Cliffs’ Q4 2015 Earnings Preview: Weakness In Demand And Pricing To Weigh On Results

Cliffs Natural Resources (NYSE:CLF) will announce its fourth quarter results and conduct a conference call with analysts on Wednesday, January 27. ^[1] We expect the decline in iron ore prices over the past year to adversely impact the company’s revenues and profitability. ^[2] Besides the decline in iron ore prices, Cliffs’ business prospects have also been negatively impacted by lower production levels at U.S. steel companies as a result of competition from cheap steel imports. In this article, we will take a closer look at what to expect from Cliffs’ Q4 results.

Declining Iron Ore Prices

Iron Ore Prices, Source: Y Charts

As illustrated by the chart shown above, iron ore prices have fallen sharply over the course of the last twelve months. Iron ore is used as an input in steelmaking. Thus, demand for iron ore by the global steel industry is a major determinant of prices of the commodity. Though most of Cliffs’ iron ore sales are to the North American steel industry, sales agreements are benchmarked to international iron ore prices. Chinese demand for iron ore is the primary determinant of international iron ore prices, since the Chinese steel industry accounts for the purchase of nearly two-thirds of the world’s seaborne iron ore supply. ^[3] As per World Steel Association estimates, Chinese steel demand will decline in 2016, following on from two consecutive years of decline, as a result of slowing economic growth in China. ^[4] Weakening demand for steel has translated into weak demand for iron ore.

Despite the weakness on the demand side, major iron ore producers such as Vale, Rio Tinto, and BHP Billiton have ramped up production levels, creating an oversupply situation. ^[5] An increase in production in the face of weak demand is expected to widen the worldwide surplus of seaborne iron ore supply to 437 million tons in 2018, from a surplus of roughly 184 million tons in 2015. ^[6] Given the prevailing oversupply situation, iron ore prices are unlikely to increase significantly in the near term.

Rising Steel Imports

A sharp increase in U.S. steel imports has adversely impacted the prospects of the domestic steel industry. Competition from low-priced steel imports has negatively impacted both pricing and shipments for U.S. steelmakers. The share of steel sheet imports in the domestic market rose sharply to 22% in 2014 from 15% in 2013, and is expected to have risen further in 2015. ^[7] The rising penetration of steel imports in the domestic market has negatively impacted the production levels of domestic steel producers and consequently, the demand for iron ore. This has forced Cliffs to lower its own production levels over the course of 2015, which will negatively impact the company’s top line in Q4 2015.

In response to the bleak prevailing business conditions, Cliffs has scaled back capital spending and has emphasized cost reduction. The company also completed the sale of its North American Coal business last month. With preserving cash flows the most pressing concern for Cliffs in the ongoing downturn in commodity prices, these steps taken in recent months will help the company in the short term. However, with no respite from weak iron ore prices on the horizon, it would be interesting to note if Cliffs’ management has any additional steps in mind to deal with the subdued iron ore pricing environment. Though any announcements will only make incremental improvements to Cliffs’ operations, with only a significant increase in iron ore prices expected to materially improve the company’s prospects, the management must remain proactive in seeking out opportunities to reduce costs, or improve operational efficiency, as the company continues to grapple with an extended downturn in iron ore prices.

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1. Cliffs Natural Resources Inc. to Announce Fourth-Quarter and Full-Year 2015 Financial Results on January 27, 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 [↩]