U.S. Markets closed

Why concerns still remain for the company

Anuradha Garg

Overview: Cliffs Natural Resources' 2Q14 earnings (Part 4 of 4)

(Continued from Part 3)

Concerns still remain

The U.S. iron ore division should return to normalcy in the second half after harsh winters impacted volumes in the first half of 2014.

Continued improvements in the labor market, construction activity, and motor vehicle production is expected to support the North American steelmaking market. Since Cliffs Natural Resources makes the bulk of its revenues from this market, it would lead to more stable revenues for the company.

China is another important market for the company. However, it remains a little tricky. Weaker-than-expected demand coupled with oversupply of iron ore should lead to depressed iron ore prices. Investors interested in investing can track indicators like real estate sales, iron ore port inventory, steel production, and China’s Purchasing Managers Index (or PMI) to see how they’re tracking, which will give a direction for iron ore demand situation there. It’s important to note that these will soon be available on the Market Realist website. However, management seems to be quite upbeat about the China’s demand situation. They cited China’s commitment to achieve targeted real gross domestic product (or GDP) growth of ~7.5%.

The liquidity position for the company remains comfortable for now, with the renegotiation of the credit line. The company should be able to honor the renegotiated debt covenants.

Operational improvement, but concerns remain

The cost cutting efforts of the management are praiseworthy, especially the structural changes in mine plan, logistics, and reduction in contractor hours for Bloom Lake and Asia Pacific iron ore.  The cash cost guidance per ton has been reduced by $5 for these two divisions. These measures would also help improve the cost profile for the mines for the long term.

Some issues of concern still remain that could have a long-term impact on the company’s performance:

  • Iron ore and coal prices are the biggest drivers for Cliffs’ earnings and share price. The outlook for these remain negative due to oversupply and weak demand.
  • Bloom Lake Phase II—expansion to 14 million tons from current seven million tons—expansion and the course taken forward by the management still remains one of the biggest short-term catalysts for the share price. However, there’s no quick fix solution to this. Management is looking for a partial or full sale, but given the capital and operating requirements, it’s very difficult to find a partner in the current pricing environment.
  • There’s uncertainty around the proxy contest with Casablanca Capital. The board’s fate would be decided in an annual general meeting (or AGM) on July 29, 2014, by proxy contest. This would lead to change in priorities with current management being more conservative while Casablanca could go for sale of international assets.

Iron ore pricing is a concern for all Cliffs Natural Resources’ (CLF) peers like Rio Tinto (RIO), BHP Billiton (BHP) and Vale SA (VALE). However, a lower cost profile should support players like RIO and BHP in the current pricing environment. The SPDR S&P Metals & Mining ETF (XME) is also exposed to the iron ore industry.

Browse this series on Market Realist: