Cleveland-Cliffs: Why Are Profits Set To Drop By 70% In A Year?

by Trefis Team
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CLF
Cleveland-Cliffs Inc.
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Cleveland-Cliffs (NYSE: CLF) is witnessing a double whammy with projections of lower revenue and sharp decrease in margins. The company’s profitability is expected to decline by more than 70% in a year, with Trefis projecting net income to drop from $1.1 billion in 2018 to $0.3 billion in 2019, translating into a net income margin of 15.5% in 2019, significantly lower than the 48.4% recorded in 2018. Deterioration in the bottom line is expected to be driven by a drop in iron ore prices in the second half of 2019, on the back of higher supply than was earlier expected and US-China trade war leading to lower demand, along with a sharp increase in the cost of production.

You can view the Trefis interactive dashboard – Cleveland-Cliffs: Cost And Profitability Analysis – to better understand the factors causing a sharp decline in margins, and alter the assumptions to arrive at your own estimates of revenue, expenses, and profits for the company.

Revenue Performance

  • CLF has added $0.78 billion in revenue between 2016 and 2018, mainly driven by an increase in iron ore volume sold and premium pricing for its high-grade ores.
  • Though freight revenue decreased in 2018, strong iron ore sales have driven healthy revenue growth.
  • However, CLF is expected to lose about $0.13 billion over the next two years, driven by a drop in iron ore prices and lower shipments, along with the loss of revenue from the sale of the Asia-Pacific operations.

To understand segment-wise revenue performance in detail, please refer to the following analysis- Cleveland-Cliffs’ Revenues: How does CLF make money?

Expenses And Profitability

  • Total expenses are expected to rise from $1,204 million in 2018 to $1,809 million in 2019, marking an increase of 50% in a year.
  • Increase in cost of sales is likely to be the primary factor for the drop in profitability.
  • With a drop in iron ore prices in the second half of 2019, the company is realizing less amount per ton, and at the same time lower volume sold is expected to contract gross margins as a high fixed cost is attributed to a lower volume.
  • Higher COGS is likely to be partially offset by lower interest expense.

a) Cost of Goods Sold

  • COGS as % of revenue sharply improved from 82% in 2016 to 65% in 2018, mainly due to increase in volume sold and a 40% rise in price per ton during this 2-year period.
  • Prices of iron ore increased to $120/ton in the first half of 2019.
  • However, this was followed by prices dropping even below $100 in September 2019, which has led to projection of a marginal (0.5%) rise in revenue in 2019.
  • At the same time, volume sold is also expected to be lower compared to 2018, due to the sale of Asia-Pacific business.
  • Thus, the high fixed mining and exploration cost would be attributed to a lower volume, thus increasing cost per ton sold, whereas lower revenue (compared to 25% growth in 2018) is expected to lead to COGS as a % of revenue to increase sharply from 65% in 2018 to 83% in 2019.

b) Loss from Extinguishment of Debt

  • Loss from debt extinguishment decreased in 2018 due to much lower redemption of notes compared to the prior year.
  • However, with redemption of all of the outstanding 4.875% Senior Notes due 2021 and the $600 million repurchase of 5.75% Senior Notes due 2025 completed during the second quarter of 2019, loss from debt redemption as a % of revenue is expected to increase from 0.3% in 2018 to a little over 3.5% in 2019.

The company’s interest expense, selling and administrative cost, along with tax expense/benefits also have a strong influence on the company’s margins. Please refer to the following Trefis analysis to understand the historical and projected performance of each expense item for the company- Cleveland-Cliffs: Cost And Profitability Analysis.

Net income is expected to drop from $1,128 million in 2018 to $332 million in 2019, which marks a decline of about 71% in profitability, driven by lower revenues and with a sharp increase in total expenses, primarily led by cost of sales and loss from debt repayment.

 

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