 2015 to 20.5 million tons from its original guidance of 22 million tons, in order to more closely align its operations with prevailing demand conditions. [8]

In order to adapt to the bleak business environment, Cliffs announced reductions in capital spending and planned production levels earlier on in the year. With the adverse business environment expected to persist in the near term, we will be looking out for more announcements from the company management in the earnings conference call, as Cliffs continues to align its business with the prevailing business environment. However, these announcements are likely to translate into incremental operational improvements, with only a significant increase in iron ore prices likely to materially impact Cliffs’ business prospects. Given the prevailing oversupply situation, a significant increase in iron ore prices looks unlikely in the near term.

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Notes:
  1. Cliffs Natural Resources Inc. to Announce Third-Quarter 2015 Financial Results on October 29, Cliffs Natural Resources News Release []
  2. Iron ore spot price chart, Y Charts []
  3. China Plans Iron Ore Subsidy for Miners Amid Rout, News Says, Bloomberg []
  4. Short Range Outlook 2015-2016, World Steel Association []
  5. BHP, Rio Gamble with Stacked Iron Ore Deck, Mineweb []
  6. Iron Ore Majors Boosting Supply as Glut, China Sink Prices, Bloomberg []
  7. U.S. Steel’s Q1 2015 10-Q, SEC []
  8. Cliffs Natural Resources Q1 2015 Earnings Call Transcript, Seeking Alpha []