Cliffs Natural Resources Worth $71 On Shipment Growth And Expansion

by Trefis Team
Cleveland-Cliffs Inc.
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Cliffs Natural Resources (NYSE:CLF) reported a significant decline in profits as iron ore prices took a toll in the first quarter compared to the same quarter last year. Revenues, however, jumped mainly on the back of higher volumes in the North America iron ore segment from the acquisition of Consolidated Thompson. Cliffs is the largest producer of iron ore pellets in North America, a major supplier of direct-shipping lump and fines iron ore out of Australia and also a significant producer of metallurgical coal. The company competes with other international mining and natural resources companies like Vale (NYSE:VALE), Rio Tinto (NYSE:RIO) and BHP Billiton (NYSE:BBL).

The company’s stock has slumped about 15% since the earnings announcement. In light of earnings and other recent developments as well as the near-term outlook for iron ore and coal, we have revised our price target for Cliffs Natural Resources from $88 to $71, which is still nearly 25% ahead of the current market price.

See our full analysis for Cliffs Natural Resources

Iron Ore Shipments to Offset Weak Prices

We expect iron ore prices to remain under pressure throughout our forecast period due to additional capacity coming online globally over the next two years. Further, a slowdown in Chinese demand should also keep the prices in check.

However, the company’s shipments may still show healthy growth on the back of a gradual recovery in the U.S. economy – North American iron ore constitutes 67% of our price estimate for the company. An increase in industrial activity and healthy automotive sales have driven steel demand recently. This should translate into an increase in iron ore demand in the U.S.

Further, in the company has reiterated its aim to strengthen its position as an iron ore giant by increasing business in Asia. We expect that recently acquired Consolidated Thompson’s shareholder Wuhan Iron and Steel, one of China’s biggest steel manufacturers, could help Cliffs in its expansion in the region.

Coal Continues to Add Value

Cliffs’ primary coal operations are in North America, consisting of five metallurgical coal mines and one thermal coal mine. We believe Cliffs enjoys a unique advantage in the highly fragmented coal industry as a result of its long-term relationships with some of the world’s largest steel manufacturers, owing to their iron ore supply contracts. These existing relationships make it easier to win coal supply contracts. We expect Cliffs’ coal shipments to increase steadily going forward, reaching nearly 9 million tons by the end of the Trefis forecast period as a result of these relationships and an expected increase in production.

Additionally, Cliffs owns a 45% economic interest in the Sonoma coal project in Queensland, Australia, which accounts for all of its coal operations in the Asia-Pacific region. The project will be running at optimum capacity beginning this year and we expect the company’s Asian coal shipments to remain relatively stable unless company acquires an additional interest in the Sonoma project.

Overall Margins to Fall, Growth to Come Organically

We expect that falling prices of heavyweight iron ore will drag the company’s overall margins down even as North America coal margins eventually improve. Rising energy, labor and other input costs will also put pressure on margins.

After a spree of acquisitions, Cliffs has decided to shift its focus to organic growth as its near-term capital expenditures will be primarily allocated to maintenance and expansion of current operations.

Customer Concentration, Natural Gas Prices Are Concerns…

Our primary concerns relate too the fact that the North American iron ore and coal divisions’ revenues are highly dependent on a few customers – ArcelorMittal, Algoma and Severstal together make up about 35% of Cliff’s total revenues. A loss of sales to any of these existing customers could have a substantial negative impact on the company’s revenues and profitability.

Adding to the company’s worries is the abundant supply and low prices of natural gas. Natural gas costs roughly the same as coal in terms of energy produced and is cleaner to burn and easier to transport than coal. Further, environmental standards are becoming increasingly strict, thus forcing companies to search for cleaner energy sources to meet these standards. 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.

… but Company is Well Positioned

In the near-term, we are cautious as a result of weakness in iron ore and coal prices as well as rising costs. However, Cliffs’ efforts to ramp up production at its mines to keep pace with increasing demand and its acquisition of Consolidated Thompson will pay long-term benefits.

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