Low Iron Prices Will Dig Into Cliffs Natural’s Results

Cliffs Natural Resources (NYSE:CLF) will announce its second quarter results on July 25, 2013. Given the lower iron ore prices this year compared to 2012, we expect the company to post lower year-over-year revenues and profits. ^[1]

The company is facing challenging times right now in both its business segments: iron ore and coal. Commodity prices have been tumbling, especially for copper, iron ore and aluminum. A lot of the blame could be ascribed to slowing Chinese growth, but there are other issues such as surplus capacity which are accentuating the negative trend. Larger players like BHP, Rio Tinto and Vale are going ahead with their expansion plans despite an unfavorable pricing environment. This will push down prices further and put pressure on margins of higher cost producers like Cliffs.

In June, Cliffs announced that it was putting its crucial Black Thor Ring of Fire chromite project on hold due to unresolved land rights and unfinished agreements with the provincial government. The project has already witnessed continuous delays and the latest move will delay it further than the original target of 2016.

See Full Analysis for Cliffs Natural Resources Here

Iron Ore Prices A Major Concern

China is the world’s biggest consumer of iron ore and its sluggish economic growth rate has dampened prices of nearly all major commodities. The country is in the process of reorienting its economy away from investment in capital assets and towards greater domestic consumption. Also, exports have fallen. China reported a GDP growth rate of 7.5% in the second quarter this year, a far cry from its double-digit growth rate days. ^[2]

Although the majority of Cliffs’ revenues come from its North American iron ore business which sells primarily to U.S. customers, sales prices are nevertheless benchmarked to global prices which are influenced to a large extent by the Chinese demand. Going forward, apart from a structural transformation of the Chinese economy, the growing role of scrap in Chinese steel production and increasing investment in Chinese domestic iron ore production will keep demand growth in check. ^[3]

Iron ore miners are in for a double whammy as supplies are expected to surge over the next few years. According to the Bureau of Resource and Energy Economics (BREE), the official Australian commodities forecasting agency, iron ore prices will decline going forward and reach its lowest levels around 2018. This is due to a lot of additional production capacity scheduled to come online in this period and a non-commensurate expected rise in demand. Beyond 2018, the balance between demand and supply is likely to be more even. ^[4]

Cliffs faces more challenging times than its bigger rivals like Vale, Rio Tinto and BHP Billiton who have much lower cash costs per ton of iron ore and coal. While Rio, BHP and Vale are estimated to have a production cost of around $50 per tonne, Cliffs has a cash cost of production in the range of $65-70 per tonne. ^[5]

In fact, it is their low operating costs which are likely responsible for the mining giants’ decision to go ahead with a production surge. They may be banking on pushing the high cost miners out of the market in an environment of falling prices and capturing their business. ^[6]

Chromite Project On Hold

Cliffs has temporarily stopped the environmental assessment process for its $3.3 billion chromite project due to unresolved land rights and unfinished agreements with the provincial government. Without substantive progress on these fronts, it is reluctant to move forward with the project, especially at a time when its resources are strained due to a difficult business environment. ^[7]

Due to the diverse nature and wide-raging concerns of the First Nations communities, which live in areas adjoining the project site, progress has been slow and negotiations complicated. Another area where progress has been tardy is the signing of a definitive agreement between the company and the Ontario government. These agreements pertain to the lack of infrastructure in the Ring of Fire area and are critical to the project’s economic viability. In the absence of an agreement, production cannot begin. Other reasons for the suspension are a delay in approval of the Terms of Reference for the provincial environmental assessment process and unresolved land surface rights issues following a February 2013 Mining and Land Commissioner hearing. The ministers in the government have refused to commit to a time period to conclude negotiations.

The Ring of Fire region is thought to hold up to $50 billion worth of minerals and is going to be North America’s first major source of chromite. Black Thor alone is expected to produce 600,000 tonnes of ferrochrome once production begins. Cliffs has a capital expenditure budget of close to $3.3 billion for this project. Ferrochrome is used mostly in the production of stainless steel and there are very few mines in the world with large deposits of chromite from which it is made.

Our price estimate for Cliffs Natural Resources is $30, which will be updated after the second quarter earnings results.

Understand How a Company’s Products Impact its Stock at Trefis

1. Iron Ore Spot Price Chart, YCharts [↩]
2. China Q2 GDP growth Slows To 7.5%, China Daily [↩]
3. The best laid plans of miners and men, Financial Times [↩]
4. Australia predicts fall in iron ore price, Financial Times [↩]
5. Cliffs Q1 2013 10-Q, SEC [↩]
6. BHP, Rio gamble with stacked iron ore deck – Russell, MineWeb [↩]
7. Cliffs Natural Resources Temporarily Suspends its Chromite Project Environmental Assessment Activities Pending Resolution of Various Issues, Cliffs News Release [↩]