Cliffs Natural Resources’ Q1 2017 Earnings Review: Debt Reduction Remains In Focus Despite Improved Operating Results

by Trefis Team
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Trefis
CLF
Cleveland-Cliffs Inc.
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Cliffs Natural Resources released its Q1 2017 earnings result and conducted a conference call with analysts on April 27. [1] The company reported a considerable improvement in its operating results as a result of an improved iron ore pricing environment and a decline in unit operating expenses for its U.S. Iron Ore operations, which account for around three-fourths of the company’s revenue. Cliffs lowered its total debt by around $540 million over the course of Q1 and as a result its net income was distorted by losses pertaining to the restructuring and extinguishment of its debt. Thus, the company’s adjusted EBITDA is a better metric to compare its operating performance in Q1 on a year-over-year basis.

CLF Q1 2017 Earnings Review 1

The improved pricing environment in Q1 was reflected in the realized prices for the Asia Pacific operations, which are closely linked to spot prices for the seaborne iron ore trade. However, since the U.S. Iron Ore division is characterized by longer term pricing contracts, the realized prices for the division did not reflect the elevated levels of iron ore prices in Q1 2017. Nonetheless, unit cash operating costs declined more than the decline in realized prices for the U.S. operations, boosting both the division’s and the company’s operating profits. Significantly improved demand conditions in the U.S. and the restart of operations at two mines idled in Q1 2016 helped lower unit cash operating costs for the U.S. operations. While Q1 was characterized by improved demand conditions, the company management focused on debt reduction, in order to maintain financial flexibility during cyclical downturns in iron ore prices. The company lowered its total debt to $1.64 billion at the end of Q1 2017 from $2.18 billion at the end of 2016. [2] Going forward, debt reduction will remain a priority for the rest of the year as the management is targeting a further reduction in its debt to below $1 billion by the end of the year. [1]

The company management’s debt reduction initiatives seem to be well timed, with iron ore prices declining sharply over the course of the last month. Iron ore spot prices fell from $93 per ton on March 16 to $62 per ton on April 18. [1] The sharp increase in iron ore prices towards the end of last year was driven by expectations of strengthening demand from China, the world’s largest market for iron ore. The Chinese government instituted a fiscal stimulus plan targeting the infrastructure sector last year, which has driven up construction activity and the demand for steel in the country. [3] However, there are indications of weakening demand conditions in China, with the growth in housing prices slowing for a fourth straight month in March. [4] This is corroborated by rising port inventories of iron ore in China, which have risen to 134 million tons, around a third more than the level in the first half of 2016. [4] As a result of the decline in iron ore spot prices, we have altered our forecasts for Cliffs’ realized iron ore prices. Our new forecast for the U.S. Iron Ore division represents an 8% decline in realized prices by the end of our forecast period, as compared to our previous forecast.

In addition, we have lowered our EBITDA margin forecast for the division by 200 basis points by the end of  our forecast period.

We have made similar changes to the forecasts for our Asia Pacific Iron Ore operations. These changes to our forecasts have translated into our new $7.45 price estimate for Cliffs Natural Resources.

Have more questions about Cliffs Natural Resources? See the links below.

Notes:

1) The purpose of these analyses is to help readers focus on a few important things. We hope such lean communication sparks thinking, and encourages readers to comment and ask questions on the comment section, or email content@trefis.com
2) Figures mentioned are approximate values to help our readers remember the key concepts more intuitively. For precise figures, please refer to our complete analysis for Cliffs Natural Resources

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Notes:
  1. Cliffs Natural Resources’ Q1 2017 Earnings Call Transcript, Seeking Alpha [] [] []
  2. Cliffs Natural Resources’ Q1 2017 Earnings Release, SEC []
  3. China Blowing Major Bubbles In 2017, Forbes []
  4. Iron ore price tumbles to a near six-month low, Financial Times [] []
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