Cliffs Natural Resources Q4 2015 Earnings Review: Weak Iron Ore Prices Negatively Impact Results

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Cliffs Natural Resources (NYSE:CLF) announced its fourth quarter results and conducted a conference call with analysts on January 27. [1] As expected, the decline in iron ore prices over the past year weighed on the company’s results. [2] Cliffs’ adjusted EBITDA (excluding $30 million worth of expenses related to the idling of mines) stood at $106 million in Q4 2015, as compared to $286 million in the corresponding period of 2014. [3] The main takeaway from the earnings conference call was the management’s focus on controlling costs and maximizing cash flows, in the midst of an extended downturn in iron ore prices.

Iron Ore Prices

Iron Ore Spot Prices, Source: Y Charts

Realized prices for Cliffs’ U.S. Iron Ore and Asia Pacific Iron Ore divisions declined by roughly 25% and 39%, respectively. [3] Realized prices for the U.S. operations declined to a lesser extent since pricing adjustments for this division are based on longer term mechanisms, as opposed to the Asia Pacific division for which pricing is more closely linked to iron ore spot prices.

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Iron ore prices have declined sharply over the course of the past year, as illustrated by the chart shown above. Since iron ore is used as an input in steelmaking, the demand for iron ore by the global steel industry plays a major role in determining the prices of the commodity. Though the majority of Cliffs’ iron ore sales are to the North American steel industry, pricing mechanisms are linked to international iron ore prices. Chinese demand for iron ore is the primary determinant of global iron ore demand, since the country accounts for the purchase of nearly two-thirds of the world’s seaborne iron ore supply. [4] According to World Steel Association estimates, Chinese steel demand will fall for the third consecutive year in 2016, as a result of slowing economic growth in China. [5] Subdued demand for steel has resulted in weak demand for iron ore.

Despite subdued demand conditions, iron ore majors such as Vale, Rio Tinto, and BHP Billiton have steadily raised production levels, creating an oversupply situation. [6] Considering the rising production levels despite weak demand conditions, the worldwide surplus of seaborne iron ore supply is expected to widen to 437 million tons in 2018, from a surplus of roughly 184 million tons in 2015. [7] Given the prevailing oversupply situation, the upside for iron ore prices remains limited in the near term.

With iron ore pricing expected to remain subdued in the near term, the company management reiterated its commitment to cost reduction in the earnings conference call. Cliffs’ ongoing measures to reduce costs and boost productivity helped lower cash costs of production for the U.S. Iron Ore operations to $45 per ton, around 23% lower than in the corresponding period of 2014. [3] Cliffs’ cost reduction initiatives and the depreciation of the Australian Dollar helped lower cash costs of production for the company’s Asia Pacific operations to a record low of $26 per ton in Q4 2015, around 40% lower than in Q4 2014. [3] Going forward, Cliffs has lowered production levels for 2016, with plans to meet part of its customers’ needs from stockpiled ore, in order to reduce inventory levels and generate cash flow from working capital. 

In spite of the management’s efforts to reduce costs and boost cash flows, only a significant improvement in the iron ore pricing environment will materially change the company’s prospects. With the adverse business environment unlikely to improve in the near term, Cliffs’ management must continue to focus on managing costs and aligning production levels with demand. These measures are necessary for Cliffs to successfully negotiate the ongoing downturn in iron ore prices.

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Notes:
  1. Cliffs Natural Resources Q4 2015 Earnings Call Transcript, Seeking Alpha []
  2. Iron ore spot price chart, Y Charts []
  3. Cliffs Natural Resources Q4 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 []