Cliffs Q3 Earnings Review: Lower Iron Ore Prices Negatively Impact Results

Cliffs Natural Resources (NYSE:CLF) announced its third quarter results and conducted a conference call with analysts on October 29. ^[1] As expected, the sharp decline in iron ore prices over the past twelve months negatively impacted the company’s results. ^[2] Cliffs’ adjusted EBITDA (excluding $33 million worth of expenses related to the idling of mines) for Q3 2015 stood at $93 million, as compared to $280 million in the corresponding period of 2014. ^[3] The main takeaway from the earnings conference call was the management’s acknowledgement of the need to continue to control costs, in the backdrop of a subdued iron ore pricing environment.

Iron Ore Prices

The realized prices for Cliffs’ U.S. Iron Ore operations declined by roughly 24%, whereas realized prices for the Asia Pacific Iron Ore division declined by around 44%. ^[3] The decline in realized prices for the U.S. operations has been lower because pricing for this division is based on longer term contracts as compared to the Asia Pacific operations.

Iron Ore Prices, Source: Y Charts

Iron ore prices have declined sharply over the past twelve months, as illustrated by the chart shown above. Since iron ore is the main raw material for steelmaking, the demand for iron ore by the global steel industry plays a major role in determining prices of the commodity. Though the North American steel industry accounts for most of Cliffs’ iron ore sales, pricing agreements are benchmarked to international iron ore prices. International iron ore prices are primarily determined by Chinese demand, since the Chinese steel industry accounts for the purchase of nearly two-thirds of the world’s seaborne iron ore supply. ^[4] With slowing Chinese economic growth, Chinese steel demand has declined over the past couple of years. As per World Steel Association estimates, Chinese steel demand will decline by 0.5% in 2015, following on from a 3.3% decline in 2014. ^[5] Weakening demand for steel has translated into weakening demand for iron ore.

On the supply side, a sustained increase in production by major iron ore mining companies such as Vale, Rio Tinto, and BHP Billiton has resulted in an oversupply situation. ^[6] Increasing 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. ^[7] As a result of the persisting oversupply situation, iron ore prices are unlikely to rise significantly in the near term.

Cost Reduction and Other Developments

Given the prevailing weakness in iron ore pricing, the company management reiterated its commitment to cost reduction in the earnings conference call. As a result of Cliffs’ ongoing measures to reduce costs and boost productivity, the company’s cash costs of production for the company’s Asia Pacific operations fell to a record low of $27 per ton in Q3 2015, as compared to $53 per ton in Q3 2014. ^[1] In addition to the operational improvements instituted by the company management, the strengthening of the U.S. Dollar against global currencies has also helped reduce costs in Dollar terms. Cash costs of production for the U.S. Iron Ore operations have also declined to $49 per ton, around 16% lower than in the corresponding period of last year. ^[3] In addition to reducing operating costs, due to the termination of a supply agreement in October and weak demand for iron ore, the company has revised downward the production guidance for its U.S. Iron Ore division to 17.5 million tons in 2015 from its previous guidance of 19 million tons. ^[1]

Despite the management’s efforts, only a significant improvement in iron ore prices will materially impact the company’s prospects. However, with the adverse business environment expected to persist in the near term, the company management must continue to focus on controlling costs and aligning production levels with demand. These steps are essential for ensuring that Cliffs successfully navigates the ongoing downturn in iron ore prices.

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1. Cliffs Natural Resources Q3 2015 Earnings Call Transcript, Seeking Alpha [↩] [↩] [↩]
2. Iron ore spot price chart, Y Charts [↩]
3. Cliffs Natural Resources Q3 2015 Earnings Release, SEC [↩] [↩] [↩]
4. China Plans Iron Ore Subsidy for Miners Amid Rout, News Says, Bloomberg [↩]
5. Short Range Outlook 2015-2016, World Steel Association [↩]
6. BHP, Rio Gamble with Stacked Iron Ore Deck, Mineweb [↩]
7. Iron Ore Majors Boosting Supply as Glut, China Sink Prices, Bloomberg [↩]