We have revised our price target for Cliffs Natural Resources (NYSE:CLF) from $103 to $89, which is nearly 25 percent ahead of the current market price. The company has had a good run this year, shipping good volumes of iron ore and realizing better prices for the ore. We have revised our estimates for the company to reflect a potential slowdown in volumes and an oversupply situation for iron ore hurting shipments and selling prices going forward. Cliffs is the largest producer of iron ore pellets in North America and a major supplier of direct-shipping lump and fines iron ore out of Australia. It is also a significant producer of metallurgical coal and competes with other international mining and natural resources companies including Vale (NYSE:VALE), BHP Billiton (NYSE:BHP) and Rio Tinto(NYSE:RIO).
Monthly pricing for iron ore contracts may hurt
Large scale iron ore miners moved to a quarterly iron ore pricing mechanism in order to take advantage of rising iron ore prices. Now that demand is falling, the customers are asking for a monthly pricing mechanism that more closely reflect the prevailing market price. Under this new mechanism, prices will be decided on the average price of ore in the preceding month. We estimate that there could be a 10-15 percent decline in the average contract prices if Cliffs is forced to move to a monthly pricing mechanism.
Natural gas hurting coal sales and margins
Environmental standards today are stricter than ever and companies are looking for cleaner energy sources to meet these standards. Natural gas costs roughly the same as coal in terms of energy produced and is cleaner to burn and easier to transport than coal. Many industrial customers in the U.S. have migrated from coal to natural gas powered units as it is easier and cheaper to modify an existing unit for the new fuel. Natural gas is available in abundance and is therefore priced significantly lower than petroleum, creating a price cap for coal producing companies and hurting their margins in the process.
Coal as a fuel is now at a critical juncture, in which new technologies need to be developed in order to make it burn more efficiently with fewer emissions. We discussed one such development by Vale in one of our previous notes, in which coal is first converted into a gas before finally burning it.
New Projects and developing regions continue to add value to the company
Cliffs is better positioned than a lot of its competitors due to its presence in the growing Asian market. The company plans to produce and ship close to 11 million tons in the Asia Pacific region in 2012. The company is also moving ahead with the ramp-up process at its Bloom Lake mining unit that serves the Eastern Canadian and Asia Pacific regions.